5. You will be able to understand.
o Definition of istisna
o Subject matter in istisna
o Contracts in istisna
o Penalties in istisna
o Difference of istisna from salam and Ijarah
o Application of istisna in Islamic banks
6. The word istisna is derived from the word Sana'a which literally
means "making, manufacturing or constructing something.“
Definition:
Istisna is an agreement in a sale at an agreed price whereby the
purchaser places an order to manufacture, assemble or construct (or
cause so to do) anything to be delivered at a future date.“
7. There are two parties in istisna
1. Sani
2. Mustani
Sani: The person who makes it is called sani'.
Mustani: person who causes it to be made
called mustani.
Masnu: the thing made called Masnu.
8. The contract is valid only for those objects that have to be
manufactured or constructed.
The subject of Istisna (the thing to be manufactured or constructed)
must be known and specified to the extent of removing any
ignorance or lack of knowledge of its kind, type, quality and
quantity.
In Istisna„a, the manufacturer arranges both the raw material and the
labour.
An Istisna„a contract may be drawn for real estate developments
Invalid subject matter.
. It is invalid for natural things or products like animals, corn, fruit,
etc.
It is not permissible that the subject matter of an Istisna„a contract
be an existing asset.
9. An Istisna„a contract must be:
definitely state in clear terms and conditions
Price must be specified
Quality and quantity of goods, the type, dimensions, period
and place of delivery of the asset
The asset can be manufactured or produced by any or a
specific manufacturer, or manufactured from specific
materials
10. The price in Istisna„a can be in the form of cash, any tangible
goods or usufruct of identified assets.
The price should be known in advance to the extent of
removing ignorance or lack of knowledge and dispute.
It is permissible that the price of Istisna„a transactions varies
in accordance with variations in delivery date.
The price, once settled, cannot be unilaterally increased or
decreased.
It is not necessary in Istisna„a price is paid in advance.
The price can be paid in installments within the agreed time
period and can also be linked with the completion stages.
11. Istisna contract also contain the penalty clauses:
an agreed amount of money for compensating the purchaser adequately if
the manufacturer is late in delivering the asset
It is not permitted to stipulate a penalty clause against the purchaser for
default in any payment because this would be Riba.
In Fiqa
This principle is termed Shart-e-Jazai (penalty condition), or the condition
of decreasing the price on account of a delay in delivery of the subject
matter of Istisna .
13. The Hanafi jurists generally divide the binding effect of this kind of contract into
three stages.
At the first stage, where the work of manufacturing has not yet started.
At the second stage, the manufacturer may finish making the needed
goods, but the purchaser has not seen the manufactured object yet.
The third stage is when the required goods have been manufactured and
presented to the purchaser.
In third stage Muslims scholars have different opinions:
AI-Imam Abu Hanifah is of the opinion that the purchaser can exercise
his option of inspection (Khiyar-e-RoiyyaT) after seeing the goods.
Abu Yusuf, a follower of Abu Hanifah, opines that if the commodity was
in conformity to the inspections agreed upon between the parties at the
time of the 'contract, the purchaser is bound to accept the goods and he
cannot exercise the option of inspection (khiyar al ru'yah).
15. In the case of general conditions, the istisna' sale must fulfill the requirement
of a valid contract as discussed by the jurists:
The capacity of the contracting parties
The subject-matter
Offer and acceptance
16. 1. The object must be precisely determined both in its essence and quality.
2. The recommended manufactured goods should be things that people
customarily deal with in the field of manufacture. Otherwise, the contract
of istisna' will be invalid.
3. It is a condition that the time of delivery is specified whether it is short or
long so as to avoid ignorance, which might lead to conflict between the
two parties.
4. The materials should be supplied by makers, if they are supplied by the
buyer, the contract is regarded as al Ijarah and not istisna'.
5. It is a condition that the place of delivery is stated if the commodity needs
loading or transportation expenses.
17. Two contracts are involved :
Contract-1
Islamic Bank Manufacturer
contract-2
Third party Islamic Bank
As a buyer
Istisna contract
As a supplierAs a buyer
Parallel Istisna
Delivery of commodity
Delivery of commodity
18. 1. There must be two different and independent
contracts, these two contracts cannot be tied up and
performance of one should not be contingent on the
other.
2. Parallel Istisna is allowed with third party only.
19. Work in Process:
Before the manufacturing both of the parties have the right to
rescind the contract.
Once the seller/manufacturer initiates the work, only changes can be
done with mutual consent.
The purchaser will make the payment as per the agreed schedule
and the manufacturer/seller will supply the asset as per the
specifications agreed.
. If the subject matter does not conform to the specifications agreed upon,
the customer has the option to accept or to refuse the subject matter.
21. 1. Before delivery of the asset to the purchaser, it will
remain at the risk of the seller.
2. After delivery, risk will be transferred to the purchaser.
3. Possession of goods can be physical or constructive.
4. If manufactured goods are delivered before agreed date,
purchaser can refuse to accept the goods.
5. If the condition of the subject matter does not conform
to the contractual specifications at the date of delivery,
the ultimate purchaser has the right to reject the subject
matter or to accept it in its present condition.
22. Potential areas are;
financing the construction industry –
apartment buildings, hospitals, schools and
Universities;
Development of residential/commercial areas
and housing finance schemes;
• financing high technology industries such
as the aircraft industry, locomotive and
shipbuilding Industries.
23.
24. MitigatesRisk
Security is available with
the bank.
The Islamic bank is not the
owner of the materials in the
possession of the
manufacturer for the purpose
of producing the asset. It can
have no claim on it in the case
of any nonperformance.
