Companies In Islamic Commercial Law

Compiled by: Zayed

Being a comprehensive way of life, Islam has laid down specific laws for trading and designated
various rules for when individuals come together to form a company for business purposes.

Basics of a Corporate or Company

1. The Company (Sharika in Arabic) is an agreement between two or more people to carry
out some business to make profit. Sole proprietors (single person company) are also
allowed in Islam.
2. The Company & its partners (owners) are one unit, not separate entities. It is their
personal wealth which is the capital of the business, and upon this the contract is formed.
3. The profit distribution ratio is agreed in the contract, e.g. 50/50 or 40/60. And it is not
linked to the ratio of investment.
4. The loss ratio is fixed to investment ratio. For example, if one person invests 40%,
he would bear 40% loss in case it happens.
5. All parties have to abide by the contract; One Party Can Not Make a Change on its
Own. Change to terms & condition can only be made by mutual agreement which basically
means agreeing upon a new contract.
6. A partner’s liability will not be limited to the amount put in; thus there is no limited liability
in Islam. This rule is a huge blessing from Allah. People cannot waste others money and
simply walk away, as is common practice in limited liability companies under capitalist
system.

Contract- The Foundation of a Corporate:

A corporate is formed when two or more persons agree upon a set of terms & conditions for
business. These are then agreed upon by all; hence forming a contract (Aqd in Arabic). This
contract has to be correct according to Islamic laws. Take for example, one party offers to setup
a business to sell bananas imported from Brazil at a shop by investing equal amount of money and
distributing profit equally among two. Other party accepts the offer & joins in, hence a
corporation is formed.

Allah Almighty has commanded two simple principals to emphasize the impotence of a contract.
These two simple rules eliminate doubts and provide convenience:

1- Write your Contracts:

“O you who believe! When you contract a debt for a fixed period, write it down……………. You should
not become weary to write it (your contract), whether it be small or big, for its fixed term, that is more
just with Allah; more solid as evidence, and more convenient to prevent doubts among yourselves”. Surah
Al Baqarah – 282

2- Take Witnesses:

“And get two witnesses out of your own men…….. ……But take witnesses whenever you make a
commercial contract.” Surah Al Baqarah – 282

Areas in which Corporate can Trade:

a. Corporate Can Operate in a Trade that is Beneficial to Society:

b. Key Utilities Can Not be Used for Private Benefits:

Any commodity that is a basic need such water, gas, electricity & petrol are not allowed to be
traded by private business (privatised). Our beloved Prophet Muhammad (SAW) said “Muslims
are partners in three things: in water, pastures & fire“. This means that the ownership of
key utilities will always remain in the hands of state who will utilize it for the benefit of its citizens
only.

In all other sectors of the economy companies can operate freely without any intervention by
the state, individuals can come together to fulfil any need in the economy.

There are 5 types of companies defined in Islamic Economic System:

1. The Company of Equals (Al-‘Inan): This is a type where all partners put their money into
a business and all work with it.

Both partners would have the right to buy and sell and make progress with the company, hence
all partners are all equal in their deposal.

2. The Company of Bodies (Al-Abdan): This is where two or more people come together
with their skills, such as doctors or builders. They may invest some of their money but their skill
is the basis for the company.

3. The Company of Body & Capital (Mudharaba): This is where one funds the capital of the
business and the other partner works with it. The partner who provides the capital element is a
silent partner and takes no part in the running of the business. The other partner buys & sells on
behalf of the company.

4. The Company of Reputation (Wujooh): This is a company similar to mudharabah but the
capital is provided by a silent partner who has respect & standing and based upon this the
company trades. For instance the partner could be a famous, known & rich merchant whose
name ensures business for the company.

5. Company of Negotiation (Mufawadha): This could be a combination of the above types.

The differences & issues between Islamic & capitalist company structures can be summarised as:

a- Modern day corporate doesn’t have formal “Offer & Acceptance”. One party can enter or
leave a business via share trading. There are incidents when a company is completely taken over
by another party by buying shares even though majority of the staff & current owners disliked it.
This could not be done in Islamic Economics.

b- The present day company is an individual & separate entity from its owners. This contradicts
Islamic law whereby the partners are “the company”; if the company is taken to court, it is the
partners who are liable. The current corporate takes all personal elements away from the
company. Public Limited Company is one such example. Thus in the case a company goes
bankrupt the owners only lose what they put in and no more and all those who are owed debt,
will receive nothing. Many people lose millions in Pakistan & abroad. Banks going bust is one good
example. If a person owes money to someone, he has to pay it back.

Trading in Current Share Business is Not Allowed:

Reasons are simple to understand:

1- In share system the share owner does not have any control or say in the company business.
Suppose you bought 25% shares in Banana Company. Out of a blue, the Banana management
decides that they would start importing Cocaine from Columbia since it is quite profitable; you
have no means of controlling this. Islam requires a partner to have an equal control over the
business so that it could be kept on track.

2- There is no offer & acceptance in present day share system. The share buyer has to accept the
laid down terms; there is no Offer & Acceptance.

3- The shares are bought & sold without the consent of existing shareholders. This essentially
means that an unknown person becomes partner in the business who might have earned money
through undesirable means. In Islam, all partners must agree upon allowing a new partner to join,
and then there should be a contract signed.

4- The share buyer has no real interest in running & growing the business. All he is after is quick
money. The moment he hears about any losses, he sells his shares and moves on.

The End.