Structuring a joint venture arrangement based on musharakah mutanaqisah

By Ahmad Syahir Yahya, AZMI & Associates

Parties to a joint venture arrangement that wish to form a joint venture in accordance with the principles of Shariah may consider forming such a venture based on the musharakah mutanaqisah concept.

Musharakah mutanaqisah
Musharakah mutanaqisah simply means diminishing partnership. According to Shariah Standards published by Accounting and Auditing Organisation for Islamic Financial Institutions’ (AAOIFI), musharakah mutanaqisah refers to “a form of partnership in which one of the partners promises to buy the equity share of the other partner gradually until the title to the equity is completely transferred to him. This transaction starts with the formation of a partnership, after which buying and selling of the equity take place between the two partners. It is therefore necessary that this buying and selling should not be stipulated in the partnership contract. In other words, the buying partner is allowed to give only a promise to buy. This promise should be independent of the partnership contract. In addition, the buying and selling agreement must be independent of the partnership contract. It is not permitted that one contract be entered into as a condition for concluding the other” (AAOIFI, 2008, Shariah Standard No.12, paragraph 5/1, page 217).

Brief description
Musharakah mutanaqisah can be applied in various types of business ventures including for property development. In the case of a venture for property development, the brief description of the venture is as follow:

Partner A and Partner B will jointly acquire and develop the project land. Partner A shall contribute a certain sum as the initial payment, being Partner A’s initial payment, for instance, 90 percent of the total cost for acquisition and development cost of the project land (Total Cost). Partner B shall contribute a certain sum as the initial payment, being Partner B’s initial payment, for instance, 10 percent of the Total Cost.
During the co-ownership period, Partner A will lease the Partner A’s ownership share to Partner B on the basis of Ijarah (Lease) for the rental payment and subject to the terms and conditions as set out in the Ijarah Agreement.
Partner A then appoints Partner B as its service agent in relation to the project land upon the terms as stated in the Service Agency Agreement.
At the expiry of the co-ownership period, Partner B undertakes to acquire Partner A’s ownership share by making the acquisition payment promptly in accordance with a sale contract. Partner A’s ownership share corresponding to the acquisition payment made by Partner B is thereafter fully transferred from Partner A to Partner B until the project land is wholly and fully owned by Partner B.
The rental payment shall cease immediately upon Partner B having fully paid the acquisition payment and fully acquired Partner A’s ownership share in the project land from Partner A, but in any case immediately upon the expiry of the Ijarah tenure.

Documents involved
Based on the brief description above, the relevant agreements involve for the joint venture arrangement based on musharakah mutanaqisah are as follows:

Musharakah Mutanaqisah Agreement, to regulate on the formation of the joint venture based on the musharakah mutanaqisah concept and the co-ownership of the project land between Partner A and Partner B.
Sale Contract, to regulate on the sale of Partner A’s ownership share in the project land from Partner A to Partner B according to the agreed terms in the Musharakah Mutanaqisah Agreement.
Ijarah Agreement, to regulate on the lease arrangement of the portion of the project land owned or beneficially owned by Partner A to Partner B.
Declaration of Trust, whereby Partner B will declare that it shall hold the portion of the ownership share and rights in the Project Land that it does not own during the co-ownership period, in trust for Partner A subject to the terms of the Musharakah Mutanaqisah Agreement.
Service Agency Agreement, to regulate on the appointment of Partner B as service agent of Partner A in respect of the project land.
Purchase Undertaking by Partner B, whereby Partner B undertakes to acquire Partner A’s ownership share in the project land upon occurrence of the event of default.

Shariah requirements
In structuring of a joint venture based on musharakah mutanaqisah, it is very important to ensure that the structure and all documents involved are in accordance with the Shariah principles. In the context of Malaysia, if the parties to the joint venture are Islamic financial institutions licensed or governed by the Central Bank of Malaysia, the parties must comply with the guidelines and all policy documents issued by the Central Bank of Malaysia including the policy document of Musyarakah issued on April 20, 2015.

Conclusion
Musharakah mutanaqisah is a viable structure as an alternative to a normal joint venture arrangement and this model can be applied and explored by any party especially for those who requires the venture to comply with the Shariah principles.

W: www.azmilaw.co.id