Transcript Document

ISLAMIC REPUBLIC OF AFGHANISTAN
Ministry of Rural Rehabilitation and Development
Afghanistan Rural Enterprise Development Program
Islamic Finance Product Development
The Use of the Commercial Contract of Bay’ Salam
to Finance Agricultural Production and Small Trade
prepared by Alberto G Brugnoni - AREDP
CONTENTS
 INTRODUCTION
 DEFINITIONS OF THE COMMERCIAL CONTRACT
 THE SHARIAH LEGITIMACY
 UNANIMOUS SHARIAH FEATURES
 DEBATED SHARIAH FEATURES
 SCOPE AND POTENTIAL OF SALAM
 RISK & RISK MANAGEMENT
 DIFFERENCES WITH SIMILAR CONTRACTS
 SALAM AS A SHORT TERM FINANCE TOOL
INTRODUCTION
 Salam is, at its origin, an agricultural product. The farmer normally needs financing for
purchasing agricultural inputs like seed, fertilizers, pesticides, diesel for tractor, payment
of water charges, labor, etc.
 Its versatility has allowed salam to become a diversified tool for liquidity management,
monetary policy management, and trade
 The strong parallel that salam bears with either futures or forward sales has allowed for
securities applications of salam
DEFINITIONS OF THE COMMERCIAL CONTRACT
 Salam (also ‘ita’ = giving, taslif = advance, sales by order) is one of the two exceptions
(rukhsa) to the three Shariah conditions of validity of sale:
→ the commodity purchased must be in existence (bay’ ma’dum)
→ the seller should have acquired the ownership of the commodity
→ mere ownership is not enough, as the commodity must be in the physical or
constructive possession of the seller
 Salam is a sale agreement whereby the seller receives the price in advance while goods
are delivered at a future specified date
 Another definition states that the seller agrees to supply specific goods to the buyer at a
future date in exchange of an advanced price fully paid at the time of contract
 It is also a sale contract over prescribed commodity sold as a deferred liability on one
party, in exchange for a price that is received during the contract session
 It is the sale of a liability whose characteristics are described in exchange for a price or
capital-sum paid in advance
DEFINITIONS OF THE COMMERCIAL CONTRACT
 Maliki defined it as a sale in which capital sum (price) is paid in advance and the object
of sale is deferred to a specified term
 AAOIFI defines salam as the purchase of commodity for deferred delivery in exchange
for immediate payment
 All definitions entail that price is always in cash and the supply of goods always deferred
→ hence: salam is, in its essence, a forward sale
TERMINOLOGY
→ salam applies to the contract as a whole, and may also refer to the goods which are
to be delivered later
→ rabb al-salam or al-musallim, refer to the owner of capital, the party purchasing the
goods (the buyer)
→ al-musallam ‘alayhi, refers to the party who takes on the obligation to deliver the
goods at a future date (the seller)
→ ra’s mal al-salam, refers to the capital, the price paid in advance of delivery of the
sale object (the price)
→ al-musallam fihi refers to the subject of the contract, the object or goods to be
delivered (the sale object)
→ Ijàb (offer) and qabul (acceptance) are other terms of use
SHARIAH LEGITIMACY
QUR’AN
 Salam legitimacy is based on its concordance with the Qur’anic verse that forbids usury
but permits/enjoins commerce:
→ “Those who eat ribà will not stand (on the Day of Resurrection) except like the
standing of a person struck by Satan leading him to insanity. That is because they
say: “Trading is only like ribà” whereas God has permitted trading and forbidden ribà
(Qur’an, 2:275)
 The salam contract also conforms to the Qur’anic instruction to write down/record any
debt transactions:
→ “O you who believe! When you contract a debt for a fixed period, write it down”
(Qur’an, 2:282)
→ one should note that ‘debt’ is comprehensive of whatever is owed and therefore may
take the form not only of monetary loans but any objects like foodstuffs (e.g. wheat
and barley), manufactured articles (paper, cars, machines, etc.) or raw materials
(e.g. copper, iron, petroleum etc.) duly specified as to quantity and quality
→ according to the tafsir attributed to Ibn ‘Abbas, this verse “was revealed to address
the salam in particular”
SHARIAH LEGITIMACY
HADITH
 There are several hadiths and reports bearing witness that the salam contract was in
use at the time of the Prophet (pbuh)
 Narrated by lbn ‘Abbas: the Messenger of Allah (pbuh) came to Medina and the society
used to pay in advance the price of fruits to be delivered within one or two years. The
