Welcome to Session

on

ISLAMIC FINANCIAL CONTRACTS:

SHARI’AH STANDARDS ON

ISTISNA’A

Tahmina Rahman CSAA,CENPL

Assistant Professor, BIBM
 Locating ‘Banking Activities’ in Shariah

Islamic Law (Shariah)

Aqidah Amaliyyah Akhlaq

(Provision related with Faith) (Provision related with Actions) (Provision related with
Moralities and Ethics)

Fiqh Ibadah Fiqh Muamalat

(Worshipping to ALLAH) (Human-to-Human)
[As per specification and direction] [Should not be Prohibited]

Political Activities Economic Activities Social Activities

Banking and Financial Activities Economy related Other Activities

Mechanism of Salam July 1, 2024 2
 Islamic Finance: Basic Modes
• Exchange-based Contract (Bai):
….. ALLAH has permitted trade… Sura: Al Baqarah, 2: 275
Musawamah, Murabahah (Muazzal), Salam, Istisna’a, Tawarruqh, Bai-al Sarf
• Equity-based Contract (Sharika):
• Mudarabah (Unrestricted and Restricted), Musharakah (Constant and
Diminishing), Mufawadah (Equal Partnership), Muzara’ah (Sharecropping
partnership for cultivation) , Musaqat(Irrigation partnership for Edible
Fruits), Mugharasah (Agricultural partnership for plantation)
• Lease-based Contract (Ijarah):
• Ijarah Tashghiliyah and Ijarah Muntahiya Bittamleek (HPSM/HPMM/Ijarah
Bil-Bai)
• Agency-based Contract (Wakalah)
• Trust (Amanah/Wadiah)
• Suretyship (Kafala)
• Hawala
• Gratuitous / Benevolent Activity
• Waiving Contract (Isqatat)

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 3

 Trade-based Contracts

Existing Future For Cash

Commodity Currency
Commodity Facility

Cash/ Only Bai al-

Credit Credit Salam Istisna’a
Sarf Tawarruq/
Bai Inah
Monitization (Allowed by
(Conditionally Few but not
Allowed by by AAOIFI)
AAOIFI)
Muajjal
Musawamah Murabahah (Without
(For Bargaining) (Profit Disclosed) Disclosing
Profit)
Agricultura Industrial Construction
Manufacturing
l Products Products

Shariah Standard on Istisna'a Tahmina Rahman

July 1, 2024 4
 General Rules of ‘Bai’ Transactions: Exceptions

The basic conditions to be a valid sale are:

1)The subject matter of the sale must have existence at the time of
contract;
2)Seller should have ownership on the subject matter at the time of
contract;
3)Seller should have physical or constructive possession on the subject
matter;
4)There are two exceptions to these principles:
• Salam and
• Istisna’a
•Bai-as-Sarf is another exception where currency is considered as
subject matter.
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 5
 Istisna’a
• Word Meaning:
• The word Istisnaa has been derived from the Arabic word “Sanya”
which means Industry.
• Istisna’a means to purchase specific product(s) by placing order to a
manufacturer or to sale specific product(s) after having the same
manufactured against order of a buyer.
• Definition:
• Istisna’a is a contract between a manufacturer/seller and a buyer
under which the manufacturer/ seller sells specific product(s) after
having manufactured, permissible under Islamic Shariah and Law
of the Country after having manufactured at an agreed price
payable in advance or by installments within a fixed period or
on/within a fixed future date on the basis of the order placed by the
buyer.
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 6
 Istisna’a: Shariah Permissibility
• Though it is a part of Muamalat, Istisna’a needs to have
Shari’ah reference because it is an exception to general sales
contract.
• The legitimacy of Istisna’a is based on the request of the Prophet
(SM) that a pulpit (a platform) for preaching and a finger ring
be manufactured for him.
• In the Hadith the Prophet (peace be upon him) requested the
manufacture of finger ring has been related by Al-Bukhari and
Muslim: ‘ Sahih Al Bukhari’ [5:220], and ‘ Sahih Muslim’
[3:1655].
• The International Islamic Fiqh Academy has issued a resolution
in support of the legitimacy of Istisna’a [Resolution No. 65 (3/7)]

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Istisna’a: Guidelines for Conducting Islamic Banking
(BRPD Circular No.15/2009): Section V (Investment Products)

• Istisna and Parallel Istisna:

• A contract executed between a buyer and a seller under which the
seller pledges to manufacture and supply certain goods according to
specification of the buyer is called Istisna. An Istisna agreement is
executed when a manufacturer or a factory owner accepts a proposal
placed to him by a person or an Institution to produce/manufacture
certain goods for the latter at a certain negotiated price.
• Here, the person giving the order is called Mustasni, the receiver of
the order is called Sani and the goods manufactured as per order is
called Masnu.
• An order placed for manufacturing or producing those goods which
under prevailing customs and practice are produced or manufactured
will be treated as Istisna contract.

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 8

Istisna’a: Conditions and Characteristics as per BB Guidelines
• a) The concerned Agreement must contain the details, such as, the
type, class, quantity and features of the goods to be produced, so that
no misunderstanding is created later on.
• b) The price has to be settled; payment time/schedule and modes
thereof is to be predetermined.
• c) When, where and on whose cost the goods to be supplied has to be
clearly mentioned.
• d) If agreed by both parties, payment may be made in advance to the
seller in part or in full or may be deferred to be paid in due course/
agreed time.
• e) Generally timeframe is not mandatory for supplying the goods
under Istisna agreement. It may be executed without determining
timeframe. But in case of bank, timeframe for supplying goods must
be determined to avoid any dispute in future.
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 9
 Parallel Istisna’a:
Conditions and Characteristics as per BB Guidelines
• If it is not stipulated in the contract that the seller himself would
produce/provide the goods or services, then the seller can enter
into another contract with third party for getting the goods or
services produced/ provided by the third party. Such a contract is
called Parallel Istisna. This may be treated as a sub-contract.
• The main features of this contract are:-
• i) The original Istisna contract remains valid even if the Parallel
Istisna contract fails and the seller will be legally liable to
produce/ provide the goods or services mentioned in the Istisna
contract.
• ii) Istisna and Parallel Istisna contracts are treated as two
separate contracts.
• iii) The seller under the Istisna contract will remain liable for
failure of the
Shariah Standard sub-contract.Tahmina Rahman
on Istisna'a July 1, 2024 10
 Istisna’a: Basic Terminology

• Buyer = Al-Mustasni
• Seller = Al-Sani
• Goods or the subject matter = Al-Masnoo

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 11

 Features of Istisna’a
 Non-existence of commodity/product.
 Used in Industrial, Manufacturing and even in
Agricultural and Construction Sectors.
 Sometimes payment made in advance, which may use
as capital for producing the goods.
 It gives the buyer opportunity to pay the price in some
future dates or by instalments.
 Taking all types of securities is permissible.
 Binding contract and no party is allowed to cancel it if
the price is paid and received in full or in part or the
manufacturer starts the work.
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 12
 Istisna’a Processing
Contract

Seller Buyer

Commodity/Product

For Sale and Purchase

BY Making Order giving Specifications

Price Must be Agreed by the Parties

Payment In advance or by instalments within a fixed

period or on/within a fixed future date.
Delivery
After making/manufacturing the goods
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 13
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 14
 Process of Istisna’a

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 Process of Parallel Istisna’a

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Process flow of Istisna’a and Parallel Istisna’a

1. The customer enters into an Istisna’a agreement with IFI for the
production of specified goods to be delivered by specified date.
2. The IFI enters into an independent parallel Istisna’a agreement
with a manufacturer to deliver the specified goods by the date
specified in the contract.
3. The customer makes progressive payments to the IFI over the
period.
4. Progressive payments are made by the IFI to the manufacturer
over the period.
5 Goods produced are delivered by the manufacturer to the IFI.
6. The IFI delivers the goods to the customer.

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 17

 Applications of Istisna’a

All work under contract

Building of body of bus, truck etc.

Construction work viz. house building,

bridge, culvert, road etc. [Project]

Furniture & fixture

Manufacturing of industrial products etc.

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 18
 Relevant Standards of Istisna’a

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 Istisna’a: Some Important Issues
SL Issues Treatment
1. Price To be known to both parties at the time of contract
2. Flexibility in Permissible to connect payment with the stage of
Payment Mode completion of work.

3. Security Permissible. IFI may demand collateral, guarantee or

other forms of security.
4. Amendment in -Permissible, even after the conclusion of the contract but
Manufacturing/ before delivery.
Construction -Price and reasonable period for the execution of new
Specification requirement will be granted accordingly and mutually.
-But additional sum cant be demanded for this extended
time, as such consideration will be treated as ‘Riba’ which
is not permissible in Shariah.

5. Party assigned Permissible for the manufacturer and ultimate purchaser

for Supervising to agree on the party who will bear the additional cost of
the supervision of the contract.
Contract/Work
6. Delivery Date Mentioning DD is not mandatory, however, no objection,
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 20
(DD) it is mentioned or fixed.
 Istisna’a: Some Important Issues……
SL Issues Treatment
7. Arboun Permissible. But preferable to adjust only the
damage suffered occurred.
8. Penalty clause It is permissible if default in showing
performance/deliver in due course.

