1. excerpt from Law Gazette –An official publication of the
Law Society of Singapore – September 2010
Full copy available http://www.lawgazette.com.sg
The Author
From origin a Belgian lawyer
specialized in international financial
regulations and corporate consulting,
Paul WOUTERS has been resident in
Istanbul-Turkey for years.
Focusing on Islamic finance and
contract law, he has introductions
from the GCC over Turkey to South
East Asia. Paul is amongst others
Member of the Advisory Board of
Islamic Finance News and consults,
lectures and writes on ethical and
legal aspects with respect to the
Islamic finance sector.
He can be reached at
pwouters.law@gmail.com
The Use of the Contract of Sale in Islamic
Finance – General Concepts
Paul WOUTERS

2. The Use of the Contract of Sale in Islamic
Finance – General Concepts
Paul WOUTERS
(excerpt from Law Gazette –An official publication of the Law Society of
Singapore – September 2010 – full copy available at
http://www.lawgazette.com.sg/2010-09/Default.htm )
Instead of extending loans of money against interest, Islamic finance
commonly uses partnerships and commercial contracts to supply
finance. Permissible profits and social justice are the cornerstones of
an Islamic-style modern economy.
Introduction
The Shari’ah is not a codified book of law. Its main sources are al-
Qur’an,1 the Sunnah,2 consensus of legal opinion of Ijma3 and
analogy or Qiyas.4 At present, there are four major schools of
interpretation for the Sunni Muslim community, and one school for the
Shia.5
Islamic banks cannot extend financial loans with interest, since that
would amount to forbidden Riba. Instead, they will use partnership
contracts (mostly silent partnerships or Mudaraba and limited
partnerships or Musharaka).
They will also use sales agreements (see hereunder),6 next to the Ijara
(similar to the conventional leasing contract)7 and Ju’alah (unilateral
contract promising a reward for the accomplishment of a specified
task) that also contain features allowing under certain conditions, pre-
financing or deferred payment but are not proper contracts of sale –

3. mostly just to name the nominate commercial contracts that are most 2. There must be mutual consent and clear consistency between offer
used in finance environments. Also, the popular Sukuk – sometimes and acceptance.
called the Islamic bond – will not be treated, since it is not a contract 3. There should be unity in session. When the meeting is broken and
of sale by itself. the parties split without consent, this equals a refusal of the offer,
unless otherwise agreed upon.
This article aims to give some basic notions of the sales contracts only. 4. The subject of the sale must be property of legal tender
For reason of simplicity, the author will neither refer to the sources, (intoxicating elements, pigs, dogs and carcasses are excluded).
nor the doctrine of the accepted schools, since it would complicate and 5. The subject of the sale must exist at the time of the sale13 and
result in large elaborations. The reader will understand that the must be owned by, or at least in the physical or constructive property
concepts have been simplified somewhat for easy accessibility. of the seller.14
6. The sale must be instant and absolute. A sale attributed to a future
Definition of Sale or Bay’ and Major date or contingent on a future event is void.
The delivery must be certain and should not depend on a
Criteria contingency or chance.
7. The subject of the sale must be properly identified, excluding
Bay’8 or the contract of sale can be described as “the exchange of uncertainty of the object, quality and quantity.
property for property”,9 or “the exchange of goods or properties” and 8. The price of the sale must be certain.
it therefore includes, besides sale proper, barter (Bay’ al-Mukdyada) 9. The sale must be unconditional, unless such a condition is
and currency exchange (Bay’ al-Sarf).10 recognised as a part of the transaction according to the usage of the
trade. The terms of the sale must be stated clearly.
The Qur’an approves the sale to the extent that no element of Riba is 10. If no modes of payment are stipulated, they are assumed to be cash
involved: “Allah permitted trade and forbidden Riba” (Sura al- and immediate. The payment of the price can be postponed to the
Baqarah, 2:275). Generally speaking, Riba is “any unjustified future and in instalments. This aspect will be useful for financing
increase of capital for which no compensation is given”, or unlawful transactions.
profit (for example: any accrual / interest on the loan of money), as 11. The goods must be free of rights of others (eg, mortgage), though
opposed to lawful profit.11 Western understanding often translates it the Hanafi allow such sale subject to prior permission of the
to usury (excessive interest), or even any interest at all. mortgagee.
A sale is concluded by a formal offer and acceptance. The redaction of The avoidance of uncertainty (Gharar) and gambling (Maysir) are
a contract is encouraged. It, however, can also be perfected by the contained in a whole subset of rules. Several different contracts cannot
simple exchange of the goods and the price sealing the transaction be mixed in a single agreement thereby, giving rise to several subsets
through mere execution (Bay’ al-Mu’atah or Bay’ al-Mu’awadah). of documentation. An Islamic contract should be fair and transparent
about the subject, the price and all conditions. Combining the different
contracts, and uncertainty about any of the details or contingent
General conditions of sale: clauses could lead to deception and should be avoided.
1. The parties must be persons of sound mind and reason. Lunatics
or minors who have not yet attained the age of intellectual ability
therefore are excluded.12

