Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 17Kafalah

Kafalah is a unilateral contract of guarantee where one party agrees to stand in the place of a debtor before his or her creditors. See Figure 17.1.

Figure 17.1 Kafalah Process Flow

The concept can be explained by using a simple example involving three parties. Party A purchases an asset from Party B on a deferred payment basis. Party B requires some assurances that Party A will make the required payments. Party C provides Party B such assurances that in the event Party A defaults on payments to Party B, Party C will make good all losses.

This arrangement can also be modified to where Party A commits to deliver certain goods in the future to Party B, for which Party A has already taken the sale price, like in salaam and istisna contracts. Party C stands in on Party A's behalf that in the event Party A does not fulfill his or her obligations, Party C will do so by providing the required goods or making good the losses incurred by Party B.

Let's assume Party A owes Party B a deferred payment of $150,000, to be made in lump sum in 90 days. Party A arranges for Party C to be a guarantor for $150,000. Now Party B has recourse to Party C in the event that Party A defaults. Party A does default on the payments due to Party B in 90 days, and Party C makes good the payment of $150,000 owed to Party B.

A question arises now: Does Party C have recourse to Party A to ...