International Journal of Islamic Financial Services Vol. 2 No.

Discussion Forum

FIQHI EVALUATION OF ORDINARY SHARE - I

Prof. Imran Ahsan Khan Nyazee

My observation pertains to the legal validity of the ordinary shares of corporations (or limited liability companies
not in the sense the term is used in the US).

I have now come to notice that many learned persons are in favor of trading in shares, which makes me feel that
I could be wrong, I must be. I am not against shares as such, but my contention is that the structure of the
corporation needs to be altered somewhat, to make it Islamic so to say, before Muslims can freely indulge in this
type of trading. What I need from the reader are arguments, that is, from some generous person who can take out
the time to think over these issues and convince me of the defect in my arguments. It does not matter whether this
person is a student or scholar or expert. My only request is that he should focus on the concepts and arguments and
not on personalities, because what I have stated below questions the views of some respected personalities. I mean
no disrespect, in fact I have great respect for all scholars, but hiding behind names sometimes distorts the argu-
ment. So please tell me what your own mind and heart has to say about the issue.

What follows is an excerpt from my book on Islamic law of business organization: corporations (download it if you
like and read it there). I have raised some objections to the rulings of the OIC about corporations and their shares.
After doing so I have tried to show the true nature of the contract with the corporation by comparing it with that of
mudarabah. What is given below comprises partial excerpts. The complete arguments can be seen in the book.

Excerpts: The OIC and Ordinary Shares

The opinions of different scholars writing on the issue has given rise to Resolution No. 7/1/65 adopted by the
Islamic Fiqh Academy of the OIC in its seventh session held in May, 1992. {See Majallat Majma al-Fiqh al-Islami,
vol. 7:1.} This resolution has been passed on the basis of the assumption that the corporation is a contract, and also
on the basis of the assumption that the share of the shareholder is an undivided co-ownership in the equity and that
this share can be sold. The relevant sections of the resolution are reproduced below:

1. Shares in Sharikat

a. As the original rule in muamalat is permissibility, the formation of a sharikat musahamah having lawful objec-
tives and activities is valid.

b. There is no disagreement about the prohibition of the shares of sharikat whose primary objective is prohibited,
like transactions in riba, or which produces and deals in prohibited products.

c. The rule of prohibition applies to the shares of sharikat that deal at times in prohibited things like riba, even when
their primary activity is permissible.

4. Shares with Respect to Their Bearer

The mabi (property sold) in the shares with respect to the bearer of the shares is an undivided share in the capital
of the sharikah, and the share certificate is the instrument that is proof of this right in the share. There is, therefore,
no shari obstacle to the issuance of shares in this way and to transactions in them.

5. The Subject-Matter of the Contract in the Sale of Shares

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The subject-matter of the contract in the sale of shares is the undivided share in the assets of the sharikah. The
share certificate is the instrument of the right to this share.

There are two types of objections to these recommendations of the Academy: general and specific. These are
given below.

[All the general and specific objections are being omitted. I reproduce here the questions I have raised for the OIC]

My text...

The approach of the modern scholars, as reflected in the resolutions of the Islamic Fiqh Academy, suffers from
two basic defects. The defects are the following:

1. Insistence on the legal validity of the fictitious personality in Islamic law and, then, wiping out its existence or
ignoring it completely in legal analysis. Thus, in the treatment of the share certificate as evidence of an undivided
share of the shareholder in the assets of the business, the corporation as a legal person has no role to play. The laws
of partnership (sharikah) are applied to resolve the issues.

2. Treating the corporation as a contract without any description or elaboration of the contract.

Questions for the Islamic Fiqh Academy (OIC)

To enable the Islamic Fiqh Academy to clearly comprehend the above discussion and possibly review its thinking
on the issue, the following questions are raised. It is to be hoped that the Academy will attempt to answer these
questions and thus arrive at the correct position, which would be acceptable even in non-Arab countries.

a. If the corporation is a contract, then, what contract is this? Who are the parties to the contract? What is the
nature of the offer (ijab) and acceptance (qabul)? How is the profit to be shared? Finally, what kind of legal
relationship is established between the shareholders; is it wakalah, kafalah, ijarah or some other contract?

b. How can the share of the shareholders be considered musha when it is the corporation that owns all the assets;
has legal personality no role to play in the analysis?

c. If the corporation is a contract between the shareholders, and the shareholders own the assets of the business,
what role does the legal person called the corporation play? What is the need of legal personality?

d. If the share certificate is evidence of the ownership of the capital or assets of the business, what is the legal
status of this certificate? Is it like a title deed, a promissory note, a kind or receipt, or some other kind of instrument?
(It is not enough to say that it is evidence of a right to the capital).

