Principles of Islamic banking and finance/PIBF201/Variable income Islamic modes of finance/Musharakah

In Arabic ‘Musharakah’ literally means sharing. Along with mudarabah, this is one of the two most preferred modes of Islamic financing and there is no controversy about this point. . In a later section, the advantages of using the two modes of Islamic finance will be discussed in detail along with the difficulties that would arise in investing funds under these two modes.

In his popular book “An Introduction to Islamic Finance”, Mufti Muhammad Taqi Usmani (1998; p.19)points out that Musharakah is a relatively new term frequently used in the context of modern Islamic finance. The original word that was widely used in the literature of Islamic jurisprudence is shirkah. The meaning of this term is a little limited than the term “shirkah” . “Shirkah” means “sharing” and it could be of two kinds: (1) Shirkat-ul-Milk: joint ownership of two or more persons in a particular property. (2) Shirkat-ul-‘Aqd: This is the second type of Shirkah which means “a partnership realized by a mutual contract” or a “joint commercial enterprise.” (Usmani, 1998, p. 20) Shirkat-ul-’aqd could be further of 3 different types: (i) Shirkat-ul-Amwal where all the partners invest some capital into a commercial enterprise. (ii) Shirkat-ul-A’mal 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. (iii) In Shirkat-ul-wujooh, the partners purchase the commodities on a deferred price, sell them at spot and distribute the profits in an agreed ratio. Musharakah is primarily Shirkat-ul-amwal, where two or more persons invest some of their capital in a joint commercial venture.

Basic Rules of Musharakah

1. Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a mutual contract free of any ambiguity and pressure

2. The proportion of profit to be distributed between the partners must be agreed upon at the time of effecting the contract. If not, the contract is not valid

3. 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 any one of the partners, or any rate of profit tied up with his investment. If a lump sum amount or a certain percentage of the investment has been agreed for any one of the partners, it must be expressly mentioned in the agreement that it will be subject to the final settlement at the end of the term, meaning thereby that any amount so drawn by any partner shall be treated as ‘on account payment’ and will be adjusted to the actual profit he may deserve at the end of the term. But if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned. (Usmani; p. 23)

4. Is it necessary that the ratio of profit of each partner conforms to the ratio of capital invested by him? There is a difference of opinion among the Muslim jurists about this question. In the view of Imam Malik and Imam Shafi’i, it is necessary for the validity of musharakah that each partner gets the profit exactly in the proportion of his investment. Therefore, if A has invested 40% of the total capital, he must get 40% of the profit. Any agreement to the contrary which makes him entitled to get more or less than 40% will render the musharakah invalid in Shari‘ah. On the contrary, the view of Imam Ahmad is that the ratio of profit may differ from the ratio of investment if it is agreed between the partners with their free consent.

Therefore, it is permissible that a partner with 40% of investment gets 60% or 70% of the profit, while the other partner with 60% of investment gets only 40% or 30%.1 The third view is presented by Imam Abu Hanifah which can be taken as a via media between the two opinions mentioned above. He says that the ratio of profit may differ from the ratio of investment in normal conditions. However, if a partner has put an express condition in the agreement that he will never 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. But in the case of loss, all the Muslim jurists are unanimous on the point that each partner shall suffer the loss exactly according to the ratio of his investment. There is a complete consensus of jurists on this principle. (Usmani 1998;p. 24)

The Nature of the Capital

Most of the Muslim jurists are of the opinion that the capital invested by each partner must be in liquid form. It means that the contract of musharakah can be based only on money, and not on commodities. In other words, the share capital of a joint venture must be in monetary form. No part of it can be contributed in kind. However, there are different views in this respect.

Termination of Musharakah

Musharakah is deemed to be terminated in any one of the following events:

(1) Every partner has a right to terminate the musharakah at any time after giving his partner a notice to this effect, whereby the musharakah will come to an end. In this case, if the assets of the musharakah are in cash form, all of them will be distributed pro rata between the partners. But if the assets are not liquidated, the partners may agree either on the liquidation of the assets, or on their distribution or partition between the partners as they are. If there is a dispute between the partners in this matter i.e. one partner seeks liquidation while the other wants partition or distribution of the non-liquid assets themselves, the latter shall be preferred, because after the termination of musharakah, all the assets are in the joint ownership of the partners, and a co-owner has a right to seek partition or separation, and no one can compel him on liquidation. However, if the assets are such that they cannot be separated or partitioned, such as machinery, then they shall be sold and the sale-proceeds shall be distributed.

(2) If any one of the partners dies during the currency of musharakah, the contract of musharakah with him stands terminated. His heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of musharakah.

(3) If any one of the partners becomes insane or otherwise becomes incapable of effecting commercial transactions, the musharakah stands terminated. If one of the partners wants termination of the musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. The partners who want to run the business may purchase the share of the partner who wants to terminate his partnership, because the termination of musharakah with one partner does not imply its termination between the other partners. However, in this case, the price of the share of the leaving partner must be determined by mutual consent, and if there is a dispute about the valuation of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or on the distribution of the assets themselves. The question arises whether the partners can agree, while entering into the contract of the musharakah, on a condition that the liquidation or separation of the business shall not be effected unless all the partners, or the majority of them wants to do so, and that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation. Most of the traditional books of Islamic Fiqh seem to be silent on this question. However, it appears that there is no bar from the Shari‘ah point of view if the partners agree to such a condition right at the beginning of the musharakah. This is expressly permitted by some Hanbali jurists. This condition may be justified, especially in the modern situations, on the ground that the nature of business, in most cases today, requires continuity for its success, and the liquidation or separation at the instance of a single partner only may cause irreparable damage to the other partners. If a particular business has been started with huge amounts of money which has been invested in a long term project, and one of the partners seeks liquidation in the infancy of the project, it may be fatal to the interests of the partners, as well as to the economic growth of the society, to give him such an arbitrary power of liquidation or separation. Therefore, such a condition seems to be justified, and it can be supported by the general principle laid down by the Holy Prophet M in his famous hadith: المسلمون على شروطهم الا شرطا احل حراما او حرم حلالا All the conditions agreed upon by the Muslims are upheld, except a condition which allows what is prohibited or prohibits what is lawful. (Usmani 1998; page 30)