|Title:||Partnership and Profit Sharing in Islamic Law|
|Author:||Muhammad Nejatullah Siddiqi|
|Publisher:||The Islamic Foundation|
The noted author in this book explains the jurisprudential rules of the two most important and distinct modes of commercial enterprise and modes of financing in Islamic finance, i.e. Shirkah (also known as Musharakah) and Mudarabah.
Shirkah or Musharakah literally means sharing. In the context of contemporary business and trade, it refers to a joint enterprise in which all the partners share the profit or loss of the joint venture. Profit is shared based on the pre-agreed profit sharing ratio. On the other hand, the loss is shared as per the capital contribution ratio.
In Musharakah, all partners work and share the profit or loss of their joint enterprise. There is no distinction between a working partner and an investing partner.
The contract of Musharakah is imbued with the spirit of risk sharing rather than risk shifting or risk avoidance. No partner has a fixed share in profit unlike the case in lending on interest where the lender gets a stipulated return on the amount lent irrespective of whether the borrower earns profit or loss from that loan.
Thus, from the viewpoint of distributive justice and income distribution, Musharakah is one of the ideal modes of financing to achieve inclusivity, economic mobility and equitable distribution of income.
On the other hand, Mudarabah is a partnership in which there are two partners i.e. Rabb-ul-Maal and Mudarib. Rabb-ul-Maal is the investing partner who contributes capital to the partnership. Mudarib is the working partner who contributes by rendering services in the partnership. Mudarabah is another type of equity based mode of financing.
In Mudarabah, there is a clear distinction of roles for the partners. It is a kind of partnership where one partner invests capital in a joint enterprise. The investment solely comes from the first partner who is called ‘Rabb-ul-Maal’, while the management and work is an exclusive responsibility of the other, who is called ‘Mudarib’.
Profit is shared based on the pre-agreed profit sharing ratio. On the other hand, the loss is shared as per the capital contribution ratio. Since only the Rabb-ul-Maal invests capital, the loss is solely borne by Rabb-ul-Maal except when there is explicit negligence by Mudarib which causes the loss. In case of loss in normal situations, the Rabb-ul-Maal loses the return on capital and bears loss while the Mudarib loses the efforts contributed to the enterprise.
In the application of Mudarabah, the scope of investment in Mudarabah can be made broad or narrow as per mutual agreement. In an unrestricted Mudarabah (i.e. Mudarabah Ghair Muqayyada), the investment can be made flexibly in any permissible enterprise. On the other hand, in a restricted Mudarabah (i.e. Mudarabah Muqayyada), the investment can only be made in a particular permissible enterprise on which both partners agree.
The difference in Mudarabah and Musharakah is that in Musharakah, all the partners work and share the profit or loss of their joint enterprise. There is no distinction between a working partner or investing partner unlike in Mudarabah.
Like Musharakah, Mudarabah is also an inclusive mode of financing facilitating artisans, innovators, architects, designers and those with skills to obtain financing and then earn the profit share in the joint enterprise.
Thus, from the viewpoint of distributive justice and income distribution, Mudarabah is even one step better than Musharakah to achieve inclusivity, economic mobility and equitable distribution of income by providing finance to a completely capital-deficient, but skilful person.
In Mudarabah, Rabb-ul-Maal does not have a fixed share in profit unlike the case in lending on interest where the lender gets a stipulated return on the amount lent irrespective of whether the borrower earns profit or loss from that loan.
The author explains the jurisprudential viewpoints about permissibility of taking loans by the partner within or beyond the limit of invested capital, allowance of credit sales and treatment of partners willing to have a fixed time period partnership.
The author also discusses that how the jurists look at handling termination of partnership. Do all partners have a right to terminate and does liquidation of partnership share of one partner requires liquidating all assets in cash.
The author also discusses the use of Shirkah and Mudarabah in commercial industrial undertaking. Since modern businesses are not just focused on trading, but on manufacturing as well, it is important to devise rules for continuation of partnership, especially if it involves several partners. Hence, smooth liquidation of partnership shares without having to terminate the whole partnership in the event of a partner exiting partnership or in the event of death, insanity of a partner etc.
Modern day corporations have evolved corporate governance rules and standards to allow flexibility in raising capital by allowing limited liability and separate juristic status to corporations. This helps in corporations surviving natural lives of their founders and allow wide participation in businesses which allays the concerns of concentration and inequality.
Unfortunately, the rules of Shirkah and Mudarabah have not evolved with same flexibility. Hence, even in Islamic finance, the Islamic financial institutions are setup as corporations and Shirkah and Mudarabah, if used, are only transaction or project based partnerships. Reason why Mudarabah is not used as a mode of financing is because it has serious agency and moral hazard problem.
Since all financial risk lies on the capital provider, bank depositors in two-tier Mudarabah would face all the financial risk while the corporations would not have any financial risk. Corporate governance in modern corporations has evolved. Covenants, incentives, and a whole mechanism of monitoring and decision approval hierarchical structure has been devised to minimize the negative effects of agency problem and moral hazard.
Involvement of independent directors and several committees looking at audit, risk and other functions ensure effective monitoring of corporate management.
Unfortunately, the jurisprudential discourse in Musharakah and Mudarabah could not move beyond the individualistic and personal relations of partners without the scope of juristic independence of partnership itself.
Eminent scholars like Maulana Mufti Muhamad Taqi Usmani had developed a synthesis to incorporate the corporate form of business organization in Islamic finance. However, the indigenous institutions of Islamic finance for partnership could not be evolved as much flexibly so as to become a distinct and meta mode of partnership.
As per authors like Timur Kuran, this had an impact on achieving scale economies, productivity and innovation.
Large corporations with sufficient funding and separate juristic personality were better equipped and funded to invest in long term contracts with skilled labour, invest in capacity building, research and development and produce at a large scale to withstand competition by achieving greater scale economies and productivity. With their financial muscle, indeed such big corporations even influenced politics and political economy and continue to do so.
Due to the specific scope of the book, the author does not shed light on the issues of moral hazard and agency problem in Islamic equity based modes of financing and lack of innovative transformation of these modes to become a potent replacement of capitalistic corporate form of organization.
However, this issue deserves attention if Islamic equity based modes of financing are to be seen as a substitute to capitalistic corporate form of organization. It requires sound changes to tackle the issue of agency problem and moral hazard while also enabling long term sustainability of the partnership through wide funding and marketability of investment share.
Appreciably, in this regard, several changes were introduced to make Islamic equity based modes of financing applicable in offering deposit products for customers.
Nonetheless, the issue of agency problem and moral hazard with all financial risk concentrating with capital investor in Mudarabah deserves attention if the Mudarabah mode of financing is to be made applicable in financing the enterprises. As of now, there is still talk of Islamic equity based modes of financing being ideal, but their actual use in financing side on genuinely risk-sharing basis is not that much.
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