In the previous article, we have presented an overview of mudarabah contract and its different types. Today, we are going to learn what are the basic rules and conditions for mudarabah contract.

Mudarabah capital

Ideally, the mudarabah capital should be in the form of cash. Because, if the capital is in the form of commodities and assets, then there would be possibility of uncertainty and dispute in their value. However, the majority of contemporary scholars are of the view that capital in mudarabah may be in the form of commodities and illiquid assets. But in this case, it is necessary to determine the value of those assets in terms of cash. So, there should be no ambiguity or uncertainty about the value of capital. In addition, the capital must be present at the conclusion of the contract. The debt or receivables cannot be used as the capital in mudarabah.

Work for the mudarabah venture

The financier or capital provider is not allowed to participate in mudarabah business. If he puts the condition that he has a right to participate in mudarabah business and involve in buying and selling activities, then the mudarabah contract become void. The manager (mudarib) has to perform his duties within the agreed terms and conditions in contract. However, the capital provider has a right to oversee the mudarabah business to make sure that manager fulfills his duties honestly and efficiently.

Profit & loss sharing in mudarabah

It is necessary in mudarabah that both parties agree on profit sharing ratio at the time the contract is concluded.  The distribution of the profit must be on the basis of the percentage of profit. It is not allowed to decide the profit on the basis of a lump sum or percentage of capital. However, the parties are at liberty to agree on equal profit sharing or allocate different proportions. For example, 50 : 50 or 40 : 60 or 30 : 70 etc.

The capital provider only bears a loss if it happens, because the manger doesn’t invest anything. So, when the mudarabah business occurs a loss, the profit is used to offset the loss at first instance, if the loss is greater than accrued profit at the time of liquidation, then it is deducted from the capital.

Differences between mudarabah and musharakah

As we discussed in the previous articles that both musharakah and mudarabah are based on profit and loss sharing. However, there are some differences between them which are summarized in the following.

1. In musharakah, both partners contribute their capital, while in mudarabah, only rabbul mal / financier invests his capital.

2. All partners have a right to participate in the management of musharakah venture. But in mudarabah, the financier cannot participate in business management.

3. In musharakah, all partners share the loss according to their ratio of capital, while in mudarabah, only financier bears loss.

In the next article, we will explore some applications of mudarabah in modern Islamic financial institutions.