Musharaka/types/rules/distribution/termination

Mudarabah/types/rules/distribution/termination
 Involve direct participation in profit and losses by the parties. These are based
on the concept of Shirkah.
 Musharaka
 Mudarabah


 Musharaka
 The literal meaning of Musharakah is sharing. The root of the word
"Musharakah" in Arabic is Shirkah, which means being a partner.


 Under Islamic jurisprudence, Musharakah means a joint enterprise formed for

conducting some business in which all partners share the profit according to a
specific ratio while the loss is shared according to the ratio of the contribution.

 Shirkat-ul-milk (Partnership by joint ownership): It means joint ownership of
two or more persons in a particular property. This kind of "Shirkah" may come
into existence in two different ways:

◦ Optional (Ikhtiari): At the option of the parties e.g., if two or more persons
purchase equipment, it will be owned jointly by both of them and the
relationship between them with regard to that property is called "Shirkat-
ul-Milk Ikhtiari”
◦ Compulsory (Ghair Ikhtiari): This comes into operation automatically
without any effort/action taken by the parties. For example, after the death
of a person, all his heirs inherit his property, which comes into their joint
ownership as a natural consequence of the death of that person.

 Shirkat-ul-Aqd (Partnership by contract): This is the second type of Shirkah,
which means, "a partnership effected by a mutual contract". It may also be
translated as "joint commercial enterprise." Shirkat-ul-Aqd is further divided
into three kinds:
◦ Shirkat-ul-Amwal (Partnership in capital) where all the partners invest
some capital into a commercial enterprise.
◦ Shirkat-ul-Aamal (Partnership in services) where all the partners jointly
undertake to render some services for their customers, and the fee charged
from them is distributed among them according to an agreed ratio.
◦ Shirkat-ul-wujooh (Partnership in goodwill). Here the partners have no
investment at all. They purchase commodities on deferred price, by getting
capital on loan because of their goodwill and sell them at spot. The profit so
earned is distributed between them at an agreed ratio.

 Each of the above three types of Shirkat-ul-Aqd are further divided into
two types:
 Shirkat-Al-Mufawada: (Capital & labour at par): All partners share capital,
management, profit, and risk in absolute equals. It is a necessary
condition for all four categories to be shared amongst the partners; if any
one category is not shared, then the partnership becomes Shirkat-ul-
Ainan. Every partner who shares equally is a Trustee, Guarantor and Agent
on behalf of the other partners.
 Shirkat-ul-Ainan : A more common type of Shirkat-ul-Aqd where equality
in capital, management or liability might be equal in one case but not in
all respect meaning either profit is equal but not labour or vice versa.
 Musharakah Contract
 Musharakah or Shirkat-ul-amwal is a relationship established by the parties
through a mutual contract.
 All the necessary ingredients of a valid contract must be present.
 The parties should be capable of entering into a contract; the contract must take
place with free consent of the parties without any duress, fraud or
misrepresentation, etc.
 Basic rules of Capital:
 The capital in a Musharakah agreement should be:
 Quantified (Ma'loom): Meaning how much etc.
 Specified (Muta'aiyan): Meaning specified currency etc.
 Not necessarily be merged: The mixing of capital is not required.
 Not necessarily be in liquid form: Capital share may be contributed either in
cash/liquid or in the form of commodities. In case of a commodity, the market
value of the commodity shall determine the share of the partner in the capital.
 Each partner has a right to take part in Musharakah management.
 The partners may appoint a managing partner by mutual consent
 One or more of the partners may decide not to work for the Musharakah
and work as a sleeping partner
 If all partners agree to work for the joint venture, each one of them shall
be treated as the agent of the other in all matters of business.
 The ratio of profit distribution must be agreed at the time of execution of the
contract
 The ratio of profit for each partner must be determined in proportion to the
actual profit accrued to the business and not in proportion to the capital
invested by him.
 It is not allowed to fix a lump sum amount for anyone of the partners or any
rate of profit tied up with his investment.
