sonal guarantees, mortgages, cheques and promissory notes. The permissible and prohibited forms of securities. It also intends to distinguish between liabilities and the assets held on trust.
Shari’ah ruling and basis for the standard on Guarantees
1. Permissibility of guarantees and their relevance to contracts
The basis of the permissibility of stipulating guarantees in contracts is that it protects property, which is one of the objectives of Shari’ah. The other authorities mentioned in the standard in support of each kind of guarantee can be cited as authority for the permissibility of guarantees in contracts.
1.1. A contract of guarantee is permissible in contracts of exchange, e.g. a contract of sale, or contract of rights, e.g. right of intellectual property. Such a guarantee contract does not affect the permissibility of the original contract in which it is required. It is, moreover, permissible to stipulate a guarantee into the body of an original at one time, because guarantee is appropriate to, or relevant in, contracts.
1.2. There is no objection in Shari’ah to include a number of guarantees in one contract, such as incorporating a personal guarantee together with a mortgage of security in the same contract.
2. Guarantees in trust (fiduciary) contracts
Assets held on trust must be returned to their owners in the manner in which they were received and in their original physical state promptly after the owners demand their return. Allah, the Almighty, says: {“Allah doth command you to render back your trusts to those to whom they are due”}.(2) Since such assets are not subject to exchange, they are purposely meant either for custody with permission to use them, such as assets on deposit, or for charitable acts, such as a loan of tangible assets. Therefore, the persons holding such assets are considered by the owners from the beginning as capable of returning them to their owners on demand, making them trustees, and as a principle of Shari’ah, a trustee is not held liable (for loss of, or damage to, an asset held on trust), except in circumstances of misconduct, negligence or violation of the conditions agreed upon, because in other circumstances it is inconsistent with the fundamental principle of trusts for a trustee to be held liable.
2.1. It is not permissible to stipulate in trust (fiduciary) contracts, e.g. agency contracts or contracts of deposits, that a personal guarantee or mortgage of security be produced, because such a stipulation is against the nature of trust (fiduciary) contracts, unless such a stipulation is intended to cover cases of misconduct, negligence or breach of conditions or stipulations. The prohibition against seeking a guarantee in trust contracts is more stringent in Musharakah and Mudarabah contracts, since it is not permitted to require from a manager in the Mudarabah or the Musharakah contract or an investment agent or one of the partners in these contracts to guarantee the capital, or to promise a guaranteed profit. Moreover, it is not permissible for these contracts to be marketed or operated as a guaranteed investment.
2.2. It is not permissible to combine agency and personal guarantees in one contract at the same time (i.e. the same party acting in the capacity of an agent on one hand and acting as a guarantor on the other hand), because such a combination conflicts with the nature of these contracts. In addition, a guarantee given by a party acting as an agent in respect of an investment turns the transaction into an interest-based loan, since the capital of the investment is guaranteed in addition to the proceeds of the investment, (i.e. as though the investment agent had taken a loan and repaid it with an additional sum which is tantamount to Riba). But if a guarantee is not stipulated in the agency contract and the agent voluntarily provides a guarantee to his clients independently of the agency contract, the agent becomes a guarantor in a different capacity from that of agent. In this case, such an agent will remain liable as guarantor even if he is discharged from acting as agent.
3. Guaranteeing existing leased properties
The lessor bears the risk associated with the leased property and the lessee holds it on a trust basis. Hence, it is not permissible for the lessor to stipulate in the lease contract that the lessee provide a guarantee or mortgage of security, etc., so that he may use it to recover the amount of the lease rental if the leased property is damaged, unless such a stipulation is restricted to cases of misconduct, negligence or breach of contract. Therefore, the lessor is liable for the consequences of any damage to the leased property that is not caused by the misconduct or negligence of the lessee, and is responsible for any related insurance expenses. The lessor also bears the expense of any major maintenance work required to keep the leased property in the condition necessary to provide the contractual benefits under the lease.
