Gharar and Islamic law of contract Essentials of

Gharar and Islamic law of contract Essentials of Islamic Banking and Finance IQRA University Gulshan Campus IRSHAD AHMAD AIJAZ irshad 786@gmail. com Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1

Contents of the lecture Gharar and its explanation; Definition of contract; Types of contract; Basics of the contract; Conditional contract; Application of law of contract; Types of sale; Q & A; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2

Gharar and its explanation Essentials of Islamic Finance – IU Gulshan Campus, Slide # 3

Gharar and its definition and explanation Gharar: – The Arabic word Gharar ( ) ﻏﺮﺮ means 'risk', 'uncertainty', and hazard. Gharar is also defined by some scholars as 'any bargain in which the result of it is hidden'. Unlike Riba, Gharar is not precisely defined by Shari'ah. Gharar is also considered to be of lesser significance than Riba; – The prohibition of Riba is absolute but some degree of Gharar or uncertainty is acceptable in Shari'ah. Normal Gharar (that does not lead to conflict) is acceptable. Also Gharar is acceptable in some social contracts; – Gharar has two ways. First, Gharar implies uncertainty. Second, it implies deceit. Shari'ah has forbidden all business transactions, which cause injustice in any form to any of the parties; – Gharar may be in the form of hazard or peril leading to uncertainty in any business, or deceit or fraud or undue advantage; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 4

Gharar and its definition and explanation Explanation of Gharar: – Inadequacy and inaccuracy of information about the essentials of the contract; The Gharar exist when a contract does not have clarity in its essential elements. Such a contract becomes matter of conflict between parties and become a way of cheating, deceiving and unjust dealing; For example if price in a contract is not clear or the attributes of sold goods are not clear to buyer or the time of payment is not clear to seller the contract becomes a point of conflict between parties; Hiring a cab without telling the deriver the destination or without agreeing on fare is case of Gharar. Also sale with through of stick on anything is a sale with element of Gharar; – Complexity in Contracts: Gharar also refers to undue complexity in contracts. Shari'ah does not permit interdependent contracts. For instance, “combining two sales in one” is not permitted; – Pure Games of Chance (Al-Qimar & Al-Maisir): The term Gharar is also used in the context of pure games of chance; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 5

Gharar and its definition and explanation Game of chance means one party's loss is confirm at the start of contract; Contracting under conditions of uncertainty and gambling (qimar) are examples of this; The two words, uncertainty and gambling are not synonymous, though related; Uncertainty is same as Gharar and under such conditions, exchange or contracting is reduced to a gamble; Contemporary scholars are of the view that forwards, futures and options contracts are financial example of this type; They are almost always settled in price differences only. Hence, these are used more as tools of gambling than as tools of risk management; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 6

Gharar and its definition and explanation Gharar sometimes appear in mechanics of the Contract; – For example (a) two Sales in One, (b) the 'Pebble', 'Touch' and 'Toss' Sales, (c) suspended (Mu'allaq) Sale and (d) the Future Sale are sales with element of Gharar; Gharar sometimes appear in object of the Contract; – For example ignorance of the Genus, Species, Attributes and Quantity of the Object fall under Gharar; – Also ignorance of the essence of the object like Ignorance as to Time, inability to Deliver, Contracting on a Non-Existent Object and Sale of the Unseen items come in sense of Gharar; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 7

Rules for Gharar Any transaction with element of Gharar is not allowed in Islam; Until the element of Gharar is removed the transaction become hung and sometimes void; Gambling and conventional insurance is not allowed for this reason. Essentials of Islamic Finance – IU Gulshan Campus, Slide # 8

Islamic law of contract and types of sale Essentials of Islamic Finance – IU Gulshan Campus, Slide # 9

Definition of contract Legally a contract is an agreement between two or more persons or parties for doing something; According to Islam every action or work that takes place between two or parties is a contract; Therefore, exchange of goods, receiving a gift, accepting a woman as wife through Nikah and agreement on partnership etc. come under the umbrella of 'contract'; Contract has different types for which the rules and law are different; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 10

Types of contract A contract can be of two nature: – Compensatory or financial contract; This is a contract in which there is exchange of either goods or services against an agreed compensation / price / fee / charges; – Non Compensatory or social contract; This is a contract in which there is exchange of either goods or services against an agreed compensation / price / fee / charges; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 11

