eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 45 communication between the buyers as to profit or loss’. Every defendant secured his share of oils respectively and no interference with the share of the others but to manage his share as his wish. Lord Loughborough (the other trial judges), concurred with what has been said by Gould J. Admitting that communion of profit and loss is essential in this question, he added that for a partnership to be constituted the shares must be joint though not necessarily be equal. If the partners be jointly concerned in the purchase, they must also be jointly concerned to sale in the future. As this is not the case, which effectively denies the existence of ‘business carried on in common', the partnership, therefore, did not exist. As such, together with other evidence, it was decided the only party liable (and from the legal standpoint, the only party the credit was given to) is Eyre. ii. The Second Element – Real Intention Apart from the commonality aspect in business, other things such as the real intention, the relevant incidents which may include written or verbal agreement, the conduct of the parties at all times as well the surrounding circumstances may also be the determinant in ascertaining the status of a partnership. This was, inter alia, established through the case of Aw Yong Wai Choo & Ors v Arief Trading Sdn Bhd & Anor. In this case, the plaintiffs had entered into a sale and purchase agreement with the first defendant, a housing developer, where the land on which the houses were planned to be built belonged to the Perak state government, the second defendant. The first defendant failed to undertake the construction. Nevertheless, it was continued by the second defendant. Upon the completion, the second defendant asked the plaintiffs to pay the houses with higher prices than what they had agreed with the first defendant, claiming that the houses were built with the superior specifications as compared to those that had been agreed before (between the plaintiffs and the first defendant.) Refusing to such, the plaintiffs claimed that both defendants had become partners in the business of developing housing estate and building houses on the land. Pursuant to which the agreement between the plaintiffs and the first defendant was entered. Hence, a legal remedy (specific performance) was sought after. In its defence, the second defendant denied,
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 46 inter alia, that it was a partner to the first defendant by claiming it was merely sought to help the latter on a social or moral duty. Further, it claimed that it was never be the plaintiffs' intention to enter into a contract with it. As a non-party to the contract in question, hence, it could not be sued for the contract. It was held by the court, inter alia, that a partnership did exist between the defendants. In the quest to determine the existence of the partnership, the court must find the real intention of the involved parties which is not necessarily the expressed intention. Rather, the relevant factors such as the relevant incidents, written or verbal agreement, the conduct of the parties at all times and all surrounding circumstances are also to be taken into consideration. In this case, there are several things that indicate the existence of the partnership between them. Among the instances is the provision in the agreement between the first and second defendant that provides 50 per cent of the profit of the development to be given to the latter, thus giving rise to prima facie evidence of partnership. Admitting that the said provision did not constitute partnership conclusively, the court had also considered all the provisions in the agreement, particularly the ones pertaining to the joint appointment of architects, surveyors and so forth, the reserved right to the second defendant to inspect the project to ensure everything complied with all specifications and the right to inspect all books of accounts and the accounts which were required to be properly kept and audited. In addition, the brochure distributed to the potential buyers mentioned a 50/50 joint venture between the first defendant as the developer and the second defendant as the landowner. Therefore, the court granted the specific performance as prayed. The discussion above triggers the question on the position of the Musharakah Mutanaqisah home financing under the PA 1961. As mentioned earlier, the product is meant as a financing tool through which the finance provision is provided by the bank to its customer. On the part of the bank, the aim is to gain profit from the selling price of its portion of the property as well as the rental payment made by the customer. The customer, on the other hand, seeks to acquire the house. As such, there is no common business carried between both parties. This situation, therefore, disqualifies this product as a partnership
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 47 recognised under the PA 1961. In addition, it is also claimed that the agreement used between the bank and its customer clearly states that this product is not a partnership and some agreements go to the extent where it is mentioned that no agency is implied. This poses a serious implication since the agency is among the essential elements of Musharakah with the commercial goal. The same concern is also relevant in the case of Musharakah Sukuk, particularly in the issuance where an intermediary entity, known as Special Purpose Vehicle (SPV) is involved. SPV is a separate legal entity, set up by the originator/obligor (the original party seeking the fund) with the sole purpose of facilitating the transaction. It serves as the issuer of Sukuk as well as the trustee over the funds received from the investors. Typically, the originator contributes in-kind (e.g. business venture) while the SPV contributes cash normally from the proceeds of Sukuk issuance. Both will enter into the Musharakah agreement in which specifies, inter alia, the profit and loss sharing ratio. Such profit (and loss) will be then distributed to the investors (via the SPV) in the form of periodic distribution amounts which will take place annually or semi-annually, depending on the agreement. On the one hand, the existence of SPV admittedly is important and benefits both parties, the originator and the investors (Sukuk holders). Being a bankruptcy-remote body, any change in the originator’s structure such as dissolution, merger or acquisition will not render effect to the relation it has with the Sukuk holders. Furthermore, the SPV is liable to the Sukuk holders for default or delay, if any, rather than the originator thus minimises the risk to the originator. On the other hand, having SPV in the bigger picture of Musharakah Sukuk arrangement would make Sukuk holders, in the real sense, are not the partners in the venture. Rather, the partnership is created between the originator and the SPV which makes both as the actual partners of the venture. As such, the question of whether or not the arrangement is a partnership recognised under the PA 1961 once again arises. As established before, it is essential in a partnership for all partners to carry on the business in common. However, in this case, there is no common business carried out by both parties. The originator is seeking for the fund for its interest (e.g. specified project development or maybe merely for the company's working capital or other purposes) whereby
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 48 the SPV is purposely being set up to serve as the conduit through which the money from the Sukuk holders is pooled. The latter (SPV) has no common interest in the business but only to channel the money into the venture while the Sukuk holders, apart from not being the partners, are merely the financiers whom their return happens to be determined by the performance of the venture. From another angle, the intention of Sukuk holders to be partners concerned with the venture activity can be highly doubted given the existence of various mechanisms embedded in the Sukuk’s structure, particularly Musharakah Sukuk. Among the examples for the said mechanisms is the purchase undertaking through which the obligor of Sukuk will undertake to buy back the underlying asset from the Sukuk holders as can be seen in the structure of Musharakah Sukuk. Upon the dissolution declaration or the scheduled dissolution (whichever earlier), the obligor shall acquire the Sukuk holders’ undivided proportionate beneficial interest in the Musharakah asset at the price which shall be calculated based on a certain preagreed formula. This mechanism allows the total return to the Sukuk holders to be ‘fixed' or ‘guaranteed’, especially if the purchasing price is at face value of the Sukuk. In such a case, the risk presented by the Sukuk will be no longer based on the performance of the asset (Musharakah business) but the creditworthiness of the obligor (purchase undertaking provider) as it assumes the ultimate obligation to repay the Sukuk. This may indicate Sukuk holders, from the beginning of their subscription to the Sukuk, did not intend to be partners of the venture but to act as mere creditors instead. Furthermore, the Sukuk structure may also feature the top-up payment mechanism. The Sukuk holders were promised with the expected return from the venture of each tranche (for example, 6 per cent). Should the actual return fall short of this expected return (for example, 4 per cent), the obligor shall cover the difference (2 per cent) via the top-up payment. Although this payment may be set-off later, the existence of this mechanism further casts doubts on the intention of the Sukuk holders; whether they genuinely want to be partners in the venture whom their return will be based on the performance of the venture or to be the creditors whom their return is guaranteed regardless of the venture performance. Should the latter prevail, Musharakah Sukuk is certainly disqualified to be recognised as a partnership under the PA 1961.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 49 iii. The Third Element – View of Profit The existence of partnership in the Musharakah Mutanaqisah home financing can also be challenged based on the absence of the profit motive as required by the PA 1961. In fact, the case of Coope & Ors v Eyre & Ors as mentioned earlier also established that a simple coownership of property cannot constitute a partnership, something which is consistent with section 4(a) of the PA 1961 as discussed earlier. This certainly disqualifies the Musharakah Mutanaqisah home financing as a form of partnership since the Musharakah regulatory policy clearly provides that the Musharakah Mutanaqisah product with the purpose of asset acquisition shall be deemed as Shirkah Al-Milk, a non-profit partnership established in acquiring a property with co-ownership between the bank and its customer. It might be argued that in this arrangement, the bank intends to make a profit. However, this argument is inaccurate for several reasons. On the bank's side, the profit is not generated from the Musharakah itself since Musharakah is only used in the stage where the bank and its customer jointly own the property. Rather, it is derived from the rental payment by the customer (Ijarah) as well as the sale of the bank's portion to the customer (Bai). On the customer's side, the intention may not be to generate profit but to acquire the house for his basic necessity (shelter). The similar argument may also relevant in Musharakah Sukuk although it might not necessarily be the case all time. Should the pooling of assets be intended for the parties to jointly own or acquire the asset (which will be determined by the agreement) rather than to generate profit, the contract shall be deemed as Shirkah Al-Milk instead of Shirkah Al-Aqd. Notwithstanding Sukuk, in general, is an investment tool, the structure that invokes Shirkah Al-Milk shall be exposed to the risk of not being recognised as a partnership by the law for the reasons as mentioned earlier. There are also some other provisions in the PA 1961 which make it impossible for the Musharakah products to be recognised as a partnership. For instance, section 6 provides for the partnership to be called a firm and the name under which the business is undertaken is called the firm name. Since the current practice of the Musharakah Mutanaqisah and also
