Bai salam is an Islamic finance tool used to generate working capital and consists of a contractual sale in which advance payment is made by the buyer to the seller for the deferred supply of goods at a specified date pre-determined in the contract. Thus, it is a sale and purchase transaction whereby the payment is made in cash at the point of contract, but the delivery of the asset purchased will be deferred to a pre-determined date…The price paid today represents a discount on the price, typically calculated by reference to a benchmark, such as LIBOR, plus a margin, that would have been paid if it were a cash sale at the time of the delivery. The implied cost of capital to the Salam seller is the difference between the present value of the future market price of the good and the price that one would receive today…The seller benefits in that she gains advance payment/liquidity and the buyer may benefit if the price of the commodity is more expensive in the future than she paid in the present.
As a matter of principle in Islamic Finance, the sale of the commodity, which is not in the possession of a seller is not permitted. But the practice of Bai Salam has been legalized as an exceptional case on the ground of necessity. The forward purchase of generically described goods for full advance payment has important potential as an Islamic financing device – especially for the production of agricultural goods. (((*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan. (2003) and (http://www.practicallaw.com/3-366-1996)
In addition to the pre-determined sale price, it is necessary that the quality and quantity of the commodity be fully specified at the time of contracting so as not create ambiguity, which may lead to a dispute. The objects of this type of sale are generally goods, which are capable of being definitely described as to quantity, quality, and workmanship and cannot be gold, silver, or any currencies based on these metals. (Wikipedia) The commodity in exchange should not be in the nature of money.
The financier may at the same time enter into a parallel but separate bai salam with a third party to resell the asset for an increased price (also calculated by reference to a conventional benchmark such as LIBOR) or it may simply sell the asset on delivery. (http://www.practicallaw.com/3-366-1996)
Conditions of the Parallel Salam
- There must be two different and independent contracts, these two contracts cannot be tied together, and performance of one should not be contingent on the other.
- Parallel Salam is allowed with the third party only.
Basic Features and Conditions of the Salam Contract
- The transaction is considered Salam if the buyer has paid the purchase price to the seller in full at the time of sale. This is necessary so that the buyer can show that he or she is not entering into debt with a second party in order to eliminate debt with the first party, an act prohibited under Sharia’h. Muslim jurists are unanimous in their opinion that full payment of the purchase price is key for Salam to exist. However, Imam Malik is of the opinion that the seller may defer accepting the funds from the buyer for two or three days but this delay should not form part of the Salam Contract.
- Salam can be affected in those commodities of which the quality and quantity can be specified exactly. For example, precious stones cannot be sold on the basis of Salam because every piece of precious stone is different from the other either in its quality or in its size or weight and it is not possible to determine exact specification. Furthermore, the commodity in exchange should not be in the nature of money.
- Salam cannot be affected 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 will be destroyed before delivery and given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity of which the supply is not certain. Therefore, the commodity should be generally available in the market at the time of delivery. It should not be non-existent, a rare commodity out of supply, or out of season- such as to become inaccessible to the seller. Please note, Sharia’h scholars vary in their view on whether the asset that is the subject of bai salam must be available in the market at the time of the agreement or whether it is sufficient that it just be available on the date agreed for delivery.
- It is necessary that the quality of the commodity (intended to be purchased through Salam) is fully specified leaving no ambiguity, which may lead to a dispute. All the possible details in this respect must be expressly mentioned.
- It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If the commodity is quantified in weight according to the usage of its traders, the commodity’s weight must be determined and if it is quantified through measures, the exact measure of the commodity should be specified.
- The exact date and place of delivery must be specified in the Salam contract.
- Salam cannot be used in respect of things, which must be delivered at spot. For example, if gold is purchased in exchange of silver, it is necessary according to Sharia’h that the delivery of both be simultaneous, therefore, in this case, Salam cannot work. Similarly, if wheat is bartered for barley, the simultaneous delivery of both is necessary for the validity of sale. Therefore, the contract of Salam in this case is not allowed.
- A Salam sale cannot take place between identical goods.
- In a Salam sale, a commodity which is not in the possession of the seller can be sold. It is also not necessary that the seller be the grower or the manufacturer of the commodity/sale-item.
- In order to ensure that the seller honors her commitments to supply to the buyer according to the terms as agreed under the Salam contract, the buyer has a right to claim surety and/or pledge/guarantee.
- The buyer cannot take ownership rights over the purchased goods before taking possession of the goods. Therefore, the buyer cannot resell the goods or contract their transference (Hawalah) nor can the buyer use the goods as partnership capital until the buyer takes possession of the goods.
- In the event of death of the seller, the Salam contract will be deemed rescinded and the buyer may claim the return of his money from the heirs of the seller. In the event of the death of the buyer, the contract will remain operative. Damage to the goods purchased may nullify the Salam contract if the damage exceeds the normal amount of damage. In the event of the termination of the contract, the buyer’s advance shall be returned to the buyer by the seller under Salam.
- The buyer has no right to change the conditions of the contract in respect of the quality, quantity, or the period of delivery of the contracted goods after payment is made to the seller. Both parties, however, have the right to rescind the contract in full or in part. In this case, the buyer may have a right to a refund of the amount paid in advance under the Salam contract.
- A Salam sale cannot be contracted against a loan or on a partly loan, partly cash basis, in which case the contract will be effective only to the extent of the cash payment.
- In case a purchaser advances money for more than one item, it is advisable to state the price of each item. This will facilitate readjustment of the contract in case of its partial fulfillment. The contract should also expressly provide for the periods or places of delivery of the different items.
and *The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan. (2003))
Origin in the Qu’ran:
Surah-al baqarah (2), Verse 282. O ye who believe! When ye deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing.
Origin in the Sunnah:
It was narrated by Ibn Abbas that the Prophet said: Those who pay in advance for anything must do so for a specified measure and weight and for a specified period.
(((*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan. (2003))
Application of Islamic Banking Instrument Bai Salam For Agriculture Financing in Pakistan
Bai Salam by Mufti Mujeeb