 If both partners agree that each will get percentage of profit based on his
capital percentage, whether both work or not, it is allowed.
 It is also allowed that if an investor is working, his profit share (%) could be
more than his capital base (%) irrespective whether the other partner is
working or not.
 If a partner has put an express condition in the agreement that he will not
work for the Musharakah and will remain a sleeping partner throughout the
term of Musharakah, then his share of profit cannot be more than the ratio of
his investment. However, Hanbali school of thought considers fixing the
sleeping partners share more than his investment to be permissible.
 It is allowed that if a partner is not working, his profit share can be established
as less than his capital share.
 If both are working partners, the share of profit can differ from the ratio of
investment. This opinion of Imam Abu Hanifa is based on the fact that capital
is not the only factor for profit but also labour and work. Therefore although
the investment of two partners is the same but in some cases quantity and
quality of work might differ.
 If only a few partners are active and others are only sleeping partners, then
the share in the profit of the active partner could be fixed at higher than his
ratio of investment
 All scholars are unanimous on the principle of loss sharing in Shariah
based on the sayings of Syedna Ali ibn Talib that is as follows:
 "Loss is distributed exactly according to the ratio of investment and the
profit is divided according to the agreement of the partners."
 Therefore the loss is always subject to the ratio of investment eg. if 'A' has
invested 40% of the capital and 'B' 60%, they must suffer the loss in the
same ratio, not more, not less. Any condition contrary to this principle
shall render the contract invalid.
 After entering into a Musharakah contract, partners have the following rights:
 The right to sell the mutually owned property since all partners are
representing each other in Shirkah and all have the right to buy & sell for
business purposes.
 The right to buy raw material or other stock on cash or credit using funds
belonging to Shirkah to put into business.
 The right to hire people to carry out business if needed.
 The right to deposit money & goods of the business belonging to Shirkah as
depositor trust where and when necessary.
 The right to use Shirkah's fund or goods in Mudarabah.
 The right of giving Shirkah's funds as hiba (gift) or loan. If one partner for
purpose of investing in the business has taken a Qard-e-Hasana, then paying it
becomes liable on both.
 If the purpose of forming the Shirkah has been achieved.
 Every partner has a right to terminate the Musharakah at any time after
giving his partner a notice to this effect.
• How will the assets be distributed ?
◦- If the assets are in liquid form,
◦- They will be distributed in proportion of investment
 If the assets are non-liquid, there are 2 scenarios
 The assets may be liquidated, and the proceeds distributed
 the assets may be distributed in their existing form after valuation
 If the assets cannot be distributed in their existing form e.g. Machinery,
They will be liquidated and the proceeds distributed.
 If any of the partners die during the currency of the Musharakah his heirs
will have the option to:
◦ a) Either liquidate their share or
◦ b) Continue with the business
 If any one of the partners becomes insane or otherwise incapable of
conducting commercial transactions .
• If one partner wants to terminate the Musharakah but other partners
want to continue this can be done by mutual agreement
• Termination of Musharakah with one partner does not mean termination
with other partners
 Price of leaving partner’s share must be determined, If assets are not
liquid their valuation must be done to distribute shares
• If partners cannot arrive at consensus on value the leaving partner can
compel others to liquidate business. However, partners may agree at the
start of the project that liquidation will require majority’s consent
 Mudarabah is a contract between a capital provider (rabbul
mal) and an entrepreneur (Mudarib) under which the
rabbul mal provides capital to be managed by the Mudarib
and any profit generated from the capital is shared
between the rabbul mal and Mudarib according to
mutually agreed profit sharing ratio (PSR) whilst financial
losses are borne by the rabbul mal provided that such
losses are not due to the Mudarib’s misconduct, negligence
or breach of specified terms.
 Mudarabah is a contract based on fiduciary relationship (aqd alamanah).
Under this principle, Mudarib manages the Mudarabah asset in trust and
is not liable for the impairment of the asset except for impairment which
is a result of the mudarib’s misconduct, negligence or breach of specified
terms.
