Musharakah — elements, profit distribution and termination

Musharakah is another leading equity-based contract in Shariah. It involves two or more contributors participating in the formulation of with the objective of investing the money and gaining profits.

Musharakah is relatively less risky compared to mudarabah as each partner has the right to be part of the management of the venture and it involves the sharing of both profits and losses among the partners. It is also more flexible in the capital contribution and and management of the venture.

Definition

The term musharakah is a derivative from the word sharaka which means “to share”. Hana scholars define musharakah as a contract between partners on both capital and profit.

Shafi’i scholars define it as the confirmation of the rights of two or more people over a common property. For Hanbali scholars, it is the amalgamation of rights and freedom to use. Maliki scholars define it as permission to transact where each of the partners permits the other to transact with the partnership property while at the same time retaining his own right to transact with the same property.

In general, musharakah is a partnership whereby profits are shared as per an agreed ratio while the losses are shared in proportion to the capital investment of each partner.

Elements

The elements of musharakah include: Offer and acceptance; contracting parties (of two or more); and the subject matter of the agreement (capital and work). The capital contributed in the venture must fulfil the following conditions:

• It should be in cash, gold, silver or their equivalence in value.

• It may also be in the form of intangible rights, such as trademark, and similar rights, provided they are valued at their cash equivalent according to what the partners have agreed upon at the initial contract.

The Shafi’i and Malikis require capital provided by partners to be commingled so that privilege is given to either partner. The Hana s do not stipulate this condition provided the capital is in cash, while the Hanbalis do not require commingling of capital at all.

Types of Musharakah

Musharakah covers both the concepts of sharikah al-milk (joint ownership of a common property) and sharikah al-aqd (contractual partnership). Sharikah al-milk refers to joint ownership of a common property and can be formulated either through an option such as purchase, or without an option such as in the case of inheritance where children get to share a common ownership over a specific property as a result of the death of their parent.

The second type is sharikah al-aqd which is a form of partnership in a business formulated as a result of contractual agreement. It is considered a proper partnership because the parties concerned willingly enter into a contractual agreement for joint investment and the sharing of pro t and risk. According to Accounting and Auditing Organisation for Islamic Financial Institutions, sharikah al-aqd means an agreement between two or more parties to combine their assets, labour or liabilities for the purpose of making pro t.

Slzarikah al-aqd can further be divided into different types: Sharikah al-Inan (unequal shares partnership), Sharikah al-Mufawadah (equal shares partnership), Shurikah al-Amwal (partnership in capital), Sharikah al-Amal (partnership in labour) and Sharikah al-Wujuh (partnership in goodwill).

Diminishing Partnership

Diminishing musharakah (musharakah mutanaqisah) is a form of partnership in which one partner promises to buy the share of the asset of the other partner gradually until the title of the equity/asset is completely transferred to him.

Profit Distribution

The proportion of profit distribution is calculated according to the agreement of the contracting parties up front.

The ratio of profit distribution must be determined according to the actual pro t accrued to the business and not according to the proportion of the capital invested by the partners.

A fixed amount, as a lump sum amount, is not acceptable in pro t distribution in musharakah, as this is tantamount to guaranteeing the fixed return — and this is riba.

Profit Ratio for Partners

The Malikis and the Sha s view that it is necessary for the validity of musharakah that the pro t should be exactly in proportion to the capital invested.

The Hanbalis view that the ratio of pro t may differ from the ratio of the capital invested if the contracting parties agreed on that. The Hana s view that the ratio of pro t may differ from the ratio of capital invested.

If one of the partners inserts a condition that he will not work in the partnership and will stay as a sleeping partner throughout the period of musharakah, then his share of pro t cannot be more than the ratio of his investment.

Termination

Musharakah can be terminated in the following cases:

• Every partner has the right to terminate musharakah at any time after giving his partner a notice to this effect.

• If the assets are not liquidated, the partners may agree to liquidate the assets and distribute it according to the agreed ratio.

• If there is a dispute between the partners on this matter, whereby one partner seeks liquidation while the other wants partition or distribution of the non-liquid assets, the latter shall be preferred because after the termination of the musharakah, all 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.

• If any one of the partners passes away during the prevalence of the musharakah.

• If any one of the partners becomes insane or incapable of effecting commercial transactions.


  • Adapted from Islamic Capital Markets: Principles & Practices, a 758-page book put together by the International Shariah Research Academy for Islamic Finance or ISRA.