Islamic Finance

Islamic banking has become today an undeniable reality. The number of Islamic banks and the financial institutions is ever increasing. New Islamic Banks with huge amount of capital are being established. Conventional banks are opening Islamic windows or Islamic subsidiaries for the operations of Islamic banking.

Even the non-Muslim financial institutions are entering the field and trying to compete each other to attract as many Muslim customers as they can. It seems that the size of Islamic banking will be at least multiplied during the next decade and the operation of Islamic banks are expected to cover a large area of financial transactions of the world. But before the Islamic financial institutions expand their business they should evaluate their performance during the last two decades because every new system has to learn from the experience of the past, to revise its activities and to analyze its deficiencies in a realistic manner. 

Unless we analyze our merits and demerits we cannot expect to advance towards our total success. It is in this perspective that we should seek to analyze the operation of Islamic banks and financial institutions in the light of Shari‘ah and to highlight what they have achieved and what they have missed.

Once during a press conference in Malaysia, this author was asked the question about the contribution of the Islamic Banks in promoting the Islamic economy. My reply to the question was apparently contradictory, I said it he has contributed a lot and they have contributed nothing. In the present chapter an attempt has been made to elaborate upon this reply. When it was said that they have contributed a lot, what was meant is that it was a remarkable achievement of the Islamic banks that they have made a great break- through in the present banking system by establishing Islamic financial institutions meant to follow Shari‘ah. It was a cherished dream of the Muslim Ummah to have an interest-free economy, but the concept of Islamic banking was merely a theory discussed in research papers, having no practical example. It was the Islamic banks and financial institutions which translated the theory into practice and presented a living and practical example for the theoretical concept in an environment where it was claimed that no financial institution can work without interest. It was indeed a courageous step on the part of the Islamic banks to come forward with a firm resolution that all their transactions will conform to Shari‘ah and all their activities will be free from all transactions involving interest.

Another major contribution of the Islamic banks is that, being under supervision of their respective Shari‘ah Boards they presented a wide spectrum of questions relating to modern business, to the Shari‘ah scholars, thus providing them with an opportunity not only to understand the contemporary practice of business and trade but also to evaluate it in the light of Shari‘ah and to find out other alternatives which may be acceptable according to the Islamic principles.

It must be understood that when we claim that Islam has a satisfactory solution for every problem emerging in any situation in all times to come, we do not mean that the Holy Qur’an or the Sunnah of the Holy Prophet صلى الله عليه وسلم or the rulings of the Islamic scholars provide a specific answer to each and every minute detail of our socio-economic life. What we mean is that the Holy Qur’an and the Holy Sunnah of the Prophet صلى الله عليه وسلم have laid down broad principles in the light of which the scholars of every time have deduced specific answers to the new situation arising in their age.

Therefore, in order to reach a definite answer about a new situation the scholars of Shari‘ah have to play a very important role. They have to analyze every new question in the light of the principles laid down by the Holy Qur’an and Sunnah as well as in the light of the standards set by the earlier jurists, enumerated in the books of Islamic jurisprudence. This exercise is called istinbat or ijtihad. It is this exercise which has enriched the Islamic jurisprudence with a wealth of knowledge and wisdom for which no parallel is found in any other religion. In a society where the Shari‘ah is implemented in its full sway the ongoing process of istinbat keeps injecting new ideas, concepts and rulings into the heritage of Islamic jurisprudence which makes it easier to find out specific answer to almost every situation in the books of Islamic jurisprudence. But during the past few centuries the political decline of the Muslims stopped this process to a considerable extent. Most of the Islamic countries were captured by non-Muslim rulers who by enforcing with power the secular system of government, deprived the socio- economic life from the guidance provided by the Shari‘ah, and the

Islamic teachings were restricted to a limited sphere of worship, religious education and in some countries to the matter of marriage, divorce and inheritance only. So far as the political and economic activities are concerned the governance of Shari‘ah was totally rejected.

Since the evolution of any legal system depends on its practical application, the evolution of Islamic law with regard to business and trade was hindered by this situation. Almost all the transactions in the market being based on secular concepts were seldom brought to the Shari‘ah scholars for their scrutiny in the light of Shari‘ah. It is true that even in these days some practicing Muslims brought some practical questions before the Shari‘ah scholars for which the scholars have been giving their rulings in the forms of fatawas of which a substantial collection is still available. However, all these fatawas related mostly to the individual problems of the relevant persons and addressed their individual needs. It is a major contribution of the Islamic banks that, because of their entry into the field of large scale business, the wheel of evolution of Islamic legal system has re-started. Most of the Islamic banks are working under the supervision of their Shari‘ah Boards. They bring their day to day problems before the Shari‘ah scholars who examine them in the light of Islamic rules and principles and give specific rulings about them. This procedure not only makes Shari‘ah scholars more familiar with the new market situation but also through their exercise of istinbat contributes to the evolution of Islamic jurisprudence. Thus, if a practice is held to be un-Islamic by the Shari‘ah scholars a suitable alternative is also sought by the joint efforts of the Shari‘ah scholars and the management of the Islamic banks. The resolutions of the Shari‘ah Boards have by now produced dozens of volumes—a contribution which can never be under-rated.

Another major contribution of the Islamic banks is that they have now asserted themselves in the international market, and Islamic banking as distinguished from conventional banking is being gradually recognized throughout the world. This is how I explain my comment that they have contributed a lot. On the other hand there are a number of deficiencies in the working of the present Islamic banks which should be analyzed with all seriousness.

