In Salam, the seller undertakes to supply specific goods to the buyer at a future date in exchange for an advanced price fully paid at the spot. The payment is at the spot but the supply of purchased goods is deferred.
Purpose of use:
This mode of financing can be used by modern banks and financial institutions especially to finance the agricultural sector.
To meet the needs and requirements of small farmers who need financing to grow their crops and to feed their families until the time of harvest. When Allah’s messenger declared Riba as haram, the farmers could not take usurious loans. Therefore, the Holy Prophet ﷺ allowed them to sell their agricultural products in advance.
To meet the need of traders for import and export business. Under Salam, it is allowed to sell the goods in advance so that after receiving cash price, they can easily undertake the aforesaid business. Salam is beneficial to the seller as he receives the price in advance and it is beneficial to the buyer also as normally the price in Salam is lower than the price in a spot safe.
The permissibility of Salam is an exception to the general rule that prohibits forward sale therefore it is subject to strict conditions, which are as follows:
Conditions for Salam
The conditions for Bai Salam are as follows:
It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of effecting the sale. In the absence of full payment, it will be tantamount to the sale of a debt against a debt, which is expressly prohibited by the Holy Prophet ﷺ. Moreover, the basic wisdom for allowing Salam is to fulfill the “instant need” of the seller. If the full price is not paid in advance, the basic purpose of Salam will not be achieved.
2) Only those goods can be sold through a Salam contract in which the quantity and quality can be exactly specified e.g. precious stones cannot be sold on the basis of Salam because each stone differs in quality, size, weight and their exact specification is not possible.
3) Salam cannot be effected on a particular commodity or for a product of a particular field or farm e.g. Supply of wheat of a particular field or the fruit of a particular tree since there is a possibility that the crop may get destroyed before delivery and given such possibility, the delivery remains uncertain.
4) All devils with respect to the quality of goods sold must be expressly specified leaving no ambiguity, which may lead to a dispute.
5) It is necessary that the quantity of the commodity is agreed upon in absolute terms. It should be measured or weighed in its usual measure only, meaning what is normally weighed cannot be quantified and vice versa.
6) The exact date and place of delivery must be specified in the contract.
7) Salam cannot be affected in respect of items, which must be delivered at the spot. For example, if gold is purchased in exchange for silver, it is necessary that the delivery of both commodities be simultaneous, thus gold or silver cannot become the subject matter of Salam if the price is paid in the form of gold/silver.
8) The commodity for the Salam contract should be available in the market at the time of delivery. This view is as per the rulings of Shaafi, Maliki, and Hanbali schools of thought.
9) The time of delivery should be at least fifteen (15) days to one month from the date of the agreement. Price in Salamis generally lower than the price in spot sale. The Salam period should be long enough to affect the prices. But Hanafi Fiqh did not specify any minimum period for the validity of Salam. It is all right to have an earlier date of delivery if the seller consents to it.
10) Since price in Salam is generally lower than the price in spot sale; the difference in the two prices may be a valid profit for the Bank.
11) A security in the form of a guarantee, mortgage or hypothecation may be required for a Salam to ensure that the seller delivers.
12) The seller at the time of delivery must deliver commodities and not money to the buyer who would have to establish a special cell for dealing in commodities.
There are two ways of using Salam for the purpose of financing:
After purchasing a commodity by way of Salam, the financial institution can sell it through a parallel contract of Salam for the same date of delivery. The period of Salam in the second parallel contract is shorter and the price is higher than the first contract. The difference between the two prices shall be the profit earned by the institution. The shorter the period of Salam, the higher the price and the greater the profit. In this way, institutions can manage their short term financing portfolios.
The institution can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. The buyer does not have to pay the price in advance. When the institution receives the commodity, it can sell it at a pre-determined price to a third party according to the terms of the promise.
Conditions of the Parallel Salam
In an arrangement of parallel Salam, there must be two different and independent contracts;
i) one, where the bank is a buyer.
ii) the other in which it is a seller.
The two contracts cannot be tied up and performance of one should not be contingent on the other. For example, if ’A’ has purchased from ‘B’ 1000 bags of wheat by way of Salam to be delivered on 31 December, ’A’ can contract a parallel Salam with ‘C’ to deliver to him 1,000 bags of wheat on 31 December. But while contracting Parallel Salam with ’C’, the delivery of wheat to ‘C’ cannot be conditioned with taking delivery from ’B’. Therefore, even if ’B’ does not deliver wheat on 31 December, ‘A‘ is duty bound to deliver 1,000 bags of wheat to ’C’. He can seek whatever recourse he has against ’B’, but he cannot rid himself from his liability to deliver wheat to ’C’.
Similarly, if ’B’ has delivered defective goods, which do not conform to the agreed specifications, ’A’ is still obligated to deliver the goods to ’C’ according to the specifications agreed with him.
2. A Salam arrangement cannot be used as a buy back facility where the seller in the first contract is also the purchaser in the second contract. Even if the purchaser in the second contract is a separate Iegal entity but owned by the seller in the first contract; it would not be tantamount to a valid parallel Salam agreement.
For example, ’A’ has purchased 1,000 bags of wheat by way of Salam from ’B’ – a joint stock company. ‘B’ has a subsidiary ’C’, which is a separate legal entity but is fully owned by ’B’. ’A’ cannot contract the parallel Salam with ’C’. However, if ‘C’ is not wholly owned by ‘B’, ’A’ can contract parallel Salam with it, even if some share-holders are common between ’B’ and ’C’.
Risk Mitigation in Salam
Some of the risks that are present in Salam financing for banks are as follows:
Delay in delivery of goods from the customer
Wait untiI the goods are available Bank can canceI the contract and recover the Salam price Bank can agree on replacement of goods provided that the market value of the replaced goods does not exceed the market value of the original goods that were subject matter of Salam.
The Customer delivers defected /inferior goods.
The Bank has the right to reject the delivery or bank can accept the delivery at discounted price
Market price of the subject matter decreases after Bank enters into Salam agreement.
Parallel Salam or promise to purchase from a third party will mitigate the risk.
