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 Course Outline

‡ Understanding Investments, Financial Assets, Real Assets, Marketable Securities

‡ Introduction to risk & return & risky and risk free investments.
‡ Indirect Investments & direct Investments and marketable securities,
‡ Capital money & market securities,
‡ Investment companies, internal funds, primary & secondary market, third & fourth
market
‡ Stock market indicators, Margin computation at brokerage houses & short selling
‡ The rise & return computation for securities
‡ Calculation for portfolio investment return with portfolio risk, Capital Assets pricing
model valuation of fixed income securities valuation of common stocks
‡ Option and futures
‡ Shari ah Compliant investment opportunities limited liability concepts in Shari ah
‡ Screening criteria for investing in listed companies, Investment in Shares
‡ Securitization principles
‡ Islamic investments funds principles Ijarah fund commodity fund Murabaha fund
‡ Concepts of bai-ud-dain & mined fund
‡ Sukuk as alternatives for conventional bonds. Different Structures of Sukuk,
‡ Term Deposits with Islamic Financial institutions.

12/4/2010 2
 ð

       

      
  
    
      

‡ |
  is the commitment of money or capital funds for the specific period of time to purchase financial
instruments or other assets in order to gain profitable returns in the form of rent (for the use of the capital good or
instrument), income {dividend (profit earned from the use of capital instrument or good)}, or appreciation of the
value of the instrument (expected inflation). Investment is related to saving or deferring consumption. The basic
meaning of the term being an asset held to have some recurring or capital gains. It is an asset that is expected to
give returns without any work on the asset per se. The term "investment" is used differently in economics and in
finance. Economists refer to a real investment (such as a machine or a house), while financial economists refer to
a financial asset, such as money that is put into a bank or the market, which may then be used to buy a real asset.
‡ |
  
   : investment is the amount purchased per unit time of goods which are not
consumed but are to be used for future production. Examples include machinery or factory construction.
Investment in human capital includes costs of additional schooling or on-the-job training.
‡ Investments are strictly knotted with the risk of the loss of the principal sum. The investment that has not been
thoroughly analyzed can be highly risky with respect to the investment owner because the possibility of losing
money is not within the owner's control. The difference between speculation and investment can be subtle. It
depends on the investment owner's mind whether the purpose is for lending the resource to someone else for
economic purpose or not.
‡ |
    : investment is the commitment of funds by buying securities or other monetary or paper
(financial) assets in the money markets or capital markets, or in fairly liquid real assets, such as gold or collectibles.
Valuation is the method for assessing whether a potential investment is worth its price. Returns on investments will
follow the risk-return spectrum.
‡  |
 : Investment is involved in many areas of the economy, such as business management and
finance no matter for households, firms, or governments. An investment involves the choice by an individual or an
organization such as a pension fund, after some analysis or thought, to place or lend money in a vehicle,
instrument or asset, such as property, commodity, stock, bond, financial derivatives, or the foreign asset
denominated in foreign currency, that has certain level of risk and provides the possibility of generating returns
over a period of time.

12/4/2010 3
 In the case of investment, rather than store the good produced or its money equivalent, the investor chooses to use that good either
to create a durable consumer or producer good, or to lend the original saved good to another in exchange for either interest or a
share of the profits. In the first case, the individual creates durable consumer goods, hoping the services from the good will make
his life better. This type of investment is called sole enterprise.
In the second, the individual becomes an entrepreneur using the resource to produce goods and services for others in the hope of a
profitable sale.
The third case describes a lender where an investor purchase a machine or tool for producing the other goods and lend it to the
other on a specific rent according to the time period. The investor bears the wear and tear and maintenance costs.
The fourth describes an investor in a share of the business. In each case, the consumer obtains a durable asset or investment, and
accounts for that asset by recording an equivalent liability. As time passes, and both prices and interest rates change, the value of
the asset and liability also change.

‡ |
 
Inventory investment refers to the accumulation of goods inventories; it can be positive or negative, and it
can be intended or unintended. In measures of national income and output, 

  (represented by the variable I) is
also a component of Gross domestic product (GDP), given in the formula GDP = C + I + G + Xp, where C is consumption, G is
government spending, and Xp is net exports. Thus investment is everything that remains of total expenditure after consumption,
government spending, and net exports are subtracted (i.e. I = GDP - C - G - Xp).
Non-residential fixed investment (such as new factories) and residential investment (new houses) combine with inventory
investment to make up I. 
  deducts depreciation from gross investment. Net fixed investment is the value of the net
increase in the capital stock per year.
Fixed investment, as expenditure over a period of time (per year), is not capital. The time dimension of investment makes it a flow.
By contrast, capital is a stock² that is, accumulated net investment to a point in time.

‡ |
   : is often modeled as a function of Income (Y) and Interest rates (r, sometimes denoted by i also), given by
the relation I = f(Y, r). An increase in income encourages higher investment, whereas a higher interest rate may discourage
investment as it becomes more costly to borrow money. Even if a firm chooses to use its own funds in an investment, the interest
rate represents an opportunity cost of investing those funds rather than lending out that amount of money for interest.
Investment related to business of a firm - business management

‡ |
   (also known as capital budgeting): is one of the fundamental decisions of business management: Managers
determine the investment value of the assets that a business enterprise has within its control or possession. These assets may be
physical (such as buildings or machinery), intangible (such as patents, software, goodwill), or financial. Assets are used to
produce streams of revenue that often are associated with particular costs or outflows. All together, the manager must determine
whether the net present value of the investment to the enterprise is positive using the marginal cost of capital that is associated
with the particular area of business.

12/4/2010 4
 In terms of financial assets, these are often marketable securities such as a company stock, an equity investment
or bonds. At times the goal of the investment is for producing future cash flows, while at others it may be for
purposes of gaining access to more assets by establishing control or influence over the operation of a second
company the investee.
Types of financial investments include shares, other equity investment, and bonds (including bonds
denominated in foreign currencies). These financial assets are then expected to provide income or positive
future cash flows, and may increase or decrease in value giving the investor capital gains or losses.
Trades in contingent claims or derivative securities do not necessarily have future positive expected cash flows,
and so are not considered assets, or strictly speaking, securities or investments. Nevertheless, since their cash
flows are closely related to (or derived from) those of specific securities, they are often studied as or treated as
investments
‡ K
|
  
 : Investments are often made indirectly through intermediaries,
such as banks, mutual funds, pension funds, insurance companies, collective investment schemes, and
investment clubs. Though their legal and procedural details differ, an intermediary generally makes an
investment using money from many individuals, each of whom receives a claim on the intermediary.
Within personal finance, money used to purchase shares, put in a collective investment scheme or used to buy
any asset where there is an element of capital risk is deemed an investment. Saving within personal finance
refers to money put aside, normally on a regular basis. This distinction is important, as investment risk can
cause a capital loss when an investment is sold, unlike saving(s) where the more limited risk is cash devaluing
due to inflation.
‡ K
|
  
 K

‡ 
K
Usually for less than one year period of time.
‡  

 Often referred to simply as "investments". Long-term investments are to be held for
many years and are not intended to be disposed of in the near future. This group usually consists of four types
of investments:
1 Investments in securities such as bonds, common stock, or long-term notes.
2 Investments in fixed assets not used in operations (e.g., land held for sale).
3 Investments in special funds (e.g. sinking funds or pension funds).
Different forms of insurance may also be treated as long term investments.
‡ 
  
  |
 : In many instances the terms saving and investment are used
interchangeably, which confuses this distinction. For example many deposit accounts are labeled as investment
accounts by banks for marketing purposes. Whether an asset is a saving(s) or an investment depends on where
the money is invested: if it is cash then it is savings, if its value can fluctuate then it is investment.

12/4/2010 5
‡ ° 
 
 : In real estate, investment money is used to purchase property for the purpose of
holding or leasing for income and there is an element of capital risk.
‡ ° 
 The most common form of real estate investment as it includes property purchased as a primary residence.
In many cases the buyer does not have the full purchase price for a property and must engage a lender such as a bank, finance
company or private lender. Different countries have their individual normal lending levels, but usually they will fall into the range of 70-
90% of the purchase price. Against other types of real estate, residential real estate is the least risky.
‡ 

: consists of multifamily apartments, office buildings, retail space, hotels and motels, warehouses, and other
commercial properties. Due to the higher risk of commercial real estate, loan-to-value ratios allowed by banks and other lenders are
lower and often fall in the range of 50-70%.
‡  K
‡ In financial accounting,  are economic resources. Anything tangible or intangible that is capable of being owned or controlled
to produce value and that is held to have positive economic value is considered an asset. Simply stated, assets represent ownership
of value that can be converted into cash (although cash itself is also considered an asset). The balance sheet of a firm records the
monetary value of the assets owned by the firm. It is money and other valuables belonging to an individual or business.[1] Two major
asset classes are tangible assets and intangible assets. Tangible assets contain various subclasses, including current assets and
fixed assets. Current assets include inventory, while fixed assets include such items as buildings and equipment.[4] Intangible assets
are nonphysical resources and rights that have a value to the firm because they give the firm some kind of advantage in the market
place. Examples of intangible assets are goodwill, copyrights, trademarks, patents and computer programs,[4] and financial assets,
including such items as accounts receivable, bonds and stocks.
‡  
 
 
‡ The probable present benefit involves a capacity, singly or in combination with other assets, in the case of profit oriented enterprises,
to contribute directly or indirectly to future net cash flows, and, in the case of not-for-profit organizations, to provide services;
‡ The entity can control access to the benefit;
‡ The transaction or event giving rise to the entity's right to, or control of, the benefit has already occurred.
‡ In the financial accounting sense of the term, it is not necessary to be able to legally enforce the asset's benefit for qualifying a
resource as being an asset, provided the entity can control its use by other means.
‡ It is important to understand that in an accounting sense an asset is not the same as ownership. Assets are equal to "equity" plus
"liabilities."
‡ The accounting equation relates assets, liabilities, and owner's equity:
‡ Assets = Liabilities +Stockholder's Equity (Owners' Equity)
‡ The accounting equation is the mathematical structure of the balance sheet.
‡ Assets are listed on the balance sheet. Similarly, in economics an asset is any form in which wealth can be held.

12/4/2010 6
‡ K

‡ !: also referred to as PPE (property, plant, and equipment), these are purchased for continued and
long-term use in earning profit in a business. This group includes as an asset land, buildings, machinery,
furniture, tools, and certain wasting resources e.g., timberland and minerals. They are written off against profits
over their anticipated life by charging depreciation expenses (with exception of land assets). Accumulated
depreciation is shown in the face of the balance sheet or in the notes. These are also called capital assets in
management accounting
‡ |  Intangible assets lack physical substance and usually are very hard to evaluate. They
include patents, copyrights, franchises, goodwill, trademarks, trade names, etc. These assets are usually
amortized to expense over 5 to 40 years with the exception of goodwill.
‡ Websites are treated differently in different countries and may fall under either tangible or intangible assets.
‡ K Tangible assets are those that have a physical substance and can be touched, such as
currencies, buildings, real estate, vehicles, inventories, equipment, and precious metals.
‡ 

 are cash and other assets expected to be converted to cash, sold, or consumed either in a year
or in the operating cycle (whichever is longer), without disturbing the normal operations of a business. These
assets are continually turned over in the course of a business during normal business activity. There are 5 major
items included into current assets:
‡   "
  ² it is the most liquid asset, which includes currency, deposit accounts, and
negotiable instruments (e.g., money orders, cheques, bank drafts).
‡ 


  ² include securities bought and held for sale in the near future to generate income on
short-term price differences (trading securities).
‡ ° 
 ² usually reported as net of allowance for uncollectable accounts.
‡ |
 
² trading these assets is a normal business of a company. The inventory value reported on the
balance sheet is usually the historical cost or fair market value, whichever is lower. This is known as the "lower
of cost or market" rule.
‡ 

!
  ² these are expenses paid in cash and recorded as assets before they are used or
consumed (a common example is insurance). See also adjusting entries.
‡ The phrase net current assets (also called working capital) is often used and refers to the total of current assets
less the total of current liabilities.
‡ #
 °°
 |
 $% 
°
&% 
'& 

 & ()
‡ As we have learned that an Investment is the reward of deferring our present (current) consumptions with future
in order to add to our wealth so that we can consume more in future.

12/4/2010 7
 Therefore we are talking about a return resulting from our investments or Change in Wealth resulting from our investments. This
change in the wealth can be either due to Cash Inflow such as rent or dividends, or caused by the Change in the price of the Asset
(Appreciation of the value of Asset).
In computation, if you commit Rs. 2000 to an investment at the beginning of the year and get back Rs. 2200 at the end of the year,
what is your return for the period? The period during which you own an investment is called the Holding Period (HP), and the return
for that period is Holding Period Return (HPR).
HPR= Ending value of Investment/ Beginning Value of Investment
HPR= 2200/2000 =1.10 (the value of HPR will always be Zero or greater----It can never be a negative value)
Holding Period Yield =HPR-1 {in our example, 1.10-1= 0.10 or 10%}
‡ °*: Risk can be defined as uncertainty concerning the occurrence of loss.
‡ °*+  can be defined as the possibility that an event will occur.
‡ ,- 
°*can be defined as the relative variation between expected loss and actual loss.
‡ - 
°* is defined as uncertainty based on a person¶s mental condition or state of mind.
‡ 
 %.

‡ Peril is the cause (reason) of loss and Hazard is a condition that creates or increase the chance of loss.
‡   %.
 is a physical condition that increase the chance of Loss and
‡ #
%.
 is dishonesty or character defects in an individual that increase the frequency or severity of loss.
‡ 
°*
‡ 
 
 
°*Pure risk is a situation in which there are only the possibilities of loss or no loss at all. While
Speculative Risk is defined as situation in which either profit or loss is possible.
‡    
 
°* Fundamental Risk is a risk that affects the entire economy or large numbers of persons or
group within the economy. And the particular risk is a risk that affects only individuals, not the entire community.
‡ K

°*
‡ 
 °* are risks that directly affect an individual; risk of premature death, risk of insufficient income during retirement, risk
of poor health, risk of unemployment
‡ 


 °* are related to the property owned by the individuals such as damage, unexpected wear and tear, lost or fire. 
 
 financial loss that results from the physical damage, destruction or theft of property.
‡  °*an individual can be liable (legally) to do something that result in bodily injury or property damage to someone else.
‡ 
 
 
*
‡ There is no maximum upper limit with respect to amount of loss (claim).
‡ A lien can be placed on your income and financial assets to satisfy a legal judgment.
‡ Legal defense costs can be enormous.
‡  
$ 
)
‡ Commercial enterprises have traditionally used securities as a means of raising new capital. Securities may be an attractive option
relative to bank loans depending on their pricing and market demand for particular characteristics. Another disadvantage of bank
loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive
financial covenants. Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a
similar way, the governments may raise capital through the issuance of securities.
12/4/2010 8
‡ °
 * 
In recent decades, securities have been issued to repackage existing assets. In a traditional securitization, a financial institution may
wish to remove assets from its balance sheet to achieve regulatory capital efficiencies or to accelerate its receipt of cash flow from
the original assets. Alternatively, an intermediary may wish to make a profit by acquiring financial assets and repackaging them in a
way more attractive to investors. In other words, a basket of assets is typically contributed or placed into a separate legal entity such
as a trust or SPV, which subsequently issues shares of equity interest to investors. This allows the sponsor entity to more easily raise
capital for these assets as opposed to finding buyers to purchase directly such assets.
‡  


Investors in securities may be retail, i.e. members of the public investing other than by way of business. The greatest part in terms of
volume of investment is wholesale, i.e. by financial institutions acting on their own account, or on behalf of clients. Important
institutional investors include investment banks, insurance companies, pension funds and other managed funds.
‡ |
 
The traditional economic function of the purchase of securities is investment, with the view to receiving income and/or achieving
capital gain. Debt securities generally offer a higher rate of interest than bank deposits, and equities may offer the prospect of capital
growth. Equity investment may also offer control of the business of the issuer. Debt holdings may also offer some measure of control
to the investor if the company is a fledgling start-up or an old giant undergoing 'restructuring'. In these cases, if interest payments are
missed, the creditors may take control of the company and liquidate it to recover some of their investment.
‡ 

‡ The last decade has seen an enormous growth in the use of securities as collateral. Purchasing securities with borrowed money
secured by other securities or cash itself is called "buying on margin". Where A is owed a debt or other obligation by B, A may require
B to deliver property rights in securities to A, either at inception (transfer of title) or only in default (non-transfer-of-title institutional).
For institutional loans property rights are not transferred but nevertheless enable A to satisfy its claims in the event that B fails to
make good on its obligations to A or otherwise becomes insolvent. Collateral arrangements are divided into two broad categories,
namely security interests and outright collateral transfers. Commonly, commercial banks, investment banks, government agencies
and other institutional investors such as mutual funds are significant collateral takers as well as providers. In addition, private parties
may utilize stocks or other securities as collateral for portfolio loans in securities lending scenarios.
On the consumer level, loans against securities have grown into three distinct groups over the last decade: /) Standard Institutional
Loans, generally offering low loan-to-value with very strict call and coverage regimens; 0) Transfer-of-Title (ToT) Loans, typically
provided by private parties where borrower ownership is completely extinguished save for the rights provided in the loan contract; and
1) Enhanced Institutional Loan Facilities - a marriage of public and private entities in the form of fully regulated, institutionally
managed brokerage financing supplemented ("enhanced") by private capital where the securities remain in the client's title and
account unless there is an event of default. Of the three, transfer-of-title loans typically allow the lender to sell or sell short at least
some portion of the shares (if not all) to fund the transaction, and many operate outside the regulated financial universe as a private
loan program. Institutionally managed loans, on the other hand, draw loan funds from credit lines or other institutional funding sources
and do not involve any loss of borrower ownership or control thereby making them more transparent.

