A Modaraba is a financing technique through
partnership. One partner provides capital investment and the
other contributes through management skills to run the business.
Profit is shared between the two in a predetermined ratio, and
losses shared strictly in accordance with the contribution to
equity.
Types of Modaraba
- Restricted Modaraba: the Management is restricted to use
the investment for a specific purpose as required by the
Investors.
- Unrestricted Modaraba: the Management has the flexibility
to use the investment in any enterprise. Investors do not
specify a business or use for the investment leaving this
option for the Management. However, Management cannot put
investment in another enterprise unless it has the express
permission of the Investors.
Investment
The investment should mainly be in liquid form. However,
assets other than cash can be used as an intermediate step
towards the final investment in the Modaraba. In such cases,
the exact market value of the assets at the time of investment
has to be correctly determined.
To avoid the liquidation of the Musharika due to one person
leaving the joint venture, a clause can be added at the onset
of the contract stating that the Musharika cannot be liquidated
unless unanimously agreed upon by all partners.
Management and Control
The Investors’ role in Management is restricted to
overseeing the Management’s activities. However, Investors
may participate in operations and control if Management consents.
Modaraba Expenses
Non-business expenses of the Management are not borne by
the Modaraba. It is only entitled to its share of the profits.
However, all expenses related to business activities are borne
by the Modaraba.
Distribution of Profit and Loss
The proportion of profit allocated to the Investors and Management
has to be determined at the inception of the Modaraba. Islamic
law has not prescribed a certain proportion, therefore the
partners have the flexibility to determine their own agreed
ratio.
Profit sharing is strictly on the basis of percentage of
net profit, i.e. profit cannot be a specific rate tied with
capital, or be a specified amount payable to any one or more
party.
It should be noted that the proportion of profit can be different
for various transactions. For example, if the Management is
set up for trading, then it can be determined that profits
from Item A will be shared on a 50:50 ratio while profits
from Item B will be shared on a 60:40 ratio.
In case a loss is suffered in one part of the business and
a profit in another, the profit is utilized to offset the
loss before it is distributed between the parties.
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