e. Finally, and this is most important, if the share certificate is evidence of an undivided share in the business capital
or assets (i) how is it that the corporation, the legal person, can sell the business assets? What is its underlying
authority? Is it acting as the agent (wakil) of the shareholders? (ii) When the shareholder is selling the capital or
share in the assets to one person in the form of share certificates, and the corporation is selling or mortgaging the
same assets to someone else, does this amount to a double sale? (iii) Does the capital (ras al-mal) have a separate
physical existence so that both can be sold or mortgaged separately? In other words, does the share certificate
have an intrinsic value of its own separate from the assets of the corporation so that both can be mortgaged at the
same time (perhaps with the same bank)? The equity (or capital) is itself a liability for the corporation: How can the
shareholder sell it? {See para 8 of the resolution.} (iv) On what basis does the corporation hold the capital of the
shareholders (amanah} through wakalah or wadiah?
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The questions listed above can be multiplied, because the assumptions made by some scholars and the Islamic Fiqh
Academy are a mass of contradictions.

The Real Underlying Contract

It has been explained, in what has preceded, that the corporation comes into being through an act of state and is not
to be associated with a contract between the shareholders or the promoters. Thus, a legal person born by the act
of the state has full legal capacity, including contractual capacity along with a dhimmah, but it does not have wealth
of its own. The need for wealth and assets leads it to a contract with those who are willing to subscribe to its
capital. This contract is between two persons alone: the corporation on the one side and the single subscriber on
the other. {The terms of this contract are listed in the subscription agreement.}

The subscriber gives money to the corporation as an investment and in return for this the corporation issues it a
share certificate.

The contract concluded resembles, on the face of it, a mudarabah contract in Islamic law. . . . It is a false analogy,
and it leads to considerable confusion in modern times. There is a vast difference between the conditions of the two
types of contracts. This distinction between the conditions must be understood in terms of what the rabb al-mal
usually says to the mudarib, and what the subscriber is presumed to be saying to the corporation.

The Ijab (Offer) of the Rabb al-Mal to the Mudarib in a Normal Mudarabah

In a normal contract of mudarabah, the rabb al-mal makes something like the following offer to the mudarib:

I have 1000 dirhams. Take these dirhams and trade with them. You are my agent. You have the right to buy and
sell on credit, but you cannot go beyond the limit of 1000 dirhams (no wilayat al-istidanah} for you). In case, the
1000 dirhams are lost and you owe money to someone on account of the mudarabah, come back to me and I will
pay the amount you owe. In other words, I will bear all the loss, have no fear, because my liability for such losses
is unlimited. Further, you hold this wealth as an amin does under a contract of amanah. At all times, I will be the
owner of the wealth of the mudarabah, but when profits emerge, you and I will own these profits under a co-
ownership. Your share of the profits will be 50% and I will take the other 50%. May Allah grant you success.

This in a nutshell, is the contract that would be concluded between an owner of capital and the worker under the
contract of mudarabah. Only the main conditions have been listed and the details have been avoided. The detailed
conditions of this contract have been elaborated in the study on partnerships in Islamic law. {Imran Ahsan Nyazee,
Islamic Law of Enterprise Organization: Partnerships. The remaining will be explained when we take up the
detailed study of the mudarabah.}

The Ijab (Offer) of the Subscriber to the Ordinary Shares of the Corporation

In practice it is the corporation that makes the offer for subscription and the agreement concluded is a standard
contract. For the sake of comparison and for understanding the real nature of this contract, the position has been
reversed. We assume that the subscriber as the owner of capital is making an offer to the corporation. Thus,
whatever the wording of the subscription agreement and whatever the fine print on the share certificate, in reality
this is what is being said to the corporation:

I have 1000 dollars. Take these dollars and trade with them. You are NOT my agent. You have the right to buy and
sell on credit, and there is no restriction on you in this; go to any limits you like. In case the 1000 dollars are lost, and
you owe something to the creditors, I will not pay you even a penny more. I will not bear any of this loss; You
stand warned. You do not hold the wealth as an amin. In fact, the money I have given you has passed into your
ownership. You owe me the 1000 dollars I have given to you as debt, which is now attached to your dhimmah, so
issue me a note of hawalah called the share certificate, so I can endorse it to someone else if I like. You are the
owner of this wealth at all times. In case you make a profit, however, the entire (net) profit is mine (because I
 International Journal of Islamic Financial Services Vol. 2 No.4

am not charging you fixed interest). You get nothing beyond the expenses you incur in making this profit. Thus, I
am not sharing the profits with you. If, on the other hand, you make a loss and your liabilities exceed your assets,
just go bankrupt. I will try to recover what you owe me, if something is left over of your wealth, according to the
priority assigned to me among other creditors. May Allah have mercy on you!

