Mudarabah financing is a kind of partnership where one partner contributes money (i.e. the financier) to another (entrepreneur, who contributes his expertise, skill, knowledge, labour, idea), for investing in a commercial enterprise. The investment comes from the first partner who is called “Rab-ul-Maal” while the management and work is an exclusive responsibility of the other, who is called “Mudarib” and the profits generated are shared in a predetermined ratio.
In the modern world, this could be structured as a Limited Liability Partnership – the General partner being the , by offering shares of different classes with pre-determined allocation of percentage of profits to the different classes e.g. Class A ordinary shares held by “Mudrib” entrepreneur with it’s agreed proportion of profit allocation and Class B held by “Rab-ul- Maal” the funder. It can also be used as Islamic Venture capital and Private Equity funds.
Types of Mudarabah
There are two (2) types of Mudarabah namely:
1) Al Mudarabah Al Muqayyadah (Restricted Mudarabah)
Here, the Rab-ul-Maal may specify a particular business or a particular place for the mudarib to carry out the business, in which case, he shall invest the money in that particular business or place. This is called “Al Mudarabah Al Muqayyadah” (Restricted Mudarabah).
2) Al Mudarabah Al Mutlaqah (Unrestricted Mudaraba)
However, if Rab-ul-maal gives full freedom to the Mudarib to undertake whatever business he deems fit, this is called “Al Mudarabah Al Mutlaqah” (Unrestricted Mudarabah). However, the Mudarib cannot, without the consent of Rab-ul-Maal, lend money to anyone. The Mudarib is authorized to do anything which is normally done in the course of business.
However, if the Mudarib wants to carry out work which is out of the ordinary scope of work, which is beyond the normal routine of the traders, he cannot do so without express permission of Rab-ul-Maal. He is also not authorized specifically to:
- a) Appoint another Mudarib or a partner
- b) Mix his own investment in the Mudarabah without the consent of the Rab-ul Maal.
All conditions of offer and acceptance are applicable to both the parties.
The Rab-ul-Maal can execute a Mudarabah contract with more than one person through a single transaction. This means that the Rab -ul- Maal can offer his money to ‘A’ and ‘B’ both, so that each one of them can act for him as Mudarib and the capital of the Mudarabah shall be utilized by both of them jointly.
Difference between Musharakah and Mudarabah Investment
In Mudarabah, the Rab-ul-maal provides the capital investment and the Mudarib looks after the management. Hence, the Rab-ul-maal hand’s over the agreed investment to the Mudarib and leaves everything to the Mudarib with no interference from his side. But he may:
- a) Oversee the Mudarib’s activities and
- b) Work with the Mudarib if the Mudarib consents
Here, the question arises, in what form should the Mudarabah capital be? Can non-liquid assets like equipment, land etc. form capital investments?
The basic principle is that the capital in Mudarabah is valid just the way it is in Shirkah, which
according to Hanafi fiqh should be in liquid form. But, according to other scholars, equipment and land etc. can also be included as capital Investment. However, all the scholars are unanimous on the following:
“Assets other than cash can be used as an intermediate step. However, this is subject to the determination of the exact value of the assets before they are used for Mudarabah. If the assets are not correctly evaluated, the Mudarabah is not valid.
|All partners invest in the business.||Only the Rab-ul-Maal invests in the business|
|All partners have the right to participate in the management of the business and work for it||The Rab-ul-maal has no right to participate in the management which is carried out by the Mudarib only.|
|All partners share the loss proportionate, to the extent of the ratio of their investment.||
Only the Rab-ul-maal bears the loss because the Mudarib does not invest anything. NB, this is subject to the condition that the Mudarib has worked diligently
|As soon as the partners mix their capital in a joint pool, all the assets become jointly owned by all of them according to the proportion of their respective investment. All partners benefit from the appreciation in the value of assets even if profit has not accrued through sales||The goods purchased by the Mudarib are owned solely by the Rab-ul-maal and the Mudarib may earn his share in the profit only if he sells the goods of the business in a profitable manner.
The Mudarib shares profit of the Mudarabah as per the agreed rate with the Rab-ul-Maal, but his personal expenses like meals, clothing, rent, conveyance and medical are not borne by Mudarabah.
However, if he is traveling on a business trip and is overstaying the night, then the expenses shall be covered from the capital of Mudarabah. If the Mudarib goes for a journey which constitutes Safar-e-Sharai (more than 48 miles), but does not overstay the night, his expenses will not be borne by Mudarabah.
All expenses which are incidental to the Mudarabah’s function like wages of employees or commissions for buying/selling etc have to be paid by the Mudarabah.
However, all the expenses can be included in the cost of commodities which the Mudarib sells in the market. For example, if the Mudarib is selling ready made garments then the stitching, dyeing, washing expenses etc. can be included by the Mudarib in the total cost of the garments.
