Introduction: Scenario
Ousmane is a businessman from Senegal who understands the importance of diversifying income. Hence, he teams up with Abdullah; an ambitious young man who knows his way around the city and is very capable of driving motor vehicles.
Seeing that there is a high-demand for taxi services in the country, Ousmane enters into a business contract with Abdullah, one in which Ousmane would give his Norton Commando (motor vehicle) to Abdullah to drive around as a taxi.
Based on their market analysis, the daily estimated return for motor taxi vehicles is roughly $170. Accordingly, the partners stipulate the following as the terms and conditions of their agreement:
Terms And Conditions of Contract
- Duration: the partners agree to a 6 months contract, renewable subject to mutual agreement
- Returns: Ousmane would receive $100 from Abdullah on a daily basis. Abdullah gets to keep all returns above $100.
- Cost: Abdullah agrees to bear all maintenance costs related to the capital (i.e. Norton Commando) throughout the tenure.
Prior to signing any documents or making any payments, Ousmane reaches out to a Shariah adviser, seeking expert judgment on whether the contract is Shariah compliant, meaning free from all Shariah issues.
Points of Discussion
To assess the validity of Ousmane’s partnership contract with Abdullah, we need to address 3 main issues:
No. 1: the Norton Commando as capital
No. 2: fixing gains in partnerships
No. 3: the entrepreneur solely bearing all maintenance costs
Before we tackle these issues head-on, it is necessary that we first unpack the partnership contract at play; a Mudharabah.
Understanding Mudharabah
A Mudharabah is commonly understood to be an equity-based contract in which one party, known as the capital provider, contributes mal or capital whilst the other, referred to as the entrepreneur, contributes labour. Scholars have also referred to the practice as a ‘silent or sleeping partnership’ seeing that one partner’s contribution is limited to providing capital.
Another scholar famously known as Ibn Rushd al-Qurtubi, in his book ‘Bidayat al-Mujtahid Nihayat al-Muqtasid’ (translated as ‘The Distinguished Jurist’s Primer’), describes it as ‘al-ijarah al-majhula’ i.e. a lease agreement for an unknown payment since the exact sum of profit awarded to each party is not determined beforehand. Although this goes against the fundamental principle that payment for service must be known, he states that this concession has been given in order to ease the affairs of trade partners, and that there is an ijma (i.e. juristic consensus) regarding its permissibility.
At this juncture, is important that we look into a number of key components of a Mudharabah contract, namely, the partners, capital, and profit-loss sharing arrangement.
Key Components of Mudharabah Contract
- Partners
With regards to the partners, it was mentioned previously that of the two types of partners, one is the capital provider (known as rabbul mal) while the other is the entrepreneur (or mudharib).
Both partners are required to have legal capacity or ahliyyah, which entails that they are of sound mind, capable of discerning between right and wrong, and able to acquire rights and bear responsibilities in the eyes of the law.
- Capital
In relation to the capital, scholars are in dispute over the kind of properties that may be considered as so. While the majority view dinar and dirham (i.e. currency) as the sole permissible Mudharabah capital, owing to the change in value of non-monetary assets that potentially results in one partner obtaining an unfair advantage over the other, scholars like ibn Abi Layla and al-Awza’i have deemed goods for sale or urudh al-tijarah as valid Mudharabah capital.
Furthermore, majority of scholars hold the view that a debt owed to the rabbul mal by the mudharib should not constitute part of the Mudharabah capital as, according to the Malikis, it constitutes an additional financial burden being imposed on an individual who is already indebted. The Shafies and Hanafies’ concur with this position.
In essence, therefore, we see that both finances and goods have been recognized by respected scholars as valid Mudharabah capital.
- Profit-loss sharing arrangement
Entities engaging in partnerships typically expect to achieve an economic gain that is, accordingly, shared between them.
The Shariah mandates that their gains are set as a ratio or a percentage of the expected returns as opposed to a fixed amount or percentage of the capital. A failure to observe this rule would render the Mudharabah venture a usurious loan or a qard ribawi, one in which the rabbul mal’s capital and/or gains are guaranteed.
The above principle is derived from the hadith of the Prophet ﷺ in which he is reported to have said, “Indeed, profit is the reward for the readiness to bear the loss.” From this, the Islamic legal maxim ‘al-ghunm-bi-al-ghurm’ is derived, which simply means that “to gain one must risk bearing losses.”