4. Written documentation and attestation
Written documentation is recommended by Shari’ah. This is the opinion of the majority of Fuqaha, in contrast to Ibn Hazm who argued that written documentation is an obligation (i.e. if one did not put his financial[1] transactions in writing he has committed a sin) relying on the literal meaning of the Qura'nic verse: {“O ye who believe! When you deal with each other, in transactions involving future obligations in a fixed period time, reduce them to writing”}[2] and the Quranic Verse: {“Disdain not to reduce to writing your contract for a future period, whether it be small or big”[3] The majority of Fuqaha have also inferred that this verse itself excluded written documentation in the cases of trustworthiness, as the last part of the following verse says: {“And if one of you deposits a thing on trust with another, let the trustee (faithfully) discharge his trust and left him fear Allah his Lord.”}
It must be noted that customary practice is the basis in
determining the form and evidential value of written documentation, because Shari’ah did not specify a particular manner of writing to be considered. As for the permissibility of attestation as documentation, the authority for that is the
following Qura'nic verse: {“And get out two witnesses, out of your own men. And if there are not two men, then a man and two women, such as ye choose, for witnesses, so that if one of them errs, the other can remind her”}.[4]
The evidential value of attestation according to traditional Fuqaha is stronger than that of written documentation. But in modern times, things have changed so that some laws rely on witnesses only in a very limited number of cases and paramount importance is given to written documentary evidence.
4.1. Documentation in writing is recommended by Shari’ah, whether such documentation is in the form of ordinary (private) or official documents. However, customary practice is applicable in the drawing up of such documents and in determining the documents that are relevant as proof (or have evidential value). It is prohibited to forge documents or to conceal their contents or to destroy them so as to bring about the loss of other peoples’ rights.
4.2. Attestation in financial transactions is recommended by Shari’ah. It is also commendable, and in case of necessity it is obligatory, to give testimony. On the other hand, perjury is prohibited and is one of the major sins.
4.3. It is not permitted to scribe or witness acts prohibited by Shari’ah, such as certifying or witnessing borrowing on the basis of interest.
5. Personal Guarantees
Personal guarantees derive their permissibility from the Qura'n, Sunnah,consensus and reasoning. In the Qura'n, Allah, the Almighty, says: {“They said: ‘We miss the great beaker of the king; for him who produces it, is (the reward of) a camel load; I will be bound by if”}.[5] In Sunnah, there is the Hadith narrated by Salamah Ibn Al-Akwa, who said: “We were with the Prophet (peace be upon him) when a deceased person was brought. They said, ‘O Prophet of Allah, perform prayers on him.’ He (peace be upon him) said, ‘Has the deceased left anything?’ They said, ‘No’ He (peace be upon him) said, ‘Is he in debt?’ They said, ‘Three dinars’ He said, ‘Perform prayers on your companion’ Abu Qatadah said, ‘O Messenger of Allah, perform prayer on him, and I am responsible for his debt’ Then the Prophet (peace be upon him) performed prayers on him.”[6] In another text of the Hadith, he (Qatadah) said: “I guarantee (to pay) his debt”[7]
The Fuqaha are unanimous on the permissibility of personal guarantees. Moreover, the need of people for personal guarantees to facilitate dealings with each other had also made them legitimate, particularly in the case of customers who lack a good credit record. In addition, personal guarantees encourage performance and prevent the contract from being breached and this security also justifies their permissibility.
The objection to taking consideration for personal guarantees is that giving a guarantee is one of the charitable acts that should be offered without consideration, and this ruling has generated consensus among the Fuqaha. Moreover, a personal guarantee indicates a readiness to give away the amount of a loan, which means that the guarantor will pay the loan (if the principal debtor fails to pay) and have recourse to the guaranteed person for fulfilment. Hence, it is not permissible to take consideration for a guarantee, because it is not permissible to take consideration for giving away the amount of the loan itself, since such consideration is considered to be Riba.
5.1. Permissibility and types of personal guarantee
5.1.1. It is permissible for an Institution to stipulate that a customer should provide one or more guarantors to secure the debts owed by the customer.
5.1.2. Personal guarantees are divided into two types. One type is a guarantee where the guarantor has a right of recourse to the debtor, and this guarantee is offered at the request or with the consent of the debtor. The other type is a non-recourse guarantee, which is offered voluntarily by a third party without the debtor’s request or consent (voluntary guarantee).
5.1.3. An
Institution is not entitled to guarantee financial commitments without a right
of recourse to the debtor, i.e. to be a non-recourse guarantor, unless the
Institution is already
authorised by its shareholders and investors to make donations or to perform
acts of benevolence.
5.1.4. It is permissible to fix the duration of a personal guarantee. It is also permissible to set a ceiling on the amount to be guaranteed and it is permissible that the personal guarantee be restricted by, or be contingent upon, a condition. In addition, it is permissible that such a guarantee be made contingent upon a future event, for example, by fixing a future date at which liability will commence and, in this case, the guarantor may validly withdraw the guarantee, by notifying the creditor, before the prospective obligation to be guaranteed arises.
