- Name : Bai Salam Contract
- Definition : Financing for future delivery (order)
- Transaction : Future Sale
- Category : Debt
- Secondary contract : nil
- Commonly used for : Agricultural financing, Working Capital Financing
WHAT IS BAI SALAM?
Bai Salam is a form of forward contract when the price for an asset is paid upfront at the time of the contract for an asset or commodity to be delivered later. it can also be defined as the sale where the Asset/Commodity is delivered on a deferred basis in exchange for the Price be paid immediately.
This is different from the idea of Murabahah where the Price is paid of deferred basis but Asset is delivered immediately.
The basis of Islamic Banking is based on the premises of an existence of an underlying asset. The asset itself must have the following attributes:
- Firstly, the asset must exist. Therefore, an asset which does not exist at the time of sale cannot be sold.
- Secondly, the seller should have acquired the ownership of that asset. Therefore, if the asset exists, but the seller does not own it, he has no right to sell it.
- Thirdly, mere ownership is not enough. It should have come into the possession of the seller, either physically or constructively. If the seller owns an asset, but he has not taken its delivery himself or through an agent, he cannot sell it.
The only exception to this rule is the contract of Bai Salam (Trust Sale) and Bai Istisna (Order Sale). These two contracts deal with the sale transaction involving an asset which is at the point of contract, is non-existance.
BASIS OF BAI SALAM
The basis of Salam comes from the traditions of the Prophet p.b.u.h. when the Prophet p.b.u.h. observed in Madinah the practiced of people paying in advance the price of fruits to be delivered within one, two or three years. The sale, however, did not specify the quality measure or weight of the dates at the start of the contract. The Prophet p.b.u.h. ordained that “Whoever pays money in advance (for fruits) (to be delivered later) should pay it for a known quality, specified measure and weight (of dates or fruit) of course along with the price and time of delivery” (Reported by Imam Bukhari, Muslim and others)
Salam therefore addresses the necessity of liquidity and the protection of rights of the buyer.
WHY IS BAI SALAM IMPORTANT?
Salam contributes to the economic well-being as it removes the liquidity shortages of one party and solves the requirement of a buyer once the asset / commodity is delivered. The contract also allows for large economic activities as the Salam contract usually involves substantial amount of funds.
It also forces one party to put forward a substantial amount of economic trust between the fund provider and the party who delivers the asset / commodity. In the modern sense, this means that the contract provide for a price hedge for the buyer and cost hedge for the party who delivers the asset / commodity.
In short, Salam allows for the future delivery of an asset / commodity at a lower cost as the funds for the asset / commodity is made available at the start of the contract.
CONDITIONS TO SALAM
Because the Salam contract deals with the delivery of an asset which is not in existence, the Shariah highlights that strict rules must be adhered to in order to ensure that the right of all parties are protected. Among the rules of a Salam include:
- The seller undertakes to supply a specific asset at a future date in exchange for full on the spot payment (in advance) at the start of the contract.
- The object of the sale (asset) becomes a debt at the point of contract, thus the payment cannot be delayed.
- The capital of Salam can be money, services or rights (usufruct).
- The object of the exchange must be fungible i.e. can be specified according to weight, size, volume, colour, quantity, quality or grade. It can also be a well defined service. The object can also be substitutable in the market and can be obtained although not in the sellers possession at the point of contract. The object of exchange cannot be paper money as it is not a commodity / asset.
- Salam cannot be valid for assets with changing values from different assessments. Values must be fixed.
- The place and time of the delivery must be specified. Delivery in instalments is allowed, if agreed by all parties. Early delivery is allowed if all parties agreed and no parties are disadvantaged.
- Salam must be concluded with actual physical delivery.
- The seller of the asset need not be the manufacturer or producer of the asset. The seller may be an agent to deliver the asset.
- The Salam is conclusive and binding upon the full payment for the sale at the start of the contract. The terms can only be reviewed and changed with consent of both parties.
- Before delivery of the asset, the risks on the asset lies with the seller and upon delivery, the risks are transferred to the buyer.
- Upon delivery of the stipulated asset, the buyer is obligated to take possession of the asset if the asset delivered according to agreed specifications. For such delivery, the seller is liability to the contract is absolved.
- If the assets to be delivered consist of different assets at different values or description, the assets must be detailed as far as possible to avoid dispute.
- The buyer can enter into a similar contract with a third party in a parallel Salam. This parallel contract is independent from the first Salam contract.
- A parallel Salam is usually practiced in modern times where Banks are entities which are not involved in agricultural endeavours. Therefore, to deliver the commodity or goods with a customer, the Bank goes into a parallel Salam with a third party supplier of commodity or goods to deliver the same on the expected delivery date.
- For example, the customer requires 1000 tonnes of rice to be delivered in 6 months time at a specific price RM5000 and enter into a Promise to Purchase.
- For Parallel Salam:
- Salam #1 : the Bank goes into the Salam contract with a third party supplier to deliver 1000 tonnes of rice in 6 months at RM4500
- Salam #2 : the Bank goes into the Salam contract with Customer to deliver 1000 tonnes of rice in 6 months at RM5000
- The Bank will earn the differential of RM500.
DIFFERENCES BETWEEN SALAM AND ISTISNA’A
There are several points of difference between Istisna and Salam which are summarized below:
- The subject of Istisna is always a thing which needs manufacturing, while Salam can be effected on any thing, no matter whether it needs manufacturing or not.
- It is necessary for Salam that the price is paid in full in advance, while it is not necessary in Istisna. Payment for Istisna can be made in staggered basis.
- The contract of Salam, once effected, cannot be cancelled unilaterally, while the contract of Istisna can be cancelled before the manufacturer starts the work.
- The object of the Salam is a liability on the seller to deliver, thus should be in the form of fungible goods i.e. easily replaced from the market should the seller be unable to deliver. Under the Istisna, the asset manufactured must meet specification of the order and the buyer has the right not to take possession of the asset if the specifications are not met.
- The time of delivery is an essential part of the sale in Salam while it is not necessary in Istisna that the time of delivery is fixed. Any penalty for charged late delivery can reduce the price of an Istisna contract but in a Salam, the penalty amount is paid to charity (not taken as benefit for the buyer).