There is no exaggeration in the above statement. This is exactly the nature of the contract between the subscriber
and the corporation. Those who are not convinced should try to substitute a natural person in place of the corpora-
tion and see if the contract would be justified or considered legally valid. This is the real test: anything that is valid
for the corporation should also be valid for a natural person.

[If this is really the true nature of the contract a shareholder makes with the corporation, I for one am not
willing to invest in shares, unless the corporation is Islamized. How about you?]

Dr Mohammad Fadel

I agree 100% with the proposition that the OIC Fiqh Academy is confused and their reasoning, not only on
corporations, but on other matters, leaves a lot to be desired. This is a necessary consequence of fatwa by
committee. Im curious if anyone could give us some insights into the manner in which they make decisions.

As to your conclusion, however, I disagree. There is nothing on mudaraba reported from the Prophet (S); there is
an athar that Ibn Umar did mudaraba with some property of the state while en route between Iraq and Madina,
and that Umar seized the profit for the benefit of the state. {See the Muwatta, Yahya b. Yahya transmission.}
Mudaraba itself is khilaf al-qawaid because it is ijara bi-gharar. It seems bizarre to me that we are going to
determine the licitness of the corporate form based on something that the Prophet (S) never even talked about! Its
quite clear to me, at least, that business forms are conventional and Islam is largely indifferent to these issues.
Limited-liability is only potentially a problem vis-a-vis tort creditors, not contract creditors. Finally, I disagree
completely with your claim that the shareholder is a creditor of the corporation. He has a residual claim on the
assets of the corporation once business is wound up and a right to dividends if any are declared. In any event, I find
bizarre the suggestion that in thinking about a legal person, it can only have the attributes available to a real person.
Does that mean it must be of limited duration, for example? In any event, if we were to attempt an analogy, which
I dont think is necessary, we should base it on iqta`, not partnership of mudaraba/qirad.

Prof. Imran Ahsan Khan Nyazee

(In response to Mohammad Fadel)

(As to your conclusion, however, I disagree. There is nothing on mudaraba reported from the Prophet (S).
Mudaraba itself is khilaf al-qawaid because it is ijara bi-gharar.)
Are you saying that all the great Imams of all the schools of law were wrong in declaring mudarabah to be a valid
contract? Yes, there is dispute about muzaraah, but I am not aware of any serious dispute about mudarabah in the
law schools.

If we assume for a second that there was a tradition declaring mudarabah to be valid or otherwise, are we to jump
to a conclusion about its legality or illegality without examining all the settled principles of Islamic law, principles
that are based on the texts? Is that how we should deal with issues that are important for our legal system?

What do you mean by property of the state - the state to be more specific? The state itself is a legal person
today and that has many implications for the Islamic legal system, but I do not wish to enter into this discussion (for
the moment).

You have assumed that I am promoting the mudarabah contract. I am not. In my work I have tried to show, and that
based on what the jurists have concluded, that mudarabah can only be a temporary contract. As soon as profits
emerge, after the first transaction, it turns into a partnership, because the mudarib becomes a partner to the extent
of his profits.
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Ijara bi-al-gharar? All ijarah is gharar in that sense. The services being hired do not exist, and it is not known what
the quality of the services will be and what benefit they will bring to the person paying for them. Gharar in Islamic
law, as far as I understand it, means something that will most likely give rise to future disputes. There are rules
for avoiding this in ijarah and there are rules for doing so in mudarabah.
(It seems bizarre to me that we are going to determine the licitness of the corporate form based on something that
the Prophet (S) never even talked about!)
By placing the two contracts side by side I am merely asking you to focus on the nature of the ordinary share and
what it implies, that is, the contract of the investor with another person called the corporation. By describing the
mudarabah contract, I was merely trying to show what Islamic law thinks about liability, sharing of profits and
economic justice in general.

I am asking you to judge the contract of the shareholder with the corporation on the basis of the rules for the
prohibition of riba and on the basis of al-kharaju bid-daman and a number of other principles.
(Its quite clear to me, at least, that business forms are conventional and Islam is largely indifferent to these issues.)
Is that right? What is all this talk about Islamic economics and commerce then? What is the use of talking about
riba and daman and other things? After all charging interest and paying it is also a conventional business form and
so are a host of other forms being practised today.

In my view, the legality or illegality of every transaction needs to be checked in light of the settled principles of
Islamic law before we can be sure about it. We can only say that Islam or Islamic law is indifferent to this or that
once we have applied the principles to the set of facts being examined. We do not expect the texts to talk, for
example, about stock options and derivatives by naming them expressly. Muslim scholars and jurists have spent
centuries of labour over these principles and their refinement. We do not wish to re-invent the wheel, so to say.
(Limited-liability is only potentially a problem vis-a-vis tort creditors, not contract creditors.)
Yes, limited liability is a problem, but why not the contract creditors? If I have sold something on credit to a
corporation whose shareholders own billions privately, but the corporation goes bankrupt, do you think they should
pass on the buck to me and ruin me when they still have enormous resources? Is that Islamic? Would Islamic law
consider that debt to be written off?
(Finally, I disagree completely with your claim that the shareholder is a creditor of the corporation. He has a
residual claim on the assets of the corporation, once business is wound up and a right to dividends if any are
declared.)

