SECURITY OF CONTRACT IN ISLAMIC FINANCE

1.0 .Transfer of Debt (Al Hiwalah)

Literally means transfer or change from one locality to another or from a person to another, or from a situation to another.

Legally, means a contract through which a debtor is released from a debt by another person who become responsible for it 

Hiwalah is similar to the sale of debt but is not sale, it also resemble kafalah and wakalah while Hiwalah is a unique contract which has its own distinct features and conditions

Three participants in Hiwalah contract are:

·         The principle debtor

·         The creditor and

·         The transferee   

Definition of Hiwala by the Malaysian Securities Commission Shariah Advisory Council is “debt assignment contract”. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) states that this is permitted in order to facilitate payments and recovery. It is a legitimate and independent contract made out of courtesy and is not a contract of sale. For an assignment of debt, Hiwala is the Shariah instrument. Literally it means “turn”, in Islamic law the transference of a debt from one person to another

However, similar conclusion reached by Fakihah Azahari (فاقاه الازهر), the assignment of debt is a situation where an outstanding balance facility is assigned to a third party who has agreed to continue with the payment of the monthly installment under the customer’s account from the date of the assignment of debt until the expiry of the facility tenor. A customer who opts to negotiate for settlement of his obligations in this way not only assigns his debts to a third party with the financial capacity to continue with the monthly payments but also releases himself from his financial obligations towards the financier. The third party is usually one with a close relationship with the customer such as from father to son or from a company to its director or shareholder. This third party would be in a position to take over the debt due to the proximity of the contractual duties, fiduciary duties or relationship. Since the accounts have been serviced for a few years, the third party would be taking over an account that has an outstanding facility reduced from the original facility. Where the facility is for purchase of an asset, the third party would be taking over a reduced debt and acquisition of asset at a price below the market price. These are factors that may persuade the third party to consider taking over the assigned debt.

1.1. Pillars of Hiwalah

From hanafi schools only hiwalah has two pillar 1 offer and acceptance

Majority of schools opinion about pillars of Hiwalah as following 

·         Principle debtor

·         The creditor

·         The transferee

·         The principle debt

·         The debt owed by the transferee to the principle debtor and

·         Expression (offer & acceptance)

1.2. Conditions of Hiwalah

•      Legal capacity

•      Agreement

•      The acceptance of the creditor & transferee should be given during the session of contract

•      Subject matter of hiwalah should be debt(dayn) & not specific thing(‘ain)

•      Both the debt should be known

•      To Malikees both debts should be identical in quality & quantity

•      The principle debtor (Muhil) should owe a debt to the creditor(Muhal)

•      To the majority Schools the transferee should owe a debt to the principle debtor

1.3. Flow of Hiwalah

al

Al-

Unrestricted hiwalah, illustration of diagram

·         A  owns B an amount of 1000

·         A is supposed to pay his debt of 1000 to B

·         A transfers his obligation to pay the debt to

·         C pays the debt (1000) to B

1.4.  Types of Hiwalah

·         Hiwalah Mutlaqah  (حواله المطلقة)

T  this type of Hiwalah is absolute hiwalah. A hiwalah which is not restricted for payment to be made from property of the transferor in the hands of the transferee. This is a type of hawalah where the contract is concluded without reference to the debt on the transferee and he accepts the transfer. The majority argues that the contract is a kafalah and not hiwalah

h  Hiwalah Muqayya

     This typreis restricted,   Hiwalahrestricted by a stipulation wherethe transferee to pay from property of the transferor, owed to him by the transferee, or in the hand of the transferee. Therefore, this type of hiwalah when a transfer is made with reference to the debt on the transferee. The majority only recognizes this type of hiwalah

·         Transfer of Right (حوالة الحق)

The transfer of right or right to claim from one person to the other (replacement  of a creditor with another creditor)

·         Hawalah al-Dayn (حوالة الدين)

The transfer of a debt from an obligation of a person to another person’s obligation “replacement of a debtor with another debtor”

However, Hiwalah al-Dayn is practically inseparable from Hawalah al-Haqq because when the debt is transferred to the transferee, it transfers other all the rights such as right of guarantee or right of surety

If the established debt for which one debtor replaces another is a fungible established as a liability, then the transfer of debt is a valid transfer of rights, which the principal debtor is the transferor and the ultimate debtor is the transferee “Agreed”

Example: A pawn-broker may transfer a creditor to the pawner for collection of his debt (restricted).

