Companies law islamic vs. conventional


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Companies law islamic vs. conventional

  1. 1. PhD Program Project PaperEast Cameron Gas Sukuk: Some Comparative Law Issues Fiqh al-Muamulat Semester September 2012 Professor Dr. Zainal Azam Abd. Rahman Mace Abdullah 1000491 Page 1
  2. 2. ABSTRACTThe East Cameron Gas Sukuk (ECGS) was the Sukuk of the year in 2006 andwas showered with every kind of accolade. It was the first Sukuk with situs inthe Unites States, the first Sukuk claiming to contain Shari’ah-compliantembedded hedges and it was the first Sukuk in the world to end in bankruptcy.Those distinctions alone make it “fertile” ground for professional and academicIslamic finance research on a variety of fronts. This paper takes a fresh look atthe ECGS, not to further rain upon it tribute. But, rather, this paper looks at itsstructural implications; in fact, its structural pluralism. The ECGS structure hadvirtually every business form known to modern finance in it within a multi-jurisdictional framework. Thus, we ask the question anew: what is a Sukuk? Weask this question from a comparative law perspective. One glowing look at theECGS structure leads to the irrefutable conclusion that it was much more than asimple a Musharakah Sukuk. To that end, this paper compares and contrasts theECGS underlying premise of being a Musharakah Sukuk; its sweeping structurehelping us to compare “partnership” and company law from a Fiqh andconventional law perspective. 2
  3. 3. OBJECTIVES OF THE PAPERThis analytic paper examines the East Cameron Gas Sukuk from a comparativelaw viewpoint, i.e. from both the Shari’ah and conventional law points of view.Specifically, this paper summarizes, compares and contrasts the legal theoriesbehind Musharakah Sukuk; e.g. the:  Fiqh of companies  Conventional law of companies  Fiqh issues relating to Sukuk  Conventional law issues relating to securitiesKey terms of the paperMusharakah; Sukuk; Islamic Companies Law; Islamic securities; ComparativeLaw 3
  4. 4. TABLE OF CONTENTSI. INTRODUCTIONII. FIQH OF COMPANIES A. Musharakah 1. Definitions & Legitimacy 2. Classifications 3. Rules & Prohibitions B. Mudharabah 1. Definitions & Legitimacy 2. Classifications 3. Rules & Prohibitions C. Conventional Counterparts 1. Originating Concepts & Conventions 2. Partnerships-General & Limited 3. Limited Liability Companies & Partnerships 4. CorporationsIII. FIQH OF SUKUK A. Definitions & Legitimacy B. Classifications C. Rules and Prohibitions D. Originating Concepts & ConventionsIV. CONCLUSION REFERENCES 4
  5. 5. I. INTRODUCTION East Cameron Gas Sukuk (ECGS) was the first Sukuk issuance to involvesecuritized assets with situs1 in the United States of America (US or America).(IFN 2006). It was touted as the first securitized Sukuk with embedded Shari’ahcompliant hedges (BSEC 2006). Its issuance was met with much fanfare. It washeralded as the harbinger of “the dawn of a new frontier” for Islamic Finance inAmerica; awarded the Islamic Finance News “Deal of the Year” (IFN opt cit);crowned with every accolade, as were the lawyers, arranger and syndicator thatstructured it. The excitement was understandable, particularly to the approximately 7million Muslims who live in America (Ilias 2008) and the many more who dobusiness there. Yet, the fear of Islamic Finance growing in America triggered aCongressional Report (Ibid). The growth of Islam itself in America has beenopposed vehemently, giving rise to a socio-political phenomenon known asIslamaphobia.2 The phenomenon is remarkable since the tragedy of September11, 2001. Islamophobia is now being added to dictionaries worldwide. Thisphenomenon is characterized by an extreme or irrational fear, prejudice orhatred towards Islam and Muslims. In its wake, masajid have been attacked,protests against the building of masajid and other Muslim activities abound;while numerous American states have sought constitutional amendmentsseeking to prohibit American courts from using any foreign law in renderingtheir decisions (the so-called Shari’ah Controversy3). Financially, the size of the American economy and its appetite for debtand equity securities makes it a likely target for growth oriented securities.American debt now approximates $15 trillion; about the same amount as itsGDP (USA Today 1/19/12). Approximately 35% of the world’s known wealthlies in America (IFSB 2011). In 2006, America’s bond market totalled $328billion; by far the largest in the world (followed by Britain with $200 billion).Combined the 2 countries comprised nearly 2/3 of the world’s total bond marketof $838 billion (McKinsey & Co. 2011). America currently has $7.4 trillion inbonds and notes outstanding (BIS 2012).1 Situs is a conventional law term that signifies location of immovable property. However, its application in modernonventional law has generally implied personal property that has the location of it owner. Hence, stock certificates in modernconventional law have the situs of a trust’s trustee. Situs can be used by courts to exercise in rem jurisdiction over a case where personal jurisdiction may be lacking. 2 The term was first appeared in a book criticizing the mistreatment of North African Muslims by French authorities entitled “La Politique Musulmane dans l’Afrique Occidentale Française” by Alain Quellien, published in Paris in 1910. 3 See for a discussion. 5
  6. 6. Moreover, the American capital market is arguably the most highlydeveloped capital market the world has ever known. In terms of size, theAmerican equities market, measured by capitalization value on its 2 exchanges(NYSE and NASDAQ), is nearly $16 trillion; more than the next 6 largestexchanges combined. By comparison, the Tokyo Stock Exchange (the nextlargest) is $3.5 trillion, while Britain’s is $2.8 trillion4. All of these data areample cause for optimism about America as a target for Sukuk expansion. And so it was in 2006, when ECGS was launched. There was muchoptimism to say the least. However, a little over 2 years after the launch, moresobering news began to surface, marked by the Chapter 115 bankruptcy filing bythe Originator, East Cameron Partners, LP6 (Reuters 1/15/09). Hence, ECGShas the dubious distinction of also being the first Sukuk in the world to filebankruptcy under any law. As can be seen from Figure 1 below, East Cameron Bay is located in theGulf of Mexico (one of the most hurricane prone locations in the WesternHemisphere). The Gulf of Mexico is notorious for its hurricanes, the mostnotable in recent years being Hurricane Katrina in 2005, which virtuallydestroyed the city of New Orleans, in the state of Louisiana, US. It is also theplace of the massive 2010 BP oil line rupture that released 4.9 million barrels ofcrude oil into the Gulf of Mexico. On or about September 14, 2008, Hurricane Ike destroyed a number of oildrilling platforms in the Gulf of Mexico, effectively halting drilling operationsfor a number of other drilling platforms7. This undoubtedly had an impact onthe hydrocarbon mix production required by the Production Delivery &Marketing Agreement of the ECGS (see Table 2 below). On September 17, 2008, ECGC’s Trustee (a Cayman Islands registeredtrust company named Walkers), sent an Enforcement Notice to Deutsch Bank(as the Escrow Agent) of a hydrocarbon mix shortfall (a so-called “exogenousenforceable event) pursuant to the Funding Agreement (see Table 2 below). Onor about that same date, there was convened a meeting of Sukuk certificateholders. The Purchaser SPV’s independent member was thereafter notified toexercise its rights under the Funding Agreement, which included its choices to: 4 See Chapter 11 is one of 6 bankruptcy types allowed under US law. All bankruptcies are governed by federal law. They will be discussed elsewhere herein.6 An LP is a limited partnership, which is a common form of partnership in America. Its characteristics are discussed in the section on Fiqh of Companies.7 See 6
  7. 7.  continue on with the regular payment schedule (effectively forgoing the delinquent payment).  accelerate payments pursuant to the Agreement.  direct the Purchaser SPV (LOH) to sell the royalties in a commercially reasonable manner.8  withdraw any amounts in the escrow accounts and forward to the Issuer.  exercise its rights as a secured creditor.9  take such other action as afforded by the Agreement, any of the other Sukuk agreements or remedies at law or equity.10 Adding “insult to injury,” so to speak, the Originator sought bankruptcyprotection against the Issuer, East Cameron Gas Company (ECGC) and theSukuk certificate holders and then filed lawsuit against the Purchaser SPV (see“Parties” below) in an attempt to treat the structured Sukuk as a loan instead of a“true sale.” Sukuk certificate holders included conventional hedge andinvestment management companies (who represented their clients) andanonymous GCC investors. Since the Sukuk certificate holders were not namedas defendants in the Originator’s lawsuit, they filed a “Motion to Intervene” toassert and protect their legal and economic interests. What follows is a discussion of the structure of the ECGS, its Shari’ahcomponent and the underlying Fiqh and conventional law (limited to Americanlaw, which has distinct ties to common law) characteristics of musharakah andmudharabah (generically partnerships) and Sukuk (generically securities). Forpurposes of this paper, Sukuk are viewed “holistically” and include theirhybridized structures; which more often than not, include conventional “parts”and aspects. This legal mix is referred to as structural pluralism. Location or Situs. It is instructive as a starting point to note that theECGS (the “Sukuk”) proceeds were used to pay-off the Originator’sconventional debt (undoubtedly imbued with riba), purchase oil and gas hedge“puts” (considered by many Fiqh scholars as being questionable or shubh11),8 Commercially reasonable manner is a conventional legal term best described in what is known as the Uniform CommercialCode; it provides for the sale of the collateralize property in a public or private manner (including sale to the creditor for theamount in default), in whole or part and may occur at any reasonable time, place and other reasonable terms. Fungible or perishable collateral must be specifically handled speedily and the debtor must be notified. 9 Under conventional law, creditors are generally either secured or unsecured. Secured creditors whose interest in theproperty is collateralized by lien, mortgage or hypothecation (e.g. recordation in public records of the interest so as to give “constructive notice” to the “world.”10 Conventional law emanating from the common law system of Britain provides for remedies at law (code or statute) orequity (which started as a special appeal to the monarchy, but later became administered by special courts, procedures that take a normative view of the law versus a positive view. 11 The fatwa describes the obligation created by the hedges as iltizam, a term which refers to a system of mutual obligations. They may be permissible or impermissible. The relevant factor that determines whether the iltizam transactio was Shariah-compliant is whether it has a real value and does not just provide value to one of the parties, instead of both, 7