12/4/2010 9
‡  

A  
 is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt securities
(such as banknotes, bonds and debentures) and equity securities, e.g., common stocks; and derivative contracts, such as forwards,
futures, options and swaps. The company or other entity issuing the security is called the issuer. A country's regulatory structure
determines what qualifies as a security. For example, private investment pools may have some features of securities, but they may
not be registered or regulated as such if they meet various restrictions.
Securities may be represented by a certificate or, more typically, "non-certificated", that is in electronic or "book entry" only form.
Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered,
meaning they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary.
They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or
other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible
      

The terms "fungible" and "non-fungible" relate to the way in which securities are held.
If an asset is fungible, this means that if such an asset is lent, or placed with a custodian, it is customary for the borrower or custodian
to be obliged at the end of the loan or custody arrangement to return assets equivalent to the original asset, rather than the specific
identical asset. In other words, the redelivery of fungibles is equivalent and not in specie [disambiguation needed]. In other words, if
an owner of 100 shares of IBM transfers custody of those shares to another party to hold for a purpose, at the end of the arrangement,
the holder need simply provide the owner with 100 shares of IBM identical to those received. Cash is also an example of a fungible
asset. The exact currency notes received need not be segregated and returned to the owner.
Undivided securities are always fungible by logical necessity. Divided securities may or may not be fungible, depending on market
practice. The clear trend is towards fungible arrangements.
Regulation
In the United States, the public offer and sale of securities must be either registered pursuant to a registration statement that is filed
with the U.S. Securities and Exchange Commission (SEC) or are offered and sold pursuant to an exemption therefrom. Dealing in
securities is lightly regulated by both federal authorities (SEC) and state securities departments. In addition, the brokerage industry is
supposedly self policed by Self Regulatory Organizations (SROs), such as FINRA (the Financial Industry Regulatory Authority),
formerly the National Association of Securities Dealers (or NASD) or the MSRB.
Due to the difficulty of creating a general definition that covers all securities, Congress attempts to define "securities" exhaustively
(and not very precisely) as: "any note, stock, treasury stock, security future, bond, debenture, certificate of interest or participation in
any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization
certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put,
call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or
based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to
foreign currency, or in general, any instrument commonly known as a 'security'; or any certificate of interest or participation in,
temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not
include currency or any note, draft, bill of exchange, or bankers' acceptance that has a maturity at the time of issuance that does not
exceed nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." - Section 3a item 10
of the Securities Act of 1934.
With respect to investment schemes that do not fall within the traditional categories of securities listed in the definition of a security
(Sec. 2(a)(1) of the 33 act and Sec. 3(a)(10) of the 34 act) the US Courts have developed a broad definition for securities that must
then be registered with the SEC. When determining if there is an "investment contract" that must be registered the courts look for an
investment of money, a common enterprise and expectation of profits to come primarily from the efforts of others.
12/4/2010 10
‡    
: may be classified according to many categories or classification systems:
Currency of denomination
Ownership right
Term to maturity
Degree of liquidity
Income payments
Tax treatment
Credit rating
Industrial sector or "industry". ("Sector" often refers to a higher level or broader category, such as Consumer Discretionary, whereas
"industry" often refers to a lower level classification, such as Consumer Appliances. See Industry for a discussion of some
classification systems.)
Region or country (such as country of incorporation, country of principal sales/market of its products or services, or country in which
the principal securities exchange where it trades is located)
Market capitalization
State (typically for municipal or "tax-free" bonds in the U.S.)
‡   "
Securities are traditionally divided into debt securities and equities (see also derivatives). : securities may be called debentures,
bonds, deposits, notes or commercial paper depending on their maturity and certain other characteristics. The holder of a debt security
is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as
the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of
that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually
"senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is
"subordinated".
‡ 


  represent the debt of commercial or industrial entities. Debentures have a long maturity, typically at least ten years,
whereas notes have a shorter maturity. Commercial paper is a simple form of debt security that essentially represents a post-dated
check with a maturity of not more than 270 days.
‡ #  
* 
  are short term debt instruments that may have characteristics of deposit accounts, such as certificates of
deposit, and certain bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Commercial paper is also
often highly liquid
‡ | 
  
 are securities issued internationally outside their domestic market in a denomination different from that
of the issuer's domicile. They include eurobonds and euronotes. Eurobonds are characteristically underwritten, and not secured, and
interest is paid gross. A euronote may take the form of euro-commercial paper (ECP) or euro-certificates of deposit.
‡ 2

   are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry
a lower rate of interest than corporate bonds, and serve as a source of finance for governments. U.S. federal government bonds are
called treasuries. Because of their liquidity and perceived low risk, treasuries are used to manage the money supply in the open
market operations of non-US central banks.
‡ 

 

  , also known as municipal bonds, represent the debt of state, provincial, territorial, municipal or
other governmental units other than sovereign governments.
‡ 

    represent the debt of international organizations such as the World Bank, the International Monetary Fund,
regional multilateral development banks and others.

12/4/2010 11
‡ " An equity security is a share of equity interest in an entity such as the capital stock of a company, trust or partnership. The
most common form of equity interest is common stock, although preferred equity is also a form of capital stock. The holder of equity is
a shareholder, owning a share, or fractional part of the issuer. Unlike debt securities, which typically require regular payments
(interest) to the holder, equity securities are not entitled to any payment. In bankruptcy, they share only in the residual interest of the
issuer after all obligations have been paid out to creditors. However, equity generally entitles the holder to a pro rata portion of control
of the company, meaning that a holder of a majority of the equity is usually entitled to control the issuer. Equity also enjoys the right to
profits and capital gain, whereas holders of debt securities receive only interest and repayment of principal regardless of how well the
issuer performs financially. Furthermore, debt securities do not have voting rights outside of bankruptcy. In other words, equity
holders are entitled to the "upside" of the business and to control the business.
‡ % 
 
 combine some of the characteristics of both debt and equity securities.
‡ 

 
 form an intermediate class of security between equities and debt. If the issuer is liquidated, they carry the right to
receive interest and/or a return of capital in priority to ordinary shareholders. However, from a legal perspective, they are capital stock
and therefore may entitle holders to some degree of control depending on whether they contain voting rights.
‡ 

 are bonds or preferred stock that can be converted, at the election of the holder of the convertibles, into the common
stock of the issuing company. The convertibility, however, may be forced if the convertible is a callable bond, and the issuer calls the
bond. The bondholder has about 1 month to convert it, or the company will call the bond by giving the holder the call price, which may
be less than the value of the converted stock. This is referred to as a forced conversion.
‡ " 

  are options issued by the company that allow the holder of the warrant to purchase a specific number of shares at a
specified price within a specified time. They are often issued together with bonds or existing equities, and are, sometimes, detachable
from them and separately tradable. When the holder of the warrant exercises it, he pays the money directly to the company, and the
company issues new shares to the holder.
‡ Warrants, like other convertible securities, increases the number of shares outstanding, and are always accounted for in financial
reports as fully diluted earnings per share, which assumes that all warrants and convertibles will be exercised.
‡ K 
#
*
‡ 

   

*
‡ In the U.S., the public securities markets can be divided into primary and secondary markets. The distinguishing difference between
the two markets is that in the primary market, the money for the securities is received by the issuer of those securities from investors,
typically in an initial public offering transaction, whereas in the secondary market, the securities are simply assets held by one
investor selling them to another investor (money goes from one investor to the other). An initial public offering is when a company
issues public stock newly to investors, called an "IPO" for short. A company can later issue more new shares, or issue shares that
have been previously registered in a shelf registration. These later new issues are also sold in the primary market, but they are not
considered to be an IPO but are often called a "secondary offering". Issuers usually retain investment banks to assist them in
administering the IPO, obtaining SEC (or other regulatory body) approval of the offering filing, and selling the new issue. When the
investment bank buys the entire new issue from the issuer at a discount to resell it at a markup, it is called a firm commitment
underwriting. However, if the investment bank considers the risk too great for an underwriting, it may only assent to a best effort
agreement, where the investment bank will simply do its best to sell the new issue.
‡ For the primary market to thrive there must be a secondary market, or aftermarket that provides liquidity for the investment security²
where holders of securities can sell them to other investors for cash. Otherwise, few people would purchase primary issues, and, thus,
companies and governments would be restricted in raising equity capital (money) for their operations. Organized exchanges
constitute the main secondary markets. Many smaller issues and most debt securities trade in the decentralized, dealer-based over-
the-counter markets.

12/4/2010 12
12/4/2010 13
‡  ,
 

  
‡ In the primary markets, securities may be offered to the public in a public offer. Alternatively, they may be offered privately to a limited
number of qualified persons in a private placement. Sometimes a combination of the two is used. The distinction between the two is
important to securities regulation and company law. Privately placed securities are not publicly tradable and may only be bought and sold
by sophisticated qualified investors. As a result, the secondary market is not nearly as liquid as it is for public (registered) securities.
‡ Another category, sovereign bonds, is generally sold by auction to a specialized class of dealers.
‡   ,K 
‡ Securities are often listed in a stock exchange, an organized and officially recognized market on which securities can be bought and sold.
Issuers may seek listings for their securities to attract investors, by ensuring there is a liquid and regulated market that investors can buy
and sell securities in.
‡ Growth in informal electronic trading systems has challenged the traditional business of stock exchanges. Large volumes of securities are
also bought and sold "over the counter" (OTC). OTC dealing involves buyers and sellers dealing with each other by telephone or
electronically on the basis of prices that are displayed electronically, usually by commercial information vendors such as Reuters and
Bloomberg.
‡ Certificated securities
‡ Securities that are represented in paper (physical) form are called certificated securities. They may be bearer or registered.
‡ 

 

‡ Bearer securities are completely negotiable and entitle the holder to the rights under the security (e.g. to payment if it is a debt security,
and voting if it is an equity security). They are transferred by delivering the instrument from person to person. In some cases, transfer is
by endorsement, or signing the back of the instrument, and delivery.
‡ Regulatory and fiscal authorities sometimes regard bearer securities negatively, as they may be used to facilitate the evasion of
regulatory restrictions and tax. In the United Kingdom, for example, the issue of bearer securities was heavily restricted firstly by the
Exchange Control Act 1947 until 1953. Bearer securities are very rare in the United States because of the negative tax implications they
may have to the issuer and holder.
‡ °
 

‡ In the case of registered securities, certificates bearing the name of the holder are issued, but these merely represent the securities. A
person does not automatically acquire legal ownership by having possession of the certificate. Instead, the issuer (or its appointed agent)
maintains a register in which details of the holder of the securities are entered and updated as appropriate. A transfer of registered
securities is effected by amending the register.
‡ Non-certificated securities and global certificates
‡ Modern practice has developed to eliminate both the need for certificates and maintenance of a complete security register by the issuer.
There are two general ways this has been accomplished

12/4/2010 14
‡   
  

‡ In some jurisdictions, such as France, it is possible for issuers of that jurisdiction to maintain a legal record of their securities
electronically.
‡ Today, most mutual funds issue only non-certificated shares to shareholders, though some may issue certificates only upon
request and may charge a fee. Shareholders typically don't need certificates except for perhaps pledging such shares as
collateral for a loan.
‡ 2 
 &* 
 
&


‡ To facilitate the electronic transfer of interests in securities without dealing with inconsistent versions of Article 8, a system
has developed whereby issuers deposit a single global certificate representing all the outstanding securities of a class or
series with a universal depository. This depository is called The Depository Trust Company, or DTC. DTC's parent,
Depository Trust & Clearing Corporation (DTCC), is a non-profit cooperative owned by approximately thirty of the largest
Wall Street players that typically act as brokers or dealers in securities. These thirty banks are called the DTC participants.
DTC, through a legal nominee, owns each of the global securities on behalf of all the DTC participants.
‡ All securities traded through DTC are in fact held, in electronic form, on the books of various intermediaries between the
ultimate owner, e.g. a retail investor, and the DTC participants. For example, Mr. Smith may hold 100 shares of Coca Cola,
Inc. in his brokerage account at local broker Jones & Co. brokers. In turn, Jones & Co. may hold 1000 shares of Coca Cola
on behalf of Mr. Smith and nine other customers. These 1000 shares are held by Jones & Co. in an account with Goldman
Sachs, a DTC participant, or in an account at another DTC participant. Goldman Sachs in turn may hold millions of Coca
Cola shares on its books on behalf of hundreds of brokers similar to Jones & Co. Each day, the DTC participants settle their
accounts with the other DTC participants and adjust the number of shares held on their books for the benefit of customers
like Jones & Co.
‡ Ownership of securities in this fashion is called beneficial ownership. Each intermediary holds on behalf of someone beneath
him in the chain. The ultimate owner is called the beneficial owner. This is also referred to as owning in "Street name".
‡ Among brokerages and mutual fund companies, a large amount of mutual fund share transactions take place among
intermediaries as opposed to shares being sold and redeemed directly with the transfer agent of the fund. Most of these
intermediaries such as brokerage firms clear the shares electronically through the National Securities Clearing Corp. or
"NSCC", a subsidiary of DTCC

12/4/2010 15
‡ 
  
 

‡ The terms "divided" and "undivided" relate to the proprietary nature of a security.
‡ Each divided security constitutes a separate asset, which is legally distinct from each other security in the same
issue. Pre-electronic bearer securities were divided. Each instrument constitutes the separate covenant of the
issuer and is a separate debt.
‡ With undivided securities, the entire issue makes up one single asset, with each of the securities being a fractional
part of this undivided whole. Shares in the secondary markets are always undivided. The issuer owes only one set
of obligations to shareholders under its memorandum, articles of association and company law. A share
represents an undivided fractional part of the issuing company. Registered debt securities also have this undivided
nature.
‡ 
3 
 
  
‡ The term "Islamic Investment Fund" means a joint pool wherein the investors contribute their surplus money for
the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shariah. The
subscribers of the Fund may receive a document certifying their subscription and entitling them to the pro-rated
profits actually accrued to the Fund. These documents may be called "certificates" "units" "shares" or may be
given any other name, but their validity in terms of Shariah, will always be subject to two basic conditions:
‡ First, instead of a fixed return tied up with their face value, they must carry a pro-rated profit actually earned by the
Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. The
subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with
the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, the return in their subscription
will increase to that proportion; however, in case the Fund suffers loss, they will have to share it also, unless the
loss is caused by the negligence or mismanagement, in which case the management, and not the Fund, will be
liable to compensate it.
‡ Second, the amounts so pooled together must be invested in a business acceptable to Shariah. It means that not
only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.