Types of contract CONTRACT Non Compensatory / Social Contract Essentials of Islamic Finance – IU Gulshan Campus, Slide # 12

Basics of a contract A Financial Contract is allowed in Islam with some conditions: – The contract should not contain any element of Riba (explicit or implicit); – The contract should not have element of Gharar (excessive uncertainty); – The contract should conform to the rules laid down by Shari'ah for execution of contracts; – The contract should not be for those activities which have been considered impermissible (Haram) i. e. general prohibitions; Element of Riba can easily be recognized and eliminated; Similarly compliance to the ruling about general prohibition can also be achieved easily; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 13

Basics of a contract The conformity with laws of Shari'ah and the element of Gharar are important points that need elaboration; Every contract has some basic elements which should conform to rules of Shari'ah; The elements of a contract are: – Parties/persons to contract (those who enter in a contract); – Wordings of contract; – Subject matter of contract (the thing/task meant by the contract); – Compensation (remuneration/price for exchange); – Mechanics of the contracts (rights and responsibilities); Essentials of Islamic Finance – IU Gulshan Campus, Slide # 14

Basics of a contract Essentials of Islamic Finance – IU Gulshan Campus, Slide # 15

Basics of a contract Parties to contract should be: – Eligible to enter in such a contract; – Sane; – Mature enough to understand the nature of transaction; – Legally allowed for executing of such transaction (licence/permit requirement etc. ); Essentials of Islamic Finance – IU Gulshan Campus, Slide # 16

Basics of a contract Wordings of a contract should: – Contain Offer from one party and Acceptance from other ( Ijab-o-Qobool) in session of contract (Majlisul A'qd); – This Offer and Acceptance can be: Oral/verbal (Qauli), purchase through bargaining; Implied/understanding (Ishsraa), purchase in super market; – Be Present i. e. they must create sense of immediate effect (words give sense of future are not allowed, “I will buy it” does not make sense of immediate effect); – Unconditional and Non-contingent – conditional wording do not create immediate effects, “I will accept if my father allow it” is a conditional wording; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 17

Basics of a contract Subject matter of a contract should be: – Lawful – legally and Islamically allowed; Subject matter and the underlying cause must be lawful; The transacted object must be legally owned by the parties to a contract; – Existent – something that exists, contract of supply of mangoes in January; – Deliverable – can be transacted and exchanged, sale of fish in water or bird in air; – Specified in clear manner, Toyota corolla, XLi, engine # and chassis #; – Quantified if quantifiable, X 1000 kg of wheat; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 18

Basics of a contract Compensation (remuneration/price for exchange): – Conditions apply to Subject matter also apply here; – In case of barter system the application becomes important; – Lawfulness, Existence, Deliverability, Specifiability and Quantifiability become important; – In normal trade specification of currency is enough; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 19

Basics of a contract Mechanics of the contracts (rights and responsibilities) should be clear; Both parties should bear the responsibility and have the rights which are required by the nature of transaction; In case of sale ownership related risks should be born by owner during the ownership, after its transfer the owner is not responsible, (reason behind the secured nature of credit sale); Any condition inserted which is against the mechanics of the contract is invalid, (making a lessee in a lease transaction responsible for ownership related expenses is not allowed. Guaranteeing of principle in a partnership is not allowed whether both parties agree on it or not); Essentials of Islamic Finance – IU Gulshan Campus, Slide # 20

Conditional contract Conditional contract are not permissible in Islam; However, business norms allow conditional contracts especially in current business scenario; Ulema and scholars have described the method for inserting a condition in a contract; Three types of conditions are allowed while one type is not allowed; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 21

Conditional contract A condition, which is not against the basic objective of the contract, is a valid condition, e. g. a condition of free delivery to buyer’s premises; A condition, which is against the basic objective of the contract, but is in the market practice, is also a valid condition, e. g. condition of five-year warranty and one year free service; A condition, which is against the basic objective of the contract, not in the market practice and not in favour of any contractor, is a valid condition, e. g. a charity imposed on a transaction; A condition that is against the basic objective of the contract and not in market practice and favours one of the contractors or subject matter or price, is a void and invalid condition, e. g. selling a car with a condition from seller of its free use for two days every month; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 22