Prophet (pbuh) said, “Whoever pays money in advance for dates (to be delivered later,
i.e.: a contract of salam) should pay it for known specified weight and measure (of the
dates) [and a specified date of delivery]”
 lbn ‘Abbas commented that: “I bears witness that al-salaf (al-salam) stipulated for a
stated term had been made legal by Allah in His holy book and His permission is in it”
IJMA’
 All Muslim jurists have given their consensus to the permissibility of bay’ al-salam:
→
it is deemed a: “facilitation and an extension that closes up the door against usury”
→
particularly, because the product in sale is one of the counter-values in the
contract
→
there is also the need of the people in it. The owners of the agricultural products
and small businesses needed some financing to support themselves or to fund
their crops until the day of harvesting
→
hence, it is made permissible to fulfill public needs
UNANIMOUS SHARIAH FEATURES
CONTRACT'S FEATURES
 The salam contract is binding and is sealed by using the word ‘salam’ or ‘salaf’ and
specifying terms:
→ neither party has the right to annul it without the other’s satisfaction unless the sale
object proves to be other than as specified
→ the seller is thus obliged to discharge his obligations towards the buyer with respect
to the sale object, just as in any other sale contract
→ thus, salam is not among those contracts in which either party is permitted to
abrogate the contract without the other’s approval, such as musharakah,
mudharabah or qirad, wakalah and wadiʼah contracts
 It is permissible to cancel the contract of salam by mutual agreement, subject to no
reduction and increase in original capital refunded
 After execution of the salam agreement, the contract cannot be revoked unilaterally:
→ nevertheless, the iqala (recession of contract) is possible. In this occurrence, the
parties freely consent to rescind it and each one gives back the consideration
received
→ the Prophet (pbuh) has stated: “He who does the iqala with a Muslim who is not
happy with his transaction, Allah will forgive his sins on the Day of Judgment”
UNANIMOUS SHARIAH FEATURES
 The salam contract may be applied to all commodities, metals, animals and livestock,
produce and manufactured goods:
→ in the view of some scholars, it can even be applied to utilities
 The subject matter of a salam contract must be different from mode of payment of price:
→ ex.: if capital is provided in currency, then commodity in salam contract must not be
currency
UNANIMOUS SHARIAH FEATURES
CASH PRICE OR SALAM CAPITAL
 The price to be paid at spot to receive the goods for future delivery should be known to
both parties involved in the salam agreement:
→ ideally it should be in cash
→ however, it is permissible to pay the price in kind subject to the (i) specification and
(ii) quantity of goods to be delivered as capital in salam contract. This could be
commodity, food or livestock
 Price should be paid in full immediately by the time contract is concluded:
→ this condition is necessary because in the absence of full payment by the musallim,
salam will become tantamount to sale of a debt against a debt
→ moreover, the basic wisdom behind the permissibility of salam is to fulfill the instant
needs of the musallam ‘alayhi. If the price is not paid to him in full, the basic purpose
of the transaction will be defeated
→ however, the musallam ‘alayhi may at its discretion give a concession of two, three
days to the musallim (Imam Malik), but this concession should not form part of the
agreement
→ in no case, payment period must be equal to or greater than the delivery time of
goods purchased under salam
→ it is not a necessary ingredient of salam that the price be always lower than the
market price on that day
UNANIMOUS SHARIAH FEATURES
 A debt receivable from the musallam ‘alayhi cannot be converted into salam capital
SUBJECT MATTERS
 Commodities involved in the salam contract must be clearly known to both parties
involved at the time of contract:
→ no ambiguity and uncertainty should be left unaddressed which may lead to a
dispute. All the possible details with regards to quality, quantity, etc. must be
expressly mentioned
→ if the commodity is quantified in weights according to the usage of its traders, its
weight must be determined, and if it is quantified through measures, according to the
usage of its traders, its exact measure should be known
→ as quantity and quality must be exactly specified precious stones cannot be sold on
the basis of salam because each stone differs in quality, size, weight, etc.
