Principles of Islamic banking and finance/PIBF201/Fixed income Islamic modes of finance/Bay Salam and Istisna

Bay al-salam and Istisna’

Bay al-salam is a sale of an object, which is not available at the time of the conclusion of the sale, but will be delivered in the future on a fixed future date. The price is, however, be paid immediately during the session of the contract. In other words, the transaction is called bay’ al-salam, when it is a sale for an agreed price with immediate payment for a determinate thing, to be delivered in the future on a fixed date. In other words, salam is the sale of a deferred item in exchange for an immediate (forward) price. It is the sale of a liability whose characteristics are described in exchange for a price or capital-sum paid in advance. The Maliki school defined bay’ alsalam as a sale in which the capital-sum (price) is paid in advance and the object of sale is deferred to a specified term. Whereas, the Shafi’i and Hanbali school defined the forward contract as a contract over described merchandise sold as a deferred liability on one party, in exchange for a price that is received during the contract session. Bay’ al-salam was allowed by the Holy Prophet Muhammad s.a.w. subject to certain conditions. The basic purpose of this sale was to meet the needs of small farmers who needed money to grow their crops and to feed their families up to the time of harvest. After the prohibition of riba, they could not take usurious loans. Therefore, it was allowed for them to sell the agricultural products in advance

Istisna’

Literally the word istisna’ is a derivative from the root word sana’ or to manufacture or to construct something. Istisna’ is an order or request to manufacture something, whereby the requestor invited, induced or caused another to make or manufacture some goods for him. Technically, it is a contract to purchase for a definite price something that may be manufactured later on according to agreed specifications between the parties. In other words, it is a contract of sale of specified items to be manufactured or constructed with an obligation on the part of the manufacturer or contractor to deliver them to the customer upon completion. In other words, istisna’, like the bay’ al-salam contract, is a contract whereby the sale of future goods is allowed on a certain condition or conditions. The istisna’ contract allow an order to be placed with a manufacturer to make a certain product, answering a definite description at an agreed price to be paid either in advance or on completion. In istisna’, the subject matter is non-existent goods at the time of the conclusion of the contract but it is treated as valid the principle of equity (istihsan) and on the basis of customary practice (‘uruf). The contract of Istisna’ creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work, any one of the parties may cancel the contract after giving a notice to the other. However, after the manufacturer has started the work, the contract cannot be cancelled unilaterally

Conditions of bay’ al-salam and istisna’

Bay’ al-salam and istisna’ have been allowed by the based on the Hadith of the Prophet which allowed the sale of future goods. All the Muslim jurists allowed such condition because it was customarily practiced in the business sector and responded to the public needs. It was, therefore, an exception to the general rule of the existence of the subject matter of sale. However, bay’ al-salam and istisna’ are bound by special rules and conditions.

Conditions of bay’ al-salam

I. Bay’ al-salam cannot be affected on a particular commodity or on a product of a particular field or farm. For instance, if the seller undertakes to supply the barley of a particular field, or the fruit of a particular tree, the bay’ alsalam will not be valid. This is because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery, and given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity the supply of which is not certain

ii. It is necessary that the quality of the object of sale is fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect must be expressly mentioned. Also, the exact date and place of delivery must be specified in the contract

iii. Bay’ al-salam can be affected in those commodities only the quality and quantity of which can be specified exactly. The things whose quality or quantity is not determined by specification cannot be sold through the contract of bay’ al-salam. For example, precious stones cannot be sold on the basis of bay’ al-salam. This is because every piece of precious stones is normally different from the other either in its quality or in its size or weight and their exact specifications is not generally possible;

iv. It is necessary for the validity of bay’ al-salam that the buyer pays the price in full to the seller at the time of affecting the sale. It is necessary because in the absence of full payment by the buyer, it will be tantamount to sale of a debt against a debt, which is expressly prohibited by the Holy Prophet s.a.w;

v. Bay’ al-salam cannot be affected in respect of things, which must be delivered at spot. For instance, if wheat is purchased in exchange of barley, it is necessary that the delivery of both be simultaneous (according to Shari’ah); and vi. It is necessary that the quantity of the object of sale is agreed upon in unequivocal terms. If the object of sale is quantified in weights according to the usage of its traders, its weight must be determined and if it is quantified through measures, its exact measure should be known. What is normally weighted cannot be quantified in measures and vice versa.

Conditions of istisna’

I. The subject matter should be well defined without ambiguity with respect to quality, quantity and other relevant characteristics. This follows since the object to be manufactured is an object of sale, which must be known by specifying those aspects. Therefore, if any of those aspects of the object of the contract is not specified, the contract would be rendered defective due to ignorance that may lead to legal dispute);

ii. The subject matter should normally be used by the people (e.g. jewelry, shoes, pots, means of transportation, etc.). The istisna’ is not proper if the subject matter is rarely used by the people;

iii. There is no specific term of deferment is specified. Hanafi school ruled that if the parties to the contract specify a term of deferment, the istisna’ becomes defective and the contract is converted to a bay’ al-salam that must satisfy all the other conditions of the latter contract;

iv. The price of the subject matter of istisna’ is known at the time of the conclusion of the contract. The price could not be increased or decreased on account of the normal increase or decrease in commodity prices or the cost of labor. This is to avoid gharar (uncertainty) in the price of the subject matter. The price or consideration for the manufactured good to be determined could be in cash or tangible goods or the usufruct of an asset for a particular duration. As a matter of fact, the utilization of the usufruct of the manufactured item itself (the subject matter of istisna’ upon completion) could also be the price of the contract; and

v. The manufacturer must undertake to construct the goods with his own material. If the buyer supplies the raw material to be manufactured it is considered then as Ijarah, instead of istisna’. It is not permitted for the manufacturer to stipulate in the contract of istisna’ that he will not be liable for defects in the subject matter. The reason for this prohibition is that istisna’ is a sale of specified goods to be delivered in future, while the exclusion of liability as to defects is valid only in the sale of particular identified goods.