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Dr. Necmeddin Guney ( نجم الدين كوناي. د )IRTI Visiting Scholar
Necmettin Erbakan University, Konya, [email protected]/02/2018 Tuesday
Theory of Legitimate Profit
in Islamic Law
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◊ Introduction
◊ Literature Review
◊ Cause of Profit in Conventional Economics
◊ Islamic Framework for Legitimate Profit
➢Hanafi Theory of Damān (الضمان)
➢Reflections of «Daman» on Different Transactions
➢Reasons for Profit in Partnerships
◊ Conclusion
Outline
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◊ Importance of «profit»➢ the focus of entrepreneurial activity
➢ needs to be understood in terms of its causes and legal entitlement
◊ Definition of «profit»➢ simply: the total cost deducted from total revenue
➢ «income» = gross revenue; «profit» = net revenue
◊ Mainstream economics➢ one of the core issues of mainstream economics
➢ the «price theory» is backed by the assumption of ‘profit maximization’.
Introduction
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◊ Early economists➢ focused on factors related to the rate or share of profit (rather than its
cause)
➢ have associated profit very closely with interest.
◊ Major attempts to understand the cause of profit ➢ J. B. Clark (1908), Schumpeter (1912), Frank H. Knight (1921)
➢ profit: a result of «dynamic changes triggered by various factors/elements in society»
➢No exhaustive work after Knight; only book chapters and articles
Literature Review
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◊ Islamic economics literature on profit➢ in the field of distribution: mainly focused on interest, rent and wages.
➢ a framework regarding profit: mostly neglected
➢ English (a few)❖more focused on economics side, superficial in terms of shariah
❖ Papers by Zubair Hasan (1983, updated 2008) and M. Imran Ismail (2007)
❖ Book by Zubair Hasan (2017)
➢ Arabic❖ better detail and focus on the shariah side
❖More than 10 books/dissertations
➢AAOIFI regulations (many referances to profit), IIFA (International Islamic Fiqh Academy) on limiting profit, SAC’s of different countries or IFI’S
Literature Review
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◊ Major attempts to understand the «cause of profit»➢ several theories of profit came into existence.➢ profit is a result of dynamic changes that occur in ‘no-profit’ models (econ.
equilibrium)➢ theories adopted different reflections of change➢ no consensus with respect to the true nature and origin of profit.
◊ J. B. Clark (1908): ‘risk of losing capital’ that is inherent in «change»
◊ Schumpeter (1912):➢ cause of profit: innovation that creates change➢ Innovations involve risk, give an advantage over competitors.➢ (over time innovating has passed from individuals to research centers and
teams)
Cause of Profit in Conv Economics I
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◊ Frank H. Knight➢BOOK: Risk Uncertainty and Profit (1921, last update 1957)
➢complemented Schumpeter’s theory (‘innovation’) by going into detail
➢real cause of profit: «uncertainty showing up during innovation»
➢made a distinction between «measurable risks» that can be insured against and «immeasurable risks» = uncertainty.
➢profit is the reward of making decisions and bearing “uncertainties” that cannot be measured and insured against
➢ two essential qualifications of entrepreneurship: «sound judgment» and «liability to loss»
➢«sound judgment» can be delegated to competent managers, «liability to loss» is inevitably bound to the person of the entrepreneur. = liability has a fundamental role in gaining profit.
◊ Today➢ focus shifted from the entrepreneur to the firm/corporation.
➢ decision making is distributed among a large number of independent functionaries
➢ corporations are owned by stockholders (= liability to loss)
Cause of Profit in Conv Economics II
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◊ Islamic approach
➢ encourages entrepreneurial activity and making profit
➢ principles and limitations/rules for legitimate profit
◊ Schools of Islamic law
➢focus on legal/ethical entitlement for revenue or profit.
➢have tried to determine the cause/basis (mabda’) for earning profit.
◊ Stipulations for Legitimate Profit in Islamic Law
➢ Negative Stipulations: No riba, gharar, gambling/bet, monopoly, deceiving etc.