 Advantages of Hiwalah

·         Creditor

Could authenticate loan repayment and ensure that he/she (the creditor) could retrieve his/ her money back by demanding payment from the transferor (muhal alaih) under normal circumstances or even in case of default payment it could be retrieved from the first debtor (transferee)

·         Debtor

Minimize and spread his/her risk because he/she can remit or pass over his debt to his own debtor and also could convince the creditor to lend him money since he/she has somebody to back him up as the transferor of the payment. 

Legal Consequences of Hiwalah

1-      The debtor is freed from a debt by another becoming responsible for it; the transfer of claim of a debt. (absolution of the transferor)

2-      It establishes the creditor’s right to demand repayment of the debt from the transferee, not the transferor (unless if the transferee denies without proof wrongfully on him or dies bankrupt or the principal creditor absolves the transferee of debt- Valid)

3-       The relationship between the parties involved where it discharges the transferor from the debt and the claims in respect of it. 

If the transfer was made on the condition that the payer must be solvent, then the creditor will reserve the right to recourse if the payer proves to be insolvent. According to Shafie , once transfer, cannot return back to Muhil

4-      The right and claim to receive the amount has passed to the transferee. The relationship between the transferee and the payer, whereby the transferee is entitled to claim debt assigned to him

2.0.    Suftaja

Suftaja is a loan of money in order to avoid the risk of transport. By this application it enables a debtor to make payments in another place through his agent or a second person.  For Example:

A person gives a portion of his property to a merchant to pay to another person in a different country. The sender benefits by insuring himself against the risks of transferring that property himself.

Other banking products and facilities

·         Issuance of a cheque against a current account (Issuer = transferor/ Bank = Transferee/ Beneficiary = Creditor)

·         Overdrawing from an account or overdraft: Issuer = Transferor (no balance)/ Beneficiary = Creditor (get cheque)/ Bank =Transferee.

·         Endorsement of a negotiable instrument and

·         Transfer of money (remittance).

3.0.   Termination of Hiwalah

•      When hiwalah is cancelled(faskh) before it becomes effective or executed

•      The hiwalah comes to an end when the transferee pay the debt to the creditor

•      When the creditor gives the debt as a gift to the transferee and latter accepts it

•      When the creditor gives the debt as a charity (sadaqah) to the transferee

•      When the creditor releases(ibra) the transferee from the debt

4.0.  Main Difference between Hiwalah, Sale of Contract and Bai Duyan

Item	Difference	Hiwalah	Sale contract	Bai dayn
1	Definition	Transfer/assignment of debt	Contract of exchange for consideration	Contract for the sale of debt
2	Origin	Legal maxim that permits indulgence in hardship	Quranic verse that enjoins man to engage in trade and business activity	Quranic verse that permits sale of intangible assets
3	Nature	Continuity of legal rights/ Obligations	Exchange of values; for example, exchange of goods for price	Exchange of values where its payment and delivery is deferred
4	Parties	Debtor, creditor and assignee	Buyer and seller	Seller and buyer
5	Subject matter	Debts	Tangible goods	Intangible goods
6	Purpose	Assist a straitened debtor	Obtain lawful profit	Redeem the goods at maturity date
7	Consideration	Not required due to it being a unilateral contract	Consideration is required due to it being a contract of exchange	Consideration is required due to it being a contract of exchange
8	Elements	Parties, acknowledgement of debt and consent from all parties to take over the debt	Parties, goods, and price	Parties, goods, price and capable of being delivered in future
9	Effect	Passing of obligations to the assignee	Passing of ownership of the goods from seller to Buyer	Passing of rights to redeem the debt
10	Features	Security subsists and not discharged	Security discharge and recharge	May be repurchased

5.0. Muqassah (Set-Off)

Musgassah mean debt settlement by contract-transaction or set off. It also means the discharge of debt receivable against a debt payable.

