In the previous, we discussed the definition and some important types of musharakah. Today, we are going to know what are the basic rules and conditions of musharakah contract and how it works in Islamic financial institutions.

Basic rules of musharakah

As we studied in the previous article that musharakah is a partnership contract among two or more parties and established by mutual consent. Therefore, it’s necessary that all the basic conditions of valid contract must be fulfilled here. For example, the contracting parties must be sane and mature, the contract must be done with mutual consent of the parties and there would be no fraud, cheating or misrepresentation. However, there are some specific conditions for the validity of musharakah contract.

Some important conditions are outlined in the following:

1. The ratio of the profit-sharing between the partners must be determined at conclusion of the contract. The profit for each partner should be in the percentage of actual profit. This is not permissible to determine a profit in lump sum amount of money or in the form a percentage of the capital. For example, if they agree that “A” will get 5% of his capital, then the contract would not be valid.

2. It’s allowed for working partner to set his profit more than his share of capital with mutual consent of the parties. However, if a partner explicitly mentions in musharakah contract that he will take part in management of the business and will remain as sleeping partner, then his ratio of profit would be more than his share of capital. For example, if he invested 50% capital in musharakah venture, then he is entitled to stipulate his profit share within 50% percent, not more than that.

3. If loss occurs in musharakah venture, every partner will suffer the loss according to his ratio of investment. This principle is agreed by all jurists and scholars across the different schools of Islamic law. For example, if a partner has invested 30% of the capital, he shall suffer exactly 30% of loss. Therefore, it’s not allowed to put any condition contrary to this principle. Otherwise, the contract become invalid.

4. In principle, the capital in musharakah contract should be contributed in the form of monetary assets. However, many contemporary scholars are of the view that capital may be contributed in the form tangible assets if all partners are agreed. In this case, it’s necessary to determine the monetary value of these assets in currency. So, the share of each partner is known clearly. 

5. In general, every partner shall have a right to participate in the management of musharakah and work for it. However, it’s permissible that the partners may agree that only one of them work for the musharakah and other remain as sleeping partners. If all the partners agree to work for musharakah venture, each one of them shall be treated as the agent of the other in all the business matters of the business.

Application of musharakah in Islamic banks

The musharakah is used as underlying contract for a number of Islamic banking and finance products such as home financing, project financing, trade financing, shares and equity products, Islamic funds and musharakah Sukuk. Especially, “musharakah mutanaqisah” is quite famous for home financing and vehicle financing. We will discuss the concept of musharakah mutanaqisah in next article in some details. The general mechanism of musharakah transaction is simplified here:

(a) The customer and the Islamic bank enter into musharakah contract and become partners in musharakah venture / enterprise.

(b) Both parties contribute their capital in musharakah venture in a ratio, for instance, 30 and 70.

(c) At the time of contract execution, both parties agree on profit-sharing ratio. If profit is realized in musharakah venture, it’s distributed among them according to pre-agreed ratio. And if any loss occurs, both parties bear it according to their ratio of capital.