  8. 8. acquire oil and gas royalties in a Gulf of Mexico wildcatting operation(speculative), as well as to otherwise “structure” the Sukuk. Wildcatting is anAmerican term used to describe risky or speculative drilling of wildcat wells,i.e. oil and gas wells in areas not known to have significant oil or gas.Notwithstanding its speculative nature, the Sukuk was based on a reportshowing a history of oil and gas production and estimates of further reserves. The underlying real assets in the Sukuk were deep water drillingplatforms, deepwater leases and their usufruct, i.e. oil & gas and the relatedroyalties. However, only the royalties to the usufruct were contributed to theSukuk. Parties. There were 6 different parties involved in the Sukuk; each with adifferent business form and each formed in a different jurisdiction. The primarymotivation for the Sukuk was the desire of the Originator, a family limitedpartnership, owned by a father and son, to buy-out a third partner. In order to doso, they needed financing. The financing available to them through conventionalmeans was unattractive and they were convinced to try Islamic financingbecause it was cost effective. Table 1 shows the main parties to the transactionand their respective jurisdictions. Figure 1-Gulf of Mexico As can be seen from Table 1, the “parties” included jurisdictionalpresences in the State of Texas (US), Cayman Islands, the State of Delaware(US), the State of New York (US), Lebanon and Britain. Moreover, the leaseswere physically located off the coast of the State of Louisiana; subject to USfederal coastal leasing law; as “securities,” the Sukuk were subject to US federal and is not speculative in nature. 8
  9. 9. securities laws (Reg. D12 and S13) because they involved an US Originator; UStax laws because the income from the Sukuk was sourced in the US; and USfederal bankruptcy law, by statute, because all US bankruptcies are governed byfederal bankruptcy laws. Hence, ECGS was truly a cross-border structuredhybridized transaction, including multiple jurisdiction law, applicable to: a trust,a private company, two corporations, a limited partnership, a limited liabilitycompany and ostensibly a partnership (ECGC). Structuring. The Sukuk, though initially contemplated as an Ijarah Sukuk,was ultimately structured as a Musharakah Sukuk. The underlying leases (EastCameron Lease Blocks 71 and 72) were let by the US government’s MineralManagement Service under authority of the Outer Continental Shelf Lands Actto the highest reasonable bidder for renewable terms ranging from 5 to 10 years(43 USC § 133714). The US and other third parties had overriding oil and gasroyalties pursuant to the leases. Table 1-the Parties Originator • East Cameron Partners, L.P.- Houston, Texas, USA • East Cameron Gas Co. (SPV)- Issuer Cayman Islands • Lousiana Offshore Holdings, Purchaser LLC (SPV)-Delaware, USA Syndicators-Arrangers • Bemo Securitisation (BCES), Beirut, Lebanon and Merrill Lynch-United Kingdom Escrow & Payment Agent • Deutsch Bank-New York, USAThe leases in question were awarded to the Originator, ECP, who did notcontribute the leases to the “Purchaser” SPV, Louisiana Offshore Holdings(LOH), LLC15, but instead contributed the oil and gas royalties to the“Purchaser” SPV.12 Reg D is a regulation under the Securities Act of 1933 of US securities law, which provides exemption from registration of the security with the Securities & Exchange Commission (SEC), the primary US capital market regulator.13 Reg S is a regulation under the Securities Act of 1933 of US securities law, which provides exemption from registration of US based securities that are offered “offshore,” thus making it easier for foreign investors to purchase the securities. 14 US federal statute containing the Outer Continental Shelf Lands Act.15 An LLC is a limited liability company under the laws of the various states in the US. It has characteristics of both acorporation and a partnership, as those terms are generally understood in the US. They are typically conduit entities that have 9
  10. 10. It’s worth mentioning that even though the oil and gas royalties weretransferred to LOH, the sole “equity” membership interest in LOH was ownedby ECP, the Originator. It is not clear why this part of the Sukuk was structuredlike this. However, the Originator, ECP, later sought to take advantage of thisstructuring “flaw” by asserting that the royalties were never transferred, butcollateralized instead. The LOH Operating Agreement did provide for an “independent”member, who had no interest in the profits or losses of LOH, had no power tobind it contractually, was not required to contribute capital, had no power tovote and its membership “interest” would terminate and/or expire uponfulfilment of certain contractual obligations by the equity member, theOriginator. The independent member did possess one power. That power was tocause the sale of the oil and gas royalties payable to LOH at commercialreasonable price and terms, without consent of the equity member, in theeventuality that the Originator failed to make payments to LOH as agreed in theFunding Agreement (see below). Figure 2-Structure of the ECGS Figure 2 shows the structure of the ECGS and all “parties” to the Sukuk.Certain other companies were involved in the drilling and extraction operations,including operators and back-up operators, who did the actual drilling, and “offtakers,” or companies responsible for buying and transporting the commodities,are not shown for the sake of brevity.particular attraction because of their asset protection features. Though named Louisiana Holdings, the LLC was formed and organized under the laws of the State of Delaware, US. 10
  11. 11. The actual musharakah was based in the Cayman Islands, structured as aso-called Star Trust (as opposed to a partnership) under that country’s SpecialTrust Law of 1997 (IFN 2010); although it seems that a partnership companyalso took residence in the Caymans, i.e. the ECGC. That jurisdiction hasspecific laws governing trusts, which are separate and distinct from itspartnership laws (which are common law based and do not require registration).As noted later, the duties of partners in Islam can include those similar to trusts. In any event, if both the Cayman trust and partnership were viewed inisolation, there would be no activity and there would effectively be no Sukuk,only a pre-mixed (i.e. capital not mixed to acquire anything), a dormat shirkatal-‘amlaak (capital partnership) or even a trust. The remaining “parties” areneeded to consummate the transactions contemplated by the Sukuk. Thus, theSukuk is for all intent and purposes comprised of all of the “parties” (which canbe descriptively called “affiliates” in modern financial parlance), each beingcontractually bound by the various contracts encompassing the Sukuk. Table 2 Underlying Contracts CONTRACT PARTIES • Certificate Purchase Agreement & • Sukuk Holders & East Cameron Gas Declaration of Trust Company (ECGC) • Funding Agreement • Lousiana Offshore Holdings, LLC (LOH) & ECGC • Purchase & Sale Agreement • LOH & East Cameron Partners, LP (ECP) • Contribution Agreement & • LOH & ECP Conveyances • Allocation Account , Deposit & • LOH, ECP & Deutsch Bank Distribution Agreements • Production Delivery & Marketing • LOH & ECP Agreement The musharakah was used to legitimatize the Sukuk Islamically andessentially had no other role than to provide capital (much as a rabb al-mal 11
  12. 12. would do in a mudharabah transaction). More will be said about theimplications of this practice later, which ironically is called “Shari’ahconversion technology” by one of the scholars that gave the fatwa on the ECGS(DeLorenzo 2007). The Shari’ah-compliance fatwa was given by Sheikh YusufTalal DeLorenzo, of the US, and Sheikh Nizam M.S. Yacubi, of Bahrain; bothprominent scholars. Table 2 shows the primary underlying contracts in the Sukuk, althoughthe Purchaser SPV’s LLC Operating Agreement16 might be considered anotherunderlying contract. The question that begs to be answered is whether or not allof the contracts were Shari’ah-compliant? Is there even a requirement that theunderlying contracts all be Shari’ah-compliant? What are the consequencesfrom an Islamic Finance perspective, if one or more of the contracts are notShari’ah-compliant, in whole or part? Undeniably, in the ECGS, some of thecontracts are conditional upon others. The basic financial terms of the Sukuk were:  Currency and pricing ……………………. USD-$165,670,000  Tenor in years …………………………… 13 years  Coupon rate 17 ……....………….……….. 11.25%  Rating 18 ……………………….….. S&P-CCC+ Litigation. A review of the bankruptcy pleadings related to the lawsuitfiled by the Originator, ECP, against the Purchaser SPV, LOH, reveals that theUS Bankruptcy Court, Western District of Louisiana rejected ECP’s contentionthat the underlying Sukuk assets were simply collateral. That court reliedheavily on a “comfort letter” written by the attorneys for the Originator toStandard & Poors (S&P), assuring S&P that the transaction was a “true sale”under Louisiana law. That “true sale” comfort letter seems to have been theproverbial “straw that broke the camel’s back.” Judgment was entered asfollows: 1. The court ruled that the transfer from ECP to LOH was a true sale under Louisiana law19 (not the same meaning as in the Shari’ah). It relied heavily on the “comfort letter” or opinion letter to Standard & Poors (for 16 An LLC’s Operating Agreement is an internal governance organizing document, which functions within an LLC much as bylaws function within a modern corporation. Both are binding on stakeholders. 17 Not guaranteed per the offering circular, but the expected return per the offering circular. 18 ECGS was S&Ps 1st Sukuk rating. The rating was reduced to CC after the bankruptcy was filed.19 "True sale," under Louisiana statutory law means a “consummated sale of all rights, title and interests that the seller may have in a receivable sold over an exchange located in this state, with the buyer acquiring all of the sellers rights and interests, and with the seller not retaining a legal or equitable interest in the receivables sold” 12