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 50 Musharakah Sukuk does not require a firm to be established, the practice is therefore against the act. Section 47(2) further provides the maximum number of partners permitted for a partnership is not more than twenty. The restriction imposed by this section might not be problematic in the case of the Musharakah Mutanaqisah home financing since the arrangement typically involves a bank and a customer. However, it is definitely not practical to impose such restriction on the Musharakah Sukuk where the number of investors might be more than 20 to correspond with the sought fund which typically huge. As such, notwithstanding the brand name that the Musharakah Mutanaqisah home financing (and Musharakah Sukuk as well) contains the term Musharakah which implies partnership, these products fail to meet the requirements for an arrangement to be recognised as one as established by the PA 1961 as well as the judgements from the courts. Although the conflict of nature (whether the products, especially the Musharakah Mutanaqisah home financing, are equity-based or debt-based) is yet to be resolved, the assertion of this failure infers that these products are not based on equity. Moreover, as highlighted in the note earlier, these products are to be booked in a financial report in the same group of other debt-based products since the financial report regards the actual substance of the product (its economic substance or financial reality) rather than its form.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 51 SHARIAH REQUIREMENTS AND OPTIONAL PRACTICES OF MUSHARAKAH
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 52 2.0 Definition and Nature of Musharakah Musharakah refers to a partnership between two or more parties, which may take effect through contractual relationship (`aqd) or by operation of Islamic law, whereby all contracting parties will share the profit and bear loss from the partnership Generally, there are two types of Musharakah (shirkah), namely: • Shirkah al-Milk (Partnership in joint ownership) Partnership in joint ownership refers to possession of an asset by two or more persons with or without prior arrangement to enter into a sharing in joint ownership. Under shirkah al-milk, the partner’s ownership is mutually exclusive. In this regard, one partner cannot deal with other partner’s asset without his consent. • Shirkah al-`Aqd (Contractual Partnership) Contractual partnership refers to a contract executed between two or more partners to venture into business activities to generate profit. Under shirkah al-`aqd, the partner is an agent to the other partners. In this regard the conduct of one partner in the ordinary course of business represents the partnership. Shirkah al-`Aqd can be divided into: • Shirkah al-Amwal : An agreement between two or more persons to invest a sum of money as capital in a business and share its profit according to agreement. • Shirkah al-A`maal : A partnership in which the partners agree to share what they earn by their labor. • Shirkah al-Wujuh : An agreement between two or more persons of good reputation to form a partnership to purchase asset on credit for the purpose of making profit whereby the partners undertake to fulfill their obligation according to the percentages agreed by the partners.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 53 2.1 Components of Syariah 2.1.1 Contracting parties ➢ Parties to a Musharakah contract are the partners who may be a natural person or a legal person. ➢ A partner to a Musharakah contract must have the legal capacity to execute the contract ➢ A Musharakah contract shall be concluded by an offer and acceptance between the partners. ➢ A partner to a Musharakah contract may conclude the contract through an agent. ➢ Partners shall be bound by the terms and conditions mutually agreed in the contract provided that they do not contravene the Shariah principle. *The legal capacity of a person is defined as capacity to have rights and responsibilities; and capacity to have legal effect to his action. Among the important conditions are that the person must possess sound mind and the capacity to distinguish between what is harmful or beneficial to one’s interests. Legal capacity of a legal entity is defined as eligibility of an entity to acquire rights and assume responsibilities 2.1.2 Management of Musharakah ➢ A Musharakah venture may be managed in the following manner: • Management by all partners; or • Management by certain partners or a single partner; or • Management by a third party ➢ The appointment of a third party as the manager shall be executed in a separate contract. ➢ The appointment of a manager may be executed based on wakalah (agency), ijarah al-ashkhas (employment contract) or Musharakah.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 54 ➢ A managing partner may be entitled to an agreed remuneration and/or any incentive as agreed by the partners for his services as manager in addition to his share in profit sharing as a partner. ➢ A managing partner shall be liable for any loss caused by his misconduct (ta`addi), negligence (taqsir) or breach of specified terms (mukhalafah al-shurut) ➢ Amendments and variations to the Musharakah agreement may take effect at any time throughout the tenure of the contract on all issues provided that such amendments and variations are mutually agreed upon by the partners and are in compliance with Shariah. ➢ The Musharakah agreement may provide that any amendment to the agreement is valid by a specified approval process such as a majority vote. 2.1.3 Capital ➢ Musharakah capital shall be identifiable, readily available and accessible. ➢ Musharakah capital may be in the form of cash or in-kind that may include intangible assets. ➢ Capital in-kind shall be valued in monetary terms by third party, which may include experts, valuers, or as agreed upon by the partners at the inception of the contract. ➢ Musharakah capital denominated in different currencies shall be valued based on a specific currency agreed by the partners at the inception of the contract. ➢ All forms of debts shall not qualify as Musharakah capital. All account receivables and payment due from other partner or third parties are considered as debt. ➢ Asset with an integral financial liability attached to it may be contributed as a Musharakah capital and the liability may be assumed by the partnership. ➢ The risk associated with the assets contributed as capital to the Musharakah venture shall be assumed by the partnership. ➢ The total amount of capital to be contributed by each partner shall be known and determined at the time of contract. ➢ Upon the disbursement of capital by the Musharakah partners, all partners’ rights and liabilities with regard to the partnership shall be established. ➢ The capital may be fully or partially disbursed as per the terms of the contract.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 55 ➢ Notwithstanding paragraph 11.10, additional capital may be injected subject to mutual agreement of all partners. In this regard, the partners may agree to vary or revise the proportion of capital contribution and the profit-sharing ratio. ➢ The effect of a failure of a partner to provide capital under a Musharakah contract (defaulting partner) in the following situations shall be as follows: a. No capital has been paid by defaulting partner within the stipulated time. The non-defaulting partners may terminate the contract with the defaulting partner and may impose on defaulting partner to indemnify the partnership for any expenses incurred due to his default. b. Musharakah contract involving staggered capital payment. In a Musharakah contract involving staggered capital payment, where the defaulting partner has made partial capital payment, the non-defaulting partners may, subject to the terms and conditions of the contract: i. revise the Musharakah contract based on the actual capital paid by the defaulting partner; or ii. terminate the contract with the defaulting partner and consequently: • the non-defaulting partner will pay the defaulting partner’s fair share of investment in the Musharakah; or • require the defaulting partner to sell his interest to the other partner(s) or a third party; and iii. based on agreed terms, the partnership may impose on the defaulting partner to indemnify the partnership for any expenses incurred due to his default. ➢ Musharakah capital either cash or kind shall form common and undivided interest of all partners. ➢ The capital invested shall not be guaranteed by any of the partners and/or managers. ➢ Any partner acting on his own or as agent who has caused the loss of capital due to misconduct (ta`addi), negligence (taqsir) or breach of specified terms (mukhalafah alshurut) shall indemnify the loss of the capital. ➢ Capital loss shall be borne by the partners proportionate to their capital contribution. ➢ A share of Musharakah capital may be transferred to existing partners or a third party according to the agreed terms and conditions of the Musharakah contract.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 56 ➢ The Musharakah agreement may impose a condition that compels a partner to offer his share of capital to existing partners based on agreed terms and conditions. ➢ Any gain or loss in the value of capital from the transfer of share capital shall be enjoyed or borne by the partner who disposes the shares. ➢ The Musharakah contract may provide for the partner to withdraw capital during the tenure of the Musharakah contract unless stated otherwise in the Musharakah agreement. ➢ Consequent to capital withdrawal, the loss sharing ratio shall be revised accordingly. ➢ A Musharakah that is specific to a project, where one or more of the partner(s) is involved in multiple projects, only direct expenses attributable to the specific project may be deducted from Musharakah capital. 2.1.4 Profit ➢ Profit is the value created over and above the Musharakah capital which is determined based on a method acceptable by market standard or practices. ➢ The partners in a Musharakah venture shall share profit based on a mutually agreed ratio among them. ➢ Profit Sharing Ratio (PSR) shall be based on proportionate capital contribution by the partners unless mutually agreed otherwise at the inception of the contract. ➢ The PSR may be revised during the tenure of the Musharakah subject to mutual agreement between the partners. The PSR may be revised either based on the mutual agreement of the partners or based on a certain benchmark agreed upon by the partners as the case may be. ➢ The partners may agree on a PSR for a certain threshold of profit. In the event that the actual profit exceeds the threshold, the excess amount may be distributed based on a different PSR agreed by the partners or be paid to any of the partners as per agreement. In the case of profit generated is below the threshold, the profit is shared based on the PSR. ➢ Musharakah contract shall not stipulate a pre-determined fixed amount of profit to any partners which may deprive the profit share of the other partners.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 57 ➢ The expected return in the form of percentage which is attributed to the Musharakah capital amount is only permissible in the form of indicative profit rate. ➢ The agreed PSR may vary to correspond with different periods of investment, different amount of capital or due to pre-mature withdrawal of capital provided that such conditions are agreed upon at the inception of the Musharakah contract. ➢ Any partner may relinquish his right to the profits, if any, to the other partner(s) on the basis of waiver (tanazul) provided that the waiver shall be exercised after recognition of the profit. ➢ Profit shall be recognised based on the following methodology: a. realised basis by actual liquidation of assets of Musharakah partnership (altandid al-haqiqi); or b. constructive basis according to acceptable profit recognition method which may include valuation according to acceptable market methodology or independent valuation or valuation based on estimated figures (al-tandid alhukmi). ➢ In the case of profit recognised based on constructive basis, a profit reserve may be created. ➢ In the case of profit recognised based on constructive basis, a final consolidation and adjustment shall be undertaken at the end of a certain period or at the times of actual realisation of profit to arrive at the actual amount of profit. ➢ It is permissible to distribute a sum of money on account prior to actual or constructive valuation provided that upon rationalisation at the actual profit recognition date, any amount paid which exceeds actual profit must be adjusted. ➢ The partners may agree to set aside the profit as a reserve or for any other purpose. ➢ n relation to paragraph 12.14, if the reserve fund is distributable to the partners, unless otherwise agreed, the distribution shall be based on the agreed profit-sharing ratio.