The concept of Shirkah & Musharakah

Ahmed Ali Siddiqui

Manager, Product Development & Shariah Compliance Meezan Bank Limited

Overview

o Terminology & Definition of Musharakah o Types of Musharakah o Structure of Musharakah o Basic Rules in Musharakah o Termination of Musharakah o Constructive Liquidation of Musharaka o Security / Collateral in Musharaka o Musharaka Management and Liability o Application of Musharaka As a Mode o Problems and Risk for Banks in Musharaka Financing
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Musharakah
Hadees-e-Qudsi

Allah (SWT) has declared that he will become a partner in a business between two Mushariks until they indulge in cheating or breach of trust

Musharakah
Terminology & Definition of Musharakah Musharakah means Sharing and in the terminology of Islamic Fiqh.

The word Musharakah has been derived from Shirkah which means being a partner

Musharakah is basically a kind of partnership in which the partners join together with different contributions, work or obligation for the common objective of undertaking business and trade in accordance with the principles of Shariah.

It is an ideal alternative for the interest based financing with far reaching effects on the economy

Musharakah

Contract of Musharakah
The contract of Musharakah can take place between two or more persons with the capital contributed by the partners/shareholders and the profit to be distributed among them according to the rates agreed upon by the shareholders.

Types of Musharakah

SHIRKAH

SHIRKAT-UL-MILK

SHIRKAT-UL-AQD

IKHTIARI

GAIR IKHTIARI

SHIRKATUL-AMWAL

SHIRKATUL-AAMAL

SHIRKATUL-WUJOOH
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Types of Musharakah
Shirkat has been divided into two kinds:

1. SHIRKAT-UL-MILK It means joint ownership of two or more persons in a particular property/asset.

2. SHIRKAT-UL-AQD This is the second type of Shirkah which means a partnership effected by a mutual contract for .

Shirkat-ul-Milk
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:
1. OPTIONAL SHIRKAT-UL-MILK (Ikhtiari)

If two or more person purchase an 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. Here this relationship has come into existence at their own option, as they themselves elected to purchase the equipment jointly.
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Shirkat-ul-Milk
2. UNOPTIONAL SHIRKAT-UL-MILK (Ghair Ikhtiari) There are cases where this kind of Shirkah comes to operate automatically without any 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 an automatic consequence of the death of that person.

Shirkat-ul-Aqd
This is the second type of Shirkah which means: A partnership effected by a mutual contract in which the partners join together with different contributions, work or obligation for the purpose of earning profit.

For the purpose of brevity it may also be translated as Joint commercial enterprise.

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Types of Shirkat-ul-Aqd

Shirkat-ul-aqd is further divided into three kinds:

1. Shirkat-ul-amwal (contractual partnership) 2. Shirkat-ul-Amal (liability partnership) 3. Shirkat-ul-wujooh (vocational partnership)

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Types of Shirkat-ul-Aqd

1. Shirkat-ul-amwal: Where all the partners invest some Capital into a Commercial enterprise. It is the most important & commonly used form of Shirkat

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Types of Shirkat-ul-Aqd

2. Shirkat-ul-Amal:
Where all the partners jointly undertake to render some services for their customers.

The fee charged from them is distributed among them according to an agreed ratio.
If two persons 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.

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Types of Shirkat-ul-Aqd
3. Shirkat-ul-wujooh

The word Wujooh comes from Wajahat meaning goodwill Hence this is a partnership in Goodwill

Here the partners contribute in the business not through capital but through their goodwill and share profit at an agreed ratio All they do is that they purchase the commodities on a deferred price and sell them at spot. The profit so earned is distributed between them at an agreed ratio.

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Musharakah
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. The term Musharakah has been introduced recently by those who have written on the subject of Islamic modes of financing

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-amal also where partnership takes place in the business of services.

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Musharakah
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

Every partner who shares equally is a Trustee, Guarantor and Agent on behalf of the other partners

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Musharakah
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.

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Rules of Musharakah
Musharakah means relationship established under a contract by the mutual consent of the parties for sharing of profits and losses,arising from a joint enterprise or venture.

Investments come from all partners / shareholders hereinafter referred to as partners.

Profits shall be distributed in the proportion mutually agreed in the contract.

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Rules of Musharakah

The existence of Mutaaqideen(Partners):

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.

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Rules of Musharakah
Asset of Musharakah All assets of Musharakah are jointly owned in proportion to the capital of each partner.

Capital of Musharakah All partners must contribute their capital in terms of money or species at an agreed valuation.

Share capital in a Musharakah can be contributed either in cash or in the form of commodities. In the latter case, the market value of the commodities shall determine the share of the partner in the capital.

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Rules of Musharakah
Distribution of Profit

The ratio of profit distribution must be agreed at the time

of execution of the contract The ratio must be determined as a proportion of the actual

profit earned by the enterprise

- Not as percentage of partners investment
-

Not in lump sum amount A sleeping partner cannot share the profit more than the percentage of his capital.
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Profit Distribution
ILLUSTRATION
If A and 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.

Similarly, if it is agreed between them that A will get 15% of his investment, the contract is not valid.

The correct basis for distribution would be an agreed percentages of the actual profit accrued to the business.
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Profit Distribution
OBSERVATIONS
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.

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Rules of Musharakah
Rules for Loss

In the case of a loss, all the Muslim jurists are unanimous on the point that each partner shall suffer the loss exactly according to the ratio of investment.
There is a complete consensus of jurists on this principle. Profit is based on the agreement of the parties, but loss is always subject to the ratio of investment.

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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.

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Termination of Musharakah
(2) If any one of the partners dies during the 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.

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Termination of Musharakah
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 partners share must be determined If assets are not liquid their valuation must be done to distribute shares
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Termination of Musharakah
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 majoritys consent If assets are not liquid their valuation must be done to distribute shares

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Security & Collateral in Musharakah

1. All partners in a Sharika contract maintain the assets of the Sharika on a trust basis. Therefore, no one is liable except in cases of misconduct, negligence or breach of contract. 2. A third party may provide a guarantee to make up a loss of capital of some or all partners. This guarantee is circumscribed with the conditions that a) The legal capacity and financial liability of such a third party as a guarantor are independent from the Sharika contract. b) The guarantee should neither be provided for consideration nor linked in any manner to the Sharika Contract.
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APPLICATION

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Application
Musharakah can be successfully used to in the following areas: Project financing Working capital financing Import Financing Export Financing Running finance Saving/Deposit account Certificates of Investments Term finance certificates Inter bank financing
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Project Financing
In the case of project financing, the traditional method of Musharaka can be easily adopted.
1
Share in Capital Share in Capital

THE PROJECT

2
PARTNER BANK

Accruing Profits

3 Share of profits

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Exercise

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Exercise
Setup a Musharakah company Data Case 1: a. Setup Jan 1 Partner A Invest 10 mn (working partner) Partner B Invest 5 mn b. Operation Dec 31: Profit earned 3.0 mn c. Distribution of profit - Dec 31 d. Termination Dec 31
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(working partner)