Essential Elements for the Validity of an Islamic Business Partnership & Contract


"A Muslim who makes up his mind to adopt trade as a profession, or to set up his own business, should first acquire a thorough understanding of the rules of business transactions codified in the Islamic Shariah. Without such understanding, he will go astray and fall into serious lapses, making his earning unlawful." (Imam Ghazali)

Those who have been in business for a while may have come across stories of people falling out with each other over business-related matters. At the heart of every dispute lies a contract that is either invalid (according to Islam), incomplete, or ambiguous.

This article will, insha'Allah, cover the essential aspects of Islamic business partnership contracts.

THE ESSENTIALS

1. Decide on a halal business model and making sure that it will be run according to the Shariah (Islamic law) in all its details.

"Whoever adopts any other way (of life, other) than this way of submission (Islam), it will not be accepted from him." Qur'an 3: 85

"Whoever commits an act which is not a part of our matter (Islam) will have it (his act) rejected." Hadith Muslim

What is legal in a country is not necessarily legal in Islam. Hence, many of us wrongly assume that everything other than riba (interest) and khamr (alcohol) is allowed in business.

This is not only incorrect, but it can even lead to problems for Muslims who are trying their best to earn a halal income and keep it that way.

2. Know the identity of your partners.

This is just one of the many reasons that trading stocks in stock markets violates shariah, as the owners of the stocks don’t really know who is buying their shares.

In Islam, each partner or shareholder must know the other, regardless of the size of his/ her equity share.

Therefore, it is not allowed for someone to enter into a contract with a man or woman who is unknown to him/her. There are many ways identity can be established without actually meeting the other person. Email me if you want to learn more about this.

3. Make the agreement in one sitting (or one agreement) - the “offer and acceptance.”

It can take weeks or months to negotiate the various points in a partnership, especially if it involves many partners.

However, when all individuals come to a decision, and they’ve committed to a contract, then that contract becomes binding on all, but only if the contract is completed in that final sitting or on the final contract. Until the final sitting/ contract, all individuals have the right to change their minds,even if they only choose to meet at a later time on the same day.

"Both parties in a business transaction have the right to annul it, so long as they have not separated; and, if they speak the truth and make everything clear, they will be blessed in their transaction; but, if they tell a lie and conceal anything, the blessing on their transaction will be blotted out." (Hadith, Muslim)

Disagreements between partners can arise when they hold each other accountable for promises made during the negotiation period that were never incorporated into the contract.

Therefore, make sure that notes are kept during negotiation, and if there is anything important that needs to be included in the contract, then make sure it’s there in the final copy at the final sitting; otherwise, there is no obligation for any of the partners to honour them.

Forgetfulness and intentions do not have any weight in Islamic contracts!

4. All partners have equal rights to the business, regardless of the size of their shares.

In the West, it’s normal for those who have the largest share of the business to drive the direction of the company. It only seems fair to give the biggest share holder more say; after all, he did invest the most and has the most to lose, doesn't he?

However, in Islam, all partners have equal say with regards to the essentials elements of the agreements that Shariah stipulates (from which no one can voluntarily opt out), as well as anything additional to which the partners have agreed.

This means that there is no majority rule in Islamic Company structure.

For example, if there were nine partners, and eight are happy to bring in another partner to raise some investment capital, if only the ninth partners votes against the deal, then they cannot add the 10th partner!

So, there must be unanimous consent when it comes to deciding what to do with business profits, or when it comes to adding another partner or buying out a partner. Basically, anything that can potentially violate the rights of a partner requires unanimous decision making.

(There are valid ways to resolve this stalemate. Contact me if you’re interested in knowing how.)

However, when it comes to decisions related to running the business on the ground, the partners who are physically involved in the business (as opposed to the silent partner/s, i.e., the partner who only invests his money) have more right to go with what they feel is right.

5. All core and critical matters of the business should be made clear.

This includes the following:

(i) What is being offered by each individual (money/ property/expertise/ consultancy/reputation/ time/ labour)

(ii) The size of the share (business share and profit share)

(iii) The nature of the business

(iv) The agreement period (the period after which there will be the right to exit or renew or amend the contract)

(v) Anything extra that is stipulated by the partners.