First of all, the concept of Islamic banking was based on an economic philosophy underlying the rules and principles of Shari‘ah. In the context of interest-free banking this philosophy aimed at establishing distributive justice free from all sorts of exploitation. As I have explained in a number of articles, the instrument of interest has a constant tendency in favor of the rich and against the interests of the common people. The rich industrialists by borrowing huge amounts from the bank utilize the money of the depositors in their huge profitable projects. After they earn profits, they do not let the depositors share these profits except to the extent of a meager rate of interest and this is also taken by them by adding it to the cost of their products. Therefore, looked at from macro level, they pay nothing to the depositors. While in the extreme cases of losses which lead to their bankruptcy and the consequent bankruptcy of the bank itself, the whole loss is suffered by the depositors. This is how interest creates inequity and imbalance in the distribution of wealth.

Contrary to this is the case of Islamic financing. The ideal instrument of financing according to Shari‘ah is musharakah where the profits and losses both are shared by both the parties according to equitable proportion. Musharakah provides better opportunities for the depositors to share actual profits earned by the business which in normal cases may be much higher than the rate of interest. Since the profits cannot be determined unless the relevant commodities are completely sold, the profits paid to the depositors cannot be added to the cost of production, therefore, unlike the interest-based system the amount paid to the depositors cannot be claimed back through increase in the prices.

This philosophy cannot be translated into reality unless the use of the musharakah is expanded by the Islamic banks. It is true that there are practical problems in using the musharakah as a mode of financing especially in the present atmosphere where the Islamic banks are working in isolation and, mostly without the support of their respective governments. The fact, however, remains that the Islamic banks should have gressed towards musharakah in gradual phases and should have increased the size of musharakah financing.

Unfortunately, the Islamic banks have overlooked this basic requirement of Islamic banking and there are no visible efforts to progress towards this transaction even in a gradual manner even on a selective basis. This situation has resulted in a number of adverse factors :

Firstly, the basic philosophy of Islamic banking seems to be totally neglected.

Secondly, by ignoring the instrument of musharakah the Islamic banks are forced to use the instrument of murabahah and ijarah and these too, within the framework of the conventional benchmarks like Libber etc. where the net result is not materially different from the interest based transactions. I do not subscribe to the view of those people who do not find any difference between the transactions of conventional banks and murabahah and ijarah and who blame the instruments of murabahah and ijarah for perpetuating the same business with a different name, because if murabahah and ijarah are implemented with their necessary conditions, they have many points of difference which distinguish them from interest-based transactions. However, one cannot deny that these two transactions are not originally modes of financing in Shari‘ah. The Shari‘ah scholars have allowed their use for financing purposes only in those spheres where musharakah cannot work and that too with certain conditions. This allowance should not be taken as a permanent rule for all sorts of transactions and the entire operations of Islamic Banks should not revolve around it. 

Thirdly, when people realize that income from in the transactions undertaken by Islamic banks is dubious akin to the transactions of conventional banks, they become skeptical towards the functioning of Islamic banks.

Fourthly, if all the transactions of Islamic banks are based on the above devices it becomes very difficult to argue for the case of Islamic banking before the masses especially, before the non- Muslims who feel that it is nothing but a matter of twisting of documents only.

It is observed in a number of Islamic banks that even murabahah and ijarah are not effected according to the procedure required by the Shari‘ah. The basic concept of murabahah was that the bank should purchase the commodity and then sell it to the customer on deferred payment basis at a margin of profit. From the Shari‘ah point of view it is necessary that the commodity should come into the ownership and at least in the constructive possession of the bank before it is sold to the customer. The bank should bear the risk of the commodity during the period it is owned and possessed by the bank. It is observed that many Islamic banks and financial institutions commit a number of mistakes with regard to this transaction:

Some financial institutions have presumed that murabahah is the substitute for interest, for all practical purposes. Therefore, they contract a murabahah even when the client wants funds for his overhead expenses like paying salaries or bills for the goods and services already consumed. Obviously murabahah cannot be effected in this case because no commodity is being purchased by the bank.

In some cases the client purchases the commodity on his own prior to any agreement with the Islamic Bank and a murabahah is effected on a buy-back basis. This is again contrary to the Islamic Principles because the buy-back arrangement is unanimously held as prohibited in Shari‘ah.

In some cases the client himself is made an agent for the bank to purchase a commodity and to sell it to himself immediately after acquiring the commodity. This is not in accordance with the basic conditions of the permissibility of murabahah. If the client himself is made an agent to purchase the commodity, his capacity as an agent must be distinguished from his capacity as a buyer which means that after purchasing commodity on behalf of the bank he must inform the bank that he has effected the purchase on its behalf and then the commodity should be sold to him by the bank through a proper offer and acceptance which may be effected through the exchange of telexes or faxes.

As explained earlier murabahah is a kind of sale and it is an established principle of Shari‘ah that the price must be determined at the time of sale. This price can neither be increased nor reduced unilaterally once it is fixed by the parties. It is observed that some financial institutions increase the price of murabahah in the case of late payment which is not allowed in Shari‘ah. Some financial institutions roll-over the murabahah in the case of default by the client. Obviously, this practice is not warranted by Shari‘ah because once the commodity is sold to the customer it cannot be the subject matter of another sale to the same customer. 