 Any of the contracting parties has the right to terminate the contract
unilaterally except in the following conditions:
 (a) The Mudarib has commenced the work relating to the management of
the capital of the rabbul mal;
 (b) Contracting parties have agreed to enter into a Mudarabah for a
specified time or have agreed not to terminate the contract within a
specified time.
 Mudarabah is categorized into two types:
 (a) Unrestricted Mudarabah (Mudarabah Mutlaqah) is a contract in which
the rabbul mal permits the Mudarib to manage the Mudarabah capital
without any specific restriction.
 (b) Restricted Mudarabah (Mudarabah Muqayyadah)
 (i) A restricted Mudarabah is a contract in which the rabbul mal imposes
specific restriction on the Mudarabah terms.
 (ii) The rabbul mal may specify conditions restricting the Mudarib such as
the determination of location, period for investment, type of project and
commingling of funds.
 The contracting parties may mutually agree to change the type of
Mudarabah they have entered into to another type of Mudarabah at any
point of time.
 Contracting Parties:
 The contracting parties in Mudarabah consist of rabbul mal and Mudarib.
 Rabbul mal and Mudarib shall have legal capacity to execute contract
including the capacity to perform agency (Wakalah) contract either as a
principal or as an agent.
 The contracting parties in Mudarabah may be a natural person or a legal
person.
 The contracting parties in a Mudarabah contract may involve more than one
Mudarib or rabbul mal.
 In the case of Mudarabah involving more than one rabbul mal, an agreement
among the rabbul mal may be established whereby:
◦ (a) An existing rabbul mal agrees to relinquish his right over certain portion
of profit if he withdraws from the Mudarabah prior to its maturity date; and
◦ (b) A new rabbul mal agrees to assume liability in respect of the Mudarabah
which is already in operation prior to his participation.
 Mudarib shall have the right to manage Mudarabah venture.
 Mudarib is responsible to ensure proper management of the Mudarabah
venture and acts in the interest of the rabbul mal.
 Mandate of the Mudarib shall be provided under the terms and
conditions of the contract.
 Mudarib may assign Mudarabah capital under his management to another
Mudarib in another Mudarabah or to another manager subject to the
condition that the consent of rabbul mal is obtained.
 Rabbul mal shall not involve in managing Mudarabah venture but shall
have a right of access to reasonable information regarding the Mudarabah
venture.
1. Ameen (Trustee): To look after the investment responsibly, except in
case of natural calamities.
2. Wakeel (Agent) : To purchase from the funds provided by Rab-ul-
Maal
3. Shareek (Partner): Sharing in any profit
4. Zamin (Liable): To provide for the loss suffered by the Mudarabah
due to any act on his part.
5. Ajeer (Employee): When the Mudarabah gets Fasid due to any
reason, the Mudarib is entitled to only the salary, Ujrat-e-Misl.
 Capital is an asset provided by rabbul mal to the Mudarib for the purpose of
Mudarabah.
 Mudarabah capital shall be provided by rabbul mal and managed by the
Mudarib.
 Mudarabah capital shall be identifiable, readily available and accessible for
Mudarib to commence business activities.
 Mudarabah capital may be in the form of cash or in-kind which may include
intangible assets.
 Capital in-kind shall be valued based on the valuation determined by a third
party which may include experts, valuers or as agreed upon by the contracting
parties at the inception of the contract.
 Mudarabah capital denominated in different currencies shall be valued based
on a specific currency agreed by the contracting parties at the inception of the
contract.
 Mudarabah capital shall not be in the form of a debt due to rabbul mal either from
Mudarib or a third party.
 All remaining capital shall be returned to the rabbul mal, if any, upon
dissolution or termination of the Mudarabah contract.
 Any amount of capital due to rabbul mal and profit, if any, shall be
deemed as liability due to the rabbul mal.
 The Mudarib shall not guarantee the Mudarabah capital except in the case
of his misconduct, negligence or breach of specified terms.