The goods once delievered by Customer wilI be at Bank’s risk before the same are sold to the ultimate purchaser.
Obtain Takaful coverage for Salam goods Minimize the time duration between acceptance of delivery under Salam and delivery to the ultimate purchaser.
”Allah Subhan-o-TaIIah has declared that He will become a partner in the business between two Mushariks until they indulge in cheating or breach of trust (Khayanah).”
In another Hadiths-e-Qudsi, it is stated:
“Allah’s hand is with both the partners unless any one of them indulges in cheating and when any one of them indulges in cheating then Allah takes back his hand from both the partners.”
Definition and classification of Musharakah
The literary meaning of Musharakah is “sharing”. The root of the term “Musharakah” in Arabic comes from the word ’Shirkah’, which means ’being a partner’. It is used in the same context as the term “shirk” meaning “partner to Allah”.
Under Islamic jurisprudence, Musharakah means “a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution”. It is an ideal alternative for the Interest-based financing with far-reaching effects on both the production and distribution of wealth in the economy. The connotation of this term is limited to the term “Shir Kah “, more commonly used in Islamic jurisprudence. For the purpose of clarity in the basic concepts, it is pertinent at the outset to explain the meaning of each term, as distinguished from the other. “Shirkah ” means “Sharing” and in the terminology of Islamic Fiqh, it has been divided into two kinds:
1) Shirkat-ul-Milk (Partnership by joint ownership)
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:
a) Optional (Ikhtiari): 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 Ikhtiari. Here, this relationship has come into existence at their own option, as they themselves have opted to purchase the equipment jointly.
b) Compulsory (Ghalr ikhitiari): This comes into existence automatically without any effort/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.
There are two more types of joint ownerships (Shirkat-ul Milk)
• Shirkat-ul-Ain • Shirkat-UI-Dain
A property in shirkat-ul-milk is jointly owned but not divided, is called “Musha “. An undivided asset can be utilized in the following manner:
a) Mushtarik intifa’ (Mutual Utilization): Mutually or jointly using an asset alternatively under circumstances where the partners or joint owners are on good terms.
b) Mohaya (Alternate Utilization): Under this arrangement, the owners will fix the number of days within a specific time interval for each partner to get usufruct of the asset. For example, one may use the product for 15 days, and then the other may use it for the rest of the month.
c) Taqseem (Division): This refers to the division of the jointly owned asset. This may be applied in cases where the asset that is owned can be divided permanently. For example, jointly taking a 1,000 sq. yards plot and making a house on 500 sq. yards by each of the two owners.
d) Under a situation where the partners are not satisfied with alternate utilization arrangement, the property or asset jointly heId can be sold off and proceeds are distributed between the partners.
2) Shirkat-ul-Aqd (Partnership by contract)
This is the second type of Shirkah, which means, “a partnership effected by a mutual contract”. For the purpose of brevity, it may also be translated as a “joint commercial enterprise.” “Shirkat-ul-Aqd” can further be classified into three kinds:
(i) Shirkat-uI-AmwaI (Partnership in the capital): where all the partners invest some capital into a commercial enterprise.
(ii) Shirkat-UI-Aamal (Partnership in services): 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 people agree to undertake tailoring services for their customers on the condition that the wages so earned will go into a joint pool which shall be distributed between them irrespective of the size of work each partner has actually done, this partnership will be a shirkat-ut-amwal which is also called Shirkat-ut-taqabbuI or Shirkat-us-Sanai or Shirkat-UI-abdan.
(iii) Shirkat-UI-Wujooh (Partnership in goodwill): The word Wujooh has its root in the Arabic word Wajahat meaning goodwill. Here, the partners have no investment at all. They purchase commodities on deferred price, by getting favorable credit terms because of their goodwill and sell goods at the spot. The profit so earned is distributed between them at an agreed ratio.
Each of the above three types of Shirkat-UI-Aqd is further divided into two types:
a) Shirkat-AI-Mufawada (Capital, Labor & Profit at par): All partners share capital, management, profit, risk & reward in absolute equality. It is a necessary condition for all four categories to be shared amongst the partners; if anyone category is not shared in absolute equality, then the partnership becomes Shirkat-UI-’Ainan. Every partner who shares equally is a Trustee, Guarantor, and agent on behalf of the other partners.
b) Shirkat-ul-Ainan: A more common type of Shirkat-UI-Amwald where the capital, management, or profit ratio is not equal in all respect.
All these modes of “Sharing” or partnership are termed as “Shirkah ” in the terminology of Islamic Fiqh, while the term “Musharakah ” is not found in the books of Fiqh. This term (i.e, Musharakah) has been introduced recently by those who have written on the subject of Islamic modes of financing and it is normally restricted to a particular type of “Shirkah”, that is, the Shirkat-ul-AmwaI, where two or more persons invest some of their capital in a joint commercial venture. However, sometimes it includes Shirkat-UI-Aamal also where partnership takes place in the business of services.
It is evident from this discussion that the term “Shirkah ” has a much wider sense than the term “Musharakah” as is being used today. The latter is limited to “Shirkat-UI-Amwal” only i.e. all the partners invest some capital into a commercial enterprise, while the former includes all types of joint ownership and those of partnership.
Rules & Conditions of Shirkat-ul-Aqd
The common conditions of 5hirkat-UI-Aqad are three which are as follows:
a} The existence of Muta’aqidain (Partners): There should be at least two living (alive) partners in the contract.
b) The capability of Partners: The partners must be sane and mature and capable of entering into a contract. The contract must take place with the free consent of the parties without any fraud or misrepresentation.
c) The presence of the commodity: This means the price and commodity itself.
There are also three special conditions which are as follows:
a) The commodity of the partnership should be capable of an agency: As each partner is responsible for managing the project, therefore he will directly influence the overall profitability of the business. As a result, each member in 5hirkat-UI-Aqd should duly qualify as legally being eligible for becoming an agent and of carrying on a business. For example, ’A’ has written a book and owns it, ’B’ cannot sell it unless ’A’ appoints ’B’ as his agent.
b) The rate of profit-sharing should be determined: The share of each partner in the profit earned should be identified at the time of the contract. If however, the ratio is not determined beforehand, the contract becomes void (Fasid). Therefore, identifying the profit share is necessary.
c) Profit and loss sharing: All partners will share in the profit as well as the loss. By placing the burden of loss solely on one or a few partners makes the partnership invalid. A condition for Shirkat- UI-Aqd is that the partners will jointly share the profit. However, defining an absolute value of profit is not permissible, therefore only a percentage of the total return is allowed.
