Islamic Commercial Matters FAQ #

Original Question: Is it alright to charge a late fee? For example, I’ve sent an invoice to a client to make payment within the month, but if they’ve yet to pay by the due date, is it alright to charge a late fee as a penalty, or would it be considered Riba?

Late payment charges or penalties in Islam can be categorized into two categories: ta’widh and gharamah. Ta’widh refers to compensation for the actual loss suffered by the creditor or financier due to late payment. On the other hand, gharamah is a penalty charge imposed without the need to prove the actual loss suffered.

In principle, charging monetary penalties or default interest is considered usury (riba al-nasi’ah) as it increases the debt in exchange for extending the repayment period. According to Islamic law, an insolvent debtor should be granted relief instead of being penalized, in accordance with the Quranic verse:

And if the debtor is in difficulty, grant a delay until a time of ease. But if ye remit it (the debt) by way of charity, that is best for you if ye only knew” (2:280)

However, Shariah aims to protect the interests of all parties involved, including the creditor or financier. In certain circumstances, penalties may be necessary to uphold contractual obligations, secure economic interests, and prevent injustice to the owner of the property. Failure to settle the outstanding amount within the stipulated period can disrupt business and negatively impact the creditor.

Therefore, late payment penalties in Islam can be summarized as follows:

1. Compensation (Ta’widh):
   • The compensation amount should be limited to actual monetary losses, fees, and expenses incurred by the creditor/financier due to late payment, such as costs related to debt collection, litigation, cost of notices, dedicated man-hour for monitoring the defaulted accounts, etc.
   • Opportunity cost is not considered an actual loss, and therefore cannot be charged as a compensation fee.
2. Penalty Charge (Gharamah):

• • A penalty fee can be imposed as part of the late payment penalty, but all such charges must be directed to charity and do not bring any benefits to the creditor.
  • The creditor/financier cannot consider the gharamah (penalty charge) as part of their income.
  • Penalty charges are permissible to prevent the debtor/borrower from taking advantage of intentional payment delays.
  • Penalty charges can be use to offset subsequent scheduled instalment payments.

It is important to emphasize that the purpose of these charges is to encourage timely payment and discourage further procrastination, rather than seeking financial gains. Even though late payment penalties (ta’widh and gharamah) are permissible, Shariah guidelines ensure that the creditor sole objective is to recover the additional expenses or damages incurred and not generate profits from them.

Allah knows best.