It is worth mentioning here that the kind of loss borne by each partner differs in nature. Whereas the rabbul mal bears losses in terms of finances invested, the mudharib bears loses in the form of labour invested. By virtue of this, the mudharib should not be liable for any financial loss unless it is established that they were negligent, disorderly or in breach of their duties.
The bottom line is that while the Mudharabah partners’ share in the gains may be agreed upon, their losses are subject to the nature of their contribution.
With this general understanding of a Mudharabah contract and its key components, we may now proceed to apply these components to the scenario. Only then would we be able to effectively determine whether or not Ousmane’s partnership contract with Abdullah is Shariah-compliant.
Applying Mudharabah Components to Scenario (Points of Discussion)
Issue no. 1: the Norton Commando as the Mudharabah capital
It was highlighted earlier that some scholars were of the view that a Mudharabah capital may be in the form of non-monetary assets. It was also stated that when it is so, whether partly or completely, then uncertainty arises with regards to the value of the capital.
Scholars on the other side of the fence countered this view stating that Valuation is a great mitigating tool against this uncertainty as it enables partners to ascertain the value of the non-monetary asset at any given time. All appreciation or growth in capital value would, accordingly, be shared between the partners.
Based on the above, Ousmane would be advised that the Norton Commando is indeed a valid Mudharabah capital in the eyes of the Shariah.
Issue no. 2: fixing gains in a Mudharabah partnership
On the issue of Ousmane receiving $100 from Abdullah every day, it was established that scholars have unanimously agreed that neither the capital nor the gains of the rabbul mal should be guaranteed. What the partners are allowed to do, nevertheless, is fix in percentage or ratio what each of them is to receive from the gains or returns.
It is important to note that this stipulation would still not be allowed even if both partners are fine with it. This is because it has categorically been ruled impermissible based on the Prophet ﷺ’s saying, “any condition that is not in Allah’s Books (Laws) is invalid even if they were one hundred conditions…”
As such, the stipulation that Ousmane would receive $100 from Abdullah on a daily basis contravenes the Shariah and, thus, must be set aside.
Issue no. 3: entrepreneur solely bearing all maintenance costs (relating to the Mudharabah capital)
The Islamic principle established on this particular matter was that ‘gains must be accompanied with risk’. Based on it, as per the view held by renowned scholars, such as al-Kasani, al-Nawawi and Ibn Qudamah, the owner of an asset is solely responsible for his/her asset in case of its destruction unless it is shown that another entity in possession of it or responsible for it caused its destruction.
Notwithstanding this principle, one must always remember that the mudharib (or entrepreneur) may very well volunteer to bear all the maintenance costs provided, however, that such bearing is not stipulated in the Mudharabah contract.
This act of volunteering would be the equivalent of a borrower, completely at its own discretion, paying the lender back more than the debt amount. Such an act is not only allowed by the Shariah, but was a Sunnah of the Prophet ﷺ, who on numerous occasions repaid his debts in excess of what was given to him.
Fundamentally, there should be no stipulation in the Mudharabah contract that the Mudharib would bear the maintenance costs of the Mudharabah capital.
Preliminary Shariah Advice
Having applied the Shariah’s principles to this Mudharabah contract, it is, unfortunately, apparent that there are a number of Shariah issues within it, particularly in relation to Ousmane fixing his returns and Abdullah being required to bear all the maintenance costs.
But wait! There’s still good news for Ousmane. The aforementioned Shariah issues are resolvable as follows:
Concluding Shariah Advice
Recommendation for Issue no. 2: Ousmane wanting fixed returns
To resolve the issue, Ousmane may adopt one of two measures:
- Remove the fixed gains
The first would be to amend the clause so that it is his percentage from the gains/returns that is determined rather than the gains themselves being pre-determined. This move is necessary in order to resolve the Shariah’s prohibition against partners fixing returns, which potentially renders the mudharib (in particular) heavily indebted to the rabbul mal.
Accordingly, it would be incumbent upon Ousmane to set aside the stipulation that he is to receive $100 daily and instead stipulate that he would receive X percentage from the gains expected to be realized.