4. Deferred Payment or Bay’ Mu’ajjal Types of Sale According to Profit Margin
This is a sale where the parties have agreed to postpone the date of Negotiated price - Hidden profit sale (Bay’ al-Musawamah)
payment. The payment can be in instalments or in full. The payment
time has to be fixed: it can be a certain date or a certain period. If the It is the regular sale where the buyer is not aware of the costs incurred
payment date refers to an uncertain time in the future, the sale is void. and profits gained by the seller.
Any period is assumed to commence at the date of delivery, unless
otherwise agreed. Set profit sale (Bay’ al-Murabaha)
In the event of a default of payment by the debtor/buyer, the price The buyer and the seller agree on the profit or mark up between the
cannot be increased, since that would lead to the forbidden Riba al- original acquisition price of the item by the seller and the sales price
Nasi’a. It is possible to pressure the buyer for punctual payment by claimed from the buyer – all costs and profits are disclosed to the
stipulating that in case of default: all outstanding sums become due at buyer.
once; or some donation for a charitable cause is due.
Set loss sale (Bay’ al-Wadi’a)
A recent decision of the Bank Negara Malaysia15 orders the Banks to
give Ibra’ (rebate on early repayment) and confirms the right to charge Parties agree on a set loss margin or mark down.
Ta’widh (compensation for actual loss as a result of late repayment).
Non profit sale (Bay’ al-Tawliya)
Payment of the price can be secured by a mortgage, a lien or charge on
any asset or on delivery of a duly signed bill of exchange or The seller sells the item to the buyer at exactly the same price he has
promissory note. Note that any transfer of such bills to a third party paid at acquisition.
has to be at face value, cash and on the spot, to be Islamic compliant.
Guarantee from a third party is also possible.16 The set profit sale or sale at mark up is the transaction that will interest
us more. It is known as the Murabaha, and can be combined with
Rescheduling of a debt is possible, but without charging interests. allowed deferred payments.
Since it should be assumed that the client-debtor has financial
problems, this creates a win-win for both sides. The client does not Types of Transactions
see his debt galloping out of control and the financier keeps
perspective on recuperation of at least a part of the sum in capital from
the non-demoralised debtor in good faith.
The Murabaha – basic notions
It has to be noted that certain goods (gold, silver, barley, wheat, salt The Murabaha is not a loan. It is the sale of a commodity at an agreed
and dates) have to be traded at face value and on the spot in order to upon mark up. That mark up may consist of the costs attached to the
avoid Riba al-Fadl.17 transaction18 such as freight and custom duties and the profit of the
seller.

5. Example 1: ascertain the conformity of the asset at the time of delivery, again
acting as an agent for the financier.
Imagine a situation where the buyer asks a professional businessman
to acquire a certain asset (using his specific negotiating skills) and The client will notify the financier of the acquisition. The financier,
where it is agreed before the acquisition that that person will sell the subsequent to the transaction becomes the initial owner of the asset by
asset down to the buyer at a fixed mark up. paying the supplier in cash (initial acquisition agreement). Then, he
will sell the asset down to the client, majored by the agreed upon mark
It is also possible that a deferred payment is negotiated in combination up (Murabaha agreement). The client will fulfill his financial dues by
with the Murabaha. This is the situation in which contemporary respecting the installment period.
Islamic finance steps in.
The application of the Murabaha and the combination with deferred
Example 2: payment are regular practices dating back to ancient times. The use
thereof on an “industrial scale” by contemporary banks only came
The client informs the financier (can be an Islamic bank or otherwise) about approximately 30 years ago with the introduction of modern
of his wish to buy an asset and his need for finance. The financier Islamic banking.
agrees to the transaction. The client promises to buy the said asset
from the financier at a certain mark up if the latter buys (or promises to The financier and the client can agree to a one-off transaction, or
buy) the goods. Sometimes, this is combined with a promise to sell by transactions up to a specified limit (facility agreement). For larger
the financier. business transactions, a syndicated revolving Murabaha agreement is
usually entered into. The client can buy
goods worth up to a certain amount provided
he keeps meeting the deadlines and maxima.
The facility is extended by a lead manager
(Islamic bank) acting on behalf of the
underlying syndicate. The duration is usually
one to three years. Depending on the
economical situation and the reputation of
the client, this is sometimes fixed at five to
seven years. Longer terms are rather unusual,
unless they are for real estate acquisitions.
To ascertain the conformity of the asset with the wishes of the client at
the time of the acquisition, the financier will usually nominate the
client as his agent (agency agreement). The client will then also