In transactions of ijarah also some requirements of Shari‘ah are often overlooked. It is a prerequisite for a valid ijarah that the lessor bears the risks related to the ownership of the leased asset and that the usufruct of the leased asset must be made available to the lessee for which he pays rent. It is observed in a number of ijarah agreements that these rules are violated. Even in the case of destruction of the asset due to force majeure, the lessee is required to keep paying the rent which means that the lessor neither assumes the liability for his ownership nor offers any usufruct to the lessee. This type of ijarah is against the basic principles of Shari‘ah. The Islamic banking is based on principles different from those followed in conventional banking system. It is therefore logical that the results of their operations are not necessarily the same in terms of profitability. An Islamic bank may earn more in some cases and may earn less in some others. If our target is always to match the conventional banks in terms of profits, we can hardly develop our own products based on pure Islamic principles. Unless the sponsors of the bank as well as its management and its clientele realize this fact and are ready to accept different - but not necessarily adverse - results, the Islamic banks will keep using artificial devices and a true Islamic system will not come into being.

According to the Islamic principles, business transactions can never be separated from the moral objectives of the society. Therefore, Islamic banks were supposed to adopt new financing policies and to explore new channels of investments which may encourage development and support the small scale traders to lift up their economic level. A very few Islamic banks and financial institutions have paid attention to this aspect. Unlike the conventional financial institutions who strive for nothing but making enormous profits, the Islamic banks should have taken the fulfillment of the needs of the society as one of their major objectives and should have given preference to the products which may help the common people to raise their standard of living. They should have invented new schemes for house-financing, vehicle- financing and rehabilitation-financing for the small traders. This area still awaits attention of the Islamic banks.

The case of Islamic banking cannot be advanced unless a strong system of inter-bank transactions based on Islamic principles is developed. The lack of such a system forces the Islamic banks to turn to the conventional banks for their short term needs of liquidity which the conventional banks do not provide without either an open or camouflaged interest. The creation of an inter- bank relationship based on Islamic principles should no longer be deemed difficult. The number of Islamic financial institutions today has reached around two hundred. They can create a fund with a mixture of murabahah and ijarah instruments the units of which can be used even for overnight transactions. If they develop such a fund it may solve a number of problems.

Lastly, the Islamic banks should develop their own culture. Obviously, Islam is not restricted to the banking transactions. It is a set of rules and principles governing the whole human life. Therefore, for being ‘Islamic’ it is not sufficient to design the transactions on Islamic principles. It is also necessary that the outlook of the institution and its staff reflects the Islamic identity quite distinguished from the conventional institution. This requires a major change in the general attitude of the institution and its management. Islamic obligations of worship as well as the ethical norms must be prominent in the whole atmosphere of an institution which claims to be Islamic. This is an area in which some Islamic institutions in the Middle East have made progress.

Here I would like to cite another example with advantage, which is the closest example to the limited liability of a joint-stock company. The example relates to a period of our past history when slavery was in vogue, and the slaves were treated as the property of their masters and were freely traded in. Although the institution of slavery with reference to our age is something past and closed, yet the legal principles laid down by our jurists while dealing with various questions pertaining to the trade of slaves are still beneficial to a student of Islamic jurisprudence, and we can avail of those principles while seeking solutions to our modern problems and in this respect, it is believed that this example is the most relevant to the question at issue. The slaves in those days were of two kinds.

The first kind was of those who were not permitted by their masters to enter into any commercial transaction. A slave of this kind was called ‘qinn’. But there was another kind of slaves who were allowed by their masters to trade. A slave of this kind was called المـأذون العبـد .

The initial capital for the purpose of trade was given to such a slave by his master, but he was free to enter into all the commercial transactions. The capital invested by him totally belonged to his master. The income would also vest in him, and whatever the slave earned would go to the master as his exclusive property. If in the course of trade, the slave incurred debts, the same would be set off by the cash and the stock present in the hands of the slave. But if the amount of such cash and stock would not be sufficient to set off the debts, the creditors had a right to sell the slave and settle their claims out of his price. However, if their claims would not be satisfied even after selling the slave, and the slave would die in that state of indebtedness, the creditors could not approach his master for the rest of their claims.

Here, the master was actually the owner of the whole business, the slave being merely an intermediary tool to carry out the business transactions. The slave owned nothing from the business. Still, the liability of the master was limited to the capital he invested including the value of the slave. After the death of the slave, the creditors could not have a claim over the personal assets of the master. This is the nearest example found in the Islamic Fiqh which is very much similar to the limited liability of the share holders of a company, which can be justified on the same analogy. On the basis of these five precedents, it seems that the concepts of a juridical person and that of limited liability do not contravene any injunction of Islam. But at the same time, it should be emphasized, that the concept of ‘limited liability’ should not be allowed to work for cheating people and escaping the natural liabilities consequent to a profitable trade. So, the concept could be restricted, to the public companies only who issue their shares to the general public and the number of whose shareholders is so large that each one of them cannot be held responsible for the day-to-day affairs of the business and for the debts exceeding the assets.

As for the private companies or the partnerships, the concept of limited liability should not be applied to them, because, practically, each one of their shareholders and partners can easily acquire a knowledge of the day-to-day affairs of the business and should be held responsible for all its liabilities. There may be an exception for the sleeping partners or the shareholders of a private company who do not take part in the business practically and their liability may be limited as per agreement between the partners. If the sleeping partners have a limited liability under this agreement, it means, in terms of Islamic jurisprudence, that they have not allowed the working partners to incur debts exceeding the value of the assets of the business. In this case, if the debts of the business increase from the specified limit, it will be the sole responsibility of the working partners who have exceeded the limit.

