Last week, I explained why Shariah principles allow a financial compensation to an Istisnah buyer in the case where the Istisnah seller fails to deliver the Istisnah asset as per the agreed delivery timeline. This feature is unique to the Istisnah contract in Islamic finance where the concept of applying a late payment penalty is alien. I will therefore spend some more time on it.
As per Shariah principles, the definition of interest or usury, in simple terms, is the money over money. Another way to understand it is that the money is on both sides of a financial transaction (lending and borrowing) — the amount of money on one side being higher than the other.
Nevertheless, in the case of an Istisnah contract, if the seller delays the delivery of the asset and pays a financial compensation to the buyer, it will be money over asset (and not money over money) and hence will not be classified as interest, and thus is permissible under the Shariah code.
Also, the obligation to pay money under an Istisnah contract is always from the buyer’s side in the shape of settlement of the purchase price to the seller, whereas the financial compensation in case of a delay is paid by the seller to the buyer, ie in the opposite direction.
Remember, the seller’s obligation under the Istisnah contract is non-financial (such as an asset). In other words, the Istisnah seller’s obligation toward the Istisnah buyer is not the payment of money but the delivery of the completed asset, and hence, if the seller pays a financial compensation to the buyer for the delayed delivery of an asset, it will not be tantamount to interest or usury.
Another important aspect on the subject is the fixation of a financial compensation in the Istisnah contract from the outset, such as at the time of signing the Istisnah contract by both parties. If such a clause was not added at that time, the Istisnah buyer shall have no right to claim a financial compensation in the case where there was a delay in the delivery of the asset by the seller.
It is possible that with the consent of both parties, the financial compensation clause is added to the Istisnah contract at a later stage in the shape of an addendum; nevertheless, it must be done prior to the arrival of the originally agreed asset delivery date.
It is also to be noted that despite the presence of a financial compensation clause in the Istisnah contract, the buyer shall not be able to exercise it should any delay in the delivery of the asset by the seller is attributed to force majeure.
While the Istisnah buyer has Shariah permissibility to claim a financial compensation from the Istisnah seller related to the delay in delivery, Shariah principles do not allow the Istisnah seller to charge a similar penalty to the Istisnah buyer should the latter not pay the purchase price on time.
Readers must have figured out why — yes, this is because the obligation of the Istisnah buyer toward the Istisnah seller is monetary in nature and any amount paid by the buyer to the seller over and above such an obligation shall be equivalent to interest.
The following are some of the other features related to the Istisnah contract:
• With mutual consent, it is permissible to alter the specifications of the Istisnah asset including an increase or decrease in price and a change in the delivery date
• Unlike the Salam contract, the subject matter of the Istisnah contract could also be an inimitable item whose substitute is not available in the market
• The defect liability period for the seller may be defined during which any shortcomings to the Istisnah asset must be rectified by the seller at its own cost
• If the buyer makes an early payment of the Istisnah price, it will not have the right to claim any rebate or discount on the original price. Nonetheless, the Istisnah seller may grant a remission in the price at its own sole discretion
• Any taxation, fee or charge introduced by the government pursuant to signing the Istisnah contract affecting the cost of developing the Istisnah asset shall be borne by the Istisnah purchaser
• If the Istisnah seller has outsourced the development of the Istisnah asset through a parallel Istisnah contract, it is permissible for the Istisnah seller to appoint the Istisnah buyer to supervise the completion of the asset under the parallel Istisnah contract. If the buyer under the original Istisnah contract accepts such a responsibility, it will concede the right to reject the Istisnah asset on account of any defect
• If the Istisnah buyer finds that the Istisnah asset has not been developed as per the specification mentioned in the contract, it can reject the asset and seek a refund of the purchase price paid by it along with a compensation, and
• The Istisnah seller shall be discharged from its obligation if it has completed the Istisnah asset according to the agreed specifications, even if the Istisnah buyer does not come forward to take delivery of the Istisnah asset due to any reason. In such a situation, the Istisnah asset shall continue to be possessed by the seller albeit in trust for the buyer and any expenses incurred by the seller in this regard shall be on account of the buyer.
With the aforementioned, we come to the end of the interesting debate on the subject of the Istisnah contract which plays a key role in Islamic finance for the development of movable and immovable assets.
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.