Islamic Contract – Bay’ al-Istisnā‘: Avoidance of Sale and Buyback Transactions ( Bay‘ al-‘Īnah ) in Ordinary and Parallel Istisnā‘

Islamic Contract – Bay’ al-Istisnā‘: Avoidance of Sale and Buyback Transactions (Bay‘ al-‘Īnah) in Ordinary and Parallel Istisnā‘
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Q1: Why must istisnā‘ avoid bay‘ al-‘īnah?

Answer:
Islamic finance requires istisnā‘ transactions to involve:

• genuine manufacturing;
• real ownership transfer; and
• actual commercial risk.

If the arrangement merely circulates assets between the same parties to obtain financing, it may resemble:
bay‘ al-‘īnah (sale and buyback transaction),
which many scholars prohibit because it may function similarly to an interest-based loan.
For this reason, AAOIFI imposes safeguards to prevent:

• artificial transactions;
• circular ownership structures; and
• disguised financing arrangements.

AAOIFI Position
According to AAOIFI Shariah Standard (Para 2/2/4):

• the manufacturer cannot be the ultimate purchaser; and
• the ultimate purchaser cannot own more than one-third of the manufacturing facility.

This ensures:

• independence between contracting parties;
• genuine transfer of ownership and risk.

BNM Position
The BNM Policy Document on Istisnā‘ is:
silent on this specific restriction.
However:

• transactions must still remain genuine and Shariah-compliant.

PART A — Ordinary Istisnā‘
1. Normal Ordinary Istisnā‘ (Permissible)
Structure
Only two parties:

• purchaser (mustaṣni‘);
• manufacturer (ṣāni‘).

Example
A hotel company orders customised furniture from an independent furniture manufacturer.
Contract Details

• Furniture manufacturing price: RM500,000
• Delivery period: 6 months

The manufacturer:

• supplies materials;
• manufactures furniture;
• delivers completed furniture to hotel company.

Analysis

• Independent parties.
• Genuine manufacturing.
• No buyback arrangement.
• Real transfer of ownership and risk.

Result
✅ Valid ordinary istisnā‘.


2. Ordinary Istisnā‘ Involving Sale and Buyback (
Bay‘ al-‘Īnah)(Problematic)
Example
A company owns a furniture manufacturing factory.
The same company:

1. asks its own factory to manufacture furniture under istisnā‘;
2. then “purchases” the furniture from the factory through financing arrangement.

Ownership Structure

• Customer owns 90% of manufacturing company.

Analysis
Although two legal entities appear to exist:

• economically they are substantially the same party.

This creates concern that:

• no genuine commercial transfer occurs;
• transaction merely simulates financing.

Result Under AAOIFI
❌ Generally prohibited due to resemblance to bay‘ al-‘īnah.


PART B — Parallel Istisnā‘
1. Normal Parallel Istisnā‘ (Permissible)
Structure
Two separate independent contracts.


First Istisnā‘ Contract
Between:

• customer;
• Islamic bank.

Contract Price
RM20,000,000
The bank promises to deliver:

• 100 buses.

Second Istisnā‘ Contract
Between:

• Islamic bank;
• independent manufacturer.

Manufacturing Cost
RM17,000,000
The manufacturer constructs buses for bank.


Profit Calculation
RM20,000,000 - RM17,000,000 = RM3,000,000
20,000,000 - 17,000,000 = 3,000,000
Analysis

• Contracts are separate.
• Manufacturer independent from customer.
• Genuine manufacturing occurs.
• No circular ownership.

Result
✅ Valid parallel istisnā‘.


2. Parallel Istisnā‘ Involving Sale and Buyback (
Bay‘ al-‘Īnah
) (Problematic)
Example
An Islamic bank enters into parallel istisnā‘ for aircraft manufacturing.


First Contract
Bank agrees to deliver aircraft to Airline A.
Contract Price
RM200,000,000


Second Contract
Bank appoints Manufacturer B to construct aircraft.
Manufacturing Cost
RM180,000,000


Problematic Ownership Structure
Airline A owns:

• 80% shares in Manufacturer B.

Analysis
Although formally:

• two separate contracts exist,

in substance:

• customer substantially controls manufacturer.

This creates risk that:

• the arrangement becomes a circular financing structure;
• rather than genuine independent manufacturing.

Concern
The aircraft effectively moves:

• from customer-controlled manufacturer;
• back to customer.

This resembles:
sale and buyback arrangement (bay‘ al-‘īnah).
Result Under AAOIFI
❌ Generally impermissible.


Simplified Comparison
Normal Ordinary Istisnā‘
✅ Independent manufacturer and purchaser.


Ordinary Istisnā‘ with
Bay‘ al-‘Īnah
❌ Purchaser substantially controls manufacturer.


Normal Parallel Istisnā‘
✅ Independent customer, bank, and manufacturer.


Parallel Istisnā‘ with
Bay‘ al-‘Īnah
❌ Customer substantially controls manufacturer used in second contract.


Important Principle
Islamic finance requires:

• genuine commercial activity;
• real manufacturing risk;
• independent contracting parties.

Transactions should not merely:

• circulate ownership artificially;
• disguise financing;
• or replicate conventional interest-based lending through formal legal structures.