  13. 13. rating purposes) by ECP’s own attorneys, who opined that the transfer of the royalties qualified as a true sale under Louisiana and bankruptcy laws. 2. It further ordered that LOH, ECGC, Deutsche Bank, in its capacity as Escrow Agent, and the Sukuk certificate holders, their principals, agents, employees, directors, representatives and any persons acting on their behalf or in active concert with them, are no longer restrained or enjoined from selling, liquidating, encumbering, conveying, or otherwise transferring all or any portion of the overriding royalty interest owned by LOH. 3. ECP was left to work-out its financial difficulties through its plan of reorganization, which appears to be still on-going. The court approved nearly $2 million in legal fees; demonstrating the need for Islamic mediation (sulh) or arbitration (tahkeem) as possibly less disruptive and more cost efficient means to resolve disputes. The S&P lead analyst20 involved in the Sukuk recently stated that themusharakah trust was, according to the most recent reports available to him,still collecting the oil and gas royalties, but at an amount less than required bythe Funding Agreement (the analyst actually used the phrase in an amount lessthan the required “interest”). One wonders whether if the Sukuk certificateholders had adhered more closely to the Islamic concept of forbearance andallowed the Originator time to recuperate from Hurricane Ike’s impact onproduction, would ECGS still be operating and doing so with more efficiencythan now is the case. ECGS was undeniably a maverick at the time of its issuance and fairlycomplex in structure. Its ground-breaking features and sudden failure raisesmany Fiqh issues relating to a variety of topics, including, but not limited to: thestatus of companies law in Islamic Finance, the special issues surroundingSukuk structures and their hybridization, the nature of property and theconcomitant rights in property under the Shari’ah, iflas (insolvency andbankruptcy), dispute resolution and sulh (mediation) and tahkeem (arbitration)and comparative or choice of law challenges. A comprehensive discussion of allof these issues, even if limited to the context of the ECGS could easily fill thepages of a book. That’s obviously beyond the scope of this analytic research paper. Hence,the remainder of this paper is restricted to a closer look at the comparative law 20 Based on an email received from the analyst on December 3, 2012. 13
  14. 14. issues of how partnerships and securities are understood under Fiqh andconventional laws. This paper proposes that from a modern Islamic Financeviewpoint, classical shirkat partnerships closely resemble conventionalpartnerships in form (albeit retaining their spiritual epistemologicalunderpinnings) and that Sukuk (being a modern financial phenomenon) closelyresemble conventional corporate structures and are not Islamic bonds andshould not be referred to as such. The ECGS serves as an excellent observationpoint for these assertions.II. FIQH OF COMPANIES A. Musharakah Fiqh al-Muamulat’s treatment of companies starts with partnerships, i.e.shirkat or musharakat. All companies in classical Islamic Law are partnerships,i.e. there is no discussion of the evolutionary forms of companies in modernfinance today. Corporations and limited liability companies are relatively newforms of doing business. The various forms of partnerships found in modernfinance are, however, seen in the classical Fiqh of companies. Definitions. According to al-Zuhayli, the word shirikat signifies the“mixing of two properties in a manner that makes it impossible to define theseparate parts” (Al-Zuhayli 2007). The basic form of sharikat in Fiqh is themusharakah. The mudhahib or different legal schools of thought differ as to theprecise definition of musharakah:  Malikis view it as “a right for all the partners to deal with any part of the partnership’s joint property.”  Hanbalis view it “as sharing the rights to collect benefits from or deal in the properties of the partnership.”  Shafi’ees view it “as an establishment of collective rights [pertaining to some property] for two or more people.”  Hanafis view it “as a contract between a group of individuals who share the capital and profits.” (Ibid). The Hanafi madhab characterizes musharakah as a contract and in thatsense, it is more preferable. This is the view of Zuhayli (ibid) and others(Nyazee 2000). The implication of the Hanafi definition is an expansive view ofthe partnership company; one that might encompass a Sukuk Musharakah. Forexample, in the ECGS, this definition might lead one to conclude that theOriginator was a partner, as it certainly shared in the capital and profits of the 14
  15. 15. venture. It is significant to note that the Originator was a party to more of thecontracts “in” the Sukuk than the Sukuk certificate holders themselves. Legitimacy. As is often the case Fiqh al-Muamulat (specificallycommercial dealing between people) the general rule is that of mubah orabahah, i.e. permissibility unless there is a specific text that forbids thetransaction. A text of nass can be narrowly or broadly construed; particularly ifthere is no specific text from the Lawgiver, Al-Hakim, i.e. Almighty Allah orHis Messenger, Prophet Muhammad, AS21, by way of delegation. In such cases,the text that is relied upon for a legal ruling may, out of necessity, come fromothers, e.g. the Sahabah, Tabi’een or latter day jurists and scholars. Moreover, ifthere is a text from the Lawgiver, it may be dhanni (open to interpretation);again giving rise to the need to search for answers to legal questions by derivingthem from the primary Sources of Shari’ah, i.e. Qur’an and Sunnah. That said, scholars of Fiqh Muamulat (fuqahah) believe that Musharakahis legitimized by Qur’an, Sunnah, Ijma and ‘Urf (Ibid). However, Musharakahas a business form is not specified in Qur’an, i.e. the word is not specificallymentioned. Instead, Almighty Allah mentions sharing and associating in wealthand business in Suratul Nisaa: Ayat 12 and Suratul Saad: Ayat 24, respectively: “…If more than two, then they share (shurakaa) in a third…” (4:12) “…Many of those who mix or associate (khulataa’), do wrong to one another, except those who believe and do the good deeds; and how very few they are…” (38:24) The former Ayat connotes the (fara’id) distribution of wealth accordingthe rules of inheritance, while the latter is used in the context of a commercialdispute between two brothers brought to Prophet Daoud, AS, as a guise byAngels to test his ability to judge fairly. Classical scholars use both to deducethe legitimacy of sharing in wealth and mixing of property for commerce. The legitimacy of musharakah or partnerships, i.e. shared commercialactivity, in this case, is buttressed by the Hadith Qudsi, narrated by AbuHurairah, RAA22, where Almighty Allah says: “I am the third of every two partners as long as neither one betrays the other. However, if one betrays the other, I leave their partnership.” (Abu Dawud and Al-Hakim; both validated its chain).21 Alayhi Salaam or Peace be upon him.22 Radhi Allaahu anhu or Pleased is Allah with him. 15
  16. 16. Moreover, the Prophet, AS, is reported to have told us in a Hadith: “If youengage in a mufaawadah (sharing of capital), do it in the best possible way” and“Engage in mufaawadah for that increases the blessings of the wealth” (IbnMajah as quoted by Zuhayli op cit). On the authority of Abu Hurairah, he isfurther reported to have said: “Allah’s Hand is with the two partners so long asone does not betray the other” (al-Dar Qutni). Finally, the Prophet, AS, found the people of his day carrying onpartnerships and he accepted it. This form of Sunnah (Sunnatul taqririyyah ortacit approval) also gives further legitimacy to the classical form of doingbusiness. (Zuhayli op cit). This acquiescence by the Prophet, AS, also givescredence to the legitimacy of ‘urf or ‘adah (custom or conventions) as a mean toderive a rule or hukm of law. Hence, we find the legal maxim or quwaid alfiqhiyyah: “Custom (‘adah) is the basis of judgment” (al-adatu mu˙akkamtun).(Mejella Article 36). Accordingly, there is ijma or consensus among thescholars of Islam that Musharakah is a valid business transaction. Classifications. Musharakah are classified in a several different ways.Notwithstanding the differences, two broad classifications are prevalent, i.e.classifications between voluntary and involuntary and classifications betweenlimited and unlimited forms. Both are discussed from the viewpoint of severalprominent scholars. Usmani (1998) prefers 2 broad classifications: (1) shirkat al-milk (jointownership of property), wherein he distinguishes between voluntary andinvoluntary ownership (as noted below) and (2) shirkat al-‘uqud (joint ormutual contract). He further categorizes the latter as either shirkat al-amwal(joint capital contribution), shirkat al-‘amal (jointly providing services tocustomers) and shirkat al-wujooh (joint use of deferred sales to acquirecommodities on credit and to then resell them for profit). The two broadclassifications above are also used by al-Fawzaan (2005). Al-Zuhayli (2007) classifies musharakah under two main classifications:sharikat al-‘amlaak (capital partnerships) and sharikat al-‘uqud (contractualpartnerships). He regards partnerships that originate without a contract as“general partnerships.” Of these he divides them into “voluntary” and“involuntary.” Voluntary general partnerships are those that originate by “jointpurchase” or “joint receivership of gifts or bequests,” i.e. they are acceptedjointly. Involuntary general partnerships are those that originate without anyaction of approval by the partners, e.g. heirs by law according to the muwarith 16
  17. 17. or the ordained distribution. Al-Zuhayli notes that in the general partnerships,neither partner has a right to deal in the other partner’s share. Al-Zuhayli points out that there is khilaaf or differences of opinion amongthe mudhahib (juridical schools) on the classification of contract-basedpartnerships. That is not surprising since only the Hanafis include the term“contract” in their definition. The following taxonomy summarizes the ikhtilaafsurrounding contract-based partnerships:  Hanafi-6 sub-classes, i.e. 2 subdivisions as either limited (‘inaan) or unlimited (mufaawadah) and within them, three further divisions, i.e. (1) capital (al-amlaak), (2) physical labor (al-‘abdaan) and (3) credit (al- wujooh).  Hanbali-5 sub-classes, i.e. (1) limited (‘inaan), (2) unlimited (mufaawadah), (3) physical labor (al-‘abdaan), (4) credit (al-wujooh) and (5) silent (mudharabah).  Maliki & Shafi’ee-4 sub-classes, i.e. (1) limited (‘inaan), (2) unlimited (mufaawadah), (3) physical labor (al-abdaan) and (4) credit (al-wujooh) Ibn Rushd classifies Musharakah as 4: (1) shirkat al-‘inaan, (2) shirkatal-‘abdaan, (3) shirkat al-mufaawadah, and (4) shirkat al-wujooh. (Ibn Rushd2003). There are legitimate theoretical differences as to the variousclassifications, although some are simply differences in terminology, e.g. withshirkat al-‘abdaan and shirkat al-‘amal and shirkat al-‘amlaak and shirkat al-amwal. One of the more significant classifications according to Fiqh is thatwhich distinguishes between a limited (‘inaan) and unlimited (mufaawadah)partnership. This distinction is comparable to the modern partnershipdistinctions. Shirkat al-‘inaan or limited partnership is the most common form ofpartnerships in Islam (Al-Zuhayli op cit). All mudhahib agree as to itslegitimacy, but differ as to the right of each partner to deal in the property of thepartnership as its legal agent (wakalah). Thus, the Hanafis and most Hanbalisallow this agency (i.e. each partner being considered the legal agent for allothers), while the Malikis do not. The Shafi’ees also allowed the mutual agencyin dealing with the partnership property, except in the case of credit sales. If arestriction is placed on this mutual right of agency, the Hanafis regard thepartnership as shirkat al-‘amlaak. The Malikis simply reclassify such anarrangement among partners as an unlimited partnership, i.e. shirkat al-mufaawadah. 17
