Current Issues in Istisna Transactions

Issues in Istisna
Some major issues related to Istisna Financing are as follows and will be covered in detail in the presentation:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

Specification of goods at the time of Written Offer Specification of goods at the time of signing of Goods Receiving Note Addendum to Written Offer Timing of signing of Goods Receiving Note (GRN) Identification of Istisna goods at the time of signing of GRN Timing of issuing Notice to the customer Advising Schedule for Incentive Fee at the time of Notice Submission of f GRN & Notice to CAD / TFD Tracking Sale of Istisna goods at the time of Confirmation of Sale of Goods Payment terms on which Istisna goods are sold Advance Payments in Istisna transaction Settlement of Istisna Financing Extended tenure in IERS Transactions Calling of Corporate Guarantee

Issues in Istisna
1. Specification of goods at the time of Written Offer
As Istisna is a sale of nonexistent goods where Deferred Delivery of goods is allowed provided specification of goods is defined at the time of Sale. Thus, in order to make the transaction Shariah Compliant, specification of Istisna goods should be mentioned in the Written Offer. For the purpose, purpose enough specification of goods should be described so that chances of conflict is omitted.

APPENDIX A WRITTEN OFFER [Date] To: [Insert name and address of the Bank] Dear Sirs, (1) Written offer for manufacture of Goods [insert description]

We (the Manufacturer) are pleased to confirm our willingness to manufacture the Goods subject to the following terms and conditions: (a) Description of the Goods: -----------------------------------------------------------------------------------------------------------------------------------------------------------Detail of Goods and Istisna Cost Price (cost of manufacture): Quantity 5000 6900 7200 Per Unit Istisna Price 158 285 352 Total Istisna Price 5,000,158 1,966,500 2,534,400 Delivery Date 14 Feb 2011 14 Feb 2011 14 Feb 2011

(b) S.no 1 2 3

Specification of Goods 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed (c) Point of Delivery:

(2) (3)

We also attach the original and valid [Letter of Credit][Purchase Order] (if available). All terms and conditions (including the definitions) of the Master Istisna Agreement shall apply to this Written Offer.

IN WITNESS WHEREOF, the Manufacturer has executed and delivered this Written Offer as of the date mentioned hereinabove. hereinabove Yours faithfully, For and on Behalf of the Manufacturer ______________________ WITNESSES: 1. __________________________ Acceptance of the above Written Offer We, Meezan Bank Limited accept the Written Offer of the Manufacturer dated ___ on the terms and conditions contained in the Master Istisna Agreement. ______________________ For and on Behalf of Meezan Bank Limited Dated: ________________ 2. __________________________

Issues in Istisna
2. Specification of goods at the time of signing of GRN
It is observed that in some cases there is a difference in the specification of goods delivered compared to the specification agreed at the time of Written Offer. This practice is against the essence of Istisna transaction. However minor differences can be accommodated

Issues in Istisna
3. Addendum to Written Offer
Istisna is a transaction in which the specification of goods, price of goods, qty of goods and delivery date of goods is agreed at the time of execution of Istisna contract (i.e. Written Offer in case of MBLs documentation structure) through negotiation and mutual consent. Hence after the signing of the Written Offer these parameters cannot be changed and the customer should be clearly advised from the start that no no changes can be made to the parameters after the signing of the Written Offer no matter what the market situation and the customer must make a well informed decision.

Issues in Istisna
3. Addendum to Written Offer (Cont..)
However in case of extreme situation where market conditions change considerably and there no other solution is possible the parameters of the Written Offer may be changed through bilateral agreement between the parties by signing an Addendum to Written Offer provided: (i) A prior written approval of Head of PDSC through an IOM is taken; (ii) The Addendum to Written Offer is signed before taking the delivery of goods.

ADDENDUM TO WRITTEN OFFER [Date] To: [Insert name and address of the Bank] Dear Sirs, Addendum to Written offer for Manufacturing of

Goods [inser t description]

Please refer to written offer for manufacturing of ________ dated _________ detailed as follows: a) b) c) d) e) f) Description of the Goods: Quantity of Goods: Specificati on of Goods: Delivery Date (M ax): Istisna Cost Price: Point of Delivery: ________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________

Currently we are facing following problems i. ii. _____________________________________________________________________________ _____________________________________________________________________________

Due to the above-m entioned reasons we hereby request to accept the following changes in the Specification (m entioned i n the above-m entioned Written Offer) of goods a) b) c) d) e) Description of the Goods: Quantity of Goods: Specification of Goods: Delivery Date (M ax): Istisna Cost Price: ________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________