 Commodities must be fungible goods that share common features, such as wheat, rice,
fruits, etc.:
→ this, may include standardized products of companies
→ it is not permitted to stipulate salam for the products of a specific tree, land or farm
(possibility of that particular fruit, crop to be destroyed before delivery). The same
rule is applicable to every commodity the supply of which is not certain
→ the things whose quality or quantity is not determined by specification cannot be
sold through the contract of salam as its supply may not be certain
UNANIMOUS SHARIAH FEATURES
 Date/dates of delivery and place of delivery should be certain and unambiguous:
→ scholars differ on the shortest duration of time of delivery: three days, fifteen day,
thirty days or whatever the contracting parties may decide
 Salam cannot be effected in respect of items that are ribawi in nature and must be
delivered on spot (gold, silver, barley, etc.):
→ similarly, cross sales (practice of selling amongst or between clients, markets,
traders) are not allowed .
 Disposal of commodities is not allowed prior to maturity of contract:
→ however, replacement with other commodities, except with cash, is allowed
SECURITY
 A security in the form of a guarantee, pledge, mortgage or hypothecation may be
required for a salam contract in order to ensure that the musallam ‘alayhi shall deliver
the commodity on the agreed date:
→ in the case of default in delivery, the guarantor may be asked to deliver the same
commodity
→ if there is a mortgage, the buyer can sell the mortgaged property and the sale
proceeds can be used either to realize the required commodity by purchasing it from
the market or to recover the price advanced by him
UNANIMOUS SHARIAH FEATURES
DELIVERY OF GOODS AT DUE DATE
 The delivery of goods at due date is the responsibility of the musallam ‘alayhi, and the
acceptance of goods by musallim is required if goods are meeting the contractual
specifications in quantity and quality:
→ possession of goods can be physical or constructive, i.e.: transfer of risk and
authority of use and utilization/consumption
 The delivery of the sale object by installments at specified times is permitted
 It is permitted to:
→ settle the contract by supplying superior goods
→ settle the contract at discount if musallam ‘alayhi provides inferior goods
→ settle the salam contract earlier than due date, if required commodities are supplied
by musallam ‘alayhi
→ replace the commodities (except with currency) and settle the contract as the case
may be
UNANIMOUS SHARIAH FEATURES
 It is not permitted to:
→ stipulate penalty clause for delay in delivery
→ however, musallam ‘alayhi can undertake in the salam agreement that in case of late
delivery of salam goods, it shall pay to the charity account maintained by the
musallim a sum calculated on the basis of a percentage per annum for each day of
default
 Before delivery, goods remain at the risk of seller. After delivery, risk is transferred to
the purchaser:
→ transferring of risk and authority of use and utilization/consumption are the basic
ingredients of constructive possession
 After taking delivery, the purchaser has the ‘option of defect’ (khiyar al-’aib):
→ whereas the goods can be returned if found defective. It is the responsibility of the
seller to supply goods free of error/defect or point out the defect to the buyer. In no
way is he allowed to cover the defect of the goods which constitutes a fraud
→ in one hadith, the Prophet has stated “He is not amongst us who indulges in fraud”
→ therefore, the buyer has the right to return the good in case of a defect which is
considered a defect in the market and which depreciates the value of the goods
.