  18. 18. In a shirkat al-‘inaan, partners may have equal sharing of capital or labor(and thus profits), or may have proportionate sharing of one or more of these 3basic elements. In any event, the three elements are jointly decided as toproportion and nature of: capital contributed, labor contributed and the ratio ofprofit based on common capital. However, there cannot be uncertainty orgharar as to these elements, i.e. the partners cannot just agree to come together,without more. Imam Malik and Imam Shari’ee required that profits be distributedequally only when capital was initially contributed equally on the bases thatprofit must follow capital, the legal maxim: “no reward without risk” (al ghormbil ghonm). (Ibn Rushd op cit). While the partners share in capital, labor orprofits according to any method of allocation they agree upon, they can onlyshare in losses according to their contributions to the partnership’s capital.Thus, the general rule: “Profits are shared according to the parties’ conditions,but losses are shared according to their share in the capital” (Al-Zuhayli op cit). Yet, it might occur to those who specialize in Islamic Finance thatIslamic scholars have “pigeon-holed” themselves into a corner by insisting onthis constraint. While it is understandable that loss should follow capital, thereasoning should not come to a “dead end.” There are adillah (proof) that mightsupport a different end, e.g.: “Damage and benefit go together. Thus, if a personwho obtains benefit from a thing, he should take upon himself also the loss fromit” (Mejalla, Art. 87). It then follows that if a partner enjoys profit(notwithstanding the paucity or lack of capital altogether), then might (s)he alsosuffer the damage? Consider further: “The burden is in proportion to the benefitand the benefit to the burden (Mejalla, Art. 88). If this maxim is construednarrowly to mean that benefit is capital, then it might be understandable.However, in shirkat- al-‘inaan, benefit (i.e. profits) may flow as the partnersagree, not necessarily as the capital is arranged. Moreover, the Prophet, AS, hasadvised us: “All the conditions agreed upon by the Muslims are upheld, except acondition which allows what is prohibited or prohibits what is lawful” (Usmaniop cit). Thus, the restriction of loss to capital account balances seems a rather“slim reed upon which to lean” an important legal principle. What might beconsidered, as is the case in conventional laws, is that a negative capitalaccount, can under certain circumstance, trigger a duty to bring the capitalaccount back into the “black.” Shirkat al-mufaawadah or unlimited partnerships allow any partner todeal in the partnership’s property, ostensibly as its agent. It requires equality 18
  19. 19. among the partners. Al-Zuhayli (op cit) asserts that this equality applies tocapital, legal rights and religion. Rules. Even though there are many differences between the legal schoolsregarding the rules or conditions for partnership in Islam, most are subtle. Al-Zuhayli (ibid) sets forth 2 general conditions for all partnerships:  The actions or purposes for which the musharakah contract is written must be permissible for delegation; and  The ratio of profit sharing must be known precisely or the partnership will be deemed to have gharar and rendered defective. Al-Zuhayli states 2 rules for sharikat al-‘amlaak (capital partnerships),that apply to both limited (‘inaan) and unlimted (mufaawadah) partnerships.These norms seem grounded on the definitional views of requirement that allpartnership property be mixed and on the ability to measure some property andthe difficulty in measuring others. Such restrictions emanate from theprohibition against bai’ al-sarf or spot transactions involving the 6 ribawi items.Hence:  Capital must be specified (again with the implication that transactions viewed impermissible as bai’ al-sarf under the legal view will also be held impermissible as contributed capital), present at the time of the contract or at the time of making a trade (which, of course, has been seen as an impediment to sharikat al-wujooh or credit partnerships that buy goods on credit and sell for cash); and  Capital must be fungible, i.e. gold, silver or contemporary currencies. Notwithstanding that this is the majority position, there is enough dissent among the mudhahib, that this norm has limited strength. For example, Shafi’ees and Malikis both allow measurable fungible non-monetary capital. Hanafis disallow fungible non-monetary capital only prior to mixing the capital of a partnership; but if this capital is of the same genus prior to mixing, it is acceptable. Al-Zuhayli also states there are 6 rules for shirkat al-mufaawadah(unlimited partnerships):  Partners must be able to delegate (yufawwiduhu) legal authority, serve as a guarantor (kafeel) and be an agent (wakeel) for one another.  Partners’ shares of capital must be equal at all times.  Each partner must include all his wealth from the genus used as capital in the partnership (although this norm is the subject of ikhtilaaf or difference of opinion, particularly by Imam Shafi’ii himself. 19
  20. 20.  Profit sharing must be equal.  All permissible trading must be part of the partnership business, i.e. partners are not allowed to trade on their own behalf because to allow it would negate the mutual delegation and representation aspects of these partnerships. Thus, according to Abu Hanifa, all partners must be Muslim, although Abu Yusuf permitted unlimited partnerships between Muslims and non-Muslims if all partners were eligible for wakalah and kafalah. Al-Fawzaan (op cit) opines that having a non-Muslim partner is permissible, provided the Muslim controls the management of the shirkat, so as to avoid any dealings that are impermissible; whether intentionally or unintentionally. This is particularly important, since the agency right of wakalah is given such prominence in the Fiqh rationale for partnership dealings.  The partnership contract must use the term mufaawadah to insure each partner understood the partnership’s conditions. In substance, the prominence of agency (wakalah) and guarantee(kafalah) in the sharikat rules (ahkam) appear to be setting forth parameters onliability and duties. That is to say, what rights do partners have to use thepartnership and its assets in dealing with those outside the musharakah?Further, it can be said that in shirkat al-‘inaan, there can be restrictions placedon a partner’s right to do so. Moreover, there appears to be the right or option inal-‘inaan partnerships for a partner to act as guarantor (kafeel) vis-à-vis some3rd party debt. Such latitude does not seem present in shirkat al-mufaawadah(Nyazee 2000). Ibn Rushd (2003) adds that among the ahkam of a valid partnership isthat the underlying contract is revocable (iqaalah) and partners may withdraw atwill; selling their partnership interest back to the other partners at cost(tawliyyah). He further notes that partners may be held liable for their negligentdealings in the properties of the musharakah; albeit liable to the other partners.He gives the example of a partner who deals with a third party without takingwitnesses of the transaction. If the third party denies the claim, the partner is leftto compensate the remaining partners for his negligence. Finally, Al-Zuhayli points out 4 instances that invalidate any partnership:  Dissolution by any partner (although the Malikis and Hanbalis require mutual consent to terminate the mutual delegation of agency).  Death of any partner (whether known or unknown). 20
  21. 21.  Apostasy by any partner is viewed in the same manner as death with respect to that partner (whether is tantamount to a prohibition against a valid partnership with a non-Muslim is otherwise addressed by the different views of Abu Hanifa and Abu Yusuf, the latter thinking the partnership still valid as long the non-Muslim does not control the management of the shirkat).  Insanity, coma or prolonged loss of capacity results in termination of the mutual agency.Al-Zuhayli adds 2 other conditions that terminate specific types of musharakah:  In shirkat al-‘amlaak (capital partnerships), if any or partner capital perishes or is diminished (in an inequitable manner) before the “mixing” of the capital, the shirkat is deemed terminated. There are minor nuances which discuss the possibility that 1 partner might engage in trading for the benefit of all partners. Thus, in that case, there are some differences as to whether the diminution of that partner’s capital causes the shirkat to become invalid.  In shirkat al-mufaawadah (unlimited partnerships), the Hanafi position is that any inequality in the capital accounts invalidates the contract. Partner Liability. Before moving on the the mudharabah (silent partner)model, it is instructive to raise the important issue of partner liability. Theliterature is clear that each partner has unlimited liability in the mufaawadahpartnership. As to whether there is limited liability for al-‘inaan partnerships, itdoes not appear that a partner can bind all other partners without their consentand any creditor may demand payment from the specific partner incurring theliability. However, this leaves open the problem of how a creditor will knowwho is the lawful obligor? This is the issue of ostensible authority and thejuristic person addressed in conventional partnership law. An ostensible partneris one “whose name is made known and appears to the world as a partner”though he may lack the actual authority to bind his partnership (Black 1968).The classical literature does not seem to confront this issue clearly (but thatcould be the result of the researcher’s limitations). The juristic person is theconcept of a separate legal existence of the partnership itself. As to the unlimited partnership (mufaawadah), Al-Zuhayli (2007) statesunambiguously:“…there are specific conditions that apply only to unlimited partnerships: 21