The upshot of the foregoing discussion is that the concept of limited liability can be justified, from the Shari‘ah viewpoint, in the public joint-stock companies and those corporate bodies only who issue their shares to general public. The concept may also be applied to the sleeping partners of a firm and to the shareholders of a private company who take no active part in the business management. But the liability of the active partners in a partnership and active shareholders of a private company should always be unlimited.

The fourth example is the property left by a deceased person whose liabilities exceed the value of all the property left by him. For the purpose of brevity we can refer to it as ‘inheritance under debt’. According to the jurists, this property is neither owned by the deceased, because he is no more alive, nor is it owned by his heirs, for the debts on the deceased have a preferential right over the property as compared to the rights of the heirs. It is not even owned by the creditors, because the settlement has not yet taken place.

They have their claims over it, but it is not their property unless it is actually divided between them. Being property of nobody, it has its own existence and it can be termed a legal entity. The heirs of the deceased or his nominated executor will look after the property as managers, but they are not the owners. If the process of the settlement of debt requires some expenses, the same will be met by the property itself.

Looked at from this angle, this ‘inheritance under debt’ has its own entity which may sell and purchase, becomes debtor and creditor, and has the characteristics very much similar to those of a ‘juridical person.’ Not only this, the liability of this ‘juridical person’ is certainly limited to its existing assets. If the assets do not suffice to settle all the debts, there is no remedy left with its creditors to sue anybody, including the heirs of the deceased, for the rest of their claims.

These are some instances where the Muslim jurists have affirmed a legal entity, similar to that of a juridical person. These examples would show that the concept of ‘juridical person’ is not totally foreign to the Islamic jurisprudence, and if the juridical entity of a joint-stock company is accepted on the basis of these precedents, no serious objection is likely to be raised against it.

Another example very much close to the concept of ‘juridical person’ in a joint stock company is found in the Fiqh of Imam Shafi’i. According to a settled principle of Shafi’i School, if more than one person run their business in partner-ship, where their assets are mixed with each other, the zakah will be levied on each of them individually, but it will be payable on their joint-stock as a whole, so much so that even if one of them does not own the amount of the nisab, but the combined value of the total assets exceeds the prescribed limit of the nisab, zakah will be payable on the whole joint-stock including the share of the former, and thus the person whose share is less than the nisab shall also contribute to the levy in proportion to his ownership in the total assets, whereas he was not subject to the levy of zakah, had it been levied on each person in his individual capacity.

The same principle, which is called the principle of ‘Khultah-al- Shuyu’’ is more forcefully applied to the levy of Zakah on the livestock. Consequently, a person sometimes has to pay more Zakah than he was liable to in his individual capacity, and sometimes he has to pay less than that. That is why the Holy Prophet صلى الله عليه وسلم has said:

يجمع بين متفرق ولا يفرق بين مجتمع مخافة الصدقة

‘The separate assets should not be joined together nor the joint assets should be separated in order to reduce the amount of Zakah levied on them.

The first precedent is that of a Waqf. The Waqf is a legal and religious institution wherein a person dedicates some of his properties for a religious or a charitable purpose. The properties, after being declared as Waqf, no longer remain in the ownership of the donor. The beneficiaries of a Waqf can benefit from the corpus or the proceeds of the dedicated property, but they are not its owners. Its ownership vests in Allah Almighty alone.

It seems that the Muslim jurists have treated the Waqf as a separate legal entity and have ascribed to it some characteristics similar to those of a natural person. This will be clear from two rulings given by the fuqaha’ (Muslim jurists) in respect of Waqf. 

Firstly, if a property is purchased with the income of a Waqf, the purchased property cannot become a part of the Waqf automatically. Rather, the jurists say, the property so purchased shall be treated as a property owned by the Waqf. [1]

It clearly means that a Waqf, like a natural person, can own a property.

Secondly, the jurists have clearly mentioned that the money given to a mosque as donation does not form part of the Waqf, but it passes to the ownership of the mosque. [2]

Here again the mosque is accepted to be an owner of money. This principle has been expressly mentioned by some jurists of the Maliki school also. They have stated that a mosque is capable of being the owner of something. This capability of the mosque, according to them, is constructive, while the capability enjoyed by a human being is physical.[3]

Another renowned Maliki jurist, namely, Ahmad Al-Dardir, validates a bequest made in favour of a mosque, and gives the reason that a mosque can own properties. Not only this, he extends the principle to an inn and a bridge also, provided that they are Waqf. It is clear from these examples that the Muslim jurists have accepted that a Waqf can own properties. Obviously, a Waqf is not a human being, yet they have treated it as a human being in the matter of ownership. Once its ownership it established, it will logically follow that it can sell and purchase, may become a debtor and a creditor and can sue and be sued, and thus all the characteristics of a ‘juridical person’ can be attributed to it.

Being public property, all the citizens of an Islamic state have some beneficial right over the Baitul-mal, yet, nobody can claim to be its owner. Still, the Baitul-mal has some rights and obligations. Imam Al-Sarakhsi, the well-known Hanafi jurist, says in his work “Al- Mabsut”:

The Baitul-mal has some rights and obligations which may possibly be undetermined. [4]

The Baitul-mal has some rights and obligations which may possibly be undetermined.4 At another place the same author says:

If the head of an Islamic state needs money to give salaries to his army, but he finds no money in the Kharaj department of the Baitul-mal (wherefrom the salaries are generally given) he can give salaries from the sadaqah (Zakah) department, but the amount so taken from the sadaqah department shall be deemed to be a debt on the Kharaj department. [5]

It follows from this that not only the Baitul-mal, but also the different departments therein can borrow and advance loans to each other. The liability of these loans does not lie on the head of state, but on the concerned department of Baitul-mal. It means that each department of Baitul-mal is a separate entity and in that capacity it can advance and borrow money, may be treated a debtor or a creditor, and thus can sue and be sued in the same manner as a juridical person does. It means that the Fuqaha of Islam have accepted the concept of juridical person in respect of Baitul-mal. 