This is the only point that needs to be discussed, in my view. Consider this:

If you and I enter into an arrangement, I give you some money to do business with and say that losses arising from
the venture are not my responsibility. All I will lose is the money I have given you. Further, all the profits that arise
are mine, because I have residual rights. Would this be a just contract? This is the contract with the corporation. All
I am saying is that there is something wrong with this contract; examine it.

While you are at it, tell me about the relationship between you and me in this arrangement. Is it agency (wakalah)
or something else? And, tell me about the legal relationship between the shareholder and the corporation. I mean
which legal category would you place it in: agency, surety, what? The same question applies to the relationship
between the shareholders themselves. There is no relationship. All that has taken place is that a piece of paper
called a share has changed hands in return for money.

Do not hold me on this, but I think it comes quite close to the relationship between the citizens with the modern
state. If I hold $10 in my hand it does not make me the owner of Manhattan. Yes, I can buy something with it,
depending on its varying value.
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Now compare an unsecured bond bearing say 10 percent interest and a share certificate that has a varying return.
If you ignore the fixed return part, as in my view that is secondary, and examine the contracts underlying both
pieces of paper in your hand, what is the difference between the two? Both are a kind of debt. Both can be lost
completely. In both the ownership in the money paid has passed on to the other person. When there is no ownership
of the assets, entitlement to profits becomes questionable: al-kharaju bid-daman. In partnerships, ownership of the
assets stays with the investor.

Further, the most important point in what I say is examine them. How do you examine them, and on what basis?
On the basis of the principle of prohibition of riba? And when does riba exist? What are the rules that confirm its
existence? On the basis of al-Kharaju bid-daman? Or some other vital principle of Islamic law of contracts? It
does not help me when you say I completely disagree without any arguments.

I have tried to bring out the rules of riba in my work. One of the rules is that riba exists when ownership passes to
the recipient. A related rule of entitlement to profits is that their is no entitlement to profits when ownership in the
underlying assets passes to someone else. The rules of damages in Islamic law are also related to this.
(In any event, I find bizarre the suggestion that in thinking about a legal person, it can only have the attributes
available to a real person. Does that mean it must be of limited duration, for example?)
I have gone to a great deal of trouble to bring out the position of Islamic law on legal personality, especially in the
context of the corporation. Someone should examine its implications in the context of politics (some work has been
done but not enough). My conclusion was that the jurists came very close to declaring it legal, but they did not do
it because you cannot expect worship from a legal person and the jurists consider legal personality (for natural
persons) to be a covenant of a kind with the Almighty, something that even the mountains refused to accept.
Accordingly, I have concluded that even if legal personality is deemed valid, the fictitious legal person should not be
expected to perform religious duties, which in this case translates into the payment of zakat. A legal person cannot
perform religious duties even in Western law.
(In any event, if were to attempt an analogy, which I dont think is necessary, we should base it on iqta, not
partnership of mudaraba/qirad.)
As I said, I want to focus on legal analysis of the contract in the light of the vital principles and not merely on
analogy, but what you say may have a sound idea in it. Could you explain in a little more detail what you mean (in
the context of iqta).

Finally, your comments are extremely valuable for me and I sincerely hope that we can all arrive at a position that
is acceptable to all, a position that ensures that all the shari norms have been checked against this transaction.

