SHIRKAH & ITS VARIANTS

SHIRK
AH

Layout
The Concept & Rules of Mudarabah
Mudarabah
Distinguished
From
Musharakah
Modern Corporations: Joint Stock
Companies
Modern Application of the Concept
of Shirkah
Diminishing Musharakah
Diminishing Musharakah as an
Islamic Mode of Finance
SHIRKAH

THE CONCEPT & RULES OF

MUDARABAH

SHIRKAH

The Concept & Rules of

Mudarabah is aMudarabah
special kind of Shirkah in which

an
investor or a group of investors provide capital to an agent
or manager who has to trade with it; the profit is shared
accordingto the pre-agreed proportion, while the loss has
to be borne exclusively by the investor. The loss means a
shortfall in the capital or investment of the financier. The
loss of the agent (Mudarib) is by way of expended time
and effort, for which he will not be given any
remuneration. There is no restriction on the number of
persons giving funds for business or any restriction on the
number of working partners. As discussed in the case of
Musharakah, profit cannot be in the form of a fixed amount
or any percentage of the capital employed. Any ambiguity
or ignorance regarding capital or ratio of profit makes the
contract invalid. If a Mudarabah contract becomes invalid
for any reason, the Mudarib will be working for the
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SHIRKAH
necessary period as a wage-earner
and will get Ujratul-

The Concept & Rules of

Mudarabah (Contd)
evident from various books of Fiqh,

As
the term
Mudarabah is interchangeably used with Qirad and
Muqaradah. It is presumed that while the latter two
originated in Hijaz, Mudarabah was of Iraqi origin.
Subsequently, the difference appears to have been
perpetuated by the legal schools, the Malikis and Shafies
adopting the terms Qirad and Muqaradah and the
Hanafis using the term Mudarabah.
Al-Sarakhsi, in his book Al-Mabsut, explains the nature of
Mudarabah in the following words:
The term Mudarabah is derived from the expression
making a journey and it is called this because the agent
(Mudarib) is entitled to the profit by virtue of his effort and
work. And he is the investors partner in the profit and in
the capital used on the journey and in its dispositions.
The people of Madina callSHIRKAH
this contract Muqaradah, and
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The Concept & Rules of

Mudarabah (Contd)

cutting; for, in this contract, the investor cuts off the

disposition of a sum of money from himself and transfers
its disposition to the agent. It is therefore designated
accordingly. We, however, have preferred the first term
(Mudarabah) because it corresponds to that which is found
in the book of Almighty Allah. He said: while others travel
in the land (yadribuna fil-ard) in search of Allahs bounty,
that is to say, travel for the purposes of trade.
With regard to the legality of Mudarabah, Al-Marghinani
says in Al-Hidaya:
There is no difference of opinion among the Muslims
about the legality of Qirad. It was an institution in the
pre-Islamic period and Islam confirmed it. They all agree
that the nature of the Mudarabah business is that a person
gives to another person some capital that he uses in the
business. The user gets,
according to conditions, some
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SHIRKAH

The Concept & Rules of

Mudarabah (Contd)
number of sayings of the holy Prophet (pbuh)

A
and
reports by his Companions on the subject indicate that
Islamic jurists are unanimous on the legitimacy of
Mudarabah. The terms of the Mudarabah contract offered
by the Prophets uncle Abbas were approved by the
Prophet (pbuh). Abu Musa, the governor of Kufa, wanted to
remit public money to the Bayt al Mal. He gave the
amount to Abdullah bin Umar and his brother, who traded
with it. The Caliphs assembly treated it as an ex post
facto Mudarabah and took half of the profits earned by the
two brothers, because the public money in their hands
was not the loan. Caliph Umar also used to invest orphans
property on the basis of Mudarabah.
This practice was rather needed, since weaker members of
society could not undertake long journeys for trading the
way that most important professions of Arabs could at that
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SHIRKAH
time. Al-Sarakhsi, in this regard, says:

The Concept & Rules of

Mudarabah (Contd)
can find his way to such activity may not have the capital.
And profit cannot be attained except by means of both of
these, that is, capital and trading activity. By permitting
this contract, the goal of both parties is attained.
By allowing Mudarabah, Islam has intended to fulfil an
important economic function by way of encouraging the
hiring of capital and that of trade skills on judicious terms
of risksharing, leading to the benefit of society and the
concerned parties. The Mudarib has to work in various
capacities like trustee, agent, partner, indemnifier/liable
and even wage-earner if the contract becomes void. Being
an agent to the Rabbul-mal, he undertakes the business
and shares the profit.
There could also be multilateral and sub-Mudarabahs. A
multilateral Mudarabah may take various forms. A number
of financiers may make aSHIRKAH
contract of Mudarabah with 8a
single person, or a financier may contract Mudarabah with

The Concept & Rules of

Mudarabah (Contd)
one subscriber. As regards a sub-Mudarabah, there seems
to be a unanimity of opinion that a Mudarib may give the
Mudarabah capital to a third party on Mudarabah terms
only if the financier has allowed it either in clear terms or
has left the business of the Mudarabah to the discretion of
the Mudarib. The absence of the owners permission will
make the former contract voidable.
Mudarabah, like other contracts, calls for lawful items of
trade, failing which the contract will become void or
voidable, as the case may be. Thus, a worker is not
allowed to trade in wine or swine with the Mudarabah
capital. The classical jurists generally restricted the use of
Mudarabah to the act of trade (buying/selling), but an
overwhelming majority of contemporary jurists and
scholars allow the use of Mudarabah with a wider scope
for use by Islamic banks as an alternative to interest9
SHIRKAH
based financing. Mudarabah is a contract of fidelity and

The Concept & Rules of

Mudarabah (Contd)
business activities. As a corollary, he is liable

for the
property in his care as a result of the breach of trust,
misconduct and negligence. A guarantee to return funds
can be taken from him but can be enforced only in two
situations: if he is negligent in the use of funds or if he
breaches the stipulated conditions of Mudarabah. Hence,
his actions should be in consonance with the overall
purpose of the contract and within the recognized and
customary commercial practice. In some situations, he
becomes an employee when he performs some duty after
the Mudarabah contract becomes invalid.
1.The Nature of Mudarabah Capital:
As described in the discussion on Shirkah, Mudarabah
capital should preferably be in the form of legal tender
money, because capital in the form of commodities may
lead to uncertainties and SHIRKAH
disputes. The value of illiquid
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assets must be clearly determined in terms of legal tender

The Concept & Rules of

Mudarabah (Contd)
debt owed by the Mudarib or another party to the capital
provider as capital in a Mudarabah contract. This is
because the capital to be given for Mudarabah business
should be free from all liabilities. The conversion of debt
into a Mudarabah is prohibited to safeguard against the
abuse of usurious loan being camouflaged as a
Mudarabah, where, in essence, the financier would
possibly ensure for himself not only the recovery of his
debt but also an illegal return on his loan under the cover
of his share in Mudarabah profits. A financier cannot give
the Mudarib two different amounts of capital with the
stipulation that profit earned from one should go to him
and from the other to the Mudarib. Similarly, he cannot
specify different periods to state that profit earned in a
specific period will be his and that of another period, the
Mudaribs. It is also not allowed to stipulate that profit
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SHIRKAHshould go to the financier
from a particular transaction

The Concept & Rules of

Mudarabah (Contd)
Mixing of Capital by the Mudarib:

A Mudarib is normally responsible for the management

only and all the investment comes from the financier.
But there may be situations where the Mudarib also
wants to invest some of his money into the business of
Mudarabah. In such cases, Musharakah and Mudarabah
are combined. Jurists allow the Mudarib to add his own
capital to the capital of Mudarabah with the permission
of the Rabbul-mal. If a Mudarib subscribes his portion
of profit or a portion of capital in the Mudarabah
business, he will become a partner to the extent of his
subscription, in addition to his remaining a worker. His
rights and liabilities will be governed by Musharakah
rules so long as his capital remains part of the business
to the extent of his share of subscription. For example,
A gives $100 000 to a Mudarib B, who also invests his
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SHIRKAH
own funds amounting to $50 000. This is the situation

The Concept & Rules of

Mudarabah (Contd)
percentage for his work as a Mudarib.

another
In the
above example, he has invested one-third of the capital.
Therefore, according to normal business practice, he will
get one-third of the actual profit on account of his
investment, while the remaining two-thirds will be
distributed between them equally. However, they may
agree on another ratio for distribution.
Islamic banks normally mobilize deposits on Mudarabah
principles and invest them in the business. If a bank also
provides funds, it is entitled to get a profit on its own
capital in proportion to the total capital of the Mudarabah.
In addition to such a share in the profit, the bank shall also
be entitled to share the remaining profit as Mudarib in an
agreed proportion. For example, depositors provide $2000
for Mudarabah and the bank contributes $1000 to the
business, and it was agreed to share the profit in the ratio
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SHIRKAH
50:50. Let us assume that the profit earned by the bank as

The Concept & Rules of

Mudarabah (Contd)
investment of $1000. The remaining profit of $200 will be
distributed between the bank and the depositors on the
agreed ratio of 50:50. In other words, out of the profit of
$200, the bank will get $100 and the depositors $100.
2.
Types of Mudarabah and Conditions Regarding
Business:
Mudarabah business can be of two types: restricted and
unrestricted Mudarabah. If the finance provider specifies
any particular business, the Mudarib shall undertake
business in that particular business only for items and
conditions and the time set by the Rabbul-mal. This is
restricted Mudarabah. But if the Rabbul-mal has left it
open for the Mudarib to undertake any business he
wishes, the Mudarib shall be authorized to invest the funds
in any business he deems fit. This is called un-restricted
Mudarabah. In both cases,
the actions of the Mudarib
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SHIRKAH
should be in accordance with the business customs

The Concept & Rules of

Mudarabah (Contd)
Accordingly, a Mudarabah contract can be conditional

or
unconditional. The conditions may pertain to the nature of
the work, the place of work and/or the period of the work.
Conditions binding the worker to trade with a particular
person or in a particular commodity, etc. are, according to
Hanafi and Hanbali jurists, permissible, but these make
the contract a special Mudarabah.
It is not legally necessary that the financier directly makes
a contract with the Mudarib. Thus, a banker may act as an
agent to an investor and become a middle man doing
business on the basis of investment agency (Wakalatul
Istismar).
The financier has a right to impose conditions on a
Mudarib, provided they are not prejudicial to the interests
of the business and are not counterproductive to the
purpose of the Mudarabah.SHIRKAH
For example:
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3.

The Concept & Rules of

Mudarabah (Contd)
He may stop the worker from dealing with a particular

person or a company.
4. He may stop the worker from travelling to a particular
place or may also specify the place where trade is to
be carried out.
5. He may ask the worker to make sure to fulfil his
fiduciary responsibilities (but not profitability).
6. According to some jurists, he may also compel his
worker to sell the goods if the bargain is profitable
(while the worker wants to hold then).
7. He also has a right to stop the worker from contracting
a Mudarabah with any other party.
The Mudarib, on his part, is bound to follow the financiers
conditions. If he violates a restriction or contravenes a
beneficial condition, he becomes a usurper and will be
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responsible in respect SHIRKAH
of capital to the capital owner.

The Concept & Rules of

Mudarabah (Contd)
the general market price or buy goods for Mudarabah at a
price higher than the common market price. He is also not
allowed to donate Mudarabah funds or waive receivables
of the business without explicit permission from the
financier.
3.
Work for the Mudarabah Business:
According to the majority of the traditional jurists, a
financier in Mudarabah is not allowed to work for the joint
business. He is not permitted to stipulate that he has a
right to work with a Mudarib and to be involved in selling
and buying activities, or supplying and ordering. However,
he has the right to oversee and ensure that the Mudarib is
doing his fiduciary duties honestly and efficiently.
It is only according to Hanbali jurists and, to some extent,
Hanafi jurists that the owner is allowed to work for the
business with the Mudarib.SHIRKAH
The reason for disapproval by
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The Concept & Rules of