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 58 2.1.5 Loss ➢ Loss is depletion from the value of capital. ➢ Loss shall be borne by the partners proportionate to the capital contribution and the loss is limited to the capital. ➢ Upon realisation of loss, any partners may voluntarily absorb such loss. ➢ Loss due to misconduct (ta`addi), negligence (taqsir) or breach of specified terms (mukhalafah al-shurut) by a partner shall be borne by that partner. 2.2 Arrangement of Musharakah with other contracts or Concepts 2.2.1 Arrangement for guarantee ➢ Partners in Musharakah shall not guarantee the capital and/or profit. ➢ Notwithstanding paragraph 14.1, the following measures may be exercised: a. each partner may be required to provide collateral, provided that the collateral can only be liquidated in the event of misconduct (ta`addi) or negligence (taqsir) or breach of specified terms (mukhalafah al-shurut) of contract by the partner(s); or b. the Musharakah venture may require for arrangement of an independent third-party guarantee including performance guarantee of the Musharakah venture or guarantee on Musharakah capital. ➢ Pursuant to paragraph (b), the following requirements shall be observed: a. the guarantee shall be executed as a separate contract and be utilised to cover for any loss or depletion of capital; and b. the third-party guarantor shall be independent from the Musharakah venture such that it shall not be a related party where the partner(s) has majority ownership and/or having control in the entity nor shall it be an entity that owns or having controls over the Musharakah venture.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 59 2.2.2 Arrangement of Musharakah with Wa’d ➢ Musharakah may be arranged with Wa`d whereby: a. a partner undertakes to purchase or sell his share to the other partners’ share upon certain specified event; b. an agent (wakeel) appointed by the partnership undertakes to purchase or sell the underlying asset of the partnership upon certain specified event; or c. a partner undertakes to waive his share of profit to the other partners upon certain specified event. 2.2.3 Arrangement of Musharakah with Wakalah ➢ Musharakah may be arranged with Wakalah either with or without fee whereby: a. the partnership appoints one of the partners as the agent (wakeel) to act on behalf of the partnership; or b. the partnership appoints a third party as the agent (wakeel) to act on behalf of the partnership. 2.2.4 Musharakah Mutanaqisah ➢ Musharakah may be entered into by two or more parties on a particular asset or venture which allows one of the partners to gradually acquire the shareholding of the other partner through an agreed redemption method during the tenure of the contract. Such arrangement is commonly referred to as Musharakah Mutanaqisah (diminishing Musharakah). ➢ Musharakah Mutanaqisah with the objective of asset acquisition must be governed by the principle of shirkah al-milk and therefore must have the effect of shirkah almilk as defined (refer 2.0). ➢ Musharakah Mutanaqisah with the objective of venturing in profit generating business activities must be governed by the principle of shirkah al-`aqd and therefore must have the effect of shirkah al-`aqd as defined (refer 2.0).
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 60 2.3 Musharakah Mutanaqisah for The Purpose of Asset Acquisition (based on Shirkah al-Milk) ➢ Musharakah Mutanaqisah for the purpose of asset acquisition may be arranged with other contracts such as ijarah (leasing), ijarah mawsufah fi zimmah (advance lease), bai` musawamah (selling) and istisna`(manufacturing). ➢ Musharakah Mutanaqisah for the purpose of acquiring completed asset may be arranged whereby both partners jointly purchase an asset from a third party. Subsequently, one of the partners will lease his share of ownership to the other partners based on ijarah. Simultaneously, the partner who is the lessee will purchase the share of the other partner on gradual basis and ultimately become the sole owner of the asset. ➢ Musharakah Mutanaqisah for the purpose of acquiring incomplete asset may be arranged with istisna` whereby both partners enter into an istisna` contract with a third party. Subsequently, one of the partners will lease his share of ownership to the other partners based on ijarah mawsufah fi zimmah until the asset is completed. Simultaneously, the partner who is the lessee will purchase the share of the other partner on gradual basis and ultimately become the sole owner of the asset. ➢ A partner under Musharakah Mutanaqisah may lease his share of the Musharakah asset to other partners. ➢ A partner, at the inception of the contract may request the other partner to give a binding promise (wa`d) to gradually purchase the former’s share of the asset over an agreed period of time at market value, fair value or any price to be agreed by the partners. ➢ *Partner may agree on a specific method of price calculation in the case where total shares are acquired earlier than the stipulated tenure. ➢ Pursuant to (refer *), the lease between the partners is dissolved. ➢ A partner may pledge his ownership share of the completed asset as collateral to the other partners. ➢ In the event where a partner (promisor) breaches his promise to acquire the Musharakah asset as agreed or fails to pay his rental, the other partner (promisee) may sell the asset to the partner or to a third party as per agreed terms and conditions.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 61 ➢ Pursuant to (refer *), the sale of the asset to a third party may be conducted based on the following approaches: Approach 1 a. Promisee invokes the promise to purchase and where the promisor fails to perform the promise; the partners shall jointly sell the asset to a third party. b. The proceeds of the sale shall be allocated to all partners based on the ownership share at the point of sale based on following options: i. allocation to all partners after deducting all costs related to asset liquidation from the proceeds of the sale; or ii. allocation to all partners without prior deduction of costs related to asset liquidation from the proceeds. Under this approach, the cost related to asset liquidation is deducted only from promisor’s share of the proceeds. c. The promisee may claim the rental due (if any) from the promisor’s share of the proceeds. d. The promisee may claim a compensation amount from the promisor’s share of the proceeds. The compensation amount shall be the difference between the agreed purchase price (as promised) and the realised proceeds portion allocated for the promisee. e. In the event where the promisor’s share of the proceeds is inadequate to meet the claim under paragraph (d), the promisee may demand the remaining difference from the promisor if the promisor is financially capable. f. If the promisor has proven that he is financially incapable to meet the difference amount, the promisee shall not make any further claim of shortfall from the promisor. g. In the event that the promisee’s share of the proceeds is equivalent or higher than the promised purchase price, the provisions on compensation under paragraphs (d), (e) and (f) shall not be applicable. h. In the event that promisee's portion of proceeds exceeded the promised purchase price the promisee may share his excess proceeds with the promisor.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 62 Approach 2 a. The promisee may invoke the promise to purchase and where the promisor fails to perform the promise, the promisor may subsequently sell his remaining ownership share to the promisor on credit based on any agreed price by both parties. b. The promisee may take the asset as collateral to secure the payments of the deferred price as agreed under paragraph (a). c. In the case where the promisee as the creditor liquidates the collateral, the following may be applied: i. The promisee may claim the rental due, the purchase price as agreed in the promise to purchase and costs related to liquidation of the collateral. ii. In the event where the proceeds from the liquidation of the collateral is inadequate to meet the claim under paragraph (i), the promisee as creditor may demand the remaining difference if the promisor is financially capable. iii. If the promisor has proven that he is financially incapable to meet the difference amount, the promisee shall not make any further claim of shortfall from the promisor. iv. If there is any excess amount from the proceeds of the collateral liquidation after the deduction of claims under paragraph (i), the excess amount shall belong to promisor. ➢ In Musharakah Mutanaqisah for acquisition of asset under construction which is arranged based on paragraph before that, if a partner (promisor) breaches his promise to acquire the ownership share of the asset as agreed or fails to pay his rental, and where the construction of asset has been completed. ➢ In Musharakah Mutanaqisah for acquisition of asset under construction which is arranged based on paragraph before that, if a partner (promisor) breaches his promise to acquire the ownership share of the asset as agreed or fails to pay his rental, and where the construction of asset has yet to be completed: a. the promisee may invoke the promise and compel the promisor to purchase the promisee’s interest in the Musharakah based on the price agreed in the promise.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 63 b. the rental paid under ijarah mawsufah fi zimmah may be set off against the purchase price of the promisee’s ownership share of the asset. 2.4 Musharakah Mutanaqisah for The Purpose of Venturing in Profit Generating Business Activities ➢ Musharakah Mutanaqisah with objective of venturing in profit generating business activities must take into consideration all provisions under this document except the provisions (follow and refer 2.6): ➢ A partner may request the other partner(s) to give a binding promise (wa`d) to gradually purchase his shares of the Musharakah venture over an agreed period of time at market value, fair value or any price to be agreed by the parties at the time of purchase. ➢ Pursuant to paragraph before that, gradual acquisition of share by one partner of the other partners’ share shall not result in a guarantee of capital. ➢ Pursuant to paragraph before that, in the case where the share acquisition is accelerated, the price determination shall be based on the market value, fair value or any price to be agreed by the parties at the time of purchase. ➢ In the event where a partner (promisor) breaches his promise to acquire the share of Musharakah venture as agreed, the other partner (promisee) may: a. invoke the promise and compel the promisor to purchase the share at market value or fair value; or b. sell the share to a third party and claim any actual cost incurred in the process to the promisor. 2.5 Dissolution ➢ A Musharakah contract may be dissolved under the following circumstances: a. Mutual agreement to terminate; b. Contract expires upon the maturity date agreed by the partners; c. Demise or dissolution of partners or loss of legal capacity;