5.1.5. It is not permissible to take any remuneration whatsoever for providing a personal guarantee per se, or to pay commission for obtaining such a guarantee. The guarantor is, however, entitled to claim any expenses actually incurred during the period of a personal guarantee, and the Institution is not obliged to inquire as to how the guarantee produced has been obtained by the customer. [see item 7/1/1 and 7/1/2)]
6. Guaranteeing unknown (Majhul) and future debts
The Shariah basis for the permissibility of guaranteeing the unknown is the general meaning of the Hadith: “The guarantor is liable"[8] because this Hadith makes no distinction between guaranteeing the known and the unknown since there is no harm or element of dispute arising due to uncertainty here, because the unknown transaction guaranteed will become certain and known, and the guarantor will know, after the debt is incurred, the actual obligation he undertakes. Another authority for the permissibility of guaranteeing what is not known is the Quranic verse: {“...for him who produces it, is (the reward of) a camel load and I will be bound by it”.[9] Here, the guarantor guaranteed a camel load although it was not yet a debt.
The evidence for the creditor’s right to demand payment from either the debtor or the guarantor is that the debt is established as liability of both of them, hence the right to demand payment from either of them. The permissibility for stipulating that the creditor has first to ask for payment from the principal debtor and that he may ask the guarantor for payment only if the debtor fails to pay, is based on an opinion in the Maliki School of law[10] and it is also an opinion of the Hanafis.[11] These opinions argued that if the debtor is solvent then demanding payment from the guarantor is pointless, unless the debtor refuses to pay. So, the requirement that payment be first sought from the debtor has a Shari’ah basis as well as being a case of adherence to a principle of natural justice.
A valid guarantee may be given for debts, the exact amount of which is unknown. Similarly, a valid guarantee may be given for a debt that will arise in the future. However, it is permissible for the guarantor to withdraw such a guarantee before a future debt is actually created, after notifying the person having interest in the guarantee. This is called a “market (business) guarantee" or a “guarantee of contractual obligation.” An example of this type is a third party’s guarantee to refund the price to the buyer if it appears that the sold commodity belongs to a person other than the seller and this guarantee is known as Daman al-Dark (dealers/business misrepresentation guarantee).
7. The effect of a personal guarantee
7.1. The creditor is entitled to claim the amount of his debt from either the debtor or the guarantor and he has the choice of claiming his right from either of them. However, the guarantor is entitled to arrange the order of liability, for example, by stipulating (at the conclusion of the contract of guarantee) that the creditor shall first claim payment from the principal debtor and that the creditor is entitled to recourse to the guarantor for payment only if the principal debtor refuses to fulfil his obligation.
7.2. If the creditor discharges the debtor from the debt, the guarantor is also discharged automatically from his liability. However, if the creditor discharges the guarantor from liability, the debtor remains in debt. If the guarantor secures a discount that results in paying an amount less than the original debt, the guarantor is entitled to recover only the amount he has actually paid to the creditor; he cannot demand that the debtor pay the debt in full ignoring the discount. This rule is intended to prevent a procedure being used that potentially leads to Riba. However, if the guarantor reaches an agreement with the creditor to settle the debt using as consideration a commodity of a different type from that in which the original debt was designated, the guarantor is entitled to recover the exact amount of the commodity provided as consideration for the debt, or the exact amount of the debt, whichever is less.
7.3. It is permissible for a personal guarantee contract to be designated in a separate contract. It can also be concluded together with, or before, or after, the conclusion of the contract of a credit transaction.
7.4. If an Institution manages transactions on the basis of Mudarabah or Musharakah or investment agency, it is not permitted for it to guarantee the fluctuations of currency exchange rates so that the investors will recover their investment shares irrespective of the behaviour of the currency market. Such a guarantee is prohibited because it is tantamount to the Mudarib or partner or investment agent guaranteeing the capital of other partners or investors, which is prohibited by Shariah. [see items 2.1 and 2.2]
7.5. If the contract of a credit transaction stipulates that the debtor shall provide a guarantor and the debtor fails to provide one, the Institution is entitled to initiate legal action to force him to provide a guarantor or to terminate the contract.