IN W ITNESS WHE REOF, the Manufacturer has executed and deli vered this Addendum to Written Offer as of the date mentioned hereinabove. Yours fait hfully, For and on Behalf of the Manufacturer ______________________ ABC Company WITNESSES: 1. __________________________ 2. __________________________

Acceptance of the above Addendum to Written Offer We, Meezan Bank Limited accept the Addendum to Written Offer of the Manufacturer dated ___________ on the terms and conditions contained therein. ______________________ For and on Behalf of Meezan Bank Limited ated: ________________

Issues in Istisna
4. Timing of signing of Goods Receiving Note (GRN)
The purpose of Physical Inspection in Istisna Transactions is to take physical delivery of goods at Manufacturers premises. Hence GRN must be signed at the time of physical delivery upon which the ownership of goods is transferred to MBL. Not signing GRN or any delay in the signing of GRN will not transfer the goods in MBLs ownership and in the meantime if these goods are sold MBL will not be entitled to the earn the income from the goods sold.

APPENDIX B
GOODS RECEIVING NOTE (for ISTISNA Transactions) [Date] To: [Insert name and address of the Manufacturer] Dear Sirs, Master Istisna Agreement dated [______] (Agreement) Goods Receiving Note (1) We confirm having received the Goods contracted to be delivered by you as per the following details: a) Date of Receipt: b) Time: c) Address: d) Description of Goods received: The quantity, quality, and other specifications of the Goods have not been ascertained. e) Specification of Goods received: cription ow Case le Fitted Sheet uble Fitted Sheet f) ) Qty (Units) 5000 6900 7200 Specification 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed Value in PKR (Per unit) 158 285 352

Goods identification Method:

g) Date of Physical Inspection:

NOTE: The specifications of the Goods must match with the specifications mentioned in the Written Offer i i.e. e Appendix A of the Master Istisna Agreement (This text box is not a part of the agreement.)

h) Additional remarks: This receipt of Goods is subject to the Goods being inspected and found in order and Meezan Bank Limited reserves its rights to claim any remedies under the law and in terms of the aforementioned Agreement from the Manufacturer if the Goods are found not to be in order and as per the specifications agreed upon. Meezan Bank Limiteds acceptance of the Goods hereunder does not amount to a waiver of any of its rights under the law and/or under the Agreement. Yours faithfully, ______________________________________ For and on Behalf of Meezan Bank Limited

Issues in Istisna
5. Identification of Goods at the time of signing of GRN
MBL representative conducting Physical inspection must ensure the existence of goods, its proper identification & separation from the customer owned stocks While taking the delivery of goods in Istisna the goods must be separately identified from other goods (of the manufacturer) which are not being determined. In case of export of goods which are packed in cartons or bags or buckets; the carton/bag/bucket number of the identified goods should be written in the GRN. In case of local goods in which there is no bag/carton/bucket number for instance in case of sugar, etc. the delivery of bags/cartons/bucket must be taken in a manner that MBLs goods are separately identified through separate stacking, storage or through any other manner

Issues in Istisna
5. Identification of Goods at the time of signing of GRN
In case separate identification is not possible due to the nature of the goods for instance for goods which are in liquid form an appropriate percentage of MBLs goods in the lot should be written on the GRN and the lot itself should be separately identified. It should also be made sure by the related RM and PDSC at the time of process flow approval that the form of delivery (carton form; bag form; etc) is written in the process flow. flow Along with this the method of separate identification (like through carton number; etc) should be mentioned in the process flow.

Issues in Istisna
6. Timing of issuing Notice to the customer
After delivery of goods, MBL appoints customer as its agent to sell the Istisna goods to credible buyers. MBL representative should advice Notice to the customer and take acknowledgment of the customer while conducting Physical inspection of Istisna goods. Advising of Notice should be advised to the customer well before the sale of Istisna goods to the credible buyers

SCHEDULE 1 (Agency Agreement)

[Date] To, [Agent] [Address] Attention: From: Notice (for ISTISNA Transactions)

[ [

] ]

Re: Authorization to Sell the Goods as Undisclosed Agent We refer to the Agency Agreement between [ ] and us dated [ ](Agency Agreement)

In pursuance of Clause 3 of the Agency Agreement, we hereby authorize you to sell the following Goods (Sale Goods) on our behalf as our undisclosed agent and following the sale of the Sale Goods collect and pay us the Sale Price immedietaly upon receipt of the Sale price. We hereby advise and authorize you to take possession of the Sale Goods from [Point of Delivery] on [ ] so as to be able to execute the sale contemplated by this Notice and the Agency Agreement. Your Agency Fee and Incentive Fee shall be as per attached Schedule 2 Minimum Target Selling Price (PKR / Unit) 158 285 352

Description Pillow Case Single Fitted Sheet Double Fitted Sheet Total Buyer (If identified)

Qty (Units) 5000 6900 7200

Specification 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed 100% Cotton Flannel Dyed

NOTE: The specification and quantity of the Goods must match with the specifications mentioned in the Goods Receiving Note. (This text box is not a part of the agreement.)

