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We do not attempt to overwhelm the reader with a plethora of Arabic words and we translate every relevant word in English for ease of understanding. Bear in mind that in a study of Islamic laws, sciences would have previously been impossible without a knowledge of Arabic and we thank all those scholars who have made efforts to translate works into language of everyday use or the language of trade, which is English today.

This chapter focuses on the controversial contract of bai al inah, a construct of a sale and buyback between two parties that creates cash flows that resemble a loan structure.

Definitions of Bai al Inah

Bai means sale, tijarat means trade, and ribbh means profit on a sale. Bai al inah or inah is a sale contract that existed in the time of the Prophet (saw).

Bank Negara Malaysia defines bai al inah in the following manner: “Bai' 'inah refers to an arrangement that involves sale of an asset to the purchaser on a deferred basis and subsequent purchase of the asset at a cash price lower than the deferred sale price or vice versa, and which complies with the specific requirements of bai al'inah.”12

The International Financial Services Board, a standard-setting body for Islamic banks, defines bai al inah as follows: “A contract involving the sale and buy-back transaction of assets by a seller. A seller sells an asset to a buyer on a cash basis and later buys it back on a deferred payment basis where the price is higher than the cash price. It can also be applied when a seller sells an asset to a buyer on a deferred basis and later buys it back on a cash basis, at a price which is lower than the deferred price.”13

Bai al inah refers to an arrangement that involves a sale and buyback. An asset is sold by a seller to a counterparty on a deferred payment basis, creating a debt obligation on the said counterparty. Immediately, the original seller buys the asset back for a spot price. This second leg of the transaction creates the cash flows that resemble disbursement of a loan. As bai al inah is a sale contract, it must follow the requirements of contract law for sale and purchase transactions. A sale contract requires 14 conditions:14

1. Presence of two parties, a buyer and a seller.

2. Both parties must be sane persons.

3. Both parties must have the legal capacity to contract.

4. There must be in existence a subject matter of the sale, an asset or a good.

5. This asset must be a permissible asset.

6. The underlying economic activity behind the sale must be permissible.

7. There must be an agreed purchase price of the asset and an agreed mode of payment.

8. The seller must disclose all features of the asset involved.

9. The buyer must have the right to inspect the asset.

10. There must be an offer (to sell from the buyer) and there must be an acceptance (to purchase).

11. Once the sellers have sold the asset they have surrendered all claims of ownership to the asset in exchange for the purchase price, whether the purchase price is paid on spot or on deferred basis.

12. Even if the buyers fail to pay for the asset if the purchase was made on credit terms, the sellers do not have the right to repossess the asset, they only have a right over the purchase price.

13. The seller may obtain a collateral from the buyer under the contract of rahn (to be discussed later), to ensure a deferred payment is fully settled. If the buyer fails to make full payment, the seller may liquidate the asset held as collateral and recover any unpaid portion of the purchase price and return any excess to the buyer.

14. The asset must be in existence at the time of the sale.

These rules apply to almost all the sale transactions and must be borne in mind by the reader. These rules are simple enough, so now let us revert to the exclusive sale contract of bai al inah. We explain the sale by using illustration for ease.

Bai al Inah in essence is a combination of bai mu'ajjal and bai haal, a sequence of a deferred sale followed by a spot buyback. These terms will be clearly explained in the subsequent chapter.

Bai al Inah Process Flow

We illustrate the process flows in bai al inah by using a simple example involving two parties, A and B.

Party A wishes to use his asset of value $10,000 but wishes to convert the asset into cash of $10,000 and at the same time does not wish to surrender ownership rights to the asset.

Parties A and B agree to a spot sale price of the asset of $10,000, and a deferred sale price of $12,000 if the payment is made in 90 days.

Step 1. Party A sells the asset to Party B on a deferred payment basis. Party B pays undertakes to pay Party A, $12,000 in 90 days and Party B now enjoys full ownership rights over the asset. Party B can sell the asset to another Party C, enjoy the usufruct of the asset, or sell the asset back to A.

Step 2. Party A instantaneously buys the asset back from Party B at a spot price of $10,000. The asset is transferred back to ownership of Party A, who has his or her original asset back, and has in receipt an obligation from Party B to pay Party A, $12,000 in 90 days. The sale contract concludes with asset remaining with the ownership of the original party and the creation of a debt obligation due on B to A.

Figure 2.1 Parties to the Contract

Figure 2.2 Step 1 – Party A Sells to Party B

Figure 2.3 Step 2 – Party A Buys Back from Party B

Step 3. At contract conclusion Party B pays the deferred price of $12,000 to Party A.

The previous sequence of transactions treated separately are merely two sales transactions between two parties, but for a credit price and for a spot price. However, when they are combined they resemble a granting of a loan from Party A to Party B of $10,000 with a repayment of $12,000 in 90 days. There is no questioning that the two sales contracts combined have developed a suspicious likeness to a loan with an interest repayment and hence riba.

Figure 2.4 Step 3 – Party B Pays Deferred Price to Party A

It seems quite judicious to question the intentions of both Party A and Party B. It seems that Party B has no real intent (however, it may remain undisclosed) to own the asset that is the subject matter of the “sale.” At each stage of these transactions the ownership of the asset is transferred from A to B; there is also no payment of any sales tax as in reality these transactions are just paper-based. Although there is a transfer of ownership from one party to another via sale and purchase agreements, there may not be any transfer of possession.