8. Mortgage (Rahn)
It is to make a financial asset or so tied to a debt so that the asset or its value is used for repayment of the debt in case of default. [see Shari’ahStandard No. (39) on Mortgage]
9. Cases of Achieving the Objectives of Securities
9.1. Bringing forward future instalments in case of default on payment
It is permissible to include a term in a debt contract to the effect that, if the debtor defaults on the payment of one or more instalments, some or all of the future instalments shall fall due immediately, provided the default was not caused by unforeseeable intervening events or force majeure. However, this term shall not be effective until the debtor has been served with a reminder notice and after a reasonable period of time has elapsed.
9.2. Termination of a sale on deferred payment terms in case of failure to pay
The seller is entitled, in a contract of sale on a deferred payment basis, to stipulate that if the buyer fails to pay the price within a certain period of time, the seller is entitled to revoke the contract and repossess the sold asset without recourse to the courts.
10.
Some Contemporary Applications of Securities
10.1. Letters of guarantee
10.1.1. It is not permissible to take remuneration for issuing a letter of guarantee, whether it is with cover or without cover, if the remuneration is intended as consideration for the guarantee per se, since the amount guaranteed and the duration of the guarantee are usually taken into consideration in computing remuneration.
10.1.2.
Asking an applicant for a letter of guarantee to bear
administrative expenses incurred in issuing a letter of guarantee of either
type (i.e. preliminary or final) is permissible in Shari’ah, provided the remuneration
for such expenses do not exceed the commission that others would charge for
such services. Where full or partial cover is provided, it is permissible, in
estimating the expenses for issuing a letter of guarantee, to take into account
anything
that will reflect the actual service to be rendered in providing a cover for
the transaction.
10.1.3. It is not permitted for the Institution to issue a letter of guarantee in favour of an applicant who will use it to acquire an interest based loan or to conclude a prohibited transaction.
It is a written undertaking by a bank (known as the
issuer) given to the seller (the beneficiary) as per the buyer’s (applicant’s or orderer’s) instruction or is issued by the bank for its own use, undertaking
to pay up to a specified amount (in cash or through acceptance or discounting of a bill of exchange), within a certain period of time, provided that the seller present documents for the goods conforming
to the instructions.
In brief, a documentary credit is an undertaking by a bank to pay subject to conformity of the documents to the contractual instructions. [see Shari’ah Standard on Documentary Credit]
10.3. Use of cheques or promissory notes
There is no Shari’ah objection to obtaining cheques or
promissory notes from the debtor (unless not allowed by law) as a means to force the debtor to make timely payment of instalments in cash, whereby
if the debtor pays on time such cheques or promissory notes shall be returned to him, and in the event of default on payment they may be produced
for recovery. The party providing these cheques or promissory notes as security
is entitled to obtain an undertaking from the Institution that they will be
used only for timely recovery of its due debts without any addition.
10.4. Insurance for doubtful or bad debts
It is permissible to subscribe to an Islamic insurance coverage as security for debt obligations and it is not permissible that debts be insured on a conventional insurance basis.
10.5. Freezing cash deposits (blocking withdrawals)
10.5.1. In order to secure the future payment of debts on a single payment or an instalment basis, it is permissible for the Institution to stipulate, that it is entitled to freeze the customer’s investment account, or to revoke his right to withdraw money from such an account entirely or to block an amount in the account equivalent to the debt, which is the preferred option. Nevertheless, the customer remains entitled to share profits on the whole balance of the investment account after deducting the Institution’s share for acting as a Mudarib.
10.5.2. In a credit transaction, it is not permitted for the Institution to stipulate a right to freeze the customer’s current account. However, a stipulation of this kind is allowed where the customer has freely, willingly and absolutely agreed to his current account to be frozen.
10.6. Third party guarantees (voluntary undertakings to compensate an investment loss)
It is permissible for a third party, other than the Mudarib or investment agent or one of the partners, to undertake voluntarily that he will compensate the investment losses of the party to whom the undertaking is given, provided this guarantee is not linked in any manner to the Mudarabah financing contract or investment agency contract.
10.7. Underwriting the subscription of shares issued (subscription guarantee)
10.7.1. It is permissible for the Institution to undertake that it will underwrite the remaining shares offered for subscription after the expiry of the offer period, provided the shares are under-written at the offer value without any consideration for the underwriting per se.
10.7.2. The underwriter is entitled to receive consideration for a service it provides other than the guarantee, such as conducting a feasibility study or marketing the shares.
