Date: 25 November, 2020
by Nirdhar Naphade, MNLU
The mudaraba or mudarabah contract is one of the most widely and frequently used financial instruments in Islamic banking sector. It is a part of the Sharia law. In India, such a contract would be governed by the Banking Regulations Act, 1949 read with the Indian Contract Act, 1872.
A mudaraba contract is based on a partnership. In it, one partner is the financer (the investor, or silent partner) while the other partner (the manager, or the working partner) is the one who manages the financer’s investment in some economic activity.
The second partner (mostly an entrepreneur) has wide expertise in applying the given venture capital into economic activities. Both the parties agree in advance to a certain profit- loss sharing (PLS) ratio.
In Arabic, the investor is called the rab al mal, while the funds' manager is called the mudarib.
In this contract, the factors of production (from the entrepreneur's viewpoint) — capital, labor, and entrepreneurship — are combined to complete an economic activity.
The rab al mal arranges for the capital, while the mudarib provides entrepreneurship and labor. The mudarib earns a portion of profit for his effort, while the rab al mal receives the remaining profits.
All mudaraba contracts are bound by specific time periods; they are not allowed to continue indefinitely.
Through mudaraba contracts, the rab al mal and the mudarib share the profits and losses based on the agreed-upon ratio. The mudarib also receives a certain fixed fee for managing the venture, in addition to a share of the profits.
ESSENTIALS OF A MUDARBAH CONTRACT
There are three essential elements of a mudarabah contract along with the other essentials of a valid contract:
1. The Mudarabah capital should be in terms of cash or should be such that its value can be easily calculated in terms of money.
2. The financer should, at no point, indulge in the business activities which are undertaken by the manager. If he does so, the contract becomes void.
3. Both parties should agree to the profit sharing ratio before the contract is made. Otherwise, the contract becomes void.
TYPES OF MUDARBAH CONTRACTS:-
A rab al mal has freedom to choose to invest in two types of mudaraba contracts:
Restricted mudaraba (mudaraba al muqayyadah):
The investor mentions the particular business idea or project where the investment funds would be used; the working partner is not allowed to use the given funds for any other business or project.
Unrestricted mudaraba (mudaraba al mutlaqh):
In this contract, the investor gives the working partner total permission to use the funds into any type of business or project that would best suit the financial goals of both the partners.
EXECUTION OF A MUDARBAH:-
The mudaraba contract gets into action when someone deposits money in an Islamic bank. They do so with the expectation of getting a return. In most of the cases, the contract applied is a first-tier (or simple) mudaraba contract, meaning that only the customer and the bank is involved. (The bank serves as the funds' manager for whatever money is deposited by the customer.)
However, there exists another type of contract which is called a two-tier (or intermediary) mudaraba contract. In this contract, the bank acts as the intermediary between the depositor and the clients of the bank to whom it provides the said money.
BREACH OF CONTRACT:
In case of any loss, it is the liability of the financer or the bank, and the other only loses his share in the profits. However, if the Mudarib is proven guilty of willful negligence, fraud, or a breach of trust while handling the funds, he/she is solely responsible for the incumbent losses.