  22. 22. 1. The partner in a mufaawadah can undertake debt on behalf of the partnership,as well as pawn objects on its behalf. This follows from each of the partnersbeing a guarantor (kafeel) for the other in this type of partnership.2. Every partner is liable for all financial liabilities induced by his partnersthrough valid sales, loans, leases, guarantees and pawning, as well as guaranteesfor usurped objects and kept deposits and loans. All those responsibilities alsofollow from each partner being a guarantor for the others…” Nyazee (2000) agrees, but does not appear to limit his view to unlimitedpartnerships. He states:“The liability of a partner for the debts of a partnership is unlimited, and Islamiclaw does not legitimate the concept of limited liability as we know it in modernlaw for corporations and limited partnerships.” Nyazee attributes this difference to the acknowledgement of the “juristicperson” in conventional law, which he unequivocally rejects as having no basisin Fiqh. He does, however, back-off this position a bit, by analogizing an al-‘inaan partner to that of a mudharib partner. He limits the liability of the rabbal-mal for actions by his mudharib that are unauthorized, and de facto does thesame as to uninvolved partners in an al-‘inaan partnership. He makes thisargument by appealing to the authority of al-Sarahkhsi, who called such actionsbateel. He buttresses his argument on the premise that the only loanspermissible in Islam are qard hasan and rejects istiqraad or debt financing. Heconcludes that both mudharib and al-‘inaan partner acting alone do not have theright to incur a liability on behalf of the partnership because they lack authorityand, in his view, more importantly, because any such authority would be bateelper se. Though one is referred to as limited (‘inaan) and the other unlimited(mufaawadah), those designations can only clearly be related to “authority”bestowed upon partners in dealing with partnership assets, not the degree oflegal exposure of partners beyond their investment. That is a distinguishingfeature of partnership law under the Shari’ah as opposed to conventional law (atleast in the common law countries). In conventional law, limited or unlimitedrefers to the exposure partners have to 3rd parties dealing with the partnership.B. Mudharabah Mudharabah has been referred to a “silent” partnership (Al-Zuhayli opcit) and “speculative” partnership (Al-Fawzaan op cit). These partnerships arealternatively called muqaradah, i.e. qiraad. The term mudharabah is prominentin Shams, while qiraad being so in the Hijaz. Shikat al-Mudharabah have been 22
  23. 23. called the “work horse” of Islamic finance. This accolade most likely has itsorigin in its wide acceptance and predominance during the time of the Prophet,AS. Definition. The definition of mudharabah is not as complex as those ofmusharakah. Also, there is little, if any, ikhtilaaf regarding the definition orclassification of mudharabah. The term mudharabah comes from darb fil-ard inthe Arabic; meaning to journey through the earth seeking the Bounty ofAlmighty Allah (Nyazee 2000). Its meaning indicating the work the mudharibdoes to seek out the profit on behalf of the rabb al-mal (provider of capital).The term muqaradah comes from the Arabic qard, meaning to abstain fromsomething. Likewise the term points to the rabb al-mal refraining frominterfering with the work of the mudharib. The Mejalla (Article 1404) defines these partnerships as: “A partnershipof capital and labor is a type of partnership where one party supplies the capitaland the other the labor. The person who owns the capital is called the owner ofthe capital (rabb al-mal) and the person who performs the work is called theworkman (al-mudharib).” It further states that the basis of the partnership isoffer (ijab) and acceptance (qabl). (Article 1405). The common thread insimilar definitions is that there is no khalt or mixture of capital. Although somedefinitions compare this form of partnership to that of a wakalah, with the rabbal-mal being the muwakeel and the mudharib being the wakeel (Nyazee op cit).The distinction is that in mudharabah there is sharing of profits based on theefforts of the mudharib and capital of the rabb al-mal. However, losses areborne by the rabb al-mal and the mudharib loses his effort and labor (ibid). Legitimacy. The mudharabah partnership finds legal authorization inQur’an, Sunnah, Ijma and Qiyas. Scholars derive implicit support for seekingout profits in 2 Ayat: “Others travelling through the land (yadriboona fil-ardee) seeking of Allah’s Bounty” (73:20).And “…and when the prayer is finished, then you may disperse through the land and seek the Bounty of Allaah and Remember Allah much…” (62:10) In the Sunnah, the scholars of Fiqh point to the life of the Prophet, AS,wherein he travelled and management the capital of his wife, Khadijah, RAAand Abu Sufyan, on the basis of mudharabah. He did so both before and afterthe advent of Islam as noted by Ibn Taimiyyah (Zuhayli op cit). Moreover, the 23
  24. 24. Hadith narrated on the authority of Ibn Abbas, RAA, that states he “used tostipulate a condition whenever he gave his money in a mudharabah, that themudharib will not take his money across any sea, into any valley or buy anyanimal with a soft belly; and if the mudharib were to do any of those actions,then he must guarantee the capital. The Prophet, AS, heard of this practice andpermitted it.” And in a Hadith, said to have a weak isnad or chain of narration(with at least 1 weak transmitter in it), Ibn Majah reported on the authority ofSuhayb, RAA, that the Prophet, AS, said: “There is blessing in threetransactions-credit sales, silent partnership and mixing wheat and barley forhome, not for trade.” There are athar or narrations regarding the Sahabah (Companions of theProphet, AS), RAA, wherein several of them invested the money of orphans insilent partnerships and no one criticized them. It is also narrated the Ibn ‘Umarand his brother, both when travelling with the Muslim armies to Iraq, tookmoney owed to the Baital-Mal (Treasury), invested it in goods in Iraq, whichthey sold in Madinah Munawarah. Their father, ‘Umar al-Khattab, RAA,objected to them doing this, bringing to their attention that other soldiers hadturned down the same proposal. Yet, upon further discussion and consultation,‘Umar, RAA, agreed to treat the transaction as a qirad and allow them to keep½ the profit and to turn the capital and the other ½ of profit over to the Baitaul-Mal. The Hanafis believe there was ijma regarding mudharabah, but the mostthat can be determined is that this belief is based on the fact that the noSahabah, RAA, objected to the practice. This would result in ijma sukuti or ijmaby tacit approval. As far as Qiyas is concerned, Shafi’ee has analogized mudharabah tomusaaqah or share cropping and given the partnership further legitimacythereby. Others, such as al-Kasani reject this approach, believing it to involveunknown or non-existent wages (Nyazee 2000). Classifications. There are 2 basic forms of mudharabah:  Restricted-wherein the rabb al-mal dictates restrictions in the contract with the mudharib. Restrictions as to time, location of performance and work to be done are examples. There is ikhtilaaf among the mudhahib as to the permissibility of these restrictions. Nevertheless, the Hadith of Ibn Abbas, RAA, offers strong evidence of permissibility.  Unrestricted-wherein the capital is turned over and there are no restrictions placed on the mudhahib. Zuhayli asserts that this is the only 24
  25. 25. permissible mudharabah according to the Malikis and the Shafi’ees (Zuhayli op cit).The classifications in the Majella (Article 1406) conform to these classes withthe use of absolute and limited in lieu of unrestricted and restricted,respectively. Rules. Al-Zuhayli states that the cornerstone of the silent partnership isthe contract that must include 3 cornerstones (rukn): (1) the parties (al-aqidan),i.e. rabb al-mal and mudharib; (2) an object of the contract (al-mawdu’ aqd);and (3) the language (sighah) of the contract, which must include an offer (ijab)and acceptance (qabl). Other general rules governing mudharabah partnerships include:  All jurists allow monetary capital.  Some (Hanafi and Hanbali) jurists reject fungible capital.  Most classical jurists reject non-monetary, non-fungible capital as being based on gharar (its initial value) and thus making the division of profits uncertain. However, ‘Abu Hanifa, Malik and ‘Ibn Hanbal all permitted listing the price of non-monetary property as capital of a silent partnership. In this instance, the rabb al-mal would give the capital to the mudharib to sell according to the listed price and subsequently use the money as the capital (in this way removing the gharar from the dealings).  Jurists agree that the capital must be present and not absent and may not be debt from the rabb al-mal (however, he may commission his agent to collect a debt owed to him and to thus use the proceeds as capital).  It is majority opinion (jumhur) with the exception of the Hanbalis that the capital must be delivered to the mudharib. The Hanbalis permitted the rabb al-mal to keep the capital in his possession, while the Malakis permit the him to make multiple contributions of capital to the mudharabah. This condition is said to differentiate the mudharabah partnership from shirkat al-‘amlaak, which allows each partner to keep his capital in his possession.  Profit ratios must be known, be in common shares and be void of any fixed monetary compensation.  Losses to capital are borne by the rabb al-mal, while the mudharib suffers the loss of his effort, work and expertise. Prohibitions. When any of the above rules are violated, the silentpartnership may be defective (fasid) and once corrected, leaves the partnership 25
  26. 26. intact. The Hanafi mudhab call our attention to 2 general conditions that willresult in defective silent partnerships:  Ignorance regarding profit sharing; and  Violations of any of the other rules or conditions, e.g. a statement that losses can be allocated to the mudharib, which would render the partnership defective (but would be ignored and losses allocated to the rabb al-mal nonetheless). All juridical schools agree that extreme profit sharing allocating renderthe partnership defective. In such cases, the jumhur position is that a failure toallocate profit to the mudharib results in the partnership being transformed intoan uncompensated agency or otherwise entitling him to his going market ratewage (referred to as quantum meruit in conventional law). The Maliki positionis one of “standard silent partnership” vis-à-vis fair wage, depending on thenature of the extreme profit sharing allocation. Thus, the mudharib is allocatedsome of the profit, if any, and none if there is none. However, if thecircumstances warrant it, a Maliki jurist might grant the mudharib quantummeruit instead. An invalid silent partnership is one that results in termination. All legalschools agree that a silent partnership may be terminated by direct voiding ofthe agreement or by withdrawal of authority to deal in the capital by the rabbal-mal, provided the following conditions are met:  The non-voiding partner is notified of the direct voiding by the voiding partners; and  The partnership capital must be in the form of monetary capital at the time authority is terminated.The Malikis make mutual consent a further condition for voiding the contractonce work has been done. The Malikis view the silent partnership contract asbinding, while the other schools regard it as non-binding. The following events may also trigger termination of the silentpartnership:  Death of one of the partners; although the Malikis disagree and state that the mudharib’s heirs may replace him if trustworthy or otherwise hire a wakeel to undertake the work.  Insanity in either party; although the Shafi’ees require it to be long-term and irreversible. The latter rule applies to comas as well. The Hanafis have an additional rule limiting termination in the case of mental 26
