Mudaraba Contract

A mudaraba contract is one of the most widely used financial instruments in the Islamic banking sector.

The Mudaraba Contract in Islamic Finance

The original mudaraba contract envisaged the capital investor as one party. In Islamic finance, mudaraba is a trust financing contract. Mudaraba may be conducted between investment account holders as fund providers.

Conditions

Widely agreed conditions applied to Asian mudarabah contracts, when the bank acts as Mudarib, are the following:

• details of the parties to the contract, as well as a description of the objects and purposes (whether general or specific) of the particular contract;
• information on the limits/restrictions on investments to be made by the bank under the contract (whether general or specific), as well as a reference to any discretion in this context which the bank has under the contract;
• details of how and by whom the contract assets will be managed and invested, as well as disclosure of any investment policies behind the contract (if applicable).(1)
• a description of how the contract is to be evidenced (e.g. by certificates) should
  be given;
• reference of the governing law of the contract (i.e. Shari’a Law, as interpreted by
  the relevant Supervisory Board) should be made. (2)
• the term/period of the contract, as well as the start and termination dates thereof,
  should be stated;
• specific reference to the segregation (or otherwise) of the contract assets from
  the bank’s assets and from the claims of the bank’s own creditors should be made
  (if applicable). (3)
• information should be provided on whether transfer or waiver of rights and
  obligations under the contract (as well as title certificates where relevant) is
  permitted and, if so, how;
• details of the liability of the bank for breach of contract and negligence, and
  whether or not a guarantee from a third party exists for that liability, should be
  given;
• information on minimum subscription levels and currency restrictions should be
  included;
• reference to the liability of investment account holders being limited to their
  contributions under the contract should be made. (4)
• full information should be included about the deduction from profits of the bank’s fees and any other relevant items. In addition, details of any unused reserves and their ultimate treatment/use by the bank should be clearly stated;
• information should be provided about the valuation of the contract assets, how often and by whom (if applicable);
• reference should be made to withdrawal/redemption (including early withdrawal/redemption) by the investment account holder and the effects thereof on his contractual rights and on the contract assets;
• the bank’s share of profits as Mudarib;
• details of how any investment account holder’s complaints are to be handled should be provided. Furthermore, provision for dispute resolutions and jurisdiction for litigation should be made;
• information should be included on the manner and timing of notices from the bank to the investment account holder and vice versa, as well as statements of account for the contract assets, which may be required from time to time;
• provision should be made for a Power of Attorney to be given to the bank by the investment account holder where necessary (5);
• provision should be made for amending the terms and conditions of the contract, as well as the early termination of the relationship between the investment account holder and the bank; and
• both the investment account holder and the bank should sign the contract.

Furthermore, the investment account holder should confirm in writing his
agreement to the terms and conditions of the contract, as well as confirming his
understanding thereof.

Finally, banks should ensure that the terms and conditions of contracts are clear, concise and
unambiguous, and are not intentionally misleading in any way which would confuse an
investment account holder or result in his entering into a relationship the impact of which he
does not appreciate. Due prominence should be given to the fact that, in contracts such as
these, the entire contractual risk is on the investment account holder except in the case of the
bank’s negligence. The extent of such risk (i.e. low, medium or high) should be explained to
the investment account holder, and a reference to such risk should be made on the face of the
contract.

Resources

Notes

1. Reference should also be made to any delegation powers of the bank in relation to such management and investment;
2. [In this context, banks should note that their Supervisory Board must both review and approve the contents of, and investments proposed for, standard-form Mudaraba contracts before they are used by the bank to enter into contractual relationships with investment account holders];
3. In addition, it should be clearly stated whether the assets of one Mudaraba contract are to be co-mingled with the assets of other contracts;
4. Furthermore, the contract should make it clear (in a prominent position and manner in the contract itself) that the contractual risk including the currency risk, is totally on the investment
5. In addition, where lien and set-off rights are to be given in favour of the bank, these should be expressly provided for

See Also

• Islamic Law
• Banking Law
• Contract Of Affreightment
• Contract Law
• Startup
• Contract Types
• C.I.F. Contract
• Contract
• Bank statement
• Contract Rate
• F.O.B. Contract
• Exclusive Patronage Contract
• Social Contract