➢ Positive Stipulations: Presence of a legitimate basis for profit [details will be provided]
Islamic Framework for Profit
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◊ Damān is bearing the results of damage & loss and fulfilling the responsibilities.
[in short: assuming the liabilities & responsibilities of sth]
◊ Hanafi’s placed the concept of damān at the root of the entire contract law.
◊ The theory is based on hadiths that link revenue/profit to contractual liability
(damān).
➢Al-Kharaj bi al-daman: “Revenue is acquired through a liability for loss (damān)”
❖ The output of sth belongs to the one who assumed the liability of loss.
➢al-Ghunm bi al-ghurm: means basically «profit is linked to loss»
➢The Prophet (s) prohibited «ribh ma lam yadman»: earning profit without
assuming/undertaking any liability
Hanafi Theory of Damān I (ضمان)
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◊ The concept of damān, in this broad manner, is applicable to both
fixed revenue and profit generating enterprises.
◊ Daman that gives birth to profit must be related either to
➢ capital/ownership (daman al-milk)
➢ some work that the person does (daman al-amal)
➢ the credibility of doing business with people (even if the person has no
money).
Hanafi Theory of Damān II
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REFLECTIONS OF «DAMAN» ON
DIFFERENT TRANSACTIONS
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◊ Loans are given by advancing the ownership of the principal amount from the lender to the borrower.
(= liability transfer)
◊ Permissible fixed returns like RENT have the element of damān, i.e. liabilities & responsibilities that
originates from ownership.
◊ Partnership contracts like mudaraba or musharakah must be solely based on a PROPORTIONATE
SHARING OF PROFIT. It is not permissible:
◊ to determine a certain money for any of the parties involved.
◊ to ask for a guarantee for the capital or a promise for guaranteed profit
◊ for one party to safeguard the other party against exchange rate fluctuations
◊ an agreement beforehand on «exit at nominal value»
Daman in Capital Revenue: Profit vs. Interest
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◊ Trading wares and goods involves ownership (damān al-milk: damān rising from this ownership)
◊ If the sold item is under the ownership of the seller, the profit is also for the seller as he/she bears any potential harm to the goods.
◊ This rule results in one of the important requirements of Murabaha. Among the requirements of a valid murabaha: ➢“It is obligatory that the Institution’s actual or constructive possession of the item
be ascertained before its sale to the customer on the basis of Murabahah.”
➢ Explanation: “The condition that possession of the item must be taken by the Institution (before its onward sale to the customer) has a specific purpose: that the Institution must assume the risk of the item it intends to sell. This means that the item must move from the responsibility of the supplier to the responsibility of the Institution. (…)” (The AAOIFI Shariah standard No: 8)
Daman in Trade and Business
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◊ Damān arises here out of ownership since the owner is fully responsible of maintenance of the property so that it continues to present its usufruct. When this fails, the ijara contract is terminated by itself.
◊ Some muslim researchers have objected «ijara of land» on the basis of damān. They have seen charging rent for land as identical to charging interest for money lending.
◊ Four schools of the schools of Islamic law have regarded it as permissible. There are a few opposite narrations from the Prophet (s) but most of the related material is positive about renting of cultivable land.
◊ Identifying land rent with interest is also logically unacceptable. There are at least two substantial differences
➢Money lending, as explained, is a transfer of ownership while renting land is a transfer of usufruct only.
➢Money is a medium of exchange while land is a real factor of production.
Daman in Ijarah of land or property
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◊ The Shafii and Zahiri’s: ONLY CAPITAL
➢They limit enterprises to those based on capital/wealth.
➢Work and liability are not regarded as a valid basis for partnership.
◊ Maliki’s: CAPITAL / WORK➢Also valid: Parnerships based solely on work like sharikat al-abdan i.e. partnership between
laborers or artisans.
◊ Hanafi’s & Hanbali’s: CAPITAL / WORK / LIABILITY➢ Investing capital (māl), labour (‘amal; as a proxy for wages), or assuming liability for
damages (damān).
➢They permit different types of non-monetary partnerships.