  27. 27. incapacity, wherein a mudharib may be subject to legal conservatorship and another legal agent commissioned for the work.  Apostasy on the part of the rabb al-mal. Apostasy includes him dying or being killed in a state of apostasy, as well as migrating to a land of war (presumptively a land at war with Islam). This rule does not apply to the mudharib.  Destruction of the capital that perishes in the possession of the mudharib before work has commenced.  Capital as credit (i.e. as receivables or other debt) after any of the above events, results in different treatment, each turning on the responsibility of the collect on the credit, if any, of if profits remain to be allocated. In conclusion to this section of the paper on classical partnerships inIslam, it is widely understood that in the area of Muamulat, there is latitude forchange due to time and place; which is not the case in the areas of ‘Ibadat(matters pertaining to worship and the rights of Almighty Allah), ‘Itiqadiyat(‘aqidat or the Islamic belief system) and ‘Akhlaqiat (moral code). That is not tosay that all conformity isn’t important; because it is. It is the measuring stickagainst which change must align itself. Yet, one must struggle to find a Hukm(i.e. other than sharing, mixing and betrayal), particularly an iqtida or talab (i.e.command) or tahrim (i.e. prohibition). Those who include ijma and qiyas in theprimary sources will take issue with that assessment. However, there is no ijmaon the primary canonical sources containing more than Qur’an and Sunnah. Infact, after consideration of what is in the divine sources, there is ikhtilaaf ordifferences of opinions as to how partnerships should be formed, operated andterminated; and what more closely resembles takhyir or option than wajib orobligatory requirements. That said, what follows is a discussion of comparativelaw similarities and differences.C. Conventional Counterparts It’s noteworthy as a preface to the comparative law issues surroundingShari’ah-compliant partnerships, that clearly much of the Fiqh of partnershipsis judicially derived. Basic premises are discerned from the “texts,” if that termis interpreted as Qur’an and Sunnah, i.e. very clear commands on sharing,mixing and prohibiting betrayal (e.g. dishonesty and lack of transparency-essentially zulm or gharar). Of course, as a threshold issue, partnerships cannotengage in business activities that are based on riba or otherwise involveprohibited lines of business. Accordingly, rules governing contribution and 27
  28. 28. mixing seem to be fairly imposed, as do the rules governing the “fiduciary”duties of wakalah owed by partners to one another. The classical view of companies in Islam is no less “structured” in thearea of partnerships than in conventional law. The principal differences betweenIslamic company laws and conventional laws can be categorized into 4 areas:(1) epistemology; (2) freedom of contract; (3) separate legal existence; and (4)evolution of forms. Categories (1) and (2) will be discussed under this sectionon partnerships. Items (3) and (4) will be discussed in the section of this papercomparing Sukuk and corporations and their related modern structures. Originating Concepts & Conventions. The epistemology of conventionalpartnerships and their concomitant laws can be traced to Near Eastern societiesand Medieval Europe (Henning 2007). These origins are said to be as old ascommerce itself. Roman expansion and conquest, along with its developingbody of law, gave shape to lex mercatoria or merchant laws. These lawscontributed several important concepts. Foremost among them was the idea ofparties coming together for consensual good faith dealings inter se or amongthemselves. Moreover, the Roman law of lex mercatoria advanced anotherfundamental legal principle still found in modern conventional partnership, i.e.the doctrine of agency or each partner having the right to participate in themanagement of the business (mutua praepositio), as well as the liability of allthe partners (in solidum) to third parties for “partnership obligations and theentity theory of the legal nature of partnership” (ibid). These principles of lawrun with the theory of general partnership till this day. They also bareresemblance to al-‘inaan and al-mufaawadah in Fiqh; although theepistemologies differ (i.e. the conventional counterparts drawing on a sort of“natural law” while the Islamic forms seeking affirmation in the Shari’ah). The other form of partnership known as a commenda or “an arrangementby which an investor (commendator) entrusted capital to a merchant(commendatarius) for employment in business on the understanding that thecommendator, while not in name a party to the enterprise and though entitled toa share of the profits, would not be liable for losses beyond his capital” (ibid).The parallel to modern Anglo-American limited partnership (see below) isclear. It also strikes an amazing similarity to Islam’s mudharabah. Finally, with respect to the origins of conventional partnerships, othersbelieve that the origins can be traced to early societal “merchant houses” orfamily businesses that ultimately formed ventures and companies with other“merchant houses” (Kohn 2003). Taking a more “organic” view of how 28
  29. 29. partnerships developed, Kohn draws a similitude between these family “houses”of merchandising and trades with family agricultural endeavours. He tracesthese origins to “sea lions” or commerce in the Mediterranean Sea and theRoman forms noted above. He repeats another theme found in other literature inthis area and that is that one of the motivations for using the partnership form inthe Roman and European environments was to avoid Roman edicts againstusury (ibid). In other words, a partner might be able to secure legitimate profitsat a rate suitable to him through the partnership form that he would not be ableto charge by simply loaning money to a merchant. This is certainly aninteresting phenomenon from the Islamic perspective. Freedom of contract has been defined as the concept that "parties to atransaction are free, or ‘entitled,’ to agree on, or ‘to choose,’ any lawful terms”to an agreement between them (Angelo 1992). From the Western perspective,freedom of contract is associated with laissez-faire capitalism (Epstein 1997).The theory assumes that “the unrestricted exercise of freedom of contractbetween parties who possess equal bargaining power, equal skill, and perfectknowledge of relevant market conditions maximizes individual welfare andpromotes the most efficient allocation of resources in the marketplace”(Edwards 2009). Obviously, as with most theories, the assumptions presentformidable limitations on application. However, there is something that can besaid of the so-called sanctity of contract. As noted earlier, the Prophet, AS, isreported to have said: “All the conditions agreed upon by the Muslims areupheld, except a condition which allows what is prohibited or prohibits what islawful” (Usmani op cit). Although freedom to contract can lead to zulm or oppression,exploitation, etc., it is an overriding principle in conventional partnership law. It“originated in the late eighteenth and the early nineteenth centuries, and wasbased on the natural law principle that it is ‘natural’ for parties to perform theirbargains or pacts. During that period, the doctrine was incorporated into thePrussian Code of 1794 and into the French Civil Code promulgated in 1804.Other continental codifications later adopted this doctrine. During this sameperiod, English law embraced the doctrine as a manifestation of freedom oftrade” (Angelo op cit). Today, freedom of contract is still part and parcel of conventional legaltheory, but with limitations imposed in equitable law, so as to prevent harshnessand unconscionable results notwithstanding that parties are assumed to be ableto “fend for themselves” while engaged in the bargaining process (ibid). The 29
  30. 30. Shari’ah by contrast, presumes that oppression may enter into the dealings andthat parties do not always have equitable positions in their dealing. Thus,parameters (dhawabit) are established from the onset. This is obviously asimplification of a subject that could easily be a paper by itself. However, it isinstructive to note that both legal systems have areas of that are deemed illegalper se, one (Islamic) more steadfastly than the other. Partnerships-General and Limited. As in Fiqh, conventionally,partnerships are given several definitions:  A voluntary contract between two or more competent persons to place their money, effects, labor, and skill, or some or all of them, in lawful commerce or business, with the understanding that there shall be a proportional sharing of the profits and losses between them (under Oregon law).  An association of two or more persons to carry on as co-owners a business for profit (Uniform Partnership Act).  A commutative contract made between two or more persons for the mutual participation in the profits which may accrue from property, credit, skill, or industry, furnished in determined proportions by the parties (Louisiana law).  It is in effect a contract of mutual agency, each partner acting as a principal in his own behalf and as agent for his copartners, and general rules of law applicable to agents apply with equal force in determining rights and liabilities of partners (US federal case law). (Black op cit).The parallels to the Fiqh definitions are striking. General Partnerships. General partnership law in America followscommon law and bifurcate partnerships as general or limited. Generalpartnerships are governed by the Uniform Partnership Act (UPA), which is a“model” set of rules for general partnerships that is promulgated by the UniformLaw Commission and adopted with or without modification by the severalstates in America. The more salient provisions include:  Partnerships may be oral or verbal, simple or complex.  Partners join their capital and share accordingly in profits and losses by default. However, the partners may agreed for an allocation that is different based upon other factors, e.g. labor or services provided, credit worthiness, expertise, etc. Certain partners may be granted “guaranteed payments.” Partners may be paid interest on their capital accounts pursuant to the terms of the partnership agreement. They may also be 30
