The basic conditions for a validity of a sale in shariah are three:
- The purchased commodity must be existing
- The seller should have acquired the ownership of that commodity
- The commodity must be in the physical or constructive possession of the seller
There are only two exceptions to this principles of shariah sale:
- Salam
- Istisna
Salam is a sale whereby the seller undertakes to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot.
Concept of salam in Islamic Banking:
- Seller agrees to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot
- Price is in cash but the supply of goods is deferred.
- The basic purpose of this sale was to meet the needs of the small farmers who needed money to grow their crops and to feed family up to the time of harvest.
Background of salam contract:
- Before prohibition of interest farmers used to get interest based loans for growing crops and harvesting. After prohibition of interest, they were allowed to do salam transactions. This helped them to get money in advance for their needs.
- During the days of our Prophet (S.A.W) the caravans used to get interest based loans for purchasing the commodities. After prohibition of interest, they were allowed to do salam contract.
Conditions of Salam:
- It is necessary for the validity of salam that the buyer pays the price in full to the seller at the time of effecting the sale.
- The goods sold need not be in existence at the time of contracting.
- Salam can be effected in those commodities only quality and quantity of which can be specified exactly. For example: precious stones can not be sold on the basis of salam, because every pieces of precious stones is normally different from the other either in its quality or in its size or weight and their exact specification is not generally possible.
- Salam can not be effected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular tree, the salam will not be valid, because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery.
- It is necessary that the quality of the commodity is fully specified leaving no ambiquity which may lead to a dispute. The quality of the items to be delivered should be defined. Items must be fungible in nature. Hence, rare items, or those that are not precisely specifiable, cannot be the subject of salam contract. If the quality of items upon delivery are found to be other than specified, the buyer has the right of refusal.
- It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weights must be determined, and if it is quantified through measure, its exact measure should be known. What is normally weighted can not be quantified in measures and vice versa. The quantity of goods purchased under salam contract can not for example be defined as that resulting from the cultivation of a given plot of land since such a quantity may vary according to unforseeable factors.
- The exact date, location and delivery must be specified in the contract.
- Salam cannot be effected in respect of things which must be delivered at spot.
- The buyer does not enjoyed ownership of the goods until delivery has taken place
- The buyer has the right to take surety from the seller as a form of performance bond.
- Where the seller is unable to produce the contracted items on the delivery date, the buyer may nullify the salam contract and exercise the performance bond.
- The seller may deliver the contracted items irrespective of the buyer's circumstances on the delivery date
The most famous Hadith, the one in which the holy Prophet has said:
"Whoever wishes to enter into a contract of salam, he must effect the salam according to the specified measure and the specified weight and the specified date of delivery"
Salam as a mode of financing
Salam, it is basically a mode of financing for small farmers and traders. This mode of financing can be used by the modern banks and financial institutions, especially to finance the agricultural sector. The price in salam may be fixed at lower rate than the price of those commodities delivered at spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions.
There are two other ways of benefiting from the contract of salam:
- After purchasing the commodity by way of salam, the financial institutions may sell it through a parallel contract of salam for the same date of delivery. The period of salam in the second (parallel) transaction being shorter, the price maybe a little higher than the price of the first transaction, and the difference between the two prices shall be the profit earned by the institution. The shorter the period of salam, the higher the price and the greater the profit. In this way the institutions may manage their short term financing portfolio.
- If a parallel contract of salam is not feasible for one reason or another, they can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. Being merely a promise, and not the actual sale, their buyers will not have to pay the price in advance. Therefore, a higher price may be fixed and as soon as the commodity is received by the institution, it will be sold to the third party at a pre - agreed price, according to the terms of the promise.
Some rules of parallel salam:
- In an arrangement of parallel salam, the bank enters into two different contracts. In one of them, the bank is the buyer and in the second one the bank is the seller. Each one of these contracts must be independent of the other. They can not be tied up in a manner that the rights and obligations of contract are dependant on the rights and obligations of the parallel contract. Each contract should have its own force and its performance should not be contingent on the other. For example: if A has purchased from B 1000 bag of wheat by way of salam to be delivered on 31 Desember, A can contract a parallel salam with C to deliver him 1000 bags of wheat on 31 Desember. But while contracting parallel salam with C, the delivery of wheat to C can not be conditioned with taking delivery from B. Therefore, even if B did not deliver wheat on 31 Desember, A is duty bond to deliver 1000 bags of wheat to C. He can seek whatever recourse be has against B, but he cannot rid himself from his liability to deliver wheat to C. Similarly, if B has delivered defective goods which do not conform with the agreed specifications, A is still obligated to deliver the goods to C according to the specifications agreed with him.
