ISLAMIC COMMERCIAL LAW

INTRODUCTION

‘Islamic law’ covers all aspects of human behaviour. It is much wider than the Western

understanding of ‘law’, and governs ‘the Muslim’s way of life in literally every detail and, of

course, it also regulates commercial transactions. It follows that the Islamic conceptual framework

is quite unlike that of Christianity in which law is secular. There is no Christian law of contract,

for example, no Christian law of property, whereas bodies of law dealing with such matters do

exist in the shari’a –the ‘legal’ verses of the Koran and the traditions of the Prophet.

The shari’a has long been abandoned and substituted by Western law. However, as a result of the

Islamic revival, the possibility of adapting the shari’a to the modern world has been considered

recently.1

Islamic Commercial Law strives to ensure fairness and certainty in contractual obligations by

requiring concise definitions, providing clear terms and conditions and ensuring the roles of the

parties to the contract are equal and no party has any advantage over the other.

Prophet Muhammad worked as a merchant before the revelation of the Qurʿān and became

increasingly concerned about unchecked materialism in Mecca. It therefore follows that the

1 Islamic Commercial Law: An Overview (I) - InDret

Sunnah prescribes strict rules regulating partnerships, leases, loans, currency exchange, and

speculative trading. Prohibitions against transactions that involve excessive uncertainty, which

are viewed as similar to gambling, also prohibit insurance contracts, since they, too, are viewed

as involving uncertain future events that are in the hands of Allāh alone. In the modern era, these

principles have been extended to prohibit derivatives, options, and contracts involving future

commodities.2

However, over time, some rules regarding to commercial transactions have changed drastically

due to the following reasons:

1. The increased wealth and investment opportunities in Islamic Communities

2. An increased desire by Muslims and Non-Muslims to engage in commercial transaction with

each other.

3. Increasing Muslim Communities who wish to bank, invest and buy property in compliance

with their religious values.

As a result of the above cited reasons, modernization strategies, which seek to harmonize

traditional Islamic values of morality and equality with demands of increasing globalization and

international trading have been developed to focus on three main areas:

a.) structuring financial transactions to bring them into compliance with Islamic principles

while providing acceptable levels of return for investors

b.) establishing Islamic institutions and markets

c.) enacting liberalized commercial codes that incorporate sharīʿah as one of the bases,

although not the sole basis, of legislation.

2 http://www.oxfordislamicstudies.com/cite/opr/t236/e0156

HISTORY AND DEVELOPMENT OF ISLAMIC COMMERCIAL LAW

Muslim conquests were a vast trading area with a lot of trading routes crisscrossing though it.

There was favorable economic development during most of the Classical Islam period. Industry

was developed, foreign trade was booming, manpower consisted of free workers and large

quantities of coins were in wide circulation3. Gold from Western Sudan came into the Muslim

World and was freely circulating. As a result, there was a lot of banking activity that meant that

bankers performed all banking operations, facilitated the exchange of money, loans and the sale

of assignments of credit.4

Following this commercial development, jurists developed which, it seems, served the needs of

participants well.

Unfortunately, the Muslim world was overtaken by the west in areas such as technology, warfare

and commercial techniques. This development was notably advanced by:

a.) the conquest of Egypt by the French in 1798

b.) the European domination of trade which was symbolized by the Treaty of Balta Liman

1838 between the Ottoman Empire and the United Kingdom.5

c.) The general political domination of the region by European powers

This culminated in a modernization movement that led to shari’a being abandoned in all areas

apart from family law. Islamic Commercial Law disappeared from almost the entire region, apart

3 ASHTOR, E (1972), p. 558. See also LABIB, SY (1969 4 ASHTOR, E (1972), p.561. 5 FEROZ, A (2000), pp.4-5.

from the Arabian Peninsula (for a considerable period) and more recently, Saudi Arabia. It is

unclear why reformers looked to Europe rather than building on pre-existing Shari’a traditions.