  31. 31. paid “guaranteed payments” (generally for services or expertise provided to the partnership) according to terms in the agreement. Partners may contribute tangible, intangible or other benefits to the partnership, including money, services, promissory notes, or agreements to contribute (in the future). A partner will be held liable for promised contributions, even after death. Partners share control over the enterprise and subsequent liabilities. Every partner is equally able to transact business on behalf of the partnership. However, the UPA permits the filing of a statement of partnership authority. The statement can be used to limit the capacity of a partner to act as an agent of the partnership, and limit a partners capacity to transfer property on behalf of the partnership. The statement is voluntary. But the statement, if filed, has an impact on third parties dealing with the partnership to the extent they know of the filing. Filings that are recorded on property records are deemed known, e.g. those that are filed against real property or in personal secured property transactions. A partner may file a statement of denial respecting facts, including limitation upon partnership authority. A partner or the partnership may file a statement of dissociation from a partner. There is also a statement of dissolution that may be filed when a partnership is dissolving. Each of these statements has a notice function. Third parties are held to have knowledge of these last two statements 90 days after they are filed. The UPA articulates the duties of loyalty and care to which each partner is to be held. There are minimum standards of conduct that each partner must meet. No agreement can abrogate these standards, i.e. they are obligatory. Moreover, there is an express good faith obligation to which each partner is subject. There is a duty not to do business on behalf of someone with an adverse interest to the partnership. A partner must refrain from business in competition with the partnership. The standard of care with respect to other partners is gross negligence or reckless conduct. A partner would be liable to another partner for such conduct, but not for ordinary negligence. The good faith obligation simply requires honest and fair dealing. Dissociation normally entitles the partner to have his or her interest purchased by the partnership, and terminates his or her authority to act for the partnership and to participate with the partners in running the 31
  32. 32. business. Otherwise the entity continues to do business without the dissociating partner. Dissolution and winding up are required unless a majority in interest of the remaining partners agree to continue the partnership within 90 days after a partners triggering dissociation before the expected expiration of the term of the partnership.  Creditors of the partnership are entitled to rely upon the assets of the partnership and those of every partner in the satisfaction of the partnerships debts.  The character of any partnership depends upon the agreement of the partners (“freedom of contract”) and great deference is given to the partnership agreement with model provisions generally not being applied unless the agreement is silent as to the model terms (so-called “default rules”). Other provisions, e.g. a partner’s right to inspect the books and records of the partnership cannot be taken away (deemed obligatory). Other provisions are regarded simply as voluntary.  A partnership is an entity, rather than an aggregation of individual partners (the “separate legal existence” concept discussed later).  A general partnership may convert to a limited partnership or a limited partnership may convert to a general partnership. A general partnership may merge with another general partnership or limited partnership, forming an entirely new partnership (Uniform Law Commissioners 1994). As can be seen, there are again, many parallels with musharakah.However, interest on capital and guaranteed payments are both prohibited inIslamic Law. There is also greater latitude in the kind of property that may becontributed to the partnership under conventional law than under the Shair’ah.One observation that should seem somewhat obvious is that there is an exampleof harmonization that Fiqh might consider, adopt or modify so as to create agreater degree of organization in the laws of partnerships. In other words, a“model” partnership “act” might be vetted, agreed upon and adopted by thevarious jurisdictions, which encompasses the rules of the various mudhahib,making certain provisions wajib, other mandub or makruh and leaving othersmubah. This would have three benefits for Muslim jurists and Islamic Finance:(1) it would quell what is perceived as “unacceptable is irresponsible,decontextualized ‘patching’ (talfiq) where rules are merely put togethermechanically to meet current commercial demands” (Hamoudi 2008); (2) help 32
  33. 33. Muslim and non-Muslim jurists alike, see where “structural pluralism” is and isnot (ibid); and (3) it would promote harmonization on points of Fiqh that will inall likelihood continue to present themselves as Islamic Finance growns. Limited Partnerships. Limited partnerships in America are outlined in theUniform Limited Partnership Act (ULPA). The source and scope are similarlyformatted as with the UPA. The more salient aspects of the ULPA can besummarized as follows:  Limited partnerships may be formed for any “lawful” purpose, but formation requires a filing with the “secretary of state” in which the limited partnership is formed. There is therefore separate legal existence and is not an aggregation of partners from a legal standpoint.  Duration may be perpetual, but the agreement may provide for automatic dissolution based upon date or completion of purposes. Annual reporting is required.  Must have at least 1 general partner and at least 1 limited partner. Partnership is managed by a general partner and the rights of the limited partners to transact any business on behalf of the partnership or with or without accessing the capital is severely restricted. General partner(s) may be granted a management fee in the partnership agreement. If there are more than 1 general partner, they may manage by majority or as otherwise stated in the partnership agreement.  Same statement filing provisions as in the UPA regarding disassociation, but may be filed by either general or limited partners. However, the partnership agreement may limit the ability of limited partners to disassociate by a statement filing. The ULPA does provide an exhaustive list of events that can trigger an involuntary disassociation of a limited partner, as well those that can trigger dissolution.  Limited partners do not have the right to bind the partnership or any other partner and therefore are liable to creditors only to the extent of their capital investment in the partnership. General partner(s) may have unlimited liability for obligations of the limited partnership if he is named in the legal action against the partnership. The limited partnership may elect limited liability partnership (LLP) status by filing the election. A limited partner who is also a general partner (dual capacity) may bind the partnership and deal in partnership capital.  Limited partners do not owe fiduciary (agency) duties to one another, but have a general duty of good faith and fair dealing among themselves and 33
  34. 34. towards the partnership. General partner has fiduciary duty towards the limited partners, as well as duty of loyalty, good faith and fair dealing. Reasonable restriction on access and use of information imposed on limited partners. Access to certain required information, including profits or losses, or information needed for consent (e.g. addition of limited partners) to certain transactions may be modified by the partnership agreement, e.g. standards for making reasonable requests, advanced notice thereof, etc. Profits and losses are allocated according to capital in the default, but may be modified by the agreement. Part of the consideration for allocation may be tax based, i.e. some partners may be allocated losses in the early stages of existence, but later receive more distributions (which in conventional partnerships may be different from profits, i.e. money distributed to a partner is not required to equal a proportionate share of profits). Non-profit partners may forgo tax deductions in favour of their for-profit partners, receive increased monetary distributions from operations and ultimately be given the right to purchase the underlying asset(s) at a bargain or nominal prices (this arrangement is common in developing so-called “low income” housing). Partners may be paid interest on their capital balances. General partner may be liable for improper distributions. The general partner has legal duty to distribute profits to limited partners. A general partner may also be a limited partner and act in a dual capacity. Limited partnership must have an “agent for service of process” recorded in public records, i.e. a person or firm designated to receive legal notifications from the public and the government. A general partner is an agent of the partnership and may have ostensible authority when acting as agent, if for example, his name has not be added to the certificate of limited partnership before he acts as the partnership’s agent. All acts performed on behalf of the partnership by the general partner are otherwise deemed authorized unless they are acts that are not customarily carried out by a partner for a partnership and those acts are not authorized in the partnership agreement. A general partner owes the duties of loyalty and care to the limited partnership and the other partners. The duty of loyalty prohibits the general partner from competing with the limited partnership. The duty of care prohibits him from grossly negligent, reckless, intentional conduct or 34