[1] Al-Fatawa al-Hindiyyah, Waqf, Ch. 5, 2:417.

[2] Ibid., 3:240. See also I‘lã’ al-Sunan, 13:198.

[3] See al-Khurashi’s commentary on Mukhtasar al-Khalil, 7:80.

[4] Al-Sarakhsi, al-Mabsut, 14:33.

The concept of ‘limited liability’ has now become an inseparable ingredient of the large scale enterprises of trade and industry throughout the modern world, including the Muslim countries. 

The present chapter aims to explain this concept and evaluate it from the Shari‘ah point of view in order to know whether or not this principle is acceptable in a pure Islamic economy. The limited liability’ in the modern economic and legal terminology is a condition under which a partner or a shareholder of a business secures himself from bearing a loss greater than the amount he has invested in a company or partner-ship with limited liability. If the business incurs a loss, the maximum a shareholder can suffer, is that he may lose his entire original investment. But the loss cannot extend to his personal assets, and if the assets of the company are not sufficient to discharge all its liabilities, the creditors cannot claim the remaining part of their receivables from the personal assets of the shareholders.

Although the concept of ‘limited liability’ was, in some countries applied to the partnership also, yet, it was most commonly applied to the companies and corporate bodies. Rather, it will be more true, perhaps, to say that the concept of ‘limited liability’ originally emerged with the emergence of the corporate bodies and joint stock companies. The basic purpose of the introduction of this principle was to attract the maximum number of investors to the large-scale joint ventures and to assure them that their personal fortunes will not be at stake if they wish to invest their savings in such a joint enterprise. In the practice of modern trade, the concept proved itself to be a vital force to mobilize large amounts of capital from a wide range of investors.

No doubt, the concept of ‘limited liability’ is beneficial to the shareholders of a company. But, at the same time, it may be injurious to its creditors. If the liabilities of a limited company exceed its assets, the company becomes insolvent and is consequently liquidated, the creditors may lose a considerable amount of their claims, because they can only receive the liquidated value of the assets of the company, and have no recourse to its shareholders for the rest of their claims. Even the directors of the company who may be responsible for such an unfortunate situation cannot be held responsible for satisfying the claims of the creditors. It is this aspect of the concept of ‘limited liability’ which requires consideration and research from the Shari‘ah viewpoint. 

Although the concept of ‘limited liability’ in the context of the modern commercial practice is a new concept and finds no express mention as such in the original sources of Islamic Fiqh, yet the Shari‘ah viewpoint about it can be sought in the principles laid down by the Holy Qur’an, the Sunnah of the Holy Prophet صلى الله عليه وسلم and the Islamic jurisprudence. This exercise requires some sort of ijtihad carried out by the persons qualified for it. This ijtihad should preferably be undertaken by the Shari‘ah scholars at a collective level, yet, as a pre-requisite, there should be some individual efforts which may serve as a basis for the collective exercise.

As a humble student of Shari‘ah, this author have been considering the issue since long, and what is going to be presented in this article should not be treated as a final verdict on this subject, nor an absolute opinion on the point. It is the outcome of initial thinking on the subject, and the purpose of this article is to provide a foundation for further research.

The question of ‘limited liability’ it can be said, is closely related to the concept of juridical personality of the modern corporate bodies. According to this concept, a joint-stock company in itself enjoys the status of a separate entity as distinguished from the individual entities of its shareholders. The separate entity as a fictive person has legal personality and may thus sue and be sued, may make contracts, may hold property in its name, and has the legal status of a natural person in all its transactions entered into in the capacity of a juridical person.

The basic question, it is believed, is whether the concept of a ‘juridical person’ is acceptable in Shari‘ah or not. Once the concept of ‘juridical person’ is accepted and it is admitted that, despite its fictive nature, a juridical person can be treated as a natural person in respect of the legal consequences of the transactions made in its name, we will have to accept the concept of ‘limited liability’ which will follow as a logical result of the former concept. The reason is obvious. If a real person i.e. a human being dies insolvent, his creditors have no claim except to the extent of the assets he has left behind. If his liabilities exceed his assets, the creditors will certainly suffer, no remedy being left for them after the death of the indebted person.

Now, if we accept that a company, in its capacity of a juridical person, has the rights and obligations similar to those of a natural person, the same principle will apply to an insolvent company. A company, after becoming insolvent, is bound to be liquidated: and the liquidation of a company corresponds to the death of a person, because a company after its liquidation, cannot exist any more. If the creditors of a real person can suffer, when he dies insolvent, the creditors of a juridical person may suffer too, when its legal life comes to an end by its liquidation.

Here comes the question whether or not bai’-al-dain is allowed in Sharî’ah. Dain means ‘debt’ and bai’ means sale. Bai’-al-dain, therefore, connotes the sale of debt. If a person has a debt receivable from a person and he wants to sell it at a discount, as normally happens in the bills of exchange, it is termed in Sharî’ah as Bai’-al-dain. 

The traditional Muslim jurists (fuqahâ’) are unanimous on the point that bai’al-dain with discount is not allowed in Shari‘ah. The overwhelming majority of the contemporary Muslim scholars are of the same view. However, some scholars of Malaysia have allowed this kind of sale. They normally refer to the ruling of Shâfi’ite school wherein it is held that the sale of debt is allowed, but they did not pay attention to the fact that the Shâfi’ite jurists have allowed it only in a case where a debt is sold at its par value.