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 64 d. The total acquisition by one partner of the other partners’ share of Musharakah; e. Invalidity of Musharakah. ➢ Notwithstanding paragraph (c), the remaining partners may agree to continue with the contract according to the terms in the Musharakah deed or agreement. ➢ Upon the termination of the Musharakah contract, Musharakah assets shall be subjected to the liquidation process. ➢ Musharakah assets may be liquidated where the assets are disposed to the market. ➢ Pursuant to paragraph before that, the proceeds of the asset disposal shall be used as follows: a. payment of liquidation expenses; b. payment of financial liabilities of the partnership; and c. distribution of the remaining assets, if any, among the partners in proportion to their capital contribution 2.6 Conclusion In conclusion, Islamic finance is an important and growing area of finance that is based on ethical and moral values. From a legal perspective, Islamic finance transactions require specialized legal expertise and are subject to Shariah law. The different structures and agreements used in Islamic finance are designed to comply with Shariah law and promote transparency, fairness, and social responsibility. By promoting ethical investment solutions, reducing legal risk, and promoting financial stability, Islamic finance can provide several economic and legal benefits to businesses and investors. The above analysis has been simplified for the sake of brevity, to give a glimpse on the different types of popular Shariahcompliant partnership arrangements. Naturally there is a host of other legal and Shariah issues to consider for each structure. Shariah-compliant solutions are no longer confined to the banking and financing industry, and they continue to grow in popularity in other areas of investments as well. These benefits make Islamic finance an attractive alternative to conventional finance for individuals and businesses looking for socially responsible and ethical investments.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 65 AN OVERVIEW OF SHARIAH PARAMETER FOR MUSHARAKAH CONTRACT
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 66 3.0 Definition Musharakah is a word of Arabic origin which literally means sharing. Other definition is; • define it as an “Agreement for association on the condition that the capital and its benefit be common between two or more persons”. • “An agreement between two or more persons to carry out a particular business with the view of sharing profits by joint investment”. • musharakah or partnership as: “A contract between two persons who launch a business of financial enterprise to make profit”. Based on the above definitions, the ideas of partnership are: First, to contribute capital to an enterprise or a venture, whether existing or new, or to owner of a real estate or moveable asset, either on a temporary or permanent basis. Therefore, the partnership can be used in the case of large users of funds to establish investment for short term or long-term basis. Second, to share profit over the business with the share of loss. Thus, a partnership needs to be defined as a contract between two or more persons in carrying out a particular business with a view of not only sharing the profit but also loss and liability. Third, partners share and control how the investment is managed. Fourth, liability in this partnership is unlimited. Therefore, each partner is fully liable for the actions and commitments of the other in financial matters. In the terminology of Islamic fiqh, the modes partnership istermed as shirkah. Shirkah means sharing and in the book of Fiqh, it has been divided into two kinds; First, 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:
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 67 i. sometimes it comes into operation at the option of the parties. For example, if two or more persons purchase 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. ii. But 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. Second, Shirkat-ul- ‘aqd which means a partnership effected by a mutual contract. For the purpose of brevity, it may also be translated as joint commercial enterprise. Shirkat-ul- ‘aqd is further divided into three kinds: i. Shirkat-ul-amwal where all the partners invest some capital into a commercial enterprise; ii. Shirkat-ul-a’mal where all the partners jointly undertake to render some services for their customers, and the fee charged from them is distributed among them according to an agreed ratio. For example, 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 the work each partner has actually done, this partnership will be a shirkat-ul-a’mal which is also called Shirkatul-taqabbul or Shirkat-ul-sana’i’ or Shirkat-ul-abdaan. iii. The third kind of Shirkat-ul- ‘aqd is Shirkat-ul-wujooh. Here the partners have no investment at all. 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.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 68 3.1 The Legitimacy of the Musharakah Contract The legitimacy of the Musharakah contract is established based on the Qur’an, the Sunnah of the Prophet Muhammad (SAW) and the consensus of Muslim jurists. Though most of the Islamic jurists agreed upon the permissibility of musharakah, The majority believes that it is permissible and shariah compliant. The following Qur’anic verses generally indicate the validity of Musharakah. “…but if more than two, they share in a third...” (Al-Nisa’:12) The verse specifically underlines the rule of Islamic inheritance. However, in general context, Muslim jurists have regarded the text as containing general permissibility of any form of partnership. “Verily many are the partners (in business) who wrong each other except those who believe and work deeds of righteousness and how few of them….” (Al-Sad: 24) Based on both, Surah al-Nisa and al-Sad, in these verses, Allah SWT describes the partnership of the property. If a person dies without leaving behind any ascendants or descendants; but he has brothers and sisters more than two in number; then they will share a third of the property of the mortal. So, based on that, the partnership of the property is legal in the shariah. Shariah scholars generally agreed on the validity of a sale contract which is combined with lease contract. Also, there is no clear text in the shariah that prohibits musharakah. Considering the public interests and benefits of musharakah in the investment, it should be permitted in the shariah. Some scholars however, disagreed to the validity of musharakah contract. To them, it should be declared invalid as it contains some elements of doubts. They claim that it is similar to interest as the primary purpose of musharakah is to give loan to the clients and to derive extra money from the amount of loan. Several hadith also narrated the permissibility of musharakah. The Narration of Abu Hurayrah. Abu Hurayrah said that: The Prophet SAW said: Allah says: I am the third (partner) of the two partners as long as they do not betray each other. When one of them betrays the other, I depart from them”. (Sunan Abu Daud)
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 69 The Narration of Abu al-Minhal. Abu al-Minhal narrated that Zayd Ibn Arqam and alBarra’ Ibn ‘Azib were partners, and they bought silver in cash and credit. Their practices were brought to the Prophet SAW, and the Prophet SAW pronounced that what was bought on cash then they could benefit from it and what was bought on credit then they should reject it.” (Musnad Ahmad) The Prophet SAW found the people using the partnership contract and did not question this behaviour, and there are many hadith that indicate his approval of the contract. One sudh hadith is: Allah supports the partners as long as they do not betray one another. In general, muslims have approved the legality of partnerships, with differences in opinion only existing over specific types. The wisdom in permitting partnerships is clear. The contract allows individuals to combine their properties in a manner that allows them to produce more wealth than they could each produce individually. It is learned from the narration that Prophet Muhammad SAW approved the partnership formed between Zayd Ibn Arqam and al-Barra’ Ibn ‘Azib but disapproved their venture into business activity of purchasing silver on credit. The above type of partnership has been practised throughout the history of Muslims without objection from the jurists. Imam Ibn al-Munzir states in his book al-Ijma’: “And they (Muslim jurists) agree on the validity of partnership where each of the two partners contributes capital in dinar or dirham, and co-mingles the two capitals to form a single property which is indistinguishable, and they would sell and buy what they see as (beneficial) for the business, and the surplus will be distributed between them whilst the deficit will be borne together by them, and when they really carry out (as prescribed), the partnership is valid.” 3.2 Terms and Conditions of the Musharakah Contract From the above discussion, we could safely infer that musharakah is a permitted contract in shariah. However, scholars suggest some principles and guidelines that are needed to be observed strictly, so that this contract does not exceed the boundary of the Shariah and does not get assimilated with the interest-based contracts.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 70 Base on the latest Bank Negara Malaysia (BNM) parameter on musharakah contract, we will review it in the light of specific definition and guidelines on the basis of legitimacy in adopting the musharakah contract. The aim is to facilitate the understanding of the shariah contract requirements. In addition, the features identified in this parameter shall serve to assist the Islamic financial services industry to identify, understand, apply and distinguish the contract from other contracts prevalent in the industry. The parameter in musharakah covers capital, management, profit sharing, loss sharing and joint ventures. This parameter will also be discussed in the context of other scholar views. The discussion of each parameter is as follows: i. Capital Contribution by All Partners The essential conditions of a valid Musharakah capital are shown under BNM parameters are: a. shall be readily available; b. shall be contributed by all partners; and c. may be in the form of monetary asset such as cash or non-monetary assets that includes tangible and intangible assets. Monetary assets denominated in different currencies shall be valued based on the currency agreed by the partnership upon conclusion of the contract. Capital in the form of non-monetary assets shall be valued based on the valuation determined by a third party which may include authoritative bodies, experts or valuers, or as agreed upon by the contracting parties at the time of conclusion of the contract. All forms of debts shall not qualify as musharakah capital. All account receivables and payment due from other partner or third parties are considered as debt. A non-monetary asset with an integral debt component to the asset may be contributed as a musharakah capital provided that the integral debt is less than 50% of the asset value. Funds placed with the Islamic financial institutions in the form of deposits may be invested as capital in a musharakah contract. The total amount of capital to be contributed by each partner shall be determined up front. The agreed capital may be contributed in one lump sum or on staggered basis. Additional capital may be injected upon mutual agreement of all partners. In this regard, the
