Requirements for a valid investment contract in Shariah

In-Depth Analysis

What is the difference between Islamic sale and lease contracts and Islamic investment contracts? While entering into an Islamic sale contract, the seller comes to know at the same time as to how much profit he/she is making from the transaction, or the extent of the loss he/she is bearing if the sale is below cost due to some reason. In an Islamic investment contract, the investor or investors shall not be in a position to ascertain the financial benefit (or otherwise); they will derive from the contract at the time of entering into the contract. Contrary to the spot sale contract where the parties part ways immediately after the transaction is completed, the parties in an Islamic lease contract or Islamic investment contract remain engaged for a longer period of time. Conditions that make an investment contract invalid from the Shariah angle: Converting a debt owed by a party to another as the capital contribution from the indebted party to the investment contract. This is because the Shariah principles require fresh capital to be introduced by the contracting parties in an investment contract, be it in cash or in kind. Another reason for rendering an investment contract void is a guarantee provided by one party to protect the capital and/or the amount of periodic profit of the other party. However, if a party provides a certain guarantee to the other party to be claimed in a situation where the party giving the guarantee has brought loss to the joint investment due to negligence, this will be acceptable under Shariah principles. A condition that a party shall be entitled to sweep the entire profit until it has recovered a certain level of return on its investment shall also make the investment contract invalid. This is due to the fact that it will be tantamount to seeking a fixed monetary gain on the investment. Another aspect which makes an investment contract repugnant to Shariah principles is the absence of the profit distribution ratio between the parties, and leaving it to be decided at a later date when the profit is required to be shared.