UNANIMOUS SHARIAH FEATURES
 After taking delivery, the purchaser does not have the ‘option of inspection’ (khiyar alruyat):
→ whereas the goods can be returned after inspection
AGENCY AGREEMENT
 If the musallim has no expertise to sell the commodities received under the salam
contract, it can appoint the musallam ‘alayhi as its agent to sell the commodity in the
market/third party, on condition that:
→ salam and the agency agreements are separate from each other
 A price at which the agent will sell the commodity must be determined:
→ but if the price increases, the benefit can be given to the agent
 On the other hand, if the musallim has expertise in the relevant commodity:
→ it can sell the commodity in the market or to a third party
→ It can hold the commodity to fetch a better market price to maximize its profit
UNANIMOUS SHARIAH FEATURES
PROMISE TO PURCHASE
 Before maturity, the musallim can take promise to purchase from a third party. After
taking delivery, the musallim will sell the same commodity to the promissee which will be
bound to purchase it according to the undertaking:
→ this promise should be unilateral
PENALTY FOR LATE DELIVERY
 Musallam ‘alayhi can undertake in the salam agreement that in case of late delivery, it
shall pay to the charity account maintained by the musallim a sum calculated on the
basis of a certain % per annum, for each day of default
→ musallim will spend this amount in charity purpose on behalf of the musallam ‘alayhi
→ this is a sort of self-imposed penalty to keep oneself away from default
DEBATED SHARIAH FEATURES
AVAILABILITY OF COMMODITIES
 It is required that commodities involved in salam contract remains available in the
market right from the day of contract up to the date of delivery:
→ if a commodity is not available in the market at the time of the contract, salam
cannot be affected, even though it is expected that it will be available in the market
at the date of the delivery (Hanafi school)
 However, the Shafi’, Maliki, and Hanbali schools are of the view that the availability of
the commodity in the market is necessary at the time of delivery only (so that in any
case the musallam ‘alayhi should be able to discharge its liability)
→ this second approach should be preferred
.
TIME OF DELIVERY
 It is necessary that the time of delivery is at least one month from the date of agreement
(this is perhaps to restrict the sale concessions and drive it towards processing in
agriculture, construction, or manufacture):
→ if the time of delivery is shorter, salam is not valid as small farmers and traders
should be given enough time to acquire the commodity (Hanafi and HanbalI)
→ Imam Malik supports this view but put the period at not be less than fifteen days
→ some other jurists, like Imam Shafi’ and some Hanafi jurists oppose it on the ground
that the Holy Prophet (pbuh) has not specified a minimum period for the validity of
salam
DEBATED SHARIAH FEATURES
→ contemporary and prevalent opinion is that this issue should be left to the
bargaining of the contacting parties
SCOPE AND POTENTIAL OF SALAM
 Salam has been applied in the agricultural sector since before the life of the Prophet
(pbuh), when it was a documented business method
 Provide Islamically accepted financing alternative and avoid any involvement in ribà
 Salam is beneficial:
→ to the musallam ‘alayhi, because it receives the price in advance and may finance
its business venture
→ to the musallim, because normally, the price in salam is lower than the price in spot
sales (or: spot price agreed is lesser than future prices on the actual date of
delivery)
 The original purpose of this sale by way of exception and the reason of its agreement by
Shariah was to address the needs of two categories of people:
→ small farmers who needed money to grow their crops (purchase seeds and
fertilizers) and feed their families up to the time of harvest without falling pray of
shark loaning
→ small traders or artisans in need of capital to export goods to other places and to
import goods to their homeland
SCOPE AND POTENTIAL OF SALAM
 The salam sale is suitable to finance the agricultural operations where the musallim can
transact with farmers who are expected to have the commodity penalized during harvest
time:
→ thus the musallim renders great services to the farmers in their way to achieve their
