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Salam (Forward Sales) as a Mode of Financing

Sep 17, 2007

By Mufti Taqi Usmani
——————–

Salam is basically a mode of financing for small farmers and traders. The mode of financing can be used by modern banks and financial institution, especially to finance the agricultural sector. The price in Salam may be fixed at a lower rate than the price of those commodities delivered at the spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions. In order to ensure that the seller shall deliver the commodity on the agreed date, they also can ask him to furnish a security, which may be in the form of a guarantee or in the form of mortgage or hypothecation. In case of default in delivery, the guarantor may be asked to deliver the same commodity by purchasing it from the market, or to recover the price advanced by him.

The only problem in Salam that may agitate the modern banks and financial institutions today is that they will receive certain commodities from their clients, and will not receive money. Being conversant with dealing in money only, it seems to be cumbersome for them to receive different commodities from different client and to sell them in the market. They cannot sell those commodities before they are actually delivered to them, because it is prohibited in Shariah.

But whenever we talk about the Islamic modes of financing, one basic point should never be ignored. The point is that the concept of the financial institutions dealing in money only is foreign to Islamic Shariah. If these institutions want to earn a Halaal profit, they shall have to deal in commodities in one way or the other, because no profit is allowed in Shariah on advancing loans only. Therefore, the establishment of an Islamic economy requires a basic change in the approach and in the outlook of the financial institutions. They shall have to establish a special cell for dealing in commodities. If such a special cell is established, it should not be difficult to purchase commodities through Salam and to sell in spot markets.

However, there are two other ways of benefiting from the contract of Salam.
First, after purchasing a commodity by way of Salam, the financial institutions may sell them 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 may be 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 portfolios.

Second, if a parallel contract of Salam is not feasible for one reason or another, they can enter into a promise to sell the commodity to a third party on the date of the delivery. 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 on a pre-agreed price, according to the terms of the promise.

A third option is sometimes proposed that at the date of the delivery, the commodity be sold back to the seller on a higher price. But this suggestion is not in line with the dictates of Shariah. It is never permitted by the Shariah that the purchased commodity be sold back to the seller before taking its delivery, and if it is done on a higher price it will tantamount to Riba which is totally prohibited. Therefore, this proposal is not acceptable at all.

It is one of the basic conditions for the validity of sale in Shariah that the commodity intended to be sold must be in the physical or constructive possession of the seller. This condition has three implications:

First, the commodity must be existing; a commodity that does not exist at the time of sale cannot be sold.

Second, the seller should have acquired the ownership of that commodity. If the commodity exists but the seller does not own it, he cannot sell it to anybody.

Third, mere ownership is not enough. It should have come in the possession of the seller, either physically or constructively. If the seller owns a commodity, but he has not acquired its delivery by himself or through an agent, he cannot sell it.

There are only two exceptions to this general principle in Shariah. One is Salam and the other is Istisna. Both are sales of a special nature, and by the present article I want to explain the concept of these two kinds of sale and the extent to which they can be used for the purpose of financing.

Meaning of Salam
Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange for an advanced price fully paid on the spot. Here the price is paid in cash, but the supply of the purchased goods is deferred. The buyer is called “rabb-us-Salam”, the seller is “Muslam ilaih”, the cash price is “ra’s-ul-mal”, and the purchased commodity is termed as “muslam fih”, but for the purpose of simplicity, I shall use the English synonyms of these terms.

Rasulullah SAW allowed Salam subject to certain conditions. 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 their family up to the time of their harvest. After the prohibition of Riba (interest) they could not take usurious loans. Therefore, it was allowed for them to sell the agricultural products in advance.

Similarly, the traders of Arabia used to export goods to other places and to import other goods to their homeland. They needed money to undertake this type of business. They could not borrow from the usurers after the prohibition of Riba. It was, therefore, allowed for them that they sell the goods in advance. After receiving their cash price, they could easily undertake the aforesaid business.

Salam was 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 used to be lower than price in spot sales.

The permissibility of Salam was an exception to the general rule that prohibits the forward sales. Therefore it was subjected to some strict conditions. These conditions are summarized below:

Conditions of Salam
First of all, 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. It is necessary because in the absence of full payment by the buyer, it will be tantamount to a sale of debt against debt, which is expressly prohibited by the Holy Prophet, Sall-Allahu alayhi wa sallam. Moreover, the basic wisdom behind the permissibility of Salam is to fulfil the instant needs of the seller. If the price is not paid to him in full, the basic purpose of the transaction will be defeated. Therefore, all the Muslim jurists are unanimous on the point that the full payment of the price is necessary in Salam.

Salam can be effected in those commodities only whose quality and quantity can be specified exactly. The things whose quality or quantity is not determined by the specification cannot be sold through the contract of Salam. For example, precious stones cannot be sold on the basis of Salam, because every piece 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 cannot be effected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply wheat of a particular field, or the fruit of a particular tree, the Salam will not be valid, because there is a possibility that of that particular field or the fruit of that tree is destroyed before the delivery, and in the presence of this possibility the delivery remains uncertain. The same rule is applicable to every commodity whose supply is not certain. It is necessary that the quality of the commodity (intended to be purchased through Salam) be fully specified leaving no ambiguity that may lead to dispute. All the possible details in this respect must be expressly mentioned.

It is also necessary that the quantity of the commodity be agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weight must be determined, and if it’s quantified through measures, its exact measure should be known. What is normally weighed cannot be specified in measures and vice versa. The exact date and place of delivery must be specified in the contract.

Salam cannot be effected in respect of those things that must be delivered at the spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shariah, that the delivery of both be simultaneous. Here, 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.

All the Muslim jurists are unanimous on the principle that Salam will not be valid unless all these conditions are fully observed, because they are based on the express Ahadith of the Holy Prophet, Sall-Allahu alayhi wa sallam. The most famous Hadith in this context is the one in which the Holy Prophet, Sall-Allahu alayhi wa sallam 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.”

However, there are certain other conditions, some of which are discussed below:
It is necessary, that the commodity (for which Salam is effected) remains available in the market at the time of delivery, only.

It is necessary that the time of delivery is, at least, one month from the date of agreement. If the time of delivery is fixed earlier than one month, Salam is not valid. Because it has been allowed for the needs of small farmers and traders, therefore, they should be given enough opportunity to acquire the commodity, and they may not be able to supply the commodity before one month. Moreover, the price in Salam is normally lower than the price of spot sales. This concession in the price may be justified only when the commodities are delivered after a period that has a reasonable bearing on the prices. A period of less than one month does not normally effect the prices. Therefore, the minimum time of delivery should not be less than one month. However, if the parties wish they may fix any date for delivery with mutual consent.

Sometimes it is more in the interest of the seller to fix an earlier date. As far as the price is concerned, it is not a necessary condition of Salam that the price is always lower than the market price on that day. The seller himself is the best judge of his interest, and if he accepts an earlier date of delivery with his free will and consent, there is no reason why he should be forbidden from doing so.

 

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