Dr Tariqullah Khan

Earlier, a question was raised about the above subject inviting the opinion of Dr. Chapra and others. I promised to
discuss the matter with Dr. Chapra and report back to the forum. According to Dr. Chapra, limited liability is the
backbone of the modern corporation and it has not been dealt with in the traditional Fiqh works. Without its
acceptance we cannot take benefit of management concepts underlying the institution of the corporation. How-
ever, its acceptance posses fundamental questions having implications for liabilities created by Qard, and other debt
creating modes of finance. Those questions need to be answered by the Fiqh scholars not to prevent the limited
liability concept, but to facilitate adapting the concept by making suitable institutional arrangements. According to
Dr. Chapra, the subject is so much important that it requires a number of serious workshops. I understand, the
discussants have already covered good grounds in raising the relevant issues for such workshops.
Dr Mohammad Fadel
In response to Prof. Imran Ahsan Khan Nyazee
(Are you saying that all the great Imams of all the schools of law were wrong in declaring mudarabah to be a valid
contract? Yes, there is dispute about muzaraah, but I am not aware of any serious dispute about mudarabah in the
law schools.)
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Absolutely not! I am just saying that, as is the case with many of the financial contracts in Islamic law, the Prophet
(S) did not issue detailed rulings as to their components, etc. Indeed, unlike salam, there is not even a report
showing the Prophets (S) approval, if only tacit, of mudaraba. But, it was well known in the Jahiliyya, and the
companions engaged in it without anyones censure. Accordingly, its asl is well-established. As for the detailed
rulings surrounding it, however, these were all filled in by the jurists according to their ijtihad.
(If we assume for a second that there was a tradition declaring mudarabah to be valid or otherwise. Are we to
jump to a conclusion about its legality or illegality without examining all the settled principles of Islamic law,
principles that are based on the texts? Is that how we should deal with issues that are important for our legal
system?)
Of course we should, but we must keep in mind that the settled principles of Islamic law, in the context of
financial transactions, are not really rules so much as they are standards, and for that reason, they are full of
exceptions and qualifications. Accordingly, fuqaha` proceeded on a case by case basis. For example, Imam Malik,
may Allah be pleased with him, forbade using anything but gold and silver as the capital for a partnership (and
perhaps for mudaraba as well, which he calls qirad), probably because of fear of riba if other commodities,
especially, foodstuff, was used. Nonetheless, later Malikis relaxed this ruling due to necessity and the scarcity of
gold and silver. The welfare impact of a rule is extremely important, at least for Malikis (Malik said: la budda li-l-
nas mimma yuslihuhum [people must have what benefits (improves) them], when asked about a partnership that
appeared to violate the rules of riba fadl), both in a distributive sense and also in an efficiency (Kaldor-Hicks and
Pareto) sense.
(What do you mean by property of the state? The state to be more specific. The state itself is a legal person
today and that has many implications for the Islamic legal system, but I do not wish to enter into this discussion for
the moment.)
The ras al-mal that constituted mal al-mudaraba in the report belonged to the state, i.e., it belonged to bayt al-mal.
Ibn Umar was the agent responsible for collecting it. On the way back, he used it for commercial purposes.

I agree this (the legal nature of the state) is a big issue. However, I would argue that sultan, as a legal term,
definitely referred to a legal personality, and not a natural person. We can defer this discussion to another day.

(You have assumed that I am promoting the mudarabah contract. I am not. In my work I have tried to show,
and that based on what the jurists have concluded, that mudarabah can only be a temporary contract. As
soon as profits emerge, after the first transaction, it turns into a partnership, because the mudarib becomes
a partner to the extent of his profits.)

I believe, that it is irrelevant what they actually held without knowing why they held those opinions. Perhaps they
simply did not conceive of an enterprise enduring beyond the natural lives of its investors?

Now, I dont know who you rely on in your claim that a springing partnership interest comes into being sponta-
neously upon the realization of profit. One obvious problem with such a concept is that suddenly the investor can
potentially become liable for his agents torts, as well as his contractual obligations. Another problem is how does
one account for revenues such as to recognize profits? Are profits not realized until the entirety of the investors
capital is returned to him (the Maliki position), or are ongoing revenues allocated over the business amortized costs
such that profit may potentially be realized in any accounting period, even though there has been no recovery of
capital? Under the Maliki position, even after the enterprise has generated enough of a return to restore the
investors capital, and net profit has been generated, the entrepreneur remains liable for the entirety of the investors
capital until it actually is returned to him, and if, the entrepreneur does not immediately repay the investor his capital
funds, and the capital account later is insufficient, the entrepreneur is required to return any amounts taken as his
share of the enterprises profits until the investors investment is returned to him.
 International Journal of Islamic Financial Services Vol. 2 No.4