production targets
→ it is a valuable tool with to provide agricultural finance to large community of
unserved/underserved farmers’
→ practically, it is used to finance the agricultural needs of farmer
 Salam sale may also be used to finance commercial and industrial activities, especially
in phases prior to production and export of commodities:
→ goods are purchased on salam and marketed for a profit
 The musallim may finance the craftsmen and small producers through the salam sale by
supplying them with the material for production as a salam capital in exchange of some
of their commodities
RISK & RISK MANAGEMENT
 Counter-party risk: the musallam ‘alayhi may default after taking the payment in
advance
 Commodity price risk: whereas at the time the goods are received the price may be
lower than the price that was originally expected
 Quality risk, low investment return or loss: occurs when goods received are not of
desired quality or unacceptable for the potential buyer
 Asset-holding risk: the musallim might not be able to market the goods in time, resulting
in possible asset loss for the unsold goods and locking funds in the goods until they are
sold, this implies possible extra expenses on storage and Takaful
 Asset-replacement risk: in case the musallim has to purchase goods from the market
where the third party fails to supply the specified goods
RISK & RISK MANAGEMENT
 Fiduciary risk: if the musallam ‘alayhi has not delivered the goods as expected
 Risk management:
→ purchase only goods that have good marketing potential
→ take proper security and a performance bond
→ require from the prospective buyers earnest money in deposit and a binding
promise to purchase
→ a penalty clause in the salam contract against late delivery from the supplier
→ parallel salam by purchasing similar goods from the market on spot
DIFFERENCES WITH SIMILAR CONTRACTS
SALAM v MURABAHAH
Murabahah, ijarah and salam are the three nominative contracts that involve either the
sale of a good or the sale of the use of a good
BAY’ AL-SALAM
MURABAHAH
Price is paid on spot
Price is paid in full
Price is either paid on spot or deferred
Price is paid in full or installment
Not executed in a particular commodity Can be executed in particular
but commodity has specifications
commodity
Cannot be effected in respect of things
which must be delivered at spot
Can be executed in things which must
be delivered at spot
DIFFERENCES WITH SIMILAR CONTRACTS
SALAM v ISTISNA’
Istisna’ is an offspring of the salam contract
BAY’ AL-SALAM
BAY’ AL-ISTISNA’
Salam can be effected on anything, no
matter whether it needs manufacturing
or not
The subject of istisna’ is always a thing
which needs manufacturing
It is necessary for salam that the price
is paid in full in advance
Payment for istisna’ can be made in
staggered basis
The contract of salam, once effected,
cannot be cancelled unilaterally
The contract of istisnà’ can be cancelled
before the manufacturer starts the work
DIFFERENCES WITH SIMILAR CONTRACTS
SALAM v FUTURES & FORWARDS
Though close parallels can be found with futures contracts or even with options,
fundamental differences exist:
 Salam sale can be affected only for halal fungible goods which are generally available in
the market at the time of delivery. Physical delivery of goods forming the subject matter
of salam contract is required by Islamic law
 In case of futures and forwards, physical delivery is not required as in most of the cases
the contract is settled on margins by the parties involved:
→ hence: goods are not sold and purchased rather claims are sold and purchased
which create no utility for the society as a whole. It is zero sum game where certain
individuals gain on the expense of others
→ this practice of settling contracts on margins has led to short selling which creates
imbalance in the market
 Hence: two basic features of the salam sale differentiate it from futures and forwards:
→ immediate payment of total price (not a percentage as margin)
→ definite delivery of goods
SALAM AS A SHORT TERM FINANCE TOOL
 Over the generations, commercial salam has expanded to meet the needs of trade
financiers:
→ it has also spawned a derivative: istisnà’
 When utilized in the financial markets, the salam sales contract effectively provides
means to finance:
→ financial institutions and investors can make a return by paying funds in full to