However, it appears that Napoleon introduced the French idea of separating commercial and

non-commercial law, culminating in the development of special courts to settle commercial

disputes. The successful adoption by the Ottoman Empire of majority of the French Commercial

Code in 1850 was made as part of a secularization process that featured the following factors:

1. European dominance of trade;

2. The desire of European merchants to avoid local courts and local law;

3. The perception that an obligation to use the shari’a disadvantaged local merchants

as against their European counterparts, who could use Western law, which was

viewed as more efficient;

4. The practice of European traders of using the French Commercial Code as a kind of

customary law to aid the resolution of their disputes;

5. A familiarity with the idea and practice of secular legislation in certain fields;

6. The influence of the Ottoman elite, who stood to gain from trade with Europe, and

the governmental desire to please them; and

7. A perception that commercial matters were of less religious significance than, say

akhlaq (morals), a perception which may have been influenced by the Egyptian

experience.6

6 On secularisation, see ASAD (2003), Chapter 7; on legal reform generally, ANDERSON, N (1976), -the Ottoman experience is

dealt with at p.15- and CASTRO, F (1985). Anderson draws attention to the importance of commercial and penal law reform: ‘a

fundamental change of attitude was inherent even in [the early commercial/penal law] stage of the reform movement’ (id, p.38);

on Egypt generally, Brown, NJ (1995); on the first separation of commercial law in Egypt, see Goldberg (1999).

Isamic commercial law can be largely divided into the law of contracts and banking.

The law of contracts under sharia law

Islamic law covers all aspects of human behavior from family relations to business relations. It

emphasizes the importance of law of contracts therefore it has an open-ended framework and

provisions governing business transactions between people and persons. Islamic law divides all

legal acts into either ibadat 7or muamalat8.

Islam generally allows trade and commerce and the contracts that are applied thereto are termed

Muamalat in the Sharia. Although it allows trade and commerce restrictions are present. It

prohibits one from making earnings from interest (Usury/Riba). This is mentioned clearly in the

holy book the Quran: ‘Taking interest on loan is prohibited for you but doing business is

permitted for you’.9

Sharia also does not allow one to carry out unlawful investment (haram investments). That is one

is not allowed to carry out a business that deals with things regarded as unlawful for example

businesses that involve pork, alcohol ,tobacco ,pornography and any other type of business

against Islamic principles and values.

What is a contract (aqd)10?

7 Acts of ritual worship such as prayer and fasting 8 Commercial and civil contracts or dealings 9 The Quran, Surah (Chapter) 2, Verse 275 10 Tying tightly

The definition of a contract in sharia law does not differ from the common law definition of a

contract as long as the contract does not involve things that are regarded to as unlawful.

Therefore, a contract is a voluntary, deliberate, and legally binding agreement between two or

more competent parties.

For a contract to be valid there are basic elements that should be present. These elements

include:

I. Offer (ijab)

A proposal to another person, offeree ,which reflects his, offeror’s, willingness to

contract. The offer can either be by writing (kitabah), conduct (amal) or verbal

(kalam).

II. Acceptance ( qabul )

Is used to represent a statement uttered indicating assent to the ‘ijab(offer).

Muslim Jurists take two different approaches interpreting “qabul”. The majority

view is that qabul is made by the buyer or the person to whom the subject matter

of the contract is addressed regardless as to whether this comes first or later.

Whereas the Hanafi school holds a more flexible approach when qabul is defined

as the word uttered later corresponding to the terms of a subsisting later. And it

may be expressed by either the seller or the buyer.11

11 El-Islam, H. 1999. Business on the Internet: The Islamic Perspective and its comparison with common law, MCL

partial thesis, IIUM, Malaysia

Acceptance must be at the same meeting place “majlis”. Sharia law insists on

immediate acceptance of an offer.

