Scope and Definition
Scope: This standard covers cases of DEFAULT by a SOLVENT debtor or guarantor. It does NOT apply to insolvent debtors (covered by the Insolvency standard on Insolvency) or debtors with a Shari'ah excuse for delay.
Definition of Procrastination: Default is established when a debtor, following a demand for payment, fails to settle the debt on its due date AND has not proven insolvency. The key test: the debtor can pay but will not.
Core Shari'ah Ruling on Default
Default is Haram: A debtor who is capable of paying but deliberately delays is committing Haram (sin). The Islamic principle is that paying debts on time is a moral and legal obligation.
Prohibited Penalties for Delay
NO FINANCIAL COMPENSATION FOR DELAY: It is absolutely prohibited to stipulate any financial compensation as a penalty for delay in payment. This applies to: (a) cash penalties (e.g., AED 100 per day late), (b) loss-of-opportunity compensation, and (c) currency devaluation compensation. ALL are prohibited, whether pre-determined or not. This would constitute Riba (usury).
NO JUDICIAL DEMAND FOR FINANCIAL COMPENSATION: Even if not stipulated in the contract, a creditor cannot demand a court to impose financial compensation for delay. This is a corollary: the state cannot impose riba.
Permissible Remedies for Default (the Procrastinating Debtor standard)
Remedy 1: Recovery of Actual Costs The procrastinating debtor is liable for ACTUAL legal and collection expenses incurred by the creditor to recover the debt. This is NOT a penalty; it is reimbursement for real costs. The creditor must document the expenses.
Remedy 2: Sale of Mortgaged Collateral If the debt is secured by a mortgage or pledge, the creditor can apply to sell the collateral. Alternatively, the creditor can require the debtor to give a mandate (power of attorney) to sell the asset without recourse to courts.
Remedy 3: Acceleration Clause If a debt is payable in installments, it is permissible to stipulate that ALL outstanding installments become immediately due if the debtor misses one payment. NOTE: This should be done only after notifying the debtor and allowing a reasonable grace period. Force majeure (acts of God) may provide a defense.
Remedy 4: Charitable Donation Clause In contracts of indebtedness (Murabahah, Salam, etc.), the creditor can STIPULATE that if the debtor procrastinates, the debtor will donate an amount or percentage of the debt to CHARITY through the financial institution. The institution acts as a facilitator, not a beneficiary. This is permissible because it directs a default consequence to a social good rather than to the creditor's pocket.
Remedy 5: Repo of Goods in Murabahah In a Murabahah sale, if the asset is still in the condition it was sold AND the buyer has defaulted and become bankrupt, the seller (bank) can repossess the asset instead of pursuing bankruptcy proceedings.
Remedy 6: Non-Material Punishments The institution can: (a) place the debtor on a "blacklist" of undesirable customers, and (b) send warnings to other companies about the defaulter. These are reputational but not financial penalties.
Remedy 7: Offset from Other Accounts The creditor can stipulate the right to offset amounts due from any of the customer's accounts (current, savings, investment) without further consent, provided the currencies match. If currencies differ, the prevailing exchange rate applies.
Guarantors and Default
A guarantor in default is subject to the same rules as a defaulting debtor. However, the creditor can demand payment from the debtor OR the guarantor, UNLESS the guarantor stipulated that payment must first be sought from the debtor. This is called "Kafalah with condition of debtor solvency."
Penalty Clauses in Construction and Supply Contracts
Construction, Istisna'a, and supply contracts often include penalty clauses for late completion. These are PERMISSIBLE (unlike penalties for late payment of debts). If a contractor refuses to pay a contractual penalty, the creditor can treat the penalty as a debt and apply default rules.