Bay Bithaman Ajil and Murabahah are two contracts

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Bay' Bithaman Ajil and Murabahah are two contracts where payments are deferred to an agreed time. Compare and contrast these two contracts and give your view with regard to Affin bank Berhad v Zulkifli Abdullah (2005) and the 2008 BBA landmark cases. A presentation by: Ahmad Murad Irqsous 2008354627 Melda Malek 2009293952 Nor Alira Ramli 2009556949 Abang Ikhbal Abang Bolhil 2009519587 1

Introduction • Nowadays, most Muslim in Malaysia are very much concern on choosing the right product or offer from bank when their application for loan or facility is approved. The main concern is that it must be in line with Islamic Banking principle. Islamic financing facilities have been growing parallel to conventional banking loan facilities. The charging of interest for a loan or riba is prohibited in Islam, therefore in Islamic financing, the purchaser will pay profit instead of interest to the bank. • Discussion on 2 types of Islamic financing product offered by banks in Malaysia. 2

Introduction - Murabahah Derived from the word 'ribh' – profit or gain A type of contract, a form of sale, where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person (the buyer) by adding some profit or mark-up thereon. One of the financing mechanisms in the muamalat system – a simple business transaction. Mechanism has to be conducted with complete sincerity by the seller/financier by stating the cost price of the purchase and the total profit incurred clearly and truthfully. Hence, a sale based on trust (amanah). Only valid for commodities whose cost price is known. Murabahah initially was not a mode of financing in its original form. It was a simple sale on cost-plus basis. However, after adding the concept of deferred payment, it has been devised to be used as a mode of financing only in cases where the buyer intends to purchase a commodity. 3

Definitions by classical jurists Ibn al-Humam's – Al-murabahah is a contract of delivery of traded goods by a seller to the buyer by offering the buyer the selling cost price plus the total profit. Ibn Qudamah – A form of business transaction whereby the customer is informed that the goods are sold at a price which includes the cost price and profit. Imam Shafi'i – When someone sell an item with a contract, for instance for every 10 products the profit is 1, the buyer thus must pay the cost price, that is 90 dirham, plus the profit of 1 dirham for every 10, hence 9 dirham and therefore eventually the total financing is 99 dirham. All support that Murabahah is a trust sale which comprises both cost price and margin of profit. 4

Legitimacy of Murabahah is a legally permissible contract by the testimony of the majority of jurists and the Companions of the Prophet (pbuh). Proof from Al-Quran: “And Allah has permitted trade” [2: 275] “O you who believe! Eat not up your property among yourselves unjustly except it is a trade amongst you, by mutual consent” [4: 29] - Murabahah is clearly concluded by mutual consent and it comes under the general permission in this verse. 5

Legitimacy - cont. Some scholars made murabahah analogous to a form of sale called Tawliyyah (sale at purchase price without making profit) The Prophet (pbuh) purchased a female camel from Abu Bakr r. a. For use as transportation to migrate to al-Madinah. Abu Bakr wanted to give it to the Prophet (pbuh) free-of-charge but the Prophet(pbuh) refused and said, “I will preferably take it at the acquisition price. ” This Hadith indirectly implied that a commodity can be sold at the acquisition price and also the acquisition price with mark up. 6

Conditions for Murabahah 5 important elements: A. Product and selling price -Product must be clearly defined including its type, quantity and other descriptions. - Selling price- its cost and profit must also be disclosed clearly and truthfully. - Act of concealing cost price and/or margin of profit render transaction null and void. B. Contracting parties - Seller/ financier – responsible for supplying the product ordered by the buyer. - Buyer/ customer – obligated to to pay for the product he purchased according to agreed terms of the agreement. - Both must be adults, rational, intelligent and can be held accountable. 7

