Lecture 3

MUSHARAKAH

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Outlineo Terminology & Definition of Musharakah o Types of Musharakah o Structure of Musharakah o Basic Rules in Musharakah o Termination of Musharakah o Constructive Liquidation of Musharaka o Security / Collateral in Musharaka o Musharaka Management and Liability o Application of Musharaka As a Mode o Problems and Risk for Banks in Musharaka

Financing2

‘Musharakah’ is a word of Arabic origin which literally means sharing. In the context of business and trade it means a joint enterprise in which all the partners share the profit or loss of the joint venture. It is an ideal alternative for the interest-based financing with far reaching effects on both production and distribution. In the modern capitalist economy, interest is the sole instrument indiscriminately used in financing of every type.

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‘Musharakah’ is a term frequently referred to in the context of Islamic modes of financing. The connotation of this term is a little limited than the term “shirkah” more commonly used in the Islamic jurisprudence.

Shirkah means sharing

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Rules of Musharakah

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Capital

Management

Settlement

Profit and Loss

Security

Rules of Musharakah- CapitalInvested capital must be in liquid form or other

kinds of assetsIt should be both quantified and specifiedIf fixes assets are being contributed, so the

value of these assets should be agreed Investments come from all partners /

shareholders hereinafter referred to as partners.

All assets of Musharakah are jointly owned in proportion to the capital of each partner.

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Rules of Musharakah-ManagementEvery partner is entitled or has right to take

a part in management Manager can be chosen/appointed by mutual

agreement of partners One of the partner can be silent partner, in

other words One or more of the partners may decide not to work for the Musharakah and work as a sleeping partner.

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Rules of Musharakah- Profit and LossProfits shall be distributed in the proportion mutually

agreed in the contract.Determined as percentage of profit and not a fixed sum of

the money or percentage of capital invested If one or more partners choose to become non-working or

silent partners. The ratio of their profit cannot exceed their proportion of investment in a certain project.

The proportion of profit to be distributed between the partners must be agreed upon at the time of effecting the contract. If no such proportion has been determined, the contract is not valid in Shari‘ah

All investors will have to share any loss in exact proportion to their investment

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Rules of Musharakah-Settelment Every partner has a right to terminate the Musharakah at

any time after giving his partner a notice to this effect, whereby the Musharakah will come to an end.

In this case, if the assets of the Musharakah are in cash form, all of them will be distributed pro rata between the partners.

But if the assets are not liquidated, the partners may agree either on the liquidation of the assets, or on their distribution or partition between the partners as they are.

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Rules of Musharakah-Settelment If any one of the partners dies during the

musharakah agreement, the contract of musharakah will be terminated. His heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of musharakah.

If any one of the partners becomes insane or otherwise becomes incapable of effecting commercial transactions, the musharakah will be terminated.

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Rules of Musharakah- SecurityIn the case of Musharakah agreement

between bank and client, the bank can obtain adequate security from client against negligence or misconduct.

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Application of Musharakah Project Financing: Manufacturer Company “A” would like to expand its

business by opening a new branch in other City. They did investment appraisal and come up with total initial investment cost of $ 300 000. However, the budget of company is limited, they are able to invest only 30% of investment cost and they decided to go with Musharakah agreement which is given by Islamic Bank. In that type of agreement, all parties agreed that profit ratio is exactly proportional with investment of partner. At the end of maturity of this project, they realized $ 50 000 as a profit.

What is investment cost in dollars of Islamic Bank and Manufacturer Company “A” respectively?

What is profit of Islamic Bank and Manufacturer Company “A” correspondingly?

How much in total Islamic Bank will get at the end of maturity of the project? Manufacturer Company “A”?

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