Partnership Based Contract

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'.
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"."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 (Ghair Ikhtiari): 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.

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 earning profit, it may also be translated as "joint commercial
enterprise."
Shirkat-ul-Aqd” can further be classified into three kinds:
(i) Shirkat-ul-Amwal (Partnership in capital): where all the partners invest some capital into
a commercial enterprise.
(ii) Shirkat-ul-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-ul-aamal which is also called
Shirkat-ut-taqabbul or Shirkat-us-sanai or Shirkat-ul-abdan.
(iii) Shirkat-ul-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 spot. The profit so earned is distributed between them at an
agreed ratio.
Each of the above three types of Shirkat-ul-Aqd are further divided into two types:
a) Shirkat-Al-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 any one category is not shared in
absolute equality, then the partnership becomes Shirkat-ul-’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-ul-Aqd where capital, management or
profit ratio is not equal in all respect.
Rules & Conditions of Shirkat-ul-Aqd
The common conditions of Shirkat-ul-Aqad are three which are as follows:
a) The existence of Muta'aqidain (Partners):
b) Capability of Partners: The partners must be sane & mature and capable of entering into
a contract. The contract must take place with 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 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 Shirkat-ul-Aqd should duly qualify
as legally being eligible of becoming an agent and of carrying on business.
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 before hand, the contract becomes void (Fasid). Therefore, identifying the profit
share is necessary.
c) Profit & 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-ul-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-Amwal 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 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:
1) 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 in terms 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 case of a commodity, the market value of the commodity
shall determine the share of the partner in the capital.
2) 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.
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.
3) Basic rules of distribution of Profit
1. 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.
2. It is not allowed to fix a lump sum amount for anyone 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.
3. If both partners agree that each one will get percentage of profit based on his capital
proportion, whether both take part in the management of the business or not, it is allowed.
4. 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 Rs.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.
5. If a partner has put an express condition in the agreement that he will not work for the
Musharakah and will remain a sleeping partner throughout the term of Musharakah, then
his share of profit cannot be more than the ratio of his investment. However, Hanbali school
of thought considers fixing the sleeping partners profit share more than his investment
share to be permissible.
6. It is allowed that if a partner is not working, his profit share can be established as less
than his capital share.
7. 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 1/3 rd of
the total profit and Bakar gets 2/3rd, this is allowed. This opinion of Imam Abu Hanifa is
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 but in some cases, quantity and
quality of work might differ.
4) Basic rules of distribution of Loss
All scholars are unanimous on the principle of loss sharing in Shariah, which says that 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.
5) Powers & Rights of Partners in Musharakah
After entering into a Musharakah contract, partners have the
following rights:
a) The right to sell the mutually owned property since all partners are representing each
other in Shirkah and all have the right to buy & sell for business purposes.
b) The right to buy raw material or other stocks on cash or credit, using funds belonging to
Shirkah, to put into the business.
c) The right to hire people to carry out business, if needed.
d) The right to deposit money and goods of the business belonging to Shirkah as depositor
trust where and when necessary.
e) The right to use Shirkah's fund or goods in Mudarabah.
f) The right of giving Shirkah's funds as hiba (gift) or loan. If one partner for purpose of
investing in the business has taken a Qard-e-Hasana, then paying it becomes liable on both.
6) Termination of Musharakah
Musharakah will stand terminated in the following cases:
1. 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 partnership is considered
terminated.
2. Every partner has the right to terminate the Musharakah at any time after giving his
partner a notice that will cause the Musharakah to end. For dissolving this partnership, if the
assets are liquidated, they will be distributed between the partners on the following basis:
a) If there is no profit and no loss to the assets, they will
be distributed on pro rata basis.
b) In case of loss as well, all assets will be distributed on pro rata basis.
3. In case of the death of any one of the partners or any partner becoming insane or
incapable of effecting commercial transaction, the Musharakah stands terminated.
4. 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 particular 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.
Security in Musharakah
In case of 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 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 or earned profit due to
the negligence of the client.