Conditions - cont. C. Offer and acceptance - it shall contain the two important elements mentioned ie. Cost price and rate of profit. - the original price must be fungible ie. The price at which the seller obtained the goods must be measured by weight, volume or number of homogeneous goods. - If the original price is not fungible (eg. A house, clothes), then the question is whether the seller is the owner or not: If the seller is not the owner then murabahah is not permitted. If seller is the owner then 2 situations : i) if the profit margin is specified as a known amount of a different item (eg. Silve coins, a specific dress etc), then the sale is permitted. In this case the first price is known and the profit is known (eg. I sell you via murabahah in exchange for the dress in your hand, and a profit of 10 dollars). ii) if the profit is made part of the initial price (eg. The profit margin is 10%), then the sale is not permitted, since the profit is made part of the object and not equally divisible. 8

Conditions - cont. D. No riba trading shall be involved. - Products traded cannot be paid by barter system from ribawi items prohibited by the Prophet (pbuh) ie. Gold for gold, silver for silver, wheat for wheat, flour for flour, dates for dates and salt for salt and barley for barley unless weight, measurement and the calculations are equal. Also forbidden eg. Selling 100 kg of good flour at the price of 120 kg of sub quality flour – constitutes riba. E. The initial contract must be valid. - The traded item or property must be lawfully owned by the seller according to Shariah requirements. 9

Basic Features of Murabahah Financing It is not a loan given on interest – it is a sale of a commodity for a deffered price which includes an agreed profit added to the cost. Murabahah cannot be used as a mode of financing except where the client needs funds to purchase a commodity. eg. If the client wants funds to purchase cotton as raw material for his factory, the bank can sell him the cotton based on murabahah. Murabahah cannot be affected if the funds are required for other purposes, like paying the price of a commodity already purchased by the client or to pay utility bills or to pay staff salary. Requires a real sale of commodities and not merely advancing a loan. Commodity in the transaction must come into the possession of the financier, whether physical or constructive – the commodity must be in his risk, though for only a short period In cases where it is not practicable for the financier to make a direct purchase, the financier is allowed to appoint the customer as his agent to purchase the commodity on his behalf. 10

Practical Steps for Murabahah Financing 1) The client and the financier sign a master agreement whereby the financier promises to sell and the client promises to buy the commodity on an agreed ratio of profit added to the cost. 2) When a specific commodity is required by the client, the financier appoints the client as his agent for purchasing the commodity on its behalf, and an agreement of agency is signed by both parties. 3) The client purchases the commodity on behalf of the financier and takes possession as an agent. 4) The client informs the financier that he has purchased the commodity on its behalf, and at the same time, makes an offer to purchase from the financier. 5) The financier accepts the offer and the sale is concluded whereby the ownership as well as the risk of the commodity is transferred to the client. - All these 5 stages are necessary to affect a valid murabahah. 11

Types of Murabahah 2 Types of Murabahah: i) Ordinary Murabahah Sale - involves 2 parties – seller and buyer. The seller is an ordinary trader who buys a commodity without depending on a prior promise of purchase, then he displays it for murabahah sale for a price and a profit to be agreed upon. (Not popular!) ii) Murabahah based on Order and Promise - widely applicable because used as one of financing tools by Islamic banks worldwide. - Murabahah to the purchase orderer (MPO) for a pre-agreed selling price, which includes a pre-agreed profit mark-up over its cost price, this having been specified in the customer's promise to purchase. - The payment is payable within a fixed future date in lump sum of by fixed instalments 12

The Prohibited Elements in Murabahah To assume that murabahah is a universal instrument which can be used for all types of financing offered by conventional interest-based banks. Clients sign the murabahah documents merely to obtain funds though they do not intend to use these funds to purchase the commodities specified in prescribed forms. Sale of commodity to the client is effected before the commodity is acquired by the seller. This usually happens when all the documents of murabahah are signed at one time without taking into account the various stages of murabahah. Entering into a murabahah contract on commodities already purchased by their clients from a third party. This practice is unacceptable in Shariah. Once the commodity is purchased by the client himself, it cannot be purchased again from the same supplier. 13

