The Role of Juristic Persons in Islamic Finance
By Ebrahim Patel
BSc, BscHons, MPhil(Ethics)
MIFM

he mechanism of business funding under an Islamic financial system is rooted in the concept of a partnership. This partnership forms the basis of essentially two types of funding transactions: firstly, where both partners contribute capital, and secondly, where one partner contributes skill/knowledge/labour and the other contributes some form of financial capital. There is no limit on the number of people that can be a part of the partnership structure. There are certain rules relating to the taking of a salary by partners and in regards to profit sharing arrangements. The administrative arrangements between the partners and record keeping, etc. are left up to the partners to determine within the broad framework of the Shariah.

Attempting to implement the Shariah partnership described above in a secular economy is, however, problematic. Firstly, the maximum number of partners that can be accomodated in a legally valid partnership under South African law are 20. Once there are more than 20 partners, the partnership has to incorporate to form a company (public or private). The partnership has many of the qualities of a partnership as prescribed by the Shariah, entrenched by way of secular law. An incorporated company, on the other hand, clashes with many of the essential requirements of a Shariah partnership. The first hurdle that must be crossed is that of whether a juristic person is a recognisable form of transacting party in an Islamic Finance framework. There are a number of different views on the matter, which go beyond the scope of this article, but the end result is that there is no consensus view that juristic entities are a permitted party to transactions in Islamic Finance. To the extent that the secular law forces the incorporation of a company, the use of a juristic person is condoned by the jurists, not because it is correct, but because no other alternative is present.

The second major objection to the use of a juristic person in Islamic Finance is the concept of limited liability. In Islam, a creditor has full recourse to a debtor and a debtor has to meet his obligation to a creditor. There is no limiting of liability in this regard to a certain pool of assets contained within a fictitious entity. The articles of association of a company, may however, be amended to limit the capacity of the company to incur debt, so as to negate the effects of limited liability. The third area in which the use of a juristic person becomes problematic regards the concept of ownership. Under secular law, the assets of the company are owned by the company, not the shareholders. The shareholders, in turn, own a collection of rights and obligations as regards the company. Under an Islamic Finance framework, the partners to a partnership have direct ownership of the underlying assets in the pre-agreed proportions, and have the right to liquidate their share of the assets. The shareholders in a company, furthermore, do not have an entrenched profit sharing right, but rather, they share in the profits through dividends, which are declared at management’s discretion.

The fourth area of concern regarding juristic persons concerns the exact conceptual make up of a “share”, especially one that trades on the stock market. Is the trading of shares merely selling of the ownership interest that one has in the assets of the company? But then again, shareholders do not have a direct claim on the assets of the company, but only a residual claim that is enforceable upon liquidation or winding up – so, what does a share really represent? If a share is said to be a collection of rights, then buying and selling shares would entail the buying and selling of certain rights – this would then entail trade in an intangible asset (rights), which would not be permissible in Islamic Finance. Furthermore, the manner in which listed shares trade is often thought to be far removed from the realities of a “physical” market, raising questions as to whether the stock exchange is a valid market place for conducting valid transactions as per Islamic Finance. This is one of the reasons as to why a portion of Islamic scholars deem the investment in stock exchange listed shares to be impermissible, hence, any resultant investment in equity mutual funds (unit trusts) will also be deemed to be impermissible. Scholars who hold this view have ruled that unit trusts labelled as “Shariah Compliant” are actually not in accordance with Islamic Finance principles.

The discussion thus far has focused on the concept of a juristic person as being synonymous with a company – there are however other forms of juristic persons that are also relevant from an Islamic Finance point of view, most notably trusts. The use of a trust in estate planning, creating legacies, and driving charitable purposes has to be in accordance with the relevant Islamic rules governing those transactions. As is the case with companies, there are a number of departure points that need to be reconciled before the use of a trust is acceptable. This is however, not the focus of this article. Coming back to the use of companies, it becomes apparent that the default form of companies is incompatible with Shariah principles – but what are the implications of this? Firstly, it would mean that the use of a juristic person is not an acceptable Islamic Finance practice, but rather an act of compromise borne out of necessity. In countries where the legal system is secular, there may very well be no other choice but to use a juristic person, but there exists a very real opportunity in Islamic countries to discard the conventional notion of a company and create an Islamic form of business entity that accords with the Shariah.

Secondly, the governing mechanisms of a company attain increased importance in an Islamic Finance set up, as the articles of association will have to be amended as much as legally possible to give expression to the true dictates of the Shariah. This will entail significant legal structuring, over and above any financial structuring that may have to take place. The use of juristic persons in Islamic Finance is a classic example of the complications that arise when attempting to implement the techniques from one financial system (the Islamic system) within the legal framework of another financial system (the conventional one).