Islamic modes of financing

Hadees-e-Qudsi Allah Subhan-o-Tallah has

declared that He will become a partner in a
business between two Mushariks until they
indulge in cheating or breach of trust
(Khayanah)
 Definition and classification of
Musharakah

• The literal meaning of Musharakah is sharing. The root of the word

"Musharakah" in Arabic is Shirkah, which means being a partner. It is
used in the same context as the term "shirk" meaning partner to Allah.
• 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. It is an ideal alternative for the interest
based financing with far reaching effects on both production and
distribution. The connotation of this term is little limited than the term
"Shirkah" more commonly used in the Islamic jurisprudence.
• For the purpose of clarity in the basic concepts, it will be pertinent at the
outset to explain the meaning of each term, as distinguished from the
other. "Shirkah" means "Sharing" and in the terminology of Islamic
Fiqh, it has been divided into two kinds:
 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" Here this
relationship has come into existence at their own option, as they
themselves elected to purchase the equipment jointly.
• 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.
• There are two more types of Joint ownerships (Shirkat-ul-Milk):
• Shirkat-ul-Ain
• Shirkat-ul-Dain
• A property in shirkat-ul-milk is jointly owned but not divided yet, is
called Musha. In Shirkat-ul-milk undivided shares or other assets
can be used in the following manner: a) Mushtarik Intifa’:
Mutually or jointly using an asset by taking turns under
circumstances where the partners or joint owners are on good terms.
b) Muhaya: Under this arrangement the owners will set turns in
days for example one may use the product for 15 days and then the
other may use it for the rest of the month.
• c) Taqseem: Referring to division of the jointly owned asset. This
may be applied for property where the asset that is owned can be
divided permanently for example jointly taking a 1,000 sq. yards
plot and making a house on 500 yards by each of the 2 owners.
• d) Under a situation where the partners are not satisfied with
Muhaya arrangement, the property or asset jointly held can be sold
off and proceeds divided between the partners.
 Shirkat-ul-Aqd (Partnership by
contract):
• This is the second type of Shirkah, which means, "a partnership effected by a
mutual contract". For the purpose of brevity it may also be translated as "joint
commercial enterprise." Shirkat-ul-Aqd is further divided into three kinds:
• (i) Shirkat-ul-Amwal (Partnership in capital) where all the partners invest some
capital into a commercial enterprise.
• (ii) 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. For example, if
two people agree to undertake tailoring services for their customers on the
condition that the wages so earned will go to a joint pool which shall be
distributed between them irrespective of the size of work each partner has
actually done, this partnership will be a shirkat-ul-aamal which is also called
Shirkat-ut-taqabbul or Shirkat-us-sanai or Shirkat-ul-abdan.
• (iii)Shirkat-ul-wujooh (Partnership in goodwill). The word has its root in the
Arabic word Wajahat meaning 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:

• a) Shirkat-Al-Mufawada: (Capital & labour at par): All partners share capital,

management, profit, 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 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.
• b) 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.
• All these modes of "Sharing" or partnership are termed as "Shirkah" in the
terminology of Islamic Fiqh, while the term "Musharakah" is not found in the
books of Fiqh. This term (i.e. Musharakah) has been introduced recently by
those who have written on the subject of Islamic modes of financing and it is
normally restricted to a particular type of "Shirkah", that is, the Shirkat-ul-
Amwal, where two or more persons invest some of their capital in a joint
commercial venture. However, sometimes it includes Shirkat-ul-Aamal also
where partnership takes place in the business of services.
 Rules & Conditions of Shirkat-ul-Aqd:
• Common conditions are three which are as follows: a) The existence of Muta‘aqideen
(Partners): b) Capability of Partners: Must be sane & mature and be able of entering into a
contract. The contract must take place with free consent of the parties without any fraud
or misrepresentation. c) The presence of the commodity: This means the price and
commodity itself. Special conditions are also three which are as follows:
• a) The commodity should be capable of an Agency: The object in the contract must
qualify as a commodity having value and not as a free good which is accessible to all. For
example grass or wood cannot be made the subject matter. As each partner is responsible
for managing the project, therefore he will directly influence the overall profitability of
the business. As a result, each member in Shirkat-ul-Aqd should duly qualify as legally
being eligible of becoming an agent and of carrying on business e.g. A‘ has written a book
and owns it, B‘ cannot sell it unless A‘ appoints B‘ as his agent.
• b) The rate of profit sharing should be determined: The share of each partner in the
profit earned should be identified at the time of the contract. If however, the ratio is not
determined before hand the contract becomes void (Fasid). Therefore identifying the
profit share is necessary.
• c) Profit & Loss Sharing: All partners will share in profit as well as loss. By placing the
burden of loss solely on one or a few partners makes the partnership invalid. A condition
for Shirkat-ul-Aqd is that the partners will jointly share the profit. However, defining an
absolute value is not permissible, therefore only a percentage of the total return is
allowed.
 The basic rules of Musharakah
• Musharakah or Shirkat-ul-amwal is a
relationship established by the parties through
a mutual contract. Therefore, it goes without
saying that all the necessary ingredients of a
valid contract must be present here also.
• For example, 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.
• But there are certain ingredients, which are peculiar to the
contract of "Musharakah". They are summarized here:
• Basic rules of Capital: The capital in a Musharakah agreement
should be:
• a) Quantified (Ma‘loom): Meaning how much etc.
• b) Specified (Muta‘aiyan): Meaning specified currency etc.
• c) Not necessarily be merged: The mixing of capital is not
required. d) 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.
 Management of Musharakah
• The normal principle of Musharakah is that every partner has
a right to take part in its management and to work for it.
However, the partners may agree upon a condition that the
management shall be carried out by one of them, and no
other partner shall work for the Musharakah. But in this case
the sleeping partner shall be entitled to the profit only to the
extent of his investment, and the ratio of profit allocated to
him should not exceed the ratio of his investment, as
discussed earlier. However, if all the 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. Any work done
by one of them in the normal course of business shall be
deemed as authorized by all partners.
Basic rules of distribution of Profit
• 1. 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. E.g. if it is agreed between
them that ‗A‘ will get 1% of his investment, the contract is not valid.
• 2. 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. Therefore if
‗A‘ & ‗B‘ enter into a partnership and it is agreed between them
that ‗A‘ shall be given Rs.10,000/- per month as his share in the
profit and the rest will go to ‗B‘, the partnership is invalid.
• 3. If both partners agree that each will get percentage of profit based
on his capital percentage, whether both work or not, it is allowed.
• 4. 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. Eg. if ‗A‘ & ‘B‘ have
invested Rs.1000/- each in a business and it is agreed that only
‗A‘ will work and will get 2/3rd of the profit while ‗B‘ will get
1/3rd. Similarly if the condition of work is also imposed on ‗B‘
in the agreement, then also the proportion of profit for ‗A‘ can
be more than his investment.
• 5. 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.
• 6. It is allowed that if a partner is not working, his profit share
can be established as less than his capital share.
• 7. If both are working partners, the share of profit can
differ from the ratio of investment. Eg. Zaid & Bakar both
have invested Rs.1000/- each. However Zaid gets 1/3rd of
the total profit and Bakar 2/3rd, this is allowed. 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.
• 8. 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 eg. ‗A‘ & ‘B‘ put in Rs.100 each and it is
agreed that only ‗A‘ will work, then ‗A‘ can take more
than 50% of the profit as his share. The excess he receives
over his investment will be compensation for his services
 Basic rules of distribution of Loss

• All scholars are unanimous on the principle of loss

sharing in Shariah based on the saying 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.
Powers & Rights of Partners in Musharakah:
• After entering into a Musharakah contract, partners have the
following rights:

• a) 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.
• b) The right to buy raw material or other stock on cash or credit
using funds belonging to Shirkah to put into business.
• c) The right to hire people to carry out business if needed.
• d) The right to deposit money & goods of the business belonging to
Shirkah as depositor trust where and when necessary.
• e) The right to use Shirkah‘s fund or goods in Mudarabah.
• f) 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.
 Termination of Musharakah

• Musharakah will stand terminated in the following cases:

• 1. If the purpose of forming the Shirkah has been achieved. For example,
if two partners had formed a Shirkah for a certain project for e.g. buying a
specific quantity of cloth in order to sell it and the cloth is purchased and
sold with mutual investment, the rules are simple and clear in this case.
The distribution of profit will be as per the agreed rate whereas in case of
loss, each partner will bear the loss according to his ratio of investment.

• 2. Every partner has the right to terminate the Musharakah at any time
after giving his partner a notice that will cause the Musharakah to end. For
dissolving this partnership, if the assets are liquidated, they will be
distributed pro-rata between the partners.
• However, if this is not the case, the partners may agree
either:
• a) To liquidate the assets or
• b) Distribute the assets as they are.
• In case of a dispute between partners whether to seek
liquidation of assets or distribute non-liquid assets, the
distribution of non-liquid assets will 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. But if the assets are in a form that
cannot be distributed such as machinery, then they shall be
sold and the sale-proceeds shall be distributed.
• 3. In case of a death of any one of the partners or any
partner becoming insane or incapable of effecting
commercial transaction, the Musharakah stands
terminated.
• 4. In case of damage to the share capital of one partner
before mixing the same in the total investment and
before affecting the purchase, the partnership will stand
terminated and the loss will only be borne by that
particular partner. However, if the share capital of all
partners has been mixed and could not be identified
singly, then the loss will be shared by all and the
partnership will not be terminated.