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Legal issues in partnership law concerning musharakah al-mutanaqisah

practised by Islamic financial institutions in Malaysia

Article · January 2014

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Nuarrual Hilal Md Dahlan Ahmad Zafarullah Abdul Jalil

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 LEGAL ISSUES IN PARTNERSHIP LAW CONCERNING
MUSHARAKAH AL-MUTANAQISAH PRACTISED BY ISLAMIC
FINANCIAL INSTITUTIONS IN MALAYSIA

Nuarrual Hilal Md. Dahlan

Ahmad Zafarullah Abdul Jalil1
Zairani Zainol2
Selamah Maamor3

ABSTRACT
One of the Islamic Banking products in Malaysia is Islamic Partnership Home
Financing Facility-Musharakah al-Mutanaqisah (‘MM’). It is a trite practice that for
Islamic Banking products to be legal and shariah compliant, the products must
fulfill the requirements of the shariah (Islamic law) and Malaysian law. Under the
Malaysian law, Partnership Act 1961 (Act 135)(‘PA’) governs partnership. It
follows that, as a matter of course, MM shall also be governed by the PA. This
paper will highlight the issues in the provisions of the existing PA with regard to
MM. The authors use a legal research methodology to under take the research.
The authors also provide, at the end part of this paper, some suggestions in
dealing with the issues to warrant the validity of the MM in the legal perspective.

Keywords: Partnership Act 1961 (Act 135); Musharakah al-Mutanaqisah Home

Financing; legal issues.

INTRODUCTION
Islamic banking and finance aroused quite an interest in the 1960s and 1970s following
the resurgence of Islam in the early twentieth century with the momentum being
spearheaded particularly by Egyptian Muslim scholars4 and thinkers such as Muhammad
Abduh, Rashid Rida, Hassan al-Banna and Jamaluddin al-Afghani. Islamic banking and
finance eventually gained foothold in Malaysia with the establishment of Bank Islam
Malaysia Berhad in 1983.5 Islamic banking and finance facilities has since expanded to
meet and serve the customers’ demand for user-friendly banking and finance facilities
and products. These Islamic banking and finance products include Mudarabah - a
general and special investment deposit in the nature of profit sharing between the
depositors/customers and the bank, acting as the entrepreneur; Wadiah - where the
bank simply acts as the safe-keeper of the deposits of the depositors/customers but it
may provide returns to the depositors as a gift (al-Hibah); Murabahah (partnership and
equity financing); Ijarah (leasing); Istisna’(a sale contract by way of order for certain


Institute for Governance and Innovation Studies, UUM College of Law, Government and International
Studies, Universiti Utara Malaysia, 06010 UUM Sintok, Kedah Darul Aman, Malaysia. Email:
nuarrualhilal@gmail.com; hilal@uum.edu.my, Tel No: +604 928 6612 Fax No: +604 928 6602, HP No:
+6012 578 5455.
1
UUM College of Business, Email: zafar@uum.edu.my
2
UUM College of Business, zairani@uum.edu.my
3
UUM College of Business, selamahm@uum.edu.my
4
Pioneered by Mir Ghamir Local Savings Bank, which was established in 1964 in a provincial rural centre in
the Nile Delta of Egypt. See also Sudin Haron & Bala Shanmugam. 1997 Islamic Banking System, Concept
& Application Pelanduk Publications, Selangor, at p. 1.
5
See generally in Sudin Haron & Bala Shanmugam, 1997 Chapter 1.
1
product), Qard (loan contract), Rahn (pledge), Tawarruq/Commodity Murabahah
(purchasing an asset with deferred price), Wakalah (agency contract), Bay’ Dayn (sale of
debt with debt), Bay’ Inah (sale contract followed by repurchase by the seller at a
different price), Musharakah (partnership) and Bay’ Bithaman al-Ajil (BBA) (ie sale by
deferred payment). Due to increasing demand for these Islamic banking and finance
products, Islamic windows (Islamic banking and finance products) are likewise
introduced by the conventional banks (Yakcop, 1996). The Islamic banking and finance
operators in Malaysia is called ‘Islamic Financial Institutions’(‘IFIs’).