Ownership of
material
1.
On the basis of the rule
of “Shart-e-Jazai”, the
bank can put in the
Istisna agreement a
clause to reduce the
Istisna price in the case
of delay.
The bank may be unable to
complete the manufacturing
of goods as scheduled due to
late delivery of completed
goods by the subcontractor in
Parallel Istisna.
Delivery risk2.
25. MitigatesRisks
The bank can take a
“promise to purchase”
from a third party and
can make
arrangements for sale
through agency.
Sale of Istisna goods is not
allowed before taking
physical possession. This
may lead to asset, price and
marketing risk
Sale not
permissibl
e before
delivery
3.
The manufacturer can
be asked to rectify
the defect.
The Manufacturer delivers
defected/inferior goods,
which is realized by
purchaser.
Quality
risk
4
27. When manufacturer makes the commodity and presents it to the
purchaser and receives the payment.
the jurists are of the opinion that the contract of istisna' can be
terminated by the death of one of the contracting parties.
But nom a days!
There are large corporation the manufacturer is not a single person.
Therefore it is not applicable the contract will be ended by the
death of one or two persons.
it will continue as long as the corporation or company is in existence
28. SalamIstisnaNo.
The Salam subject can be either
natural products or manufactured goods.
The subject of Istisna is always a
thing which needs
manufacturing.
1
The price has to be paid in full in advance.The price in Istisna does not
necessarily need to be paid in
full in advance.
2
Penalty for late delivery shall go to charity and
the P&L Account of the purchaser (bank) will be
unaffected
Penalty in the form of a
reduction in price on account of
a delay in delivery will reflect the
income of the purchaser (the
principle of Shart-e-Jazai
approved by the jurists.)
3
Salam is a binding contract; once executed, it
cannot be rescinded without the consent of the
other.
As long as work has not started,
Istisna is nonbinding; any of the
parties can revoke the contract.
4
29. IjarahIstisna
The manufacturer on an Ujrah
basis uses the material provided by the
buyer and he is paid the agreed wages.
The manufacturer uses his own
materials and the sale price is
fixed.
1
Ijarah can be only on those assets
the corpus of which is not consumed
with use.
Istisna can be of anything that
needs manufacturing.
2
In Ijarah, asset risk remains with
the owner (lessor) and the lessee
has to give rental only if the assets
capable of being used as per normal
market practice.
In Istisna, asset risk is
transferred to the purchaser
soon after delivery of the item
to him and he has to pay the
price irrespective of what
happens to the asset.
3
31. Housing Finance through Istisna:
Rs.5million+rent
over a period of 5ears
Istisna-Housing Finance during Construction Phase
Bank Rs.5M
Diminishing
Musharakah
Rs.2M Customer
Deferred
Spot
Constructer
Spot
32. 1. Suppose a builder/contractor C has announced a scheme
for the construction and sale of apartments costing Rs. 7
million each. (He demands cash and has no financial
relationship with the bank.)
2. Client A decides to have an apartment; he has Rs. 2 million
and needs financing from bank B of Rs. 5 million for ten
years.
3. A and B create a Musharakah pool of Rs. 7 million under
the principle of Shirkat_ul_ milk and jointly enter into Istisna
agreements with C for the construction and sale of an
apartment of defined specifications and pay Rs. 7 million in
four installments.
33. 4. C starts building the apartment as per the requirements of
the Istisna contract.
5. The bank appoints A its agent to supervise the
construction work.
6. C hands over the apartment to A; B leases out its part of
ownership to A in rent.
7. A purchases one unit of the bank‟s part every month; the
rental starts decreasing after each payment and after ten
years, the bank‟s investment is redeemed and ownership is
transferred to the client.
35. 1. Client A gets an export order for the export of ready-made
garments of value Rs.110 million.
2. A approaches bank B for financing and indicates that he has the
expertise to prepare the consignment.
3. B enters into an Istisna agreement with A for the supply of
garments of a specified nature for Rs. 100 million within a period of
three months. This contract will be a sale; A will make delivery at
the agreed time.
4. B also appoints A its agent for export of the garments when they
come under its ownership.
5. A foreign importer opens an L/C of value Rs. 110 million in the
name of B (the L/C can also be in the name of A but that would be
under an agency agreement). If an L/C has already been opened,
Istisna is not possible (avoiding Bai„ al „Inah).
36. 6. A prepares the garments and informs B to take delivery; the bank takes
actual/constructive delivery of the garments and henceforth the garments
come under its risk/liability.
7. A exports the consignment as agent of B, sending documents on behalf of
B. B gets Rs. 110 million, as per the terms of the L/C.
37. The above discussion can be safely concluded that
istisna contract in Islamic Commercial Laws is one of
the important methods of investment in Islamic
banking and can play an important role in economic
development. It encourages the demand for
manufacturing goods, financing economic activities,
contributing to the stabilization of prices of
manufactured goods, promoting industrial and
technological advancement and making use of the
available possibilities of the economy.
38. Meezan Bank's Guide to Islamic Banking by Dr. Imran
Ashraf Usmani.
Istisna in Islamic Banking: Concept and Application by
Joni Tamkin Borhan.
Understanding Islamic Finance by Muhammad Ayub.
AAOIFI, 2004–5a, clauses.
Muhammad al-Bashir, op.cit, pp. 80-82.
Majallah al-Ahkam al- 'Adliyyah, Art. 388.
Draft Shariah Parameter Reference5:Istisna Contracts
by Central Bank Of Malaysia
Istisna by Al Maali Islamic Finance Training &
Consultancy
Islamic Banking and Finance By Mufti Muhammad
Taqi Usmani.
