MUDARABAH

AIFM Directive vs UCITS Directive

07 Feb 2012 MUDARABAH

Mudarabah, like Musharakah is also a kind of partnership, whereby one partner provides finance to the other for investing in a commercial enterprise. The profits generated are shared in a predetermined ratio. Thus, a Muradabah arrangement looks very much like an equity investment by a shareholder in a public listed company. In fact, Islamic banks consider Mudarabah financing to be the equivalent of equity financing.

This publication provides a general overview on the Mudarabah structure of finance.

TYPES OF MUDARABAH

There are two types of Mudarabah:

  1. Restricted Mudarabah
  2. Unrestricted Mudarabah

Restricted Mudarabah

In a restricted Mudarabah, also known as the (Al-Mudarabah-al-Muqayyaddah), the Rab-ul-Mal, also known as the investor may specify a particular business for the Mudarib ( manager), in which case he shall invest the money in that specified business only.

Unrestricted Mudarabah

In an unrestricted Mudarabah, also known as the Al-Mudarabah-al-Mutlaqh, if the Rab-ul-Mal leaves it open for the Mudarib to undertake whatever business he wishes, the Mudarib shall be authorized to invest the money in any business he wishes.

ROLE OF MUDARIB[1]

  • The Mudarib acts as a Trustee (Ameen), who is responsible to look after the investment, with an exception of natural calamities.
  • The Mudarib acts as an agent (Wakeel), as he makes the purchases from the funds provided.
  • The Mudarib acts as a partner (Shareek), thus sharing the profits with Rab ul Mal.
  • The Mudarib also acts as a possible liable (a Zamin), and thus will have to compensate for any loss suffered during the course of Mudarabah, due to any erroneous act on his part.
  • The Mudarib also acts as an employee (Ajeer) who is entitled to receive a fee is the Mudarabh becomes void.

ELEMENTS OF MUDARABAH[2]

Capital

Capital is the principal element of Mudarabah forming the substance of the contract. It shall be contributed by the Rab–ul-Mal only. The capital may be in the form of monetary or non-monetary assets and shall be managed by the partner to generate income. Debts such as account receivables or loans due to a capital provider do not qualify as capital of Mudarabah.

The agreed capital shall be made available to the manager to commence the business activities. The capital may be fully or partially disbursed or made available to the manager at the time of conclusion of the contract and based on terms of the contract. Failure to provide capital by the capital provider as per the agreed schedule shall constitute a breach of promise according to specified terms and conditions of the contract.

Management

All work and activities undertaken by the manager in relation to the Mudarabah capital shall be Shariah-compliant. The manager shall have the exclusive right to manage the Mudarabah venture. The capital provider shall be precluded from managing the venture. However, the capital provider has the right to information regarding the conduct of the manager. The manager shall not be liable  for any loss of capital unless such loss is due to the loss manager’s negligence, dishonesty, misconduct or breach of terms of the contract.

Profit sharing right

The manager enters into Mudarabah seeking his share of profits, thus this integral part of the contract must be known, otherwise the contract would be rendered defective. If the Mudarabah contract is concluded without specifying the manager ratios in profits then the default ruling is that they divide profits between them equally.

The profit sharing ratio shall be determined at the time of the conclusion of contract and may be revised from time to time during the contract subject to mutual agreement. It is not permissible to include a condition in Mudarabahah contract that stipulates a pre- determined fixed amount of profit to one partner which deprives the profit share of the other partner.

Distribution of profit upon termination[3]

  • 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 agreed ratio.
  • If the assets of the Mudarabah are not in cash form, they will be sold and liquidated so that the actual profit may be determined.
  • If there is a profit upon the terminiation, then it hsall be distributed between the Rabul mal and Mudarib. If there is no profit left, then the Mudarib shall not get anything.

Cure of losses

Mudarabahah operating loss which is measured during the operating period may be offset against prior or future profits.

In case of operational capital loss due to decline in market prices sales of goods by Mudarabah venture is much lower than the cost of purchase. As a result the asset value decreases with given amount of outstanding liability and Mudarabah capital. Hence the Mudarabah venture reports a loss for the net decrease in capital. Mudarib decides to offset the loss against undistributed profit for the previous period.

The manager may not undertake to bear the loss. However, the manager may bear the loss at the time the loss is realized without any prior condition or undertaking. A third party may undertake to bear the loss of capital due to misconduct or negligence on the part of the manager. The capital provider may take collateral from the Mudarib, provided that the collateral could only be liquidated in the event of negligence or misconduct or violation of term of contract by the Mudarib.

TERMINATION OF MUDARABAH CONTRACT

In general the Mudarabah contract may be terminated due to the following reasons:

  • Unilateral termination of by any of the parties when the Mudarabah does not constitute a binding Mudarabah.
  • Mutual agreement to terminate between the parties.
  • The contract expires as at the maturity date agreed by the parties.
  • The impairment of the Mudarabah fund does not favour the continuity of the venture.
  • The demise of the manager or the liquidation of the managing institution.

 

  • The existence of the one of the conditions that would consequently render a Mudarabah contract invalid. In this case, the Mudarib is deemed as the worker/agent who deserves fair and reasonable wages or fees only.

Disclaimer

The information contained herein is for informational purposes only and is not meant to serve and should not be relied upon as professional advice. Further information on the subject matter of this publication may be obtained from lecocqassociate.

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[1] Ibid at 11, page 111

[2] BNM 2009

[3] The Concept of Mudarabah, Dr.Muhammad Zubair Usmani.