Last week, we pondered over how the parameters of Islamic sale and lease contracts provide logical sagacity and deliver justice to all parties concerned. Today, we shall review the Shariah approach for the investment contracts.
What is the difference between Islamic sale and lease contracts and Islamic investment contracts? While entering into an Islamic sale contract, the seller comes to know at the same time as to how much profit he/she is making from the transaction, or the extent of the loss he/she is bearing if the sale is below cost due to some reason.
Similarly, a landlord is able to measure the rent received from the tenant to the effort of owning the property.
In an Islamic investment contract, the investor or investors shall not be in a position to ascertain the financial benefit (or otherwise) they will derive from the contract at the time of entering into the contract. Contrary to the spot sale contract where the parties part ways immediately after the transaction is completed, the parties in an Islamic lease contract or Islamic investment contract remain engaged for a longer period of time.
For example, the sale and purchase contract for the grocery items from the supermarket culminates at the checkout counter whereas the landlord and tenant continue with their relationship for as long as the tenancy period is valid. Similarly, the parties to an investment contract may carry on with their relationship for a much longer period, depending on the nature of investment.
Let us examine the Shariah parameters for entering into an investment contract. We shall discuss in detail the different types of investment contracts and their needs and implications in the subsequent articles; however, at this point, we shall simply learn what conditions in an investment contract can result in it being annulled from the Shariah angle.
To start with, all those aspects we earlier debated such as holding perfect capacity, free will, offer and acceptance and the text and subject matter of the contract being Shariah compliant will apply mutatis mutandis on the investment contract as well.
Nonetheless, what shall make an investment contract out-of-line from Shariah canons is considering a debt owed by a party to another as the capital contribution from the indebted party to the investment contract. This is because the Shariah principles require fresh capital to be introduced by the contracting parties in an investment contract, be it in cash or in kind.
The Shariah wisdom to prohibit this feature is to protect the rights of the creditor since the debtor is required to pay him the indebted amount in its entirety and by converting the debt (in part or in full) into the capital of the investment contract, the indebted amount shall be exposed to the risk of loss to the creditor.
Another reason for rendering an investment contract void is a guarantee provided by one party to protect the capital and/or the amount of periodic profit of the other party. However, if a party provides a certain guarantee to the other party to be claimed in a situation where the party giving the guarantee has brought loss to the joint investment due to negligence, this will be acceptable under Shariah principles provided it must then be utilized only in the case of a loss related to negligence.
A condition that a party shall be entitled to sweep the entire profit until it has recovered a certain level of return on its investment shall also make the investment contract invalid. This is due to the fact that it will be tantamount to seeking a fixed monetary gain on the investment (ie interest), as well as denying the second party its right to share the profit in terms of the investment contract.
Another aspect which makes an investment contract repugnant to Shariah principles is the absence of the profit distribution ratio between the parties, and leaving it to be decided at a later date when the profit is required to be shared.
Last but not the least, in an investment contract where both parties have invested equity (such as a Musharakah or a joint venture), it will be impermissible to restrict the bearing of loss by one or both parties to the extent of their respective capital contribution. As per Shariah, the parties must bear the residual loss after exhaustion of the capital in the same ratio as their original investment.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next Week: Final points on the validity and breach of Shariah contracts.