HAIZAM FITRI BIN ABDUL JALIL 1 2008268206 SITI

HAIZAM FITRI BIN ABDUL JALIL 1 2008268206 SITI NURAMANI BINTI ABDUL MANAB 2008261672 SITI NUR HANIM BINTI ISMAIL 2008268228

ISLAMIC LAW OF TRANSACTIONS (LAW 737) Research Topic: Mudharabah and Musyarakah are among the products introduced in Islamic Law in order to avoid the practice of riba (interest). Compare and contrast these two contracts. 2

Definition: - Mudharabah : means that one party provides capital and the other utilises it for business purposes under the agreement that profit from the business will be shared according to a specified proportion. (Partnership and Profit-Sharing in Islamic Law, Muhamad Nejatullah Siddiqi, The Islamic Foundation, London, U. K, 1985 pg 15) - Musyarakah : means participation of two or more persons in a certain business with defined amount of capital according to a contract for jointly carrying out a business and for sharing profit and loss in specified proportions. (Partnership and Profit-Sharing in Islamic Law, Muhamad Nejatullah Siddiqi, The Islamic Foundation, London, U. K, 1985 pg 15) 3

DEFINITION (CONT. . ) Riba (interest): the extra money that you pay for borrowing money from bank or the money that you earn when you keep money in a bank. (Oxford Wordpower Dictionary, new 3 rd edition) Prohibited in Islam through Al-Quran verse (3. 130) “You who believe, devour not usury, double and multiplied; but fear God that you may [really] prosper. ’ (Article by Hussein Hassan; Contracts in Islamic Law: The Principles of Commutative Justice & Liberality (2002)) The Prophet p. b. u. h said: “Gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, of the same quantity and quality, from hand to hand. If there is a surplus, this is usury. If the article are of different nature, sell as you please, but from hand to hand. ” (from same article) 4

CONT. . Furthermore, Al-Quran verse 2: 275; “Allah permitted bay (sale and purchase) and prohibited riba (interest or usury)”. [The Practices of Shariah Principles in Instrument of Islamic Financial System : An Overview by Fadillah Mansor) In applying the above verse, muslim scholar as well as the practitioners established principles of mudharabah and musyarakah. 5

FEATURES OF MUDHARABAH ü Agreement between at least 2 parties known as lender/investor (I) (ra’s al-mal) & entrepreneur (E)(mudarib). ü I entrust money to E who will manipulate for profit in the agreed manner. If any, I will receive principles and profit on pre agreed proportion and remaining balance will be kept by E. ü Profit will be on proportional basis not on lump sum or guaranteed return. It revealed no unfair terms to be shouldered by E. ü Uncontrollable loss by E, I will face it consequence of financial losses (tangible) but E only losses time, effort or may be reputation in the eye of future investor (intangible). ü I tend to act as “sleeping partner”. ü Only I contribute the capital. (all from Fadillah Mansor’s article) 6

CONT… Ali bin Abi Talib empahsised that all losses must be paid for out of capital. If the profits are divided equally as per their agreement, no losses will be charged to the mudarib. If the investor has stipulates the conditions that the mudarib should not enter into any transaction involving certain conditions and the investor did not follow the instruction the investor is not liable to any repayment or replacement of the capital 7

FEATURES OF MUSHARAKAH Ø Ø 2 broad categories: v Sharikah al-mulk i. e property partnership v Sharikah al-’aqd i. e contractual partnership 5 types of Sharikah al-’aqd: v Sharikah al-mal or finance partnership v Sharikah al-a’mal or labour partnership v Sharikah al-wujuh or credit partnership v Sharikah al-’inan or limited investment partnership 8 v Sharikah al mufawadah or unlimited investment

CONT, . ü Joint-venture agreement involves 2 parties for specific business activity for the sake of profit. ü Timely based agreement or fulfillment of certain objective ü Both parties will contribute capital and involve in the management of that business activity. Capital can be in any form of immovable property or cash. ü Profit sharing based on specified agreed ratio. ü Consequence of any loss, parties shoulder the loss in proportion to their share of financing. 9

SHARIKAH AL-MULK The origin of the partnership is the joint ownership of property. Joint ownership is its only qualification, and no joint exploitation of property is necessary. It occurs when two or more people are partners in the possession of property. The rule governing this type of sharikah is that any increase in the property shall be shared by the co-owners in proportion with the extent of their ownership. Each of them is in the category of a stranger in regard to any action on the part owned by his colleague. It is unlawful for either partner to perform any act with respect to the other’s share except with the latter’s express permission. 10

CONT… In terms of liability of the partners, they are quite independent of each other, except for actions based on express authorizationby any of the partners. Their partnership is only in terms of ownership and potential sharing of any profit or increase in the co-owned property, not in term of sharing the liabilities arising from the partners’ actions. This type of sharikah may not be known in the common law or Malaysian law. In fact mere joint-ownership is generally insufficient to constitute a partnership in common and Malaysian law 11

SHARIKAH AL-’AQD The origin of the partnership is the contract between the parties. The structure of this type of sharikah may have more similarities with the normal partnership in common law and Malaysian law. For sharikah al `aqd, joint ownership is not an element necessary for the establishment of the partnership. The emphasis is rather on the joint exploitation of capital and the joint participation in profits and losses, based on the terms of the partnership contract. Joint ownership is one possible consequence, and not a prerequisite for the formation of sharikah al `aqd 12

CONT… The jurists further sub-divide Sharikah Al Aqd into various other categories. The subdivisions depend on a number of factors. If the underlying factor is the subject matter of capital contribution, sharikah al `aqd can be subdivided into three main categories: (1) sharikah al amwal, (2) sharikah al a`mal (3) sharikah al wujuh. When the subject matter of the capital is money, it becomes sharikah al amwal (monetary partnership). If the capital is in the form of labour, it becomes sharikah al a`mal (labour partnership). If the capital is in the form of reputation or creditworthiness, it becomes sharikah al wujuh (reputation partnership). 13

CONT… The jurists also make further sub-divisions to sharikah al `aqd based on the terms of the contract, i. e. , whether the partners are required to contribute equally to the capital and enjoy full equality in exploiting the capital and sharing the profit or not. Based on this consideration, sharikah can be divided into two types, sharikah al mufawadah and sharikah al ‘inan. Sharikah al mufawadah means an unlimited investment partnership, whereby each partner must contribute equally to the capital, and enjoys full and equal authority to transact with the partnership capital or property. The Hanafis consider each partner as an agent (wakil) for the partnership business and stands as surety (kafil) for the other partners. Thus, the partners can be made jointly and severally responsible for the liabilities of their partnership business provided that such liabilities have been incurred in the ordinary course of business. 14

CONT… This type of sharikah clearly implies unlimited liability on the part of partners since they are both agents and guarantors of each other. Sharikah al’inan can be defined as a limited investment partnership. Whereby each partner may only transact with the partnership capital according to the terms of the partnership agreement and to the extent of the joint capital. Hence, their liability towards third parties is several but not joint. The liability of partners in Sharikah Al`inan resembles that of modern-day limited liability partnerships. Both Sharikah Al-Mufawadah and Sharikah Al`inan can occur in all the three earlier types of sharikah, i. e. , Sharikah Al Amwal (monetory partnership), Sharikah Al A`mal (labour partnership) and Sharikah Al Wujuh (reputation partnership). 15

CONT… Sharikah Al Mufawadah is rarely opted for due to the higher degree of responsibility and the practical difficulty to achieve full equality between the partners in all aspects of the partnership 16

COMPARE AND CONTRAST MUDHARABAH Definition Profit sharing. Sunnah It was narrated by Ibn Majah that the Prophet was reported to have said: “Three things done which have a blessing in it, namely, credit sale, Mudharabah, and a mixture of flour and barley for the purpose of invitation, and not for the purpose of sale” MUSYARAKAH Definition Partnership. Literally it means a joint venture agreements between 2 parties to engage in a specific business activity with an aim making profit. 17