Mudarabah (Contd)
position is understandable if the basic idea that a person
enters into a Mudarabah contract because he lacks
business skill is presumed to exist. But if the financier also
has skill and has contracted Mudarabah simply because he
cannot do the entire work single-handedly, the rationale
behind prohibiting him to work is not understandable.
Moreover, it now seems more reasonable to allow the
owner to ensure honesty and efficiency of the worker by
taking a personal interest in the affairs of the business.
Even some Hanafi jurists have allowed the financiers sale
of Mudarabah goods if it is profitable.
In present circumstances, it can be left to the parties, who
may agree on any role by the investor keeping in mind its
impact on profitability of the joint business. After transfer
of the capital by the financier, the Mudarib needs to be
given independence for the normal conduct of business.
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SHIRKAH
However, the financier can impose restrictions on the

The Concept & Rules of

Mudarabah (Contd)
Mudarib may trade within a certain marketing zone.
4.
Treatment of Profit/Loss:
Both parties in Mudarabah are at liberty to agree on the
proportion or ratio of profit-sharing between them with
mutual consent. This ratio has to be decided at the time
the contract is concluded. They can agree on equal
sharing or allocate different proportions. A lump sum
amount as a profit/return on investment for any of the
parties cannot be allowed or agreed upon.
In other words, they can agree on, for example, 50, 40 or
60% of the profit going to the Rabbul-mal and the
remaining 50, 60 or 40 %, respectively, going to the
Mudarib. Different proportions can be agreed upon for
different situations.
SHIRKAH

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The Concept & Rules of

Mudarabah (Contd)
the capital of Mudarabah is maintained intact.
The distribution of profit depends on the final result of the
operations at the time of physical or constructive
liquidation of the Mudarabah. Reserves can be created
with mutual consent and if a Mudarabah incurs a loss, the
loss can be compensated by the profit of the future
operation of the joint business or the reserves created in
the past.
At the time of profit allocation, one partner can donate a
part of his profit to the other partner(s).
A financier can also award a good management bonus to a
Mudarib. If losses are greater than profits at the time of
liquidation, the balance (net loss) has to be deducted from
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SHIRKAH
the capital.

The Concept & Rules of

Mudarabah (Contd)
The Mudarib is entitled to a share of profit as soon as it is
clear that the operations of the Mudarabah have led to the
realization of a profit. However, this entitlement is not
absolute, as it is subject to the retention of interim profits
for the protection of the capital.
For valuation, receivables should be measured at the cash
equivalent, or net realizable, value, i.e. after the deduction
of a provision for doubtful debts. In measuring receivables,
neither time value nor discount on current value for an
extension of the period of payment shall be taken into
consideration.
Parties can change the ratio for profit distribution at any
time, but that ratio will remain effective for the period for
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which it has been mutuallySHIRKAH
fixed.

The Concept & Rules of

Mudarabah (Contd)
Although one party in Mudarabah cannot stipulate

for
himself a lump sum amount of money, the parties can
agree with mutual consent that if the profit is over a
particular ceiling, one of the parties can take the greater
share of the profit and if the profit is below or equal to the
stipulated ceiling, the distribution will be according to the
agreed ratio. The profits realized from Mudarabah cannot
be finally distributed until all expenses have been paid, in
accordance with custom and the original agreement. Final
accounting will be undertaken against the net profits of
the Mudarabah operations. The part of profit of the
Mudarib becomes secure after the liquidation of the
Mudarabah and the capital owner recovers its capital and
part of profit.
The Mudarib cannot claim any periodical salary or a fee or
remuneration for the work done by him for the Mudarabah
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SHIRKAH
business over and above his share as agreed in the

The Concept & Rules of

Mudarabah (Contd)
principle, in Mudarabah it is only the financier

As a
bears the loss.

who

However, if a Mudarib has also contributed capital, which

he can do with mutual consent, he will bear the pro rata
loss. If profit has been distributed upon constructive or
actual liquidation of business, it cannot be withdrawn in
order to make up for a later loss or for any other purpose.
If loss has occurred in some transactions and profit has
been realized in some others, the profit can be used to
offset the loss at the first instance, then the remainder, if
any, shall be distributed between the parties according to
the agreed ratio.
SHIRKAH

