UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for December 7, 2010

The Sukuk Musharakah Structure


“What Does Musharakah Mean?
A joint- enterprise or partnership structure (with profit/loss sharing implications) that is used in Islamic finance instead of interest-bearing loans. Musharakah allows each party involved in a business to share in the profits and risks. Instead of charging interest as a creditor, the financier will achieve a return in the form of a portion of the actual profits earned according to a predetermined ratio. However, unlike a traditional creditor, the financier will also share in any losses.

Investopedia explains Musharakah
Musharakah plays a vital role in financing business operations based on Islamic principles, which prohibit making a profit on interest from loans. For example, suppose that an individual (A) wants to begin a business, but has limited funds. Individual (B) has excess funds and wishes to be the financier in Musharakah with A. The two people would come to an agreement to the terms and begin a business in which both share a portion of the profits and losses. This negates the need for A to receive a loan from B.”

In the Musharakah Structure, both parties contribute capital to the joint-venture.  Cash or in-kind assets are permissible (capital) and may be contributed in any proportion amongst the partners.  In this structure, the profit can be fixed according to the proportion of capital or can be negotiable.  However, the loss must be shared in accordance to the capital contribution of each party and each partner is limited in liability to the extent of the partner’s capital contribution.  A partner may have recourse to another partner who is managing the joint-venture in the case of negligence or misconduct.  Common Musharakah activities include:  construction and manufacturing; trading; services; investment related activities, etc.

In sum, Sukuk Musharakah is a partnership arrangement between two parties or more to finance a business venture whereby all parties to the agreement contribute either cash or in-kind capital for the purpose of financing the business venture.  The profit derived from the business venture shall be distributed based on a mutually pre-agreed profit ratio while any losses will be shared on the basis of equity participation.  (Amanie)

Musharakah According to Wikipedia

Musharakah (joint venture) is an agreement between two or more partners, whereby each partner provides funds to be used in a venture. Profits made are shared between the partners according to the invested capital. In case of loss, each partner loses capital in the same ratio.

If the Bank provides capital, the same conditions apply. It is this financial risk, according to the Sharia’h, that justifies the bank’s claim to part of the profit.  Each partner may or may not participate in carrying out the business. A working partner gets a greater profit share compared to a sleeping (non-working) partner.

The difference between Musharakah and Mudharabah is that, in Musharakah, each partner contributes some capital, whereas in Mudharabah, one partner, e.g. a financial institution provides all the capital and the other partner, the entrepreneur, provides no capital. Note that Musharakah and Mudharabah commonly overlap.[34]

Legal Structure of Sukuk Mudharabah and Sukuk Musharakah

  1. Use of the proceeds of the issuance of the certificates will be used by the Issuer to pay the Issuer’s capital contribution to the Mudharabah or Musharakah, as the case may be.
  2. The transaction documents may include the Mudharabah/Musharakah Agreement; the Management Agreement; the Purchase Undertaking; the Declaration of Trust; and the Agency Declaration.
  3. The Sukuk Certificates have limited recourse as the certificates are not debt obligations of the Issuer.  The certificates represent entitlements solely to the trust assets.  Therefore, recourse to the issuer is limited to the trust assets and the proceeds of the trust assets are the sole source of payment on the certificates.
  4. In a dissolution event, the certificate holder can require the issuer to serve an exercise notice and exercise the option under the Purchase Undertaking to require the obligor to purchase the issuer’s units at the exercise price and to enforce any pledge, if any, if the obligor fails to pay.  Dissolution events must be clearly defined in both positive and negative covenants.  (Amanie)


The Parties to the Musharakah Agreement

The Issuer could be a party or partner to the Musharakah; an agent to the Musharakah Investor; or Manager (Mudharib) under the principle of Mudharabah.  The Mudharabah/Musharakah Investors may not be the manager.  The day-to-day business of the venture shall be performed by the Issuer.  (Amanie)

