Penalty and Compensation in Financial Commitments - A Critical Shariah Review

Abstract

Purpose: The aim of this paper is to critically review the position of Shariah and contemporary ijtihād on penalty provisions in financial commitments. It is also to show that some relevant fiqh resolutions have dealt differently with similar issues despite the absence of any grounds for such differentiation and to show how penalty provision in contracts has been expanded to include what cannot be accommodated by Shariah principles. All this necessitates a review of those stances, as they may have both unnecessarily burdened the Islamic finance industry and challenged some Shariah principles.

Methodology: This paper employs a qualitative research methodology that adopts textual and fiqh comparative analysis approaches. The methodology also incorporates a macro perspective for treating the subject by analyzing the issues being examined from the perspective of Maqāṣid al-Shariah (Shariah objectives) in consideration of existing market practices and needs.

Findings: This study primarily indicates that penalties or compensation provisions in contracts are accepted if they are intended to prevent actual harm rather than for gain, because profiting merely through stipulation is forbidden in Islamic law.

Originality: Although this paper addresses an issue that has been addressed before, it acquires significance and value by setting the basis for what constitutes a valid penalty provision in Islamic finance and by showing areas of conflict and inconsistency in some of the contemporary stands on the matter, thus necessitating a review of these stances.