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On the face of it, it can seem that Musharakah contracts aren’t that different from conventional partnership agreements in any business, with the sole limitations being on the activities involved and the lack of interest-bearing financing.
Read more about: Basic Guide to Musharakah Contracts
There are distinct differences between Musharakahs and their non-Islamic counterparts that we hope to explain here.
One of the key principles of Musharakah agreements is the idea that all profits and losses are shared between the partners proportionate to their ownership shares. As such, there is no mechanism in a Musharakah to shield shareholders from losses incurred by the business.
Partners cannot be offered guaranteed payments outside of their standard share of the profit of the company.
This may not be the case in more conventional corporations and businesses, where investors could be granted a guaranteed return on their investment. One example is the preferred equity investments in the partnerships, which typically come in the form of a coupon providing an annual rate of return on the capital invested and a preferred return.
As these forms of guarantees have to be paid regardless of the performance of the business, they in some ways can constitute a form of interest-bearing financing, which Islam considers as riba, and is forbidden.
A typical Musharakah is a purely contractual arrangement between the founding partners. In effect, this binds the obligations of the parties personally to the Musharakah, making the “personhood” of the Musharakah inseparable from the partners.
As such, the partners liabilities in the business are typically unlimited. Each partner could be held personally liable for the debts and obligations incurred by the business according to their share in the business. It also means that in the event of any legal action, the partners can be dragged into it.
This, however, can be mitigated by structuring the Musharakah under a limited liability corporation (LLC) or joint stock company. But this is an added layer to the Musharakah and isn’t automatically embedded in the initial setup of the original contract.
This is different from the legal structure of a conventional business or company, which is registered as a wholly separate entity from the partners themselves, giving them limited liability in the event the business incurs debts or faces lawsuits – particularly in the case of a LLC.
A Musharakah gives the partners the right to participate in the management of the venture, although this isn’t an obligation. Partners can choose to delegate one of their own to act on their behalf.
In a conventional business, management – with various roles and responsibilities – is typically structured right from the onset and may not require the participation of all the partners and investors in the business.
This structure is typically rigid for a set period of time. This more clearly centralizes the decision-making process. For example, in a typical corporation, shareholders vote to appoint a board of directors that selects a management team to oversee operations.
A typical Musharakah does not include a built-in mechanism for issuing shares. This is because the partnership is built on proportionate ownership and not by the amount of shares owned in a business.
This makes it difficult for a business to securitize equity and raise capital.
However, by incorporating the Musharakah under a separate corporate entity, such as joint stock company.
Partners can exit the venture at any time, thereby terminating the partnership. Each partner has the right to withdraw under certain conditions, including that their exit does not cause any losses or damage to the business and after providing proper notice. The business is then liquidated.
Partners cannot simply exit a Musharakah by selling their stake in the business to someone else.
In a conventional partnership, a partner leaving the business does not terminate the business itself, and their equity can be sold to the existing partners or to a separate party.
It goes without saying that a Musharakah is forbidden from engaging in any activity considered haram, including engaging in interest-bearing finance.
Read more about: The Pros & Cons of Musharakah Contracts
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