It’s a good idea to write down a general plan of what the business is and how the partnership will work. This is also known as a 'constitution' or 'charter.'

I’ve heard of many horror stories regarding businesses that fail to follow these quidelines.

The most common one goes like this: A brother takes some money from another brother for a share of a new business. When the business collapses, the other brother asks for his money back, as he feels his partner is to blame for mismanagement! So, was the money taken as loan or investment? These things must be made clear right at the beginning.

Other stories go like this: A group of Muslims decide to invest in a business, but they haven’t agreed on a time period or met with one another or agreed on anything in writing, other than discussing the equity share. Then when months turn to years, and there is no sign of the business making much progress - as the lead partner seems to have encountered some unanticipated problems - pressure for the return of the investment starts coming to him from every direction.

What's more, some of these investors entrusted their investments to their relatives, who then made the investment on their behalf, but these investors never actually met the other business partners. Before long, investors start demanding their money back!

Some of the partners made non-Islamic promises to their investors, such as; “There will be no loss, nothing to lose, just profits!” Or, “For this much of investment, we will definitely give you this much profit.” Well, isn't this riba? Who is liable for the loss, then?

Anyway, Allah (swt) has blessed us with a deen (Islam) that is comprehensive. It gives us detailed guidance in all aspects of life.

In Islam, business partnerships are all viewed with partnership over profit and loss. If one takes an investment by promising indemnity against loss, then this is invalid in Islam.

For example, if you invest £100,000 on a 50/50 partnership, and you make a loss of £10,000, then you must pay £5,000 from your pocket (if the business can’t pay that back).

The following makes the business contract incomplete, but it does not invalidate the contract:

1. What is the exact business being agreed over?
2. Who runs the business?
3. Who pays the zakat?
4. What is the length of the partnership period?

Additional Points to Note:

It's not a requirement in Islamic law for contracts to be put down in writing. Although, no serious businessman should proceed with any partnership without a written agreement, especially as it’s encouraged in the Qur’an! The bigger the investment, the more you should formalise this process, including getting witnesses, or even signing the contract in a lawyer's office.

A contract can be as short as this: “I have agreed to partner with £100,000 of my money for a 50% ownership with you to open a grocery shop that you will run for at least ten years.”

There’s no need to add the phrase ”according to shariah,” since that's a implied statement, but I tend to add this term in case doubts and temptations start entering our hearts in the years down the line.

What is Prohibited (This is not an exhaustive list.):

It is not permitted for business partners to pay each other a salary, as there is no 'offer and acceptance' possible (How can you offer yourself a job and then accept?). This concept goes against the company set-up most of us are familiar with. If one partner is to expend more time in the business than the other partner, then this partner can have a larger share of profit, while keeping the percentage ownership of the company the same. (Contact me if you want more details regarding this.)

Others:

1. Offering prohibited products and services
2. Offering prohibited types of sales and transactions
3. Conditional contracts
4. Indemnifying one or more partner for loss

Personal Comments: I have discussed with several knowledgeable people before finalising this article. All of these points are correct to the best of my knowledge and understanding. Please email me if you find anything incorrect. Jazakumallahu khairan

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Posted by Johar Ali Shah on 31-12-2015

Respected Sir !
I with some of my friends decided to start a business of construction due to the shortage of funds we decided to get funds by two modes first by one off investment to start works and the second to collect from some friend on monthly installment and invest the amount when it pre-decided amount is collected.
Please guide us according to Shariah.


Replied by Abid

Assalamu'alaikum. I am a little unsure what the question is, so I'll give some general advice insha'Allah. Please get back to me if I haven't addressed your issue.

With regards to investment from any investors, whether they are friends or family members, Islamically they become your business partners even if they release the money in tranches (stages).

It's essential that you let the investor/s know how much of the business they will own if they pay an x amount of money.

If an investor invests money on a monthly instalment basis, then there's nothing wrong with that. All this means is that the investor will own a little more of the business every time he deposits his monthly investment! That's of course if this is how you have agreed to give away the share to the investor.


