I had started explaining the parameters of Mudarabah … and we ran out of space for the week. So let me commence from where I had left off.
There are three essential strictures based on which a Mudarabah contract is made. These are the objective or purpose of the Mudarabah must not be repugnant to Shariah permissibility, the invitation or the offer to enter the Mudarabah — from either party — must be unambiguous and finally the acceptance by the counterparty should be to the same offer made to it.
I will now delve upon the parameters of Mudarabah in more detail which shall make readers fairly clear as to the difference of the purpose of investment-based contracts from sale-based contracts. These are enumerated in the following:
a. A time-bound contract: A Mudarabah contract cannot be for an indefinite period. In essence, a Mudarabah contract is the trusteeship arrangement since the Mudarib uses someone else’s capital and shares the ensuing profit with the permission from the capital provider which must be subject to a designated duration.
However, once the Mudarabah contract is terminated upon completion of its period and pursuant to settlement whereby the Rab Al Maal receives the capital back and the Mudarib gets his share of the profit, both may agree to enter into a totally new Mudarabah contract for a different period, purpose and terms.
I pondered over this point enough to discover that making a Mudarabah contract limited by time actually protects the interest of both parties. As for the capital provider, his investment does not become ‘hardcore’ since it is returned to him along with the purpose for which it was invested, ie the profit. On the other hand, the Mudarib not only earns its share of the profit, the rule also introduces discipline and ethics on how to protect other people’s money.
b. A binding contract: The Mudarabah contract is binding on both parties once the capital has been delivered by the Rab Al Maal to the Mudarib in order to commence the work on the Mudarabah business plan. This is because unilateral termination of the Mudarabah contract by the Rab Al Maal pursuant to deployment of capital by the Mudarib shall defeat the objective of the Mudarabah and cause damage to the Mudarib’s interest since it might not be able to receive any compensation for the work carried out by it until that time. On the other hand, termination of the Mudarabah contract by the Mudarib at such an advanced stage shall also harm the Rab Al Maal’s interest. Nevertheless, either party may unilaterally terminate the Mudarabah contract prior to delivery and deployment of the capital.
c. Certainty of Mudarabah capital: The precise amount of the Mudarabah capital in cash must be clearly known, appropriately documented in the Mudarabah contract and handed over to the Mudarib upon signing the Mudarabah contract. If the Mudarabah capital is in the shape of kind (such as inventory, gold, silver or precious metals, etc), it should be well-defined in terms of quality, quantity and current value acceptable to both parties (or professionally valued by a third party), in a manner that eliminates any possibility of uncertainty or ambiguity. This is important since the determination of profit subsequently is dependent upon the amount of the original capital remaining intact by the date of the Mudarabah liquidation. Also, the redemption of the Mudarabah capital cannot be measured if the amount was unknown or uncertain at the outset, and this lack of knowledge may potentially lead to a dispute between the Rab Al Maal and the Mudarib. On another note, it is permissible in Shariah if the Mudarabah capital is a mix of cash and kind, provided the aforementioned degree of care is applied.
d. Sharing of actual profit: Both parties must agree to share the resultant Mudarabah profit, and not a predetermined amount or a fixed rate which has no connection to the actual Mudarabah profit (or loss). As explained earlier a few times in this series, the Shariah definition of profit in an investment-based contract is an amount exceeding the originally invested amount. In Mudarabah, it will be an amount over and above the starting capital if ascertained on the maturity of the Mudarabah contract. Elaborating this point further, a businessperson will never categorize an amount as profit unless he is sure that the capital he had invested is secured. As such, distribution of an amount as profit prior to the recovery of the capital in full (or unless the capital is maintained or is intact) is impermissible in Shariah. Moreover, profit is an offshoot of the capital and this addition to the capital (ie profit) cannot be recognized or realized unless the capital itself is maintained.
e. Non-interference by the Rab Al Maal: This is the extremely important condition of the Mudarabah contract that the Rab Al Maal must not interfere in the day-to-day running of a Mudarabah entity which is solely carried out by the Mudarib. The basis for allowing the Mudarib freedom to act in a Mudarabah arrangement is that the Mudarib has the responsibility of achieving the objective of a Mudarabah investment, which is to make profit for both parties, and this is not possible unless the capital is dynamically put into operation by utilizing the Mudarib’s expertise.
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: Mudarabah explanation shall continue.