Salam Alaikum,
Continuing with more on “Buy Now, Pay Later”
In continuing our discussion of “Buy Now, Pay Later” transactions, I wanted to let you all in on some of the nuts and bolts of contracts under Islamic law. As you know, contracts have form and substance, and they work hand in hand in determining the final ruling for something being permitted or not.
With regard to contract forms, Ibn Rushd al-Ḥafīd says in Bidāyat al-Mujtahid:
“Every transaction that occurs between two parties must be one of the following: an immediate exchange of goods, an immediate exchange of goods for an obligation of future payment, or an exchange of obligations. Each of these three can be either deferred or immediate. Furthermore, each of these can also be immediate from both parties, immediate from one party and deferred from the other, resulting in a total of nine types of transactions.”
basic building blocks for every contract
From this text, we can see that there are basic building blocks for every contract between two people.
Each of these components can be generally defined in the following way:
1. Goods (ayn - عين): Tangible assets or commodities that can be exchanged between parties. Goods refer to the physical, tangible assets or commodities that are being exchanged between the parties involved in the transaction. These can include items such as rice, fruits, cars, land, houses, shops, phones, laptops, or any other tangible property. Depending on whether or not these items are related to a proscribed category or not (like pork, alcohol, etc.) or a proscribed mode of exchange (whether the assets are fungible foodstuff/currency or not) may add additional restrictions to the transaction.
2. Obligations (dhimma - ذمة): Legal duties or commitments to deliver goods, services, or payments in the future. Obligations are the legal duties or commitments that one party owes to another in a transaction. These obligations can be in the form of delivering goods, providing services, or making payments. When a party incurs an obligation, they are legally bound to fulfill it according to the agreed-upon terms and conditions.
3. Immediate Timing (naajiz - ناجز): An immediate transaction is one where the exchange of goods or the fulfillment of obligations takes place on the spot or within a short period. In an immediate exchange, both parties perform their respective parts of the transaction simultaneously or close to each other in time.
4. Deferred Timing (nasee'a - نسيئة): A deferred transaction is one where the exchange of goods or the fulfillment of obligations is postponed to a later date. In a deferred exchange, one or both parties agree to perform their respective parts of the transaction at a specified time in the future, based on the agreed-upon terms and conditions.
nine logical results from this breakdown
These components can be logically combined into nine types of transactions, considering the timing of the exchange (immediate or deferred) and the nature of the items being exchanged (goods or obligations).
Goods for Goods:
1. Immediate exchange of goods from both parties: Exchanging a bag of rice for a box of fruits on the spot.
2. Immediate exchange of goods from one party, deferred from the other: Delivering a car immediately and receiving a piece of land after a month.
3. Deferred exchange of goods from both parties: Agreeing to exchange a house for a shop after a year.
Goods for Obligations:
4. Immediate exchange of goods for an immediate obligation of future payment: Buying a phone with the immediate obligation to pay cash for it within a week.
5. Immediate exchange of goods for a deferred obligation of future payment: Receiving a laptop immediately and incurring an obligation to pay for it after two months.
6. Deferred exchange of goods for a deferred obligation of future payment: Agreeing to deliver a car after a month and incurring an obligation to pay for it after two months.
Obligations for Obligations:
7. Immediate exchange of obligations from both parties: Immediately exchanging an obligation to deliver a shipment of goods for an obligation to provide a service.
8. Immediate obligation from one party, deferred obligation from the other: Immediately incurring an obligation to pay for a service, while the other party incurs an obligation to provide the service after a week.
9. Deferred exchange of obligations from both parties: Agreeing to exchange obligations of delivering goods and providing a service after a month.
with Type #1 above, there are three possibilities:
- When assets, excluding staple food commodities and currencies, are exchanged for cash, it is considered a regular sale. This is the most common type of transaction.
- When two parties exchange assets directly without involving cash, it is considered a barter transaction. This can include the exchange of commodities (e.g., oil for gold) or non-commodities (e.g., a car for a piece of land). If this involves staple food commodities, they must be different genera and traded at spot.
- When cash is exchanged for cash, it is typically classified as a currency exchange, especially if the transaction involves different currencies. For example, exchanging US dollars for euros would be considered a currency exchange. There are specific rules for this to be permitted, such as the counter-values being different currencies and the transaction being spot, not deferred.
We could also take these ideas of barter, sale, and currency exchange (which deal with the nature of the exchange), we could get 27 possible types of transactions between two parties.
how does this relate to
“Buy Now, Pay Later”?
Here’s an example for “Buy Now, Pay Later”:
- Party A sells a phone to Party B for 100 dollars.
- Party B puts $25 dollars down, and Party C steps in and completes payment to Party A of $75 dollars.
- Then Party C agrees that Party B will pay him $75 in 30 days.
- Party C also negotiates an exclusive rebate of $5 dollars from Party A.
There are three distinct contracts or transactions taking place. (note: we’re taking our legal forms rubric by Ibn Rushd above, and exploring where two or more seemingly separate transactions converge or interact.)
Contract 1:
Between Party A and Party B
- Party A sells a phone to Party B for $100.
- Party B pays $25 as a down payment.
This is a "Goods for Obligations" transaction, where the phone is immediately delivered by Party A, and Party B has an obligation to pay the remaining $75. Since Party B's payment is partial and deferred, it can be classified as "Goods for Obligations, immediate for one party (Party A), deferred for the other (Party B)."
Contract 2: Between Party A and Party C
- Party C pays Party A the remaining $75 on behalf of Party B.
- Party A gives Party C an exclusive rebate of $5.
