Tuesday, January 12, 2010

12 Tips Islamic Business Contract- a Detailed Study

Basic Shariah Principles or Fiqh-al-Muamalat of the Islamic Business Contracts

Broad-based economic well-being, social and economic justice, and equitable distribution of income and wealth is the primary objective of Islamic economics. The intense commitment of Islam to brotherhood and justice makes the well-being or 'falah' of all human beings the principal goal of Islam. To achieve falah, Islamic economics and banking has developed different Islamic investment products.

Forbidden Elements in Contract :

Among the most important teachings of Islam for establishing justice and eliminating exploitation in business transactions is the prohibition of all sources of unjustified enrichment. Three aspects of forbidden elements in contracts which may induce people for unjustified enrichment are : Riba, Gharar and Maysir.

(a) Riba or Interest :

Riba or interest is completely prohibited under Islamic law. Riba is a prominent source of unjustified advantage, because Shariah does not consider money as a commodity such that there should be a price for its use. Money is a medium of exchange in an asset oriented economy, and a store of value. However, the term riba or interest is used in the Shariah in two senses, riba-an-nasiah and riba-al-fadl. Riba-an-nasiah refers to the time allowed to the borrower to repay the loan in return for addition (financial increment) (nasiah is related to the verb nasa'a, meaning to postpone, defer or wait). It makes no difference whether the return is a fixed or a variable percentage of the principal, an absolute amount to be paid in advance or on maturity, or a gift or service to be received as a condition for the loan. This leaves no room for arguing that riba refers to usury and not interest. Riba-al-fadl, on the otherhand, is related with the transactions of the homogeneous goods. Riba-al-fadl arises if gold, silver, wheat, barley, dates and salt are exchanged against themselves with unequal proportion. That is, they should be exchanged on the spot and be equal and alike, otherwise any change in transactions will create riba-al-fadl. However, the absolute prohibition of riba or interest in the Quran and Hadith is a command to establish an economic system from which all forms of exploitation are eliminated, in particular, the injustice of the financier being assured of a positive return without doing any work or sharing in the risk, while the entrepreneur, in spite of his management and hard work, is not assured of such a positive return. The prohibition of interest is, therefore, a way to establish justice between the financier and entrepreneur.

(b) Gharar or Dubiousness in Contract :

The Shariah determined that in the interest of fair and transparent dealing in the contracts between the parties, any unjustified enrichment arises out of uncertainty or undefined of the essential pillars of contract is prohibited. Gharar is originated out of deception through ignorance by one or more parties to a contract. Gambling is also a form of gharar because the gambler is ignorant of the result of the gamble. There are several types of gharar, all of which are haram. The following are some examples:

i. Selling goods that the seller is unable to deliver ;

ii. Selling known or unknown goods against an unknown price, such as selling the contents of a sealed box ;

iii. Selling goods without proper description, such as shop owner selling clothes with unspecified sizes ;

iv. Selling goods without specifying the price, such as selling at the 'going price' ;

v. Making a contract conditional on an unknown event, such as when my friend arrives if the time is not specified ;

vi. Selling goods on the basis of false description ; and

vii. Selling goods without allowing the buyer to properly examine the goods.

In order to avoid gharar, the contracting parties must (i) ascertain that both the subject and prices of the sale exist, and are able to be delivered ; (ii) specify the characteristics and amounts of the counter values ; (iii) define the quantity, quality and date of future delivery, if any.

(c) Maysir or Gambling

The prohibition of maysir arises from the premise that an apparent agreement between the parties is in actually the result of immoral inducement provided by false hopes in the parties mind that they will profit unduly by the contract.

The Nature of the Forbidden Contracts

A number of barter arrangements peculiar to pre-Islamic market trading was expressly forbidden by the Prophet Muhammad (salla-llahu alaihi wa sallam). The characteristic they have in common is that they depend on conjectured or uncertain definition of the goods being traded. It is from the explicit prohibition of such barter arrangements that Islamic law developed its strict rules about definition of the objects (and terms) of contract. Examples of forbidden contracts are :

Muzabana : The exchange of fresh fruits for dry such that the quantity of the dry fruit is measured and fixed but the quantity of the fresh to be given in exchange is estimated while still on the trees.

Muhaqalah : The sale of grains still growing (that is, unharvested) in exchange for an equal quantity of harvested grains. ( The prohibition of this particular transaction is an important element in the general discussion of gharar (uncertainty), the basis of the prohibition of futures trading in grain and other foodstuff and stock commodities).

Mulamasah : An historic sales contract in which the sale was finalised with the buyer or seller touching a piece of cloth.

Munabudhah : An historic sales contract in which the sale was finalised with the buyer or seller throwing a piece of cloth towards the other.

Basic Shariah Principles of Business Contracts

While the nature of all the forms of business contracts are different from each other, the basic principles of the Shariah with regard to them are almost similar. These basic principles are as follows :

(1) The terms and conditions of a contract of joint venture should be so designed as to avoid any possibility of dispute during the conduct of business or at the time of sharing the profits or bearing the loss.

(2) Business capital should be in the form of money. If any or some of the partners are joining with their running business or commodity or property the value of their business, commodity or property should be determined in terms of money and this amount should be treated as the partners' contribution.

(3) In a partnership the relationship between the partners is that of a principal and agent. In joint stock companies the shareholders are only the co-owners without enjoying agency rights.

(4) Capital and labour and in some cases goodwill and credit-worthiness are jointly responsible for creating profits and are jointly responsible to a share in the profits. In case only one single factor is responsible for creating profits it will solely be eligible to it.

(5) The rights and duties of the partners depend on the nature of the joint business and are largely governed by the custom, convention and usage. In this respect the interest of the business is the most important criterion of determining the rights and duties of the partners.

(6) Rights are concomitant to responsibilities. Thus a dormant partner may be disallowed to bind the firm by his commitments. The partners would not claim any fixed return for their work except a share in profits, but the employees would receive their wages from the business account.

(7) In a joint business, productivity and profit are measured on the basis of invested capital. But it is labour that contributes to productivity and profit. Thus the proportion of partners respective shares in capital alone cannot be a factor of determining the respective shares of the partners in the profits of the business. The proportion of profits cannot, therefore, necessarily be commensurate with the share in capital. The partner with a higher contribution of labour may be allowed a higher share in profits although his capital contribution may be lesser than others.

(8) Loss is incurred in case capital fails to grow and diminishes. Thus in the event of a loss non-payment of profits to working partners amounts to loss of labour. Loss in capital is exclusively to be borne by capital. In this way while the profit may be distributed according to the stipulated condition loss is to be borne by partners proportionately with their respective shares in business capital.

(9) The basic principle is that profits go with liability. Thus a partner who is ready to bear a liability would share in profits also. Persons joining the business to take a share only in profits without contributing anything to business and without accepting any liability are not eligible to profits as a matter of right.

(10) Profits are concomitant to risk. No partner has a right to set apart a fixed portion of profits, thus ensuring for himself a sure return. If profits arise all partners would share in it proportionately. If there are no profits no partner would be privileged to take any share by way of his exclusive right.

(11) Loss arising out of wilful negligence would be indemnified by the partner who is responsible for it.

(12) The liability of the partners would depend on the nature of the joint venture.
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