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The Concept & Rules of

Mudarabah (Contd)
Termination of a Mudarabah Contract:

5.
The general principle is that Mudarabah is not a binding
contract and each of the parties can terminate it
unilaterally except in two cases:
(i) when the Mudarib has already commenced the
business, in which case the contract becomes binding
up to the date of actual or constructive liquidation; and
(ii) when the parties agree on a certain duration of the
contract, in which case it cannot be terminated before
expiry of that period except with mutual agreement.
For termination, the Mudarib will be given time to sell
the illiquid assets so that an actual amount of profit
may be determined.
The unlimited power to terminate the Mudarabah may
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create difficulties in SHIRKAH
the context of the present

MUDARABAH DISTINGUISHED FROM

MUSHARAKAH

SHIRKAH

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Mudarabah Distinguished from

Musharakah
Mudarabah is distinguished from Musharakah briefly

on

the following grounds:

1.The investment in Musharakah comes from all the
partners, while in Mudarabah, investment comes from a
person or a group of persons, but not from the Mudarib.
2.In Musharakah, all partners have a right to participate in
the management of the business and can work for it, while
in Mudarabah, the Rabbul-mal has no right to participate
in management. With mutual consent, however, he can
work for the venture. Further, the financier has the right to
ensure that the Mudarib is doing his fiduciary duties in the
true sense.
3.In Musharakah, all the partners share the loss according
to the ratio of their investment, while in Mudarabah, the
loss, if any, is suffered by the Rabbul-mal only. However,
if the Mudarib has conducted
business with negligence 26
or
SHIRKAH

4.

Mudarabah Distinguished from

Musharakah
(Contd)
The liability of the partners in Musharakah is normally

unlimited. However, if all the partners have agreed that

no partner shall incur any debt during the course of
business, then the liabilities exceeding assets shall be
borne by that partner alone who has incurred a debt on
the business in violation of the aforesaid condition.
5. Contrary to this, in Mudarabah, the liability of the
Rabbul-mal is limited to his investment unless he has
permitted the Mudarib to incur debts on his behalf.
6. In Musharakah, profit can be distributed on an annual,
quarterly or monthly basis by valuation of the assets. In
the case of Mudarabah, final distribution can take place
only after liquidation of the Mudarabah business.
However, on account payment of profit is possible
subject to ultimate adjustment. To avoid problems in
perpetual Mudarabah, SHIRKAH
the contemporary jurists have
27
accepted the concept of constructive liquidation of

6.

Mudarabah Distinguished from

Musharakah
(Contd)
In Musharakah, all assets of the Musharakah become

jointly owned by all of the partners according to the

proportion of their respective investment. Therefore,
each one of them can benefit from the appreciation in
the value of the assets, even if profit has not accrued
through sales. In Mudarabah, however, all the
goods/assets purchased by the Mudarib are solely
owned by the Rabbul-mal, and the Mudarib can earn
his share in the profit only if he sells the assets
profitably. However, there are some exceptions to this
rule according to a minority view.
7. If the Mudarabah business is dissolved, its assets and
profit, if any, can be distributed only after assessing its
value in terms of money. In the case of Shirkah, this is
not necessary.
SHIRKAH

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Referring to the following given details:

Contract : Musharakah
Investor A Capital Contribiution: PkR 180 Mn
Investor B Capital Contribution: PkR 20 Mn
Profit Sharing Ratio - A:B = 40:60

Calculate the profit and loss shared by the 2 parties in the following cases:

Profit of PkR 20 Mn
Profit of PkR 50 Mn
Loss of PkR 100 Mn
Loss of PkR 50 Mn

Contract : Mudaraba
Investor Capital Contribiution (A) : PkR 200 Mn
Mudarib or Entrepreneur (B) Contributes Labor
Profit Sharing Ratio - A:B = 60:40
Calculate the profit and loss shared by the 2 parties in the following cases:
Profit of PkR 20 Mn
Profit of PkR 50 Mn
Loss of PkR 100 Mn
Loss of PkR 50 Mn

SHIRKAH

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