Now, I know of no revelatory basis for these accounting rules, so how should we evaluate them other than in
efficiency terms?
(Ijara bi-al-gharar? All ijarah is gharar in that sense. The services being hired do not exist, and it is not known what
the quality of the services will be and what benefit they will bring to the person paying for them. Gharar in Islamic
law, as far as I understand it, means something that will most likely give rise to future disputes. There are rules
for avoiding this in ijarah and there are rules for doing so in mudarabah.)
There is a deeper gharar in mudaraba that would be easily avoided if the parties entered a sharika instead of a
mudaraba. The essential difference between a mudaraba and a sharika is that in the former, the entrepreneur is
not receiving fixed compensation for his labor. Thus, if A gives B 100 as a mudaraba, and B works for a year, and
at the end of the year, the enterprise is valued only at 100, he must return the entire value to A. If A gives B 100
as a sharika and B is to manage the property for a year, then we would have to assign a value to that labor, for
example, 100, in which case the enterprises capital would be 200, not 100, with A and B 50-50 partners in the
capital. Therefore, if at the end of the year the enterprise is only worth 100, B will now get 50, not 0. Therefore,
although they could have bargained and given B a specific, contractually determined value to his labor, by choosing
the mudaraba form, they are giving B only a contingent payoff. This is classic gharar, and the Malikis say so
specifically. {See, al-Sawi, Bulghat al-salik, 4:68} huwa mustathna li-l-darura min al-ijara al-majhula. Note, of
course, the laxity of the darura: there is no darura at all, because there could be a partnership which would remove
the gharar. The inconvenience of a partnership, however, is that it requires active participation, and is not conducive
to passive investors. Al-Sawi basically says as much: It existed in the Jahiliyya, and the Mustafa (S) permitted it
[to continue] in Islam, because necessity requires it due to the need of the people to use their property and not
everyone is able to invest it directly (wa laysa kullu ahad yaqdir ala al-tanmiya bi-nafsihi). Note how this
assumes that everyone has a right to invest his property, and that therefore, legal forms have to adopt to the reality
that not everyone can do so actively, not the reverse, that everyone must adopt to the legal norm.
(By placing the two contracts side by side I am merely asking you to focus on the nature of the ordinary share and
what it implies, that is, the contract of the investor with another person called the corporation. By describing the
mudarabah contract, I was merely trying to show what Islamic law things about liability, sharing of profits and
economic justice in general.)
I suggest that we not engage in anachronisms. I dont think they were thinking about economic justice as that term
is used today at all. For the most part, they were describing what people did, and were keen to make sure that such
arrangements did not violate rules of riba and gharar. They were hardly trying to develop a theoretical account of
what forms of business should be permissible for all times because something abstract like economic justice
limited business organizations to the forms known by the early Muslim community. Compare, however, al-Dardirs
statement that copper coins cannot be used for mudaraba, even if they are the main unit of exchange, because
qirad is a license (rukhsa) limited to the circumstances described in what was transmitted to us, and anything other
than those, remains prohibited under the basic rule (prohibiting gharar).
(I am asking you to judge the contract of the shareholder with the corporation on the basis of the rules for the
prohibition of riba and on the basis of al-kharaju bid-daman and a number of other principles.)

A shareholder is liable up to the amount of her investment. The corporation is liable for its torts and contracts. The
shareholder will not receive a return on its investment if the corporation goes bankrupt and is unable to pay its
debts. When I contract with a corporation, I know that I cannot look to the assets of its shareholders to satisfy my
claim, and therefore, I will take that fact into account in determining my compensation. The only thing that is
problematic is tort creditors they obviously do not bargain with the corporation, and therefore, there is a problem
of distributive justice when a tort creditor is unable to collect compensation. For that reason, in a bankruptcy
situation, I believe that tort creditors should be given priority over contract creditors to the assets of the enterprise.
Wa-allahu alam.
 International Journal of Islamic Financial Services Vol. 2 No.4

(Yes, limited liability is a problem. But why not the contract creditors. If I have sold something on credit to a
corporation whose shareholders own billions privately, but the corporation goes bankrupt, do you think they should
pass on the buck to me and ruin me when they still have enormous resources? Is that Islamic? Would Islamic law
consider that debt to be written off?)
I explained why that is not an issue above. It is only a problem if you were decieved into thinking you could look to
the assets of those private person, when you could not. Really, the situation is no different than the concept of
giving secured creditors priority over unsecured creditors it is defensible only if the latter are on notice of the
superior rights of the former, and can therefore adjust the terms of the credit. That is why in medieval Islamic law
a security interest lapsed immediately upon the mortgaged propertys return to the possession of the debtor. In this
case, the next creditor would naturally think that he owns the property that is in his possession and extends credit
on that basis.
Prof. Imran Ahsan Khan Nyazee

(In response to Br. Mohammad Fadel and Dr. Tariqullah Khans message about limited liability)
Limited Liability

You Say: When I contract with a corporation, I know that I cannot look to the assets of its shareholders to satisfy
my claim, and therefore, I will take that fact into account in determining my compensation.

1. The real issue is: why cant you look to the assets of the shareholders for the satisfaction of your claims on the
basis of Islamic principles and rules, or standards if you like? Is it because the relationship between the shareholder
and the corporation that of a creditor-debtor?

2. If it is not a debtor-creditor relationship, it will amount to the shareholder saying this to you: I am dealing with you
through this device called the corporation, and if the funds associated with this device are not sufficient, I will not
pay my debts in full even if I have personal funds available? On what Islamic principles is this justified?

This pertains to limited liability.

Nevertheless, these questions do give rise to the old question about the nature of the ordinary share, so I am
repeating my questions again.

Q. 1: What is the nature of the relationship between the shareholder (ordinary share) and the corporation. Is it
Agency (wakalah)? Is it surety (kafalah)? Is it some other legal category? If we cannot find a legal category, is it
the relationship between debtor and creditor?

