Musharakah: Sharing Profits and Losses

Vol 1-Issue 2   Islamic FinanceWhat is Musharakah?

Musharakah means ‘sharing.’ The root of the word is Shirkah, which means ‘being a partner.’ Under Islamic law, Musharakah is a joint enterprise, formed for conducting business, in which all partners share the profit according to a specified ratio, while the loss is shared according to the ratio of the contribution.

Differences Between Interest-Based Financing and Musharakah

1. In interest-based financing, the financer predetermines a fixed rate of return on a loan, irrespective of the profit earned or loss suffered by the debtor. In Musharakah, the return is based on the actual profit earned by the joint venture.

2. If a Musharakah joint venture fails, the financier also suffers a loss. In a system based on interest, the financier secures himself against such an eventuality by fixing a rate of interest.

Basic Rules

Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a mutual contract. Therefore, all the necessary ingredients of a valid contract must be present. For example, the parties should be capable of entering into a contract; the contract must take place with the free consent of the parties, without any duress, fraud, or misrepresentation. However, there are certain rules specifically related to a Musharakah contract.

Rules of Capital

The capital in a Musharakah agreement should be:

  • quantified (Ma’loom),
  • qsecified (Muta’aiyan),
  • not necessarily merged,
  • not necessarily in liquid form.

Management

Every partner has the right to manage the business as well as to work for it. However, the partners may agree upon a condition that the management would be carried out by one of them, and no other partner would work for the Musharakah. In such case, the ‘sleeping partner’ would be entitled to the profit only to the extent of his investment – the ratio of his profit would not exceed the ratio of his investment. However, if all partners agree to work for the joint venture, each one of them would be treated as the agent of the other in all matters of business.

Rules Regarding the Distribution of Profit and Loss

1. Profit:

  • The profit ratio of each partner must be determined proportionally to the actual profit of the business and not in proportion to the capital invested by him.
  • It is prohibited to set a fixed amount for any partner or attach any specific rate of profit to his investment.
  • It is allowed for both partners to agree on profit percentage according to their investment, no matter if both of them work or not.
  • If an investor is working, his profit share can be more than his capital investment, no matter if the other partner is working or not.

2. Loss:

  • Loss is distributed exactly according to the ratio of investment.

Termination of Musharakah

A Musharakah will stand terminated in the following cases:

1.  If the purpose of forming the business has been achieved. For example, if two persons had formed a partnership for a certain project, e.g., buying a specific quantity of cars in order to sell them, and the cars are purchased and sold with mutual investment, then the contract stands terminated.

2.  Every partner has the right to terminate the Musharakah at any time, after giving his partner a notice that will cause the Musharakah to end.

3.  In case of a death of any one of the partners or any partner becoming insane or incapable of carrying out commercial transactions, the Musharakah stands terminated.

Termination of Musharakah Without Closing the Business

If one of the partners wants termination of the Musharakah, while the other partner would like to continue with the business, a mutual agreement should take place. The partner interested in the business may purchase the share of the partner wishing to terminate his partnership.

(Courtesy: Meezan Bank’s Guide to Islamic Finance)