 Rabbul mal and Mudarib may agree for a gradual withdrawal of
Mudarabah capital by the rabbul mal.
 Mudarib may with the consent of rabbul mal commingle the Mudarabah
capital with other investment fund.
 Mudarib may inject his own fund into the Mudarabah capital subject to
the consent of rabbul mal and hence a Musharakah contract is formed
between the Mudarib (as partner under Musharakah) and the Mudarabah
venture.
 The capital may be fully or partially disbursed as per the terms of the contract.
 Mudarabah expenditure may be charged to Mudarabah capital.
◦ The Mudarabah expenditure shall be direct expenses that are
identifiable and measurable with regard to a specific investment
activity.
◦ If the Mudarib is travelling for business and is overstaying the night,
then the expenses are covered from capital.
◦ If the Mudarib manages the Mudarabah within his city, he will not be
allowed any expenses, only his profit share. Similarly, if he keeps an
employee, this employee will not be allowed any expenses, just his
salary.
 The effect of a failure of rabbul mal to provide capital under a Mudarabah
contract (defaulting rabbul mal) in the following situations shall be as
follows:
 (a) No capital has been paid.
 In this situation, the contracting parties may unilaterally terminate the
contract. If the Mudarib has commenced work, the rabbul mal has to
reimburse the Mudarib for any Mudarabah expenditure incurred and pay
the Mudarib fair and reasonable wages or fees.
 In this situation the contracting parties may, subject to the terms and
conditions of the contract:
 (i) Revise the Mudarabah contract based on the actual capital provided; or
 (ii) Terminate the contract and consequently:
 Mudarib shall return the capital contributed to the rabbul mal if any and
share the profits with the rabbul mal, if any; and
 Rabbul mal shall bear the Mudarabah expenditure incurred by Mudarib. If
the justified Mudarabah expenditure incurred exceeds the actual capital
contribution, such liability shall be borne by the rabbul mal up to the limit
of the total capital amount committed under the contract.
 In this situation, the Mudarib may agree to terminate the Mudarabah
contract with rabbul mal who failed to pay and may based on agreed
terms impose on him to indemnify the Mudarabah venture for any
expenses incurred due to his default.
 In this situation, the non-defaulting contracting parties shall have the
following remedies including:
 (i) Requiring the defaulting rabbul mal to sell his interest to the other
rabbul mal or a third party;
 (ii)The non-defaulting contracting parties may agree to revise the
Mudarabah contract based on actual capital paid; or
 (iii)The non-defaulting contracting parties may agree to terminate the
Mudarabah contract with the defaulting rabbul mal and may, based on
agreed terms, require him to indemnify the Mudarabah venture for any
expenses incurred due to his default.
 Profit sharing is the primary motive of the Mudarabah contract and
therefore it is a fundamental component of the contract.
 Profit is the value created over and above the Mudarabah capital which is
determined based on profit determination method acceptable by market
standard or practices.
 The Mudarib shall not guarantee any profit.
 Rabbul mal and Mudarib shall share profit based on a ratio mutually
agreed between them.
 PSR shall be determined at the inception of the contract. Nonetheless,
PSR may be revised during the tenure of the Mudarabah subject to mutual
agreement.
 Mudarabah contract shall not stipulate a pre-determined fixed amount of
profit to one contracting party which deprives the profit share of the
other contracting party.
 The profit in the form of certain percentage shall not be linked to the
Mudarabah capital amount.
 In a multi-tiered Mudarabah, two or more profit sharing arrangements
may be agreed upon. In the first tier, rabbul mal and Mudarib may agree
on a certain PSR. Whilst in the second tier the rabbul mal (Mudarib in the
first tier Mudarabah) and the other Mudarib may agree for another PSR.
Such arrangement may apply to the following tier respectively. The profit
generated in each tier shall be shared according to the respective PSR.
 In the case where Mudarib commingled or injected his own fund to the
Mudarabah, the Mudarib is entitled to the profit based on his capital
contribution in the commingled fund and the remaining profit shall then
be distributed based on PSR in the Mudarabah.
