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Salam  and  Istisna’a   1  

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

SALAM and ISTISNA’A
Report
Thursday 4 November, 2015

Aboulkassim Elarbi
Akajni Laila
Darouichi Hamza
El Kandouchi Moustapha
Mfaraj Youssef
Supervised by Mr Bouarich Badre

Salam  and  Istisna’a   2  

 
Table of contents
Introduction

I-SALAM
SALAM BACKGROUND
Definition of Salam
Bai’ Salam/Salaf
Benefits of Salam and the economic role of Bai’ Salam
SALAM FLOWS
Features of a valid Salam contract
Subject matter of Salam
Payment of price: Salam capital
Period and place of delivery
Khiyar in Salam
Amending or revoking the Salam contract
Penalty of non-performance
Security, pledge and liability of the sureties
Disposing of the goods purchased on Salam
Alternatives for marketing Salam goods
Salam: post-execution scenarios
Supply of goods as per contract
Failure in supply of goods
Supply of inferior goods
Salam certificates/sukuk
SALAM USE
Salam as a financing technique by banks
Risks in Salam and their management
BENCHMARK

II- ISTISNA’A
BACKGROUND
Definition and concept
Subject matter of Istisna’a
ISTISNA’S FLOWS
Price in Istisna’a
Penalty clause: delay in fulfilling the obligations
The binding nature of an Istisna’a contract
Guarantees
Parallel contract: subcontracting
Istisna’a and agency contract
Post execution scenario
ISTISNA’A USE
The potential of Istisna’a
Risk management in Istisna’a
BENCHMARK
Case study
Debate questions

Salam  and  Istisna’a   3  

 
INTRODUCTION

As we have seen in class up to now, there are three basic conditions for the
validity of a sale: the commodity to be sold must exist, the seller should have acquired
ownership and the commodity must be in the physical possession of the seller
...
Both are sales of a
special nature: Salam is used to finance agricultural like goods, and Istisna’a is used to
finance manufactured like goods
...


SALAM
BACKGROUND
Definition
Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer
at a future date in exchange of an advanced price fully paid at spot
...
The term Salam
has been used in Hadith to describe the contract for future delivery of specified goods
with up-front payment of the price
...
This is different than Bai’ Mu’ajjal, in which
goods are delivered to the purchaser in advance and the agreed price is paid at a
stipulated date in the future
...
Salam has many
benefits for both parties
...
Thus, he benefits from the Salam

Salam  and  Istisna’a   4  

 

sale by covering his cash and liquidity needs in respect of his personal expenses
...
The
purchaser also benefits from cheap prices, because usually the Salam price is cheaper that
the cash market price
...

Differences existed among the traditional jurists regarding the list of commodities that
can be sold under Bai’ Salam
...

The contemporary scholars have come to the conclusion that all goods that can be
standardized into identical units can become the subject of Salam (for example wheat,
rice, oil, iron etc
...

Salam cannot take place where both items of exchange are identical (for example
exchanging potatoes for potatoes)
...
Salam is not allowed for
anything the seller may not be held responsible for, like land, buildings or products of a
specific field
...
The commodity to be sold
through Salam should not be of the nature of money because the currency notes
(Thaman, which is paper money) have no value in the absence of government
commitment and are wanted only for the purpose of exchange and payments, and not for
themselves
...
These “Fulus” can be
used for trading on the basis of their metallic content
...
However, some jurists allow delayed payment, provided this delay
is not prolonged to make it like a debt
...

Contemporary jurists also allow a delay of two to three days, but only if it has been
stipulated between the parties, and only if it is before the delivery period of the
commodity
...
Indeed, the
price can be credited to the seller’s account
...

Price is normally stipulated and paid in the form of money
...
For example, the buyer may advance a tractor as the price for an
agreed amount and quality of rice
...

3- Period and place of delivery
For the period of delivery in Salam, the early compilations of the Hadith mention the
practice of fixing a period of one to three years for delivery of farm products
...
Also, the delivery can be made in a precise agreed upon date, but it
may also be made in a rough date but definite period of time
...
Before delivery, goods will remain at the risk of the seller, and the risk will
be transferred to the buyer after the delivery
...

4- Khiyar
The jurists disallow the operation of the Islamic law of option (Khiyar alShart) in the
case of Salam
...
However, after taking delivery of the
goods, the purchaser has the option to defect (Khiyar al’Aib)
...
In this case, only the paid amount
of price can be recovered without any increase
...
However, both parties have the right to rescind the contract with
mutual consent
...

Therefore, to avoid any problems, it is advisable to make the Salam contract irrevocable
with mutual consent
...
In this case of
revocation of the contract, the buyer will charge exactly the same amount paid at the
beginning
...

6- Penalty for non-performance
If the seller fails to fulfil his obligation, he should be granted an extension of time for
delivery
...
In other words, the seller will
pay into the Charity account maintained by the bank an amount on behalf of the buyer
...