In fact, the prohibition of bai’-al-dain is a logical consequence of the prohibition of ‘riba’ or interest. A ‘debt’ receivable in monetary terms corresponds to money, and every transaction where money is exchanged for the same denomination of money, the price must be at par value. Any increase or decrease from one side is tantamount to ‘riba’ and can never be allowed in Shari‘ah.

Some scholars argue that the permissibility of bai’-al-dain is restricted to a case where the debt is created through the sale of a commodity. In this case, they say, the debt represents the sold commodity and its sale may be taken as the sale of a commodity. The argument, however, is devoid of force. For, once the commodity is sold, its ownership is passed on to the purchaser and it is no longer owned by the seller. What the seller owns is nothing other than money. Therefore if he sells the debt, it is no more than the sale of money and it cannot be termed by any stretch of imagination as the sale of the commodity.

Murabahah is a specific kind of sale where the commodities are sold on a cost-plus basis. This kind of sale has been adopted by the contemporary Islamic banks and financial institutions as a mode of financing. They purchase the commodity for the benefit of their clients, then sell it to them on the basis of deferred payment at an agreed margin of profit added to the cost. If a fund is created to undertake this kind of sale, it should be a closed-end fund and its units cannot be negotiable in a secondary market. The reason is that in the case of murabahah, as undertaken by the present financial institutions, the commodities are sold to the clients immediately after their purchase from the original supplier, while the price being on deferred payment basis becomes a debt payable by the client.

Another possible type of Islamic Funds may be a commodity fund. In the fund of this type the subscription amounts are used in purchasing different commodities for the purpose of their resale. The profits generated by the sales are the income of the fund which is distributed pro rata among the subscribers.

In order to make this fund acceptable to Shari‘ah, it is necessary that all the rules governing the transactions of sale are fully complied with. For example:

1. The commodity must be owned by the seller at the time of sale, because short sales in which a person sells a commodity before he owns it are not allowed in Shari‘ah.

2. Forward sales are not allowed except in the case of salam and istisnâ’ (For their full details the previous chapter of this book may be consulted).

3. The commodities must be halâl. Therefore, it is not allowed to deal in wines, pork or other prohibited materials.

4. The seller must have physical or constructive possession over the commodity he wants to sell. (Constructive possession includes any act by which the risk of the commodity is passed on to the purchaser).

5. The price of the commodity must be fixed and known to the parties. Any price which is uncertain or is tied up with an uncertain event renders the sale invalid.

Another type of Islamic Fund may be an ijârah fund. Ijârah means leasing the detailed rules of which have already been discussed in the third chapter of this book. In this fund the subscription amounts are used to purchase assets like real estate, motor vehicles or other equipment for the purpose of leasing them out to their ultimate users. The ownership of these assets remains with the Fund and the rentals are charged from the users. These rentals are the source of income for the fund which is distributed pro rata to the subscribers.

Each subscriber is given a certificate to evidence his proportionate ownership in the leased assets and to ensure his entitlement to the pro rata share in the income. These certificates may preferably be called ‘sukûk’—a term recognized in the traditional Islamic jurisprudence. Since these sukûk represent the pro rata ownership of their holders in the tangible assets of the fund, and not the liquid amounts or debts, they are fully negotiable and can be sold and purchased in the secondary market. Anyone who purchases these sukûk replaces the sellers in the pro rata ownership of the relevant assets and all the rights and obligations of the original subscriber are passed on to him. The price of these sukûk will be determined on the basis of market forces, and are normally based on their profitability.

However, it should be kept in mind that the contracts of leasing must conform to the principles of Shari‘ah which substantially differ from the terms and conditions used in the agreements of conventional financial leases. The points of difference are explained in detail in the third chapter of this book. However, some basic principles are summarized here:

1. The leased assets must have some usufruct, and the rental must be charged only from that point of time when the usufruct is handed over to the lessee.

2. The leased assets must be of a nature that their halâl (permissible) use is possible.

3. The lessor must undertake all the responsibilities consequent to the ownership of the assets.

4. The rental must be fixed and known to the parties right at the beginning of the contract.

In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari‘ah subject to the following conditions:

1. The main business of the company is not violative of Shari‘ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shari‘ah, such as companies manufacturing, selling or offering liquors, pork, harâm meat, or involved in gambling, night club activities, pornography etc.

2. If the main business of the companies is halâl, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.

3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the share-holder must be given in charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given in charity.

4. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money they cannot be purchased or sold except at par value, because in this case the share represents money only and the money cannot be traded in except at par. What should be the exact proportion of illquid assets of a company for warranting the negotiability of its shares? The contemporary scholars have different views about this question.

Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and therefore, all its assets should be treated as liquid on the basis of the juristic principle: لللأكثر حكم الكل

The majority deserves to be treated as the whole of a thing. Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable. The third view is based on the Hanafi jurisprudence. The principle of the Hanafi school is that whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions:

Firstly, the illiquid part of the combination must not be in ignore-able quantity. It means that it should be in a considerable proportion.

Secondly, the price of the combination should be more than the value of the liquid amount contained therein. For example, if a share of 100 dollars represents 75 dollars, plus some fixed assets, the price of the share must be more than 75 dollars. In this case, if the price of the share is fixed as 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the balance of 30 dollars is in exchange of the fixed assets. Conversely, if the price of that share is fixed as 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is less than 75. This kind of exchange falls within the definition of ‘riba’ and is not allowed. 