Summary A contract, whether it is a sale contract or Ijarah contract or partnership contract, should conform to these basic rules; Violation of these rules make the contract unacceptable to Shari'ah; As a matter of principle a contract in one sector may differ in application of these rules from other contract in other sector; Oil sector has different meaning for specification and quantification from what sugar industry has; Market norms of every sector are the decisive factors in this regard; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 23

Application Islamic law of contract applies on all types of contracts; Here we will see its application to sale (being the vast mode of financing in Islamic banking industry); According to Islamic laws of sale these are key elements of a sale transaction: – Contract of sale: Wordings i. e. Offer & Acceptance ( Ijab-o-Qobool) Oral/verbal (Qauli) or Implied (Ishsraa); Parties to contract (buyer and seller) [Muta’aquadain] must be Sane and Mature; Does not contain any unacceptable element i. e. sale must be non-contingent, immediate and unconditional; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 24

Application – Subject Matter (sold good) [Mabee']: Should be Existing, Valuable and Usable, Capable of ownership/title; Deliverable, Specified and Quantified; Seller should have title and risk. – Price: Quantified [Maloom] Specified and certain [Muta’ayyan]; Time and mode of payment should be well known; – Delivery and Possession of the sold goods: Delivery and possession either Physical/Actual or Constructive; Place and method of delivery should also be known; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 25

Types of sale The application of the law of contract into Sale and Purchase elaborates to us the way an Islamically acceptable sale should be; A sale sometimes does not comply with these laws and misses some or one of the important elements; In such case the sale is considered unacceptable to Islam; There different levels in unacceptability to Shari'ah; Coming slide elaborate these levels and types; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 26

Types of sale According to the nature of contract the sale has four types: – Valid sale ( Bai Sahih): A sale that meets all requirements laid down by Shari'ah for its contractual nature; – Void/Non existing Sale [Bai'-e-Baatil]; A sale that does not meet basic requirements of its contractual nature; – Existing sale but void due to defect (hung sale) [Bai'-e-Fasid]; A sale that meets basic requirements of its contractual nature but contains an impermissible element; – Valid but disliked sale (Bai Makrooh): A sale that meets basic requirements of its contractual nature but executed in bad/unethical manners. Essentials of Islamic Finance – IU Gulshan Campus, Slide # 27

Types of sale Valid sale ( Bai'-e-Sahih): – A sale that meets all requirements laid down by Shari'ah for its contractual nature; – A sale that executed by: Eligible parties; With proper wordings; For exchange of a permissible thing which is identified, quantified and well known to both parties; With specific price; and Delivery of the sold goods – Exchange of a 'Citizen cx 200 golden chain with black dial' watch against cash payment of PKR 10, 000/= with immediate delivery is a Valid Sale transaction; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 28

Types of sale Void/Non existing Sale [Bai'-e-Baatil]; – A sale that does not meets some or all basic requirements laid down by Shari'ah for its contractual nature; – A sale that executed: By ineligible parties; or For exchange of a impermissible thing; or For a thing which is not owned by seller; or For a thing which is not deliverable; – Sale of stolen watch is an invalid (Baatil) sale which does not benefit in creation of ownership for buyer nor the price received by seller is Halal for him; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 29

Types of sale Existing sale but void due to defect (hung sale) [Bai'-e-Fasid]; – A sale that meets basic requirements of its contractual nature but contains an impermissible element; – A sale that executed: With element of Gharar; For an unspecified thing; or With unknown price; Conditionally or contingently; Sale of one Toyota corolla from a lot of cars with explaining the specifications; – Such sale is a hung sale meaning the ownership transferred if the buyer takes delivery but the status will be hung unless the element is removed; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 30

Types of sale Valid but disliked sale (Bai'-e-Makrooh): – A sale that meets basic requirements of its contractual nature but executed in bad/unethical manners. A sale that executed at the time of Azaan for Jum'ah; Sale of grapes to wine maker; Sale of tranquilizer to addictive person; Interruption in an ongoing deal between two; – Such sale is allowed but disliked by Shari'ah and sometimes highly discouraged; Essentials of Islamic Finance – IU Gulshan Campus, Slide # 31

Questions? Essentials of Islamic Finance – IU Gulshan Campus, Slide # 32