Posted by Azraar Azward on 21-12-2015

Assalamu Alaikum,

I am seeking for a Mashoora on a issue raised due to allocating shares in a partnership business among 4 best friends.

The industry was Islamic clothing and capital is 400k.

I shall name the business partners as A,B,C,D

A is inputting 160k, and being a sleeping partner. (from London)
B is inputting 160K, and at Saudi. (coming to SL on End of February 2016)
C is inputting 40K
D is inputting 40K

A has no roles and responsibilities.
B will do the purchasing once in 3 months or once in 6 months or as the stock finishes.
C and D will be conducting the daily operation and sales.


The shares that was allocated considering the money and effort was,
A - 20%
B - 40%
C - 20%
D - 20%

And it came in the following manner

Capital Share from 400K - A 40%, B 40%, C 10%, D 10%

Effort Share - A - 0%, B - 40%, C 30%, D%30

so Capital + Effort share = 40%, 80%, 40%, 40% out of 200

so out of 100 = 20,40,20,20. %

so the 2 problems that raised are,

1/ B is only doing purchasing once in 3 months or 6 months or as soon as stocks finish. C and D says Operation and Sales task are daily on going work and time consuming, so how can someone working in once in 3 months or 6 momnths have a greater effort share than Daily on going time consuming tasks. so they are demanding for more than purchasing or to reduce the purchasing share.


so isn't it fare to go for a percentage of

Capital Share from 400K - A 40%, B 40%, C 10%, D 10%

Effort Share - A - 0%, B - 20%, C 40%, D% 40

so final profit/loss share will be 20%, 30%, 25%, 25% ?

2/ having two separate shares for Ownership & Profit. 2 partners are saying to merge it and keep only Ownership share, the other 2 are saying only capital is counted for Ownership share so there should be both Ownership share and Profit/Loss Share


I would like to know how Islamically one should handle this situation?


I would also appreciate if you take the effort to post a article on acju website about Musharaka and Mudaraba, so everybody get a chance to refer and update their knowledge also to avoid minor problems will be helpful.

Jazakallah
Azraar Azward


Replied by Abid

Dear br Azraar, jzk for your question.

Masha'Allah, I love the way you guys have quantified the effort in terms of percentages as this is something overlooked by a lot of business partners.

One important point to note is that the Islamic method of quantifying effort is done by looking at the 'time the work takes' and the 'type of work' it is. So, if a person who has specialist knowledge about purchasing then he can argue for a bigger share. E.g. compare the work of a brain surgeon with that of a nurse. Although they both spend the same amount of time in the operation theatre, the surgeon gets paid more.

You asked; how one would handle this situation Islamically. The answer is simple; through mercy and understanding. We should be gentle on our partners, especially because of what I am going to say next.

Islamically, there's nothing wrong with one asking for a greater share of business in return for a small amount of money and little effort. You see, the partners must come to an agreement through negotiation. Whatever you negotiate and agree on is your partnership.

It might be that you haven't considered his perspective. For example, a business partner can argue that he has more business experience and hence deserve higher share even if his effort and investment is the same. Or you could have someone who invests his lifesavings which, to him, is worth a lot more percentage than he is being given. They both have valid points, but it's up to the partners to negotiate who gets how much.

Finally, having separate shares for ownership and profit or merge them into just ownership, both ways are fine. Again, it's up to the partners to negotiate what would be best for them. Remember though, share on loss is only on those who have business ownership not on profit share. But, if the business is sold then only business owners get a share of the sale value not those who have profit share. There are pros and cons to consider.

My advice is for all partners to meet or do teleconference and discuss it in a brotherly manner explaining their view.

May Allah swt bless this partnership of yours and help you grow an amazing business. Ameen


Posted by Arfan Ulhaq on 14-12-2015

Good evening
To whom it may concern I am looking for business partner or investor for my business idea, I am based in Birmingham West midlands, I would be grateful if I could receive a call or email from yourself's.


Replied by Abid

Please contact us via the contact form or Submit A (Business) Proposal here insha'Allah: https://www.seed.org.uk/submit-proposal