III. Subject matter (mahal al-‘aqd )

It must be mal12 (property) and the parties to a contract must legally own the object

“qabd” and apart from that it should exist at the time of the contract and be able to be

delivered at its precise quantity and value. The Islamic law of contract usually

discourages the making of a sale contract on non-existent or future goods as they

cannot be seen when the contract is made as the type and quality of the goods is not

known and whether it would be available at all for delivery on the time fixed in the

contract. However, non-existent goods or invisible commodities can be a subject

matter of a contract if the nature of the subject matter and its quality are properly

described, well defined and is predominantly available for delivery on the appointed

time.13

IV. Consideration

There must be consideration in a contract. In a sale of goods contract the consideration is

the price. Sharia does not restrict it to monetary value alone it can also be any other

commodity. The price must be in existence and determined at the time of the contract and

12 something which can be secured for use at the time of need 13 Abudallah Mace , 'islamic law of contracts' ( 2013) <http://www.slideshare.net/maceabdullah/islamic-law-of-

contracts> accessed June 10 ,2015

cannot be fixed at a later date with reference to the market price, nor can it be left subject

to determination by a third party. This is due to the Islamic prohibition on uncertainty.14

V. Capacity (ahliyyah)

The legal capacity to transact business by any Muslim male or female is regarded

as prudent judgment (Rushd).The Rāshidīn are the people who have attained the

age of puberty (bulūgh),mentally all right (‘Aql)and not prodigal. Anyone who is

not Rāshid is interdicted. Hence, his/ her guardian (Waliyy) is to manage his/her

affairs, because he/she is not capable to transact effectively without the assistance

of a guardian. It is noteworthy that the exact age of puberty cannot be mentioned

specifically because it is more or less the matter of physical development. The

variation is caused by many factors including heredity, exposure to sexual

relation, food, liquid and drug, but in some Muslim states for example Malaysia

the age is set as the age of majority which is fifteen years.15

According to Abudallah and Razali Islamic scholars defined the capacity as a

quality, which makes a person qualified for acquiring rights and undertaking

duties and responsibilities.16

14 ibid 15 Dr. W. E. A. Adeleke , Prof. A.F- Ahmed , ' AL-MU‘ Ā MAL Ā T IN THE SHAR Ī ‘H' (National open

universityof Nigeria.com 2012) <http://www.nou.edu.ng/NOUN_OCL/pdf/edited_pdf3/ISL332%20Al-

Muamalat%20in%20the%20Shariah%20CG%20&%20Material.pdf> accessed 10 June 2015 16 Abdullah, N. I. & Razali, S.S. 2008. Commercial Law in Malaysia, Kuala Lumpur: Pearson; Zuhayli, W. 2003.

Financial Transactions in Islamic Jurisprudence. Lebanon: Dar al-Fikr al-Mouaser.

VI. Certainity

Islamic law of contract, the terms of an agreement must be definite, clearly defined and

unambiguous. Islamic contract law doesn’t give any space for uncertainty this is seen with the

requirement that a subject matter must exist and it should be possible for it to be delivered and

inspected at the agreed time. . If the subject matter does not exist when the contract is made the

element of gharar (uncertainty) may occur and can invalidate the contract.

Islamic Banking

Islamic banking is based on the principles of Islamic law (Shariah) and guided by Islamic

economics.17 The originators of modern banking based their system on interest-oriented

investments and earnings which are prohibited in the Shari'ah of Islam. Many Muslims, believing

in the prohibition of interest, remained aloof from this modern system of banking.18 Proponents

of Islamic banking believe the Islamic banking system is superior to the capitalistic model of the

West, because it is structured around a “strict code of ethics” (based on the Quran) and is

prohibited from “exploitative practices” (including the charging of interest). According to

Islamic banking proponents, capitalism is solely focused on money (profit) and this incites greed

and the exploitation of others, which leads to social problems.19

In its operation, Islamic banking is based on various principles.These are:

1. Prohibition of Interest or Usury.

2. Adherence to ethical standards.

17 http://www.investopedia.com/terms/i/islamicbanking.asp#ixzz3cdXKbZxO 18 http://www.islamic-banking.com/shariah-rulings-finance.aspx 19 What is Sharia Banking-John L. Terry III

3. Moral and social values( Quard Al Hassan Loans)

4. Fairness

These principles have formed the basis under which various products have been formulated by

the Islamic banks.