12/4/2010 16
‡ 
 

 
 
  
‡ An investment fund can be structured based on the Mudaraba contract under which an investor (rabb al-mal) provides capital to another
person/body (akin to a fund manager - mudarib), who uses their expertise to devise a suitable investment strategy. Any profits generated
by the joint enterprise are divided between the mudarib and the rabb al-mal in accordance with a predetermined formula (management
and performance fees are permitted under the Mudaraba contract). If any financial losses occur, these will be borne by the investor to a
maximum of his capital investment. Conversely, the mudarib's loses are limited to that of his time and efforts if the venture is not profitable.
Certificates evidencing the rabb al-mal's investment, such as shares in the company constituting the investment fund can be issued in
negotiable form akin to conventional fund practices.
‡ Many of the basic collective investment characteristics applying to conventional investment funds also apply to Shariah compliant funds,
including, the technical structure of the fund, the role of the fund's service providers and the appointment of a board of directors or trustee
to take overall responsibility for the fund. The Mudaraba contract provides sufficient flexibility to structure a fund with broad investment
criteria. However, there are certain overreaching principles of Shariah which need to be factored into a fund's investment strategy:
‡ (°
‡ Shariah prohibits usury (Riba), which may be defined as exploitation by the owner of a product which another requires. The payment or
receipt of interest is usury and therefore investments in entities involved in lending (or borrowing) are prohibited. This will preclude
investment in certain key sectors, such as conventional banking, even though the activity of banking is not, in itself, contrary to Shariah.
Debt is frowned upon in the same way as the payment or receipt of interest. As a result highly geared companies will not constitute
acceptable investments. It was once thought that an absolute ban on companies relying on debt finance was a Shariah compliant
investment fund's only way of ensuring compliance with this tenet of Shariah. Clearly, such a hard-line approach dramatically reduces a
fund's investment pool. Shariah has evolved and such a blanket prohibition no longer applies. Modern Islamic jurisprudence accepts a
debt to equity ratio of 1:32.
‡ A fund offering a fixed or guaranteed return on capital will be prohibited. Rather a fund must link profit to actual earnings generated from
the underlying assets. This should be made clear to potential investors at the outset in any marketing material.
‡ Notwithstanding the prohibition against Riba, investment funds can be structured which may make leveraged investments in underlying
assets. Such investments may be made within the confines of Shariah by utilising the diminishing Musharaka contract.
‡ (%

‡ It is well-known that companies involved in certain products and industries will, as a rule, constitute forbidden investments. These are,
principally, alcohol and the gambling industry, as well as entities engaged in illicit, immoral or dubious trade. Companies engaged in these
or related activities (e.g. a restaurant where alcohol is sold and which makes up a large proportion of its revenue) may not form part of a
Shariah compliant fund's investments strategy.
‡ (#

‡ Shariah imposes an absolute prohibition on gambling. This may extend to futures and options in certain circumstances.
‡ However, this area is currently being revisited by Shariah scholars to determine whether the traditional prohibition on futures and options
is still justified.

12/4/2010 17
‡ 
 

32

 | |
  
‡ There are several types of Shariah compliant fund which manage to operate within the confines of Shariah. The most
common forms of Shariah compliant funds and the techniques they utilise in their investment strategy are outlined below.
‡ Equity Fund
‡ Conditions for Investment in Shares
‡ Ijarah Fund
‡ Commodity Fund
‡ Murabahah Fund
‡ Bai'-al-dain
‡ Mixed Fund
‡ "  
‡ In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly achieved through
the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also achieved by the
dividends distributed by the relevant companies. Profits in equity funds are generally derived from capital gains and
dividends paid by investee companies. It is evident that on a strict interpretation of Shariah there are a limited number of
companies in which Shariah compliant fund may legitimately invest. Most companies partake in interest-based debt finance
and invest surplus cash in interest bearing bank accounts and other investments. There are currently two schools of thought
regarding investments made in companies which, although predominantly Shariah compliant, may incidentally breach
Shariah (for example, the prohibition against Riba) from time to time as the company carries on its principal activities. The
traditional school of thought was that every investor in a fund is a partner and impliedly consents to, and is responsible for,
every transaction.
‡ Unless a company was engaged exclusively in halal practices, the concern was that each and every investor could be
implicated by the dealings of the fund manager, whether or not the investors actually consented to these (or were even
aware of them in any detail). The more contemporary school of thought adopts the view that investors are not partners in a
fund but are merely investors. Since no one investor has the power of veto, it would be wrong to ascribe responsibility to an
individual for any particular transaction. This may allow some leeway to invest in entities which have merely incidental non-
halal features, since investors will not be deemed under Shariah necessarily to have authorised the investment.
Nevertheless, there is still a belief among Shariah scholars that investors should raise any concerns they have as to the
running of the fund generally, or over specific transactions, especially if the fund is thought to be staying away from Shariah
principles.

12/4/2010 18
‡ Clearly, this raises a practical issue given that most funds will be involved in many different trades on an ongoing basis and it will be
impracticable for investors to be kept informed of each and every one.
‡ It is widely believed that if a company is engaged predominantly in halal business, but earns interest on account, an equivalent proportion
of any dividend paid to a Shariah compliant fund must be given to charity (purification), be it at the fund or the investor level. Some
scholars believe the same concept of purification also applies to capital gains, to the extent that the market price of the stock incorporates
any discernible element of interest. It is also important that the company invested in owns at least some non-liquid assets, otherwise its
securities will be classified as non-negotiable by Shariah. Opinion is divided as to the appropriate ratio of non-liquid assets to liquid assets.
It appears safe to say, however, that a company with at least 51% of non-liquid assets will be suitable for these purposes.
‡ It is obvious that if the main business of a company is not lawful in terms of Shariah, it is not allowed for an Islamic Fund to purchase, hold
or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business.
‡ Similarly the contemporary Shariah experts are almost unanimous on the point that if all the transactions of a company are not in full
conformity with Shariah which includes that the company borrows money on interest nor keeps its surplus in an interest bearing account,
its shares can be purchased, held and sold without any hindrance from the Shariah side. But evidently, such companies are very rare in
the contemporary stock markets. Almost all the companies quoted in the present stock market or in some way involved in an activity
which violates the injunctions of Shariah.
‡ Even if the main business of a company is halal, its borrowings are based on interest". On the other hand, they keep their surplus money
in an interest bearing account or purchase interest bearing bonds or securities.
‡ The case of such companies has been a matter of debate between the Shariah experts in the present century. A group of the Shariah
experts is of the view that it is not allowed for a Muslim to deal in the shares of such a company, even if its main business is halal. Their
basic argument is that every share-holder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic
jurisprudence, is an agent for the other partners in the matters of the joint business. Therefore, the mere purchase of a share of a
company embodies an authorization from the share-holder to the company to carry on its business in whatever manner the management
deems fit. If it is known to the share-holder that the company is involved in an un-Islamic transaction, still, he holds the shares of that
company, it means that he has authorized the management to proceed with that un-Islamic transaction. In this case, he will not only be
responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the
management of the company is working under his tacit authorization.
‡ Moreover, when a company is financed on the basis of interest, its funds employed in the business are impure. Similarly, when the
company receives interest on its deposits an impure element is necessarily included in its income which will be distributed to the share-
holders through dividends.
‡ However, a large number of the present day scholars do not endorse this view. They argue that a joint stock company is basically
different from a simple partnership period. In partnership, all the policy decisions are taken by the consensus of all the partners, and each
one of them has a veto power with regard to the policy of business. Therefore, all the actions of a partnership are rightfully attributed to
each partner. Conversely, the policy decisions in a joint stock company are taken by the majority. Being composed of a large number of
share-holders, a company cannot give a veto power to each share-holder. The opinions of individual share-holders can be overruled by a
majority decision. Therefore, each and every action taken by the company cannot be attributed to every share-holder in his individual
capacity. If a share-holder raises an objection against a particular transaction in an annual general meeting, but his objection is overruled
by the majority, it will not be fair to conclude that he has given his consent to the transaction in his individual capacity, especially when he
intends to withdraw from the income attributable to that transaction.
‡ Therefore, if a company is engaged in a Halal business, however, it keeps its surplus money in an interest-bearing account, wherefrom a
small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the
shares of such a company with clear intention that he will oppose the incidental transaction also, and will not use that proportion of the
dividend for his own benefit, how can it be said that he has approved the transaction of interest and how can that transaction be attributed
to him?

12/4/2010 19
‡ The other aspect of the dealing of such a company is that it sometimes borrows money from financial institutions which are
mostly based on interest. Here again the same principal is relevant. If a share-holder is not personally agreeable to such
borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him.
‡ Moreover, according to the principals of Islamic jurisprudence borrowing on interest is a grave sinful act for which the
borrower is responsible in the Hereafter; however, this sinful act does not render the whole business of the borrower as
haram impermissible. The borrowed amount being recognized as owned by the borrower, anything purchased in exchange
of that money is not unlawful. Therefore, the responsibility of committing a sinful act of borrowing on interest rests with the
person who willfully indulged in a transaction of interest, but this fact does not render the whole business of a company as
un-lawful.
‡ |-
 
‡ Another type of Islamic Fund may be an Ijarah fund. Ijarah means leasing. An Ijarah fund will usually be established for the
purpose of purchasing assets (property, machinery etc) and then leasing those assets to third parties in return for rental
income. Legal ownership of the assets remains with the fund as does responsibility for the management of such assets. A
management fee will normally be paid to the manager. It is important to bear in mind that with an Ijara fund, the assets that
are leased out must be used in a halal manner. Furthermore, the leasing arrangement put in place between the fund and the
lessees must comply with Shariah.
‡ In this fund the subscription amounts are used to purchase assets like real estate, motor vehicles, or other equipment for the
purpose of leasing them out to their ultimate users. The ownership of these assets remains with the Fund and the rentals are
charged from the users. These rentals are the source of income for the fund which is distributed prorated to the subscribers.
Each subscriber is given a certificate to evidence his subscription and to ensure his entitlement to the pro rated share in the
income. These certificates may be preferably called "sukuk" -- a term recognized in the traditional Islamic jurisprudence.
Since these sukuk represent the pro-rated ownership of their holders in the tangible assets of the fund, and not the liquid
amounts or debts, they are fully negotiable and can be sold and purchased in the secondary market. Anyone who purchases
these sukuk replaces the sellers in the pro-rated ownership of the relevant assets and all the rights and obligations of the
original subscriber are passed on to him. The price of these sukuk will be determined on the basis of market forces, and are
normally based on their profitability.
‡ However, it should be kept in mind that the contracts of leasing must conform to the principles of Shariah which substantially
differ from the terms and conditions used in the agreements of the conventional financial leases. The points of reference are
explained in detail in my book "Islamic Finance." However, some basic principles are summarized here: 1. The leased assets
must have some usufruct, and the rental must be charged only from that point of time when the usufruct is handed over to
the lessee.
‡ 2. The leased assets must be of a nature that their Halal (permissible) use is possible.
‡ 3. The lessor must undertake all the responsibilities consequent to the ownership of the assets.
‡ 4. The rental must be fixed and known to the parties right at the beginning of the contract. In this type of the fund the
management should act as an agent of the subscribers and should be paid a fee for his services. The management fee may
be a fixed amount or a proportion of the rentals received. Most of the Muslim jurists are of the view that such a fund cannot
be created on the basis of Mudarabah, because Mudarabah, according to them, is restricted to the sale of commodities and
does not extend to the business of services and leases. However, in the Hanbali School, mudarabah can be affected in
services and leases also. This view has been preferred by a number of contemporary scholars.

12/4/2010 20
‡   
‡ Another possible type of Islamic Funds may be a commodity fund. In the fund of this type the subscription amounts are used
in purchasing different commodities for the purpose of the resale.
‡ A commodity fund derives income from the purchase and resale of commodities. However, it is strictly prohibited by Shariah
to sell a commodity before it is actually owned. Therefore, short sales (as commonly entered into by traditional hedge funds)
are not permissible. A product must be held physically, or at least constructively, before it may be sold. Therefore, forward
sales are also forbidden in most cases. Nevertheless, the following contracts may legitimately be used by a fund of this type
(or indeed any Islamic investment fund) to generate profits:
‡ (i) Istisna'a is a contract of exchange that allows the deferred delivery of goods at a specified date. The contract relates to the
production of made-to-order items and allows a manufacturer to fund the production process by receiving the sale price of
the produce up front. A detailed specification of the item to be produced must be agreed between the buyer and seller prior
to the commencement of the production process. Once production has commenced, the contract may not be unilaterally
cancelled. The consideration must be paid in full on the date the contract is entered into, otherwise the contract may be
classified as a future and consequently prohibited.
‡ (ii) Bay al-salam is a sale contract in which the buyer pays immediately against the deferred delivery of a specified amount of
fungible (not uniquely identifiable) goods of a given quality at a given date in the future. The contract is most like a forward
contract, but is different in two material respects. In a forward contract, exchange of the underlying goods and cash are
deferred to the maturity date. The seller in a bay al-salam contract has full use of the cash from the time the bay al-salam
contract is agreed. Hence the credit risk is on the buyer, whose exposure relates to whether the seller will fulfil its obligations
± the reverse of a conventional forward contract. The other difference relates to pricing. In a forward contract prices are
derived by considering, for example, what the benefits are to the buyer/seller of the assets by deferring payment and delivery
rather than a contemporaneous deal in the cash market. However, the delivery price in a bay al-salam contract is the spot
price minus a discount. The rationale being that the buyer must be compensated for credit risk exposure as well as some
performance flexibility. The profits generated by the sale are the income of the fund which is distributed pro rated among the
subscribers. In order to make this fund acceptable to Shariah, it is necessary that all the rules governing the transactions and
fully complied with. For example:
‡ 1. The commodity must be owned by the seller at the time of sale, therefore, short sales where a person sells a commodity
before he owns it are not allowed in Shari¶ah.
‡ 2. Forward sales are not allowed except in the case of Salam and Istisna'.
‡ 3. The commodities must be Halal; therefore, it is not allowed to deal in wines, pork, or other prohibited materials. 4. The
seller must have physical or constructive possession or the commodity he wants to sell. (Constructive possession includes
any act by which the risk of the commodity is passed on to the purchaser).
‡ 5. The price of the commodity must be fixed and known to the parties. Any price which is uncertain or is tied up with an
uncertain event renders the sale invalid.
‡ In view of the above and similar other conditions, it may easily be understood that the transactions prevalent in the
contemporary commodity markets, especially in the futures commodity markets do not comply with these conditions.
Therefore, an Islamic Commodity Fund cannot enter into such transactions. However, if there are genuine commodity
transactions observing all the requirements of Shari ah, including the above conditions, a commodity fund may well be
established. The units of such fund can also be traded in with the condition that the portfolio owns some commodities at all
times.