- Transform the Mudharabah contract into an ijarah (lease agreement)
Alternatively, the partners may opt to reconsider the nature of their relationship. So instead of capital provider-entrepreneur, their relationship would be one of lessor-lessee (as per the contract of ijarah). It is through this new relationship that Ousmane would be allowed to fix his daily returns in the form of lease payments.
The reason the lessor is allowed to fix the lease payment in a lease contract – in case you were wondering – is owing to the fact that the lessor takes up the ownership risk of the lease asset, ensuring that it remains suitable for use throughout the lease period. The lessor is, therefore, entitled to charge any amount he deems fit to anyone who wants to enjoy the usufruct of the asset.
This is different from the case of a Mudharabah contract, where income is generated as a result of synergizing two kinds of capitals, namely, financial and entrepreneurial. Hence, gains in Mudharabah contracts should only be based on the outcome of such synergy.
Applying this change in relationship would mean that Ousmane would be able to receive his intended fixed daily income of $100. Nonetheless, Ousmane would be required to guarantee the functionality and suitability of the lease property (i.e. the Norton Commando) throughout the rental period. Once again, the exception to when Abdullah would be required to bear the maintenance costs is if it shown that it was him who caused damage to the lease property either due to negligence, misconduct or breach of contractual terms.
Recommendation for Issue no. 3: entrepreneur bearing all the maintenance costs
Lastly, with regards the issue of Abdullah bearing all the maintenance costs, this issue is rectified simply by way of the partners avoiding any contractual stipulation stating that the mudharib would bear the maintenance costs of the Mudharabah capital except in cases of negligence, misconduct and/or contractual breach by the mudharib. If the mudharib so decides to bear such costs, as per his own discretion and in the absence of any contractual stipulation, then that would be fine and there wouldn’t be any Shariah issues.
Conclusion (for Ousmane)
All in all, it has been shown that there were two major Shariah issues in Ousmane’s Mudharabah contract with Abdullah. While the first was pertaining to the rabbul mal fixing his gains or returns, the second was regarding the mudharib taking up all the maintenance costs of the Mudharabah capital.
To resolve Issue no. 2, Ousmane, as the rabbul mal, is advised to either set his gains as a percentage of the profits to be realized rather than guaranteeing them, or convert the Mudharabah agreement into an ijarah agreement, thereby permitting him to claim a fixed (rental) income.
With regards to Issue no. 3, Ousmane is advised to avoid including any stipulation in the contract that shifts all the maintenance costs (of the Mudharabah capital) onto the mudharib, even if they mutually agree upon it. Nevertheless, it was made clear that it would be permissible for the mudharib to discretionally, non-contractually bear such costs.
This would constitute the advice Ousmane needs to ensure his Mudharabah contract with Abdullah is Shariah-compliant.
Wassalam!
References
Ibn Rushd, A. (2000). Bidāyat Al-Mujtahid (The Distinguished Jurist’s Primer). ISBN 1859641490.
Nik Abdul Ghani, N. A. R., Mat Zain, M. N. B., Zakaria, Z., and Yaacob, S. E. (2020). Analysis of Responsibility toward Leased Asset in Ijarah Financing from the Shariah Perspective: A Special Focus on Al-Ijarah Thumma Al-Bay. International Journal of Academic Research in Business and Social Sciences 10(10).
Noor, N. S. M, Ismail, A. G., Shafiai, M. H. M. (2018). Shariah Risk: Its Origin, Definition, and Application in Islamic Finance. SAGE Journals. https://doi.org/10.1177/2158244018770237
Rahman, M. H. (2018). Mudarabah and Its Applications in Islamic Finance. 33-46.
Sahih al-Bukhari 2168, Book 34, Hadith 119
Sahih Bukhari, Vol. 3, Book 34, Hadith 377
Sapuan, N. M. (2016). An Evolution of Mudarabah Contract: A Viewpoint From Classical and Contemporary Islamic Scholars. Procedia Economics and Finance, 35, 349-358. https://doi.org/10.1016/S2212-5671(16)00043-5
Zuḥaylī, W. and El-Gamal, M. A. and Eissa, M. S. (2007). Financial Transactions in Islamic Jurisprudence. Damascus, Syria: Dar al-Fikr