Issues Relating to Musharakah

Musharakah is a mode of financing in Islam. Following are some issues relating to the tenure
of Musharakah, redemption in Musharakah and the mixing of capital in conducting
Musharakah.
Liquidity of Capital
Imam Malik 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 and Imam Ahmad do not allow capital of
investment to be in kind.
Mixing of the Capital
According to Imam Shafi 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 , Imam Malik and Imam Ahmed bin Hunbul , 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. Since these 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:
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
• Project financing
• Small & medium enterprises setup financing
• Large enterprise financing
• Import financing
• Import bills drawn under import letters of credit
• Inland bills drawn under inland letters of credit
• Bridge financing
• 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 predetermined ratio)
• Inter- Bank lending / borrowing
• Term Finance Certificates & Certificate of Investment
• T-Bill and Federal Investment Bonds / Debenture.
• Securitization for large projects (based on Musharkah)
• Certificate of Investment based on Murabahah (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 measure risks and problems that are being faced by Islamic Banks in extending
Musharkah or Mudarbah based financing are as follows:
1) Business Risk: In Musharakah Financing, the bank is sharing the business risk with the
customer since the return in Musharkah financing is dependant 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 exposure of bank is on the business performance and not on the
customer, unless and until fraud or negligence is established on part of the customer.
2) Risk of Proper Book Keeping: Another problem in Musharkah transaction is lack of
transparent book keeping 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 ate
shared between the partners therefore if the business performs higher then the expectation
then it will generate higher profits. If high profits are generated by the business then 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 the dishonest
clients may exploit the instrument of musharakah by not paying any return to the 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 will be jeopardized.
5) Operational Risk: 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 following steps for proper
management of Operational risks in Musharakah. By appointing bank’s representatives in:
• Company’s BOD
• Finance
• Internal audit
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 Musharkah 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.
• Evaluation of customers credit history
• Past relationship with bank.
Modern Forms of Partnership
The Islamic financial institutions frequently use mushārakah as a mode of financing which is
considered also a real alternative to interest under an Islamic economic system. Following
are some forms of mushārakah financing.
1. Project financing
Islamic Banks provide project finance on the basis of mushārakah One or two or more
entrepreneurs approach the bank for finance and the bank along with other partners
provides complete finance. All the partners, including the bank, have the right to participate
in the management of the project. Any one or all of them also have right to waive this right.
The profits are distributed according to agreed ratios, which need not be the same as capital
proportion but loss has to be shared exactly in the same proportion in which different
partners provided finance.
Since the finance in the above mentioned case is provided completely by the bank and its
partners, they jointly assume the role of arbāb al-māl (financers) and the entrepreneurs, the
Muāribūn. Thus, it is a type of muārabah partnership. But if the investment is provided by
both the parties, i.e., the bank and entrepreneurs or the businessmen then it is a
mushārakah arrangement. The bank before financing any project gets it evaluated by its
experts. If it is found feasible and is expected to be profitable, and there is satisfaction on
the part of bank that the entrepreneurs have sufficient experience to handle the project,
then the partnership is negotiated. Profits are allocated according to an agreed proportion,
allowing for managerial skills to be remunerated. This type of mushārakah terminates with
the project’s completion.
2. Financing of a single transaction
Islamic banks also provide finances in order to meet day to- day needs of small traders. The
traders approach the bank requesting it to finance purchase of certain goods. Now if the
bank considers transaction profitable, it finances purchase of required goods on the basis of
mushārakah. Then the goods are sold in the market and both the parties share profit in
proportion to their investment.
This instrument can also be employed for financing of imports and exports. If the
letter of credit has been opened without any margin, the form of mur┐ba╒ah is adopted,
and if the L/C is opened with some margin, the form of mushārakah is observed. After the
import goods are cleared from the port, their sale proceeds are shared by the importer and
the financer according to a pre-agreed ratio. In this case the ownership of the imported
goods remains with the financer, to the extent of the ratio of his investment.
3. Redeemable Mushārakah
In this category, the bank participates in the capital of a company, or a business venture or
agricultural project on the condition that it will recapture its initial investment along with its
agreed share in the profit. The other partner or partners also promise at the time of
contract that they will purchase the share of bank in the investment and will gradually
become the sole owners of that project. Suppose A, a client, owns a piece of land worth
100,000/- rupees. He does not have money to construct house. So he approaches B, a bank
for finances. B agrees to provide required finance on the condition that it will share the rent
of that house and will also get back its initial investment of Rs. 100000. They also agree that
on the return of B’s capital, A, the client will become the sole owner of that house. On the
completion of house, rent is fixed, say, at Rs. 1000/- per month, which is to be shared by the
parties in proportion to their share in the investment. It is also agreed between the parties
that A, the client will pay to the bank after every six month a sum of Rs. 20000 worth capital
of bank B. The client A pays first instalment of the capital to A on stipulated date. This
payment increases the share of A in the investment from Rs. 100000 to Rs. 120000 i.e. from
50% to 60%, and consequently his share in the rent is also increased from Rs. 500 to Rs. 600.
After the payment of second instalment share of A in investment goes up to Rs. 140000
raising his ratio of capital also to 70% while the share of B, the bank is reduced to Rs.
60000/- and consequently its share in rent is also reduced to that proportion. This process
goes on until after the payment of all instalments in a period of two years and half, the
client becomes the sole owner of that house.
Diminishing Partnership in Islamic Banks

DM Defined
“A partnership in which a party after participation in ownership of an asset can redeem his
capital along with some profit gradually”.
DM Contract
 DM consists of three contracts i.e, co-ownership, ijarah and sale in the following
manner:
 A contract between bank and client partner to create a joint ownership.
 Promise by client partner to purchase the share of bank.
 Bank gives units of his share to the clients on lease.
 Client partner goes on purchasing the units of ownership of bank and the rent goes
on decreasing.
 After the purchase of shares of bank, client partner becomes the sole owner of asset.