12/4/2010 21
‡ #
 
‡ Murabaha is a type of 'cost-plus' financing. It is a specific kind of sale where the commodities are sold on a cost-
plus basis. This kind of sale has been adopted by the contemporary Islamic banks and financial institutions as a
mode of financing. They purchase the commodity for the benefit of their clients, then sell it to them on the basis of
deferred payment at an agreed margin of profit added to the cost. If a fund is created to undertake this kind of sale,
it should be a closed-end fund and its units can not be negotiable in a secondary market. The reason is that in the
in the case Murabahah, as undertaken by the present financial institutions, the commodities are sold to the clients
immediately after their purchase from the original supplier, while the price being on deferred payment basis
becomes a debt payable by the client. Therefore, the portfolio of Murabahah does not own any tangible assets,
rather it comprises of either cash or the receivable debts, and both these things are not negotiable, as explained
earlier. If they are exchanged for money, it must be at par value. Typically the fund in question will acquire goods
and will resell them to a third party at their cost plus a fixed profit. As such the fund will not own tangible assets but
will instead consist of obligations owed to it by third parties. The costs and profit margin must be agreed in
advance. However, a Murabaha fund should always be closed-ended, since the fund will not actually own any
tangible assets as such, and cash/debts are not classified as negotiable instruments by Shari¶ah.
‡ 4 $ )
‡ Here comes the question whether or not Bai'-al-dain is allowed in Shariah. Dain means "debt" and Bai' means sale.
Bai'-al-dain, therefore, connotes 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. The
overwhelming majority of the contemporary Muslim scholars are of the same view. However, some scholars of
Malaysia have allowed this kind of sale. They normally refer to the ruling of Shaf'ite school wherein it is held that
the sale of debt is allowed, but they do not pay attention to the facts that the Shaf'ite jurists have allowed it only in
a case where a debt is sold on its par value.
‡ 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 money is exchanged from the
same denomination of money, the price must be at par value. Any increase or decrease from one side is
tantamount to "riba" and can never be allowed in Shariah. Some scholars argue that the permissibility of Bai'-al
dain is restricted to a case where the debt is created through a sale of a commodity. In this case, they say, the
debt represents the sold commodity and its sale may be taken as a sale of the commodity. The arguments,
however, is devoid of force. For, once the commodity is sold, its ownership is passed on to the purchaser and it is
no longer commodity of the seller. What the seller owns is nothing other than money, therefore if he sells the debt,
it is no more than a sale of money and it cannot be termed by any stretch of imagination as the sale of the
commodity. That is why this view has not been accepted by the overwhelming majority of the contemporary
scholars. The Islamic Fiqh Academy of Jeddah which is the largest representative body of the Shariah scholars
and is represented by all the Muslim countries, including Malaysia, has approved the prohibition of Bai'-al-dain
unanimously without a single decent.

12/4/2010 22
‡ #! 
‡ Another type of Islamic Fund maybe of a nature where the subscription amounts are employed in different types of
investments, like equities, leasing, commodities, etc. This may be called a Mixed Islamic Fund. In this case if the tangible
assets of the Fund are more than 51% while the liquidity and debts are less than 50% the units of the fund may be
negotiable. However, if the proportion of liquidity and debts exceeds 50%, its units cannot be traded in according to the
majority of the contemporary scholars. In this case the Fund must be a closed-end Fund.
‡ 5 5
‡ Recent innovations in Islamic finance have changed the dynamics of the Islamic finance industry. Specially in the area of
bonds and securities the use of Sukuk or Islamic securities have become increasingly popular in the last few years, both as a
means of raising government finance through sovereign issues, and as a way of companies obtaining funding through the
offer of corporate sukuk. Beginning modestly in 2000 with total three sukuk worth $336 millions the total number sukuk by
the end of 2006 has reached to 77 with over US$ 27 billion funds under management. By the end of 2007 the total figure is
expected to exceed US$35 billion. Sukuk has developed as one of the most significant mechanisms for raising finance in the
international capital markets through Islamically acceptable structures. Multinational corporations, sovereign bodies, state
corporations and financial institutions use international sukuk issuance as an alternative to syndicated financing. What are
sukuk? how are they structured? and how they are different from the conventional bond and the conventional securitization
processes is discussed in this paper in some detail.
‡ 6**
‡ Sukuk in general may be understood as a shariah compliant µBond¶. In its simplest form sukuk represents ownership of an
asset or its usufruct. The claim embodied in sukuk is not simply a claim to cash flow but an ownership claim. This also
differentiates sukuk from conventional bonds as the latter proceed over interest bearing securities, whereas sukuk are
basically investment certificates consisting of ownership claims in a pool of assets. Sukuk (plural of word sak) were
extensively used by Muslims in the Middle Ages as papers representing financial obligations originating from trade and other
commercial activities. However, the present structure of sukuk are different from the sukuk originally used and are akin to the
conventional concept of securitization, a process in which ownership of the underlying assets is transferred to a large
number of investors through certificates representing proportionate value of the relevant assets. The ð



is similar to an
obligation backed by an asset but is not in anyway a bond because it is not based on debt. It can be regarded as a
commercial paper which gives the investor a share of ownership in the underlying asset.
‡ The issuer must identify the assets to be sold to investors by transferring it to an ad hoc basis.
‡ Investors enjoy the usufruct of the assets in proportion to their investment and bear the credit risk of the issuer.
‡ The ð



are therefore equity securities which have the following characteristics:
‡ They are issued by pooled funds (


) ;
‡ They are based on hard assets that generate steady income and expectation;
‡ They may be guaranteed or not by their originators;
‡ Investors receive a fee equal to the income of the underlying assets;
‡ The ð



are issued by SPVs, often subsidiaries of banks or trusts called SPV.

12/4/2010 23
‡ **  
‡ A bond is a contractual debt obligation whereby the issuer is contractually obliged to pay to bondholders, on
certain specified dates, interest and principal, whereas, the sukuk holders claims an undivided beneficial
ownership in the underlying assets. Consequently, sukuk holders are entitled to share in the revenues generated
by the sukuk assets as well as being entitled to share in the proceeds of the realization of the sukuk assets.
‡ A distinguishing feature of a sukuk is that in instances where the certificate represents a debt to the holder, the
certificate will not be tradable on the secondary market and instead is held until maturity or sold at par.
‡ Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines sukuk as being:
‡ ³Certificates of equal value representing after closing subscription, receipt of the value of the certificates and
putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity
of a given project or equity of a special investment activity´.
‡   

‡ Tradable shariah-compliant capital market product providing medium to long-term fixed or variable rates of return.
Assessed and rated by international rating agencies, which investors use as a guideline to assess risk/return
parameters of a sukuk issue.
‡ Regular periodic income streams during the investment period with easy and efficient settlement and a possibility
of capital appreciation of the sukuk.
‡ Liquid instruments, tradable in secondary market.
‡ 5** 
‡ The most common uses of sukuk can be named as project specific, asset-specific, and balance sheet specific.
‡ ( 
- 
  **
‡ Under this category money is raised through sukuk for specific project. For example, Qatar Global sukuk issued by
the Government of Qatar in 2003 to mobilize resources for the construction of Hamad Medical City (HMC) in Doha.
In this case a joint venture special purpose vehicle (SPV), the Qatar Global sukuk QSC, was incorporated in Qatar
with limited liability. This SPV acquired the ownership of land parcel, that was registered in the name of HMC. The
land parcel was placed in trust and Ijara-based Trust Certificates (TCs) were issued worth US$700 million due by
October 2010. The annual floating rate of return was agreed at LIBOR plus 0.45 per cent.
‡ ( 
  **
‡ Under this arrangement, the resources are mobilise by selling the beneficiary right of the assets to the investors.
For example, the Government of Malaysia raised US$ 600 million through Ijara sukuk Trust Certificates (TCs) in
2002. Under this arrangement, the beneficiary right of the land parcels has been sold by the government of
Malaysia to an SPV, which was then re-sold to investors for five years. The SPV kept the beneficiary rights of the
properties in trust and issued floating rate sukuk to investors.
‡ Another example of Asset-specific sukuk is US$250 million five-year Ijara sukuk issued to fund the extension of
the airport in Bahrain. In this case the underlying asset was the airport land sold to an SPV.

12/4/2010 24
‡ (  
  **
‡ An example of the balance sheet specific use of sukuk funds is the Islamic Development Bank (IDB) sukuk issued in August 2003.
The IDB mobilised these funds to finance various projects of the member countries. The IDB made its debut resource
mobilization from the international capital market by issuing US$ 400 million five-year sukuk due for maturity in 2008.
‡ K
**
‡ Sukuk can be of many types depending upon the type of Islamic modes of financing and trades used in its structuring. However,
the most important and common among those are Mudaraba, ijarah, shirkah, salam and istisna. Among the fourteen eligible
sukuks identified by the AAOIFI, following are more common:
‡ /( #
**
‡ These are investment sukuk that represent ownership of units of equal value in the Mudaraba equity and are registered in the
names of holders on the basis of undivided ownership of shares in the Mudaraba equity and its returns according to the
percentage of ownership of share. The owners of such sukuk are the rabbul-mal. (AAOIFI). Mudarba sukuk are used for
enhancing public participation in big investment projects.
‡  

‡ Following are the salient features of mudarba sukuk:
‡ Mudarba sukuk (MS) represent common ownership and entitle their holders share in the specific projects against which the MS
has been issued.
‡ The MS contract is based on the official notice of the issue of the prospectus which must provide all information required by
shariah for the Qirad contract such as the nature of capital, the ratio for profit distribution and other conditions related to the issue,
which must be compatible with shariah.
‡ The MS holder is given the right to transfer the ownership by selling the deeds in the securities market at his discretion. The sale
of MS must follow the rules listed below:
± If the mudarba capital, before the operations of the project, is still in the form of money, the trading of MS would be like exchange of
money for money. In that case the rules of bay al-sarf would be applied.
± If muqarda capital is in the form of debt then it must satisfy the principles of debt trading in Islam.
± If capital is in the form of combination of cash, receivables, goods, real assets and benefits, trade must be based on market price
evolved by mutual consent.
‡ IV. The Manager/SPV who receives the fund collected from the subscribers to MS can also invest his own fund. He will get profit
for his capital contribution in addition to his share in the profit as mudarib.
‡ V. Neither prospectus nor MS should contain a guarantee, from the issuer or the manager for the fund, for the capital or a fixed
profit, or a profit based on any percentage of the capital. Accordingly;
‡ a. The prospectus or the MS issued pursuant to it, may not stipulate payment of a specific amount to the MS
holder,
‡ b. The profit is to be divided, as determined by applying rules of shariah; that is, an amount access of the capital, and not the
revenue or the yield; and
‡ c. Profit and Loss account of the project must be published and disseminated to MS holders.
‡ VI. It is permissible to create reserves for contingencies, such as loss of capital, by deducting from the profit.
‡ VII. The prospectus can also contain a promise made by a third party, totally un-related to the parties to the contract, in terms
of legal entity or financial status, to donate a specific sum, without any counter benefit, to meet losses in the give project, provided
such commitment is independent of the mudarba contract.
‡ On the expiry of the specified time period of the subscription, the Sukuk holders is given the right to transfer the ownership by
sale or trade in the securities market at his discretion.

12/4/2010 25
‡ 


 
 

‡ Mudarib enters into an agreement with project owner for construction/commissioning of project.
‡ SPV issues sukuk to raise funds.
‡ Mudarib collects regular profit payments and final capital proceeds from project activity for onward distribution to
investors.
‡ Upon completion, Mudarib hands over the finished project to the owner.
‡ 
 
| **#

‡ The procedure for this type of Sukuk is quite simple. The process is applied as follows; the company needs the
funds make a consultation with an investment bank (also called as arranger) to manage a Special Vehicle Project
(SVP), against which the Sukuk are issued. The company purchases the SPV on Murabaha basis. The periodic
installments paid by company in future to the SPV for the repayment of the cost and the profit component.

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12/4/2010 26
‡ #
** 

  
‡ Shamil Bank of Bahrain raised 360 million Saudi Riyal investment capital through the Al Ehsa Special Realty
Mudaraba, representing an investment participation in a land development transaction with a real estate
development company in the Kingdom of Saudi Arabia. The investment objective of the Mudaraba is to provide
investors with annual returns arising from participation in the funding of a land financing transaction Profits due to
investors will be accrued on the basis of returns attained from investing the subscriptions.
‡ 0( #
***
‡ These are investment sukuk that represent ownership of Musharaka equity. It does not differ from the Mudaraba
sukuk except in the organization of the relationship between the party issuing such sukuk and holders of these
sukuk, whereby the party issuing sukuk forms a committee from the holders of the sukuk who can be referred to in
investment decisions (AAOIFI).
‡ Musharaka Sukuk are used for mobilizing the funds for establishing a new project or developing an existing one or
financing a business activity on the basis of partnership contracts. The certificate holders become the owners of
the project or the assets of the activity as per their respective shares. These Musharaka certificates can be treated
as negotiable instruments and can be bought and sold in the secondary market.
‡ ³These are certificates of equal value issued with the aim of using the mobilized funds for establishing a new
project, developing an existing project or financing a business activity on the basis of any partnership contracts so
that the certificate holders become the owners of the project or assets of the activity as per their respective shares,
with the Musharaka certificates being managed on the basis of participation or Mudaraba or an investment
agency.´ (AAOIFI Standard 17, 3/6)
‡ 


 
 

‡ Corporate and the Special Purpose Vehicle (SPV) enter into a Musharaka Arrangement for a fixed period and an
agreed profit-sharing ratio. Also the corporate undertakes to buy Musharaka shares of the SPV on a periodic basis.
‡ Corporate (as Musharik) contributes land or other physical assets to the Musharaka
‡ SPV contributes cash i.e. the issue Proceeds received from the investors to the Musharaka
‡ The Musharaka appoints the Corporate as an agent to develop the land (or other physical assets) with the cash
injected into the Musharaka and sell/lease the developed assets on behalf of the Musharaka.
‡ In return, the agent (i.e. the Corporate) will get a fixed agency fee plus a variable incentive fee payable.
‡ The profits are distributed to the sukuk holders.
‡ The Corporate irrevocably undertakes to buy at a pre-agreed price the Musharaka shares of the SPV on say semi-
annual basis and at the end of the fixed period the SPV would no longer have any shares in the Musharaka.

12/4/2010 27
‡ #
*** 
  
‡ US$550 million sukuk transaction for Emirates airline, the seven-year deal was a structured on a Musharaka
contract. The Musharaka or joint venture was set up to develop a new engineering centre and a new headquarters
building on land situated near Dubai's airport which will ultimately be leased to Emirates. Profit, in the form of lease
rentals, generated from the Musharaka venture will be used to pay the periodic distribution on the trust certificates.
‡ Sitara Chemical Industries Ltd, a public limited company, made a public issue of profit-and-loss sharing based
term finance certificates (TFC¶s) worth Rs 360 million which were subscribed in June 2002. The TFC¶s had a fixed
life tenor of five years and profit and loss sharing was linked to the operating profit or loss of the Chemical Division
of the company.
‡ Kuwait Finance House (KFH), Liquidity Management Center (LMC) and Al Muthanna Investment Company (MIC),
the mandated lead arrangers launched US$ 125 million Lagoon City Musharaka sukuk to support the Lagoon City
residential and commercial real estate development as part of Kheiran Pearl City project.
‡ ð  Ô  
‡ Under this scheme the Sukuk holders¶ contribute capital amount to the issuer. The issuers then enters into a joint
venture with the party seeking finance (the originator) where the issuer provides the capital received from the
Sukuk holders, and the originator supplies the assets and or their own capital required for the business to function.
The profits from the Musharakah are distributed to the issuer and the originator at a predetermined basis. Any
losses are shared in proportion to the capital contribution, and the issuer pays a periodic distribution amount to
Sukuk holders from the 

 profit distribution

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12/4/2010 28
‡ 1( |-
**
‡ These are sukuk that represent ownership of equal shares in a rented real estate or the usufruct of the real estate. These sukuk give their
owners the right to own the real estate, receive the rent and dispose of their sukuk in a manner that does not affect the right of the lessee,
i.e. they are tradable. The holders of such sukuk bear all cost of maintenance of and damage to the real estate. (AAOIFI)
‡ Ijarah sukuk are the securities representing ownership of well defined existing and known assets tied up to a lease contract, rental of
which is the return payable to sukuk holders. Payment of ijarah rentals can be unrelated to the period of taking usufruct by the lessee. It
can be made before beginning of the lease period, during the period or after the period as the parties may mutually decide. This flexibility
can be used to evolve different forms of contract and sukuk that may serve different purposes of issuers and the holders.
‡ 
|-
**
‡ 1. It is necessary for an ijarah contract that the assets being leased and the amount of rent both are clearly known to the parties at
the time of the contract and if both of these are known, ijarah can be contracted on an asset or a building that is yet to be constructed, as
long as it is fully described in the contract provided that the lessor should normally be able to acquire, construct or buy the asset being
leased by the time set for its delivery to the lessee (AAOIFI, 2003: 140-157). The lessor can sell the leased asset provided it does not
hinder the lessee to take benefit from the asset. The new owner would be entitled to receive the rentals.
‡ 2. Rental in ijarah must be stipulated in clear terms for the firs term of lease, and for future renewable terms, it could be constant,
increasing or decreasing by benchmarking or relating it to any well-known variable.
‡ 3. As per shariah rules, expenses related to the corpus or basic characteristics of the assets are the responsibility of the owner,
while maintenance expenses related to its operation are to be borne by the lessee.
‡ 4. As regards procedure for issuance of ijarah sukuk, an SPV is created to purchase the asset(s) that issues sukuk to the investor,
enabling it to make payment for purchasing the asset. The asset is then leased to third party for its use. The lessee makes periodic rental
payments t the SPV that in turn distributes the same to the sukuk holders.
‡ 5. Ijara sukuk are completely negotiable and can be traded in the secondary markets.
‡ 6. Ijara sukuk offer a high degree of flexibility from the point of view of their issuance management and marketability. The central
government, municipalities, awqaf or any other asset users, private or public can issue these Sukuk. Additionally, they can be issued by
financial intermediaries or directly by users of the leased assets.
‡ 


 
 

‡ The obligator sells certain assets to the SPV at an agreed pre-determined purchase price.
‡ The SPV raises financing by issuing sukuk certificates in an amount equal to the purchase price.
‡ This is passed on to the obligator (as seller).
‡ A lease agreement is signed between SPV and the obligator for a fixed period of time, where the obligator leases back the assets as
lessee.
‡ SPV receives periodic rentals from the obligator;
‡ These are distributed among the investors i.e. the sukuk holders.
‡ At maturity, or on a dissolution event, the SPV sells the assets back to the seller at a predetermined value. That value should be equal to
any amounts still owed under the terms of the Ijara sukuk.