Security, Pledge and liability of the sureties
In Salam contracts it is lawful to ask for a security or a pledge and it is divided into two
chapters “Kafeel fi Salam” & “Al Rihn fi Salam”
...
A pledge is the delivery of goods or personal property as security for a debt
or obligation
...
In case of the bank getting back its money,
the amount of money cannot be more than the price paid in advance, the advance prices
is a liability outstanding on the seller
...
As a result, the seller may be involved in the process
...
Only the seller is authorized to revoke the contract and not the surety, in that case,
only the price paid will be taken by the bank
...

Disposing of the goods purchased on Salam
There is a difference of opinion among Muslim jurists regarding the legality of selling
the purchase goods prior to taking delivery
...

Therefore, the seller cannot resell an item, cannot contract its transference and cannot
make it partnership capital
...
Therefore, it cannot be the basis of any ruling
...

Ibn Taymiyah and Ibn Al-qayyim maintain the permission of a parallel Salam
...
Many Muslim authorities approve these views such as
Companion Ibn Abbas Imam Ahmed and the Maliki view
...

In the current framework of Islamic finance, the use of parallel Salam and certificates
based on Salam seems logical since the transfer of ownership to the purchaser imply the
transfer of the risk risk to him
...
The
first one is to enter into a parallel Salam: In Salam contract, both the buyer and the seller
can enter into a parallel Salam contract
...


The second option is an agency contract
...
An agency agreement is obligatory, it states the price at which the
commodity must be sold and any benefit above the price can be given to the agent
...


The third option is the sale in the open market by the bank itself by entering into a
promise with any third party or direct selling upon taking delivery
...
The bank may
take earnest money (Hamish Jiddiyah) from the promisor and if the latter changes his
decision about buying the goods the bank may take a sum of money to cover the loss
...
The
first situation is when the seller fail to supply the goods to the buyer
...
To wait until the commodity is available, if the seller fails to
present the goods the buyer have the right to sell the pledge and buy the goods and if
there is remainder the bank will give it to the seller and if the amount of money is not
sufficient the bank has the right to ask the seller for the amount needed to buy the
commodity
...
The two other options are to
cancel the contract and recover the paid price and to agree about a replacement with
mutual consent and subject to the relevant rules
...

In this case, the buyer may refuse to accept the goods and insist on the supply of the
agreed goods according to the procedure mentioned earlier or get the price paid at the
time of contract back
...

If the seller is not able to supply the agreed item, and the item is absolutely out of stock
in the accessible market, the bank may ask the seller to supply any other good
...

The new commodity has to be a different type from the original commodity
...

The third situation is when the seller can only partly supply the agreed goods, the bank
may accept the same and revise the purchase order to the extent of the remaining
quantity, or it may claim a refund of the balance
...
Countries that have

Salam  and  Istisna’a   10  

 

large amount of natural resources can issue certificates for the future delivery of products
at a price that is paid on the spot
...
Those who buy a Salam certificate take the risk of price variation, due to different
factors, from the one agreed on in the salam contract
...

The price should be known in advance in order to remove any risk of dispute between parties
due to a lack of knowledge
...
There is also a possibility to negociate the price
between parties, provided that eventually both of them will end up on an agreed upon price,
which will be chosen for concluding the Istisna’a contract
...
However, as the
manufacturing of some kinds of huge assets may take a lot of time (and necessitate some
changes), the price can be readjusted after the contract has been signed, but only if both parties
give their mutual consent
...


  

Salam  and  Istisna’a   11  

It is not necessary in Istisna’a that the price is paid in advance
...

A contract of Istisna’a cannot be drawn up on the basis of Murabaha sale (for example by
determining the price of Istisna’a on a cost-plus basis); this is because the subject matter of
Murabaha should be something already in existence, its cost should be known and it should be
owned by the seller before conclusion of Murabaha, so that a profit margin may be added to
that
...


Penalty clause: Delay in fulfilling the obligations:
An Istisna’a contract may contain a penalty clause stipulating an agreed amount of money
for compensating the purchaser adequately if the manufacturer is late in delivering the asset
...
Also,
it is not permitted to stipulate a penalty clause against the purchaser for default in any payment
because this would be Riba
...

It can be agreed, in other words, between the parties that in the case of delay in delivery, the
initial price shall be reduced by a specified amount
...

By analogy, experts allow a penalty clause in the istisna’a agreement in the case of a delay in
delivery, supply or construction of the subject of Istisna’a
...
This
reduction will enhance the income of the purchaser and it will not go to the charity as in the
case of all other modes
...
If the seller
does not allocate his full time to completion of the requirements of a particular contract and
engages in other contracts (to increase his own personal earnings), he can be defined
...
Any such undertaking by the manufacturer would be binding on him
...
Therefore, before the manufacturer starts the work, any one of the parties has
the right to cancel the contract
...
The majority of contemporary Shariah scholars treat
Istisna’a as a binding contract, provided that certain conditions are fulfilled
...
He however, has the
“option of defect” (khiyar al Aib) and the option of specified quality, meaning that if the asset
has any proven defect or is not conform to the agreed upon specifications, the purchaser has the
right to be indemnified
...
It can also get “Arbun”, which will either be part of the
price if the contract is fulfilled, or forfeited if the contract is rescinded
...

