UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for Istisnaa

Istisna’a (Commissioned Manufacture) and Back-to-Back Istisna’a in Islamic Finance

 

 

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“Istisna`a is a contract of exchange with deferred delivery applied to specified made-to-order items.” (http://www.islamic-finance.com/item_istisna_f.htm)

“It is a commissioned manufacture where one party buys goods that the other party undertakes to manufacture according to the specifications given in the contract.”

(*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

According to islamicfinance.com, “The General principles of Istisna’a are as follows:

  • The nature and quality of the item to be delivered must be specified;
  • The manufacturer must make a commitment to produce the item as described;
  • The delivery date is not fixed (Otherwise, it would be a Bai Salam);
  • The item is deliverable upon completion by the manufacturer;
  • The contract is irrevocable after the commencement of manufacture except where delivered goods do not meet the contracted terms; According to Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan, if the thing made does not agree with the description in the contract, the person who has given the order has the option whether to accept it or not;
  • Payment can be made in one lump sum or in installments and at anytime up to or after the time of delivery;
  • Title to the asset to be manufactured is transferred to the person who commissioned its manufacture at the end of the construction period according to Norton Rose; (“Unless the items are completely or partially delivered, the ultimate purchaser has no prior right (in the event that the supplier is declared bankrupt or insolvent) over a third party to the items that are the subject-matter of the contract while they are still in the process of being produced and have not yet been delivered to him.  In addition, the ultimate purchaser cannot be regarded as the owner of the materials in the possession of the manufacturer for the purpose of producing the subject-matter of the contract, unless, the manufacturer has previously undertaken, as a guarantee for the completion of the work, that such materials will only be used for the order of the ultimate purchaser.  This form of guarantee is only enforced in the event that the manufacturer has required the ultimate purchaser to pay part of the price in advance for acquiring some of the materials needed.  In practice it would be a good idea to request a down-payment to protect the manufacturer’s interest.”)
  • “Istisna’a exists only in the Hanafi School of Law.  The majority view in that school allows the contract only on condition that it binds neither party until the goods are made and accepted by the buyer.  But a minority view now followed in Islamic finance holds that it is binding on both parties to perform immediately.”

(*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

  • The manufacturer is responsible for the sourcing of inputs to the production process.

 

Istisna`a differs from Ijara in that the manufacturer must procure his own raw materials. Otherwise, the contract would amount to a hiring of the seller’s wage labor as occurs under Ijara.

Istisna`a also differs from Bai Salam in that a) the subject -matter of the contract is always a made-to-order item, b) the delivery date need not be fixed in advance, c) full advance payment is not required and d) and the Istisna`a contract can be cancelled, but only before the seller commences manufacture of the agreed items.”

(http://www.islamic-finance.com/item_istisna_f.htm)

“In Istisna’a, the purpose of a buyer is to obtain the manufacture of goods that otherwise would not exist, while in Bai’ Salam a buyer seeks to fix the price for future goods that are virtually assured to exist anyway.  In Bai Salam, the rules forbid the tying of the contract to any particular production process since that exposes the parties to risks.  In contract, the Istisna’a involves a unique production process.”  (*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

Parallel or Back-to Back Istisna’a

In a parallel Istisna’a arrangement, according to Norton Rose, the client commissions the financier to manufacture the specified asset for one price (the purchase price).  In parallel, the financier then commissions a third party (the contractor) to manufacture the same asset for a lower price (the sale price).  “The difference between the present value of payments under the two contracts is the banks compensation for the finance.  For back-to-back Istisna’a, it is important to distinguish the contracts as two separate deals of Istisna’a.  The separation of the two contracts has the effect of making the transaction a non-riba based finance transaction.”  (*The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

Salam and Istisna’a by Maulana Taqi Usmani

http://www.accountancy.com.pk/docs/islam_salam_istisna.pdf

Difference Between Istisna’a and Ijarah

http://www.kantakji.com/fiqh/Files/Finance/N275.pdf

Back-to- Back Istisna’a

http://www.bankalbilad.com/en/corpser04.asp?TabId=2&ItemId=23  

Sharia’h Opinion (Fatwa) on Istisna’a, Contracting, and Salam by Dr. Ahmed Moheiddin Ahmed and Reviewed by: Dr. Abdul Sattar Abu Ghuddah

http://www.albaraka.com/media/pdf/Research-Studies/RSIS-200706201-EN.pdf

 

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