12/4/2010 29
‡ 
 
|-
**|
‡ These Sukuk are issued on stand-alone assets identified on the balance sheet. The assets can be parcels of land
to be leased or leased equipment such as Motor Vehicle, Transport machines such as: Ships aircrafts or trains.
The rental rates of returns on the Sukuk can be both fixed and floating depending on the particular originator. The
income generated under Sukuk al Ijara comes from the underlying rent receivables. The process for generating
funds under this scheme is simple and can be explain as followings. The company seeking to raise finance sells
certain asset to the issuer, and then pays for the assets on trust for the Sukuk holders. The issuer leases the
assets back to the originator for affixed period of time and for a rent. At maturity, the originator may have the right
to purchase the asset back from the issuer at a price which would represent the redemption value for the Sukuk
holders at maturity.

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12/4/2010 30
‡ |-
** 
  
‡ In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5 billion (US$400 million) Al-Ijara Al-
Muntahiyah Bit-Tamik by a consortium of banks. The original facility was raised to re-finance Guthrie¶s acquisition
of a palm oil plantation in the Republic of Indonesia. The consortium was then invited to participate as the
underwriter/primary subscriber of the Sukuk Transaction.
‡ US$350 million sukuk Trust Certificates by Sarawak Corporate Sukuk Inc. (SCSI) Sarawak Economic
Development Corporation (SEDC) raised financing amounting to US$350 million by way of issuance of series of
trust certificates issued on the principle of Ijara sukuk. The certificates were issued with a maturity of 5 years and
under the proposed structure, the proceeds will be used by the issuer to purchase certain assets from 1st Silicon
(Malaysia) Sdn Bhd. Thereafter, the issuer will lease assets procured from 1st Silicon to SEDC for an agreed
rental price for an agreed lease period of 5 years.
‡ 7( #
**
‡ In this case the issuer of the certificate is the seller of the Murabaha commodity, the subscribers are the buyers of
that commodity, and the realised funds are the purchasing cost of the commodity. The certificate holders own the
Murabaha commodity and are entitled to its final sale price upon the re-sale of the Commodity. The possibility of
having legally acceptable Murabaha-based sukuk is only feasible in the primary market. The negotiability of these
Sukuk or their trading at the secondary market is not permitted by shariah, as the certificates represent a debt
owing from the subsequent buyer of the Commodity to the certificate-holders and such trading amounts to trading
in debt on a deferred basis, which will result in riba.
‡ Despite being debt instruments, the Murabaha Sukuk could be negotiable if they are the smaller part of a package
or a portfolio, the larger part of which is constituted of negotiable instruments such as Mudaraba, Musharaka, or
Ijara Sukuk. Murabaha sukuk are popular in Malaysian market due to a more liberal interpretation of fiqh by
Malaysian jurists permitting sale of debt (bai-al-dayn) at a negotiated price.
‡ 


 
 

‡ A master agreement is signed between the SPV and the borrower
‡ SPV issues sukuk to the investors and receive sukuk proceeds.
‡ SPV buys commodity on spot basis from the commodity supplier.
‡ SPV sells the commodity to the borrower at the spot price plus a profit margin, payable on installments over an
agreed period of time.
‡ The borrower sells the commodity to the Commodity buyer on spot basis.
‡ The investors receive the final sale price and profits.
‡ ð  Ô  
‡ It is a two-tear agreement where the Vender and company enter into one agreement and Vender and SPV made
second agreement; where as SPV and company enter into another agreement. In this procedure, the Sukuk
issuing authority raise fund through the selling of an asset under the 
 scheme. In this structure too, as
similar to ð




, a SPV is created by the company that needs funds in consultation with an
investment bank. The company purchases the asset from the SPV on Murabaha basis.

12/4/2010 31
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‡ Arcapita Bank, a Bahrain-based investment firm has mandated Bayerische Hypo-und Vereinsbank AG (³HVB´),
Standard Bank Plc (³SB´) and WestLB AG, London Branch (³WestLB´) (together the ³Mandated Lead Arrangers´),
to arrange a Five Year Multicurrency (US$, ¼ and £) Murabaha-backed Sukuk. Sukuk will have a five-year bullet
maturity and proposed pricing three month LIBOR +175bps.
‡ 8( **
‡ Salam sukuk are certificates of equal value issued for the purpose of mobilising Salam capital so that the goods to
be delivered on the basis of Salam come to the ownership of the certificate holders. The issuer of the certificates is
a seller of the goods of Salam, the subscribers are the buyers of the goods, while the funds realized from
subscription are the purchase price (Salam capital) of the goods. The holders of Salam certificates are the owners
of the Salam goods and are entitled to the sale price of the certificates or the sale price of the Salam goods sold
through a parallel Salam, if any.
‡ Salam-based securities may be created and sold by an SPV under which the funds mobilized from investors are
paid as an advance to the company SPV in return for a promise to deliver a commodity at a future date. SPV can
also appoint an agent to market the promised quantity at the time of delivery perhaps at a higher price. The
difference between the purchase price and the sale price is the profit to the SPV and hence to the holders of the
Sukuk.

12/4/2010 32
‡ All standard shariah requirements that apply to Salam also apply to Salam sukuk, such as, full payment by the
buyer at the time of effecting the sale, standardized nature of underlying asset, clear enumeration of quantity,
quality, date and place of delivery of the asset and the like.
‡ One of the Shariah conditions relating to Salam, as well as for creation of Salam sukuk, is the requirement that the
purchased goods are not re-sold before actual possession at maturity. Such transactions amount to selling of debt.
This constraint renders the Salam instrument illiquid and hence somewhat less attractive to investors. Thus, an
investor will buy a Salam certificate if he expects prices of the underlying commodity to be higher on the maturity
date.
‡ 


 
   
‡ SPV signs an undertaking with an obligatory to source both commodities and buyers. The obligator contracts to
buy, on behalf of the end-Sukuk holders, the commodity and then to sell it for the profit of the Sukuk holders.
‡ Salam certificates are issued to investors and SPV receives Sukuk proceeds.
‡ The Salam proceeds are passed onto the obligator who sells commodity on forward basis
‡ SPV receives the commodities from the obligator
‡ Obligator, on behalf of Sukuk holders, sells the commodities for a profit.
‡ Sukuk holders receive the commodity sale proceeds.
‡ ** 
  
‡ Aluminum has been designated as the underlying asset of the Bahrain Government al Salam contract, whereby it
promises to sell aluminum to the buyer at a specified future date in return of a full price payment in advance. The
Bahrain Islamic Bank (BIB) has been nominated to represent the other banks wishing to participate in the Al
Salam contract. BIB has been delegated to sign the contracts and all other necessary documents on behalf of the
other banks in the syndicate. At the same time, the buyer appoints the Government of Bahrain as an agent to
market the appropriate quantity at the time of delivery through its channels of distribution. The Government of
Bahrain provides an additional undertaking to the representative (BIB) to market the aluminum at a price, which
will provide a return to al Salam security holders¶ equivalent to those available through other conventional short-
term money market instruments.
‡ 9( | **
‡ Istisna Sukuk are certificates that carry equal value and are issued with the aim of mobilizing the funds required for
producing products that are owned by the certificate holders. The issuer of these certificates is the manufacturer
(supplier/seller), the subscribers are the buyers of the intended product, while the funds realized from subscription
are the cost of the product. The certificate holders own the product and are entitled to the sale price of the
certificates or the sale price of the product sold on the basis of a parallel Istisna, if any. Istisna Sukuk are quite
useful for financing large infrastructure projects. The suitability of Istisna for financial intermediation is based on
the permissibility for the contractor in Istisna to enter into a parallel Istisna contract with a subcontractor. Thus, a
financial institution may undertake the construction of a facility for a deferred price, and sub contract the actual
construction to a specialized firm.
‡ Shari ah prohibits the sale of these debt certificates to a third party at any price other than their face value.
Clearly such certificates cannot be traded in the secondary market.
12/4/2010 33
‡ 


 
 

‡ SPV issues Sukuk certificates to raise funds for the project.
‡ Sukuk issue proceeds are used to pay the contractor/builder to build and deliver the future project.
‡ Title to assets is transferred to the SPV
‡ Property/project is leased or sold to the end buyer. The end buyer pays monthly installments to the SPV.
‡ The returns are distributed among the Sukuk holders.
‡ | ** 
  
‡ Tabreed¶s five-year global corporate Sukuk (on behalf of the National Central Cooling Company, UAE) provided a
fixed coupon of 5.50%. It is a combination of Ijara Istisna and Ijara Mawsufah fi al dhimmah (or forward leasing
contracts). The issue was launched to raise funds to retire some existing debt, which totals around US$136 million,
as well as to finance expansion.
‡ The Durrat Sukuk will finance the reclamation and infrastructure for the initial stage of a broader US$ 1 billion
world class residential and leisure destination known as 'Durrat Al Bahrain', currently the Kingdom of Bahrain's
largest residential development project. The return on the Sukuk is 125 basis points over 3 months LIBOR payable
quarterly, with the Sukuk having an overall tenor of 5 years and an option for early redemption. The proceeds of
the issue (cash) will be used by the Issuer to finance the reclamation of the land and the development of Base
Infrastructure through multiple project finance (Istisna) agreements. As the works carried out under each Istisna
are completed by the Contractor and delivered to the Issuer, the Issuer will give notice to the Project Company
under the Master Ijarah Agreement and will lease such Base Infrastructure on the basis of a lease to own
transaction.
‡ :( % 
**
‡ Considering the fact that Sukuk issuance and trading are important means of investment and taking into account
the various demands of investors, a more diversified Sukuk - hybrid or mixed asset Sukuk - emerged in the market.
In a hybrid Sukuk, the underlying pool of assets can comprise of Istisna, Murabaha receivables as well as Ijarah.
Having a portfolio of assets comprising of different classes allows for a greater mobilization of funds. However, as
Murabaha and Istisna contracts cannot be traded on secondary markets as securitized instruments at least 51
percent of the pool in a hybrid Sukuk must comprise of Sukuk tradable in the market such as an Ijarah Sukuk. Due
to the fact the Murabaha and Istisna receivables are part of the pool, the return on these certificates can only be a
pre-determined fixed rate of return.
‡ 


 
 

‡ Islamic finance originator transfers tangible assets as well as Murabaha deals to the SPV.
‡ SPV issues certificates of participation to the Sukuk holders and receive funds. The funds are used by the Islamic
finance originator.
‡ Islamic finance originator purchases these assets from the SPV over an agreed period of time.
‡ Investors receive fixed payment of return on the assets.

12/4/2010 34
‡ % 
** 

  
‡ Islamic Development Bank issued the first hybrid Sukuk of assets comprising 65.8% Sukuk al-
Ijara, 30.73% of Murabaha receivables and 3.4% Sukuk al-Istisna. This issuance required the
IDB¶s guarantee in order to secure a rating and international marketability. The $ 400 million
Islamic Sukuk was issued by Solidarity Trust Services Limited (STSL), a special purpose
company incorporated in Jersey Channel Islands. The Islamic Corporation for the Development of
Private Sector (ICD) played an intermediary role by purchasing the asset from IDB and selling it to
The Solidarity Trust Services Limited (STSL) at the consolidated net asset value.
‡ 
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‡ Investment in equity shares can be acceptable in Shari ah subject to the following conditions:
‡ 1. The main business of the company is not in violation of Shari¶ah. Therefore, it is not permissible
to acquire the shares of the companies providing financial services on interest, like conventional
banks, insurance companies, or the companies involved in some other business not approved by
the Shari ah, such as the company¶s manufacturing, selling or offering liquors, pork, haram meat,
or involved in gambling, night club activities, pornography etc.
‡ 2. If the main business of the companies is Halal, like automobiles, textile, etc. but they deposit
there surplus amounts in an interest-bearing account or borrow money on interest, the share
holder must express his disapproval against such dealings, preferably by raising his voice against
such activities in the annual general meeting of the company.
‡ 3. If some income from interest-bearing accounts is included in the income of the company, the
proportion of such income in the dividend paid to the share-holder must be given charity, and must
not be retained by him. For example, if 5% of the whole income of a company has come out of
interest-bearing deposits, 5% of the dividend must be given in charity.
‡ 4. The shares of a company are negotiable only if the company owns some non-liquid assets. If all
the assets of a company are in liquid form, i.e. in the form of money that cannot be purchased or
sold, except on par value, because in this case the share represents money only and the money
cannot be traded in except at par.

12/4/2010 35
‡ What should be the exact proportion of non-liquid assets of a company for the negotiability of its shares? The
contemporary scholars have different views about this question. Some scholars are of the view that the ratio of
non-liquid assets must be 51% at the least. They argue that if such assets are less than 50%, the most of the
assets are in liquid form, therefore, all its assets should be treated as liquid on the basis of the juristic principle:
The majority deserves to be treated as the whole of a thing. Some other scholars have opined that even if the non-
liquid asset of a company or 33%, its shares can be treated as negotiable.
‡ The third view is based on the Hanafi jurisprudence. The principle of the Hanafi School is that whenever an asset
is a mixture of liquid and non-liquid assets, it can be negotiable irrespective of the proportion of its liquid part.
However, this principle is subject to two conditions:
‡ First, the non-liquid part of the mixture must not be in a negligible quantity. It means that it should be in a
considerable proportion. Second, the price of the mixture should be more than the price of the liquid amount
contained therein. For example, if a share of 100 dollars represents 75 dollars, plus some fixed assets the price of
the share must be more than 75 dollars. In this case, if the price of the share is fixed as 105, it will mean that 75
dollars are in exchange of 75 dollars owned by the share and the rest of 30 dollars are in exchange of the fixed
asset. Conversely, if the price of that share fixed as 70 dollars, it will not be allowed, because the 75 dollars owned
by the share are in this case against an amount which is less than 75. This kind of exchange falls within the
definition of "Riba" and is not allowed. Similarly, if the price of the share, in the above example, is fixed as 75
dollars, it will not be permissible, because if we presume that 75 dollars owned by the share, no part of the price
can be attributed to the fixed assets owned by the share. Therefore, some part of the price (75 dollars) must be
presumed to be in exchange of the fixed assets of the share. In this case, the remaining amount will not be
adequate for the price of 75 dollars. For this reason the transaction will not be valid.
‡ However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation
where a price of the share goes lower than its liquid assets.
‡ Subject to these conditions, the purchase and sale of shares is permissible in Shariah. An Islamic Equity Fund can
be established on this basis. The subscribers to the Fund will be treated in Shariah as partners "inter se." All the
subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies.
The profits can accrue either through dividends distributed by the relevant companies or through the appreciation
in the prices of the shares. In the first case i.e. where the profits earned through dividends, a certain proportion of
the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The
contemporary Islamic Funds have termed this process as "purification."
‡ The Shari¶ah scholars have different views about whether the "purification" is necessary where the profits are
made through capital gains (i.e. by purchasing the shares at a lower price and selling them at a higher price).
Some scholars are of the view that even in the case of capital gains the process of "purification" is necessary,
because the market price of the share may reflect an element of interest included in the assets of the company.
The other view is that no purification is required if the share is sold, even if it results in a capital gain. The reason is
that no specific amount of price can be allocated for the interest received by the company. It is obvious if all the
above requirements of the halal shares are observed, the most of the assets of the company are Halal, and a very
small proportion of its assets may have been created by the income of interest. This small proportion is not only
unknown, but also a negligible as compared to the bulk of the assets of the company. Therefore, the price of the
share, in fact, is against the bulk of the assets, and not against such a small proportion. The whole price of the
share therefore, may be taken as the price of the halal assets only.
12/4/2010 36
‡ Though, the second view is not without force, yet the first view is more cautious and far from doubts. Particularly, it
is more equitable in an open-ended equity fund because if the purification is not carried out on the appreciation
and a person redeems his unit of the Fund at a time when no dividend is received by it, no amount of purification
will be deducted from its price, even though the price of the unit may have increased due to the appreciation in the
prices of the shares held by the fund. Conversely, when a person redeems his unit of the Fund at a time when no
dividend is received by it, no amount of purification will be deducted from its price, even though the price of the
unit may have increased due to the appreciation in the prices of the shares held by the fund. Conversely, when a
person redeems his unit after some dividends have been received in the fund and the amount of purification has
been deducted there from, reducing the net asset value per unit, he will get a lesser price compared to the first
person.