10.8. Guarantees in tenders, security deposits in Murabahah transactions and Arboun (Earnest Money)
10.8.1. It is permissible to obtain guarantees for tenders and this includes both the amounts paid for participating in the bid (primary cash security for participating in the bid) and the amounts paid when the contract is awarded to the successful bidder (final cash security providing evidence of ability to complete the project). Such amounts shall be considered as being held on trust by the offeror of the bid on behalf of the successful bidder, and are not viewed as Arboun (Earnest Money). Hence, such amounts are recoverable if they are intermingled with other amounts of money (i.e. irrespective of any unwanted circumstances). Moreover, it is not permissible to confiscate such amounts of money, except in compensation for an equivalent amount of financial damage actually sustained in the tendering process. Such amounts may be invested in the benefit of the customer with his consent, unless he requests it to be credited to his current account.
10.8.2. It is permissible for the Institution, in the case of a unilateral binding promise, to take a sum of money called Hamish Jiddiyyah (security deposit) from the purchase orderer (customer) as security for his promise. This sum of money is held on trust, not as ‘Arboun, because no contract has been established. The rules set out in item 6/8/1 apply here. Where the customer fails to honour his binding promise, the Institution is not permitted to retain the security deposit as such. Instead, the Institution’s rights are limited to deducting the amount of any damage actually incurred as a result of the breach, namely the difference between the cost of the item to the Institution and its selling price to a third party.
10.8.3. It is permissible to take Arboun from a buyer or lessee when a sale or lease contract is concluded, on condition that, if the contract is not terminated within the specified period during which the option to terminate the contract remains valid, such an amount will be considered as part of the consideration for the contract and, if the buyer or lessee fails to perform the contract within this period, the seller or lessor is entitled to retain the amount. It is, however, preferable that the Institution should refund to the customer any balance remaining after deducting from the Arboun the amount of any damage actually sustained by it.
10.9. Priority right of recovery and the right to follow up
10.9.1. The Institution is entitled to recover first its tangible items that were sold to or manufactured for a customer and have not been paid for and can be identified among the assets of the customer.
10.9.2. The Institution is entitled to protect the integrity of the subject of a guarantee, such as a mortgaged asset, and pursue a legal action against misusing it if it is established that the person holding it is using it in a manner that may lead to losses to be borne by the Institution.
10.9.3. The rights of the parties holding mortgages of security shall be given priority over the rights of the parties who are unsecured. [see Shariah Standard No. (39)]
10.9.4. In the event of bankruptcy or liquidation, the parties in charge of the liquidation have a preferential right or priority over other creditors in recovering their rights; i.e. the cost of any services provided in the process of liquidation. [see Shari’ah Standard No. (43) on Insolvency]
⃟ ⃟ ⃟
Definitions of Terms
Debts that are absolutely payable and liabilities held on trust basis, either because of being contractually created, or because unjust enrichment has given rise to a liability for restitution.
Liabilities held on trust basis, i.e., obligations that are not subject to compensation for any loss suffered except in circumstances of misconduct, negligence or violation of the conditions agreed upon.
⃟ ⃟ ⃟[1] [Al-Nisa' (Women): 58].
[2] [Al Baqarah (The Cow): 282].
[3] [Al Baqarah (The Cow): 282].
[4] [Al Baqarah (The Cow): 282].
[5] [Yusuf (Joseph): 72].
[6] Related by Al-Bukhari in his “Sahih” [2: 800], Dar Ibn Kathir and Yamamah
[7] “Sunan Al-Nasa`i” [7: 317]; “Sunan Ibn Majah”, [2: 804]; and Al-Bayhaqi in “Al-Sunan
Al-Kubra” [4: 95].
[8] The Hadith has been related by Ahmad, Abu Dawud, and Al-Tirmidhi: “Al-Darari AlMudiyyah” [1: 399], Dar Al-Jil; Ibn Majah in his “Sunan Ibn Majah” [2: 804], Dar AlFikr; and Al-Bayhaqi in “Al-Sunan Al-Kubra” [6: 72], Maktabat Dar Al-Baz.
[9] [Yusuf (Joseph): 72]. “I will be bound by if’ means being a guarantor.
[10] Ibn Rushd, “Al-Bayan Wa Al-Tahsil” [11: 291].
[11] “Bada'i’Al-Sana'i’” [7: 2423].
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