Legal Documentation in Islamic Financial Institutions

Topics: Contract, Contract law, Common law Pages: 3 (808 words) Published: April 9, 2014
Shariah Aspects of Business and Finance (SH1002)
Legal Documentation
Legal documentation can be defined as the legal document that shows the rights and liabilities of two contracting parties as a result of entering into a particular contract. It is very important in ensuring that the rights and liabilities of these parties conform to Shariah; the contract does not possess any element of interest, gharar (uncertainty), exploitation or injustice and it is valid and enforceable from a legal perspective.

There are some salient features of legal documentation. One of them is the prohibition of combining two primary contracts in one contact or two sales in one sale, such as: Sale and Lease or Lease and Partnership contracts. This is because of the element of gharar they possess. Although a primary contract can be combined with a supporting contract (if their legal conclusion is not prohibition) such as Contract of Sale with deferred payment (permissible) and Musharaka with guaranteed profit (prohibited). Other contract combinations like Lease with pledge (Rahn/secured), Diminishing partnership and Tawarruq with Wakala are all permissible by Shariah.

The second feature relates to the use of conventional financial terms which do not contain any elements of interest or penalty in the legal documentation. Neutral terms like: Right to recall, Cross default, Consolidation and set off, Pre-payment clause and Penalty / Compensation clause are used after some adjustments by the jurists, to ensure their conformity to Shariah. The usage of these terms in the legal documentation ensures the protection of the rights of the parties in the contract and establishment of obligations and penalties for not fulfilling the contract.

Let us have a look at the implication of the usage of the above terms and clauses in the legal documentation: Right to recall - gives the bank (financier) the right to accelerate the outstanding payment by the defaulting customer. This...
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