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 71 partners may agree to vary or revise the proportion of capital contribution, the profit-sharing ratio or change of partners. Failure to contribute capital by the capital provider as per the agreed schedule shall constitute a breach of promise according to specified terms and conditions of the contract. The partners have an option to terminate the agreement or may agree to revise the agreement based on actual capital contribution. Musharakah capital comprising of monetary and non-monetary assets invested by each partner should be commingled representing the collective rights of each partner. Once contributed as capital, the rights, obligation and liabilities of all assets contributed to the musharakah venture shall be jointly and severally assumed by partners. The capital invested shall not be guaranteed by any of the partners. Any of the partners acting as agents of each other shall be liable for misconduct or negligence to the partnership as a whole. Any partner acting on his own or as agent who has caused the loss of capital due to misconduct or negligence shall be liable to refund the loss of capital to the other partners. Any loss of capital in the course of the venture shall be recognized as capital impairment. Upon termination of the partnership, capital impairment loss shall be borne by the partners proportionate to capital contribution. A share of a musharakah capital may be transferred to existing partners or a third party according to the existing terms and conditions of the musharakah contract. The Musharakah agreement may impose a condition that compels a partner to offer the redemption of the partner’s share of capital to existing partners based on certain agreed terms and conditions. New partners may enter the musharakah during the tenure of the existing contract subject to the agreement of existing partners. Any gain or loss in the value of capital from the transfer of share capital shall be enjoyed or borne by the partner that disposes of the shares. Any realized losses arising from the conduct of musharakah during the period shall be borne by each partner proportionate to equity share of each partner. Most of the Muslim jurists are of the opinion that the capital invested by each partner. Taqi Usmani says that capital contribution must be in liquid form. It means that the contract of Musharakah can be based only on money, and not on commodities. In other words, the share capital of a joint venture must be in monetary form.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 72 No part of it can be contributed in kind. However, there are no different views in this respect like views by Imam Malik, Imam Abu Hanifa and Imam Shafi’i. Imam Malik is of the view that the liquidity of capital is not a condition for the validity of Musharakah, therefore, it is permissible that a partner contributes to the Musharakah in kind, but his share shall be determined on the basis of evaluation according to the market price prevalent at the date of the contract. This view is also adopted by some Hanbali jurists. Imam Abu Hanifa and Imam Ahmad are of the view that no contribution in kind is acceptable in a Musharakah. Their standpoint is based on two reasons: Firstly, they say that the commodities of each partner are always distinguishable from the commodities of the other. For example, if X has contributed one motor car to the business, and Y has come with another motor car, each of the two cars is the exclusive property of its original owner. Now, if the car of X is sold, its sale-proceeds should go to X. Y has no right to claim a share in its price. Therefore, so far as the property of each partner is distinguished from the property of the other, no partnership can take place. On the contrary, if the capital invested by every partner is in the form of money, the share capital of each partner cannot be distinguished from that of the other, because the units of money are not distinguishable, therefore, they will be deemed to form a common pool, and thus the partnership comes into existence. Secondly, they say, there are a number of situations in a contract of Musharakah where the partners have to resort to redistribution of the share capital to each partner. If the share-capital was in the form of commodities, such redistribution cannot take place, because the commodities may have been sold at that time. If the capital is repaid on the basis of its value, the value may have increased, and there is a possibility that a partner gets all the profit of the business, because of the appreciation in the value of commodities he has invested, leaving nothing for the other partner. Conversely, if the value of those commodities decreases, there is a possibility that one partner secures some part of the original price of the commodity of the other partner in addition to his own investment. Imam al-Shafi’i has come with a via media between the two points of view explained above. He says that commodities are of two kinds.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 73 First, Dhawat-ul-amthal i.e. the commodities which, if destroyed, can be compensated by the similar commodities in quality and quantity, e.g. wheat, rice etc. If 100 kg. of wheat are destroyed, they can easily be replaced by another 100 kg. of wheat of the same quality. Second, Dhawat-ul-qeemah i.e. the commodities which cannot be compensated by the similar commodities, like the cattle. Each head of sheep, for example has its own characteristics which cannot be found in any other head. Therefore, if somebody kills the sheep of a person, he cannot compensate him by giving him similar sheep. Rather, he is required to pay their price. Imam al-Shafi’i, says that the commodities of the first kind (dhawat-ulamthal) may be contributed to the Musharakah as the share of a partner in the capital, while the commodities of the second kind (dhawat-ul-qeemah) cannot form the part of the share capital. By this distinction between dhawat-ul-amthal and dhawat-ul-qeemah, Imam al-Shafi’i has met the second objection on ‘participation by commodities’ as was raised by Imam Ahmad. For in the case of dhawat-ul-amthal, redistribution of capital may take place by giving to each partner the similar commodities he had invested. However, the first objection remains still unanswered by Imam al-Shafi’i. In order to meet this objection also, Imam Abu Hanifah says that the commodities falling under the category of dhawat-ul-amthal can form part of the share capital only if the commodities contributed by each partner have been mixed together, in such a way that the commodity of one partner cannot be distinguished from that of the other. In short, if a partner wants to participate in a Musharakah by contributing some commodities to it, he can do so according to the Imam Malik without any restriction, and his share in the Musharakah shall be determined on the basis of the current market value of the commodities, prevalent at the date of the commencement of Musharakah. According to Imam al Shafi’i, however, this can be done only if the commodity is from the category of dhawat-ul-amthal. According to Imam Abu Hanifa, if the commodities are dhawat-ul-amthal, this can be done by mixing the commodities of each partner together. And
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 74 if the commodities are dhawat-ul qeemah, then they cannot form part of the share capital. It seems that the view of Imam Malik is simpler and more reasonable and meets the needs of the modern business. Base on the discussion on capital contribution by Taqi Usmani that the share capital in a musharakah can be contributed either in cash or in the form of commodities. However, according to Wahbah Zuhaili, contract musharakah is a form of partnership in which one of the partners’ promises to buy the equity share of the other partner gradually until the title to the equity is completely transferred to him. The transaction starts with the formation of partnership, after which buying and selling of the equity take place between the two partners. It is therefore necessary that this buying and selling should not be stipulated in the partnership contract. In addition, the buying and selling agreement must be independent of the partnership contract. It is not permitted that one contract be entered into as a condition for concluding the other. Wahbah agree that partnership capital must be non-fungible example specified, and present at the time of the contract or at the time of making a trade. This follows from the fact that the partnership is initiated to realize profits through dealing in the property. If the capital were a liability or a non-present property, then dealing in it would be impossible, and the reason for having a partnership would be nullified. However, it is not always necessary for the capital to be present at the time of writing the contract, but it must be present at the time of trading. Thus, consider the case where a person gives another RM1000 and asks him to match it with another RM1000, and to trade with the total capital and share the profits with him. If the second person later brings RM1000 and trades with the RM2000, the partnership is valid. In this regard, the partnership is actually realized only when the trading begins, and that is when the capital needs to be present. The Hanafis, Malikis, and Hanbalis ruled that it is not necessary to mix the properties of the partners, since the purpose of the partnership is realized through the contract, and not through the physical mixing of properties. In analogy to silent partnership, profits from the capital are shared in accordance with the contract with mixing properties of the partners. Moreover, a partnership is primarily a contract of agency and delegation, which may be exercised without mixing properties. Therefore, the partnership is valid if the partners explicitly mention that one of them uses some Ringgit for trading, while the other uses certain
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 75 other currencies. On the other hand, the Malikis argued that there must be some form of mixing of the capital, either physically or legally. Thus, Ibn Rushd said: ‘Legal understanding would point out that partnerships are made better through mixing the capital, since partners would then have equal incentives in preserving each other’s wealth that they have in preserving their own’. At the other extreme, Zufar, the Shafi’i, and the Zaydis ruled that the two properties must be mixed in a manner that makes them indistinguishable from one another. Moreover, they ruled that the mixing must occur prior to the conclusion of the contract. This follows since any part of the partnership’s capital that perishes must perish in the property of all partners, thus requiring mixture lest only one of the partners incur the entire loss. In this regard, they ruled that partnership essentially means the mixing of capital, without which it serves no economic purpose. This difference in opinion results in different rulings for partnerships with capital of difference genere examples gold and silver. Since the majority of jurists do not require mixture of the capital, they permit partnerships where the partners contribute capital of different genera. On the other hand, the Shafi’i and Zufar do not allow such partnerships, since they require capital mixture to the point where the components cannot be recognized. Most jurists agree that the capital of a partnership must be made of fungible monies examples gold and silver coins, or contemporary currencies. Thus, non-fungibles examples real estate and cars, may not be used as capital in partnerships. This follows since such nonfungibles have varying values, thus rendering the different partner’s shares in capital and thus shares in profits unknown, leading to potential legal disputes. Moreover, non-fungible properties are not eligible for agency and delegation. For instance, it is not permitted for someone to tell another ‘sell your house, and we share the price’, since the house clearly belongs to the owner. In contrast, it is permissible to say to another ‘you buy goods with RM1000 and I buy goods with RM1000, and we share whatever each of us makes. The Hanbalis and most of the Hanafis take this requirement to imply that gold and silver dust and nuggets are not permissible as contributions to the capital of a partnership, judging that such metals are non-fungible. Some of the Hanafis ruled that such raw metals may be used as money, and thus the ruling depends on convention.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 76 The Shafi’is went further by ruling universally that such raw metals are fungible, and hence permissible as capital in a partnership. The Hanafis also differed over copper coins, which are sometimes treated as money and at other times are not accepted as legal tender and treated as non-fungible properties. Thus, Abu Hanifa, Abu Yusuf, the Shafi’is, the Hanbalis, and the Maliki jurist Ibn Al Qasim ruled that copper coins may not be used as capital in a partnership, whereas Muhammad ruled that if such coins are accepted as money, then they may be used as capital in a partnership. On the other hand, the Malikis ruled that a partnership’s capital need not be monetary. Thus, they allow non-fungibles of similar or different genera to be used as contributions to a partnership’s capital. In this case, the partner’s shares in capital are determined based on the values of their contributions. Since those values are known, they ruled that the contact is established in the same manner whether or not the capital is monetary. ii. Management of Musharakah Venture BNM suggest that, Musharakah venture may be managed in the following manner: - a. Management by all partners; or b. Management by certain partners or single partner; or c. Management by a third party. In the case of management by certain partners and by a third party, the non-managing partners shall not act on behalf of the partnership. A managing partner may be entitled to an agreed remuneration for their services as the manager in addition to their share in profit sharing as a partner. Alternatively, the agreed remuneration may also be in the form of a greater profit-sharing ratio. Pursuant to management by a third party, the musharakah venture may appoint a third party to manage the venture based on relevant contract such as wakalah, ujrah or mudarabah contract. Non-managing partners may waive their voting rights relating to the management of musharakah and this shall be specified in the contract. The managing partners as an agent shall be liable for any loss caused by his negligence or misconduct or breach of management contract.