Salam Shortfall: Crop Failure, a Parallel Salam and a Prohibited Delivery Guarantee
A bank has financed a wheat farmer with a salam contract: it paid PKR 8 million in full on 1 November for 200 tonnes of wheat to be delivered on 1 April at PKR 40,000 per tonne. It also signed a parallel salam to sell the same 200 tonnes to a flour miller at PKR 44,000 per tonne for delivery on 15 April. Unseasonal hail destroys most of the crop; the farmer can deliver only 60 tonnes and asks to be excused. The miller demands delivery of the full 200 tonnes and threatens penalties. The risk officer notes that the parallel salam was signed before the bank took possession of any wheat, and that the farmer was also required to provide a third-party 'guarantee of delivery', which the bank's own Shariah manual prohibits. The bank must decide within a week whether to buy wheat on the spot market to cover the shortfall.
1. Set out the salam requirements and identify which features of this transaction are defective.
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Requirements. In salam the full price is paid at inception; the quantity, quality, delivery date and place must be precisely specified; the subject matter must be a fungible, standardised commodity capable of description; the seller must be able to deliver. The bank, as buyer, carries the credit risk of non-delivery.
Checks on this deal:
- Price paid in full on 1 November: satisfied.
- Quantity, quality and date fixed: satisfied on the facts given.
- Parallel salam: permissible in principle as a separate, independent contract, provided it is not conditional on the first contract and the bank is not selling specific identified goods it does not own. The bank's obligation to the miller is a generic 200 tonnes, which is acceptable; linking it to the farmer's contract would not be.
- Possession timing: signing a parallel salam before receiving the goods is not in itself invalid, but the bank must be satisfied it can obtain the goods.
- The 'guarantee of delivery' is the real defect. A third-party guarantee that converts the bank's delivery risk into a secured claim, when the bank's own manual prohibits it, means the clause must not be enforced and should be removed from the template. It also shows the product was documented inconsistently with policy.
2. Recommend how the shortfall should be covered and how loss should be allocated between the parties.
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Options, in order of preference:
- Cover in the market. Buy 140 tonnes on spot, even at a higher price, to meet the miller's delivery date. The bank honours its parallel salam and protects its reputation. Any loss is the difference between the spot cost and the salam price received.
- Renegotiate with the miller. If spot cover is uneconomic, seek agreement to extend the delivery date or reduce quantity, in writing, before the due date. Penalty clauses that operate as compensation for time are not enforceable; the miller's remedy is the actual loss.
- Recover from the farmer. The farmer owes delivery or return of the price for the undelivered 140 tonnes. If the failure is force majeure, the bank may grant respite or reschedule; it may not simply add a delay charge to his debt.
- Check security. Ensure any kafala or mortgage taken is valid and enforceable; the prohibited delivery guarantee should not be relied on.
Allocation principle: business risk of the underlying commodity sits with the bank as salam buyer; credit and performance risk sits with the farmer. The bank cannot shift its market risk to the farmer by inflating his liability.
3. What documentation and risk-control changes should the bank make before writing more salam business?
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- Separate contracts. Keep the salam and the parallel salam independent: no cross-default, no condition that the parallel salam depends on the first, no reference to the farmer's goods in the miller's contract.
- Generic subject matter. Describe goods by specification, not by reference to a specific field or consignment.
- Remove prohibited clauses. Delete the third-party delivery guarantee from templates and confirm that existing ones will not be enforced; replace with permissible security such as a personal kafala or a mortgage over identifiable property that secures a monetary debt.
- Pre-contract checks. Confirm the farmer's capacity, historical yield, acreage and alternative supply, and stress-test the parallel salam for a shortfall scenario.
- Delivery monitoring. A diary of delivery dates, inspection criteria and a market-cover plan approved in advance.
- Governance. Submit the revised product programme and templates to the SSB for approval, and add salam files to the Shariah audit sample.