Another area of controversy lies in the fact that the first sale transaction is conditional on the second sale. A will sell the asset to B for $12,000 on the implicit or explicit condition that B will sell the asset back to A for $10,000. As per Islamic contract law, one contract cannot be made conditional to another, based on the hadith of the Prophet (saw, pbuh) that states that two transactions cannot be combined into one.15

Nevertheless, the impact of the contract is as follows: Party A sells an asset for $12,000 and buys it back for $10,000, making a profit of $2,000 over a period of 90 days and Party B is able to raise $10,000 of funds for 90 days with committing to repay $12,000 in 90 days.

Let us look at a riba contract in Figure 2.5.

Figure 2.5 Riba Contract

Can the reader observe any substantial difference between both the contracts? One is a set of contracts of sale, where an asset is sold and then bought back. The other is a contract of lending, where A lends B money. Money here is treated as the sole subject of exchange; one nominal amount is exchanged for another nominal amount over a period of time. The architects of Islamic finance do not recognize the exchange of money in this fashion, where an excess amount is repaid. The excess repayment is considered to be riba.

Legal Issues with Bai al Inah

Proponents of theories on Islamic finance do recognize the difference between a spot price for an asset and a deferred price for an asset. Shariah scholars recognize that the deferred price of an asset can be greater than the spot price of an asset in a sale transaction. They also recognize that a seller can repurchase an asset sold to a buyer and vice versa, but do comment on the combination of two sale contracts between a buyer and a seller that result in cash flows that resemble a loan disbursement and repayment with interest. There is no difference between bai inah and riba in essence, but there is considerable difference in form as the former is a sequence of sale contracts and the latter is a contract of lending. In essence it seems that a sequence of legal sales has resulted in a transfer of money for money. This is referred to as “legal means to illegal ends.”16

Can the element of the intentions of both parties be taken into consideration? Here arises a fundamental question of what madhab (school of thought) we are referring the judgment to and what methodology of usul ul fiqh we are referring to. The Shafi madhab accepts this transaction as it does not (apparently) recognize the relevance of intentions especially if they are undisclosed by either party.17 So in essence, intentions are left to be between man and God.

Imam Al Shafi writes, “When one purchases a commodity from another and takes its delivery, and the price happens to be on deferred terms, it is not objectionable for him to sell it to the person from whom he had purchased it or to someone else, for a cash price less than his purchase price or higher, or on credit, or against another commodity.”18

Many scholars, however, feel that this saying has been taken out of context, and Imam Shafi did not refer to the contract of inah by name. Were two parties contracting merely to create cash flows that replicate loans, and “the second sale is considered to be conditional on the first, by virtue of custom, thus resulting in both contracts being invalid”?19

The Shafi madhab also does not recognize saad ul dhariah as a source of shariah law. Saad ul dhariah means to block legal means to result in illegal ends and as an approach to law is a secondary source of law in shariah.20 The Shafiis would contend that if each sale contract were to fulfill the requirements of a sale contract, they cannot be termed invalid.

Nevertheless, the contract of bai al inah remains controversial to this date and is accepted in Malaysia, but is frowned on in the Gulf Cooperation Council, or GCC, Saudi Arabia, Pakistan, and other Muslim countries.

Taken as a financial transaction, it is also implied that the original sale is based on the condition that A will buy back the asset from B and the second offer and acceptance is already agreed on. Would it make any difference if the deferred price was not calculated by either party but was merely the market price for a heavily traded asset, like wheat, for instance? What are the risks that Party A is exposed to? Party B could in essence sell the asset to Party C, or decide to hold the asset and enjoy its usufruct. The rapid sequencing of both these sales mitigates this risk. Party A is also exposed to credit risk, in that Party B may be unable to make the required payment in 90 days. Party A can demand that some other asset be held as collateral with Party A to ensure repayment. The asset here plays a crucial function.

If this transaction seems charged with controversy for the reader, let it be no surprise as it has been so for more than 1,200 years. Scholars have seen it as an attempt to circumvent the contract of riba; others have seen it as an alternative to riba, depending on the intentions of the parties involved. This contract, however, if deemed permissible, allows economic units short of liquidity but with an availability of fixed assets to use their assets to raise funds or liquidity. This need is fundamental in any business, no less a bank that is in a perpetual state of asset/liability mismatches.

12

Bank Negara Malaysia (BNM) (2013), Tawarruq (Shariah Requirements and Optional Practices) Exposure Draft December 2013, www.bnm.gov.my/documents/SAC/13_Tawarruq.pdf, accessed July 2014.

13

Islamic Financial Services Board, www.ifsb.org, acessed June 10, 2014.

14

Muhammad Yusuf Saleem, Islamic Commercial Law (Hoboken, NJ: John Wiley & Sons, 2013).

15

Sunan Al-Tirmidhi 2/514.

16

Muhammad Ayub, Understanding Islamic Finance (Hoboken, NJ: John Wiley & Sons, 2007).

17

Abu Ishaq al-Shatibi, Al-Mufawaqat fi usul al Shari'ah, vol. 4, 435–436. (Cairo: al-Maktabah al-Tijariyyah al-Kubra, 1983).

18

Imam Shafi–Al–Umm. Extracted from Shariah Rules in Financial Transactions course SH1003, 2013, INCEIF.

19

Shariah Rules in Financial Transactions, course SH 1003, 2013, INCEIF.

20

Muhammad Yusuf Saleem, Islamic Commercial Law (Hoboken, NJ: John Wiley & Sons, 2013).