After defining the Musharakah Mufawadah or unlimited partnership and its lack of relevance in the contemporary Islamic finance industry, in this article I will commence discussions on the Musharakah Inan or limited partnership. Nonetheless, before I attempt it, I would like to ask whether you have gathered the reason why Musharakah Mufawadah is termed as an unlimited partnership.
Let us pick last week’s example of four sons who have inherited a running business from their father who was a prudent trader. The sons hold the equity equally and share the profits by the same token.
All are fully authorized to trade in the name of the business which includes buying goods on credit.
Since the entity is licensed as a general trading business, the sons can deal in any type of merchandise. As such, they individually go all out in trying their hands on anything they believe can make money while representing the entity.
Out of the four partners, two got involved in a sticky situation whereby they overcommitted themselves by buying certain merchandise on credit, thinking the price will go up and they will contribute decently to the entity’s profits.
However, being relatively new, they misjudged the market and ended up being stuck with considerable quantity in a slowing market.
The situation badly impacted the entity’s cash flow and as a result they could not pay the debts falling due and the past-due obligations started piling up.
And the time came when the partners were forced to gradually start selling the gathered merchandise at a deep loss, thereby creating a big dent in the equity.
The slide continued and the time came that the losses exceeded the entity’s capital base. Some of the creditors took legal action and the matter was decided by the court by ordering all four partners to settle the entire liability owed to the creditors in a joint or several manner, ie even if it goes beyond the exhaustion of the entity’s capital.
The judgment was based on the court’s knowledge that the entity is Musharakah Mufawadah by nature where all partners act as agents and guarantors for one another and irrespective of the fact that the goods were bought by two partners, all four shall be liable to meet with the obligation to pay to all creditors beyond the entity’s capital.
If you think Musharakah Mufawadah is nothing but a catastrophic proposition and without any benefit, please read on.
Can there be any benefit hidden in this type of Musharakah? Of course, the most valuable advantage to Musharakah Mufawadah partners is the high degree of comfort the suppliers derive in dealing with such an entity compared with Musharakah Inan. What is the reason for it?
While Musharakah Inan is a limited liability entity in the sense that the partners are only liable to the extent of capital they have invested, the partners in Musharakah Mufawadah are held liable beyond the entity’s capital.
This makes the Musharakah Mufawadah entity more creditworthy for the suppliers since they know they can make partners pay by liquidating their personal assets even if the liabilities exceed the entity’s capital.
This is not enough — all partners shall be held jointly and severally liable toward the entity’s entire financial obligations even if the losses were not brought on by some of them.
The partners to a Musharakah Mufawadah entity enjoy the opportunity to deliver a sterling performance compared with a Musharakah Inan entity since by technical definition, the former is far more creditworthy than the latter as explained above.
A question may come to mind whether the partners are required to execute a personal guarantee in favor of each supplier to be able to stand personally liable to them.
The fact is that the Shariah principles for Musharakah Mufawadah provide an in-built phenomenon to make partners the agents and guarantors for one another without needing to sign any formal agency and guarantee document.
I hope you all have gathered the peculiarity of Musharakah Mufawadah compared with what I will now explain which is Musharakah Inan.
In accordance with the AAOIFI Shariah Standard No 12, Article 3.1, the Sharikat al-inan (or Musharakah Inan) is a partnership between two or more parties whereby each partner contributes a specific amount of money in a manner that gives each one a right to deal in the assets of the partnership, on the condition that the profit is distributed according to the partnership agreement and that the losses are borne in accordance with the contribution of each partner to the capital.
I will have to stop here as the space seems to have run out.
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: Explanation of Musharakah Inan to continue in the coming week.