The basic rules of Musharakah
Musharakah or Shirkat-ul-AmwaI is a relationship established by the parties through a mutual contract. Therefore, it goes without saying that all the necessary ingredients of a valid contract must be present here also. For example, the parties should be capable of entering into a contract; the contract must take place with the free consent of the parties without any duress, fraud or misrepresentation, etc. But there are certain elements, which are peculiar to the contract of “Musharakah”. They are summarized here:
Basic rules of Capital
The capital in a Musharakah agreement should be:
a) Quantified (Ma’loom): Meaning how much money is invested.
b} Specified (Muta’aiyan): Meaning specified interim of currency.
c) Not necessarily be merged: The mixing of capital is not required.
d) Not necessarily be in liquid form: Capital share may be contributed either in cash/liquid or in the form of commodities. In the case of a commodity, the market value of the commodity shall determine the share of the partner in the capital.
Management of Musharakah
The normal principle of 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 shall be entitled to the profit only to the extent of his investment, and the ratio of profit allocated to him should not exceed the ratio of his investment, as discussed earlier.
However, if all the partners agree to work for the joint venture, each one of them shall be treated as an agent of the other in all matters of business. Any work done by one of them in the normal course of business shall be deemed as authorized by all the partners.
Basic rules of distribution of profit
The ratio of profit for each partner must be determined in respect of the actual profit earned by the business and not in proportion to the capital invested by him. For example, if it is agreed between them that ‘A’ will get 1% of his investment, the contract is not valid.
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’ & ’B’ enter into a partnership and it is agreed between them that ’A’ shall be given Rs. 10,000/- per month as his share in the profit and the rest will go to ’B’, the partnership is invalid.
If both partners agree that each one will get a percentage of profit based on his capital proportion, whether both take part in the management of the business or not, it is allowed.
It is also allowed that if an investor is working, his profit share (%) could be more than his capital share (%) irrespective of whether the other partner is working or not. For example, if ‘A’ & ’B’ have invested Rps.1,000/- each in a business and it may be agreed that only ’A‘ will work will get 2/3rd of the profit while ‘B’ will only get 1/3rd. Similarly, if the condition of work is also imposed on ‘B’ in the agreement, then the proportion of profit for ’A’ can be more than his investment.
If a partner has put an express condition in the agreement that he will not work for the Musharakah and will remain sleeping partner throughout the term of Musharakah, then his share of profit cannot be more than the ratio of his investment. However, the Hanbali school of thought considers fixing the sleeping partners’ profit share more investment share to be permissible.
It is allowed that if a partner is not working, his profit share can be established as less than his capital share.
If both are working partners, the share of profit can differ from the ratio of investment. For example, ’Zaid’ & ’Bakar’ both have invested Rs.1,000/- each. However, Zaid gets 1/3rd of the total profit and Bakar gets 2/3rd, this is allowed. This opinion of Imam Abu Hanifa based on the fact that capital is not the only factor for profit distribution but also labor and work. Although the investment of two partners is the same, in some cases, the quantity and quality of work might differ.
Basic rules of distribution of loss
All scholars are unanimous on the principle of loss sharing in Shariah, based on the saying of Syyednna Ali Ibn Talib that is as follows:
“Loss is distributed exactly according to the ratio of investment and the profit Is distributed according to the agreement of the partners.”
Therefore, the loss is always subject to the ratio of investment. For example, if ’A’ has invested 40% of the capital and ’B’ has invested 60%, they must suffer the loss in the same ratio as of their investment proportion, not more, not less. Any condition contrary to this principle shall render the contract invalid.
Powers and rights of partners In Musharakah
After entering into a Musharakah contract, partners have the following rights:
The right to sell the mutually owned property since all partners are representing each other in Shirkah and all have the right to buy and sell for business purposes.
The right to buy raw material or other stocks on cash or credit, using funds belonging to Shirkah, to put into the business.
The right to hire people to carry out business, if needed.
The right to deposit money and goods of the business belonging to Shirkah as depositor trust where and when necessary.
The right to use Shirkah ’s fund or goods in Mudarabah.
The right of giving Shirkah’s funds as Hiba (gift) or loan. If one partner for the purpose of investing in the business has taken a Qard-e-Hasana, then paying it becomes liable on both.
Termination of Musharakah
Musharakah will stand terminated in the following cases:
If the purpose of forming the Shirkah has been achieved. For example, if two partners form a Shirkah for a certain project such as buying a specific quantity of cloth in order to sell it and the cloth is purchased and sold with mutual investment, the rules are simple and clear in this case. The distribution of profit will be as per the agreed rate, whereas in the case of loss, each partner will bear the loss according to his ratio of investment.
Every partner has the right to terminate the Musharakah at any time after giving his partner a notice that will cause the Musharakah to end. For dissolving this partnership, if the assets are liquidated, they will be distributed between the partners on the following basis:
If there is no profit and no loss to the assets, they will be distributed on a pro-rata basis.
In case of loss as well, all assets will be distributed on a pro-rata basis.
In case of the death of any one of the partners or any partner becoming insane nr incapable of effecting the commercial transaction, the Musharakah stands terminated.
In case of damage to the share capital of one partner before mixing the same in the total investment and before affecting the purchase, the partnership will stand terminated and the loss will only be borne by that partner. However, if the share capital of all partners has been mixed and could not be identified singly, then the loss will be shared by all and the partnership will not be terminated.
Termination of Musharakah without closing the business
If one of the partners wants termination of the Musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. The partners who want to run the business may purchase the share of the partner who wants to terminate his partnership because the termination of Musharakah with one partner does not imply its termination between the other partners. However, in this case, the price of the share of the leaving partner must be determined by mutual consent. If there is a dispute about the valuation of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or on the distribution of the assets 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 want 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.
