I shall pick up the thread from where I left off last week. I had explained a difference between Mudarabah and Musharakah, which is that as against Mudarabah, in Musharakah all the partners are agents for one another and also act as the guarantor for each other. What does it mean?
Elaborating further, it was explained while discussing Mudarabah that in the case of genuine loss not caused by the Mudarib’s negligence or breach of contract, the entire loss shall be borne by the Rab Al Maal and the Mudarib shall not be asked to bear such damage.
The reason for such a principle stems from the fact that bearing of loss is directly connected to the sustaining power. As such, it will be logical to make the capital provider (Rab Al Maal) endure the loss in Mudarabah since it is the one who has contributed the entire capital, whereas the entrepreneur (Mudarib) has not provided any part of the capital.
Many times in the past articles I have emphasized that the popular conventional financing maxim of ‘one size fits all’ cannot be applied on Islamic finance. Hence, the Shariah contract must be carefully chosen given the situation.
The circumstances surrounding a Mudarabah contract are indeed different than the state of affairs found in a Musharakah pact. In the case of the former, the counterparty does not chip in with capital in cash or kind but it is a must in the latter that all parties share the capital.
Another stark difference between the two is that the Mudarabah rule does not allow active participation by the investor or the capital provider in the day-to-day running of the business whereas in Musharakah there is no such Shariah restriction and all partners are equally eligible to share the operating responsibilities. I have underlined the word eligible with a purpose since I will come back later to elaborate on it.
One wonders why the Rab Al Maal is prevented from managing the business affairs of Mudarabah despite the fact that it is the one who has provided the capital in full. You see, the reason why in Shariah, the capital provider is not given the right to work with the Mudarib, or to get involved in acts relating to the Mudarabah operation, is because such a provision would curtail the freedom of the Mudarib, limit the investment scope and hinder the Mudarib in achieving the objective of the Mudarabah contract, which is to deploy the capital prudently, efficiently and profitably for the mutual benefit of both parties.
Also, the Rab Al Mal enters into a Mudarabah contract with an expert since he or she lacks the business acumen and know-how and by undue interference, it may jeopardize the very purpose of signing the Mudarabah contract with that professional. For further explanation, please review article 84 where I have explained it in detail.
Returning to the differences between Musharakah and Mudarabah, in Mudarabah, the ownership of the entire assets developed through deploying the capital belongs to the Rab Al Maal, or in other words, the capital provider becomes the de-facto owner of all the Mudarabah assets. This is not the case in Musharakah where all partners jointly own the Musharakah assets, albeit in proportion to the ratio of investing the capital.
Next, if there is an increase in the value of the Mudarabah fixed assets, it will solely belong to the Rab Al Maal and the Mudarib will not be able to share it. Why? Simply because another name for Mudarabah is partnership in the operating profit. As such, the Mudarib is only eligible to share the outcome which is a direct consequence of its effort by utilizing its expertise.
Nevertheless, it is important to differentiate here that if there is an increase in the market value of the trading inventory and, as a result, the Mudarabah produces a higher profit, the Mudarib shall be entitled to share such earnings.
On the contrary, if there is an increase in the value of fixed assets owned by the Musharakah entity, such benefit shall be shared by all partners in the same ratio as they have funded the capital.
This is in addition to the operating profit shared by the partners, nonetheless, with the difference that its distribution is not subject to the ratio of contributing the capital but based on the mutually agreed percentage for each partner. It does not mean that there is any Shariah issue if the profit-sharing ratio is set as a replica of the ratio of sharing capital.
Another difference between the two investment-based contracts is that the liability of the Rab Al Maal in a Mudarabah contract is limited to the capital paid by it, provided that the Rab Al Maal has not given the authority to the Mudarib to amass debt on the Mudarabah entity in which case the Rab Al Maal shall be responsible for such liability as well in addition to the capital, if the situation warrants.
On the contrary, all partners in a Musharakah contract are exposed to the unlimited liability. I plan to explain it in next week’s issue.
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].
Next week: Differences between Mudarabah and Musharakah to continue next week.