Islamic Banking and Finance: Contract and Elements of Contract

A contract is a legally binding agreement which identifies and directs the rights and obligations of the parties to the agreement and is legitimately enforceable as it fulfills the endorsement of the law. In the occurrence of a breach of contract, the law grants the damaged party access to legal solutions such as damages and cancellation. The Islamic contract law which was in existence in the 6th-century matches with almost all components and elements of Modern low of contract. 

The elements of Contract in Islam:

1.       The contracting parties:

The contracting parties; ie, buyer and seller are two basic components of any contract. The following conditions are mandatory for the contracting parties for being eligible to participate in any contract:

Capacity: The contracting parties should have the mental and physical capacity to be part of the contract. Those who are considered as a child in Islam (below 15 age or not reached puberty), having required physical disabilities which are mandatory for some specific deals, mental disability are not considered as eligible to be part of any contract.

Free intend:  Free intend of the parties to be part of the contract is also mandatory for any contracts to be valid. The participation of any in a contract due to threat or forced compulsion will be considered as a void contract in Islam.  

2. The subject matter: product/service

      Lawful object: The product or the service should be permitted to exchange in Islam. The exchange of a prohibited subject matter or through a prohibited process is considered as an invalid contract. Such as interest, gambling, Haram (Prohibited) activities such as adultery or  Najas (ritually unclean) items like wine and other spirituous drinks, dogs, swine, dead animals that were not ritually slaughtered, blood, excrements, and the milk of animals whose meat Muslims are not allowed to eat etc.

      Should be specific: There should not be any ambiguity regarding the quality, quantity, pricing, delivery and any other important aspects of the product.  Both contracting parties should be clearly understood regarding the specificity of the product. The documentation is also mandatory in legal contracts.

3. Offer:

An offer is an expression of readiness to contract on certain terms made with the purpose that an obligatory agreement will happen once the offer is accepted.

Termination of offers:

Death of offeror or offeree

Lapse of time

Revocation (cancellation)

Counteroffer

4. Acceptance:

Once valid acceptance takes place a binding contract is formed.

It is therefore important to know what constitutes a valid acceptance in order to establish if the parties are bound by the agreement.

The  rules related to acceptance:
1. The acceptance must be communicated to the offeree.
2. The terms of the acceptance must exactly match the terms of the offer.

Some Important Technical Terms Related to Contract:

      Al-wa-ad (promise): Al-wa-ad refers to the offeror willingness of an offeror.  It is unilateral, the only offeror do promise; so that he has to fulfill the promise.  Such as Govt advertisements of rewards for ‘wanted’s; anyone can accept the offer.

      Muwahada: Muwahada is the mutual promise between two parties with the purpose to conclude a contract in the future.

      Aqd: Aqd is a legal obligation arising out of a mutual agreement.  It is a crucial tool in Islamic finance.

Features of Aqd:

• There should be 2 parties
• There should be an offer and acceptance
• A legal union between two declarations regarding the subject matter