Similarly, if the price of the share, in the above example, is fixed as 75 dollars, it will not be permissible, because if we presume that 75 dollars of the price are against 75 dollars owned by the share, no part of the price can be attributed to the fixed assets owned by the share. Therefore, some part of the price (75 dollars) must be presumed to be in exchange of the fixed assets of the share. In this case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets. 

Subject to these conditions, the purchase and sale of shares is permissible in Shari‘ah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in Shari‘ah as partners inter se. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits are earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. 

The contemporary Islamic Funds have termed this process as ‘purification’. The Shari‘ah scholars have different views about whether the ‘purification’ is necessary where the profits are made through capital gains (i.e. by purchasing the shares at a lower price and selling them at a higher price). Some scholars are of the view that even in the case of capital gains, the process of ‘purification’ is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. 

The other view is that no purification is required if the share is sold, even if it results in a capital gain. The reason is that no specific amount of the price can be allocated for the interest received by the company. It is obvious that if all the above requirements of the halâl shares are observed, then most of the assets of the company are halâl, and a very small proportion of its assets may have been created by the income of interest. This small proportion is not only unknown, but also ignore-able as compared to bulk of the assets of the company. 

Therefore, the price of the share, in fact, is against bulk of the assets, and not  against such a small proportion. The whole price of the share therefore, may be taken as the price of the halâl assets only. Although this second view is not without force, yet the first view is more precautious and far from doubts. 

Particularly, it is more equitable in an open-ended equity fund, because if the purification is not carried out on the appreciation and a person redeems his unit of the Fund at a time when no dividend is received by it, no amount of purification will be deducted from its price, even though the price of the unit may have increased due to the appreciation in the prices of the shares held by the fund. 

Conversely, when a person redeems his unit after some dividends have been received in the fund and the amount of purification has been deducted therefrom, reducing the net asset value per unit, he will get a lesser price as compared to the first person.

On the contrary, if purification is carried out both on dividends and on capital gains, all the unit-holders will be treated at par with regard to the deduction of the amounts of purification. Therefore, it is not only free from doubts but also more equitable for all the unit- holders to carry out purification in the capital gains also. This purification may be carried out on the basis of an average percentage of the interest earned by the companies included in the portfolio.

The management of the fund may be carried out in two alternative ways. The managers of the Fund may act as mudâribs for the subscribers. In this case a certain percentage of the annual profit accrued to the Fund may be determined as the reward of the management, meaning thereby that the management will get its share only if the fund has earned some profit. If there is no profit in the fund, the management will deserve nothing. The share of the management will increase with the increase of profits. 

The second option for the management is to act as an agent for the subscribers. In this case, the management may be given a pre- agreed fee for its services. This fee may be fixed in lump sum or as a monthly or annual remuneration. According to the contemporary Shari‘ah scholars, the fee can also be based on a percentage of the net asset value of the fund. For example, it may be agreed that the management will get 2% or 3% of the net asset value of the fund [1] at the end of every financial year.

However, it is necessary in Shari‘ah to determine any one of the aforesaid methods before the launch of the fund. The practical way for this would be to disclose in the prospectus of the fund the basis on which the fees of the management will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the prospectus. Therefore, the manner of paying the management will be taken as agreed upon by all the subscribers.

In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly derived through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also earned through dividends distributed by the relevant companies.

It is obvious that if the main business of a company is not lawful in terms of Shari‘ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business.

Similarly the contemporary Shari‘ah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with Shari‘ah, which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account, its shares can be purchased, held and sold without any hindrance from the Shari‘ah side. But evidently, such companies are very rare in the contemporary stock markets. Almost all the companies quoted in the present stock markets are in some way involved in an activity which violates the injunctions of Shari‘ah. Even if the main business of a company is halâl, its borrowings are based on interest’. On the other hand, they keep their surplus money in an interest bearing account or purchase interest-bearing bonds or securities.

The case of such companies has been a matter of debate between the Shari‘ah experts in the present century. A group of the Shari‘ah experts is of the view that it is not allowed for a Muslim to deal in the shares of such a company, even if its main business is halâl. Their basic argument is that every share-holder of a company is a sharîk (partner) of the company, and every sharîk, according to the Islamic jurisprudence, is an agent for the other partners in the matters of the joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the share-holder to the company to carry on its business in whatever manner the management deems fit. If it is known to the share-holder that the company is involved in an un-Islamic transaction, and still he holds the shares of that company, it means that he has authorized the management to proceed with that UN-Islamic transaction. In this case, he will not only be responsible for giving his consent to an UN-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.

Moreover, when a company is financed on the basis of interest, its funds employed in the business are impure. Similarly, when the company receives interest on its deposits an impure element is necessarily included in its income which will be distributed to the share-holders through dividends.

However, a large number of the present day scholars do not endorse this view. They argue that a joint stock company is basically different from a simple partnership. In partnership, all the policy decisions are taken through the consensus of all the partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the policy decisions in a joint stock company are taken by the majority. Being composed of a large number of share-holders, a company cannot give a veto power to each share-holder. The opinions of individual share-holders can be overruled by a majority decision.

Therefore, each and every action taken by the company cannot be attributed to every share-holder in his individual capacity. If a share-holder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude that he has given his consent to that transaction in his individual capacity, especially when he intends to refrain from the income resulting from that transaction.

Therefore, if a company is engaged in a halâl business, but also keeps its surplus money in an interest-bearing account, wherefrom a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, how can it be said that he has approved the transaction of interest and how can that transaction be attributed to him?