Parallel contract – subcontracting
Istisna’a is not restricted to what is made by the seller himself; indeed, if the contract is
silent or if it expressly allows such, the seller/supplier can get the commodities manufactured
from anyone else, as long as the specifications stipulated in the contract are respected
...

An Istisna’a contract shall be entered into, on the one hand, between the bank and a
customer, while on the other hand, the bank may enter into a parallel Istisna’a with a third
party (contractor) for preparation of the subject matter of the first Istisna’a
...
In one
contract, the bank will be the buyer and in the second, the bank would be the seller
...
Each of the two
contracts is independent from the other
...
Further, Parallel Istisna’a is allowed
with the existence of a third party only
...
Subsequently, the bank may enter into a contract with another party in order to sell,
in the capacity of manufacturer or supplier, items whose specifications conform to the wishes
of that other party, on the basis of parallel Istisna’a and fulfil its contractual obligation
accordingly
...
It can ask the client/manufacturer to act as an agent to sell the
subject matter
...
The seller can sell that asset in
the market and pay the amount back to the purchaser, as well as his dues (if any)
...

The bank can also engage any consultant firms to supervise the construction work and to
determine whether the subject matter conforms to the stipulated specifications or for other
advisory services
...

Post execution scenario
Before the manufacturer starts working on the subject matter of Istisna’a, both of the parties
can still cancel the contract
...

The parties are inevitably bound by any obligations and consequences resulting from the
agreement
...
If the subject matter does not conform to the specifications agreed upon,
the customer has the option to refuse it
...


  

Salam  and  Istisna’a   14  

If the actual cost incurred by the bank (as seller) on an asset sold on Istisna’a is less than the
forecast cost, or the bank gets a discount from the subcontractor on a parallel Istisna’a basis,
the bank is not obliged to give a discount to the purchaser and any additional profit, or loss if
any, pertains to the bank
...

If so desired by a customer, the Islamic bank (as purchaser) may replace an existing
contractor to complete a project which has already been commenced by the previous contactor
...

The bank, working as a manufacturer (seller), must assume liability for ownership, risk,
maintenance and takaful expenses prior to delivering the subject matter to the purchaser as well
as the risk of the theft or any abnormal damage
...
Therefore, if the bank is the manufacturer
for the purpose of an Istisna’a contract, it cannot absolve itself from loss on this account
...


Delivery and disposal of the subject matter
Before delivery of the asset to the purchaser, it will remain at the risk of the seller; in other
words, any loss occurring in the process of manufacturing will be borne by the seller
...

If a manufactured asset is delivered before the agreed date, the purchaser should accept it is
the asset meets the stipulated specifications
...

Possession of goods can be physical or constructive, depending upon the nature of the asset
and transfer of ownership/risk
...

If the condition of the subject matter does not conform to the contractual specifications at
the date ode delivery, the ultimate purchaser has the right to reject the subject matter or to

Salam  and  Istisna’a   15  

 

accept it in its present condition, in which case the acceptance constitutes satisfactory
performance of the contract
...
It can also be used for housing and export
financing , meeting working capital requirements in industries where sale orders are
received in advance
...
)

CASE STUDY

Case I: Salam-Wheat Mill “Working Capital”
Wheat mill A needs working capital and approaches Bank B on 1st October, 2015
...
At

Salam  and  Istisna’a   16  

 

this stage, the bank can appoint the mill its agent for sale of the wheat when received, or
get or get a promise to buy from any third party
...
135 US dollar) per 1kg bag for the sale of sugar in the market by Wheat Mill A as its
agent
...
A delivers the wheat on 31st December, 2015;
upon taking physical or constructive possession, it comes under the liability/risk of Bank
B
...
If wheat’s prices
fall and wheat is sold at 7 Rs (for example), despite effort by A, B will have to suffer the
loss
...
The total is
agreed at 120M Rs
...
Bank B enters into a Paralle Istina’a with Contractor C for the
construction of flats of the same specification against the total cost of 100M Rs up to the
end of 2015 and makes payment in four instalments, as per the agreement
...
Contractor C gives possession of the flats at the end of December, 2015 to
Bank B, which hands them over to Builder A
...
The allottees will make
periodical payments for rental and purchase of units from the bank; ultimately, the
ownership will transfer allottees
...
(2007)
...
In Understanding Islamic finance (Vol
...

Hoboken, NJ: John Wiley & Sons
...
(n
...
Retrieved November 4, 2015

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