Debt and Bankruptcy in Classical Islamic Law

Student editor Esther Agbaje (Harvard Law School) explores classical Islamic law’s basic conceptions of debt and bankruptcy. While the main Islamic texts, the Qur’ān and Sunna (records of the Prophet Muhammad’s teachings), provide principles for fiscal  matters, these principles are not enough to establish systems as complex as those in modern finance with a guarantee of soundness in terms of Islamic law. As financial systems increase in complexity and number of actors, for better or worse, so too does the necessity of a clear set of sharīʿa-compliant  standards. Agbaje suggests starting with classical Islamic law, which explicitly summarizes the principles of finance into “four distinct areas: prohibition on earning interest (riba), the prohibition on speculation (maysir), the prohibition on illegal activities (haram), and the obligation of banks to give back to the community (zakat).” These principles naturally make for a financial model “based on partnership” that emphasizes both debt repayment and tolerance. “This tension between the obligation of a debtor to repay and the obligation of a creditor to forgive (or at least allow more time for repayment)” manifests as equal treatment for personal and commercial bankruptcy. How bankruptcy is practically dealt with, however, differs among schools of jurisprudence, as they diverge on how a creditor may humanely demand repayment.

The Qur’ān and the Sunna describe not only how to worship and live morally as a Muslim, but they also prescribe rules for commercial life.[1] Despite the rules in the Qur’ān and the Sunna, there seems to be no clear standards for what constitutes an Islamic finance system. For entrepreneurs who are concerned about how to start and dissolve a business, how Islamic law regards financial transactions like bankruptcy is important. What exactly is Islamic financial law concerning bankruptcy? Who holds the standard in the modern era?  To better answer these questions it is useful to explore what classical Islam says about finance and bankruptcy.

Islamic finance differs from conventional finance in four distinct areas. These are: the prohibition on earning interest (Riba), the prohibition on speculation (Maysir), the prohibition on illegal activities (Haram), and the obligation of banks to give back to the community (Zakat).[2] The Islamic financial model is based on partnership. According to Ibrahim Warde, “Islamic finance should not be based on interest-based finance, but rather on the double mudaraba principle. The mudaraba (or commenda partnership) is an association between the rabb-el-maal (financier) and the mudarib (entrepreneur) where profits and losses are shared based on an agreed-upon ratio.”[3] For example, if an investor decides to lend money to an entrepreneurial project, the partnership requires that the investor provides the financing for a legal venture, and the entrepreneur provides the work. If at the end of the venture there is profit, it is shared between the investor and the entrepreneur. If the venture fails, both the investor and the entrepreneur walk away with their portion of the loss.

The Qur’ān specifically addresses debt (Iflas). The Qur’ān emphasizes the debtor’s obligation to repay their debts.[4] The Qur’ān at 5:1 it states, “O you who have believed, fulfill [all] contracts.”[5] Within the hadith there are some examples in which the Prophet tells followers to repay their debts. Jason Kilborn notes, “In an oft-cited narration from Abu Hurayra, the Prophet defends a creditor who had harshly and rudely demanded a camel that Muhammad owed him. The Prophet ordered his companions to give the man a better camel, noting that “the best among you are those who repay their debts handsomely.”[6] Other hadith make it clear that having debt after death will not be forgiven. “All the sins of a Shahid (martyr) are forgiven except debt,”[7]and “Death in the way of Allah blots out everything except debt.”[8] From the high moral value placed on debt repayment, it would seem that a country using Islam as its base or as a legal influence would have tough laws concerning debt and repayment. Could such insolvency laws be a potential barrier or burden to the already risky venture of starting new businesses?

The Qur’ān also addresses how creditors should treat debtors who are having trouble repaying or who have failed to repay their debts. The Qur’ān advises creditors, “And if someone is in hardship, then [let there be] postponement until [a time of] ease. But if you give [from your right as] charity, then it is better for you, if you only knew.”[9] This means that creditors should be patient with repayment, and if the debtor has a hardship, then it is best for the creditor to forgive the debt.  Another hadith that tell of how a man, who did nothing else right, forgave the debts of those who owed him or allowed them time to repay, and was still able to enter heaven.[10] Being tolerant about debt repayment is just as highly valued as repayment in Islam and forms the values from which lending laws derive.

Having identified this tension between the obligation of a debtor to repay and the obligation of a creditor to forgive (or at least allow more time for repayment), we can look closer at how classical Islamic law deals with bankruptcy. In classical Islamic law there is no difference between personal bankruptcy and commercial bankruptcy.[11] The person in debt is responsible for repayment. If someone cannot repay their debt then a creditor can take a debtor before a judge (qāḍī) who determines the dispute of the debtor’s willingness to pay. If a debtor continues to delay payment, which is an injustice, “Islamic jurists all but unanimously endorsed imprisonment (habs) for a debtor evading payment.”[12] These debtor’s prisons are not meant to be inhumane.[13] The other option that the qāḍī has for compelling a debtor to repay debts is to force the debtor to use his non-essential assets to repay the debt. The Hanafi School is opposed to this action because it takes away from the dignity of a sane adult and because it interferes with use of personal property, which is highly regarded in Islam. Other schools of Islamic law think that a qāḍī is able to liquidate the non-essential assets of a debtor in order to secure repayment, and they differ between themselves on what is considered non-essential.[14]

Classical Islamic law treats debt and bankruptcy with seriousness, but there is a measure of mercy to the law. Future posts will discuss whether classical Islamic law is the actual basis for commercial and bankruptcy codes in Muslim majority countries, and whether there is a standard followed by such countries.

[1] Abed Awad & Robert E. Michael, Iflas and Chapter 11: Classical Islamic Law and Modern Bankruptcy, 44(3) Int’l Law. 975, 977 (2010).

[2] Patrick Imam & Kangni Kpodar, Islamic Banking: How Has it Diffused? Int’l Monetary Fund, Working Paper No. 10/195 4 (2010).

[3] Ibrahim Warde, The Relevance of Contemporary Islamic Finance, 2 Berk. J. Middle E. & Islamic L. 159, 166 (2009).

[4] Jason J. Kilborn, Foundations of Forgiveness in Islamic Bankruptcy Law: Sources, Methodology, Diversity, 85 Am. Bankr. L.J. 323, 325 (2011).

[5] The Noble Qur’ān 5:1 http://Qur’ā

[6] Kilborn, at 331.

[7] Sahih Muslim Book 20, Hadith 4649

[8] Sahih Muslim Book 20, Hadith 4650

[9] The Noble Qur’ān 2:280 http://Qur’ā

[10] Kilborn, at 333.

[11] Awad, at 985.

[12] Kilborn, at 344.

[13] Kilborn, at 345.

[14] Id at 351-352.