If the Mudarib manages the Mudarabah within his city, he will not be allowed any expenses, but only his due profit share. Similarly, if he keeps an employee, this employee will not be allowed any expenses, but his salary.
If the Mudarabah agreement becomes invalid (Fasid) due to any reason, the Mudarib’s status will be that of an employee, meaning:
- a) Whether he is traveling or doing business in his city, he will not be entitled to any expenses such as meal, conveyance, clothing, medicine etc.
- b) He will not be sharing any profit and will just get Ujrat-e-Misl (prevalent remuneration) for his job.
Distribution of Profit & Loss
It is necessary for the validity of Mudarabah that the contracting parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled.
The Shariah has prescribed no particular proportion; rather it has been left to the partners’ mutual consent. They can share the profit in equal proportions and they can also allocate different proportions for the Rab-ul-Maal and Mudarib. However, in such cases where the parties have not predetermined the ratio of profit, the profit will be shared at the ratio of 50:50.
The Mudarib and the Rab-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital. For example, if the capital is Shs.100,000/-, they cannot agree on a condition that Shs 10,000/- out of the profit will be the share of the Mudarib, nor can they say that 20% of the capital will be given to the Rab-ul-Maal. However, they can agree that 40% of the actual profit will go to the Mudarib and 60% to the Rab-ul-Maal or vice versa.
It is also allowed that different proportions could be agreed for different situations. For example, the Rab-ul-Maal can say to the Mudarib “If you trade in wheat, you will get 50% of the profit and if you trade in flour, you will have 33% of the profit”. Similarly, he can say “If you do the business in your own town, you will be entitled to 30% of the profit and if you do it in another town, your profit share will be 50%”.
Apart from the agreed proportion of the profit (as determined in the above mentioned manner), the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah. All schools of Islamic Fiqh are unanimous on this point.
However, Imam Ahmad bin Hanbal has allowed for the Mudarib to draw his daily expenses for food only from the Mudarabah Account. The Hanafi jurists restrict this right of the Mudarib only to a situation where the Mudarib is on a business trip outside his own city. In this case, he can claim his personal expenses for accommodation and food, etc. but he is not entitled to get anything as daily allowances when he is in his own city.
If the business has incurred loss in some transactions and has gained profit in others, the profit shall be used to offset the loss in the first instance, then the remainder (if any) shall be distributed between the parties according to the agreed ratio.
The Mudarabah becomes void (Fasid) if the profit is fixed in any way. In this case, the entire amount (Profit + Capital) will be the Rab-ul-Maal’s. The Mudarib will just be an employee earning Ujrat-e-Misl (market equivalent salary/wages). The remaining amount will be called Profit.
Roles of the Mudarib
Ameen (Trustee): Responsible for safeguarding the investments, except in the case of natural calamities.
Wakeel (Agent): To make purchases from the funds provided by the Rab-ul-Maal.
Shareek (Partner): Sharing in any profit from the business.
Dhamin (Liable): To provide for the loss suffered by the Mudarabah due to any act of negligence on his part.
Ajeer (Employee): When the Mudarabah is Fasid for some reason, the Mudarib is entitled to only the salary, Ujrat-e-Misl.
Termination of Mudarabah
The Mudarabah will stand terminated when the period specified in the contract expires. It can also be terminated any time by either of the two parties by giving notice. In case the Rab-ul-Maal has terminated the services of the Mudarib, the latter continues to act as Mudarib until he is informed of the termination and all his previous acts will remain a part of the Mudarabah.
If all assets of the Mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the pre-agreed ratio. However, if the assets of the Mudarabah are not in cash form, they will then be sold and liquidated so that the actual profit may be determined
All loans and payables of the Mudarabah will be recovered. Before termination the provisional profit earned by the Mudarib and the Rab-ul-Maal will also be taken into account and when the total capital is drawn, the principal amount invested by the Rab-ul-Maal will be given to him and the balance will be called profit which will be distributed between the Mudarib and the Rab-ul-Maal at the agreed ratio.
If no balance is left, then the Mudarib will not get anything. If the principal amount is not recovered fully, then the profit shared by the Mudarib and the Rab-ul-Maal during the term of the Mudarabah will be withdrawn to pay the principal amount to the Rab-ul-Maal. The balance will be profit, which will be distributed between the Mudarib and the Rab-ul-Maal. In this case too if no balance is left, the Mudarib will not get anything.
Uses of Mudarabah
Asset Side Financing
- Project financing
- Small and medium enterprises setup financing
- Import financing
- Import bills drawn under import letters of credit
- Bridge financing
- LC without margin (for Mudarabah)
- Export financing (Pre-shipment financing)
- Working capital financing.
Liability Side Financing
- Saving/investment accounts (giving profit based on Mudarabah – with predetermined ratio)
- Inter- Bank lending / borrowing
- T-Bill and Sovereign Investment Bonds (Sukuk )
- Certificates of Investment based on Mudharabah.