Istisna'

Istisna' (Arabic for a request to manufacture) is a contract in Islamic commercial law under which one party, the manufacturer or contractor, undertakes to make or build a specified asset for another party, the buyer, at an agreed price and to an agreed specification. Unlike most sales in fiqh al-mu'amalat, the classical law of transactions, the subject matter does not exist when the contract is made. The price can be paid in advance, in stages as work progresses, or on delivery. Istisna' is the main Sharia-compliant tool for financing construction, manufacturing and infrastructure.

In modern Islamic finance, banks usually use the contract in two linked layers, known as parallel istisna', so that the bank finances a project without becoming a builder itself.

Classical Islamic law generally forbids the sale of something that does not yet exist, because of the uncertainty, or gharar, involved. Two exceptions are recognized for forward production: salam, a forward sale of fungible goods with the full price paid upfront, and istisna'. The Hanafi school treated istisna' as an independent contract justified by long-standing custom, since people had always commissioned shoes, furniture and buildings from craftsmen. Other schools tended to treat it as a form of salam. Contemporary practice follows the Hanafi view, and the AAOIFI Shari'ah standard on istisna' and parallel istisna' sets out the conditions most institutions apply.

A valid contract specifies the asset precisely, including type, quantity, quality and design, so that there is no material dispute about what is to be delivered. The price must be known when the contract is concluded. The manufacturer provides the materials and labor; if the buyer supplies the materials, the arrangement becomes a contract for hire instead. A delivery date can be agreed, and many contracts include a penalty clause for late completion, which most scholars accept for istisna' even though penalties for late payment of debts are restricted.

Differences from salam

• In salam the full price must be paid at the outset; in istisna' payment can be deferred or staged.
• Salam covers goods that can be described generically, such as grain or metal; istisna' covers things that must be manufactured or built.
• Salam is binding from the start under all schools; the binding nature of istisna' was debated historically, though modern standards treat it as binding once concluded.

A bank financing a building or a plant enters two contracts. In the first, the bank sells the asset to the client under istisna', with payment deferred and spread over time. In the second, the parallel istisna', the bank orders the same asset from a contractor, paying in stages as construction proceeds. The bank's profit is the difference between the two prices. The two contracts must be independent: the bank remains liable to its client even if the contractor fails, which gives the bank a genuine construction risk that it usually manages through performance bonds and careful contractor selection.

Istisna' is often combined with an ijarah. During construction, funding is advanced under istisna'; once the asset is completed and delivered, the bank leases it to the client for rent, and ownership passes at the end. This istisna'-ijarah structure is common in power, water, real estate and transport projects, and is used in some project sukuk. Purchase obligations in such deals are often backed by a purchase undertaking or a unilateral promise, or wa'd.

A developer needs a warehouse costing 8 million to build. A bank signs a parallel istisna' with a construction company for 8 million, payable in four quarterly installments as work is certified. It simultaneously signs an istisna' with the developer to deliver the warehouse for 9.2 million, payable in monthly installments over five years after completion. The 1.2 million difference compensates the bank for financing and construction risk. Because the price is fixed when the contract is made, it cannot be increased later if the developer pays slowly, which is a key difference from an interest-bearing loan and reflects the prohibition of riba.

A murabaha requires the bank to own an existing asset before reselling it at a markup, which makes it unsuitable for assets that do not yet exist. A musharakah or diminishing partnership shares ownership and risk, and can finance construction, but requires the bank to share in losses. Istisna' sits between these, offering a fixed price for a future asset and allowing staged payments that match the construction cycle.

Key risks include contractor default, cost overruns, delays and disputes about whether the delivered asset meets the specification. Institutions must also manage Sharia non-compliance risk, for example if the parallel contracts are drafted so that they depend on each other. Critics argue that in some deals the bank passes all construction risk to the contractor and the client, leaving an arrangement economically close to a conventional construction loan; supporters point to the fixed-price discipline and asset link as meaningful differences.