Al-Dardir defines mugasah as the setting-off of a debt that is due to the debtor by creditor is at the same time indebted to the debtor with certain conditions.( Al- Dardir, Al-sharh Al-kabir,3/227). Ibn Al-Qayyim define it as the clearance of the debt which is due, with a debt similar in nature and character ( Ibn al-Qayyim, alam al-muwaaqqi’in 1/232)

5.1.  Legality of Mugasah

Basically there is not explicit qur’anic verse that indicates the legality of muqasah. However there are a few verses that sued thee work qisas that is derived from the same root of muqasah. Allah the Almighty says” o you who believe! The law of equality is prescribed for you in cases of murder (qisas): free for free …….” ( 1:178) in other verse, Allah ( S.W.T) says: “ in the law of equality ( qisas) there is saving of life for you ( 2:179) some Muslim scholars are of the view that the meaning of the word “qisas” mentioned in the verses refere to the arrangement of setting-off by way of payment of the compensation money (diyyah) by the murderer. In this context the diyyah is regarded as a kind of debt which is due on the offender.

From tradition of the prophet (p.b.u.h) narrated by Ibn Umar as follow: “ I came to the prophet (p.b.u.h) and said that I sell camels in Baqi’ for a price name in gold coins, but I collected in siver, and vice versa. The prophet (p.b.u.h) said: there is no harm to do so if the exchange is carred out according to the exchange rates of the day, and as long as you part without any dets between you.’ “(sunan Al-Nisa’I 7/281). So based in these evidence, it is logic to accept muqasah in practice. Muqasah is acceptable by modern Muslim scholars as stated in AAOIFI’ shari’ah Standard No 4, Clause 3 that spells out it is permissible for Islamic financial institutions and their customers to exchange bilateral promises that debts which may be created between them in the future will be stteled by way of set-off/ muqasah

5.2.   Example of Muqasah

Mohamed Thierno owns Abbas RM2, 000 then Abass owes Mohamed thierno the same amount 2,000. This mean Mohamed thierno and Abass are no longer in debt with each other.  Because implicit settlement takes place between Mohamed and Abass to discharge of a debt receivable against a debt payable 

5.3.   Types of Muqasah

The muqasah is divided into three types and each type has certain element of conditions

1.      Mandatory Set-Off (al-muqasah Al-jabrairyyah)

A mandatory set off is the spontanous discharge of two debts that is noot contingent on the consent of both or either party. The majority of muslim schoolars are of the opinion that this type of muqasah is prmissible. On ther other hand Maliki scholars opine that muqasah shall only be allowed with demenad with mutua agreement (Alhattable mawahib Al-jalil, 4/549)

Ø  The Mondatory Set-Off has four Condtion

a)      Each party should be a creditor and debtor simultaneously

b)      Both debt should be equal in kind, types description and maturity

c)      Neither of the two debts should be encumbered by an obligation to third party ( rights of pledgee to one of the debts . in other words the muqasah shall not bring any harm to the contracting parties or other related parties

d)     The muqasah should not result in the violation of the shari’ah (involves riba)

2.      Mandatory Set-Off on Demand (al-mugasah al-Talabiyah)

This type of muqasah is affected by the demand of one of the parties to discharge the debts by away of set-off. Usually it is effective upon the request of the superior creditor, who has a preference over the other,

The Condition for a Muqasah Set-Off on Demand has for Condition

a)       Each party should be a creditor and debtor simultaneously.

b)      The creditors for the superior debt in terms of quality and duration should consent to relinquish his additional right or privilege

c)      Both debts should be equal in kind and types but not necessarily in quality and date of maturity

d)     The muqasah should not result in the violation of the Shari’ah such as involves in Riba

3.       Contractual Set-Off ( al mugasah al-Itifaqiyyah)

This type of mugasah is the discharge of tow debt by the consent of the tow parties to extinguish their obligation toward each other. In contractual set off, there is no need for the debt to be similar in kind, type, desperation or maturity.