Application of DM for house financing

 A, a client and B, a bank buy a house for one lac rupees with contribution of
Rs.20000/- and Rs.80000/- respectively.
 A, owns two units and B owns eight units of ownership. Value of each unit is
Rs.10000/-.
 B, promises to buy one unit of A’s share quarterly.
 A, gives his share (Eight units) to B on lease of Rs.1000/- per month.
 A’s share in rent is Rs.200/- and B’s share is Rs.800/-.
 After three months A buys one unit by paying Rs.10000/-.
 Now share of bank’s ownership is decreased from eight units to seven units.
 Share of bank in rent is decreased from Rs.800/- to Rs.700/-.
 After the purchase of all units the house becomes the sole property of the client.
  Bank’s share of Rs.80000/- may be divided into 20 or 40 units depending on the
capacity of client to pay back bank’s share.
Diminishing Musharakah for Construction
 DM may be used for construction of house.
 A, a client owns land worth 10 million rupees and needs 8 million from B, an Islamic
bank for construction.
 B, Islamic bank buys part of plot for 8 million (buys 8 units).
 Pays this amount in four equal installments.
 When the house is complete, bank leases its part of ownership to the client, at
agreed rentals.
 One year after the disbursement of last installment, the bank would start selling its
units.
 Up to one year, client will only pay rent on the bank’s part of house.
 On purchase of unit, by the client, ownership of bank in house will decrease and its
share in rent will also decrease.
 On the purchase of last unit, the client will become sole owner of house.
The concept of Diminishing Musharakah
According to this concept, a financier and his client participate either in the joint ownership
of a property or an 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 financier 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:
1. 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 financier 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 financier is further divided into eight equal units,
each unit representing 10% ownership of the house. The client promises to the financier
that he will purchase one unit after every three months.
Accordingly, after the first term of three months, the client purchases one unit of the share
of the financier 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 two years, the client purchases the entire share of the financier
reducing the share of the financier 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 periodical return of a part of his principal
through purchases of the units of his share.
2. '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 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 of 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 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 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 the above mentioned way.
3. 'A' wants to start the business of ready-made garments but lacks the required funds for
that business. 'B' agrees to participate with him for a specified period, say two years. 40% of
the investment is contributed 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 these units on 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 which come to play their role at different stages. Therefore, each one of the
foregoing three forms of Diminishing Musharakah is discussed below in the light of the
Islamic principles:
Home Financing on the basis of Diminishing Musharakah
The proposed arrangement is composed of the following transactions:
1. To create joint ownership in the property (Shirkat-ul-Milk).
2. Giving the share of the financier to the client on rent.
3. Promise from the client to purchase the units of share of the financier.
4. Actual purchase of the units at different stages.
5. Adjustment of the rentals according to the remaining share of the financier in the
property.
Steps in detail of the arrangement
i) The first step in the above mentioned arrangement of Diminishing Musharakah is to
create a joint ownership in the property. It has already been explained in the beginning of
this chapter that 'Shirkat-ul-Milk' (joint ownership) can come into existence in different
ways including 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.
ii) 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.
iii) 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
relates 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 for 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 share of the financier on lease and pay the agreed rent, and secondly, to purchase
different units of the share of the financier of the house at different stages. This leads us to
the fourth step, which is the enforceability of such a promise.
iv) It is generally believed that a promise to do something creates only a moral obligation on
the promisor, which cannot be enforced through courts of law. However, there are a
number of Muslim jurists who declare that promises are enforceable, and the court of law
can compel the promisor to fulfill his promise, especially, in the context of commercial
activities.
On the basis of this analysis, Diminishing Musharakah may be used for Home Financing with
the following conditions:
a) 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 one-sided promise to purchase different units of the share of the financier
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.
b) 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.
c) 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 it as a hired vehicle to earn income. This arrangement consists of the following
elements:
a) Creating joint ownership in a taxi in the form of Shirkat ul- Milk. As already stated, this is
allowed in Shariah.
b) Musharakah in the income generated through the services of the taxi. It is also allowed,
as mentioned earlier in this chapter.
c) 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 Home financing and the arrangement suggested in this second example.
The taxi, when used as a hired vehicle, normally depreciates 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 financier.
Diminishing Musharakah in Trade
The third example of Diminishing Musharakah as given above is 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:
1) 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.
2) 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 financier
cannot be fixed in the promise to purchase, because if the price is fixed before hand at the
time of entering into Musharakah, it will practically mean that the client has ensured the
principal invested by the financier with or without profit, which is strictly prohibited in the
case of Musharakah.
Therefore, there are two options for the financier 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 valuation of the business at
the time of the purchase of each unit. If 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 any body 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 before hand.
Although, both these options are available according to the principles of Shariah, the second
option does not seem to be feasible for the financier, 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.
Uses:
• All Purchase of Fixed Assets.
• Home Financing.
• Plant & Factory Financing.
• Car / Transport Financing.
• Project Financing of fixed assets.