Mudharabah capital represents savings for the owner or investor but is generally a source of livehood for the working partner or entrepreneur. Method It the basis of reorganizing banking activity in an interest free framework. This can be done by entering into 2 tier Mudharabah Agreement. Method The Islamic investment company and the client agree to participate in a joint venture to be completed within an agreed period of time. 18

First Tier Between the bank and the depositor who agrees to put money in the bank’s investment account and to share profit with it. In this case, the Depositors are the providers of the capital and the Bank functions as the Manager of funds. Both parties contribute to the capital of the operation in varying degrees and agree to divide the net profit in proportion to the amounts invested by each. 19

Second Tier Between the bank and the entrepreneurs who seek finance from the Bank on the conditions that profit accruing from their business will be shared between them and the bank in previously agreed proportion, but the lost shall be borne by the financier only. In this case, the Bank functions as provider of capital and the Entrepreneur work as the Manager. 20

In case there is more than one financier of the same project i. e one project is jointly financed by several Banks, profits are to be shared in mutually agreed proportion previously determined but lost is to be shared in the proportion in which the different financier’s have invested the capital. 21

Principle As a basis of financial intermediation in the Islamic economy is offered as a viable basis for an interest free banking system. Both parties will provide capital and the investor or lender may also participate in the management. The creditor does not earn interest on the fixed rate in this system but participate in the business risks and earn the share of the profit. Thus, under an Islamic Banking system, the cost of capital is not zero, i. e, analogous to a zero interest rate, as some people assume it to be. 22

The only difference between Islamic banking and the interest banking in this respect is that the cost of capital in interest based banking is expressed in terms of a predetermined fixed rate, while in Islamic Banking, it is expressed in absolute amount which may also be expressed as a ratio of profit. The distribution of profit between two parties must necessarily be on a proportional basis and cannot be a lump sum or a guaranteed amount. 23

In the case of loss as a result of circumstances beyond the control of the entrepreneur, the investor will bear all the financial risk and the entrepreneur losses the time and his effort s only. Profit distribution No profit can be recognized or claimed unless the capital of the Mudharabah is maintained intact. Profit distribution Profit will be shared by two parties in the agreed ratio and the ratio not coincide with the ratio of participation in the financing activity. 24

Whenever the Mudharabah incurred losses, such losses stand to be compensated by the profits of future operation incurs losses, such losses stand to be compensated by the profits of future operations of the Mudharabah. The losses brought forward should be set again the future profits. All in all, the distribution of profit depends on the final result of the operations at the time of liquidation of the Mudharabah contract. 25

If losses are greater than the profits at the time of liquidation, the balance (net loss) must be deducted from the capital. If the total Mudharabah expenses are equal to the total Mudharabah revenues, the capital provider will receive his capital back without either profit or loss, and there will be no profit in which the entrepreneur is entitled to share. If profit realized, it must be distributed between parties as per Agreement. 26

Liability Entrepreneur shall not be liable for any loss of the venture. In the event of loss, all parties bear the loss in proportion to the share of financing Thus, if the Mudharabah business runs into a loss, only the investor will have to bear the loss. 27

Period Continues as such for as long as the entrepreneur does not contribute his own funds to the business. Each partner is entitled to terminate the partnership after giving his partner(s) due notice to the effect, in which the case he shall be entitled to his share in the partnership, and the withdrawal would not necessitate the termination of the partnership of the remaining partners. It come to an end at the expiry date or before the expiry date if the partners agree to terminate it prematurely, or, in the case of partnership in a particular business, by actual liquidation of the assets that constitute the subject matter. 28

CONCLUSION Although equity financing was not dealt with th Quran, the Sunnah affirmed that Uqud al Ishtirak (profit sharing contracts of Al Mudharabah and Al- Musharakah practised by pre-Islamic Arab society are allowed in Islam. As stated earlier, this would extend to the profit sharing contracts practised by Pre. Islamic Arab society. On this basis, equity financing was allowed in islam as well. Surah An-Nisa(4), verse 32 : “ Do not convert the bounties which God has bestowed more abundantly on some of you than on others. Men are allowed what they earn, and women are alloted what they earn. Ask God for something of His bounty…. - The above verse reiterates the principle that no one may claim more than he has earned. 29