Bai' Bihtaman Ajil (BBA)- Intro. • The most popular type of financing. • The Majallah (mainly Hanafi-bases codification) refers to BBA as Bay' al-Muajjal. This term is employed in Pakistan. • In Bangladesh, it is known as Bay'Muazzal. • In the Middle East, a similar practice is used under the term Murabahah. • However, in Malaysia both terms refer to two different products. Definition: - • BBA is a sale contract in which the payment of the price is deferred and payable at a certain particular time in the future. • Therefore, BBA can be implicated for other sale contracts inc. Musawamah and Murabahah. (not applicable for salam contract) 14

Legality of BBA: - • In general, no issue arises from the practice of deferring the payment of sale price. • It is reported in a Hadith by a Companion, Jabir, that the Prophet (pbuh) bought a camel from him outside the city of Madinah whereby the payment was settled later on in Madinah. • In another Hadith, it was narrated that the Prophet (pbuh) purchased a quantity of grain from a Jew on the basis of deferred payment and he pledged his armour by way of security. • The dispute arises from the practice of increasing the price due to deferrment. • According to majority jurists inc. Al-Kasani, Ibn 'Abidin, Ibn Rushd and Al. Nawawi increasing the price due to the deferment in the payment is permissible because the increase is against the commodity and not against the money. 15

BBA Financing • In Malaysia, BBA financing is employed by bank to provide medium to long term financing to clients for acquiring eg. Property, land, motor vehicle, consumer goods, shares, overdraft facility, education financing package etc • House financing is the most popular facility granted under the concept of Bai Bithaman Ajil (BBA) either to purchase existing completed houses, build or construct new house on customer’s land even as a refinancing facility. In BBA, the customer sells the property purchased to the bank for a cash sum paid to the customer and the property will then be immediately resold back by the bank to the customer at higher price which include the bank’s profit on the sale, payable by the customer to the bank by monthly installments over a fixed period of time. 16

BBA- documentation • 3 main ingredients of BBA facility: • Sale and Purchase Agreement - Not part of the documentation of the facility but is required to obtain the facility. • Property Purchase Agreement(PPA) - This is an agreement made between the client and the bank. -most of the time the purchase price consists of the remaining balance of the price of the property (eg 90%) and some other costs such as lawyer's fees, MRTA etc. • Property Sale Agreement(PSA) -This agreement is signed between the client and the bank. - PSA should be signed after the signing of the PPA so as to allow the bank to sell back the asset to the client. 17

Some issues with BBA Selling of the non-existent • For houses under construction, property transacted is not yet in existence and may fall under non-completion. • Even if the opinion of Ibn Taymiyyah and Ibn al-Qayim that allows the selling of non-existent subject matter is to be followed, the ruling is based on the near certainty of delivery. • To avoid conflicting issue such as this, banks are recommended to use other types of financing for property under construction eg. Istisna (future delivery) 18

Issues with BBA - cont. Transfer of ownership • Issue of possession (al-qabd) – since BBA is actually a sale contract, the transfer of ownership and the taking of possession must truly happen even for a little while. • Dato' Haji Nik Mahmud bin Daud v Bank Islam (1996) CLJ p. 582 - The issue arisen was whether the execution of PSA and PPA amounted to a transfer of ownership of the Malay reserved lands in question. - Court held that it was never the intention of the parties to involve any transfer of ownership and that the executions of the PPA and PSA were part of the process required by Islamic banking procedure. • Although justice and equity have been carried out in this case, the judgment caused serious conflict with the concept of BBA whereby, the contract should, result in the transfer of ownership of the property, even only for a 19 second.

