Friday, June 26, 2015



In one of the previous posts, we raised up an issue pertaining to the use “waad” or promise in Islamic finance and how it seems that this concept has been widely employed to achieve some objectives aimed at helping one party but denying justice to the other side in a transaction. For a start, Islamic law right from the outset has recognized a distinction between a promise and a contract (‘aqd) where a contract has been viewed more important than a promise at least in the context of external binding effect. However even in the case of contracts, Islamic law does look at the nature of the contracts concerned when it comes to the question of their external binding effect  that will define whether the court will enforce the ensuing obligations or not.

In this connection there are at least three major categories of contract to talk about in terms of the binding effect of a contract. Firstly there are contracts held to be binding on both contracting parties upon their formation where none of the parties are allowed to unilaterally terminate the relevant contract, and among others this includes sale and purchase and leasing or contract of/for service known as ijarah. The second type comprises contracts that are held to be not binding on both of the parties such that at any time any one of them can unilaterally put an end to the relationship without any need to get approval from the other side like in the case of the contract of wakalah (agency), mudarabah, sharikah (partnership) and the likes. And lastly there are contracts that are viewed to be of special category when one of the party is allowed to terminate while the other is to stick to them with no right to terminate unless with the consent of the first party. One example is the contract of surety or guaranty, where the creditor can always free the guarantor from the contract at any time, but the guarantor has no such a right as he is to stick to it as per the term agreed.

It is interesting to note, even in the case of the contracts that are supposed to be binding on both of the parties like sale and ijarah, both parties if they wish, can insert the right to terminate the contract in their agreement based on a concept known  as khiyar al-shart as they may have provided in the contract according to which the party who asks for it will have the right to terminate such a contract within a specific time period.  This concept is very similar to the modern notion of right of cooling off (cooling off period) where the parties can provide for it as part of the contractual terms, in which case they have right to set aside the duly formed contract within specific period of time.

Coming back to the issue of binding promise as previously discussed (refer to previous post), now it has become clear that if the concept is relied upon, it  (binding promise) will take away the flexibility of the law of contracts  itself by not allowing the relevant parties to have equal bargaining power in their dealings. The binding effect of a contract of exchange like sale and purchase derives its sanctity from the fact that if one of the parties unilaterally backs off from his contractual duty without agreement from the other side (who is ever willing to provide his part of the bargain), then the one who is ready to continue can pursue the first party in the court of law for enforcement (for specific performance). Therefore, in the case of a contract that is binding on both of the parties, there is an element of consideration where there are bargains on both sides which is not the case in a one-sided promise. One basic question to ask here is how can a party (promisee) who himself has not made any commitment to provide any bargain/return/consideration to the other side is allowed to pursue the first party (promisor) for an enforcement of a promise. Promise itself is said to be not more than a statement by a person that he intends to carry out some good deeds in future, such that it is up to the promisor to fulfill it or not even though in a religious/moral term he is commanded to fulfill it unless there is any justified reason not to fulfill it. Given that the promisee has not made similar commitment, he cannot enforce the unilateral declaration of promise made by the promisor, as there is no equal bargaining/fairness in the equation. Apart from that, there is always a general Shariah prohibition on taking away anything from an owner except based on the owner’s consent either premised on a sale or gift contract. In short, if the notion of binding promise is to be widely applied, it will defeat the purpose of the law of contract in accordance to which people generally bargain their positions on a level playing field. Although the approach that allows for a promise to be made binding seems to address the issue of a customer not wanting to conclude a promised sale contract like in Murabahah for instance, the danger of putting aside the general  theory/rule of Islamic  contract is far more serious than the anticipated benefit as it will defeat the very contractual framework that has been laid down for the general benefit/protection  of all, not to mention the flexibility of the law of  contract itself when it recognizes the different categories of contracts from their binding effect perspective.

It is interesting to note in this connection that in May this year (2015), Islamic Fiqh Academy of Muslim World League (Rabitah al-Aalam al-Islami) based in Mecca, issued a fatwa prohibiting the use of “waad” in forward currency exchange as employed in Islamic finance. It emphasized that Islamic rule prohibiting sale of currency not on cash/spot basis is far more important to be observed as compared to the need to hedge against currency exposure/risk based on doubtful method that clearly goes against Shariah ruling. As known, Islamic finance practitioners have been using “waad” to structure the so-called Islamic version of currency swap that has raised serious concern among many Shariah scholars.

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