This condition may be justified, especially in modern situations, on the ground that the nature of the business, in most cases today, requires continuity for its success. 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 have 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 Prophet(SAW) in his famous hadith:
“All conditions agreed upon by the Muslims are upheld, except a condition which allows what Is prohibited or prohibits what is lawful”.
There shall be a provision for adjudication by a Review Committee to resolve any difference that may arise between the bank and its clients (partners) with respect to any of the provisions contained in the Musharakah Agreement.
Security in Musharakah
In the case of the Musharakah agreement between the Bank and the client, the bank shall in its own right and discretion, obtain adequate security from the party to ensure the safety of the capital invested/ financed as also for the profit that may be earned as per profit projection given by the party. The securities obtained by the bank shall, also, as usual, be kept fully insured at the party’s cost and expenses with Takaful (Islamic Insurance). The purpose of this security is to utilize it only in case of damage or loss of the principal amount of earned profit due to the negligence of the client.
The difference between interest-based financing and Musharakah
A fixed-rate of return on a loan advanced by the financier is predetermined irrespective of the profit earned or loss suffered by the debtor.
Musharakah does not envisage a fixed rate of return. The return is based on the actual profit earned by the joint venture.
The financier cannot suffer a loss
The financier can suffer a loss if the joint venture fails to produce fruits.
Issues Relating to Musharakah
Musharakah is a mode of financing In Islam. The following are some issues relating to the tenure of Musharakah, redemption in Musharakah, and the mixing of capital in conducting Musharakah.
Liquidity of capital
A question commonly asked in the operation of Musharakah is whether the capital investment needs to be in liquid form or not. The answer as to whether the contract in Musharakah can be based on commodities only or on money varies among the different schools of thought In Islam. For example, if ’Zaid’ and Bakar agree to invest Rs. 1000/- each in a garment business and both keep their investments with themselves. Then, if ’Zaid’ buys cloth with his investment, will it be considered belonging to both Zaid and Bazar or only to Zaid? Furthermore, if the cloth is sold, can Zaid alone claim the profit or loss on the sale? In order to answer this question, the prime consideration should be whether the partnership becomes effective without mixing the two investments profit or loss. This issue can be resolved in light of the following schools of thought of different fiqh:
Imam Malik(R.A) is of the view that liquidity is not a condition for the validity of Musharakah. Therefore, even if a partner contributes in kind to the partnership, his share can be determined on the basis of the evaluation according to the prevalent market price at the date of the contract. However, Imam Abu Hanifa (RA) and Imam Ahmad (RA) do not allow capital of investment to be in kind. The reason for this restriction it as follows:
Commodities contributed by one partner will always be distinguishable from the commodities given by the other partners, therefore, they cannot be treated as homogenous capital.
If in case of redistribution of share capital to the partners, tracing back each partner’s share becomes difficult. If the share capital was in the form of commodities then redistribution cannot take place because they may have been sold by that time.
Imam Shafi(RA) has an opinion dividing commodities into two:
• Dhawat-ul-AmchaI (Homogeneous Commodities)
Commodities which if destroyed can be compensated by similar commodities in quality and quantity. Example rice, wheat etc.
• Dhawat-UI-Qeemah (Heterogeneous Commodities)
Commodities that cannot be compensated by similar commodities, like animals.
Imam Shafi (RA) is of the view that commodities of the first kind may be contributed to Musharakah in the capital while the second type of commodities cannot be a part of the capital, In case of Dhawat-ul-Amthal, redistribution of capital may take place by giving each partner the similar commodities he had invested earlier, the commodities need to be mixed so well together that the commodity of one partner cannot be distinguished from commodities contributed by the other.
The illiquid goods can be made capital of investment and the market value of the commodities shall determine the share of the partner in the capital. It seems that the view of Imam Malik (RA) is simpler and more reasonable and meets the need of the modern business therefore this view can be acted upon.
We may therefore conclude from the above discussion that the share capital in a Musharakah can be contributed either in cash or in the form of commodities. In the Iatter case, the market value of the commodities shall determine the share of partner in the capital.
Mixing of the Capital
According to Imam Shafi (RA) the capital of partners should be mixed so well that it cannot be discriminated, and this mixing should be done before any business is conducted. Therefore, partnership will not be completely enforceable if any kind of discrimination is present in the partners’ capital. His argument is based on the reasoning that unless both investments will be mixed, the investment will remain under the ownership of the original investor and any profit or loss on trade of that investment will be entitled to the original investor only. Hence such a partnership is not possible where the investment is not mixed.
According to Imam Abu Hanifa(RA), Imam Malik(RA) and Imam Ahmed bin Hunbul(RA), the partnership is complete only with an agreement and the mixing of capital is not important. They are of the opinion that when two partners agree to form a partnership without mixing their capital of investment, then if one partner bought some goods for the partnership with his share of investment of Rs.100,000/-, these goods will be accepted as being owned by both partners and hence any profit or loss on sale of these goods should be shared according to the partnership agreement.
However, if the share of investment of one person is lost before mixing the capital or buying anything for the partnership business, then the loss will be borne solely by the person who is the owner of the capital and will not be shared by other partners. However, if the capital of both had been mixed and then a part of whole had lost or stolen, then the loss would have been borne by both.
Since in Hanafi, Maliki and Hanbali schools of thought mixing of the capital is not important, therefore, a very important present-day issue is addressed with reference to this principle. If some companies or trading houses enter partnership for setting up an industry to conduct business, and they need to open LC for importing the machinery. This LC reaches the importer through his bank. Now when the machinery reaches the port and the importing companies need to pay for taking possession, the latter need to show those receipts to take possession of the goods.
Under Shafi school of thought, the imported goods cannot become the capital of investment but will remain in the ownership of the person opening the LC because, at the time of opening the LC, the capital has not been mixed and without mixing the capital, Musharakah cannot come into existence Under this situation, if the goods are lost during shipment, the burden of loss will fall upon the opener of the LC, even though the goods were being imported for the entire industry. This is because even though a group of companies had asked for the machinery or imported goods, the importers had not mixed their capital at time of investment.
