THE CONCEPT OF MUSHARAKAH

Outline
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

2
 Musharakah
• ‘Musharakah’ is a word of Arabic origin which
literally means sharing.
• In the context of business and trade it means
a joint enterprise in which all the partners
share the profit or loss of the joint venture.
• It is an ideal alternative for the interest-
based financing with far reaching effects on
both production and distribution.
• In the modern capitalist economy, interest is
the sole instrument extensively used in
financing of every type.

3
• ‘Musharakah’ is a term frequently
referred to in the context of Islamic
modes of financing.
• The meaning of this term is a little
limited than the term “shirkah” more
commonly used in the Islamic
jurisprudence.
• Shirkah means sharing
4
Islamic Modes/Instruments – Participatory Modes:

Musharakah:
The Concept of Musharakah:
Meanings:
– Sharikah Arabic
– Shirkah Arabic
– Shirkat Urdu
– Partnership English
Shirkah Definition : “commingling money or
property (that no share can be distinguished)
by two or more parties with an objective of
sharing profits and contributing losses"
 Islamic Modes/Instruments – Participatory Modes:

Musharakah:
1. Shirkat ul Milk (co-ownership)
– The existence of thing in the joint ownership of two or
more persons in an ascertained thing (ayn) or debt (dayn)
• Shirkat ul Jabr
• Shirkat al Ikhtiar
2. Shirkat ul Aqd “Partnership through contract”
(Partnership referred by law)
– Shirkat ul Amwal (Wealth)
– Shirkat ul amal (services)
– Shirkat ul Wujuh (liability)

Wider definition of Shirkatul Aqd: “Contract between two or

more people for participation in capital and its profits”
“Participation in profits, partnership in capital”
(Mudarabah).
 The basic rules and Features of
Musharakah (General)

• 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.
7
 Rules of Musharakah

Capital

Management

Profit and Loss

Settlement

Security

8
 1. Rules of Musharakah-
Capital
• Invested capital must be in liquid form or
other kinds of assets
• It should be both quantified and specified
• If fixes assets are being contributed, so the
value of these assets should be agreed
• Investments come from all partners / shareholders
hereinafter referred to as partners.
• All assets of Musharakah are jointly owned in
proportion to the capital of each partner.

9
 2. Rules of Musharakah-
Management
• Every partner is entitled or has right to
take a part in management
• Manager can be chosen/appointed by
mutual agreement of partners
• One of the partner can be silent
partner, in other words One or more of
the partners may decide not to work for the
Musharakah and work as a sleeping partner.
10
 3. Rules of Musharakah- Profit
and Loss
• Profits shall be distributed in the proportion mutually agreed in
the contract.
• Determined as percentage of profit and not a fixed sum of the
money or percentage of capital invested
• If one or more partners choose to become non-working or silent
partners. The ratio of their profit cannot exceed their
proportion of investment in a certain project.
• The proportion of profit to be distributed between the partners
must be agreed upon at the time of effecting the contract. If
no such proportion has been determined, the contract is not
valid in Shari‘ah
• All investors will have to share any loss in exact proportion to
their investment
11
 4. Rules of Musharakah-
Settelment
 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.

12
 Rules of Musharakah-Settelment
 If any one of the partners dies during the
musharakah agreement, the contract of musharakah
will be 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.

 If any one of the partners becomes insane or

otherwise becomes incapable of effecting commercial
transactions, the musharakah will be terminated.
13
 5. Rules of Musharakah-
Security
• In the case of Musharakah agreement
between bank and client, the bank can
obtain adequate security from client
against negligence or misconduct.

14
 The basic rules and Features
of Musharakah
The existence of Muta’aqideen (Partners):
• Capability of Partners: Must be sound & 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.
• If one or more partners choose to become non-
working or silent partners.
• The ratio of their profit cannot exceed the ratio
which their capital investment bears so the total
capital investment in Musharakah.

15
 The basic rules and Features
of Musharakah
• It is not allowed to fix a lump sum amount
for any of the partners or any rate of
profit tied up with his capital.
• A management fee however, can be paid to
the partner managing the Musharakah
provided the agreement for the payment
of such fee is independent of the
Musharakah agreement.
• Losses are shared by all partners in
proportion to their capital.
16
 The basic rules and Features
of Musharakah
• All assets of Musharakah are jointly owned in
proportion to the capital of each partner.
• 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.

17
 The basic rules and Features
of Musharakah
• The presence of the commodity: This means the
price and commodity itself.
• 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.

18
 Distribution of Profit
 The proportion of profit to be distributed
between the partners must be agreed upon at the
time of effecting the contract. If no such
proportion has been determined. The contract is
not valid in Shari’ah.
 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.
 

19
 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.

20
 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.