DEFINITION OF MUSHARAKAH
The word musharakah comes from the word sharaka. Sharaka means to share. In
practice musharakah means to share and to participate, between two or more persons,
in a business undertaking subject to the terms and conditions of the agreement between
the parties (Kamus Besar Arab – Melayu, 2006). The sharing and participation between
these persons can be in the form of capital financing and management of the venture.
The parties will share in the profits and losses arising from the business undertaking. In
IFIs in Malaysia, musharakah concept is applied in investment and financing
transactions. Financing based on musharakah embraces working capital financing, trade
financing and asset financing (Bank Negara Malaysia, 2010).

Musharakah Mutanaqisah(‘MM’)
MM is a home financing product offered by IFIs in Malaysia. It is based on the principle
of Musharakah (Islamic partnership). In MM, the house purchaser and the IFI purchase
the housing unit. The purchaser normally pays 10% of the purchase price as deposit,
while the IFI pays 90% of the purchase price. The purchaser and the IFI are considered
partners in the housing transaction. Then IFI requires the purchaser to buy up the 90%
share of the IFI for certain duration, monthly and gradually, by way ijarah (lease), until
the whole 90% portion has been decreased and fully bought by the purchaser. If the 90%
of the portion has been fully bought, the whole housing unit will be transferred and
registered into the purchaser’s name (Bank Negara Malaysia, 2010).

LEGAL ANALYSIS
The legal analysis that this paper will deal with is the Partnership Act 1961 (Act 135)
(‘PA’) insofar as MM is concerned.

Partnership Act 1961 (Act 135) (‘PA’)

The discussion under the PA will involve the following provisions.
1) Section 3(1) of the PA;
2) Section 6 of the PA; and,
3) Section 47 of the PA.

Section 3(1) of the PA: The Definition of Partnership

Section 3(1) of the PA provides:

“Partnership is the relation which subsists between persons carrying on

business in common with a view to profit”

Pursuant to section 2 of the PA, “business” includes every trade, occupation or

profession. According to the above provision, it is a must that the persons, forming a
2
partnership, have a relation of carrying on business in common with a view to profit. If
there is no such a relationship, there will be no partnership recognized by the PA. In
other words, their relation does not constitute a partnership.

In this respect, Lee Heng Cheong JC in Martin Mairin Idang v Rakanan Jaya Sdn Bhd &
Anor (High Court of Borneo at Sandakan) [2011] MLJU 670, said:

“Partnership is the relation, which subsists between persons carrying on

business in common with a view to profit. There cannot be a partnership
under Section 3 Partnership Act 1961 if there is no "view to profit". I
find that the Plaintiff is not doing business in common with PW4 Mr.
Rantau in Sandakan and I find that the Plaintiff does not share with PW4
Mr. Rantau in the profits of the Sandakan legal firm. Nor does the
Plaintiff exercise any degree of management or control over the
Sandakan legal firm or vice versa... As clearly stated at Page 13 under
General Note on the Partnership Act 1961, "there can be no partnership if
there is no business carried on with a view to profit" and a person cannot be
a partner if he has no beneficial right to share profits.”

In the Federal Court case of Chooi Siew Cheong v Lucky Heights Development Sdn Bhd
(1995) 1 MLJ at Page 521, the Federal Court held:-

"The term "partnership" is defined in S. 3(1) of the Act as the relationship

which subsists between persons carrying on a business with a view to profit.
In deciding whether a partnership exists, the Court must have regard to the
relevant rules in S. 4 of the Act and intention of the parties."

… Applying the above principle to our present case, I find that the Plaintiff
and PW4 Mr Rantau never intended to be partners

… Finally, I refer to the dicta of Tan Sri Richard Malanjum in Fu Yen

Development Sdn Bhd (suing as a firm) v Shelley Yap Leong & Co (sued as
a firm) (2001) 3 AMR 3736 his Lordship said:-

"Having perused the trading license exhibited as "A" in Encl 61

agreed with learned counsel for the respondent that the word "New"
was obviously written on it. And there was only one name as the
proprietor. Nothing to indicate that it had any connection with
the previous trading licence issued under the same name.
Accordingly I was inclined to accept that on the trading licence
alone it was obvious that there was no partnership in existence
when the action was commenced.