 Rabbul mal and Mudarib may agree on a PSR for a certain threshold of
profit. If the actual profit exceeds the threshold, the excess amount may
be distributed based on a different PSR agreed by the parties or be paid to
any of the contracting parties as per agreement.
 Rabbul mal and Mudarib may agree on a threshold of profit whereby in
the case of profit generated exceeds the threshold, an amount of profit
equivalent to threshold is paid to one of the contracting parties and the
remaining is shared according to PSR. In the case of profit generated is
below the threshold, the profit is shared based on PSR.
 The agreed PSR may vary to correspond with different periods of
investment, different amount of capital or due to pre-mature withdrawal
of capital provided that such conditions are agreed upon at the inception
of the Mudarabah contract.
 In a single Mudarabah contract involving more than one Mudarib, a
common profit sharing ratio is agreed between rabbul mal and all the
Mudarib. All Mudarib shall share the mudarib’s profit portion as per
agreed terms.
 The profit may be measured based on the operating performance of the
fund, gains realized from the disposal of ownership rights to the fund or
dissolution of the fund.
 The profit shall be recognized on a realization basis by selling the assets of
the Mudarabah partnership or on a constructive basis by constructive
valuation of the assets including accounts receivables.
 In the case of constructive valuation which is based on market valuation
or a third party verification, the constructive profit reserve may be
recorded. The reserve from the constructive valuation may be distributed
when gains are realized at the time of disposal.
 If profit was distributed based on estimated figures, a final consolidation
and rationalization shall be undertaken at the end of a certain period or at
the times of actual realization of profit to arrive at the actual profit
available for distribution as per agreed profit sharing ratio.
 Profit shall be finalized, realized and distributed at an agreed period e.g. quarterly, with
mutual consent of the contracting parties.
 Unrealized gains recognized during the Mudarabah tenure shall be recognized as profit
and be included in the profit and loss calculation for the Mudarabah.
 A Mudarib is only entitled to profit for works which are integral to the Mudarabah
venture and shall not earn any additional fee for such works.
 Rabbul mal may commission Mudarib for a fee to perform works apart from the works
integral to Mudarabah venture.
 A party may waive his right to the profits, if any, to the other contracting party on the
basis of waiver on the date of distribution of the profit.
 The parties to the contract may agree to set aside the profit as a reserve (e.g. profit
equalization reserve) or for any other purpose.
 The reserve shall only be created from the profit of the Mudarabah
 In case where profit reserved is utilised to cover depletion of Mudarabah capital, only
the profit portion of the rabbul mal in the reserve shall be utilised.
 Contracting parties may agree to a condition whereby rabbul mal may be subject to
lower or no profit payment if capital is withdrawn before the maturity of the
investment period.
 A loss is depletion from the value of capital.
 Loss shall be borne by the rabbul mal up to the capital value.
 The Mudarib shall not be liable for any impairment of asset unless such
loss is due to the mudarib’s misconduct, negligence or breach of specified
terms of the contract.
 In the case of loss the Mudarib shall furnish the reason for the occurrence
of loss.
 In the case of multiple rabbul mal in a single Mudarabah, the loss shall be
borne by each rabbul mal proportionate to his capital contribution. In the
case where Mudarib commingled or injected his own fund to the
Mudarabah, the loss shall be borne based on the proportion of the
mudarib’s capital contribution in the commingled fund.
 The Mudarib may voluntarily absorb the loss upon the maturity or
dissolution of Mudarabah.
 Unilateral termination by any of the parties in the absence of any
prohibitive circumstances.
 Unilateral termination by any of the parties due to misconduct ,
negligence or breach of specified terms of contract by the other;
 Mutual agreement to terminate between the parties;
 Contract expires upon the maturity date agreed by the parties;
 Demise or dissolution of either Mudarib or rabbul mal or loss of legal
capacity;
 Invalidity of Mudarabah.