◊ AAOIFI Shariah Standards adopted the latter view (cf. AAOIFI Shari’ah Standard No. 12/2.1)
Basis for Profit in Partnerships
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◊ AAOIFI regulations to protect Daman:
◊ “It is not permitted that the conditions or modes of profit allocation in a Sharikahcontract include any clause or condition that may result in the probable violation of the principle of sharing profit. (AAOIFI Shari’ah Standard No. 12/3.1.5.7)
◊ “It is not permitted to stipulate that a partner in a Sharikah contract guarantees the capital of another partner.” (AAOIFI Shari’ah Standard No. 12/3.1.4.1)
◊ The proportions of losses must always be commensurate with the proportions of their contributions to the capital.
◊ What if some of the partners contribute more in managing the funds or providing other services like accounting?
➢AAOIFI has choosen the view of Hanafi and Hanbali’s, that they may be given more percentages in profit, provided that “it is not in favour of a sleeping partner.” (AAOIFI Shari’ah Standard No. 12/3.1.5.3)
1. Musharakah (Capital Partnership)
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◊ One party (Rab al-Mal) provides CAPITAL and the other party (Mudarib)
provides ENTREPRINEURSHIP/WORK.
◊ The capital owner must bear the daman of the capital. Two situations
where this condition is not fulfilled:
➢ Transfer of damān (warranty) to the mudarib by stipulating in the contract:
❖ consensus: impermissible (different views on its effect on profit distribution)
➢ Transfer of damān due to the agression or negligence of the mudarib in
protecting the capital (yad al-amanah turns to yad al-daman)
❖ the warranty of the capital passes to the mudarib.
❖ If a loss occurred, the mudarib may be hold liable for the loss of capital but not the profit
(AAOIFI Shari’ah Standard No. 45/3.7)
2. Mudaraba (Silent Partnership)
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◊ Two or more workers/professionals agree to contribute their labour to a joint enterprise and share the earnings.
◊ The partners assume a liability to perform (damān al-amal). Each partner is liable and bound for the performance of work the other partner has agreed to.
◊ Shafiis and Zahiris have opposed this contract since they don’t see labor as a legal basis for gaining profit in partnerships.
◊ The entitlement to compensation is linked both to the liability to perform a specific work (damān al-amal) and the actual work done by the partners.
◊ Hanafis and a view from Hanbalis see damān al-amal as the reason for entitlement to profit, whereas Malikis and Hanbalis see work itself as the reason.
◊ The result of this disagreement is that, according to the first group the profit can be shared according to the condition in the partnership agreement whereas the latter group argues that it has to be shared according to the work done by partners.
3. Sharikat al-A’mal (Partnership of Services)
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◊ Partners don't contribute any capital but agree to purchase goods upon
their personal credit and to sell them through their joint efforts.
◊ Hanafi’s and Hanbali’s have accepted this type of partnership. The other
schools of law opposed it since they do not see «pure daman» as a legal
basis for gaining profit in partnerships.
◊ Hanafi’s: the percentage of profit and loss must be the same.
◊ Hanbali’s: percentage of profit and loss may be different.
4. Sharikat al-Wujuh (Partnership of Creditworthiness)
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◊ Trading in Currencies
◊ Investment agency (al-Wakalah bi al-Istishmar) - fee
◊ Charging for «money order»
◊ Brokerage or middleman's fees
◊ Network Marketing? →→→→→
Use of the Theory in new Issues
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New Issues
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◊ The concept of Damān is at the root of the entire contract law.
◊ Money and work are independent sources for profit whereas daman
(warranty) is a dependent source that creates its effect either with
money or work. Risk itself is not an independent reason for profit.
◊ If one of these factors are present and there is no other element
that violates Islamic principles, profit is legitimate.
CONCLUSION
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QUESTIONS?
COMMENTS?
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Contacts of the presenter Contacts of IRTI
Website: www.irti.org
Phone: +966 (0)
126466377
Fax: +966 (0) 126378927
P.O. BOX 9201 - Jeddah
21413
Kingdom of Saudi Arabia
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Dr. Necmeddin Guney( نجم الدين كوناي. د )
[ IRTI Visiting Scholar ]
Assistant Professor, Islamic Law Department,
Necmettin Erbakan University, Konya, TURKEY