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 77 Based on Taqi Usmani’s view, the normal principle of the Musharakah is that every partner has a right to take part in its management and to work for it. However, the partners may agree upon a condition that the management shall be carried out by one of them and no other partner shall work for the Musharakah. But in this case the sleeping partner should be entitled to the profit only to the extent of his investment, and the ratio of the profit allocated to him should not exceed the ratio of his investment. However, if all the other parties agree to work for the joint venture, each of them shall be treated as the agent of the other in all the matters of the business and any work done by one of them in the normal course of business shall be deemed to be authorized by all the partners. While, management of musharakah venture for Wahbah Zuhaili is a practice under which Islamic banks lend funds to companies by issuing floating rate interest loans pegged to the company’s rate of return. When the purpose of the loan is to acquire real estate, then an imputed rent will be agreed on and this will be shared between the borrower and the lender. It is used for investment project finance and for letters of credit as well as real estate. With a musharakah contract, where all parties must contribute a share of the capital, and they share in any profits or losses in proportion to their investment contributions. Musharakah contracts hence represent a type of joint venture, one practical application being for syndicated financing to reduce the risk to each partner. Although there was no concept of limited liability in classical fiqh, this is now permitted otherwise the risks would deter investors. iii. Profit Sharing Right BNM view regarding profit, shall be measured as an amount exceeding capital after deducting the cost and expenses attributable to musharakah venture. In cases where the musharakah is specified and meant for a specified project or activities, only expenses that can be identified by the partners or deemed direct expenses to the project may be deductible. The profit-sharing ratio may either be proportionate to the capital contribution or be based on a ratio or percentage which is agreed upon by all partners irrespective of their capital contribution. It is not permissible to include a condition in musharakah contract that
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 78 stipulates a pre-determined fixed amount of profit to one partner which deprives the profit share of the other partner. Based on that, a lump sum amount or fixed amount of profit may be permissible if it does not deprive the other partner from benefiting from, and sharing the profit. The profit-sharing ratio may be revised either subject to the mutual consent of the partners or subject to a certain benchmark agreed upon by the partners as the case may be. The profit expressed in the form of a certain percentage should not be linked to the capital amount. However, a profit-sharing ratio may be ultimately translated into a fixed percentage based on the capital investment amount once profit is realized. A partner who has agreed to a certain profit-sharing ratio may waive the rights to profits to be given to another partner on the basis of Tanazul (waiver) at the time of profit realization and distribution as well as at the time of the contract. However, a waiver of profit that takes place at the time of contract shall be by way of unilateral promise (wa’d). The mechanism for estimating profit on Musharakah capital employed may be benchmarked to conventional benchmarks, such as but not limited to Base Lending Rate (BLR) in order to determine the indicative profit rate. Profit may be distributed from actual or realized profits through the sale of assets of the Musharakah partnership (al-tandhid alhaqiqi or al-fi’li) 6. Profit distribution may also be on the basis of constructive valuation (al-tandhid al-hukmi) on the assets including accounts receivables. In the case of constructive valuation based on market valuation or a third-party verification, the unrealized profit shall be recorded as a reserve. Any allocation of funds to any partner prior to actual profit realisation shall be rationalized at a later stage. The partners shall then reimburse the amount they have received in excess of the rationalised profit, if applicable. During the Musharakah contract period, the partners may mutually agree to set aside a portion of the profit as a reserve or for any other purpose specified and mutually agreed by the partners. If the reserve fund is distributable to the partners, equitable claims by the partners shall be specified. Partners in Musharakah, shall not fully or partially guarantee the principal and profit of another partners. A third party who is not related to any party in the Musharakah in terms of equity ownership and management control may guarantee the profit to the Musharakah venture
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 79 subject to certain conditions. Pursuant to the principle of Tanazul (waiver), some partners may give some preferential treatment to other partners with regard to profit distribution. Any unusual investment income from Shariah prohibited activities of a Musharakah venture due to extenuating circumstances may be distributed to charity. The proportion of profit to be distributed between the partners by Taqi Usmani must be agreed upon at the time of affecting the contract. If no such proportion has been determined, the contract is not valid in shariah. The ratio of the profit for each of the 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. Therefore, if A and B enter into a partnership and it is agreed between them that A shall be given RM 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 percentage of the actual profit accrued to the business. 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. Although, is it necessary that the ratio of the profit of each partner confirms to the ratio of the capital invested by him? There is a difference of opinion among the Muslim jurists about this question. In the view of Imam Malik and Imam Shafi’i, it is necessary for the validity of musharakah that each partner gets the profit exactly in the proportion of his investment. Therefore, if A has invested 40% of the total capital, he must get 40% of the profit. Any agreement to the contrary which makes him entitled to get more or less than 40% will render
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 80 the musharakah invalid in shariah. On the contrary, the view of Imam Ahmed is that the ratio of profit may differ from the ratio of investment if it is agreed between the partners with their free consent. Therefore, it is permissible that a partner with 40% of investment gets 60% or 70% of the profit, while the other partner with 60% of the investment gets only 40% or 30%. The third view is presented by Imam Abu Hanifah which can be taken as a discussion between the two opinions mentioned above. He says that the ratio of profit may differ from the ratio of investment in normal conditions. 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 musharakah, then this share of profit cannot be more than a ratio of his investment. In this type of partnership, Wahbah suggest that profit sharing must be distributed in proportion to the partners’ contributions to the capital of the partnership, regardless of whether they both worked or only one did. This Hanafi ruling follows from the view that profits are earned either by investing capital, by working, or by assuming liability for damages. In this first ruling, equality of capital shares leads to equality in profit shares. Many Hanafis, with the notable exception of Zufar, also allowed unequal sharing in profits with equal capital shares if both parties worked, or if the one with the larger profit shares if both parties worked, or if the one with the larger profit share worked alone. In this case, the higher profit share can be justified by more work, either in terms of quantity or skill. This ruling is validated by the hadith: ‘Profits are shared as stipulated in the contract, while losses are shared in proportion to capital shares. This profit and loss sharing rule was also adopted by the Hanbalis and Zaydis. However, the Hanafis did not permit the one who worked less to collect a larger profit share, and did not permit one of the partners to collect the entire profit. In all of the above, notice that what matters for those legal opinions is the condition of work, not the actual realization of work. The contrast, the Malikis, Shafi’is, Zahiris and the Hanafi jurist Zufar ruled that both profits and losses must be shared in proportion to capital in a limited partnership. Thus, they consider all profits and losses to be related to the capital, and hence must be shared according to the capital shares. Thus, they say that since it is not allowed for only one
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 81 party to collect all of the profit or bear all of the losses, any proportion that deviates from capital shares would be equally impermissible. iv. Loss Sharing Based on BNM view, capital loss incurs when a capital asset (investment or real estate) decreases in value. The loss is not realized until the asset is sold for a lower price than the purchase price. Loss shall be shared on the basis of pari-passu among the partners and proportionate to the capital contribution. Preferential treatment to a particular partner over the others in the same Musharakah venture in absorbing the loss shall not be permissible. The loss to the partners shall be limited to the capital contribution of each partner. Upon realization of loss, a partner may agree, without any prior condition, to bear the loss of another partner at the time such a loss is realized. A third party may undertake to bear the loss of a partner. Specific conditions on third party guarantee of the capital are as follows: - a. The legal capacity and financial soundness of such a third party as a guarantor shall be independent from the Musharakah contract and partners; b. The guarantee shall neither be provided in consideration for nor linked in any manner to the Musharakah contract; c. The third-party guarantor shall not hold the majority ownership of the guaranteed party; and d. The guaranteed party shall not hold the majority ownership of the third-party guarantor. The loss due to misconduct, negligence and breach of terms and conditions by a managing partner shall be borne entirely by that partner. But Maulana Taqi Usmani, in the case of loss, all the Muslim jurists are unanimous on the point that each partner shall suffer the loss exactly according to the ratio of his investment. Therefore, if a partner has 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 the jurists on