trader for future delivery of commodities knowing there is a third-party buyer and
ready supply in the market
→ like other Islamic commercial methods, it might be better characterized as
process
a
a
a
a
 The salam has the flexibility to cover the needs of various sectors of activities where
farmers, industrialists, contractors, exporters or traders are involved:
→ it can be used to meet the capital requirements as well as to meet the cost of
operations
 Salam, as a short term financial tool, allows an entreprise to limit its risks, define future
profit opportunities with reasonable accuracy, and manage production timing to demand
cycles
SALAM AS A SHORT TERM FINANCE TOOL
EXIT STRATEGY
 Off-take mechanism: before entering into a salam agreement, the musallim, who will be
acquiring title to the commodities on deferred delivery and who is not a direct consumer
of the goods, has to have in place a creditworthy pre-agreed on-sale (or other exit
strategy) mechanism with the end-consumer/buyer
 Agency agreement: the musallam ‘alayhi negotiates terms and conditions (price,
qualifications, quality, quantity, delivery, etc.) with the end-buyer (if it acts as agent of
the musallim through an agency agreement)
 The musallim and the end-consumer/buyer execute an agreement for sale of the
commodities that will be acquired by the musallim from the musallam ‘alayhi. This
agreement represents an exit strategy and can be implemented via a number of
mechanisms:
→ parallel salam: (i) receives the payment and signs contract of salam with promise to
deliver the goods at a point in time in future
SALAM AS A SHORT TERM FINANCE TOOL
→ ijarah wa iqtinà’
→ letter of credit
→ purchase order
The end-buyer may secure the musallim’s delivery commitment with a mortgage,
guarantee or letter of credit
SALAM AS A SHORT TERM FINANCE TOOL
STEPS OF THE PROCESS AND MAIN AGREEMENTS
 The salam (deferred delivery) agreement is signed between the musallim and the
musallam ‘alayhi in line with the above:
→ optional associated security agreements (guarantee or mortgage) may be signed
 Musallam ‘alayhi draws up a Transaction Notice (communication) with terms reflecting
the above agreement
 Musallim confirms acceptance (if agreeable with the Transaction Notice) to the
musallam ‘alayhi by sending a Purchase Order
 Musallim pre-pays musallam ‘alayhi for the commodities for future delivery
 Musallim assumes titles to the commodities which are delivered by the musallam ‘alayhi
to the end-buyer who signs off on acceptance
 End-buyer pays musallim as per the off-take mechanism agreed upon
→ letter of credit or promise to pay between producer and end-buyer
SALAM AS A SHORT TERM FINANCE TOOL
PARALLEL SALAM
 After the execution of the salam agreement with one party, musallim or musallam ‘alayhi
may execute another salam agreement, for the same date of delivery, to sell the
proceeds once taken over, under the following conditions:
→ all rulings listed for the salam contract apply to the parallel salam agreement
→ there must be two different and independent contracts, these two contracts cannot
be tied up and performance of one (rights and obligations) should not be contingent
on the performance of the other. In other words, execution of the second contract is
not conditional to the fulfillment of the first contract of salam
→ parallel salam is allowed with third party only. Otherwise, it will become a buy-back
contract, which is not permissible in Shariah
PRACTICAL STEPS
 step 3: musallam ‘alayhi in first salam contract delivers the goods to musallim on due
date to discharge its liability
→ step 4: musallam ‘alayhi of the 2nd salam delivers the goods to 2nd musallim in
parallel salam contract
ISLAMIC BANKING PRODUCTS
 Hybrid Salam Financing
 Salam Financing Working Capital
 Parallel Salam Financing
SALAM COMBINED WITH MURABAHAH
 Musallim can sell the salam commodity to the musallam ‘alayhi on murabahah, subject to
the following terms:
→ salam agreement and murabahah agreement should be independent, not contingent
and with free will of the parties
→ murabahah will be executed after taking the possession of salam goods
→ musallim shall assume the risk of loss by taking delivery and execution of the
murabahah
→ musallim cannot take undertaking from the musallam ‘alayhi that it will purchase the
salam commodity from bank on a murabahah basis