Mudarabah agreement: complete summary

In-Depth Analysis

Phew, what a long journey we have covered in 5.5 months to understand all aspects of Mudarabah. This well-rounded discussion shall be completed today by discussing what a master Mudarabah contract is. Have you heard of an MoU? As per Investopedia, an MoU is an agreement between two or more parties outlined in a formal document. It is not legally binding but signals the willingness of the parties to move forward with a contract in future. You could consider an MoU as parallel to a letter of intent (LOI). The LOI too is a written but non-binding document that suggests that a binding contract may be followed soon; however, the difference between an MoU and an LOI is that the latter is signed simply by the issuer, as against the former which is jointly signed. With the aforementioned prelude, the author is sure most of you may have already guessed that a master Mudarabah contract (or agreement) is also like an MoU. That is right. AAOIFI Shariah Standard No 13 has three articles on master Mudarabah agreements and that too during the opening of the chapter. The following is the gist of them: Shariah permits entering into a master Mudarabah agreement on the basis of a general understanding that actual transactions shall follow suit; the master Mudarabah agreement should lay down the nature of actual Mudarabah transactions whether they will be executed on a restricted or unrestricted basis; it should also stipulate the ratio for distribution of the actual profit between the parties which will emanate from the transactions, as well as define clearly if the Mudarib shall provide any guarantee, security, or collateral; and all transactions subsequently taking place in terms of the master Mudarabah agreement shall be subject to its terms and conditions. So, how do you think the actual transactions will take place in terms of a master Mudarabah agreement? Actually, the master Mudarabah agreement provides a mechanism for transactions within its contents. There is usually a template attached as an appendix to the master Mudarabah agreement for the Mudarib to fill, sign, and submit to the Rab Al Maal each time it needs funds for deployment in a profitable transaction within the purview of the arrangement. This will be regarded as the offer by the Mudarib to invest the Rab Al Maal's capital. The Rab Al Maal shall countersign the same in acceptance, or may provide the acceptance through a separate template, also part of the master Mudarabah agreement. Another effective use of a master Mudarabah agreement is when the originator of Sukuk (the obligor or the party needing funds) declares a Sukuk program, revealing its intention to keep returning to the capital market from time to time by issuing a string of Sukuk under the program. It is also referred to in the banking circle as the euro medium-term notes or EMTN, or simply MTN. Here, the originator pays the heavy legal fee to the appointed law firms only once to prepare the Sukuk program documentation and subsequently pays a considerably lower amount to issue a legal opinion on the issuance of each Sukuk. Similarly, the cost of getting a Shariah Fatwa approving the transaction is borne upfront by the obligor. Why is there a need to enter into a master Mudarabah agreement when no transaction is going to take place at the time of the parties executing it? Well, there are a few valid reasons for doing so, as both parties wanting to ensure they are available to each other when the right investment opportunity arrives. Moreover, in case of big-ticket transactions such as consortium financing for projects, the entire funding is not required at the same time but is obtained piecemeal as and when the need arises. In such situations, a master Mudarabah agreement is an ideal arrangement as it not only provides assurance to the obligor that the funding for the project has been lined up by the participating banks, but it also saves a considerable amount of time and legal fees since there will be no need to prepare the entire documentation by the transaction law firm for each drawdown and simply executing the supplemental schedules to the parties will serve the purpose.