‡ On the contrary, if purification is carried out both on dividend and capital gains, all the unit-holders will be treated
at par with the regard to the deduction of the amounts of purification. Therefore, it is not only free from doubts but
also more equitable for all the unit-holders to carry out purification in the capital gains. This purification may be
carried out on the basis of an average percentage of the interest earned by the companies included in the portfolio.

‡ The management of the fund may be carried out in two alternative ways. The managers of the Fund may act as
mudaribs for the subscriber. In this case a certain percentage of the annual profit accrued to the Fund may be
determined as the reward of the management, meaning thereby that the management will get its share only if the
fund has earned some profit. If there is no profit in the fund, the management will deserve nothing, but the share of
the management will increase with the increase of profits.

‡ The second option of the management is to act as an agent for the subscribers. In this case, the management
may be given a pre agreed fee for its services. This fee may be fixed in lump sum or as a monthly or annual
remuneration. According to the contemporary Shari ah scholars, the fee can also be based on a percentage of
the net asset value of the fund. For example, it may be agreed that the management will get 2% or 3% of the net
asset value of the fund at the end of every financial year.

‡ However, it is necessary in Shariah to determine any of the aforesaid methods before the launch of the fund. The
practical way for this would be to disclose in the prospectus of the fund on what basis the fees of the management
will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the
prospectus. Therefore, the manner of paying the management will be taken as agreed upon on all the subscribers.

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‡  

‡ In response to recent concerns regarding the difference of opinion in the Shar¶i permissibility of shares, stocks,
companies, the concept of limited liability and other interrelated transactions, we present this treatise investigating
the realities of these modern business practices and examining how they fare in terms of the Shariah. We will
commence this discourse by providing an understanding of these commonly misunderstood financial aspects.
Thereafter, we will proceed to mention various points of contention in regards such misunderstandings between
those who permit shares and those who prohibit them. In conclusion, we will present the reasons of
impermissibility in light of the proofs presented.
‡ 5 
   
 &
 
‡ The majority of information in this chapter has been summarized from the book, ³Islam aur Jadid Ma¶ishat wa
Tijarat´ authored by the Mufti Taqi Uthmani. The views and understanding of the workings of shares are of those
Ulama who deem shares permissible.
‡ Understanding of a Company: In a Shirkah (partnership), every individual is deemed to have his own independent
ownership in the business. Depending upon the amount of capital invested by the partner, proportionately he will
be an owner of the business as well as all of its assets and liabilities. The assembly of partners in this type of
business is known as the partnership. However, in a company, the collection of these individuals is established as
one ³juristic person.´ This juristic person is then referred to as the company.1 This Company performs all the
functions of the business as a separate legal entity and not as an agent for the partners of the company. It bears
its own rights and responsibilities and accepts and bestows ownership in its own individual capacity as opposed to
playing the role of a Wakeel (agent). A more detailed explanation of a juristic person is forthcoming.
‡ K
  
 

 
 :
‡ 1. Every individual in a partnership is an owner of the assets and liabilities of a business in an undivided manner.
Each partner acts as an agent for the other partners. Every partner shares the same degree of liability in that if
one partner incurs a debt on behalf of the business, all the partners will be equally liable for it. On the contrary, a
company does not function in this manner. A company is a ³juristic person´ and in the eyes of the law, it has its
own independent existence apart from the existence of the shareholders. The esteemed Ulama who deem shares
permissible are of the view that shareholders own the assets of the company. Because of this ownership, in the
event of dissolution of the company whereby some residual assets remain, they will share in the assets
proportionate to their investment. However, before the dissolution of the company, shareholders are by law not
able to transact in the assets of the company. It is for this reason that an indebted shareholder¶s personal assets,
including his shares in the company, can be seized to pay off his debts; however, the company¶s assets
proportionate to his share allocation cannot be seized. The laws of the company do not allow outside transaction in
any of its assets. Other Ulama disagree with this supposition of shares as will be discussed further.

12/4/2010 38
‡ 2. If an indictment is laid by or against any of the partners of the business, all of the partners will collectively
assume the role of the plaintiff or defendant. On the contrary, a company is an independent ³juristic person´
hence; it will in its individual right become the plaintiff or defendant in a court of law and not the shareholders.

‡ 3. Outside of the partnership, there is no independent existence contrary to a company which is considered an
independent ³juristic person.´

‡ 4. If any partner wishes to annul his partnership and reclaim his capital, he may do so. In a company, a
shareholder will not be able to recover his investment. He can only sell his shares as an alternative.

‡ 5. In a partnership, the liability is generally not limited to its assets contrary to a company. The partners in their
personal capacities and properties can be sought to fulfill unpaid debts.

‡ Initiation of a Company:

The first step in initiating a company or incorporating an existing business is obtaining approval for the proposed
name of the company. The second step involves drawing up a Memorandum of Association. This Memorandum
includes the name of the company, the classification of the company, its authorized share capital, and the
subscribers (original shareholders of the company). The next step is drawing up the Articles of Association. These
are the regulations and principles that govern the relationship between the shareholders and directors of the
company. The Articles of Association coupled with the Memorandum of Association makes up the constitution of a
company. Once the legal requirements are met for incorporation, the relevant fees paid and the corresponding
paperwork submitted, permission must be granted from the government in

‡ order for the company to come into existence as a separate legal entity commonly referred to as a ³juristic
person.´ Once the company comes into existence, it will be necessary for it to issue a prospectus before it can
solicit funds through the sale of shares to the public. In this manner the public will be informed regarding the inner
workings, business and finances of the company in order to assess whether they deem it profitable to invest in it.

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‡ Shares of the Company:
‡ Once a specific amount of capital is paid to the company, the company issues the investor a Certificate stating that
the individual has a certain vested portion of funds in the company. This Certificate is what is referred to as a
³share.´4 According to some, the share represents one unit of the equally divided capital of a company. For
example, if a company maintains $10 million of capital and they issue 10 million shares, the value of each share
will be valued at one dollar. There is a difference of opinion among the Ulama in regards to what a share actually
represents. Does it represent an actual percentage of ownership of the company and its assets or does it merely
represent a percentage of rights to claim proportionate dividends (profit) without ownership? This issue plays a
pivotal role in the permissibility or impermissibility of shares.
‡ An Illustration of the Workings of a Company: The company is technically a ³juristic person´ which enjoys the legal
rights and responsibilities of transacting given to natural persons. However, considering the fact that it is not a
natural person that can act and think for itself, a group of shareholders will be designated as a Board of Directors
to represent its interests. The Board is generally elected by the shareholders of the company. The Board of
Directors will then elect one person as its head known as the Chief Executive. Once a year, all the shareholders
will conduct a meeting to discuss the various affairs and policies of the company.
‡ Assets:
‡ 1. Current Assets: These are such assets that are either current cash or easily turned into cash. These are of four
types:
‡ a. Cash
‡ b. Accounts Receivable
‡ c. Notes Receivable
‡ d. Investments
‡ 2. Fixed Assets: These are such assets that are not easily turned into cash such as property and equipment etc.
‡ 3. Non Tangible Assets: These are such non-monetary assets that cannot be perceived by the senses that
develop over time with effort. Some types of intangibles are trade secrets, copyrights, patents, the company¶s
brand name and goodwill. Despite the fact that these assets are not physical in nature where by some physical
value can be attached to them, they can have great value to a company and to its profits.
‡ Liabilities:
‡ Current Liabilities: debts or obligations of a company due within one year. Essentially, these are bills that are due
to creditors within a relatively short period of time.
‡ Long Term Liabilities: liabilities of a company for leases, loans, bonds and other items not due within one year.

12/4/2010 40
‡ Distribution of Earnings:
Once a year, the company will account for its losses, earnings, assets and liabilities. If the company yielded
earnings higher than its liabilities, it will distribute the earnings known as³profit´. First, a specific percent of the
earnings will be allocated to its Reserve. This is a precautionary measure for future unknown expenses and
liabilities. After allocating this reserve amount, the remainder of the earnings will be termed as ³dividends´which
are distributed to the shareholders. The earning of the company as a whole is termed ³profit´ whereas the earnings
of the shareholders are termed ³dividends.´

‡ Limited Companies:
Limited Liability refers to the company bearing a limited or restricted liability to its creditors. The company will only
be legally responsible to pay off any debts or liabilities to the amount of its assets. Additionally, the shareholders of
the company are limited in liability to the extent of their investment. Neither the company nor its shareholders will
be responsible to pay creditors above and beyond these limitations. If the company suffers any loss, the most that
the shareholder will lose is his capital investment. If the company incurs a debt, the shareholders cannot be sought
to fulfill that debt. In the event of bankruptcy, only the assets of the company can be seized and it cannot be
sought for anything beyond that. For this same reason, it is binding
‡ upon such companies to affix words like ³Limited Company´ etc to their company name. In this manner, the
creditor can be aware that in the event of a debt, there is a restricted level of liability.

‡  

 =

 
 
The first point of contention lies in the Shar¶i permissibility of a company. There are five types of Shirkah
(partnership) as mentioned in the books of Fiqh, namely, Shirkat al-Mufawadah, Shirkat al-Inan, Shirkat al-Sani,
Shirkat al-Wujuh and Mudarabah. Mufti Taqi Uthmani states that some Ulama contend that since a company
doesn¶t fall within the parameters of any one of these five, it will not be a permissible form of partnership. He then
disproves this rationale by stating that the categorization of these five types of partnerships from the Fuqaha
(Jurists) does not constitute a binding proof since the Fuqaha never mentioned that if a partnership does not fall
within the classification of these types of partnership, it will not be permissible. We accede to the fact that a
company cannot be deemed impermissible simply because it does not fall under one of these five types of
partnerships. However, by looking at the individual rudiments of each type of partnership, general all-
encompassing principles and preconditions can be extracted for all partnerships. If the company adheres to these
principles then such a company will be permissible, otherwise not. One such principle derived by the Fuqaha is
that profits from a Shirkah are derived from one of three avenues; ownership of the assets, work provided upon
the assets as a Mudarib or by bearing liability of the assets despite not being the owner.

12/4/2010 41
‡ In the case of a shareholder, not a single one of these three factors is found entitling the shareholder a right to the
profits. Thus, how can it be argued that a company falls under the ambit of Shirkah (partnership) when its
corollaries oppose the rudimentary characteristics of partnership?
‡ Another contentious issue involves the Shar¶i recognition of the concept of a ³juristic person.´ For the benefit of
those who are not versed in legal and financial terminology, we present hereunder a definition and description of a
³juristic person´ as presented in the books of law:
‡ "We already know that the law regards a human being as a legal subject the natural person. But the law also
provides for the recognition of entities, called juristic persons, which may take the form of a company or close
corporation in the commercial world. (An "entity" can be described as something that exists independently, that is,
apart from the members of which it consists. Note that a partnership is not a juristic person, because it does not
exist as an entity apart from its members.) It is important for you to realize that a juristic person is not a human
being. The only similarity between a natural person (human being) and a juristic person is that a juristic person
also has legal capacity and is therefore the bearer of rights and duties. Furthermore, you must remember that it is
not the human beings within, for example, a company, who are the juristic persons; it is the company itself that is
the juristic person. The company, a juristic person, exists as an independent entity. It has an identity that is
separate from its shareholders or members and it owns the assets and incurs the obligations of the undertaking
(the company). If the undertaking (the company) becomes insolvent, only the assets or property of the undertaking
will be seized, and not the assets of any shareholder or member, because the undertaking is a separate entity.
‡ Some Ulama are of the opinion that the concept of a juristic person as a viable entity with its own financial
responsibility capable of entering into transactions, taking possession and bestowing ownership is valid and
acceptable in Shariah. However, other Ulama oppose this opinion. In argument in favor of its permissibility, the
esteemed Mufti Taqi Uthmani presents four examples of the concept of a juristic person in the Shariah, namely
Waqf, Bait al-Mal, the residual wealth of an insolvent person and Khultat al-Shuyu.
‡ The purpose of this exposition is not to delve into the legitimacy of a juristic person as that will entail an in depth
explanation leading to undue length which will draw attention away from the actual matter of discussion. For the
sake of brevity, we will explore the consequences of both scenarios, namely, assuming its permissibility and its
impermissibility.
‡ ³The Rukn (basic element) of Tasarruf (transacting) is legally acknowledged speech and that can materialize from
slaves. As for considering speech, it is based on the reason that it emanates from a discerning individual and this
(discernment) is not lacking in slaves. The emplacement of Tasarruf is a personal liability capable of obligating
legal claims upon itself and that is not negated due to slavery. The capability of obligating something in one¶s
liability is from the honorable traits of humanity and a person does not cease being a human due to slavery.´8
‡ This passage clearly elucidates that only human beings have the capability and right conducting transactions and
obligating claims as opposed to the theory allowing abstract entities such as juristic persons to carry out the same.

12/4/2010 42
‡ Limited Liability:
As previously mentioned, Limited Liability is a concept that limits the amount of accountability for which a shareholder is
accountable. The shareholder cannot be held legally responsible above and beyond his capital investment. A brief history of
limited liability shows that in and around the middle of the 19th century, various laws such as the Limited Liability Act of 1855
were enacted legalizing the concept in numerous western countries. This edict was enacted as a means of spurring
economic growth in certain limited sectors.