The other aspect of the dealings of such a company is that it sometimes borrows money from financial institutions. These borrowings are mostly based on interest. Here again the same principle is relevant. If a share-holder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him.

The term “Islamic Investment Fund” in this chapter means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari‘ah. The subscribers of the Fund may receive a document certifying their subscription and entitling them to the pro-rata profits actually earned by the Fund. These documents may be called ‘certificates’, ‘units’, ‘shares’ or may be given any other name, but their validity in terms of Shari‘ah, will always be subject to two basic conditions:

Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. The subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, the return on their subscription will increase to that proportion. However, in case the Fund suffers loss, they will have to share it also, unless the loss is caused by the negligence or mismanagement, in which case the management, and not the Fund, will be liable to compensate it.

Secondly, the amounts so pooled together must be invested in a business acceptable to Shari‘ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.

Istisna’ can be used for providing the facility of financing in certain transactions, especially in the house finance sector. If the client has his own land and he seeks financing for the construction of a house, the financier may undertake to construct the house at that open land, on the basis of istisna’, and if the client has no land and he wants to purchase the land also, the financier may undertake to provide him a constructed house on a specified piece of land.

Since it is not necessary in istisna’ that the price is paid in advance, nor is it necessary that it is paid at the time of delivery, (it may be deferred to any time according to the agreement of the parties).[18]

Therefore, the time of payment may be fixed in whatever manner they wish. The payment may also be in installments. On the other hand, it is not necessary that the financier himself constructs the house. He can enter into a parallel contract of istisna’ with a third party, or may hire the services of a contractor (other than the client). In both cases, he can calculate his cost and fix the price of istisna’ with his client in a manner which may give him a reasonable profit over his cost. The payment of installments by the client may start, in this case, right from the day when the contract of istisna’ is signed by the parties, and may continue during the construction of the house and after it is handed over to the client.

In order to secure the payment of the installments, the title deeds of the house or land, or any other property of the client may be kept by the financier as a security, until the last installment is paid by the client.

The financier, in this case, will be responsible for the construction of the house in full conformity with the specifications detailed in the agreement. In the case of any discrepancy, the financier will undertake such alteration at his own cost as may be necessary for bringing it in harmony with the terms of the contract.

The instrument of istisna’ may also be used for project financing on similar lines. If a client wants to install an air-conditioning plant in his factory, and the plant needs to be manufactured, the financier may undertake to prepare the plant through the contract of istisna’ according to the aforesaid procedure. Similarly, the contract of istisna’ can be used for building a bridge or a highway.

The modern BOT (Buy, Operate and Transfer) agreements may also be formalized on the basis of istisna’. If a government wants to construct a highway, it may enter into a contract of istisna’ with a builder. The price of istisna’, in this case, may be the right of the builder to operate the highway and collect tolls for a specified period.

As pointed out earlier, it is not necessary in istisna’ that the time of delivery is fixed. However, the purchaser may fix a maximum time for delivery which means that if the manufacturer delays the delivery after the appointed time, he will not be bound to accept the goods and to pay the price.[16]

In order to ensure that the goods will be delivered within the specified period, some modern agreements of this nature contain a penal clause to the effect that in case the manufacturer delays the delivery after the appointed time, he shall be liable to a penalty which shall be calculated on daily basis. Can such a penal clause be inserted in a contract of istisna’ according to Shari‘ah? 

Although the classical jurists seem to be silent about this question while they discuss the contract of istisna’, yet they have allowed a similar condition in the case of ijarah. They say that if a person hires the services of a person to tailor his clothes, the fee may be variable according to the time of delivery. The hirer may say that he will pay Rs. 100/- in case the tailor prepares the clothes within one day and Rs. 80/- in case he prepares them after two days.[17]

On the same analogy, the price in istisna’ may be tied up with the time of delivery, and it will be permissible if it is agreed between the parties that in the case of delay in delivery, the price shall be reduced by a specified amount per day.

[16] Ibn ‘Abidin, Radd al-Muhtar, 5:225.

It should also be kept in mind that the manufacturer, in istisna’, undertakes to make the required goods with his own material. Therefore, this transaction implies that the manufacturer shall obtain the material, if it is not already with him, and shall undertake the work required for making the ordered goods with it.

If the material is provided by the customer, and the manufacturer is required to use his labor and skill only, the transaction is not istisna’. In this case it will be a transaction of ijarah whereby the services of a person are hired for a specified fee paid to him.[14]

When the required goods have been manufactured by the seller, he should present them to the purchaser. But there is a difference of opinion among the Muslim jurists whether or not the purchaser has a right to reject the goods at this stage. Imam Abu Hanifah is of the view that he can exercise his ‘option of seeing’ (khiyar-ur-ru’yah) after seeing the goods, because istisna’ is a sale and if somebody purchases a thing which is not seen by him, he has the option to cancel the sale after seeing it. The same principle is also applicable to istisna’.

However, Imam Abu Yusuf says that if the commodity conforms to the specifications agreed upon between the parties at the time of the contract, the purchaser is bound to accept the goods and he cannot exercise the option of seeing. This view has been preferred by the jurists of the Ottoman Empire, and the Hanafi law has been codified according to this view, because it is damaging in the context of modern trade and industry that after the manufacturer has used all his resources to prepare the required goods, the purchaser cancels the sale without assigning any reason, even though the goods are in full conformity with the required specifications.[15]

[14] Khalid al-Atasi, Sharh al-Majallah, 2:403.