Contrary to this, since the other three schools of thought believe that partnership comes into existence at the time of agreement rather than after the capital has been mixed, therefore, the burden of loss will be borne by all. This has two advantages:
In case of loss, the burden of loss will not fall upon one partner rather, it will be shared by all partners of the firm.
If the capital is provided at the time the agreement, it stays blocked for the period during which the machinery is being imported. While if the capital were not kept idle until the actual operation could be conducted with the machinery, the same capital could have been used for something else as well.
This shows that the decision of the three combined schools of thought is better equipped to handle the current import situation.
Tenure of Musharakah
For conducting a Musharakah agreement, questions arise pertaining to fixing the period of the agreement. For fixing the tenure of the Musharakah following conditions should be remembered:
a) The partnership is fixed for such a long time that at the end of the tenure no other business can be conducted.
b) Can be for a very short time during which partnership is necessary and neither partner can dissolve the partnership.
Under the Hanafi school of thought, a person can fix the tenure of the partnership because it is an agreement and an agreement may have a fixed period of time. In the Hanbali school of thought, the tenure can be fixed for the partner as it is an agency agreement and an agency agreement in this school can be fixed. The Maliki school however says that Shirkah cannot be subjected to a fixed tenure. Shafi school Iike the Maliki consider fixing the tenure to be impermissible. Their argument is that fixing the period will prohibit conducting the business at the end of that period which in turn means that the fixing will prevent them from conducting the business.
Uses of Musharakah / Mudarabah
These modes can be used in the following areas (or can replace them according to Shariah rules)
Asset Side Financing
Short/medium/long – term financing
Small and medium enterprises set up the financing
Large enterprise financing
Import bills drew under import letters of credit
Inland bills drawn under inland letters of credit
LC with margin (for Musharakah)
Export financing (Pre-shipment financing)
Working capital financing
Running accounts financing / short term advances
Liability Side Financing
For current/saving/Mahana amdani/ investment accounts (Deposit giving profit based on Musharkah/Mudarbah – with a predetermined ratio)
Inter- Bank lending/borrowing
Term Finance Certificates & Certificate of Investment
Bill and Federal Investment Bonds / Debenture
Securitization for large projects (based on Musharl‹ah)
Certificate of Investment based on Murabaha (e.g: Meezan Riba free)
Islamic Bank Musharakah bonds (based on projects requiring large amounts – profit based on the return from the project).
Risks in Musharkah Financing
Some of the major risks and problems that are being faced by Islamic Banks in extending Musharkah or Mudarbah based financing are as follows:
Business Risk: In Musharakah financing, the bank is sharing the business risk with the customer since the return in Musharkah financing is dependent on the actual performance of the business. The bank should make a feasibility study of the business of the customer and should prudently evaluate all the risks of any business before making Musharakah financing decisions, since the exposure of the bank is on the business performance and not or the customer, unless and until fraud or negligence is established on part of the customer.
Risk of Proper Book Keeping: Another problem in Musharkah’s transaction is the lack of transparent bookkeeping practices adopted by various companies due to taxation reasons. Due to this lack of transparency, it is difficult to evaluate the actual performance of any business since it is not completely portrayed in the disclosed accounts of the company, and in the absence of such information, it is difficult to enter Into a Musharkah arrangement with the customer.
3) Customer Mindset: In Musharkah financing the actual profits and loss of the business are shared between the partners therefore if the business performs higher than the expectation then it will generate higher profits. If high profits are generated by the business then the bank will also be getting high profits as per the profit-sharing arrangement but many customers are hesitant in providing profit that is more than the average market benchmark rate of financing.
4) Dishonesty: Another apprehension against musharakah financing is that a dishonest client may exploit the instrument of musharakah by not paying any return to be financiers. They can always show that the business did not earn any profit by manipulating the records of the company. Indeed, they can claim that it has suffered a loss in which case not only the profit but also the principal amount be jeopardized.
5) Operational Risk: The success of Musharakah depends upon better management of the factors of operational risks, which include:
a) Control over management b) Transparency in income c) Commitment by management
Islamic banks can take the following steps for proper management of operational risks in Musharakah.
By appointing bank’s representative in:
These representatives should be given proper authority & will be directly reporting to Bank’s management.
6) Credit Risk: In Musharakah, the Musharik bank is exposed to similar credit risks if some amount is payable by customs under the Musharakah agreement, as other banks, which include: Risk of default and Party risk.
Credit risk can be mitigated by:
Proper evaluation of the customers financial position.
Any Shariah Compliant security can be taken to secure the bank against any dishonesty or act of negligence by the customer.
Another form of Musharakah, developed in the near past, is the ’Diminishing Musharakah’. According to this concept, a financier and his client participate either in the joint ownership of a property or equipment or in a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financer are purchased by the client so as to make him the sole owner of the property, or the commercial enterprise, as the case may be.
The diminishing Musharakah based on the above concept has taken different forms in different transactions. Some examples are given below:
It has been used mostly in home financing. The client wants to purchase a house for which he does not have adequate funds, He approaches the financer who agrees to participate with him in purchasing the required house. For Instance, 20% of the price is paid by the client and 80% of the price by the financier. Thus, the financier owns 80% of the house while the client owns 20%. After purchasing the property jointly, the client uses the house for his residential purposes and pays rent to the financier for using his share in the property. At the same time, the share of the financier is further divided into eight equal units, each unit representing 10% ownership of the house. The client promises to the financer that be will purchase one unit every three months.
Accordingly, after the first term of three months, the client purchases one unit of the share of the financer by paying 1/10th of the price of the house. This reduces the share of the financier from 80% to 70%. Hence, the rent payable to the financier is also reduced to that extent. At the end of the second term, he purchases another unit thereby increasing his Share in the property to 40% and reducing the share of the financier to 60% and consequently reducing the rent to that proportion as well.