9. Pricing Not Cost-plus method, like Murabaha.

10. Force Majeure Possible to adjust/change in price but not for
delayed delivery.
11. Appointing Client Permissible (With or Without Fee, but generally it
as an agent for is without fee).
Supervision
12. Appointing Client Permissible (But IFI needs to manage it’s
as an agent for Ownership related Risk).
Selling the Subject-
matter
Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 21
 Istisna’a: Some Important Issues……
SL Issues Treatment
13. Appointing Client for Permissible (here cost will be borne as per
Supervision agreement).

14. Delivery before the Due Bound to accept. But may deny in case of
Date genuine reason/ground.

15. Delivery after the Due May cancel the contract OR may impose
Date penalty OR adjust Arboun OR may wait for
Delayed delivery
16. Delivery of Superior Bound to accept by the buyer but seller may
Goods not ask/claim additional price for that
17. Delivery of Inferior Buyer is not bound to accept but may ask for
Goods discount for that.
18. Cancellation of Usually cancel the contract mutually but may
Contract cancel it unilaterally before the manufacturer
Shariah Standard on Istisna'a
starts the work.
Tahmina Rahman July 1, 2024 22
 Istisna’a: Some Important Issues……
SL Issues Treatment
19. Use of Gold/Silver There is no objection if subject matter is
made of by Gold or Silver, like Jewelry
business.
20. Selling the Subject-matter Not permissible as it is Bai-al-Inah.
to the original seller

21. Selling Goods before taking Not Permissible.

Possession
22. Linkage between Istisnaa No Linkage
and Parallel Istisnaa
23. Refuse to Accept Delivery If the buyer refuse to accept the delivery
goods will remain in the possession of the
manufacturer on a trust basis OR may sale
as an agent.

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 Istisna’a and Parallel Istisnaa: AAOIFI FAS 10
SL Issues Treatment
1. Istisnaa Cost - Direct Cost and Indirect Cost
-Operating expenses are not included in Istisnaa contract
cost.
-Istisnaa costs incurred during a financial period shall be
recognized in an Istisnaa WIP.
2. Istisnaa - Istisnaa revenue is the ‘Total Price’ agreed upon between
Revenue and the IFI (as AL-Sani) and the Client (as Al-Mustasni)
Profit including the profit margin on the contract.
- Istisnaa Revenue and associated Profit are recognized
either the percentage of completion OR the completed
contract method.

3. Early If Al-Mustani makes a payment in Advance of the due date

Settlement for such a payment, the IFI may waive part of it’s profit in
recognition of this earlier payment.
4. Parallel Parallel Istisnaa Revenue and Profit for each financial
Istisnaa period shall be measured and recognized according to the
Revenue and percentage of completion method since in Parallel Istisnaa,
Profit both costs and revenue are known to the IFI with reasonable
Shariah Standard on Istisna'a
certainty. Tahmina Rahman July 1, 2024 24
 Parallel Istisna’a (Istisnaa Muwazi): Business Case
• Mr. Fuad wants to buy a flat. He finds that AK Developer developing a building
which would be completed within 18 months.
• Mr. Fuad choose Flat#7A, south facing 1500sft of the under construction
building.
• AK Developer’s asking price for the flat is BDT 1 (one) crore. However, Mr.
Fuad is not capable to pay the price as per schedule of the developer (Down
payment: BDT 30 lacs, BDT 60 lacs within 15 months and remaining on
delivery).
• Mr. Fuad approaches to an Islamic bank (say, IFI limited) for financial
assistance.
• As per discussion with the client, IFI Ltd. fixed the price for the flat is BDT 1.50
crore, where down payment would be BDT 20 lacs and remaining would be paid
within 120 months on EMI basis (108,333).
• Based on the discussion with the developer, it was decided that, the price would
be reduced to BDT 95 lacs if BDT 85 lacs is paid at the time of ‘Contract of Sale’
and remaining on delivery. The bank accepted the offer.
• The client was agreed to supervised the activities during the construction
period.
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 Parallel Istisna’a (Istisna’a Muwazi):
Process flow of Business Case

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 Salam and Istisna’a: Different Issues
SL Issue Salam Istisna’a
1. Primary Application Agriculture Manufacturing

2. Nature of Goods Readily Available/ Customized/Rare

Common
3. Payment System Must be in Advance Spot/Progressive/
Deferred
4. Change in Not Permitted May be with
Specification Mutual Consent
5. Time of Delivery Has to be May not be
Mentioned Mentioned
6. Cancellation/ Must be by Mutual Unilaterally before
Revoking of Contract Start the Work

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 Salam and Istisna’a:
Recent Status and Study Findings-
BD Context

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 Mode-wise Investment of Islamic Banks
(October-December, 2023)
(Source: Dev of IB Seg in BD, October-December,2023, BB)

Mechanism of Salam July 1, 2024 29

Shariah Standard on Istisna'a Tahmina Rahman July 1, 2024 30