CASE REVIEW (cont’d) • Affin Bank Berhad v Zulkifli Abdullah [2006] 1 CLJ 438 • Facts of the case • Zulkifli bought a house from a vendor and applied for BBA financing from his employer, Affin bank. The bank paid the balance sum due to the Vendor (seller) amounting to RM 346, 000 -00 which is the approved facility amount and Zulkifli was required to repay to the bank the facility amount over a period of 18 years by a fixed monthly amount. The bank selling price to Zulkifli is RM 466, 847. 28. The said facility was then restructured because he had defaulted in his repayment and also because he had left his employment with the bank. The restructuring involved a revision of the bank’s purchase price, the bank’s selling price, the tenure of the facility and the monthly installments payable. Zulkifli agreed with all the terms of restructuring hence agreed to pay the bank the revised selling price of RM 992, 363 -40. After few payments, Zulkifli then defaulted again and the bank commenced an action to sell the property by way of public auction. The bank claimed that the balance due from Zulkifli was 20 RM 958, 909 -12, being the difference between the revised selling price and the amount he had paid.

• The Learned Judge held that the bank is not entitled to claim for profit margin for the full tenure of the vacility for over 25 years. • He did not agree with the bank’s calculation of the amount due and stated that bank’s selling price in BBA financing is not a sale price paid in a single payment but a series of equal monthly instalments. The profit margin is culculated with the profit rate applied to the full tenure. • What is immediately striking is the amount of the claim whereby the revised facility had mushroomed into a claim for a debt of RM 958, 909. 12 which is more than double. • If the customer is not given the full tenure to pay the selling price, then the bank is not entitled to claim for the bank’s’ profit margin of the full tenure. The profit margin charged on the unexpired part of the tenure is unearned profit and not actual profit and therefore cannot be claimed under BBA. • The reason behind this judgement is obviously on the following : as the facility was terminated way before the expiry of the tenure, the bank was not entitle to the unearned portion of the full profit. The sum that the 21 bank was allowed to recover was the sum of RM 582, 626. 80 which was culculated base on profit per day which is 9% per annum from the revised facility amount of RM 394, 172. 06 until the judgment date.

CONCLUSION • Zulkifli then got away with having to pay substantially less than what he had agreed to pay to the bank for the restructured facility and the bank did not appeal against the decision. • In light of this decision, it is important for a purchaser/customer who requires financing to fully understand his or her obligations and liabilities under BBA financing. This is because the customer has to pay what he has agreed upon and what both parties have contracted with each other i. e. to pay and to repay. The bank’s selling price which is calculated up to the full period of the loan need to be fully served. • It is the term in the facility that allowed the bank to claim the full selling price and in this case, the judge seems to rewrite the contract and re calculate the balance due by Zulkifli and the bank is not entitle for the actual or the total selling price as agreed during the execution of the Property Sale Agreement. • Therefore it is vital to understand all terms and conditions stated in Facility 22 agreement and questions, discussion and clear explanation of the implication of default payment and early settlement is a must. Both parties need to be clear on this issue or else the concept and principle of predetermined profit in BBA does not serve the purpose.

ARAB-MALAYSIAN FINANCE BHD v. TAMAN IHSAN JAYA SDN BHD & ORS; KOPERASI SERI KOTA BUKIT CHERAKA BHD (THIRD PARTY) AND OTHER CASES (2008) HIGH COURT MALAYA, KUALA LUMPUR ABDUL WAHAB PATAIL J 23

• Background the The respective defendants had already purchased property from a third party and paid part of the price. • The defendants approach the plaintiff banks for facilities to complete the purchase, were there are required to sell the property they had bought to the respective banks for that balance sum stipulated in the banks’ property purchase agreement (‘PPA’). • The bank then sold the property to the defendants via the banks’ property sale agreement (‘PSA’). • According to the PSA the defendants would pay an agreed number of installments of specific sums to the banks, the total of which made up the banks’ “selling price”. • As security this Al Bai’ Bithaman Ajil facility, the respective defendants were required to and had executed a charge cum assignment of the property to the bank. 24

• The defendants defaulted in the payment of the banks’ selling price, and the banks in consequence applied for an order for sale of the charged property. • The defendants argued that the transaction herein, comprising the letter of offer, the PPA, the PSA and the charge or assignment in question, became transparently financing in nature and smacked of transactions for profits. • Defendants beseeched the court to examine the same and determine whether it involved elements not approved by the religion of Islam – or had otherwise contravened the provisions of the Islamic Banking Act 1983 or the Banking and Financial Institutions Act 1989. 25