This process goes on in the same fashion until after the end of no years, the client purchases the entire share of the financer reducing the share of the financer to ‘zero’ and increasing his own share to 100%
This arrangement allows the financier to claim rent according to his proportion of ownership in the property and at the same time allows him a periodical return of a part of his principal through purchases of the units of his share.
’A’ wants to purchase a taxi to use it for offering transport services to passengers and to earn income through fares recovered from them, but he is short of funds. ‘B’ agrees to participate in the purchase of the taxi, therefore, both of them purchase a taxi jointly. For instance, 80% of the price is paid by ‘B’ and 20% is paid by ’A’. After the taxi is purchased, It is employed to provide transport to the passengers whereby the net income of Rs. 1,000 is earned on a daily basis. Since ’B’ has 80% share in the taxi, it is agreed that 80% of the fare will be given to him and the rest 20% will be retained by ‘A’ who has a 20% share in the taxi. It means that Rs. 800 is earned by ‘B’ and Rs. 200 by ‘A’ on a daily basis. At the same time, the share of ‘B’ is further divided into eight units. After three months ‘A’ purchases one unit from the share of ‘B’. Consequently, the share of ‘B’ is reduced to 70%, and the share of ‘A’ is increased to 30% meaning thereby that as from that date ’A’ will be entitled to Rs. 300 from the daily Income of the taxi and ‘B’ will earn Rs. 700. This process will go on until after the expiry of two years, the whole taxi will be owned by ’A’ and ’B’ will take back his original investment along with the income distributed to him in an above-mentioned way.
’A’ wants to start the business of ready-made garments but lacks the required funds for that business. ‘B’ arees to participate with him for a specified period, say two years. 40% of the investment is contributed to by ’A’ and 60% by ’B’. Both start the business on the basis of Musharakah. The proportion of profit allocated for each one of them is expressly agreed upon. But at the same time, B’s share in the business is divided into six equal units and ‘A’ keeps purchasing those units on a gradual basis until after the end of two years ’B’ comes out of the business, leaving its exclusive ownership to ‘A’, apart from the periodical profits earned by ‘B’, he gains the price of the units of his share which, in practical terms tend to repay to him the original amount invested by him.
Analyzed from the Shariah point of view, this arrangement is composed of different transactions that come to play their role at different stages. Therefore, each one of the foregoing three forms of diminishing Musharakah is discussed below in light of the Islamic principles.
Home Financing on the basis of Diminishing Musharakah
The proposed arrangement is composed of the following transactions:
To create joint ownership in the property (Shirkat-ul-Milk).
Giving the share of the financer to the client on rent.
A promise from the client to purchase the units of share of the financier.
Actual purchases of the units at different stages.
Adjustment of the rentals according to the remaining share of the financier in the property.
Steps In detail of the arrangement
The first step in the above-menitioned arrangement of Diminishing Musharakah is to create joint ownership in the property. It has already been explained at the beginning of the chapter that ‘Shirkat-ul-Milk’ (joint ownership) can come into existence in different years including the joint purchase by the contracting parties. All schools of Islamic jurisprudence have expressly allowed this type of contract. Therefore, no objection can be raised against creating this form of joint ownership.
The second part of the arrangement is that the financier leases his share in the house to his client and charges rent from him. This arrangement is also permissible because there is no difference of opinion among the Muslim jurists in the permissibility of leasing one’s undivided share in a property to his partner. If the undivided share is leased out to a third party, its permissibility is a point of difference between the Muslim jurists. Imam Abu Hanifa and Imam Zufar are of the view that the undivided share cannot be leased out to a third party, while Imam Malik, Imam Shafi, Abu Yusuf, and Muhammad Ibn Hasan hold that undivided share can be leased out to any person. But so far, as the property is leased to the partner himself, all of them are unanimous on the validity of ‘Ijarah’.
The third step In the aforesaid arrangement is that the client purchases different units of the undivided share of the financier. This transaction is also allowed. If the undivided share relaxes to both land and building, the sale of both is allowed according to all the Islamic schools, Similarly, if the undivided share of the building is intended to be sold to the partner, it Is also allowed unanimously by all the Muslim jurists. However, there is a difference of opinion if it is sold to a third party. It is clear from the foregoing three steps that each one of the transactions mentioned above is allowed, but the question is whether these transactions may be combined in a single arrangement. The answer is that if all these transactions have been combined by making each one of them a condition to the other then this is not allowed in Shariah, because it is a well-settled rule in the Islamic jurisprudence that one transaction cannot be made a pre-condition of another.
However, the proposed scheme suggests that instead of making two transactions conditional to each other, there should be a one-sided promise from the client, firstly, to take a share of the financier on lease and pay the agreed rent, and secondly to purchase different units of the share of the financer of the house at different stages. This leads us to the fourth step, which is the enforceability of such a promise.
However, the proposed scheme suggests that instead of making two transactions conditional to each other, there should be a one-sided promise from the client, firstly, to take a share of the financier on lease and pay the agreed rent, and secondly to purchase different units of the share of the financer of the house at different stages. This leads us to the fourth step, which is the enforceability of such a promise.
The Hanafi jurists have adopted this view with regard to a particular sale called ‘bai-bilwafa’. This bai-bilwada is a special arrangement of the sale of a house whereby the buyer promises to the seller that whenever the latter gives him back the price of the house, he will resell the house to him. This arrangement was in vogue in the countries of Central Asia, and the Hanafi jurists have declared that if the resale of the house to the original seller is made a condition for the initial sale, it is not allowed. However, if the listed sale is affected without any conditions, but after affecting the sale the buyer promises to resell the house whenever the seller offers to him the same price, this promise is acceptable and it creates not only a moral obligation but also an enforceable right of the original seller. Tho Muslim jurists allowing this arrangement have based their view on the principle that “the promise can be made enforceable at the time of need”.
Even if the promise has been made before affecting the first sale, after which the saIe has been effected without a condition, it is also allowed by certain Hanafi jurists.
One may raise an objection that if the promise of resale has been taken before entering into an actual sale, it practically amounts to putting a condition on the sale itself, because the promise is understood to have been entered into between the parties at the time of sale, and even if the sale is without an express condition, it should be taken as conditional because a promise in an express term has preceded it.