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 82 this principle. Therefore, according to Imam Shafi’i, the ratio of the share of a partner in profit and loss both must conform to the ratio of his investment. But according to the Imam Abu Hanifa and Imam Ahmad, the ratio of the profit may differ from the ratio of investment according to the agreement of the partners, but the loss must be divided between them exactly in accordance with the ratio of capital invested by each one of them. It is this principle that has been mentioned in the famous maxim: Profit is based on the agreement of the parties, but loss is always subject to the ratio of investment. Losses in contract partnership by Wahbah scholar must be shared in proportion to the ratio of liabilities specified in the contact example that one of them will take two thirds of the work and the other will take one third. Thus, both profits and losses must be shared according to the same formula, which is equality to liability shares. In this regard, if losses are caused by the transgression of one of the partners, it is still shared by all partners according to the liability ratio, since they guarantee the work according to that ratio. v. Partnership Venture Business ventures of musharakah shall be shariah compliant and may be conducted in various sectors such as trading, plantation, construction, manufacturing, investment and services. A musharakah contract may be adopted for non-commercial activities which are non-profit oriented. Pre-contracting costs incurred to conclude musharakah contract such as the conduct of technical and feasibility studies of the financial viability of the musharakah venture by the Islamic financial institutions may be charged to the customer subject to the latter’s consent. No discussion concerning partnership venture by Taqi usmani. However, Wahbah Zuhaili jurist agree that any partnership property in the possession of one partner is considered a trust, since he would thus hold it with his partners’ permission. Thus, since the partner is not holding the partnership property to collect a price or to guarantee some other payment as in pawning, he is not responsible for the perishing of what is kept in his possession. Thus, the partner’s possession of such property is considered holding by legal proxy on behalf of his partners, and if the property were to perish in his possession, he is not
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 83 required to pay any compensation. In this regard, the partner’s claims regarding profits, losses, and perishing of properties, are all accepted based on his oath. On the other hand, as in all trusts, he is still responsible to compensate the other owners if he destroys their property through negligence of transgression. In addition to the above parameters, BNM also introduce the following enhanced features of musharakah contract. vi. Origination and Execution of Musharakah Agreement BNM stressed a valid musharakah contract shall be concluded by an offer and acceptance between the partners and may be expressed by way of suitable documentation. A party to a musharakah contract shall conclude the contract personally or through an agent. A party to a musharakah contract shall have the legal capacity to enter into a contract and provided that he is not restricted by any law. Upon the disbursement of the capital by the musharakah partners, all partners’ rights to the profit and liability to losses are established. Any term or condition mutually agreed upon which does not contravene shariah shall be binding on the partners. vii. Termination and Dissolution of Musharakah Agreement BNM agree that partners may mutually agree to terminate the contract at any time unless stated otherwise in the Musharakah agreement. Upon termination of Musharakah agreement, a partner may elect to acquire the entire asset of the Musharakah partnership. The acquisition by one partner of the other partner’s entire asset may be satisfied as a debt due to the other partner, after taking into consideration the liabilities and determining profit and loss. A Musharakah contract shall be terminated upon expiration of specified tenure of the contract, even though the venture is still in progress unless the partners mutually agree to extend the partnership. Parties to a Musharakah contract may agree to end the partnership upon completion of business venture. A Musharakah contract may be terminated if a considerable portion of the capital is impaired, subject to terms and conditions. Such
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 84 impairment may arise from losses due to extenuating circumstances that hinder the partnership to continue for the remaining period or from being on going concern. The demise or bankruptcy of one of the partners shall terminate the Musharakah contract. However, the partners may agree to continue with the contract according to the terms in the Musharakah deed or agreement. A Musharakah financing agreement between an Islamic financial institution and a customer specifies that the agreement is terminated if any of the following conditions occurs: a. Both partners mutually agree to terminate after determining the liabilities of each partner; b. Upon demise of the customer; c. Court order to terminate the Musharakah is obtained by Islamic financial institutions; d. Significant loss of capital that incapacitates the partnership; e. Insolvency or bankruptcy of the customer; and f. Violation of conditions in the agreement by any partner. In the event that any of these conditions are met, both partners need to settle any outstanding liabilities at the date of termination. Upon the termination of the Musharakah contract, Musharakah assets shall be subjected to the liquidation process. Musharakah assets may be liquidated through actual liquidation in which the assets are disposed to the markets or third parties. The proceeds of the disposal shall then be measured against the capital to recover the capital and to distribute the profit or to record a loss accordingly. In the case of an actual liquidation, the assets shall be sold at market value and the proceeds of the sale shall be used as follows: - i) Payment of liquidation expenses; ii) Payment of financial liabilities that are owing to the partnership; and iii) Distribution of the remaining assets, if any, among the partners in proportion to their capital contribution.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 85 A constructive liquidation of the partnership asset may be affected in the case where the partners agree to dissolve existing partnership and venture into another new partnership by investing the initial asset as capital in kind. Related with Taqi Usmani, musharakah is deemed to be terminated in anyone of the three following events. First, 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. If there is a dispute between the partners in this matter i.e. that if partner seeks liquidation while the other wants the 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 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. Second, if any one of the partners dies during the currency of 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 the Musharakah. Third, if any one of the partners becomes insane or otherwise becomes incapable of effecting commercial transactions, the Musharakah stands terminated. Nevertheless, in case 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 the Musharakah with one partner does not imply its termination between the other partners. 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
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 86 of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or the distribution of the assets themselves. The question arises whether the partners can agree, while entering into the contract of the Musharakah, on a condition that the liquidation or separation of the business shall not be affected unless all the partners, or the majority of them wants to do so, and that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation. Most of the traditional books of Islamic Fiqh seem to be silent on this question. However, it appears that there is no bar from the Shari’ah point of view if the partners agree to such a condition right at the beginning of the Musharakah. This is expressly permitted by some Hanbali jurists. This condition may be justified, especially in the modern situations, on the ground that the nature of business, in most cases today, requires continuity for its success, and the liquidation or separation at the instance of a single partner only may cause irreparable damage to the other partners. If a particular business has been started with huge amounts of money which has been invested in a long-term project, and one of the partners seeks liquidation in the infancy of the project, it may be fatal to the interests of the partners, as well as to the economic growth of the society, to give him such an arbitrary power of liquidation or separation. Therefore, such a condition seems to be justified, and it can be supported by the general principle laid down by the Holy Profit (PBUH) in his famous hadith: “All the conditions agreed upon by the Muslims are upheld, except a condition which allows what is prohibited or prohibits what is lawful.” Certain factors or actions invalidate all types of partnership, while others invalidate certain types only. Wahbah Zuhaili enumerates four actions or factors that invalidate any partnership. First, if any of the partners dissolves a partnership, it becomes invalid. This follows from the non bindingness of the partnership contract. Have also seen that the Malikis consider the contract binding, and thus ruled that the partnership may only be dissolved by mutual consent. The Hanbalis allow each of the partners to terminate his partners’ agency, in
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 87 which case they no longer have the right to deal in his portion of the partnership property. Also allow unilateral dissolution of the partnership, in which case each partner is allowed access only to his own property. Second, if a partner dies, the partnership is dissolved, whether or not the other partners know of his death. This follows since the joint agency and delegation is terminated by death. Third, if one of the partners reverts from Islam and joins its enemies, his legal status is equivalent to death, and the partnership is dissolved. Lastly, if any of the partners loses his sanity, or goes into a coma, for an extended period of time (some Hanafis said one month or more, while others said six months or more), then mutual agency is violated, and the partnership is dissolved. 3.3 Termination and Dissolution of Musharakah Agreement Since the guideline does not focus on the types of musharakah, hence, the issue of conflicts of these contracts has also been recently voiced due to being Islamic financing transaction. However, a number of transactions that have been structured using recently developed musharakah financing techniques have been categorized by some as being shariah compliant and it has been argued that only products based on classical principles of musharakah are shariah based. To determine the correctness of these categorizations, one must have a general understanding of the concepts of musharakah, and in particular the categories of three types of musharakah contract: shirkat al Aqd (contractual partnership), shirkat al Milk (co-ownership) and Musharakah Mutanakisah (diminishing Musharakah). In addition, the parameter also creates an implication on investment and financing. Those comments will be discussed separately below. 3.3.1 Shirkat al Aqd ( Contractual Partnership ) In the context of shariah compliant financing, shrikat al Aqd means the creation of a joint venture partnership in which all the partners share the profit or loss generated by that