No doubt the appellant could adduce other evidence to show

existence of a partnership. But from the several affidavits filed
they contained nothing more than assertions of the deponents.
Surely there should be at least some evidence of partnership in
the form of accounts, bank statements or income tax returns if
indeed there was one. Even if it was not in operation at the
material time there should have been records to show that there
was a continuation of the partnership since 1979 onwards. I was
aware of the explanation given for the absence of such documents.
But I do not think it would make any difference if the same
assertions were to be repeated by the same deponents in a full trial.
3
 In this case the trading licence indicated nothing more than it was a
new licence. Steps could have been taken to rectify the error in the
1995 trading licence if indeed there was partnership even at the
material time. That is the first limb of Order 77 r 1 of the Rules.”
(emphasis added).””

Issue:
Whether in MM Home Financing, the partnership so formed may not be said as “carrying
on business in common with a view to profit”? In MM, it is observed that there is a lack of
activities in carrying business to get profit, at least by the customer/purchaser partner.
Only the IFI can be considered as carrying out a business for profit. On the other hand, it
may be argued that the IFI and the customer/purchaser partner will get profit and benefit
from the partnership. The IFI will get the monthly installment consisting of rental (Ijārah)
payment (installment payment) from the customer/purchaser partner. While the
customer/purchaser partner will get gradual accumulating equity/share in the house
property which increases in pro-rata with the monthly installment payment made to the
IFI. The greater the settlement made by the customer/purchaser partner, the greater will
his proprietorship equity/share be in the house property.

Following the above contention, a question can be posed, viz whether the IFI and the
customer/purchaser partner in the MM are carrying out “business”?

If the former argument is true, i.e the MM’s theory and practice do not involve ‘persons
carrying on business in common with a view to profit’, MM cannot be considered a
‘partnership’ under the PA and thus it shall not be subject to the PA altogether. In this
situation, MM may fall into the definition of ordinary contract which is subject to the
Contract Act 1950 (Act 136, Revised 1974) and the contract law, not to the PA.

Nevertheless, if the latter argument is preferable to the former, MM is a partnership

recognized under the PA and shall be subject to the PA.

It is suggested that in order to warrant MM to still fall under the PA, certain provisions in
the PA, particularly section 3(1) should provide some proviso/qualification to the effect of
covering MM as well.

The above issue so far has not been dealt with by courts in Malaysia. Thus, in the near
future, it is the hope of the authors that the above issues can be determined by courts for
the benefit of the stakeholders.

Section 6 of the PA: Meaning Of Firm And Firm-Name

This section stipulates:

“Persons who have entered into partnership with one another are, for the
purposes of this Act, called collectively a firm, and the name under which
their business is carried on is called the firm-name.”

According to the above provision, the partnership venture composing the partners will be
called a firm. All the ventures the partnership undertakes will use the firm name.

Issues:
1) Whether the venture between the bank and the customer partner in the MM
must be called a firm?
4
 2) Whether a firm must be formed for the purpose of implementing MM?
3) Is there a need to establish a firm, before MM can be practised?

It is opined, if the current practice of MM does not in need of creating and establishing a
firm as required by the above provision, the practice is against the PA and will affect its
legality. Unless and until the current practice of MM is further governed by other
provision legalizing its establishment and operation without the need to comply with the
above provision, the legality of MM may be at stake.

Similarly this issue has not been dealt with by courts in Malaysia, for otherwise, the
findings and decisions can be helpful to the industrial players of MM.

Section 47 of the PA
Section 47(1) of the PA states:

“The rules of equity and of common law applicable in partnership shall

continue in force, except so far as they are inconsistent with the express
provisions of this Act.”

While section 47(2) provides:

“Nothing in this Act shall be read to permit any association of more than
twenty persons to be formed or to carry on any business in partnership
contrary to paragraph 14 (3) (b) of the Companies Act 1965.[Act 125]”

The provision under section 47(1) above requires that the partnership venture must
comply with the law prescribed by the PA. However, the rules of equity and common law
of England may be applicable as long as they do not contravene the PA. This is also in
line with the provisions under section 5 of the Civil Law Act 1956, which emphasizes that
the rules of equity and common law of England shall be applicable to commercial cases,
including partnership as long as there is no written law on partnership. As there is a
written law passed by the Malaysian Parliament on partnership viz the PA, then the rules
of equity and common law of England shall not be made applicable to partnership’s
matters if the matters have been determined under the PA.

Section 47(2) requires that the total number of persons that can form a partnership is
twenty. If the number is more than twenty, then that venture shall not become a
partnership. It will become a company subject to the Companies Act 1965 (Act 125).

Issues:
a. Whether the above subsection 1 of section 47 can be made applicable in the
MM products?
b. Whether subsection 2 of section 47 can be applied to MM products?