- Parallel salam is allowed with a third party only. The seller in the first contract cannot be made purchaser in the parallel salam, because it will be buy back contract, which is not permissible in shariah. Even if the purchaser in the second contract is a separate legal entity, but it is fully owned by the seller in the first contract the arrangement will not be allowed, because in practical terms it will amount to buy back arrangement. For example, A has purchased 1000 bags of wheat by way of salam from B, a joint stock company. B has a subsidiary C, which is separate legal entity but is fully owned by B. A cannot contract the parallel salam with C.
- Salam is a sale whereby the seller undertakes to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot.
- The basic purpose of this sale was to meet the needs of the small farmers who needed money to grow their crops and to feed family up to the time of harvest.
The most famous Hadith, the one in which the holy Prophet has said:
"Whoever wishes to enter into a contract of salam, he must effect the salam according to the specified measure and the specified weight and the specified date of delivery"
Salam as a mode of financing
Salam, it is basically a mode of financing for small farmers and traders. This mode of financing can be used by the modern banks and financial institutions, especially to finance the agricultural sector. The price in salam may be fixed at lower rate than the price of those commodities delivered at spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions.
There are two other ways of benefiting from the contract of salam:
- After purchasing the commodity by way of salam, the financial institutions may sell it through a parallel contract of salam for the same date of delivery. The period of salam in the second (parallel) transaction being shorter, the price maybe a little higher than the price of the first transaction, and the difference between the two prices shall be the profit earned by the institution. The shorter the period of salam, the higher the price and the greater the profit. In this way the institutions may manage their short term financing portfolio.
- If a parallel contract of salam is not feasible for one reason or another, they can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. Being merely a promise, and not the actual sale, their buyers will not have to pay the price in advance. Therefore, a higher price may be fixed and as soon as the commodity is received by the institution, it will be sold to the third party at a pre - agreed price, according to the terms of the promise.
Some rules of parallel salam:
- In an arrangement of parallel salam, the bank enters into two different contracts. In one of them, the bank is the buyer and in the second one the bank is the seller. Each one of these contracts must be independent of the other. They can not be tied up in a manner that the rights and obligations of contract are dependant on the rights and obligations of the parallel contract. Each contract should have its own force and its performance should not be contingent on the other. For example: if A has purchased from B 1000 bag of wheat by way of salam to be delivered on 31 Desember, A can contract a parallel salam with C to deliver him 1000 bags of wheat on 31 Desember. But while contracting parallel salam with C, the delivery of wheat to C can not be conditioned with taking delivery from B. Therefore, even if B did not deliver wheat on 31 Desember, A is duty bond to deliver 1000 bags of wheat to C. He can seek whatever recourse be has against B, but he cannot rid himself from his liability to deliver wheat to C. Similarly, if B has delivered defective goods which do not conform with the agreed specifications, A is still obligated to deliver the goods to C according to the specifications agreed with him.
- Parallel salam is allowed with a third party only. The seller in the first contract cannot be made purchaser in the parallel salam, because it will be buy back contract, which is not permissible in shariah. Even if the purchaser in the second contract is a separate legal entity, but it is fully owned by the seller in the first contract the arrangement will not be allowed, because in practical terms it will amount to buy back arrangement. For example, A has purchased 1000 bags of wheat by way of salam from B, a joint stock company. B has a subsidiary C, which is separate legal entity but is fully owned by B. A cannot contract the parallel salam with C.
Purpose of salam Islamic Finance:
- Salam contract is usually used to meet the need of small farmers who need money to grow their crops and to feed their family up to the time of harvest. When Allah declared riba Haram, the farmers could not take usurious loans. Therefore Holy Prophet allowed them to sell their agricultural products in advance.
- To meet the need of traders for import and export business. Under salam contract, it is allowed for them that they sell the goods in advance so that after receiving their cash price, they can easily undertake the aforesaid business.
Salam in Islamic banking is beneficial to the seller because he received the price in advance and it was beneficial to the buyer also because normally the price in salam Islamic Finance is lower than the price in spot sales.
Istina, like salam, is a special kind of sale contract where sale is transacted before the goods come into existence. However, there are several points of difference between Istisna'a and Salam. In fact, the subject of Istisna'a is always a thing which need manufacturing while Salam can be effected on anything, no matter whether it needs manufacturing or not. Also, it is necessary for Salam that the price is paid in full advance, while it is not necessary in Istisna'a where payment can be made in staggered basis. And the object of Salam is a liability of the seller to deliver, thus should be in the form of fungible. Under the Istisna'a, the asset manufactured must meet the specification of the order and the buyer has the right not to take possession of the asset if the specifications are not met. In addition, the time of delivery is an essential part of the sale in Salam while it is not necessary in Istisna'a that the time of delivery is fixed. Any penalty for charged late delivery can reduce the price of an Istisna'a contract, but in a Salam, the penalty amount is paid should not be taken as benefit for the buyer.
References:
http://www.aims.education/study-online/salam-contract-in-islamic-banking/
http://www.financialislam.com/salam.html
https://www.islamicbanker.com/education/salam-contract-in-islamic-finance
Ethica, Handbook of Islamic Finance 2017 Edition