‡ Originally, this concept was considered nefarious due to the inequitable imbalance of risk to gain. In fact, in countries such
as England, a company needed a decree from Parliament before being registered as a Limited Liability Company. By limiting
the shareholder¶s legal responsibility and risk of losing his personal assets, the shareholder will invest more of his capital.
More access to this capital will increase the productivity and profitability of the company. Furthermore, the directors and
founders of the company, being practically untouchable in terms of fulfilling the debts of the creditors, will invest in more
precarious, high-profit ventures without fear of accountability. Charlie Cray states the following, ³Thus, µlimited liability¶ refers
to the fact that outside ³investors´ (versus active participants) can pool their capital in new ventures without worrying that
they might lose their entire worth. It allows those with significant wealth to make capital available for research, innovation and
technical progress, without having to oversee the management of their investment on a daily basis. Thus, the limited liability
corporation has been considered a key feature of economic progress.´

‡ However, this economic progress comes at a price. The question then arises, ³What is the price? And, Who bears the
burden of this price?´
‡ Jacqui Cohen alludes to the answer in her thesis entitled Externalizing of Risk, and states, ³A further advantage of limited
liability is that it allows companies to externalize the risk involved with modern industrial enterprise and passes the risk to the
creditor.´10
‡ Explaining further, Lawrence Mitchell, in Corporate Irresponsibility presents the following, ³Because it shields the owners and
managers from personal liability, limited liability creates what economists call a moral hazard, an increase in the risk of bad
behavior because the costs of that behavior are shifted onto someone else (creditors).´ Put more blatantly he states,
³defining limited liability is simple. « no matter how much pain it causes, the corporation is responsible for paying damages
(if at all) only in the amount of assets it has«You can¶t go after the stockholders for any more than they¶ve invested. You
can¶t go after the managers or employees except in limited and largely irrelevant cases. No matter what kinds of harms the
corporation causes, and no matter what kinds of judgments a court may levy against it, it must pay only what it has.´

‡ Summing up the unjust disproportion of Limited Liability, Jacqui Cohen reiterates, ³Accordingly, the most a member in the
company can lose is the amount paid for the shares themselves and thus the value of his/her investment. As such, creditors
who have claims against the company may look only to the corporate assets for the satisfaction of their claims as creditors
and generally cannot proceed against the personal (separate) assets of the members. This has the effect of capping the
investors risk whilst, consequently, their potential for gain is unlimited.´
‡ The concept of Limited Liability where the risk of the investment is placed on the credulous creditor and the potential of profit
rests as the sole privilege of the investor glaringly contrasts the ethical economic principles laid down by the Shariah which
demand equity and justice.
‡ Shariah, not to mention rudimentary ethics demand that the opportunity for gain be coupled with the risk of liability.

12/4/2010 43
‡ Aisha (may Allah Be pleased with Her) states, ³Rasulullah (Peace be upon Him) decreed that proceeds are based
on liability.
‡ The circumstance of this judgment was that one person sold a slave to another person who assigned the slave to
work in the market and reaped proceeds from his labor. Shortly thereafter, the purchaser discovered defects in the
slave which led him to return the slave and demand a refund. The seller insisted that in exchange of the refund,
the purchaser should return the slave as well as the proceeds earned through his work. The two presented their
case to Rasulullah (Peace be Upon Him) who decreed that the purchaser of the slave was entitled to keep the
proceeds because the proceeds were earned in a period where he was liable for the slave. Had the slave passed
away during that period, the purchaser would have been liable for the loss thus; he was entitled to the earnings.
Decreeing in favor of the seller would have sanctioned him receiving profit and proceeds without being liable for
any loss. That would be unfair and unethical, thus Rasulullah (Peace be Upon Him) prohibited it. This concept is
more clearly presented in another Hadith wherein Rasulullah (Peace be Upon Him) stated, ³There is no profit
without liability.´
‡ From these Ahadith, it becomes clear that the moral philosophy of Islamic Finance and Commerce differs from the
self-centered µdog-eat-dog¶ business policies of the modern era. The notion of Limited Liability pierces the heart of
ethical commerce as alluded to by even non-Muslim western critics such as the following editorial of The Times of
London of 25 May 1824. It declared: ³Nothing can be so unjust as for a few persons bounding in wealth to offer a
portion of their excess for the formation of a company, to play with that excess to lend the importance of their
whole name and credit to the society and then should the funds prove insufficient to answer all demands, to retire
into the security of their unhazard fortune, and leave the bait to be devoured by the poor deceived fish.´
‡ Furthermore, Allah Ta¶ala states,³O you who believe, do not devour each otherµs property unjustly, save through
trade conducted with your mutual satisfaction.´(4:29)
‡ In the case of limited liability companies, how can it be perceived that the creditor would be content and
complacent to lose his commodities without being recompensed for them? The company and the shareholders,
protected by the law of the state, merely abdicate the responsibility to pay their debts after enjoying the profitability
and productivity of the commodities. Mufti Taqi Uthmani holds the view that this concept could be permissible
according to the Shariah and in Islam aur Jadid Ma¶ishat wa Tijarat, he presents a Shar¶i example for it. The
example presented is what in Fiqh is termed as Al-Abd al-Madhoon, namely, a slave who is permitted to work. In
such a scenario, a master permits his slave to trade and conduct business. The master will stipulate a specific fee
upon the slave for this liberty of trade. This creates an opportunity for the slave to work his way to freedom. When
he fulfills a predetermined amount stipulated by the master, the slave purchases his freedom. If during the course
of trade he becomes indebted, he can be sold in lieu of the debt. The master will not be liable for the debt of the
slave. Thus, according to the Honorable Mufti Taqi Usmani, a similar case applies to the shareholders of a
company. The shareholders are similar to the slave owner and the company is like the slave. If the company
becomes indebted, the shareholders will not be held liable. Despite the fact that outwardly this seems like a clear
example of Limited Liability to a layman, in reality the two examples have a great deal of dissimilarity.

12/4/2010 44
‡ The Fuqaha (Jurists) mention that partnership is based on Wakalah (agency).

‡ Since the company and its directors, according to those who permit shares, act as agents on behalf of the shareholders, the transactions
in reality take place on behalf of all the shareholders as if they themselves conduct the business deals. A company bearing a debt in
reality symbolizes the shareholders bearing that debt. Hence, the shareholders are responsible to uphold the conditions of all the
contracts and liable for any deficiency. On the contrary, the slave is not considered as an agent for his master. The slave possesses his
own Milk-al-Yadd, (authority of possession). His business dealings are restricted to himself for himself, excluding the fact that he happens
to be the property of the master and obliged to pay his monthly dues. As such, the slave¶s transactions are not considered as the master¶s
transaction since he is not conducting business on behalf of the master. If the slave incurs a debt, the debt will be restricted to him and
would not transcend to the master. As a means of protecting the general public from uncollected debts of working slaves, the Shariah
permitted selling the slave as a means of fulfilling the debt. Since the slave is not considered as an agent of the master, the creditors are
not allowed to demand the master to fulfill the outstanding debts. However, they can force him to sell the slave and collect their debts from
the sale. A further distinction between the slave and the company is that in the event that the sale price of the slave fails to cover the debt
of the creditors, they still maintain the right to pursue the slave for the remainder of the debt after his freedom.

‡ In the case of a company, there is no such recourse for creditors after the company has claimed insolvency. In conclusion, the Shariah
has stipulated one particular set of rules for a slave permitted to work and a different set of rules for partnerships. It is not proper to
analogize one to the other especially in light of clear Ayat and Ahadith as mentioned above.

‡ Ownership of Shares:
Before delving into the discussion of the permissibility or impermissibility of shares, it is imperative to get a proper understanding and
denotation of shares. The crux of the difference of opinion regarding the legitimacy of shares pivots around what the word ³share´ denotes.
Ulama who permit trade in stocks and shares perceive shares representing one connotation whereas the Ulama who prohibit it argue that
shares represent a different connotation. We will commence by presenting the understanding of shares by those who deem it permissible.
‡ Thereafter we will present the view of the Ulama who disagree coupled with proofs and explanations of the experts of the financial and
legal sectors.

‡ The Understanding of the Ulama who Permit Shares:

The Ulama who surmise that shares are permissible consider them to represent definitive ownership of the assets of the company
proportionate to their investment. Respected Mawlana Qasimi states in his compilation, Jadid Fiqhi Mabahith, ³the Ulama are unanimous
that a purchased share from a company represents the ownership of the shareholder. It is for this reason that when everyone mutually
agrees to dissolve the company, the shareholders will receive a proportionate percentage of the assets.´

‡ Mufti Taqi Usmani states ³These shares in reality represent a proportionate percentage of the
shareholder¶s ownership in the assets of a company.´After being asked about shares, esteemed Mawlana Ashraf Ali Thanwi by and large
permitted shares with the condition that no Haram transactions take place. This was based on the perception that the shareholder owned
the assets of the company in proportion to his investment. The following is the question and its reply: Q: It has become rife that many
people establish partnerships and start companies. Thereafter they conduct business and sell a majority of the shares. Those who
purchase these shares receive a proportionate profit from the earnings of the company. At times it will be more and at times it will be less.
Similarly, if the company bears a loss, then the shareholders will be responsible for a proportionate amount of loss in their respective
shares. Will purchasing such shares be permissible or not? (Note: the answer of Mawlana Ashraf Ali Thanwi is given based upon the
understanding of shares given by the questioner. In reality, shares do not function exactly in this manner.)

12/4/2010 45
‡ A: Trade companies conduct business in various fields (some permissible and others not) and are at times involved in
interest-bearing transactions. Considering the fact that each shareholder is an owner of his own share (of the company) and
that the directors are the agents of the shareholders in the transactions whereby the acts of the directors are attributed to the
shareholders according to the Shariah, if any impermissible transactions take place, and they definitely do, to such an extent
that they even receive interest from Muslims, then this will be considered as if the shareholders themselves conducted it.
Therefore, it will not be permissible to become a partner of such a company«(the understood meaning of this Fatwa based
upon the previous Fatwa on the same page is that if Haram transactions like interest-bearing loans don¶t take place, it will be
permissible.
‡ In establishing the ownership of the assets by the shareholders, the majority of the Ulama present the following two
substantiations:
‡ 1. The shareholder receives an equal portion of the profits as well as suffers from the loss of value in his share as opposed
to bonds where he is guaranteed to receive his original investment as well as a certain fixed percentage of interest
regardless of whether the company is profitable or not.
‡ 2. The shareholder is entitled to receive the residual assets of the company after dissolution in proportion to his shares as
opposed to receiving the exact value of the share certificate as in the case with bonds and other loans.
‡ In the above-mentioned substantiations, it is clearly visible that these Ulama are basing their understanding of shares in
comparison to bonds21, bills, notes and similar types of loans. Bonds generally refer to a long-term loan to the company
where the company guarantees the return of the principle amount of the bond certificate coupled with a specific amount of
interest upon maturity. Regarding these types of loans, it is unanimously agreed that the owners of such certificates do not
own any assets of the company and that any surplus on his original investment will be interest (Riba). Furthermore, in the
event of bankruptcy, owners of bonds and bills etc are entitled to receive the full amount mentioned on the bond certificate as
opposed to shares certificates.
‡ The Ulama who permit shares compare the characteristics of shares to bonds and other loans and infer that shares must
denote ownership of the assets since there is such a distinct difference with the loans. However, merely having the right to
receive residual assets after dissolution and the lack of assurance of profit on the investment does not necessarily denote
ownership of assets. Generally, when a person owns partial assets of a company, the above two characteristics will be found.
However, ownership of assets is not the sole cause of this effect. There could be many other causes producing the same
effect. A logical example of this principle is that a person who leaps from a high-rise building will generally perish; on the
other hand, it is not necessary that every deceased person must have jumped from a building. There are many other causes
that could have led to his demise. Similarly in the case of ownership of assets, there are two effects which are not necessary
corollaries of the existence of ownership in the assets. Considering the fact that a company is a juristic person as explained
in the previous chapters, neither it nor the assets belongs to any shareholder. The assets belong to this new juristic person.
Thus, when the company is dissolved, a sort of metaphysical and theoretical ³death´of the company takes place. In such an
instance the company can no longer remain the owner of its own assets thus its residual assets must be wound up. The laws
of the state suppose that who better to receive these assets than the shareholders; therefore they allocate the assets to them.
Hence, receiving these assets does not necessarily substantiate ownership of the assets prior to the ³death´ of the company.
A similitude of a deceased relative and an heir can also be presented for better illustration. Inheritance of the assets of a
relative does not necessitate that the heirs are the owners of the assets prior to the death of the deceased.

12/4/2010 46
‡ Furthermore, we fail to see how proportionately sharing in the profits and loss of a company necessitates ownership of the
assets. These two conditions can easily be allocated by the company for non-owners as well. They merely have to state that
in return for purchasing the share certificate, a person will receive the right to claim a proportionate profit in the event of gain.
Similarly, they add the disclaimer that in the event of loss, the value of the certificate will also lose its worth. Such conditions
in no way prove ownership of the assets. Understanding of the Ulama who Prohibit Shares Coupled with Juridical
Corroboration: If a person holds a share in a company, it does not imply that he owns the assets of the company.
Linguistically, one would assume that the word µshare¶ denotes a portion or a percentage of ownership in the assets of a
company. However, this is not the case. The definition of the word ³share´ has under gone many changes in history resulting
in a departure from its literal meaning to more of a figurative meaning. The following is a passage of The Conceptual
Foundations of Modern Company Law describing this metamorphosis of meaning:
‡ ³Throughout the eighteenth and early nineteenth centuries, the term 'share' was "used in its natural sense, namely as an
appreciable part of a whole undertaking".22 To possess a share in a joint stock company implied ownership of a share of the
totality of the company's assets. "Shareholders", says D. G. Rice, "were regarded as owners in equity of the company's
property."'23 It followed that, as property, shares were directly related to and co-extensive with the assets of the company
and that their legal nature depended on the nature of those assets. Shares could be either real or personal estate depending
on whether or not the company owned land. When the courts had to decide whether shares (in both incorporated and
unincorporated companies) were realty and, therefore, within the Statutes of Mortmain or Frauds, they uniformly held that the
matter turned on the nature of the company's asset. 24 In the early 1830s it was still consistently being held that company
shares were realty if "the corporation were seized of real estate".25 Crucially, while the share was legally perceived as an
equitable interest in the company's assets, shareholders ± the equitable co-owners of those assets ± were necessarily
closely identified with their companies. They could not be 'completely separate'. From the 1830s, however, the legal nature
of shares began to be re-conceptualized, and by the mid-nineteenth century the close link between shares and the assets of
companies had been severed. The crucial case, Bligh v Brent, was decided in 1837 and concerned shares in an
incorporated waterworks company. The issue before the court was whether the company's shares were realty and within
Mortmain. In accordance with the prevailing view, counsel argued that the nature of the company's shares as property
depended on the nature of the company's assets. In every joint stock company, he asserted, "the shareholder has an estate
of the same nature as the company". Despite the overwhelming weight of the authorities, the court rejected this view. They
argued that the case turned on "the nature of the interest which each shareholder is to have", and in their view shareholders
in incorporated joint stock companies had interests only in the profits of companies and no interest whatsoever in their
assets. The shares were personality, irrespective of the nature of the company's property. Bligh v Brent was the turning
point, although uncertainties remained for some years after, particularly in relation to the nature of shares in unincorporated
companies and in companies whose business activities were closely connected to land. By the mid 1850s, however, these
had largely disappeared. In Watson v Spratley, decided in 1854, the court had to determine the nature of the shares of an
unincorporated mining company. It held that the matter turned on "the essential nature and quality of a share in a joint stock
company", and declared its shares to be interests only in profits. Henceforth, shareholders, even in unincorporated joint
stock companies, had no direct interest in the physical assets of their companies. Shares were personality irrespective not
only of the nature of the company's assets but also of its legal status. They were an entirely separate form of property: legal
objects in their own right. They had been freed from their direct link to the property of joint stock companies. By 1861 Sir
John Romilly was asserting that "shares in joint stock companies . . . are, in fact, in the