This is an "Obligations for Obligations" transaction, where Party C immediately fulfills Party B's obligation to Party A, and in return, Party A has an obligation to provide a $5 rebate to Party C. This can be classified as "Obligations for Obligations, immediate for both parties."
Contract 3: Between Party B and Party C
- Party B agrees to pay Party C $75 in 30 days,
- as Party C has paid this amount to Party A on behalf of Party B.
This is an "Obligations for Obligations" transaction, where Party C has immediately fulfilled an obligation to Party A on behalf of Party B, and Party B now has a deferred obligation to pay Party C. This can be classified as "Obligations for Obligations, immediate for one party (Party C), deferred for the other (Party B)."
the Net result of this transaction
The net result of this is that Party A has successfully sold the phone and received the full payment of $100, albeit from two different parties. Party B has acquired the phone for $100 but has only paid $25 upfront, with an obligation to pay the remaining $75 to Party C within 30 days. Party C has effectively extended a short-term loan of $75 to Party B, which Party B must repay within the agreed-upon timeframe.
Additionally, Party C has negotiated a $5 rebate from Party A, which can be seen as a form of interest or compensation for facilitating the transaction and extending credit to Party B. This complex arrangement demonstrates how multiple contracts and obligations can be intertwined to enable a single transaction, with each party having different roles and responsibilities.
Of particular interest to us above is this sentence: "Additionally, Party C has negotiated a $5 rebate from Party A, which can be seen as a form of interest or compensation for facilitating the transaction and extending credit to Party B."
On the one hand, if Party B entered the transaction as a co-purchaser, then Party C paying them back would be a sale of ownership. If party B entered as an extension of interest free credit, then Party C paying them back would be a repayment of an interest free loan.
The relationship between party A and Party C in this situation would depend on how the transaction between Parties B and C is characterized. Was it extension of credit? Was it a sale? How can we tell the difference between the two?
determining the nature of “Buy Now, Pay Later”
To determine the nature of the relationship between Party A and Party C, we need to examine the transaction between Parties B and C more closely. The key question is whether the transaction between Party B and Party C is an extension of credit, or if it is a sale of ownership in the asset.
Extension of Credit:
If Party B entered the transaction as a borrower and Party C as a lender, then the transaction between them would be characterized as an extension of interest-free credit. In this case, Party C is essentially loaning Party B the $75 to complete the purchase, and Party B is obligated to repay this loan to Party C within 30 days. The $5 rebate from Party A to Party C could be seen as a form of compensation for facilitating the transaction and extending credit to Party B.
Sale of Ownership:
If Party B and Party C entered the transaction as co-purchasers, then Party C's payment of $75 to Party A would be considered a purchase of a partial ownership interest in the phone from Party B. In this scenario, Party B and Party C would be joint owners of the phone, with Party B owning 25% (based on their $25 down payment) and Party C owning 75% (based on their $75 payment). Party B's agreement to pay Party C $75 in 30 days would be seen as a purchase of Party C's 75% ownership stake, making Party B the sole owner of the phone after the payment is made.
To differentiate between these two scenarios, we need to look at the intentions and understanding of the parties involved:
- If there was an explicit or implicit agreement that Party C was loaning money to Party B, and Party B was obligated to repay the full amount to Party C, then it would be considered an extension of credit.
- If there was an agreement or understanding that Party C was purchasing a partial ownership interest in the phone, and Party B's future payment was to buy out Party C's share, then it would be considered a sale of ownership.
In practice, the distinction may be determined by factors such as the language used in the agreements, the ongoing relationship between the parties, and the economic substance of the transaction. Additionally, the $5 rebate from Party A to Party C would depend on the nature of the transaction between Party B and Party C. If it's an extension of credit, the rebate could be seen as compensation for facilitating the transaction and extending credit. If it's a sale of ownership, the rebate could be seen as a discount on Party C's purchase price, possibly reducing their ownership stake and possibility obligating them to pass along this discount to the original buyer (Party B).
but is “Buy Now, Pay Later” acceptable!?
You may be saying “I still want to know if Buy Now, Pay Later is acceptable!” and I understand your desire to walk away with a conclusive answer. I believe however, that when debating modern transactions, it is very important to not just dictate a conclusion for one particular application of Buy Now, Pay Later, but to realize that there are a number of ways that this type of transaction can be completed.
It could be an interest-free loan from Party C to Party B. In that case would it be permitted for Party C to negotiate a rebate from party A? It could be a sale of ownership from party C to party B. In this case, would it be permitted for Party C to extend the payment schedule and add to the price, like any other deferred asset sales?
More importantly, how do we determine the difference between the extension of credit secured by an asset under Islamic law, and the sale of an asset collateralized by itself under Islamic law?
To me there are a number of questions that still remain unanswered in order to make that determination:
1- What is the economic substance of a transaction? Why is the economic substance doctrine used when determining the characterization of a transaction? What are some factors that could influence this? What purpose does the economic substance serve in determining the true economic impact of the transaction?
2- Does Islamic law only recognize legal form, or does it also consider the economic substance of a transaction? How does the economic substance of a transaction differ from its legal form or structure?
3- What role does the economic substance of the transaction play in the scenario with Parties A, B, and C? How would the transaction differ if Party B bears the risk of ownership and the benefits of using the phone? What if Party C is acquiring a genuine ownership interest in the phone, with the potential risks and rewards that come with ownership?
4- What factors must absolutely be avoided in order to make such transactions permitted? Which are within the realm of legal discretion ? Can the force of law determine how such things are characterized? What are the implications of this, if we say this?
Next week, inshallah 😊
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