6. Instant sale-repurchase or Bay’ al-Inah the latter acquires the ownership rights, but the difference lies in the
fact that the financier does not acquire the right to alienate / sell the
asset further down. In that sense, it is not a perfect and complete sale,
A good businessman probably knows how to by an asset from a
because that important right stays with the client.
supplier with a deferred payment and to sell it almost instantly down
for a profit, and for cash to his client. He then, not only makes nice
In general, Islamic law does not prohibit the sale/buy back of the same
money, but also holds the consideration in his possession before his
item between the same parties, provided the argument of Riba is not
installments to the supplier are due. He now has cash working capital
lurking around the corner, and as long as all the different obligations
at his disposal. This would be a genuine business transaction.
are not incorporated in the same contract. This could lead for instance,
to the subsequent redaction of a sales contract, a promise to buy and a
Shrewd clients and financiers could make a simple two-party setup
rent agreement.
with combined deferred payment sale / cash resale that amounts to a
regular conventional loan.
The scenario is simple: the client buys a commodity from the
financier with a deferred payment and resells that instantly back to the
financier for cash. The result: nothing really happens to the commodity
( it is still with the financier where it originated), but the client now
holds the cash of the latter (from second sale), combined with a
deferred payment (first sale) against a profit. Basically, the financier
extends a loan against interest. Such an organised same-item sale-
repurchase between the same parties is called Bay’ al-Inah and is not
allowed in many jurisdictions.
A variation on that theme is the delayed sale/buy back. In this type of
transaction, the client sells an asset to the financier in return for a cash
payment. The financier then acquires the ownership rights (and
assumes the ownership risks) and thus, also has title to the usufruct of
the asset. Usually, the asset is rented back to the client and that rent
will generate an income stream to the financier. The client usually
promises to buy back at maturity in a different paper. That promise
will usually be executed at the original sales price. Often, the parties
also agree upon a “put option or push back” clause, that allows the Though sometimes contested within the different schools of thought
financier to sell the asset back to the client in case of the default of the and therefore not universally accepted, both sales may show up in
client. Sukuk-structures. In this type of securitisation, the asset is sold by the
client to a Special Purpose Vehicle (“SPV”) in return for cash. The
Another variation of this is the custody sale / trust sale or Bay’ al-Wafa financier obtains the (negotiable) Sukuk (financial paper representing
(sometimes also called Bay’ al-Uhda). The client will sell the asset to the ownership in the SPV in the underlying asset) in return for his
the financier in return for a cash settlement of the price. Just as above, investment. The result: the client disposes of a certain amount of cash

7. for a certain period. The financier owns that asset through the Sukuk Example:
and earns revenue (rent or profit) during the lifetime of the Sukuk. At
maturity, the asset is usually transferred back to the client, who will re- A good businessman could ask his financier to buy some commodities
purchase at the agreed upon price, if not, the market price (depending from a supplier and sell them down to him with a Murabaha, at an
on the jurisdiction). The basics of Sukuk-issuance will be discussed in agreed upon profit. The businessman could then sell that commodity to
a later article. a third party for cash. He again makes a nice profit and holds cash with
only the deferred payment obligation brought about by the Murabaha
with the financier. This would be a legitimate business transaction.
Cash procurement or Tawarruq
Shariah-compliance has been questioned in some
jurisdictions when all is part of a pre-arranged 4-
party setup. Here, the client approaches his
financier who pre-arranged the following scenario
without any real intervention of the client.
Example:
The goods that are withheld for the intended
transactions are commodities that have a small
“spread” between buy and sell prices eg, buy at
$100 and sell at $99.9, (mostly copper and the
like). The subsequent buy and sell transactions as a
consequence thereof, will only result in a small
trading loss (of costs and profits to the
commodities traders).
The financier first buys the commodity from the
commodity seller for cash. He then sells the
commodity immediately down to the client using
the Murabaha with a deferred payment, and with
the agreed upon mark up. The client then
immediately sells the commodity further down to
We will describe the most commonly used version of the Tawarruq as the commodity buyer in a cash transaction. In a simple meet, sign and
used in contemporary Islamic finance. The same frame used for the exchange of contracts (maybe even over coffee), the parties initiate
Bay’ al-Inah may be employed here using a 4-party structure. real cash flows and a real flow of goods from the inventory of the
commodity seller to the inventory of the commodity buyer.
The commodity traders generate a profit and fees. The financier
generates a profit on the Murabaha and the client walks out with cash