12/4/2010 47
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12/4/2010 48
 extinguished by the mechanisms provided by the articles of association or the Companies Act.´
The following is another citation clearly defining who the actual owner of the assets is and what the shareholders possess:
"Important consequences of the fact that a company is a separate entity existing apart from its members are the following:
(a) The company estate is assessed apart from the estates of individual members; consequently the debts of the company are
the company s debts and not those of its members. The sequestration of the estates of members will not lead to liquidation of
the company and, conversely, the liquidation of the company will not necessarily entail the sequestration of estates of the
members. The position is different with a partnership which does not exist as a separate person: the estates of the partners and
that of the partnership are sequestrated simultaneously.
(b) The profits of the company belong not to the members, but to itself. Only after the company has declared a dividend, may the
members, in accordance with their rights, as defined in the articles of the company, claim that dividend.
(c) The assets of the company are its exclusive property and the members have no proportionate proprietary rights therein. Only
on liquidation of the company are members entitled to share in a division of the assets of the company."
From the above judicial verdicts and legal texts we come to know that a share has, in our era, come to denote set of rights rather
than referring to partial ownership of the assets as previously understood. These rights generally entail voting rights during the
Annual General Meeting, rights to a monetary payout referred to as a dividend in the event of a profitable fiscal term, and rights
to the residual assets in the rare event of dissolution of the company.
The Fuqaha have codified the following principle that fits quite aptly in the case at hand, ³The ruling will, at times, change with
the changing of eras.´33 As previously explained, the term µshare¶ in the previous era denoted actual ownership in the assets of
a company; therefore, in such an era, purchasing and investing in shares would have been permissible according to the Shariah.
However, as the times changed, the meaning of µshare¶ changed whereby a shareholder no longer purchased a fractional
percentage of the company¶s assets, therefore, in such an era, it will not be permissible according to the Shariah to purchase
shares since such a transaction does not fulfill the Shar¶i prerequisites of Shirkah (partnership). It is due to this reason that some
illustrious Ulama of the past issued verdicts of permissibility regarding shares. However, it will not be correct for Ulama of the
modern era to issue a Fatwa of permissibility based upon the view of the Ulama of the previous eras.
From the above passages, this much becomes clear that in the eyes of the legal and financial sectors, a shareholder is not
deemed the owner of the assets of a company. It is important to bear in mind that it is the state that brings companies into their
metaphysical existence. Therefore, the state decrees how the directors and shareholders relate to a company. If the state
decrees that the shareholders do not own assets of the company, then under the authority of the state, the shareholder cannot
own the assets. If the state decrees that the company, in itself as a juristic entity, owns all of the assets of the company, then
under the authority of the state, only the company will be regarded as the owner. We are convinced that if this proper
understanding of companies and shares is presented before the Ulama, they will also issue the verdict of impermissibility. All of
the Ulama agree in regards to two scenarios, namely, if the shareholder does not own the assets, his profit will be Riba and if he
is the owner of the assets, then the profit will be permissible as long as the other preconditions of trade are upheld. The main
difference rests upon the perception of who the owners of the assets are. Presenting the above-mentioned proofs clearly shows
that the shareholder does not own the assets. Therefore, it is a natural and juristic corollary that all of the Ulama with this
understanding pass the verdict of impermissibility. The Fuqaha (Jurists) clearly mention that there is only one of three ways that
a person can receive a profit upon his investment:
1. Growth of his owned assets in a partnership
2. Work conducted on behalf of the partnership as the case with a Mudarib
3. 12/4/2010
Bearing complete liability (as in the case of purchased assets on credit) despite not being the owner. 49
 Bearing the above three pointes in mind, we come to know that the shareholder is not entitled to receive any
amount of profit upon his purchase of shares. The shareholder neither bears complete responsibility of the
assets of the company, nor provides any service for the company as a Mudarib, nor owns any percentage of
the assets of the company whereby the profits earned through the shares could be termed as the growth of
his personal assets. Thus, considering the fact that a shareholder receives dividends and profits in absence of
any exchange, the surplus amount beyond his initial investment will be considered as interest. This ruling is
based on the juristic definition of Riba, ³Riba is any excess amount free from a reciprocal substitute or
exchange.´
‡ K


<:
The concept of a company or a corporation existing as a separate juristic person is frequently referred to as a
³Corporate Veil´. The Corporate Veil refers to an abstract cloak masking the founders, directors and
shareholders of a company from the being held personally responsible for any action conducted on behalf of
the company, directly or indirectly. All of the affairs of the company are deemed self existent and attributed
directly to the company itself as a juristic person. The actions of those who run the company will not be
attributed to the individuals in their personal capacities, rather their actions will be deemed to be the actions of
the figurative organs and limbs of the company as subordinates to the corporation. However, there are certain
rare circumstances where the state decides to disregard the Corporate Veil and the juristic personality of a
company and regards the fraudulent activities of directors or shareholders to be actions conducted in their
personal capacities. In such a situation, the shareholder will not be able to mask his identity behind the
Corporate Veil attempting to elude the law. Section 424(1) of the Companies Act reads:
³Where it appears that the business of the company is being carried on recklessly or with the intent to defraud
creditors of the company, the Court may, on application, declare that any person who was knowingly a party
to the carrying on of the business in the manner aforesaid, shall be personally responsible, without limitation
of liability for all or any of the debts
or other liabilities of the company as the Court may direct´.
The general rule is that a company including its directors and shareholders will be deemed as a legal entity.
However, when the concept of juristic person is misused to commit fraud, defend crime or any other illicit
activity, the law will regard the corporation or a segment of the corporation, namely the perpetrators of such
misdeeds, as merely a coalition of persons and not as a constituent of the company.

12/4/2010 50
Jenkinson J, in Dennis Willcox Pty Ltd v Federal Commissioner of Taxation, stated that:
³The separate legal personality of a company is to be disregarded only if the court can see that there is, in fact or in law, a partnership
between companies in a group, or that there is a mere sham or facade in which that company is playing a role, or that the creation or use of
the company was designed to enable a legal or fiduciary obligation to be evaded or a fraud to be perpetrated.´ 36
One of the most oft cited cases of piercing the Corporate Veil due to fraudulent activity is the case of Jones v Lipman [1962]. In this case
Lipman agreed to sell land to Jones but before completion of the contract he changed his mind and sold the land to a company which he
and another were the sole directors and shareholders. The judges ordered specific performance (fulfilling the promised obligation) against
Lipman and the company. The company was described as a device and a sham, ³a mask which Lipman held before his face in an attempt
to avoid recognition by the eye of equity.´
The court of law will only intervene in clear cases of deception and fraud. However, the court is very precautious in its approach striving to
maintain the fundamental principles established to protect legal lawbiding companies and its directors and shareholders.
An example of such precaution is the 2006 Supreme Court of Appeal case of Heneways Freight Services v Klaus Grogor. Mr. Grogor was
the sole director and manager of a company that imported exotic cars. Heneways were clearing and forwarding agents contracted by
Grogor. He applied to Heneways for credit and after being granted, he incurred a debt of approximately R300, 000. Grogor sent a post-
dated check for the amount. However, before the date of payment arrived, he stopped payment on the check. His company filed for
bankruptcy and thus was later liquidated. The Heneways did not receive payment and it seemed that they were left with no recourse
against Mr. Grogor¶s company. With no other alternative, Heneways sued Grogor personally for reckless and fraudulent trading under
section 424(1) of the Companies Act. In their claim, Heneways presented evidence that Grogor had a habit of issuing post-dated checks on
behalf of the company which were later stopped before the date of payment arrived. They claimed that Grogor was aware of the company¶s
unstable financial situation when he applied for credit. They alleged that he knew that his company would not be able to pay its debts when
they became due. They argued that his business practices were fraudulent and/or reckless. In defense, Grogor admitted that the company
was in financial straights thus he adopted the method of settling more pressing debts first and making arrangements to settle the others. He
presented that the company was to be bought out by a large partner shortly after the R300, 000 debts was incurred. He claimed that debt
was to be paid from the proceeds of that deal. He further stated that in the event that this deal did not materialize, the company would have
been able to settle its debts by selling some of its assets to revive the company¶s cash flow. The court accepted Grogor¶s explanations and
held that a reasonable businessman in his position would have acted in the same way. His conduct was not found to be reckless or
fraudulent.
The central aspect of concern here is that only such members responsible for the reckless behavior will be held liable and not the innocent
shareholders. When the personal liability is placed upon certain shareholders or directors, it will be placed upon the responsible parties
directly involved and not upon all the shareholders as they were not directly involved in the fraud etc thus, they remain free from liability.
Furthermore, in a typical scenario where no fraud or deception takes place and the company incurs debt and thereafter files for bankruptcy,
the creditor will remain exploited with no legal recourse. The shareholders are absolved from any personal financial accountability despite
the fact that the level of profitability is limitless. The above-mentioned Heneways Freight Services v Klaus Grogor case is a clear example of
this injustice. Despite the fact that the secular law doesn¶t consider this act as deceitful and fraudulent, the Shariah considers it nefarious
and reprehensible.
Assuming this company had shareholders, each shareholder would be proportionately responsible for this oppression, injustice and
usurpation of wealth.
The fact that the state, at times, restrictedly disregards the juristic person and Corporate Veil does not negate the corruptive and iniquitous
aspects of limited liability, lack of ownership of the assets and the legal reality of the ³legal entity as a whole in respect to the general
shareholders.´
An apt example in the Shariah of a similar type of exemption from the general rule is the case of a person who gifts away a considerable
amount of his wealth whilst on his death bed. In this scenario, the dying person is suspected of fraudulent activity by attempting to deprive
some of his heirs from their rightful inheritance. Thus, the Shariah will restrict the transactions of such a person looking after the best
interest of the public, namely the heirs who stand to inherit. The Shariah disregards the intrinsic right of the living person to transact in his
12/4/2010
own property in order to circumvent his fraud. However, it would not be proper to state that the Shariah does not consider a person 51to
possess the right of disposal in his personal wealth. This case is merely an exception to the general rule.
 Similarly, it cannot be said that shareholders are personally held liable for the company¶s debt or that the
juristic person is merely a legal fiction therefore; shareholders are not participants of the usurpation of wealth
and are the legitimate owners of the company respectively. The seldom cases where the state pierces the
Corporate Veil is an exception to the general rule and it applies in a very restricted manner to specific
individuals. It does not encompass the normal shareholders of a company who will still be participants to the
injustice of limited liability and the sin of earning interest upon un-owned assets.
‡  
Shareholder has been likened to a partner in a Shirkah; therefore, since a company or corporation has been
likened to a Shirkah, we will entertain this premise and delve into the various possibilities therein. As is known
to the honorable Ulama, in order for a person to enter into an existing partnership, he / she must purchase a
certain percentage of the company assets so that he can become an undivided partner in every portion of all
the assets. A person cannot enter into a Shirkah without this essential phase. The same concept applies to a
new Shirkah in that Khulta (mere pooling of wealth) will not constitute the Shirkah. The Shirkah will only
convene after purchasing commodity with that joint wealth. Thus, the very first step of becoming a partner in
the company is purchasing undivided assets from it. This demands that a Bai¶ (contract of sale) take place
between the prospective partner / shareholder and the company. In a Bai¶ there must be a seller and
purchaser. In the case at hand, the seller is the company and the purchaser is the prospective shareholder. In
defining both of the parties on either side of the transaction, there are two possibilities;
1. where the Shariah recognizes the concept of a juristic entity with its own dhimmah (legal financial
responsibility)
2. where it the Shariah does not recognize the juristic entity as such In subsequent scenarios, we will see that
its recognition and lack thereof will not bear any relevance to its permissibility.
In the first scenario, the prospective shareholder will accede to purchase a specific percentage of the
company¶s assets from the company itself. As well all know, the basic Rukn (element) of Bai¶ is Ijab (offer)
and Qabul (acceptance). One party presents an offer and the other party has the right to accept or reject the
offer. The purchaser will present its offer to purchase ³shares´ from the company which he deems to
represent a specific percentage of ownership in the company¶s assets. However, there is no acceptance on
the very same offer. As previously mentioned, the company, by law, is not selling percentages of the physical
assets rather, it are merely selling a ³bundle of rights´ as a ³share.´ Thus, we have inconsistency and
discrepancy in the very Arkan of the Bai¶. With such discrepancy in the Arkan (base elements), the Bai¶
cannot take place, hence, the partnership will cease to exist for the prospective shareholder since he failed to
purchase an undivided percentage of the assets of the company. Assuming that both parties concur on the
Mabee¶ (article of sale), in the transaction, then the Arkan of the Bai will be established. In this case, the
purchaser will concur with the company in that the Mabee¶ will consist of merely a ³bundle of rights.´ In this
regard the Fuqaha have clearly stated, ³The independent sale of rights is not permissible.´37
12/4/2010 52
‡ Thus, in this scenario, the partnership still fails to materialize; firstly due to the fact that such a transaction is neither permissible nor
recognized by the Shariah and secondly due to the fact that the partnership can only commence after purchase a percentage of the
physical assets and not a ³bundle of rights.´ Before continuing further, it is important to understand why the commodity of sale is a
³bundle of rights´ and not a percentage of the assets. We previously mentioned that the respected Ulama who permit shares presume
shares to be ownership in the assets based upon two indicative after-effects of ownership, namely;
‡ 1. The shareholder receives an equal portion of the profits as well as suffers from the loss of value in his share as opposed to bonds
where he is guaranteed to receive a certain percentage of interest regardless of whether the company it profitable or not.
‡ 2. The shareholder is entitled to receive the residual assets of the company after dissolution in proportion to his shares as opposed to
receiving the exact value of the share certificate as in the case with bonds and other loans.
‡ These effects merely indicate to the possibility of ownership of the assets. However, effects can have more than one cause.
Therefore such evidence is insubstantial.
‡ As previously mentioned, a juristic person is an abstract intangible creation of the state. The state defines what a juristic person is
and what role it plays in the workings of a company. If a juristic person is likened to Waqf (trust) as indicated by the Honorable Mufti
Taqi Uthmani, then the authority of defining the juristic person and its function is similar to what a Waqif does in the initiation of a
Waqf. The Fuqaha state, ³The conditions set by a Waqif (initiator of a trust) are similar to the clear text of the legislator of the
Shariah.´
‡ This precept demands that all conditions laid down by the Waqif in the initiation of the Waqf (trust) be treated similar to a direct text of
the Shariah in that all conditions must be fulfilled without fail by the guardians of the Waqf. A Waqif initiates the existence of a Waqf;
similarly, the state initiates the existence of the company.
‡ Therefore, similar to the conditions laid down by the Waqif, the conditions and directives of the state must be recognized and upheld.
Among various conditions, one includes the company being the sole owner of all the company¶s assets. The Ulama, therefore, cannot
disregard the definitions and denotations presented by the state in regards to companies and juristic persons when deliberating over
the aspect of shares.
‡ Moreover, the Fuqaha mention the following principle,
‡ ³The Implicit will not be granted any consideration in the face of the Explicit.´
‡ From this principle, we understand that the substantiation used by such Ulama will not be considered in the face of an explicit edict
given by the courts in regards to the nature of a share. The court has explicitly defined a share as a ³bundle of rights´; therefore, any
implicit indication by means of inference that a share refers to a percentage of the assets cannot be juristically entertained.
‡ In the second scenario, namely in the event that the Shariah fails to recognize the concept of a juristic entity as a viable entity that
possesses its own dhimmah capable of entering into transactions, possessing and bestowing ownership, all of the transactions will
be directed and attributed to the founding members of the company.
‡ Similar to the above scenario, the prospective shareholder will be incapable of purchasing the required assets of the company
because, it is not the assets that are being sold, rather ³shares´ i.e. ³bundle of rights.´ The question that might linger in the mind is
that what if the purchaser and seller both agreed to this sale of ³bundle of rights´ as opposed to the assets?
‡ The answer is that the proceeds of such a transaction will be considered as Riba. As previously mentioned, the Fuqaha state that
there is one of three ways to earn a profit;
‡ 1. Growth of his owned assets in a partnership
‡ 2. Work provided upon the assets on behalf of the partnership as the case with a Mudarib
‡ 3. Bearing complete liability of assets despite not being the owner as the case with Shirkat al-Wujuh etc.
‡ In the mentioned transaction and so-called partnership, the ³shareholder´ neither owns any physical assets where the profit will be
considered as the growth of his assets, nor does he provide any work for the company as a Mudarib nor does he bear any liability for
the assets of the company. Thus, the proceeds awarded to him will be free from any exchange in a binding contract which fits the exact definition
of Riba;
12/4/2010 53
‡ Our opinion, based upon the above-
mentioned substantiations, is that purchasing
shares is not permissible and receiving
proceeds upon them will be Riba. We urge
the public to refrain from investing in such
ventures. There are other permissible income
generating alternatives. Thus, we advise
looking into other alternatives as a means of
saving one¶s income from Haram wealth.

12/4/2010 54