It is opined that section 47(1) emphasizes the universal duty to uphold justice and equity.
It follows that this call also does not go against the Shariah. This is because Islam also
calls for justice and equity. Nonetheless, it is opined that, the obligation to apply the rules
of equity and fairness may be a heavy duty and responsibility on part of the IFIs in
implementing Mushārakah. This is because the terms and conditions in Mushārakah
should be equitable and fair to both parties – the partners. There should not be any one
sided agreement and unfair contract terms favourable to one party only. For an instance,
in MM, there is no corresponding and reciprocal duty and liability of the IFIs in case the
housing developer abandons its housing project. In this situation, the IFIs should join the
5
customer/purchaser partner (being also the purchaser and the borrower) to become
plaintiff or claimant to sue and get appropriate remedies from the defaulting abandoned
housing project’s developer, not that the IFIs commence legal action against the
customer/purchaser partner owing to the customer/purchaser partner’s default on the
loan. Otherwise, it is unfair, absurd and oppressive to the customer/purchaser partner
altogether. The major reason leading to abandoned housing projects is usually due to
the faults of the housing developer, not the customer/purchaser partner (the
purchaser/borrower). Thus, the customer/purchaser partner should not be unfairly
overburdened with the legal action of his partner (being the IFIs) in abandoned housing
projects. What is fair and just for both partners – the IFIs and the customer/purchaser
partner, is to ensure that the abandoned housing projects can be revived, the
customer/purchaser partner can get the duly completed house and thus he can service
the monthly installment to IFIs until settlement not otherwise (Md. Dahlan, 2009 & 2011;
Md Dahlan & Aljunid, 2011; Md Dahlan & Aljunid, 2010a; Md Dahlan & Aljunid, 2010b).

On the other hand, it is opined that, there are certain provisions in the PA that give
flexibility in the formation and practice of partnership in order to depart from the
obligation to follow section 47(1) above, if the partners so agree and incorporate this in
the partnership agreement. This statutory flexibility can be used creatively to implement
MM in home financing. These provisions in the PA are as follows:

Section 20. Revocation of continuing guarantee by change in firm.

“A continuing guarantee given either to a firm or to a third person in respect

of the transactions of a firm is, in the absence of agreement to the
contrary, revoked as to future transactions by any change in the constitution
of the firm to which, or of the firm in respect of the transactions of which, the
guarantee was given” (emphasis added).

Section 21. Variation by consent of terms of partnership.

“The mutual rights and duties of partners, whether ascertained by agreement

or defined by this Act, may be varied by the consent of all the partners,
and such consent may be either express or inferred from a course of dealing”
(emphasis added).

Section 23. Property bought with partnership money.

“Unless the contrary intention appears, property bought with money

belonging to the firm is deemed to have been bought on account of the firm.”
(emphasis added).

Section 24:Conversion into personal estate of land held as partnership

property.

“Where land or any interest therein has become partnership property, it shall,
unless the contrary intention appears, be treated as between the partners
(including the representatives of a deceased partner), and also as between
the heirs of a deceased partner and his executors or administrators, as
personal and not real estate” (emphasis added).

Section 26. Rules as to interests and duties of partners, subject to special

agreement.

6
“The interests of partners in the partnership property, and their rights and
duties in relation to the partnership, shall be determined, subject to any
agreement, express or implied, between the partners, by the following
rules:…” (emphasis added).

Section 27. Expulsion of partner.

“No majority of the partners can expel any partner, unless a power to do so
has been conferred by express agreement between the partners”
(emphasis added).

Section 34. Dissolution by expiration or notice.

“(1) Subject to any agreement between the partners, a partnership is

dissolved -
(a) if entered into for a fixed term, by the expiration of that term;
(b) if entered into for a single adventure or undertaking, by the termination of
that adventure or undertaking; or
(c) if entered into for an undefined time, by any partner giving notice to the
other or others of his intention to dissolve the partnership” (emphasis added).

Section 35. Dissolution by bankruptcy, death or charge.

“(1) Subject to any agreement between the partners, every partnership is

dissolved as regards all the partners by the death or bankruptcy of any
partner.
(2) A partnership may, at the option of the other partners, be dissolved if any
partner suffers his share of the partnership property to be charged under this
Act for his separate debt” (emphasis added).