Murabaha is the most popular and most common mode of Islamic financing. It is also known as

Mark up or Cost plus financing.Originally, Murabaha was a contract of sale in which a

commodity is sold on profit. The seller is obliged to tell the buyer his cost price and the profit he

is making. It has been estimated that 80 to 90 percent of financial operations of some Islamic

banks belong to this category. Some portion of the total finance may be offered as an interest free

loan. Since the banking institutions have to make profit in order to stay in business, the

Murabaha model offers a solution. The bank purchases the commodity on cash and sells it to the

customer on a profit. Since the client has no money, he buys the commodity on deferred payment

basis. Thus, the client gets the commodity for which he wanted the finance and the Islamic bank

makes some profit on the amount it had spent in acquiring the commodity. 20

Mudarabah refers to a form of business contract in which one party brings capital and the other

brings personal effort. The proportionate share in profit is determined by mutual agreement but

the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets

nothing for his labour. As a financing technique adopted by Islamic banks, it is a contract in

which all the capital is provided by the Islamic bank while the business is managed by the other

party. The profit is shared in pre-agreed ratios, and loss, if any, unless caused by negligence or

20 http://www.islamic-banking.com/shariah-rulings-finance.aspx

violation of terms of the contract by the other party is borne by the Islamic bank. The bank

passes on this loss to the depositors.

As a matter of principle the owner of the capital does not have a right to interfere in the

management of the business enterprise which is the sole responsibility of the Agent x. However,

he has every right to specify such conditions that would ensure better management of his money.

That is why sometimes Mudaraba is referred to as a sleeping partnership.21

Ijarah means to transfer the usufruct of a particular property to another person in exchange for a

rent claimed from him. In this case, the term Ijarah is analogous to the English term leasing. The

rules of Ijarah, in the sense of leasing, are very much analogous to the rules of sale, because in

both cases something is transferred to another person for a valuable consideration. The only

difference between Ijarah and sale is that in the latter case the corpus of the property is

transferred to the purchaser, while in the case of Ijarah, the corpus of the property remains in the

ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the

lessee. While fixing the rent, the financial institutions calculate the total cost they have incurred

in the purchase of these assets and add the stipulated interest they could have claimed on such an

amount during the lease period. The aggregate amount so calculated is divided on the total

months of the lease period, and the monthly rent is fixed on that basis.

In some agreements of financial leases, a penalty is imposed on the lessee in case he delays the

payment of rent after the due date. This penalty, if meant to add to the income of the lessor, is

21 ibid

not warranted by the Shari‘ah. The reason is that the rent after it becomes due, is a debt payable

by the lessee, and is subject to all the rules prescribed for a debt. A monetary charge from a

debtor for his late payment is exactly the riba prohibited by the Holy Qur’an. However, the

lessee may be asked to undertake that, if he fails to pay rent on its due date, he will pay certain

amount to a charity. For this purpose the financier / lessor may maintain a charity fund where

such amounts may be credited and disbursed for charitable purposes, including advancing

interest-free loans to the needy persons. 22

Musharaka is another popular technique of financing used by Islamic banks. It could roughly be

translated as partnership. In this technique two or more financiers provide finance for a project.

All partners are entitled to a share in the profits resulting from the project in a ratio which is

mutually agreed upon. However, the losses, if any, are to be shared exactly in the proportion of

capital proportion. This is based on the reason that in Islam, one cannot loose what they did not

contribute. All partners have a right to participate in the management of the project. The partners

also have a right to waive the right of participation in favor of any specific partner or person.

