Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 15Musharakah

Musharakah is primarily a contract of partnership and mutual agency. Two or more legal entities may combine labor, expertise, capital, reputation, fixed assets, and other assets and create a legal commercial enterprise to undertake economic activity. Profits and losses are shared by the partners as is the management of the enterprise. The shariah dictates how profits and losses are to be shared. The Prophet ([saw] peace be upon him) specified in a hadith that profits may be shared on a pre-agreed ratio but losses are to be shared on the basis of the capital contributed by each participant.¹ This hadith is a precursor of the concept of limited liability the potential of which was not fully recognized by Muslim traders as much as it was by European merchants in the sixteenth century.

The concept of mushrakah allows numerous capital providers to contribute capital to commercial enterprises. The commercial enterprise created what is known as the sharik and it is a legal entity separate from partners that contributed capital to create it. This entity can undertake business in its own name, own assets, and incur debt. The most crucial point of the sharik is that in the event of default, partners in the sharik are only liable to lose the capital injected into the company and not their personal capital. Personal assets were segregated from assets of the sharik and the assets invested in the sharik. The sharik is therefore the forefather of the joint stock company, ...