8. in his hands by way of the deferred payment and cost (eg, transaction crop in return for the proceeds from the sale of a specified quantity and
costs such as fees, commissions, “spread” and profit/cost of the quality of the crop yield (not a percentage of the crop). The payment
deferred payment itself). is made at the conclusion of the sale, or the delivery of the goods at a
pre-specified maturity date.
Whilst the basic scheme is valid enough, the organized Tawarruq has
been questioned, mostly in the Gulf Cooperation Council (“GCC”) Since the Islamic bank does not want to own those commodities, it
member states. will sell them instantly down in the market using a parallel salam with
the same maturity date for delivery. This can be done.
The Organization of Islamic Conference (“OIC”) Fiqh Academy, an
Islamic studies academy in Jeddah, Saudi Arabia, in April 2009, ruled
that organized Tawarruq was “impermissible” due to the arranged
Commission to Manufacture or Bay’ al-
nature between the Islamic financial institutions and the clients. Istisna’
The Islamic banking industry is aware of the issues and their possible Just like the Salam, the Istisna’ allows pre-financing. The subject
impact on compliancy, credibility and reputation. The issues are matter of the sale is an individualized and clearly specified asset that
properly addressed with either prohibition or regulation combined with has to be manufactured or constructed (engine, ship, building etc).
transparency. Payment can be at the outset, or during the progression of works. The
seller may sub-contract, unless otherwise agreed that it is not allowed.
Pre-paid Forward Sale or Bay’ al-Salam A client / buyer who has no financial means to order the manufacture
of the item, could order it from the financier through Istisna, where
after, the financier will sub-contract to the actual builder using a
Another sales contract that is used for financing is the forward sale or
second Istisna. The Istisna is typically used in combination with
Bay’ al-Salam. The Salam was basically intended to pre-finance
forward lease and lease, giving rise to BOT (Build-Operate-Transfer)
agricultural exploitations to allow farmers to receive some finance in
structures for infrastructure developments and other large projects.
attendance of the crop to grow.
Its main features – different from the regular sales contract – are: Conclusion
1. Future goods allowed; The Islamic economy strives to be just and equitable. Extending loans
2. Quantity, quality and time have to be specified; with interest is unfair and leads to exploitation. It is permissible,
3. The commodity must be composed of units with homogenous, however, to make profits based upon commercial trade or within
genus-like characteristics and which are traded by counting, business partnerships (sharing of risk, profit and loss).
measurement or weight according to usage and customs of trade
(excluding precious stones … where quality can differ); Some finance – such as consumption finance (refrigerators, cars,
4. Payment must be on the spot; and washing machines etc) – is difficult to frame within business
5. Instant buy-back not allowed. partnerships between the client and the financier. Islamic banks
therefore commonly use nominate contracts akin to Western-style
The client obtains financial means to buy the materials needed for the sales contracts.