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 88 joint venture. For example, if two persons agree to undertake laundering 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 quantity of work each partner has actually done. Therefore, any of the partners may take a greater share of the profits than the others because of his superior skill or special job or any other reason. If losses will be shared according to the partner’s share in the profits. The application of Shirkat al Aqd is said to encapsulate the core principles of Islamic finance, namely the sharing of risk and profit and loss. By implementing a joint venture with its customer, the financier will directly participate in the risk of the business that it is seeking to finance. In simple terms, if the joint venture is successful both the financier and the customer will benefit, as the profits will be distributed between them according to the pre-agreed ratios. If the joint venture is not successful, the financier and the customer will share the losses of the business in proportion to each of their respective investments. In any event, the customer will never be under an obligation to repay the capital investment made by the financier. The majority of classical Islamic finance focus almost exclusively on principles that relate to shirkat al Aqd. The main principles of shirkat al Aqd are as follows: i) The proportion of profit to be distributed between the partners must be agreed upon prior to the consummation of the musharakah; ii) The shariah does not permit any of the partners to be guaranteed a predetermined fixed return; iii) There is a difference of opinion among classical shariah scholars as to whether the ratio of profit for each partner should be proportionate to each partner’s investment. The majority of contemporary scholars, however, permit the ratio of profit to differ from the proportion of investment made by each of the partners; and iv) There is unanimous consensus among both classical and contemporary shariah scholars that loss must be shared proportionately to each partner’s investment.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 89 3.3.2 Shirkat al-Milk (Co-Ownership) Shirkat-ul-milk is a form of partnership in which one of the partners’ promises to buy the equity share of the other partner gradually until the title of the equity share is completely transferred to him. This transaction starts with the formation of a partnership, after which buying and selling of the equity takes place between the two partners. Shirkat-ul-milk can be used for plant and machinery, equipment, buildings and automobile financing. Hence, this contract means joint ownership of two or more persons in a particular property. This kind of shirkah may come into existence in two different ways, optional and compulsory. Optional (Ikhtiari): At the option of the parties e.g., if two or more persons purchase 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 Ikhtiari Here this relationship has come into existence at their own option, as they themselves elected to purchase the equipment jointly. Compulsory (Ghair Ikhtiari): This comes into operation automatically without any effort or 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 a natural consequence of the death of that person. Whilst the principles of Shirkat al Milk are not new to Islamic finance, they have recently been used together with recently developed Musharakah Mutanaqisah principles to create a new form of Musharakah financing. 3.3.3 Musharakah Mutanaqisah (Diminishing Musharakah) The Musharakah Mutanaqisah Partnership (MMP) contract, on the other hand, is based on a diminishing partnership concept. The MMP consists of three contracts, example; a. musharakah, b. ijarah and; c. bay’. First, the customer enters into a musharakah under the concept of ‘Shirkat-al-Milk’ (joint ownership) agreement with the bank to co-own the asset being financed.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 90 Second, the bank leases its share in the asset ownership to the customer under the concept of ijarah. For example, customer pays a% of the asset cost as the initial share to coown the asset whilst the bank provides for the balance of b%. Third, the customer gradually buys the bank’s b% share at an agreed portion periodically until the asset is fully owned by the customer. The periodic rental amounts will be jointly shared between the customer and the bank according to the percentage shareholding at the particular times which keeps changing as the customer purchases the financier’s share. The customer’s share ratio would increase after each rental payment due to the periodic redemption until eventually fully owned by the customer. Musharakah mutanaqisah can be applied in home financing products. Based on the joint-ownership concept, the banking institution leases the property to the customer who undertakes to incrementally acquire the full ownership of the property from the banking institution over an agreed period. The banking institution and the customer contribute their respective shares of the capital required to acquire the property according to a predetermined ratio agreed to between them at the beginning of the contract. Once the customer has fully acquired the banking institution’s share of the property, the partnership comes to an end with the customer becoming the sole owner of the property. This contract incorporates elements of both sale and lease or in ijarah contracts, which are integral in ensuring that no element of riba is involved in the musharakah mutanaqisah transaction. The dynamics, at different transaction stages, of a musharakah mutanaqisah contract for completed property. 3.4 Implication to Investment ad Financing In this section, the implication of musharakah contract on investment and financing will be discussed. The aim is to evaluate the performance of musharakah (equity participation) in terms of profitability and risk; to investigate musharakah management to recognise the obstacles and factors influencing decision-making.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 91 3.4.1 Implication to Investment A musharakah contract is very similar to the conventional sense of a partnership arrangement where each party contributes capital in their specific capacity and each partner has management rights in proportion to their investment. However, the share of profit for each partner is determined as a proportion of the final total profit rather than a ratio of capital invested. In the event of a loss, each partner is obliged to lose only the amount invested in the project. Implication from the various features exposed the different types of business entity of investment sukuk. First type of investment sukuk is certificates of ownership in leased assets. For a description of investment sukuk, these are certificates that carry equal value and are issued either by the owner of a leased asset or an asset to be leased by promise, or by his financial agent, the aim of which is to sell the asset and recover its value from subscription, in which case the holders of the certificates become owners of the assets. Shariah rulings and requirements, issuer sells a leased asset or an asset to be leased on promise. The subscribers are buyers of the asset. Mobilized funds are the purchase price of the asset and certificate holders become the owners of the assets jointly with its benefits and risks. Second, the viability of certificates of ownership in usufructs. These certificates have various types, including the following: a) Certificates of ownership of usufructs of existing assets. These are documents of equal value that are issued either by the owner of usufruct of an existing asset or a financial intermediary acting on the owner’s behalf, with the aim of leasing or subleasing this asset or receive rental from the revenue of subscription. In this case, the holders of the certificates become owners of the usufruct of the asset. Issuer sells usufruct of an existing asset. Subscribers are buyers of the usufructs.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 92 Mobilized funds are the purchase price of the usufructs and certificate holders become the owners of the usufructs jointly with its benefits and risks. b) Certificates of ownership of usufructs to be made available in the future as per description. These are documents of equal value issued for the sake of leasing assets that the lessor is liable to provide in the future whereby the rental is recovered from the subscription income, in which case the holders of the certificates become owners of the usufruct of these future assets. Issuer sells usufruct of an asset to be made available in the future as per specification. Subscribers are buyers of the usufructs. Mobilized funds from subscription are the purchase price of the usufructs and certificate holders become the owners of the usufructs jointly with its benefits and risks. Third, the applicability of certificates of ownership of services of a specified supplier. These are documents of equal value issued for the sake of providing or selling services through a specified supplier such as educational programmes in a nominated university and obtaining the value in the form of subscription income, in which case the holders of the certificates become owners of the services. Issuer sells services. Subscribers are buyers of the services. Mobilized funds are the purchase price of the services and certificate holders are entitled to sell all types of usufructs in addition to the funds of reselling such usufructs. 3.4.2 Implication to Financing Theoretical models of Islamic banking were based on the concept of profit and loss sharing (PLS) through musharakah modes of finance. There is still need for further auxiliary legislation in order to fully realize the goals of Islamic banking. No law has been introduced to define modes of PLS financing in Musharakah. It is observed that whenever there is a conflict between the Islamic banking framework and the existing law, the latter prevailed. In essence, therefore, the relationship between the bank and the client, which of creditor and debtor, is left unchanged as specified by the existing law. The existing banking law was developed to protect mainly the credit transactions. Its application to other modes of financing also results in the treatment of those modes as credit transactions.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 93 As we can find, there are three main areas where the Islamic banks find it difficult to finance under the PLS: a. Participating in long-term and low-yield projects, b. Financing the small businesses, and c. Granting non- participating loans to running businesses. The banks are unable or unwilling to participate in long-term projects. It is also observed from the term structure of investment of Islamic banks that most of their investments are of short term and medium term. The main reason, of course, is the need to participate in the enterprise on a PLS basis, which involves time consuming complicated assessment procedures and negotiations, requiring expertise and experience. The banks do not seem to have developed the latter and they seem to be averse to the former. There are no commonly accepted criteria for project evaluation based on PLS partnerships. Small-scale business plays a major role in productive sectors. They are also a major group among the bank’s clientele. Yet it seems difficult to provide them with the necessary finance under the PLS scheme, even though there is excess liquidity in the banks. Many of these small producers, who traditionally were able to obtain interest-based credit facilities on the basis of collateral, are now finding it difficult to raise funds for their operations. Running businesses frequently need short-term capital as well as working capital, and ready cash for miscellaneous on the spot purchases and sundry expenses. This is the daily reality in the business world. The PLS system is not geared to cater to this need. Even if there is complete trust and exchange of information between the bank and the business it is nearly impossible or prohibitively costly to estimate the contribution of such short-term financing on the return of a given business. Added to this are the delays involved in authorizing emergency loans.
eBook PSP | Partnership Based Contract in Islamic Banking P a g e | 94 3.5 Conclusion The existences of instrument in Islamic banks come not only with profit-motive but also with socio-economic objectives. In conventional banking, most of the funds flow to large industries, multinational corporations and big industrialists. This is because, in an interestbased system, the sole criterion for the distribution of credit is the credibility of the entrepreneur. Therefore, the distribution of credit in a conventional banking sense is directed in favour of large, rich industrialists, whereas in a profit-sharing system, bank finances will be more equitably distributed. This is because the criterion for the distribution of credit is the productivity of the project and therefore, the financing will go to the more productive project, even if the credibility of the enterprises is lower. Islamic banks are the only resorts for small and middle-class entrepreneurs who do not get financing even for very good projects from conventional banks. Thus, with Shariah Parameter for Musharakah, Islamic institution can able to help and contribute into the development of socio-economic of the country. The features identified in this parameter shall serve to assist the Islamic financial services industry to identify, understand, apply and distinguish the contract from other contracts prevalent in the industry.