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Diminishing Musharaka

Lecture 8

Diminishing Musharakah

This is a contract between a financier and a beneficiary in which the two agree to enter into a partnership to own an asset, but on the understanding that the financier will gradually sell their share to the beneficiary in accordance with an agreed schedule. The price at which the shares will be sold should ideally be determined at the time of sale, taking into consideration the market value of the asset at that time.

Example of Diminishing Musharakah

Year Client-to- bank ownership ratio

Client’s share in the rent (Rs)

Bank’s share in the rent (Rs)

Purchase of units in ownership by the client

Payment made to the bank

0 30:70 30,000 70,000 -^ 70, 1 40:60 40,000 60,000 1,000,000^ 1,060, 2 50:50 50,000 50,000 1,000,000^ 1,050, 3 60:40 60,000 40,000 1,000,000^ 1,040, 4 70:30 70,000 30,000 1,000,000^ 1,030, 5 80:20 80,000 20,000 1,000,000^ 1,020, 6 90:10 90,000 10,000 1,000,000^ 1,020, 7 100:0 100,000 0 1,000,000^ 1,000,

Purchase of a taxi on Musharaka

Basis

 A wants to purchase a taxi to earn income

and approaches Islamic bank.

 Islamic Bank provides 80% and A provides

20% of the price.

 Taxi earns 1000 rental income on daily

basis

 Both agree to share the profits at ratio

80:20 between the bank and client.

2. The purchase of bank’s share by client

and determination of their price should

be done in separate contract.

3. There should be offer and acceptance

each time the share is passed on to the

client.

4. Taxi gets depreciated in value over time

therefore depreciation in the value of taxi

must be kept in mind while determining

price of different units of the share of

financier.

Diminishing Musharaka in Trade

 Client and Islamic bank undertake a do

business of selling ready made garments.

 Bank contributes 60% of the capital and

client contributes 40%.

 It is also agreed that client will be buying

different units of the share of financier by

the client.

Conditions for Diminishing Musharakah

1. It is necessary that the buying and selling

of shares should not be stipulated in the

partnership contract. In other words, the

buying partner is allowed to give only a

promise to buy. The promise should be

independent of the partnership contract

i.e., the buying and selling agreement

must be independent of the partnership

contract.

2. The general rules for partnerships must be

applied to a diminishing partnership. Therefore, it is not permitted that the contract of diminishing partnership includes any clause that gives any of the parties a right to withdraw their share in the capital.

3. It is not permitted to stipulate that one partner

should bear all of the cost of insurance or maintenance on the grounds that they will eventually own the subject matter of the partnership.

5. The ratio of profit or income of the partnership that each partner is entitled to should be clearly determined. However, it is permissible for the partners to agree on a ratio of profit sharing that is disproportionate to the ratio of equity ownership. It is also permissible for the partners either to maintain the ratio of profit determined in the beginning, even if the ratio of equity sharing due to the change in the ratio of equity shares. In doing so, they must ensure that the principle of allocation of losses in accordance with the ratio of equity share of ownership is maintained.

6. It is not permitted to stipulate that one partner has a right to receive a lump sum out of the profits.
7. It is permissible for one of the partner to give a binding promise that entitles the other partner to acquire, on the basis of a sale contract, their equity share gradually, according to the market value or a price agreed at the time of acquisition. However, it is not permitted to stipulate that the equity share be acquired at their original or face value, as this would constitute a guarantee of the value of the equity share of one partner (the institution) by the other partner, which is prohibited by Shariah.

11. In case a co-owner fails to honor their undertaking, as aforesaid with regard to the periodic payment and purchase or sale of units as the case may be, the asset shall be sold in the open market and the co-owner aggrieved by such failure shall be entitled to recover:

a. actual loss defined as the difference between the market price mentioned in the undertaking, if any, not being the opportunity cost;

b. any gain on sale of property shall be shared by the co-owners in proportion of their respective investment at the time of such sale.