  35. 35. conduct that is knowingly in violation of law. The partnership agreement may alter these duties.  Partners may contribute tangible, intangible or other benefits to the partnership, including money, services, promissory notes, or agreements to contribute (in the future). A partner will be held liable for promised contributions, even after death. However, this will generally require that such an obligation be in writing, in order for it to be enforceable (Uniform Law Commissioners 2001). Again, generally, there are parallels between conventional and Islamiclimited partnerships. However, some of the same differences noted for generalpartnerships, also are present with respect to limited partnerships. Limited Liability Partnerships & Companies. Both Limited LiabilityCompanies (LLC) and Limited Liability Partnerships (LLP) are hybridcompany structures seeking to encompass the best of both the partnership andcorporate structures. Hybridization would seem to be the trend in businessorganizations, both Islamically and conventionally. Sukuk are, in fact, almostuniversally now, hybrid in structure. Both are relatively new as business forms.Yet, their underlying conceptual bases are not. There is, as we have seen,nothing new about partnerships. They are ancient. Similarly, the evolution oflimited liability can be traced to the early business models, e.g. mudharabah, upto the more recent legal principles surrounding corporations. And likecorporations, these companies require explicit governmental approval andcompliance to come into existence and to remain in existence. LLCs are modelled after the Revised Uniform Limited LiabilityCompany Act of 2006 (Uniform Law Commissioners 2006). The noteworthyprovisions of LLCs can be summarized as:  They are based on foundational contracts called operating agreements.  They have “articles” which are filed with governmental agencies, much as a corporation files articles; which in turn results in the state issuing a “charter” or authorization for the company to do business as an LLC.  Rather than “cabining-in” the fiduciary duties of members and managers (who may also be members), the model Act leaves it to the members, through their operating agreement, to delineate the duties and responsibilities of the parties. However, the Act does identify major fiduciary duties which are more or less beyond the reach of the freedom of contract and in a cautiously scaled back manner imposes the duty of 35
  36. 36. loyalty, care and good faith and fair dealing on members towards the company and other members.  Members are not agents of the company simply because they are members. They must have authority to bind the company and rarely have authority, if ever, to bind other members. Moreover, the doctrine of ostensible or apparent authority is not as well defined in these companies. Once third parties know that the company is an LLC, then there is a developing area of law in the conventional space that more or less resembles “caveat emptor” in real estate law, i.e. the third party must beware that who he is dealing with has express authority, just with corporations.  Either members or managers or both may manage the affairs of an LLC, although the Act’s defaulting methods are managed and member- managed.  Charging orders are again the sole remedy against the individual acts of members “outside” of the LLC construct.  The so-called organic transactions, e.g. mergers, conversions, and domestications are sustained.While the Act does not sanction them, many states in the US do sanction“series” LLCs. These LLCs are allowed to have companies within the LLC, i.e.“series” within one umbrella LLC that are insulated from the rights andobligations of any other series in the LLC. Each series has its own assets andliabilities, revenue, expenses and gains and losses (Uniform LawCommissioners 2006). As noted elsewhere, LLPs are simply limited partnerships that afford thegeneral partner limited liability, just as the limited partners are allowed. Thus,putting the general partner on equal footing with limited partners as far asliability is concerned. But, the general partner retains his management powersboth within and outside of the partnership. Moreover, the partners in an LLP arenot subject to personal vicarious liability for the malfeasance liabilities of thefirm merely because they are members of the LLP. Only those partners who arepersonally implicated in wrongful acts or omissions are subject to unlimitedpersonal liability. Otherwise, LLPs retain the definitional aspects ofpartnerships. They are relatively recent entrant into the world of companies,appearing in the US in the state of Texas around 1991 and now in virtuallyevery state (Oxtoby 2006). 36
  37. 37. The distinguishing features of LLPs and LLCs are a greater degree ofprotection for all partners, i.e. generally, no partner is liable beyond his or herinvested capital, and the primacy of contract. There is also a greater flexibilityof management options. Accordingly, members (the equivalent of partners) maymanage or managers may be engaged to manage. The primacy of contract or“freedom of contract” is most evident in these companies, as it is generallyaccepted that their operating agreements may override most statutory provisionsregarding the internal operation of the company. It would further appear that, at least in the case of LLCs, the Islamicconcept of “mixing” of capital has been recognized, because outside creditors,i.e. those creditors who seek the partners as debtors for transactions outside thescope and course of business of the LLC, are only able to obtain a “chargingorder” upon judgment. That means that they can wait for any distribution fromthe LLC and take it, but they cannot invade the LLC’s capital to do so. Corporations. Corporations have their historical roots in the same earlycompanies that gave genesis to modern partnerships. However, corporationshave the added feature of duration. Duration allows corporations, if so desired,to outlive any one person or groups of people. In other words, a corporationneed not terminate or dissolve simply because someone dies, becomesincapacitated or otherwise is indisposed. Shares are inheritable, as arepartnership interests in the West. They represent the quintessential form ofkhultah or mixture of financial interests. Shareholders need not even know eachother, though they may. Shares are the most mobile of all mobile securities. In American jurisprudence, corporate rights and the contract betweenshareholders and the corporation are constitutional. Such rights, with the Stateas an ever present third party is based on the Tenth Amendment to the USConstitution, which states: “The powers not delegated to the United States bythe Constitution, nor prohibited by it to the States, are reserved to the Statesrespectively, or to the people” (US Constitution). Thus, it is the reserved powerof the State to regulate that gives rise to the right of people to form corporationsand to operate them within the framework established by the State. Again, wereturn to the Islamic guidance to see the wisdom of such a framework. “All theconditions agreed upon by the Muslims are upheld, except a condition whichallows what is prohibited or prohibits what is lawful” (Usmani op cit). Thus, thearticles of incorporation of each corporation are subject to the reservation oflegislative power of the State to amend the corporate laws and change the rightsand liabilities of the shareholders, notwithstanding the freedom to contract, 37
  38. 38. wherein provisions in the articles become repulsive under the law (Ballatine2012). So, why was there such lethargy in the development of the corporate model in Islam? Kuran (2006) identifies 3 potential causes. He was interested in identifying the causes of underdevelopment in the Middle East. He identifies 3 distinct mechanisms that inhibited the transformation of its partnerships into corporations: “Persistent simplicity of business partnerships caused by Islamic inheritance law, which by dividing the fortunes of a wealthy merchant discouraged the formation of large and long lasting partnerships. As wealth could not be accumulated generations after generations due to its division amongst legal heirs businesses did not grow to an extent that might require corporate structure... The second mechanism operated in the form of waqf, Islamic charitable trust, which was used to provide public services. However, it was also used as a family settlement. It was the only permanent institution under Islamic law that enjoyed some features of a corporation but it stagnated over the time and failed to evolve into a self-governing institution like modern corporations. The third mechanism involved the state, which discouraged the development of permanent organisations that might pose any political challenge to the state authority. But financially weakened because of the fragmentation of wealth caused by inheritance law, the private sector led by the merchant class could not stand against the powerful state” (ibid).III. FIQH OF SUKUK Without a doubt, Sukuk are the “creme de la crème” of the IslamicFinance world today. They comprise a substantial share of the internationalIslamic Finance market, are a driving force in the nascent Islamic CapitalMarket, yet still regarded as a mere “drop in the bucket” when compared to theconventional securities market (Iqbal 2012). Nonetheless, Sukuk have, in asense, given Islamic Finance something it has not had before, i.e. a viablesubstitute for near non-existence Islamic corporate securities. More to the point,Sukuk are Islamic securitizations or securities backed by assets in a manner thatcomplies with the Shari’ah. Securitization is by definition a process of poolingassets and issuing securities against them (ibid). 38
  39. 39. A. Definitions & Legitimacy Definition. Technically, the Accounting and Auditing Organization ofIslamic Financial Institutions (AAOIFI) defines “sukuk” as: “… certificates of equal value representing, after closing subscription, receipt of the value of the certificates and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services, or equity of a given project or equity of a special investment activity” (AAOIFI FAS 17). Linguistically, Sukuk is simply the Arabic plural for sakk, meaningcertificate. It has been said that the modern word “check” has derivation fromsakk (Iqbal op cit). It is interesting to note that stock was originally referred toas stock certificates. Legitimacy. Sukuk gain their legitimacy from the underlying legitimateShari’ah-compliant contract, i.e. musharakah, ijarah, etc. That has been theanecdotal and prevalent view since their appearance in the modern Islamicfinancial markets. Thus, some attribute this aspect of legitimacy to the Words ofAlmighty Allah: “O you who believe! When you contract a debt for a fixed period, write it down…But take witnesses whenever you make a commercial contract…” (2:282).Moreover, they gather further legitimacy by avoiding riba and other prohibitedaspects of conventional finance. Scholars are also quick to note that the sakk is not new in Fiqh muamulat.They note that in classical period of Islam, Imam Malik recorded in his famoustreatise al-Muwatta, that in the first century of Islamic history, the Umayyadgovernment would pay soldiers and public servants both in cash and in kind.The payment in kind was in the form of Sukuk al-bad’ia. This term has beentranslated to mean “commodity coupons” or “grain permits” (Iqbal op cit). Theholders of the certificates would redeem them at the treasury or Bait al-Mal fora fixed amount of the subject commodity. Others sold their Sukuk for cashbefore the maturity date thereon. Thus, the concept of a tradable certificate hasbeen known in Islam from its first century (ibid). B. Classifications Modern day efforts to use Sukuk were said to have begun in Jordan circa1978 (ibid). There were 457 Sukuk issuances in 2011; considered by most to bean “off year” (ibid). The great majority of Sukuk are either musharakah 39