RESOLUTION No. 109(3/12)

"Penalty Provision"

Quote - The Council of the Islamic Fiqh Academy of the Organization of the
Islamic Conference in its Twelfth Session held in Riyadh (Kingdom of Saudi
Arabia) during the period from the 25th of Jumad Thani to 1st of Rajab 1421
H (23-28/9/2000).

And after considering the research papers on Penalty Provision presented to
it, and listening to the discussions of its members, experts and some other

Decides the following:

Firstly:        A Penalty Provision in legal terminology is a condition
agreed to by the two parties of a contract as to how compensation
stipulated for one of them in case of default or delay from the part of the
other can be assessed.
Secondly:The Council confirms its previous resolutions regarding Penalty
Provision including the following:
·Its Resolution No. 85 (2/9) on Salam which stipulates that "it is
impermissible to include a Penalty Provision for delay of providing the
commodity since a commodity sold through Salam is a debt and it is
impermissible to impose an additional charge for delayed repayment of debt."
·Its Resolution No. 65 (3/7) on Istisna'a which stipulates that, "It is
permissible to include a penalty provision in the Istisna'a contract except
for inevitable circumstances."
·Its Resolution No. 51(2/6) on Instalment Sale which stipulates that "When
the purchaser delays payment of due instalments no additional charge should
be imposed on him whether by virtue of a predetermined condition or
otherwise. Such a practice amounts to commitment of prohibited usury."
Thirdly:It is permissible to include the Penalty Provision in the original
contract or make it as a separate agreement that succeeds the contract and
precedes the occurrence of the anticipated loss.
Fourthly:It is permissible to include a Penalty Provision in all financial
contracts except when the original commitment is a debt. Imposing a Penalty
Provision in debt contracts is usury in the strict sense.
Consequently, it is permissible, for instance, to make a Penalty Provision
on the contractor in contractual agreements, the deliverer in delivery
contracts and the manufacturer in Istisna'a contracts who fails to or delay
in meeting his commitments.
Whereas it is impermissible, for instance, to make a Penalty Provision in
Instalment Sale on a debtor who delays repayment of outstanding
instalments, whether due to insolvency or payment evasion. It is also
impermissible to impose such a provision in the Istisna'a contract on a
purchaser who delays or fails to meet his obligations.
Fifthly:The loss that may be compensated includes actual financial loss
incurred by the partner, any other material loss and the certainly
obtainable gain that he misses as a result of his partner's default or
delay. It does not include moral losses.
Sixthly:The Penalty Provision should become null and void when the
concerned partner proves that his failure to meet obligations was due to
reasons that fall out of his control, or when he proves that no loss has
been incurred by his partner as a result of his breach of the contract.
Seventhly:The Court may, if so required by one of the two parties, adjust
the amount of the compensation, subject to a reasonable justification, or
when the compensation proves to be exaggerated.
The Council recommends convening of a specialized seminar to work out the
conditions and arrangements that could enable the Islamic banks to
guarantee collection of their outstanding debts.
And Allah (S.W.T.) knows better. Unquote

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