Q. 2: It must be a debtor-creditor relationship, because property in the money paid has passed to the corporation
and property in the share-certificate, like any other debt instrument, has passed to the shareholder. Is it because of
this reason that the shareholder can sell, pledge, or deal in his share independently, while the corporation can
dispose of its assets independently, like all debtors and creditors, and unlike partners in a sharikah. (The shareholder
has nothing to do with the assets of the corporation)?

Q 3: If it is a debtor-creditor relationship, or something similar, on what Islamic basis is the shareholder entitled to
profit earned by the corporation, taking into account the fact that he neither owns the assets nor is he in any way
liable for losses arising out of these assets. (Limited liability is a misnomer, the shareholder in fact has no liability.
All he has done is buy a debt-instrument)

Q 4: If you treat the corporation like any other natural person, and you are able to find some justification in Islamic
law for this arrangement, on what basis does the shareholder stipulate that he has residual rights and will take away
(or is entitled to) all the profits left with the corporation? Would this be justified between two natural persons?
 International Journal of Islamic Financial Services Vol. 2 No.4

My own feeling is that a discussion about limited liability can become more meaningful once the relationship
between the shareholder and the corporation is analyzed and, if possible, justified on the basis of Islamic legal
principles. The question is limited liability for whom?

Dr Mohammad Fadel

If all you mean to say is that the concept of corporation cannot be made to fit into the recognized categories of
classical/medieval Islamic law, then I agree, but I also say So what? Shaykh Mustafa Zarqa, may Allah have
mercy upon him, in his work al-Madhkhal al-Am li-l-fiqh al-islami al-muasir, expressly notes that the notion of
a corporation was unknown to Muslim jurists, and that its rules must be borrowed, virtually wholesale, from non-
Muslim legal systems.

As I tried to point out earlier, mudaraba is also highlty problematic if you try to place it into accepted legal catego-
ries. In fact, it ought to be prohibited, and hence it is deemed a rukhsa, whose justification is the need for a vehicle
to promote passive investment. If I were interested in attacking the legitimacy of mudaraba, I could something like
Is it fair that the entrepreneur expend all this labor and get nothing when his partners capitl is guaranteed? It is
fair because thats the terms of the deal. If he really wanted a return on his human capital, he could have refused
to deal except as a partner, rather than as a mudarib.

If we can accept the fact that in mudaraba, the capital is guaranteed to the investor, but the agent bears the entire
risk of his expended human capital, I cant really see why we should be concerned that a creditor cant sue the
individual shareholders in the event the corporation goes belly up. Moreover, the principle of al-kharaj bi-l-daman
is fully satisfied, so long as the corporation has a positive value. And, it goes without saying, the shareholder gets
nothing if the corporation has a negative value and is unable to pay its debts. Thus, the shareholders do bear the
liabilities of the corporation for purposes of determining whether their entitlement to dividends is legitimate. In fact,
one of the factors in American law that allows creditors to pierce the corporate veil is when distributions are made
to shareholders despite the corporation being undercapitalized, i.e., its liabilities exceed its assets. When the
corporation enters a profitable deal, the book value of a share will correspondingly increase. Conversely, when it
loses money on a deal, the book value of each share will decline. The point of limited liability is simply that the
shareholders can lose no more than their contribution to the corporation. Unlike partnerships, their shares cannot
have a negative book value. Once debts exceed the capital of a corporation, the creditors effectively become its
owner by operation of bankruptcy law, and they decide whether to sell its remaining assets, or to reorganize it as an
ongoing enterprise.

Now, assuming that the corporations activities are conducting within the requirements of Islamic law, why should
I believe that I am doing something haram by investing in such an enterprise?

Mohamed M. Abbas
(If all you mean to say is that the concept of corporation cannot be made to fit into the recognized categories of
classical/medieval Islamic law, then I agree, but I also say So what? Shaykh Mustafa Zarqa, may Allah have
mercy upon him, in his work al-Madhkhal al-Am li-l-fiqh al-islami al-muasir, expressly notes that the notion of
a corporation was unknown to Muslim jurists, and that its rules must be borrowed, virtually wholesale, from non-
Muslim legal systems.)
Does this not go against the axiom that states Islam is a comprehensive legal system/way of life as pointed to in
several ayat and ahadith in the quran/sunnah? What is attempted to be said here is there is no need to have a
Daleel for the idea of the corporation whatsoever and we should just borrow wholesale the idea from non-Islamic
legal systems. Im wondering how is that defended at all? Could you please elaborate on this point?
 International Journal of Islamic Financial Services Vol. 2 No.4

Dr Mohammad Fadel

I think it has been stated on this forum before, in detail, the fundamental difference between muamala and ibada,
and that the presumption in the former is permissibility and in the latter is prohibition. In fact, the precise term
among the usulis is baraat al-dhimma, i.e., there is no obligation in the absence of a dalil. In this case, i.e., the
absence of a dalil, one is obliged to ask whether, in light of revelation, the proposed conduct is more similar to that
which has been permitted, or if it is closer to that which has been forbidden. I am simply pointing out that the
Muslim jurist allowed mudarabah (which the Malikis call qirad, to emphasize the debtor-creditor relationship be-
tween the agent and the investor) despite the gharar inherent in it because of the need for a vehicle to allow passive
investment.