• Held, granting order for sale, ordering return of original facility amounts to plaintiff banks. Ratio • The plaintiffs’ submission in reliance upon Bank Islam Malaysia Berhad v. Adnan Omar [1994] 3 CLJ 735, [1994] 4 BLJ 372 that since the parties have agreed upon a selling price, there is “aqad” and the court must look no further does not appear to be right. The fact there is an “aqad”, and before that an “ijab” and “qabul” does not prevent an examination of the terms as to the transaction in fact is. It is necessary to look beyond the labels used and look at the substance. (paras 60 & 62) • Where the bank becomes the owner under a novation agreement, the sale to the customer is a bona fide sale, and the selling price is as interpreted in Affin Bank v. Zulkifli Abdullah [2006] 1 CLJ 438. Thus, where the bank is the owner of the property, by a direct purchase from the vendor or by a novation 26 from its customer, and then sells the property to the customer, the plaintiffs’ interpretation of the bank’s selling price is rejected and the court will apply the equitable interpretation. (para 68)

• Where the bank purchases directly from its customer and sells back to the customer with deferred payment at a higher price in total, the sale is not a bona fide sale, but a financing transaction, and the profit portion of such Al. Bai’ Bithaman Ajil facility renders the facility contrary to the Islamic Banking Act 1983 or the Banking and Financial Institutions Act 1989. (para 69) To understand more on this matter, we will look into para 56 • But it must be said that, bearing in mind that deferred payment of the selling price is a credit or a loan, permissible only because no riba is charged, any profit claimed or charged by the seller from deferred payment by adding to the cost above a profit for himself for the time given to make full payment, that profit arising from the giving of time to make payment is interest, is riba and the very element prohibited in the Religion of Islam. 27

The court distinguish benevolent loan • If interest is no more than an increase, expressed as a sum or rate, for the facility of a loan, profit upon a sale is the increase upon the sale. The sum of the seller’s cost and his profit is the selling price. The selling price is ordinarily paid upon delivery. If the payment is to be made later, the seller in effect is extending a credit, in other words, a loan, of that selling price. If there is no increase of the selling price as a consequence of granting time to make payment, it is a benevolent loan (qard al-hasan). (Para 53) • Since the bank’s action resulted more likely from a misapprehension rather that of intent aforethought, the plaintiffs were entitled under s. 66 of the Contracts Act 1950 to return of the original facility amount they had extended. (para 70) 28

View • Al Bai Bithaman Ajil concept exclude riba, its no more then a deferred sale. In most cases the three simultaneous transaction is adhered but in this case the BBA facility contain financing transaction and its rendered riba contrary to IBA 1983 and BAFIA. • In this case when the bank claim profit for himself from the time given to make full payment, that profit arising from the giving time of payment is constitute of interest. We cant charge profit based on time given to make full payment. • In the issue of agreed selling price. If the bank can fulfill the Bona Fide requirement of sale, then the bank may entitle to the selling price. 29 • BBA concept is acceptable and reliable as long the customer is not in default.

Recent case Bank Islam Malaysia Bhd Vs Ghazali Shamsuddin and 2 others 2009 • On 31 March 2009 Court of Appeal unanimously overturned Abdul Wahab Patail much debated judgement in the Arab Malaysia case discussed above and held that BBA is in line with shariah in Malaysia. 30

Conclusion • Murabahah and BBA are 2 separate components but can also be 2 parts of one product. • BBA originally refers to the method of payment when the payment is deferred and paid by installments. • The mandatory requirement of Murabaha is that the original purchase price as well as the profit added on, must be clearly revealed to the purchaser. This requirement is not necessary for BBA unless it is attached to Murabahah as a product. • As separate products, Murabahah is usually utilised for short term financing whereas BBA is utilised for long term financing. • Murabahah can only be utilised for the purchase of a commodity and can not be utilised for personal financing needs unlike BBA which in practice, can be used for other financing needs. 31

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