Permanent Musharaka: In this form of Musharaka an Islamic bank participates in the equity of

a project and receives a share of profit on a pro rata basis. The period of contract is not specified

so it can continue so long as the parties concerned wish it to continue.

Diminishing Musharaka: This form allows equity participation and sharing of profit on a pro

rata basis but also provides a method through which the bank keeps on reducing its equity in the

project and ultimately transfers the ownership of the asset to one of the participants. The contract

provides for a payment over and above the bank share in the profit for the equity of the project

22 Islamic Finance by Maulana Taqi Usmani

held by the bank. At the same time the entrepreneur purchases some of its equity. After a certain

time the equity held by the bank shall come to zero and it shall cease to be a partner. 23

Bai Salam is a contract in which advance payment is made for goods to be delivered at a future

date, following Islam and Islamic Shariah. The seller undertakes to supply some specific goods

to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It

is necessary that the quality of the commodity intended to be purchased is fully specified leaving

no ambiguity leading to dispute. Bai salam covers almost everything which is capable of being

definitely described as to quality, quantity and workmanship.24

Bai-Salam has been permitted by the Islamic prophet Mohammed himself, without any

difference of opinion among the early or the contemporary jurists, notwithstanding the general

principle of Shariah that the sale of a commodity which is not in the possession of the seller is

not permitted. Mohammed ordained: “Whoever pays money in advance for fruit to be delivered

later should pay it for a known quality, specified measure and weight (of dates or fruit) of course

along with the price and time of delivery”25

Most products offered through Islamic banks include a profit (mark‐up) rather than charging

interest on the amount at risk. Islamic banking prohibits trading in debt, so Islamic banks do not

issue conventional bonds. Islamic bonds are not interest based, but returns are based on a

mathematical formula that links the cash flow (that will be generated by the asset to be

23 ibid 24 Banglapedia: Islami Bank Bangladesh Limited 25 ibid

purchased) to the cost of the asset itself. Islamic banks also use collateral to secure finance

because al-rahn(an asset as a security is a deffered obligation) is allowed in the Sharia.26

In order to ensure that the principles of Islamic banking are followed, each Islamic institution

must establish and provide itself with an advisory council known as a Sharia'a Board. The

members of Sharia'a Boards can include bankers, lawyers or religious scholars as long as they

are trained in the Islamic law, or Sharia'a. The function of a Shari'ah Supervisory Board is of a

very delicate nature. On the one hand, they are meant to abide strictly by Islamic principles, and

on the other they have to fulfill the requirements of the constantly emerging needs of the

contemporary marketplace. 27

The various instruments of Islamic banking serve as the basic building blocks for developing a

wide array of more complex financial instruments, suggesting that there is great potential for

financial innovation and expansion in Islamic financial markets even as the growth and

preference of Islamic banking in states by both Muslims and non-Muslims increases. 20% of the

enquiries on Sharia banking in England are from non-Muslims28 and if this is anything to go by

then Islamic commerce might take over the industry ,given time.

26 Handbook of Islamic Banking by Kabir Hassan, Mervyn Lewis 27 Shariah Supervisory Board by(Ret'd) Justice Muhammad Taqi Uthmani, International Shari'ah Scholar 28 What is Sharia Banking-John L. Terry III

BIBLIOGRAPHY

Abdullah, N. I. & Razali, S.S. 2008. Commercial Law in Malaysia, Kuala Lumpur: Pearson;

Zuhayli, W. 2003.

ASHTOR, E (1972)

El-Islam, H. 1999. Business on the Internet: The Islamic Perspective and its comparison with

common law, MCL partial thesis, IIUM, Malaysia

Financial Transactions in Islamic Jurisprudence. Lebanon: Dar al-Fikr al-Mouaser

Handbook of Islamic Banking by Kabir Hassan, Mervyn Lewis

Islamic Commercial Law: An Overview (I) - InDret

Islamic Finance by Maulana Taqi Usmani

The Quran

.

What is Sharia Banking-John L. Terry III