Section 45. Retiring or deceased partner's share to be a debt.

“Subject to any agreement between the partners, the amount due from
surviving or continuing partners to an outgoing partner or the representatives
of a deceased partner in respect of the outgoing or deceased partner's share
is a debt accruing at the date of the dissolution or death” (emphasis added).

Section 46. Rules for distribution of assets on final settlement of accounts.

“In settling accounts between the partners after dissolution of partnership, the
following rules shall, subject to any agreement, be observed:
(a) losses, including losses and deficiencies of capital, shall be paid first out
of profits, next out of capital and lastly, if necessary, by the partners
individually in the proportion in which they were entitled to share profits; and
(b) the assets of the firm, including the sums, if any, contributed by the
partners to make up losses or deficiencies of capital, shall be applied in the
following manner and order:
(i) in paying the debts and liabilities of the firm to persons who are not
partners therein;
(ii) in paying to each partner ratably what is due from the firm to him for
advances as distinguished from capital;
(iii) in paying to each partner ratably what is due from the firm to him in
respect of capital; and

7
 (iv) the ultimate residue, if any, shall be divided among the partners in the
proportion in which profits are divisible” (emphasis added).

As regards section 47(2), which requires the maximum total number for a partnership is
20 persons, MM home financing should adhere to this requirement. For otherwise, the
transaction will not be called a partnership and unenforceable and will not be subject to
the PA. If the total number of partner exceeds 20, the venture shall be subject to the
Companies Act 1965 (Act 125) and must be registered as a company. Thus, if there are
20 purchasers buying a house/property financed through MM, then this transaction
cannot be considered a ‘legal’ partnership and shall not be subject to the PA.
Likewise, unfortunately, to date, the above issues have not been dealt with by courts in
Malaysia.

CONCLUSION AND SUGGESTIONS

The above discussions illustrate some of the legal issues concerning MM in the PA. So
far there is no case law that have dealt with the above issues. It is suggested that some
amendments should be made to the PA to accommodate and settle the issues as
discussed and proposed above.

REFERENCES
Bank Negara Malaysia Central Bank of Malaysia.(2010). Shariah Resolutions in Islamic Finance,
nd
2 edition, Kuala Lumpur: author.
Chooi Siew Cheong v Lucky Heights Development Sdn Bhd (1995) 1 MLJ at Page 521
Civil Law Act 1956 (Revised 1972(Act 67).
Companies Act 1965 (Act 125).
Dewan Bahasa dan Pustaka. (2006). Kamus Besar Arab – Melayu. Kuala Lumpur: author.
Haron, S. & Shanmugam, B. (1997). Islamic Banking System, Concept & Application Pelanduk
Publications: Selangor.
Martin Mairin Idang v Rakanan Jaya Sdn Bhd & Anor (High Court of Borneo at Sandakan) [2011]
MLJU 670.
Md Dahlan, N.H. & Aljunid, S.Z.S,A.K. (2010a). Legal and Shariah Issues in Bay’ Bithaman al-Ajil
(BBA): A Viewpoint. Malayan Law Journal MLJ. 6: lxxv—cxiii.
Md Dahlan, N.H. & Aljunid, S.Z.S.A.K. (2010b). Shariah and Legal Issues in the Bay’ Bithaman al-
Ajil (BBA): A Viewpoint. Shariah Law Reports. 3: 90-123.
Md Dahlan, N.H. & Aljunid, S.Z.S,A.K. (2011). Shariah and Legal Issues in House Buying in
Malaysia: The Legality of Bay’ Bithaman al-Ajil (BBA) with Special Reference to
Abandoned Housing Projects. Journal of Social Science and Humanities. 19(2): 349—
362.
Md Dahlan, N.H. (2009). Abandoned Housing Projects in Peninsular Malaysia: Legal and
Regulatory Framework. Unpublished Ph.D in law dissertation. Ahmad Ibrahim Kulliyyah of
Laws, International Islamic University Malaysia, Gombak, Selangor.
Md Dahlan, N.H. (2011). Legal Issues in the Rehabilitation of Abandoned Housing Projects.
Sintok: Universiti Utara Malaysia Press.
Partnership Act 1961 (Act 135).
Yakcop, N.M. (1996). Teori, Amalan dan Prospek Sistem Kewangan Islam di Malaysia. Kuala
Lumpur: Utusan Publications & Distribution Sdn. Bhd

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