This objection may be addressed by the fact that there is a big difference between putting a condition in the sale and making separate promises without making it a condition. If the condition is expressly mentioned at the time of sale, it means that the sale will be valid only if the condition is fulfilled, meaning thereby that if the condition is not fulfilled in the future, the present sale will be void. This makes the transaction of sale contingent on a future event, which may or may not occur. It leads to the uncertainty of (Gharar) in the transaction, which is totally prohibited in Shariah.
Conversely, if the sale is without any condition, but one of the two parties has promised to do something separately, then the sale cannot be held contingent of conditional with the fulfillment of the promise. It will take effect irrespective of whether or not the promisor fulfills his promise. Even if the promisor backs out of his promise, the sale will remain effective. The most the promises can do is to compel the promisor through a court of law to fulfill his promise and if the promisor is unable to fulfill the promise, the promise can claim actual damages he has suffered because of the default. This makes it clear that a separate and independent promise to purchase does not render the original contract conditional or contingent. Therefore, it can be enforced.
On the basis of this analysis, diminishing Musharakah may be used for Home Financing with the following conditions:
The agreement of joint purchase, leasing, and selling different units of the share of the financier should not be tied-up together in one single contract. However, the joint purchase and the contract of lease may be joined in one document whereby the financier agrees to lease his share, after joint purchase, to the client. This is allowed because, as explained in the relevant chapter Ijarah can be affected for a future date. At the same time, the client may sign a one-sided promise to purchase different units of the share of the financer periodically and the financier may undertake that when the client will purchase a unit of his share, the rent of the remaining units will be reduced accordingly.
At the time of the purchase of each unit, the sale must be affected by the exchange of offer and acceptance at that particular date.
It will be preferable that the purchase of different units by the client is affected on the basis of the market value of the house as prevalent on the date of purchase of that unit, but it is also permissible that a particular price is agreed in the promise of purchase signed by the client as it is a ‘Shirkat ul Milk” transaction and the partnership Is only over the assets and not in the business.
Diminishing Musharakah for Services
The second example given earlier for diminishing Musharakah is the joint purchase of a taxi for using is as a hired vehicle to earn income. This arrangement consists of the following elements:
Creating joint ownership in a tax in the form of Shirkat ul- Milk. As already stated, this is allowed in Shariah.
Musharakah in the income generated through the Services of the taxi. It is also allowed, as mentioned earlier in this chapter.
Purchase of different units of the share of the financier by the client, This is again subject to the conditions already explained in the case of Home financing. However, there is a slight difference between the Home financing arrangement suggested in this second example. The taxi, when used as a hired vehicle, normally depreciated in value over time, therefore, depreciation in the value of the taxi must be kept in mind while determining the price of the different units of the share of the financer.
Diminishing Musharakah in Trade
The third example of Diminishing Musharakah as given above that the financier contributes 60% of the capital for starting a business of ready-made garments, for example. This arrangement is composed of two elements only:
In the first place, the arrangement is simply a Musharakah whereby two partners invest different amounts of capital in a joint enterprise. This is obviously permissible subject to the conditions of Musharakah already spelled out earlier in this chapter.
Secondarily, it entails the purchase of different units of the share of the financier by the client. This may be in the form of a separate and independent promise by the client. The requirements of Shariah regarding this promise are the same as explained in the case of Home financing with one very important difference. Here the price of units of the financer cannot be fixed beforehand at the time of entering into Musharakah, it will practically mean that the client has ensured the principal invested by the financer with or without profit, which is strictly prohibited in the case of Musharakah.
Therefore, there are two options for the financer about fixing the price of his units to be purchased by the client.
One option is that he agrees to sell the units on the basis of the valuation of the business at the time of the purchase of each unit. It the value of the business increases, the price will be higher, and if it decreases the price will be lower. Such valuation may be carried out In accordance with the recognized principles through the experts, whose identity may be agreed upon between the parties when the promise is signed.
The second option is that the financier allows the client to sell these units to anybody else at whatever price he can, but at the same time he offers a specific price to the client, meaning thereby that if he finds a purchaser of that unit at a higher price, he may sell it to him, but if he wants to sell it to the financier, the latter will be agreeable to purchase it at the price fixed by him beforehand.
Although both these options are available according to the principles of Shariah, the second option does not seem to be feasible for the financer, because it would lead to injecting new partners in the Musharakah which will disturb the whole arrangement and defeat the purpose of Diminishing Musharakah in which the financier wants to get his money back within a specified time period. Therefore, in order to implement the objective of Diminishing Musharakah, only the first option is practical.
The term khiyar refers to an option or right of tic buyer & seller to rescind a contract of sale.
There are five Khiyars in a contract which are as follows:
Khiyar-e-Shart (Optional condition)
At the time of sale, the buyer or seller can put a condition that either party has an option to rescind the sale within the specified number of days (such as 4 days). This option is called ”Khiyar e shart”.
Specification of the days is necessary for this Khiyar. Within this period, either party has the right to rescind/terminate the sale without any reason. If the buyer puts the condition, it is called Khiyar-e-Mushtari (option of the buyer) and when put by the seller, it is called Khiyar-e- Bai (option of the seller). This Khiyar is nontransferable to the heirs.
Khiyar-e -Roiyyat (Option of inspecting goods)
Here the goods can be returned after inspection if they are not up to the specifications. This applies automatically to all contracts. For example, ’A’ buys machinery from ’B’ without seeing. However, ’A’ has the option to return the machinery after inspection.
Khiyar-e-Aib (Option of the defect)
Where the goods can be returned if found defective. It is the responsibility of the seller to supply the goods free of defect or point out the defect to the buyer. The seller is not allowed to hide the defect of the goods because it constitutes fraud. In one of the hadiths, Prophet P.B.U.H has stated:
“He is not amongst us who indulges in fraud.”
Therefore, the buyer has the right to return to good in the case where the presence of a deficiency is considered a defect in the market practice and which depreciates the value of the goods. For example, ‘A’ buys batteries from ‘B’. However, ‘A’ has the option to return them to ‘B’ if the batteries are found to be defective or not in working condition.