For me, corporations also serve that purpose, with the advantage that it allows several people to contribute capital
while minimizing the transaction costs connected to coordinating the activities of all the persons involved in running
a corporations activities.

As I have said, the only potential problem with a corporation arises at the time of bankruptcy when there are
competing claims to its assets, in which case I believe, as a matter of distributive justice, greater priority should be
given to tort, as opposed to, contract creditors. Wa-allahu alam.

Prof. Imran Ahsan Khan Nyazee

In response to Mohammad Fadel

(If all you mean to say is that the concept of corporation cannot be made to fit into the recognized catego-
ries of classical/medieval Islamic law, then I agree, but I also say So what? Shaykh Mustafa Zarqa, may
Allah have mercy upon him, in his work al-Madhkhal al-Am li-l-fiqh al-islami al-muasir, expressly notes
that the notion of a corporation was unknown to Muslim jurists, and that its rules must be borrowed,
virtually wholesale, from non-Muslim legal systems.)

Some other modern personalities say that the concept was known to Islamic law, but that is not important. The
important thing is that you cannot adopt the rules wholesaleblindly. Modern banking was not known to Muslim
jurists, but you question it on the basis of riba, and alter it according to Islamic norms and call it Islamic banking.
Likewise, all modern transactions borrowed from the West must be checked against the fundamental rules. What
are these rules?

In my view, and I think you will agree, at least two types of rules are extremely important and they are usually inter-
dependant.

1. The rules of riba

2. The rules of daman as enshrined in al-kharaju bid-daman.

In the questions I have listed in the previous message, this is all I am trying to do: to apply these two principles to the
transactions called the ordinary share. In fact, I have already done so in considerable detail (in my two books on
Islamic law of business organization that are available for downloading at www.islamicfiqh.com for whoever
wants to look at them). My conclusion is that the transaction of the ordinary share, under the present corporate
structure, does amount to riba, and that this can only be understood once we break down the contract into its
various components and analyze it in the light of the two principles above. I, therefore, ask you again and again to
look at the relationship between the shareholder and the corporation, which is to be treated like any other natural
person for analyzing the transaction.
 International Journal of Islamic Financial Services Vol. 2 No.4

Does that mean we give up the modern corporate form which is so useful and which in fact forms the basis of so
many democratic structures as well? No, we alter it slightly to make it conform to the Islamic principles so that we
can confidently go ahead and invest in modern corporations without being suspicious all the time.

(As I tried to point out earlier, mudaraba is also highly problematic if you try to place it into accepted legal catego-
ries. In fact, it ought to be prohibited.)

I find your views about mudaraba above to be untenable for two reasons:

1. The views are based on the principle of gharar, which is not as strong a basis as the two principles mentioned
above (and which our economists have bloated out of proportions, but that is a separate discussion).
2. You are assuming that mudaraba is a continuing arrangement and can proceed till the end of the year. I disagree.
My findings are different. You asked for references last time. I have to request you to download my book on
partnerships from www.islamicfiqh.com and there I have tried to document what I have said. If what I have said
is incorrect or shaky, I am ready to change my view.
(When the corporation enters a profitable deal, the book value of a share will correspondingly increase. Con-
versely, when it loses money on a deal, the book value of each share will decline. The point of limited liability is
simply that the shareholders can lose no more than their contribution to the corporation. Unlike partnerships, their
shares cannot have a negative book value.)
This is a very sharp observation; I never thought of it this way. But that, Sir, is exactly the point. A debt instrument
does not have a negative value. Just like your currency note cannot have a negative value. A fully risk bearing
investment can give you a negative value as in a partnership, as you rightly point out; an investment in which you
are ready to fully bear the losses arising from your actions.
(Now, assuming that the corporations activities are conducting within the requirements of Islamic law, why should
I believe that I am doing something haram by investing in such an enterprise?)
I am merely saying that you (and especially you, for you have a knowledge of these matters) must take a deep and
long look at what we are getting into. If you are fully satisfied that the norms of the shariah have been satisfied,
then, we should all go ahead and participate in something that is lawful and good. If, however, this is not your finding
then we should try to improve things. For all we know Muslims may come up with more efficient and just legal and
financial structures.

- To be Continued -