Following the logical sequence on the aspects of a Mudarabah transaction, our next stop is very important from the perspective of the Rab Al Maal who provides 100% capital and takes a backseat, and to a lesser extent the Mudarib whose efforts are at stake.
Although the matter of ‘risk’ has been discussed on several occasions in this ‘Back to Basics’ series including in the articles on the current subject of Mudarabah, I believe it is time that we gather all of them in one place when it comes to Mudarabah transactions and also add some other risks which have not been discussed in order to be able to fully comprehend the overall risk proposition for both the Rab Al Maal and Mudarib and how either of the parties can mitigate them to safeguard their respective interest.
Before hitting the road, it is important to clear our understanding of ‘risk and return’ through the prism of Islamic finance. You see, in Islamic jurisprudence, risk has been categorized in the following three levels:
Essential risks
These are the risks which are essential and obligatory to make a contract or transaction Shariah compliant. The following are a few illustrations:
1. A sale agreement requires that the seller must bear all risks related to the commodity (ie the risk of loss, damage, defect, depreciation, etc) until the time that it is sold and delivered to the buyer in a manner that the buyer is satisfied and is fully capable of benefiting from the purchased commodity as the new owner. When the buyer takes the commodity in his possession, all the ownership risks get transferred from the seller to the buyer from that point onwards, including any loss, defect, damage or depreciation developed in the goods after the sale. Any condition to restrict or eliminate such risks shall render the transaction void from a Shariah perspective.
2. A lease agreement requires that the subject matter of the lease agreement, ie the usufruct of the property being leased, is the risk of the lessee upon his taking delivery of the leased property pursuant to signing the lease agreement. If the lessee does not live in the leased house, does not cultivate the leased land or does not drive a leased vehicle after taking possession, the loss is for him alone and the lessor will not be responsible for such a loss. Nevertheless, the risk relating to the corpus of the leased property itself will continue to be borne by the owner, who is the lessor, and any loss (partial or total) on the property — as far as it is not due to the lessee’s fault — will be endured by the owner. Also, the risk of any major maintenance, payment of insurance premium and property taxes will rest with the owner and any effort to transfer them to the lessee shall make the lease agreement void in a Shariah court.
3. This one is already explained in the current topic but let me repeat while we are discussing the essential risks in Shariah finance. A Mudarabah agreement requires that the risk of the Mudarabah capital is borne by the Rab Al Maal with respect to the genuine loss, damage or decrease in the value of the Mudarabah assets, as far as there is no default, misconduct or breach of the Mudarabah terms by the Mudarib. On the other hand, the Mudarib must be exposed to his performance risk based on which he will be able to claim any benefit from this association.
Prohibited risks
These risks make a transaction/contract void from a Shariah perspective and are called ‘Gharar Jaseem’ (excessive or gross risk or speculation). I have provided the following examples:
Risk in existence: For example, the sale of a non-existent object the delivery of which cannot be made even under Salam. The forward and future contracts for commodities and currencies respectively where both considerations (ie delivery and price) are deferred to a future date fall under this category.
Risk in possession: For example, the sale of a public domain property or stolen object as the seller did not hold the legal title to it and the buyer will be required to surrender the same upon disclosure. The modern short-sale transactions come under this category since the seller does not have the legal title and possession to the subject matter at the time of the sale.
Risk in quantity: For example, the number of units or weight (or any other recognized measure) being unknown in a sale contract, such as the sale of rice for an amount leaving the quantity in metric tons to future assessment, thus creating uncertainty.
Risk in quality: For example, the type, grade or specifications of the subject matter of the contract being unknown.
Risk in payment: For example, a deferred sale with a specified quantity but without fixing the price. An example could be the bullion trade until the recent past where a certain quantity of gold was delivered to the buyer but without knowing the sale price which was closed within a certain defined number of days.
The involvement of any of the aforementioned types of risks will make a contract void in the Shariah with the unanimous opinion of jurists over the subject of the ‘contracts of consideration’ or exchange (Oqood Al Muawadat) and with a majority opinion in ‘contracts of gift’ or donation (Oqood Al Tabarro’at), with the exception being the Maliki jurists who say that a risk in a gift agreement is permissible due to the absence of payment consideration.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the senior advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].