Purchase Undertaking

It is the obligation of the Obligor to execute a purchase undertaking in favor of the Issuer/Investors.  This purchase undertaking will be on the Relevant Exercise Price on the Relevant Exercise Date.  The Relevant Exercise Price could be: 1.) an amount equal to the aggregate of the outstanding Sukuk Amount and the scheduled Accumulated Sukuk Return Amount, or 2.) an amount which is equivalent to the fair value or market value of the Trust Assets.  (Amanie)

The financial ratio or balance sheet of the Musharakah Asset is relevant for Sharia’h compliance purposes.  In addition, the commencement of actual work is relevant to the rendering of the permissible trading of Sukuk.  (Amanie)

According to the Islamic Life Forum:

 Musharakah: This simply refers to a partnership. This is like a joint-venture agreement, which stipulates the conditions of a partnership. For this joint-venture to be in line with Islamic law, both parties must participate in profits and losses, not just in profits. This technique can be used for short-term financing.

In Detail:

Musharakah is a type of Shirkat-ul-Amwal, which literally means sharing. In the context of business, it refers to a joint -enterprise in which partners (or parties) to the enterprise share the profit and loss of the enterprise. Musharakah has far reaching implications for Islamic banking and finance in the modern context and provides an excellent alternative to the interest-based economy.

In a Musharakah, the party investing the capital shares equally in both the profit and loss, which is different from an interest-based system where the upside is limited while the downside is very nearly non-existent.

The Basic Rules of Musharakah:

Since Musharakah is, in essence, a contract, all conditions and rules of a contract must be met. Apart from those, there are some basic rules that apply specifically to Musharakah.


Distribution of Profits:

  1. The proportion of profit to be distributed among the partners must be determined and agreed upon at the time of the contract. Otherwise, the contract is not valid under Sharia’h.
  2. According to Imam Malik and Imam Shafi’i, it is necessary that each partner’s share in the profit is exactly equal to the proportion of initial investment into the partnership.
  3. According to Imam Ahmed, the ratio of profit distribution may vary, without restriction from the ratio of investment.
  4. According to Imam Abu Hanifah, the ratio of profit distribution may vary, however, for silent partners (non-active partners, who only contribute capital), it cannot be any higher than the ratio of investment.

Distribution of Loss:

All the Muslim jurists are unanimous that each partner’s share in loss must be exactly equal to the ratio of initial investment. Anything to the contrary will render the contract invalid.

The Nature of Capital:

There are the following opinions on this:
  1. According to Imam Malik and some Hanbali jurists, the nature of capital is not a restriction in a Musharakah arrangement. Therefore, in-kind (non-cash) contributions by partners are allowed. The share in partnership will be determined based on the market value of the commodity contributed.
  2. According to Imam Abu Hanifah and Imam Ahmed, no in-kind contributions are allowed in a Musharakah arrangement. This is because they believe it poses problems if the partnership needs to be liquidated or redistributed.
  3. Imam Shafi’i makes a distinction between replaceable commodities and irreplaceable commodities (like cattle). The view is rather complex and not important for our purposes.

For the purposes of modern business, the view of Imam Malik has been widely accepted.

Management of Musharakah:

The norm is for each partner to take part in the management of the partnership, with each partner acting as an agent of the partnership and any work done by one partner deemed to be authorized by all partners. However, if the partners wish they can contract under alternate arrangements for the management of the partnership.

Termination of Musharakah:

It is agreed upon by the jurists that a partnership is terminated if:

  1. One of the partners terminates the partnership;
  2. One of the partners dies (where the heirs get the choice to continue the partnership or liquidate it to draw their share from the partnership);
  3. One of the partners becomes insane.

If the remaining partners wants to continue the business under any of the above scenarios, it is achievable with mutual agreement. The remaining partners would have to purchase the share of the out-going partner.
Another question raised is whether the partners can agree, at the time of contracting, that the partnership will not be terminated unless all partners agree to the termination. Though the earlier fiqh books are silent on the issue, there is nothing in the Sharia’h that would prohibit such an arrangement.




