Islamic Finance: Principles and modus operandi of Musharika

Continuing with our understanding of the original Islamic financing products, today we will learn about the definition of Musha-rika, its principles, categories and adoption by Islamic banks.

The literal meaning of the word Musharika is partnership or sharing. When two or more parties join hands by contributing equity towards developing a commercial activity, they enter into Musharika. Following are the main characteristics of Musha-rika:

• Musharika can be entered into for one line of business activity or more. This is suitable to a situation where the equity contributed could be utilised to develop and promote a set of activities, for example general trading.

• The ratio of sharing the profit must be pre-determined between the contributing parties. It is not necessary that such ratio is the replica of the equity contribution percentage. It may depend upon the role played by each partner in developing the business and generating profit.

Expanding this point, please note that some partners may be passive whereas the others playing key role in running the business. As such, former's right over the profit should be lesser than the latter.

• However, when it comes to sharing the liabilities, damages or losses, it must be done according to their equity contribution ratio.

• Through Musharika, an interested party can invest in a running business temporarily without becoming a direct shareholder. In such a situation, the Musharika agreement should clearly spell out role of the new equity and the period for which it is being deployed.

However, the responsibility of the existing liabilities on the entity will continue to rest with the actual shareholders. The interested party could seek exit upon completion of Musharika tenure or opt to continue. As per the agreement, he may also exercise equity conversion option, third party sell down or by going public through an IPO.

• All the partners in a Musha-rika are the agents of one another and also act as guarantor for each other.

There can be different kinds of Musharika. Main concepts can be categorised as follows:
A. Musharika Mutavadha: all partners hold equal stake, take active part in running the business, enjoy equal right to the profits and of course share the losses equally. It is commonly seen amongst members of one family.

B. Musharika Inam: partners have different, but agreed, positions in respect of the number of shares, facilities, remuneration, profit, etc. Partners are not agents for one another nor do they act as guarantors for each other. Therefore every partner is individually responsible for his share of liability.

C. Musharika Wujooh: partners do not contribute capital but share profit or loss in the ratio of their pre-agreed responsibilities. They purchase goods on credit, based on their credibility and sell them on cash or short-term credit and repay the suppliers by utilising sale proceeds. The balance, being profit, is distributed bet-ween partners.

Some scholars consider it too a Musharika when a group of people such as factory workers, artisans, peasants, technicians, lab-ourers, etc join hands to accomplish a certain job without any equity contribution but by utilising their skills. Since it is a partnership without capital, the partners are entitled to draw an agreed wage rather than profit. An example could be the sale proceeds of the agricultural output on the tenanted land, masonry work, etc. This is termed as Musharika Sanai.

Like any other Islamic financing mode, the pre-requisite of Musharika is the complete lack of the element of riba (interest) at all stages of its operation. Further-more, the nature of activity should be compliant to the principles of Sharia (excluding liquor, pork, gambling, etc). Another important feature is that the return should not be guaranteed or fixed in monetary terms.

In a continuing Musharika, in the event of loss in a year, it is allowable to adjust it out of the accumulated reserve since it was originally carved out of the partners' share of profits. However, if that does not suffice, the residual loss should be absorbed by partners in accordance with their equity ratio.

Due to the nature of Musha-rika, the following accepted norms of partnership would also apply to it:

1. A partner cannot start a separate business of his own in the same line as of the Musharika he has entered into.

2. He is not authorised to enter into any other Musharika without the consent of the other partners. However, he may start a different business in the individual capacity (sole proprietorship).

3. A partner is solely responsible towards the other partners for any loss which he may have caused to the Musharika due to his own negligence.

Islamic banks do enter into Musharika transactions with clients. However, such transactions are redeemable in nature since it has been seen that clients do not want banks' permanent presence in their field of activity.

Under redeemable Musharika, an Islamic bank finances part of the total cost of, say, a real estate asset, and register its ownership rights by way of an agreement entered into with client. In the agreement, the client undertakes to:

1) Buy back bank's share of ownership in the asset, gradually in pre-agreed periodical installments or lump sum in bullet payment, and;

2) Rent out bank's part of the ownership in the asset at an agreed leasing rate.

In case of gradual buy-back scenario, repayment installment is comprised of two components, buy-back of bank's ownership in the asset (principal) and the rent on the remaining part of bank's ownership in the asset (profit).

In case of bullet repayment, client will continue to pay the rent on bank's part of the ownership for each rent period, till the end of Musharika tenure when the bullet payment is due.

It will be worthwhile to note that once the Musharika agreement is made, it cannot be revoked or modified. Therefore, in case of default from client, bank can exercise its right to take full control of the asset, dispose it off to a third party and apply the sale proceeds to recover its financing. In the event of a shortfall, bank cannot have recourse to the client.

Since Islamic banks act as Modareb for depositors and shareholders, they undertake Musharika transactions carefully and obtain additional securities from clients in order to cover any shortfall. This is aimed at safeguarding the trusted funds and as such is allowed by Sharia.