SS 4: Settlement of Debts by Set-Off

What this standard is about

The standard covers set-off (muqassah). When two parties are both creditor and debtor to each other, their debts can be netted against each other instead of being paid separately. There are two kinds. Contractual set-off happens when both parties agree to cancel their debts against each other. Mandatory set-off takes effect automatically once its conditions are met, without either party asking for it.

Why it exists

Set-off is a practical way to settle mutual debts without moving money twice. The standard sets conditions so that the netting does not become a back door to riba (interest) or other Shariah violations.

The key rules, simply put

• Each party must be a creditor and a debtor at the same time.
• For contractual set-off, both parties must agree. Mandatory set-off takes effect without either party's request or consent.
• The set-off must not be arranged in a way that breaks a Shariah rule, such as riba.
• For contractual set-off, the two debts do not need to be the same kind, type, description, or maturity date. Each party agrees to give up any advantage tied to those differences. For mandatory set-off, the debts must be equal in kind, type, description, and maturity.
• If the amounts are not equal, the smaller debt cancels an equal part of the larger one. The party owed the larger amount can claim the remaining balance.

An everyday example

A owes B $5,000 and B owes A $3,000. They agree to set off the debts. The $3,000 cancels out, and A now owes B only $2,000.

Words to know

• Set-off (muqassah) — canceling mutual debts against each other.
• Contractual set-off — set-off that happens because both parties agree to it.
• Mandatory set-off — set-off that takes effect automatically once its conditions are met. Neither party needs to ask for it.
• Riba — interest; any guaranteed extra on a loan or debt. Not allowed in Islamic finance.

Source

• AAOIFI Shariah Standard No. 4 — https://aaoifi.com/wp-content/uploads/2020/08/SS-4-Settlement-of-Debt-by-Set-Off.pdf