Musharakah is a type of Shirkat-ul-Amwal which literally means sharing. In the context of business, it refers to a joint enterprise in which partners (or parties) to the enterprise share the profit and loss of the enterprise. Musharakah has far reaching implications for Islamic banking and finance in the modern context and provides an excellent alternative to the interest-based economy.
In a Musharakah, the party investing the capital shares equally in both the profit and loss, which is different from an interest-based system where the upside is limited while the downside is very nearly non-existent.
The Basic Rules of Musharakah
Since Musharakah is, in essence, a contract, all conditions and rules of a contract must be met. Apart from those, there are some basic rules that apply specifically to Musharakah.
Distribution of Profits
- The proportion of profit to be distributed among the partners must be determined and agreed upon at the time of the contract. Otherwise the contract is not valid under Shari’ah.
- According to Imam Malik and Imam Shafe’i, it is necessary that each partner’s share in the profit is exactly equal to the proportion of initial investment into the partnership.
- According to Imam Ahmed, the ratio of profit distribution may vary, without restriction, from the ratio of investment.
- According to Imam Abu Hanifah, the ratio of profit distribution may vary, however, for silent partners (non-active partners, who only contribute capital), it cannot be any higher than the ratio of investment.
Distribution of Loss
All the Muslim jurists are unanimous that each partner’s share in loss must be exactly equal to the ratio of initial investment. Anything to the contrary will render the contract invalid.
The Nature of Capital
There are the following opinions on this:
- According to Imam Malik and some Hanbali jurists, the nature of capital is not a restriction in a Musharakah arrangement. Therefore, in-kind (non-cash) contributions by partners are allowed. The share in partnership will be determined based on the market value of the commodity contributed.
- According to Imam Abu Hanifah and Imam Ahmed, no in-kind contributions are allowed in a Musharakah arrangement. This is because they believe it poses problems if the partnership needs to be liquidated or redistributed.
- Imam Shafe’i makes a distinction between replaceable commodities and irreplaceable commodities (like cattle). The view is rather complex, and not important for our purposes.
For the purposes of modern business, the view of Imam Malik has been widely accepted.
Management of Musharakah
The norm is for each partner to take part in the management of the partnership, with each partner acting as an agent of the partnership and any work done by one partner deemed to be authorized by all partners. However, if the partners wish they can contract under alternate arrangements for the management of the partnership.
Termination of Musharakah
It is agreed upon by the jurists that a partnership is terminated if:
- One of the partners terminates the partnership;
- One of the partners dies (where the heirs get the choice to continue the partnership or liquidate it to draw their share from the partnership);
- One of the partners becomes insane.
If the remaining partners want to continue the business under any of the above scenarios, it is achievable with mutual agreement. The remaining partners would have to purchase the share of the out-going partner.
Another question raised is whether the partners can agree, at the time of contracting, that the partnership will not be terminated unless all partners agree to the termination. Though the earlier fiqh books are silent on the issue, there is nothing in the Shari’ah that would prohibit such an arrangement.
Source: Usmani, Chapter 1.