Source:Usmani, Chapter 1.
Taken from:




Data Sources:

Materials handed out at the Amanie School’s Islamic Finance Workshop in Dubai, UAE on December 14-15, 2008.

Guidelines on Musharakah and Mudharabah Contracts for Islamic Banking Institutions by Bank Negara Malaysia

The Sukuk Mudharabah Structure


“The Arabic word “mudharabah” means to travel the earth for trade or business. It is even a term mentioned in the Quran, the holy book of Islam revealed to the Prophet Muhammad (S) by the angel Gabriel. It is written: “Others (making dharb on earth) traveling through the land, seeking of Allah‘s bounty” [74:20]. The term refers to those who can almost be called nomadic businessmen, traveling around the world seeking God’s help and sustenance in business and trade.” (Huma Rashid)

This Islamic Finance structure is designed to allow entrepreneurs to carry out large-scale business projects, where one party provides the capital and the other party or the entrepreneur provides the know-how and management.  The party, which provides the management, can also sub-invest the capital to another party to manage the investment.  In terms of liability, the party providing the financing is liable to the extent of her capital, while the manager loses her time, work, and expected profit.  Basically, only the party who provides the capital is liable for losses. The party providing the capital has no recourse to the manager except in the case of negligence and misconduct.

In this structure, it is possible to arrange profit distribution based on ratio or percentage.  However, pre-arranging a fixed amount of profit is not possible unless subject to certain conditions.  Waiver of certain profit based on performance is permissible.  Mudharabah activities include construction and manufacturing, trading, services, investment, etc.  This structure is generally used to encourage public participation in large investment projects.

“The worker should not use the money of Mudharabah for traveling or other expenses, unless she specified that to the owner of the capital and the latter agreed to it. The worker works in the Mudharabah to get a part of the profit only.  Therefore, she is not supposed to get anything extra unless it is made clear at the start of the Mudharabah or the nature of the business that they do requires it.

The profit of the Mudharabah is not to be divided between the two before the end of the contract unless they both have agreed to that. This is because there may be a loss in the trade. If the profit is divided before the end of the contract and loss occurs later, there will be no funds to cover this loss. For this reason, the worker is not entitled to any of the profit until the completion of the contract.

The worker is a trustee in this contract, so she should fear Allah, subhanahu wa ta’ala, in what she is entrusted.  Her claim of destruction or loss should be accepted. She should be believed in what she states about things purchased, whether they are for her own use or for the Mudharabah.”  (

If the Mudharabah contract is nullified, then the profit remits to the owner of the capital because it is an increase in her money and the worker gets paid for the work she completed.

According to Huma Rashid, “Mudharabah in Shar’iah, or Islamic law, refers to the payment of a specific amount of money to a person who uses it for business and makes a profit from it or an investment.   This form of contract was present during the time of the Prophet (S) and he approved of it and it was also approved by his first four caliphs and others.

Ibn al Qayyim said, “The mudharib is a trustee, an employee, a deputy and a partner. She is a trustee when she takes the money; a deputy when she uses it, an employee in the work that she executes, and a partner in the profit. For Mudharabah to be (Islamically) valid, the share of the worker should be named.”

The Arab Muslims were prominent businessmen and responsible for much of the economic growth and triumph enjoyed by the Middle East and outreaching parts of the world for many, many centuries. In addition to that, the Qu’ran was not only a moral and religious guide, but a social, legal and business guide that instructed its followers on how to conduct themselves in business and other legal matters.”

Data Sources:

Rulings on Partnerships in Mudharabah

Interesting Paper on Mudharabah

Materials handed out at the Amanie Islamic Finance School Workshop in Dubai, UAE on December 14-15, 2008.

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance