Last week’s article (113) explained how a partner can retire without the business of the contractual Musharakah being wound up. One situation discussed was for the continuing partner to purchase the stake of the exiting partner at a mutually agreed price. The price can be paid upfront in a lump sum or in a phased manner, and both ways are acceptable from a Shariah perspective.
The second option discussed was the induction of a new partner with the continuing partner’s assent in which case both the retiring and the incoming partners shall negotiate and agree over the price of equity being bought and sold and the terms of payment for the agreed price.
Although the continuing partner shall have no part to play in the process of negotiating the price for the sale of the equity, he will need to enter into the addendum to the original contractual Musharakah agreement evidencing the replacement of the original partner with the new one.
Another aspect which needs to be given due consideration is that the incoming partner must assume the exact ratio of the Musharakah capital which was hitherto owned by the retiring partner irrespective of the fact that the incoming partner may have paid a premium price for assuming the stake in the business.
For example, the original capital invested by the retiring partner amounted to US$100,000 for a 50% stake three years ago for a five-year contractual Musharakah term. Nevertheless, the deal between the retiring and incoming partner was finalized at US$150,000 which shall not fetch the new partner a 75% equity in the running business but the same 50% stake as was originally obtained by the retiring partner. The extra US$50,000 paid to the retiring partner shall be the premium coughed up by the new partner who must have done his due diligence whether paying US$150,000 for the equity costing US$100,000 is something worth undertaking.
Another situation which needs to be understood is what happens when the continuing partner acquires the stake from the retiring partner? What will be the contractual Musharakah position in such a case? Let me explain. If there were two partners and one of them purchases the equity from the other at a price acceptable to the exiting partner, the Musharakah shall cease to exist.
Yes, that is correct. I have not said that the business will not continue, but that the Musharakah will not continue. This is because as per Shariah principles, it takes a minimum of two parties to constitute a contractual Musharakah entity.
So, what shall be the legal and Shariah status of the business upon completion of the exit by one of the partners? The Musharakah will get converted into a sole proprietorship concern for which necessary legal documentation, such as the deed of partnership dissolution, shall be signed and a notarized version of which shall be required to be filed with the relevant authorities for the alteration of the legal status of the business from partnership to sole proprietorship.
Another point which needs explanation is how to judge the value of the equity from time to time in a contractual Musharakah with a long tenure, eg 10 years? This is carried out through a process called constructive liquidation in which it is assumed that the Musharakah assets are sold at the current market price and all liabilities are paid out from the hypothetical sale proceeds, leaving behind the surplus which is then compared with the originally invested equity to arrive at the extent of appreciation in the value of the Musharakah equity. The surplus will then be regarded as the capital of the contractual Musharakah for the new fiscal term. It is quite possible that the constructive liquidation exercise results in a deficit in the dull market conditions where the Musharakah assets do not fetch the positive (hypothetical) price which is insufficient to square up the Musharakah liabilities, leaving a shortfall. An example could be the investment of excess cash in Shariah compliant listed stocks from time to time at bullish conditions which have turned bearish at the time of carrying out the constructive liquidation. Also, the market value of the Musharakah inventory may decline owing to increased supply and lower demand.
In the situation of a shortfall, the partners need to ensure that the trade receivables and inventory adequately cover the outstanding trade Murabahah and the other current liabilities on the assumption of a ‘going concern’ since this is not actual but constructive liquidation. However, the partners should be ready to top up the capital or arrange any Shariah compliant bridge financing to help them through the difficult times.
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.
Next Week: We shall continue our discussion on contractual partnership for the next few weeks.