Terms: Advance ____ days before sale (advance payment to be received after Notice) Advance ___ days before sale (advance payment already received before Notice) Spot (Cash) Credit ____ days from Sale Sale Price Payment Date (If identified): [ ]

Payment Instructions: [to be credited to our account [ ] with [ ] Without limiting the applicability of any other provision of the Agency Agreement or any of the other related transaction documents) the provisions of the Agency Agreement shall apply (mutatis mutandis) to this Notice as if the same were herein set out in full. In addition to the terms of the Agency Agreement, the above authorization to sell as our undisclosed agent is subject to the following conditions: Examples of conditions include: a. b. c.
Sale price below Rs. 40 per unit not allowed

(This text box is not a part of the agreement.)

IN WITNESSES WHEREOF, the Principal has executed and delivered this Notice as of the [*] day of [*] For and on behalf of ______________________________________ For and on Behalf of Meezan Bank Limited WITNESSES: 1. _____________________ 2. _____________________

Issues in Istisna
7. Advising Schedule for Incentive Fee at the time of N ti Notice
Schedule of Incentive fee should be advised to the client along with the Notice; the Notice is redundant and incomplete with out attaching the filled in Schedule of Incentive Fee and Fixed Fee. Working Model is for Internal working only.

Issues in Istisna
8. Submission of GRN & Notice to CAD/TFD
The executed GRN and the Notice should be immediately submitted to CAD and TF Dept (in case of export of Istisna goods) either on the same day or the next working day so that appropriate entries related to inventory and Istisna financing are booked. In some cases it has been observed that the documents are not timely submitted to CAD/TF Dept which creates doubts over the Shariah compliance level of the transaction. In case back dated documents are being submitted to CAD/ TF Dept; the personnel of these departments should immediately report these observations to PDSC and do not accept these documents before approval is taken from PDSC

Issues in Istisna
9. Tracking of Sale of Istisna goods & Confirmation of Sale of f Goods G d
Sale of Istisna goods should be tracked and evidence of the same should also be taken from the customer at the time of signing of Confirmation of Sale of Goods In case of Export cases / Local sale against LC, customer should route the shipping documents through MBL counter only.

Issues in Istisna
10. Payment terms on which Istisna Goods are sold
Payment terms for Sale of Istisna goods should be understood at the time of initiation of Istisna Financing. Different treatment for Advance, Spot and Credit Sale.

Issues in Istisna
11. Advance Payment in Istisna transactions
In case advance Payment is received by the Agent against sale of Istisna Asset, Advance should be booked right after issuance of Notice and our agent assigning the advance payment received from the buyer of MBL. In this case MBLs goods should then be delivered to that assigned buyer. Delivery of goods other than MBLs will make the transaction invalid. The advance shall be recorded as liability. liability On the day the Istisna goods are sold to the buyers, Istisna Financing should be booked and subsequently settled through the Advance already booked.

Issues in Istisna
12. Settlement of Istisna Financing
Istisna Financing can only be settled through proceeds received from the sale of Istisna goods. If the customer pays to MBL before the receipt of proceeds from the actual buyer; such payment by the customer will be deemed as Qard and any incremental Incentive Fee paid to the customer will be riba paid by MBL to the customer. customer

Issues in Istisna
13. Extended Tenure in Istisna transaction
In case Istisna was initially disbursed on different rate and later the rate was revised due to the extended tenure, Revised rate should be catered at the time of delivery. At the time of delivery, Schedule of Incentive Fee should be Revised to cater the changed rate for the extended tenure. No change in rate/ incentive fee/ agency fee can be made once the goods have been sold.

Issues in Istisna
14. Calling of Corporate Guarantee
Customer in an independent capacity guarantees the credit worthiness of the Buyer and will undertake to compensate the Bank in case of failure from the Buyer to pay the sale price to the Bank. Corporate Guarantee can only be called when Istisna Goods are sold to credible buyers and the Credit Period, if any, is exhausted. Thus, at the time of issuance of Notice, Payment terms should not deliberately be changed to accommodate Corporate Guarantee.

Thank You