21
 OBSERVATIONS
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 Musharakha, then his share
of profit cannot be more than the
ratio of his investment.
22
 Sharing of loss
• In the case of a loss, all the Muslim jurists are
agreed on the point that each partner shall suffer
the loss exactly according to the ratio of
investment.
• Therefore, if a partner have invested 40% of the
capital, he must suffer 40% of the loss, not more,
not less, and any condition to the contrary shall
render the contract invalid.
• 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.
  23
 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.
24
 Termination of Musharakah
IN CASE OF A DISPUTE
• 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.
25
 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
completing commercial transactions, the
musharakah stands terminated.
26
 Termination of Musharakah
without closing the business
• 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
27
termination between the other partners.
 Termination of Musharakah
without closing the business
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 28
themselves.
 Diminishing
Musharakah (DM)
 Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
A form of Musharakah where the financier
and the client participate in a joint commercial
enterprise or property. This enterprise is
converted into undivided ownership of both the
financier and the client. Over certain period the
equity of financier, divided into equal value
units, is purchased by the client. And ultimately
the client becomes the sole owner of the
enterprise.
Uses of DM
– Agric. Machinery and implements financing
– Storage facility construction/sheds
– Transport vehicles, etc.
Diminishing Musharakah (DM):
Procedural details:
– Client requests the bank for DM
– Appraisal is accorded
– Approval is conveyed.
– bank releases its share to become partner in
the asset. And contract of Musharakah is
executed.
– This asset becomes undivided ownership of
both the bank and the client [Musha] None of
the parties can withdraw its equity till DM is
terminated
– General rules of partnership apply
Diminishing Musharakah (DM):
Procedural details: (contd..)
– At the same time, uni-lateral promise from
client is obtained to purchase the units of
bank’s equity.
– The price of one unit of bank’s equity is valued
– Ijarah Agreement is signed
– In case of Ijarah the rent is realized while in
case of business or services profit and losses
are shared
– Expenses connected to asset are borne by the
partners respectively
Diminishing Musharakah (DM):
Procedural details: (contd..)
– Equity of bank is periodically purchased by the
client
– Bank’s share in the asset decreases while that
of client increases – so happens to the rent or
profit
– Ultimately the client becomes the sole owner of
the asset [Bank’s share reduces to zero]
DIMINISHING MUSHARAKAH

Share in Share in
capital capital

2
Partner Bank

3. Accruing Rentals

4
Pays price of Sell its
the units of share in
bank’s equity equity
Diminishing Musharakah (DM):
Example – Financing Purchase of Tractor:
A client wants to purchase a tractor by
sharing of equity of Rs. 40,000 against price of
Rs. 400,000. The bank shares rest of the price
of tractor ie. Rs. 360,000. How his request can
be accommodated by a bank?

Bank agrees to finance the purchase

of tractor through DM.
Diminishing Musharakah (DM):
– 10% of the cost (Rs. 40,000) is paid by
the client and 90% of the cost (Rs.
360,000) by the bank. [Musharakah
Contract is signed]
– The rental of tractor is fixed according to
certain reference price [Ijarah for future
date is signed]
– The client promises (unilateral promise) to
the bank to purchase banks equity divided
in to equal value units
– Say, rent is fixed @ 15% p.a.
– The DM terminates after 3 years
– Installments can vary [Seasonal, quarterly,
monthly]
Diminishing Musharakah (DM):
– After acquisition, the client uses tractor
and pays rent to bank for using bank’s
share in the property
– At the same time, purchases unit(s) of
equity after expiry of each rental period
– The equity of bank diminishes to zero on
expiry of three years, the rent as well,
client becomes sole owner
Diminishing Musharakah (DM): (Amount in rupees)

Total value of Asset: 400000

Share of client 40000
Share of Bank 360000
No. of units 36
Value of one unit 10000
Rent per month 4500
Rent per unit per month 4500 / 36 =
125
End of Rent Value unit Total Remainin Remainin
Month purchased payment g units g balance
0 0 0 0 36 460000
1 125 x 36 10000 14500 35 450000
= 4500
2 125 x 35 10000 14375 34 440000
= 4375
3 125 x 34 10000 14250 33 430000
= 4250
35 125 x 2 = 10000 10250 1 10000
250
36 125 x 1 = 10000 10125 0 0
125
Total ?? 460000 ??
 Assignment
• Project Financing: Manufacturer Company “A” would like to expand its
business by opening a new branch in other City. They did investment
appraisal and come up with total initial investment cost of $ 300 000.
However, the budget of company is limited, they are able to invest only
30% of investment cost and they decided to go with Musharakah
agreement which is given by Islamic Bank. In that type of agreement,
all parties agreed that profit ratio is exactly proportional with
investment of partner. At the end of maturity of this project, they
realized $ 50 000 as a profit.

• What is investment cost in dollars of Islamic Bank and Manufacturer

Company “A” respectively?
• What is profit of Islamic Bank and Manufacturer Company “A”
correspondingly?
• How much in total Islamic Bank will get at the end of maturity of the
project? Manufacturer Company “A”?

40
Q & A

41