9. Whilst the application of the contracts dates back for more than 1.400 X., Islamic Commercial Law (Fiqh al-Muamalat), Islamic Capital
years, they have only in the last 30 years been introduced in large scale Market – Securities Commission Malaysia (Lexis Nexis-Malaysia,
modern banking. The industry is still young and just now matures 2009) p 143.
enough to enter the first innovation phase. New products will be
developed and consensus on the use of the existing structures will
arise.
Notes
1 The Revelation of Allah to the Prophet Mohammad (PbuH) as …
The result is deeper then the perceived “interest-free” economy.
Indeed, a system that does not lend money as a goal in itself, but transmitted to us from him through an authentic continuous narration
requires underlying real economy involving existing commodities and (Tawatur) without doubt. Imran Ahsan Khan Nyazee, Islamic
goods, will develop very differently from the Western-style economy. Jurisprudence, (Usul al-Fiqh) (The Other Press, Petalang Jaya-
Malaysia, 2003) (405) p 156.
Paul Wouters 2 Literally meaning: “the well known path”. It is the righteous life
E-mail: pwouters.law@gmail.com of the Prophet Muhammad (Peace be upon Him) – it consists of the
sayings, acts and approvals of the Prophet (PbuH) as written down in
References the canonized Hadith collections.
3 Ijma. This means the consensus of the mujtahids (independent
Mohd. Ma’sum Billah, Modern financial transactions under Shari’ah
jurists) from the ummah of Momammad (PbuH), after his death, in a
(Ilmiah Publishers, Selangor-Malaysia, 2003) p 144.
determined period upon a rule of Islamic law. Imran Ahsan Khan
Mohd. Ma’sum Billah, Shari’ah standard of business contract (AS Nyazee, Islamic Jurisprudence, (Usul al-Fiqh) o.c., p 80 – these are
Noorden, Kuala Lumpur-Malaysia, 2006) p 155. usually the Companions and the Followers – for a more detailed
analysis, see, J. Brill ed, The Encyclopedia of Islam, New Edition,
Ala’Eddin Kharofa, Transactions in Islamic Law (AS Noorden, Kuala (Leiden-Netherlands, 1986) Vol III – H-IRAM, Idjma, p 1023.
Lumpur-Malaysia, 2004) p 215. 4 Qijas - it is a restricted form of analogy - Imran Ahsan Khan
Nyazee, Islamic Jurisprudence, (Usul al-Fiqh), o.c., p 213 and The
Razali H.J. Nawabi, Islamic Law on Commercial Transaction (CERT,
Kuala Lumpur Malaysia, 2009) p 276. Encyclopedia of Islam, o.c., Vol V – KHE-MAHI, Kiyas, p 238.
5 Or mazhab or madh’hab – for the Sunni : Hanafi, Maliki, Shafi’I
Imran Ahsan Khan Nyazee, Islamic Jurisprudence, (Usul al-Fiqh) and Hanbali – for the Shia : Ja’afari.
(The Other Press, Petalang Yaya-Malaysia, 2003) p 405. 6 Will not be developed further because of the lack of apparent
financing possibilities is the Bay’ al-Urbun or earnest money. This
Maulana Taqi Usmani, “Murabahah”, online publication by
involves earnest money or a deposit given by the buyer. If the sale
accountancy.com.pk.
proceeds, it will be calculated as a pre-payment and deducted from the
USMANI, Maulana Taqi Usmani, “Salam and Istisna”, online amount due. If the sale is cancelled, it will be forfeited in favor of the
publication by accountancy.com.pk. seller as a Hibah or gift. Furthermore, there is the Bay’ al-Wafa or
Bay’ al-Udah where the seller has the option to buy back the goods at

10. repayment of the sales price. In the mean time, full ownership is peace be upon him) as saying: “Gold is to be paid for by gold, silver
transferred to the buyer, who bears the risk but cannot sell it further by silver, wheat by wheat, barley by barley, dates by dates, salt by salt,
on. The use of the Wafa remains contested in some circles. There also like by like, payment being made hand to hand. He who made an
is the Bay’ al-Dayn or sale / transfer of debt. If this would be to addition to it, or asked for an addition, in fact dealt in usury. The
another party then the debtor himself, it should be on the spot and receiver and the giver are equally guilty.”
without discount in order to avoid Riba. There also is the Bay’ al- 18 Regular exploitation costs such as salaries and rent cannot be
Muzayadah or sale by auction, just to name the most obvious. charged.
7 Traditionally used formats are the Ijara Tasqhilliyah (similar to
operational leasing contract), the Ijara Wa Iqtina or Ijara Muntahia bi
Tamleek (similar to financial leasing) and the Ijara Mausufa fi al-
Dhimmah (forward lease).
8 Originally means the clasping of hands on concluding an
agreement – The Encyclopedia of Islam, o.c., Vol V – KHE-MAHI,
Bay’, p 1111.
9 The Majallah al-Ahkam-I-Adliya – art 105 (Civil Code of the
Ottoman Caliphate 1877-1926).
10 The Encyclopedia of Islam, o.c., Vol V – KHE-MAHI, Bay’, p
1111.
11 The Encyclopedia of Islam, o.c., Vol VIII – NED-SAM, Riba, p 238
– for a general introduction, Abdulkader Thomas (Ed.), Interest in
Islamic economics – understanding Riba, Routledge Islamic Studies,
London-UK, 2006 (146).
12 The exact interpretation of minors and the result of inability
remains debated between the different schools or mazhab.
13 A forward sale or salam is only possible under restrictive
conditions.
14 Meaning under his control and all the rights and liabilities have
been transferred to him, including the risk of destruction.
15 Bank Negara Malaysia, June 29th, 2010.
16 Do note that an Islamic guarantee is an act of goodwill. The
guarantor cannot ask for a remuneration, but only for a nominal fee
based upon secretarial costs … .
17 Consult for instance: Muslim: Book 10: Hadith 3854 Abu Sa’id al-
Khudri (Allah be pleased with him) reported Allah’s Messenger (may