Condition of a Contractual Muqasah/ Set Off

a)      Each party should be creditor and debtors simultaneously

b)      Both parties must consent to the muqasah /set –off

c)      The muqasah should not result in the violation of the Shari’ah such as Riba and so on

6.0. Letter of Credit

A Letter of Credit, basically defined, is a written instrument issued by a bank at the request of its customer, the Importer (Buyer), whereby the bank promises to pay the Exporter (Beneficiary) for goods or services, provided that the Exporter presents all documents called for, exactly as stipulated in the Letter of Credit, and meet all other terms and conditions set out in the Letter of Credit. A Letter of Credit is also commonly referred to as a documentary Credit

6.1 Advantage and Disadvantage of Letter of Credit from Importer Perspective

a.       Importer is assured that the Exporter will be paid only if all terms and conditions of the Letter of Credit have been met.

b.      Importer is able to negotiate more favorable trade terms with the Exporter when payment by Letter of Credit is offered.

Disadvantages

a.       A Letter of Credit does not offer protection to the Importer against the Exporter shipping inferior quality goods and/or a lesser quantity of goods. Consequently, it is important that the Importer performs the appropriate due diligence to assess the reputation of the Exporter. If the Exporter acts fraudulently, the only recourse available to the Importer is through legal proceedings.

b.      It is necessary for the Importer to have a line of credit with a bank before the bank is able to issue a Letter of Credit. The amount outstanding under each Letter of Credit issued is applied against this line of credit from the date of issuance until final payment.

 Advantages and disadvantages of letter of credit from exporter perspective •

a.       The risk of payment relies upon the creditworthiness of the Issuing Bank and the political risk of the Issuing Bank’s domicile, and not the creditworthiness of the Importer

b.      Exporter agrees in advance to all requirements for payment under the Letter of Credit. If the Letter of Credit is not issued as agreed, the Exporter is not obligated to ship against it.

c.       Exporter can further reduce foreign political and bank credit risk by requesting confirmation of the Letter of Credit by a Canadian bank.

Disadvantages

a.       Documents must be prepared and presented in strict compliance with the requirements stipulated in the Letter of Credit.

b.      Some Importers may not be able to open Letters of Credit due to the lack of credit

c.       Facilities with their bank which consequently inhibits export growth.

6.3. Letter of Credit from Islamic Transaction

Islamic letter of credit (ILC) is a written undertaking given by the Islamic bank to the seller (beneficiary) at the request and on the instruction of the buyer (the applicant) to pay at sight or at a determinable future date, a stated sum of money within prescribed time limit and against stipulated documents which must comply with  term and condition. An Islamic ban may offer ILC under the some sharia’ah contract namely waklah (agency), murabahah (cost-plus profit) and musharakah (partnership)

6.3  Wakalah Islamic Letter of Credit

In the case of wakalah Islamic letter of credit, the customer must pay in advance the full value of the item in question prior to the issuance of the ILC. Furthermore, the Islamic bank will receive a commission or service fee upon the service rendered to the customer. To under the process of wakalah Islamic letter of credit let’s look at this model

1.  The customer informs the Islamic bank of his ILC requirements and requests the Islamic bank to provide the facility
2.  The Islamic bank may require the customer to place a deposit to the full amount of the price of the good to be purchased or imported, which the Islamic bank accepts under the principle of wadiah  yed dhamanah
3.     The Islamic bank established the ILC and pays the proceeds to the negotiating bank, utilizing the customer’s deposit, and subsequently release the documents to the customer
4. The negotiating bank claims reimbursement from the Islamic bank as per the reimbursement instruction.
5.  The Islamic bank charges the customer fees and commission for its services under the principle of al-ujr based on the wakalah principle.

