Islamic Law of Contract

Shariah restrictions on certain financial and trade transactions is the raison d’être for the emergence of Islamic banking. It is, therefore, important for any student of Islamic banking to grasp the basic elements of the Islamic law of contract.

Meaning of contract

Contract in Shari’ah, Aqd, means a tie or a knot binding two parties together. The contract is a declaration of offer and acceptance. Unlike English law which developed through the work of judges, Islamic law of contract developed through the work of Fugaha (jurists), based on the principle laid down by the Quran and the narrations from the Prophet (P.B.U.H).

The Qur’an contains a large number of specific contracts, and axioms of wide application m the area of contractual relationships. These include various commercial contracts such as sale, hire, guarantee, security and deposits. In some of the verses of the Qur’an where such contracts are stated, foundation for rules of new contracts were initiated, in others recognition and legitimization of already existing practice at the advent of Islam are confirmed.

The Islamic contract law is wider in scope than the English or French because it embraces some dispositions which are not considered “contract” in either English or French legal systems. Endowment is an example of such dispositions.

Contrary to some western writings, Shari’ah does have a general theory of contract. Therefore, Shari’ah has facilities to accommodate uncatalogued agreements. Contracting an arrangement that is not falling in the categories of recognized nominate contracts is not forbidden in Shari’ah. Furthermore, conditions attached to an irrevocable contract have been used by Muslims to extend the applications of such contracts.

Moreover, declaration of intention and consenting is central to the law of contract in Shari’ah. Though contracts in Shari’ah are not as consensualist as ones in English law, consenting is central to the law of contract in Islam, for without consent a contract will not have a binding force. Furthermore, the intention to create a contract is actually more important in Shari’ah than the formalities of a contract. This shows that Shari'ah capability to respond to people's needs is limited by people's ability to understand its rules.

Classification of contracts in Shari’ah

There are several classification for contracts in Shari’ah. What we are concerned with, however, are those doing with Islamic banking.

Definitive and suspensive contracts

A contract is definitive when the offer and acceptance are both categorical and the contract is validly concluded. A contract is suspensive when the offer and acceptance are kept in suspense i.e. for future effect. The latter is not permitted in Shari’ah, particularly in sale contracts. Hire contracts, to majority of scholars, may be suspensive.

Binding (or obligatory) and facultative (or permissible)

Some contracts are binding, Lazim, once concluded they cannot be revoked except by mutual consent of the two parties. Some are facultative, Jaiez, which can be revoked by either party, and in some cases by a given party.

An example of the binding contracts are the contracts of sale, hire and lease... etc. An example of the permissible contracts are agency, deposit, and Mudarabah. These can be revoked by either party any time. While the contract of security (rahn) can be revoked any time, this can only be done by the beneficiary, i.e. the creditor.

Some contracts start as facultative and then turn to be binding such as donation. Donation becomes binding only after delivery. Distinguishing obligate from facultative is important. However, such classification is itself subject to Ijtihad. For example, the Mudarabah contract in Islamic banking is no longer facultative but binding for the duration of the contract. Contemporary jurists think that it was quite logical for Mudarabah to by facultative in the old days since it had no time limit. Once a maturity has been agreed on by the two parties, it makes no sense to give either one the right, still, to revoke any time without the consent of the other. Furthermore, most investment opportunities require time, which means that, unlike the old days, investment assets cannot be liquidated before maturity.

Correct and corrupt contracts

A contract is correct (sahih) when it is valid, effective and enforceable. A contract is considered corrupt (faced) when it is none of the above and referred to as a void one. Some contracts are salvageable when they become corrupt. For example if the reason for corruption is a non- permissible condition in the contract, then removal of such condition will correct it. For example a Mudarabah contract with a condition that the agent guarantees capital for rubb-ul-mal is corrupt. It can be valid again by just removing this condition. If the reason for corruption is the object of the contract, like purchase of non-permissible goods such as wine then it can’t be salvaged.

Contracts of Exchange and Contracts of Gratuities

Contracts of exchange are those where the two parties interchange price on the one hand and a good or a service sold on the other. Sale, hire...etc. are all examples of exchange contracts. Contracts of gratuities are those which are done for benevolence purposes such as donation which is considered in Shari’ah a contract. Distinction between the two is important particularly when Gharar is present.

Specific or nominate contracts

Shari’ah includes certain pre-designed contracts derived from the Quran, Sunnah and Ijma. These are, basically, sale hire, agency, guarantee, donation, partnership and Mudarabah.

Islamic Shari’ah, nevertheless does have its own theory of contract and hence, allows contracting arrangement not falling in the categories of recognized nominate contracts, given that they are within the parameters of Shari’ah. A new contract may not be completely new, but an amalgamation of a number of nominate contracts. The modern Murabaha contract may be considered an example.

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.