Khiyar-e-Wasf (Option of quality)
This option is available where the seller sells the goods by specifying a certain quality that is absent in the goods. For example, ’A’ buys a car from ‘B’ who has specified automatic transmission in the car. However, when ’A’ uses the car, he finds the transmission to be manual. Therefore, he has the right to return the car to ’B’ in the absence of that specific quality.
Khiyar-e-Ghaban (Option of price)
Where the seller sells the goods at a price which is far expensive than the market price and the market price is not known to the buyer, a buyer has the right the return it to the seller. For example, a Parker pen is sold to ’A’ by ’B’ at a price of Rs.500. However, after the sale, ’A’ discovers its market price to be Rs. 250, In this case, “A” the option to return the pen to ‘B’.
Iqala (Recession of Contracts)
Where the parties freely consent to rescind the contract i.e. each party will give back the consideration received by it at the time of execution of the contract.
Neither the buyer nor the seller has the sole right to rescind the contract after the execution of a contract. Often the buyer wants to remind the contract after buying goods. In this case, it is necessary that he gets the consent of the seller. Therefore, this mutual agreement between buyer and seller to rescind the contract is called “Iqala.”
In one of the narrations, Prophet P.B.U.H has stated:
“He who does the Iqala (rescinding of the contract) with a Muslim who is not happy with his transaction, Allah will forgive his sins on the Day of Judgment.”
However, it may be noted that the price of the goods being returned under Iqala will remain unchanged.
Sale (Bai) is commonly defined in Shari’ah as “the exchange of a thing of value by another thing of value with mutual consent”, For example, “the sale of a commodity in exchange for cash”.
Valid Sale (Bai Sahih)
A sale becomes valid if the following elements are present along with all other necessary conditions:
Subject Matter (Mabee’)
Possession or delivery (Qabza)
Void/Non-Existing Sale (Bai Baatil)
SaIe will be void if any one of the conditions of offer and acceptance (1.1) [Refered to elements of valid sale], Conditions of Buyer & seller (1.2), and good for sale or subject matter (2.1 – 2.5) are not complied with. In a void sale, the buyer does not have title to the subject matter and the seller does not have title to the price.
Existing Sale but void due to defect (Bai Fasid)
The sale will exist but will be void due to defect if the conditions of contract (1.3), subject matter conditions (2.6 & 2.7), and conditions of the price (3.1 & 3.2) are not complied with. However, if the defect is rectified, the sale becomes valid. In a fasid sale, the buyer should not possess the subject matter. If possessed with the consent of the seller, title or ownership will pass to the buyer but the usage of the subject matter will be impermissible. He must return the goods to the seller.
Valid but disliked Sale (Bai Makrooh)
A sale will be valid but Makrooh when the transaction is complete and one gets possession of the goods but is disliked e.g. saIe after Juma Azaan, sale after hoarding or where a third party intervenes to buy Something which was under negotiation of sale between other parties.
Types of Sale
Following are the common types of Sale:
Bai Musawamah: It refers to a normal sale in which cost price is not known to the buyer.
Bai Murabaha: It refers to a sale in which the cost of the goods and profit amount is known to the buyer.
Bai Muqayada: It refers to a barter sale excluding currency
Bai Surf: It refers to the sale of gold, silver, and currency.
Bai Salam: It is a kind of sale in which full payment is in the advance spot while the delivery of the good is deferred to a future date.
Bai Istisna: It refers to a sale In which commodity is sold before it comes into existence. It is basically an ar order to manufacture.
Bai Muajjal: It refers to a sale in which delivery of goods is at the spot while payment of the price is deferred to a future date. The cost is unknown in Bai Muajjal.
Bai Taulia: It is the type of sale where sale price is equal to the cost of goods.
Bai Waddiyah: It is the type of sale where the sale price is less than the tic cost of goods.
Prohibited Sale Transactions
Some of the major types of sale transactions that are prohibited by Shariah are as follows:
Short Selling (Qabl as Qabza-Sale before possession)
It is the type of sale where the subject matter is sold by the seller without getting its possession is prohibited as per the following Hadiths of Prophet P.B.U.H.
“Whoever purchases foodstuff, should not sell it until he takes its possession.” (Bukhari)
Short selling in currency markets, equity markets, commodity markets in the current world scenario falls under the same category.
Sale of Debt (BaI at Dain)
Dain means “debt” and “Bai” means sale. Bai’-al-dain, therefore, denotes the “sale of debt”. If a person has a debt receivable from a person and he wants to sell it at a discount (as normally happens in the bill of exchange), It is termed in Shariah as Bai’- al- dain. The traditional Muslim jurists (fuqaha’) are unanimous on the point that Bai’-al-dain is not allowed in Shariah. In fact, the prohibition of Bai-al- dain is a logical consequence of the prohibition of “riba” or interest. A “debt” receivable in monetary terms corresponds to money, and every transaction where the money is exchanged from the same denomination of money, the price must be at par value.
Similarly, debt cannot be traded at face value since It Includes a greater degree of Gharar as the party to whom the debt is sold is not certain about the delivery of currency since the original debtor may default. Therefore, debt can not be sold, however, it can only be assigned at face value and with recourse i.e assigner of debt will be liable to fulfill its obligations even if the original debtor defaults in paying its obligations.
Bai AI Kali Bid Kali
It is referred to as a Sale Transaction where both the subject matter and the price are deferred after the execution of sale contract. This type of sale is also not allowed since either price or delivery of the subject matter can be deferred at a time but both these elements cannot be deferred in a single sale transaction. It should be noted that this ruling is restricted to the condition that both price and the sold commodity are fungible i.e. they can be replaced with exact replica if they are destroyed.
Bai al Innah (Buy Back)
Control of the sale, where a person sells an asset on credit and then buys back at a less price for cash. This transaction Is prohibited since it creates a back-door for earning a profit over a loan transaction. For example: ’A’ asks a loan of $10 from ’B’, ’B’, instead of asking for interest on this loan applies a contrivance. He sells an article to ’A’ for $12 on credit and then buys back from him the same article for cash at $10.