6.4 Murabaha Islamic Letter of Credit

Under the principle of murabaha (cost plus profit) where the customers is unable is unable to pay the purchase price, the bank issues the ILC and pays the purchase price to the exporter. The bank immediately sells to the customer at a markup for a deferred payment. The model of murabahah letter of credit as follow

1.    The customer inform the Islamic bank of his ILC requirement and requests the Islamic bank to purchase or impart the goods indicating that he would be willing to purchase the goods from tIslamic bank upon negotiation of the ILC on the principle of murabah concept
2. The Islamic bank appoints the customer as its agent to purchase the required goods on his behalf.
3.    The Islamic bank establishes the ILC and pays the proceed to the negotiating bank utilizing its own funds.
4. The Islamic bank sells the goods to the customer at a sale price comprising its cost and profit margin under the principle of murabaha for settlement on deferred term
5. The customer takes possession of the goods and disposes of them in the manner agreed.

6.5. Musharakah Islamic Letter of Credit

Under the principles of musharakah (partnership) the Islamic bank issues the ILV and both the bank and customer contribute to the purchase price under ILC, and later share. The procedures of the sale of the asset based on the pre-agreed profit sharing ratio. Losses are born proportionate to the capital contribution. In order to understand to process of musharakah Islamic letter of credit let’s look at this diagram

1. 1.      The customer informs the Islamic bank of his ILC requirement and negotiates the terms of musharakah financing for his requirement.
2. 2.      The customer places with the Islamic bank a deposit ofr his share of the cost of goods to be purchased or imported as per the musharakah agreement which the Islamic bank accepts under the principle of wada’ah yad dhamanah.
3. 3.      The Islamic bank establishes the ILC and pays the proceeds to the negotiating bank, utilizing the customer’s deposit as well as its won shares of financing.
4. 4.      The Islamic bank releases the documents to the customer.
5. 5.       The customer takes possession of the good and disposes of them in the manner agreed.
6. 6.      The Islamic bank and the customer share the profit from the venture as provided for in the agreement
7. 
   

7.0  Ibra’

Ibra in Islamic Law means purification, release relief or abandoning. It is an act by a person to withdraw his rights. For example: A person may choose to withdraw his rights to collect payment from a person who has the obligation to repay the amount borrowed from him.

One of its special meanings is in financial agreements. Ibra in a financing agreement is named the concept of giving a rebate to a customer in case of early settlement.

In Islamic law a contract shall have a fixed price in advance and not different prices attached to it. This condition is argued with the prohibition of uncertainty (Gharar.) Therefore many sharia boards have ruled that a financier can give a rebate at his discretion but not binding on him in advance.

Ibra’ literally means purification, release relief or abandoning. From Figh perspective, Ibra refers to a contact where a person waives or abolishes his right on another person

The Shariah Advisory Council, Central Bank of Malaysia accepts a unilateral promise of the financier, whereby the institution promises the rebate and the potential mechanism of calculation, hence transparency and legal security for the client is enhanced for this purpose. The permission for doing so is justified by the concept of public good (Maslaha and the principle of dha wa taajjal

Background

In the conventional system, customer has to pay only the outstanding principal amount and earned interest at the time when early settlement is made. The unearned interest is normally waived by the financier. Contractually, customer in Islamic financial system has to settle total outstanding selling price in the case of early settlement. However, Islamic bank normally give rebate to its customer who made early settlement. This practice of rebate is important to maintain the competitiveness Islamic banking. Therefore, the concept of ibra’ which resembles the rebate payment is introduced. The concept of ibra’ is more suitable for the financier who wants to surrender its right over the debt to the customers..

For example Ibra is concluded when creditors releases his debtor   releases his debtor from the payment of his debt.

7.1. Legality of ibra

“If, however, (the debtor) is in strained circumstance,(grant him) a delay until a time of ease and it would be for you own good if you knew it to remit (the debt entirely by way of charity” 2:280

The subject matter of Ibra

The subject matter of irba could be rights, debts and rights over things

7.2. The pillar of ibra

For the Hanafi School, the pillar of ibra is offer which could clearly indicate the abandoning of a claim. In The majority Ibra has four pillars

·         The creditor or a person who has a right on another

·         The debtor who is under obligation or owes a duty toward another

·         The claim could be in relation to a certain right over things, or a right or a debt.

·         The offer and acceptance.

7.3. The conditions for Ibra

The condition for the creditor

1.      He should have complete legal capacity.

2.      He should be the owner of the right or an agent acting on behalf of the owner

3.      The consent must be obtained willingly and not by coercion

4.      The ibra of one is dying is not valid except it there consent form the heirs

The condition for the debtor

1.      The person should be known and specified

The conditions for the subject matter

·         It must be known specifically (be it a debt right or tangible goods.

·         It should not be tangible asset (ayn). This is because the tangible existing physical asset cannot be treated as debt.

·         Established and confirmed ownership.  The party who wants to absolve must confirm ownership of the rights because ownership in transaction among making must be established.

·         Existence of rights or existence of its causality. Ibra can be executed after a right has been established.

Condition for the expression

Should be immediate, should not depend on a condition or deferred to future. This is the condition for the majority except the Maliki’s who allow. However if it depend on death is not allowed.

It is also not allowed if a creditor releases the debtor from some of the debt on the condition that the latter should pay the balance in shorter period as this may resemble usury.

Ibra should not go against the rules of Shariah such as in a Sarf contract a person cannot release another from the condition of possession. Similarly, it is not possible for a person to release himself from the duty of guardianship over a minor.

The expression should be made in relation to an already established right and not in relation to a future right. The person who makes an offer of Ibra should do so in relation to his own right. He should be the owner of the right or his authorized agent.

7.4.  Types of Ibra’

Ibra’ can be of two types, specific and general. Specific Ibra’ (Ibra’ khas) refers to a type of Ibra where a person releases another from a claim arising out of a particularthing.

General Ibra’ (Ibra aam), on the other hand, refers to a release from all claims. This may include releasing a person from all claims that might have arisen from different causes.

           

            Ibra’ can also be classified based on the way it is expressed into the following two types:

Bara’at al-Isqat where a person releases another person by dropping all the claims/rights which he has against him, or by subtracting or diminishing a certain quantity of them.

Bara’at al-Istifa it is a type of admission. It is made when a person admits that he has received his right from another person. While Ibra’ al-Isqat is only applicable to debts and rights, Ibra’ al-Istifa is also

The Hukum of Ibra’

The effect of Ibra’ is that the debtor is released from the claim depending on the type of iIbra’ that is made. If it is a particular ibra’ then the debtor is released from a particular Dain. If it is a general Ibra’ in favor of a person, the person is totally released from all the claims. It is not allowed for the person who has made ibra’ to retract it.

7.5 The Differences between bay al-dayn,hawalah, mugasah and Ibra

Bay al day mean the sale of debt for discount to a third party while hiwalah is defined as a contract though which a debtor is released from a debt by another person who become responsible for it.

Ø  Bay al dayn mean the sale of debt for discount to a third party

Ø  Hiwalah is defined as a contract though which a debtor is released from a debt by another person who become responsible for it.

Ø  Ibra refers to a contact where a person waives or abolishes his right on another person.

Ø  Musgassah mean debt settlement by contract-transaction or set off. It also means the discharge of debt receivable against a debt payable.

References

Islamic financial system (principles and operations (isra)

A handbook on Fiqh mu’amalah in Banking and finace ( Dr. Muhammad Yusuf Saleem

Banking and finace ( Dr. Muhammad Yusuf Saleem