Sleeping Partnership

In lieu of capital one or more partners contribute entrepreneurial skill, labour or other expertise in a particular business undertaking. This person will hereinafter be described as ‘the entrepreneur.’ The other partner(s) contribute capital (‘the investor’). These roles will for convenience be described in the singular in what follows although Islamic law does not specify the number of entrepreneurs or investors who may enter into a contract of Sleeping Partnership.

Comparison of the Sleeping Partnership Contract with Other Contracts

The usual requisites of contract, parties (investor and entrepreneur) and the exchange of their mutual offer/acceptance apply. The contract of Sleeping Partnership specifies the respective rights and duties of the partners, including contributions and share of profits. As with other partnerships the ratio of returns to the parties must be fixed, while the absolute amount of return must not be.

Unlike in other partnerships recognised by Islamic law, the liability of the investor is limited to the capital contributed. The entrepreneur is obliged to take precautions to protect against loss of the capital and to refrain from committing the partnership to liabilities exceeding available capital. Should losses exceed assets due to no negligence of the entrepreneur only the investor may be held liable for the shortfall.

The investment is not a loan to the entrepreneur; the entrepreneur is not a debtor and the investor is not a creditor. Security or collateral cannot be supplied. The entrepreneur acts as the agent of the investor.

Clauses Regarding Duration

Two of the four legal schools consider sleeping partnerships of limited and pre-agreed duration valid. The other two mandate that it must be open-ended in time, although there are liberal conditions under which investor may end the partnership (see Termination, below)

The Capital

The contribution of the investor, the capital:

  • must be present at time of contracting
  • cannot include receivables
  • amount must be known to the partners (whether entrepreneur or investor)
  • must be liquid (cash)
    • however the investor may give the entrepreneur goods or other property with instruction that these are to be liquidated and the proceeds treated as capital contribution
  • must be transferred and retained in the possession of the entrepreneur for the creation and operation of the business
  • must not be used by the entrepreneur to pay for his/her personal expenses
    • except as allowed by some of the legal schools (for example when the entrepreneur travels on business)

Profit

Profit, the amount in excess of the capital contributions by the investor, is only distributed after outstanding liabilities are paid. It is allocated according to the contractually agreed ratio between investor and entrepreneur. It may be paid at one time or over installments during the life of the partnership with reserves being retained in the case of the latter, in readiness for seen and unforeseen future liabilities.

Investor Control

As with agency contracts sleeping partnerships span a spectrum from unrestricted (in which the entrepreneur is authorized to exercise a high degree of discretion and autonomy) to restricted partnerships where the investor exercises a greater degree of control. However in any case the investor does not have a right to manage the business, and the following restrictions apply to the entrepreneur:

  •  cannot re-direct the capital to another sleeping partnership thereby taking on the role of investor under that subsequent contract
  • cannot re-direct the capital to another partnership of any other kind
  • purchase goods on a credit or deferred basis
  • borrow money from third parties
  • lend partnership money to third parties

Although not a matter of legal obligation, the investor clearly should guard against potential moral hazard posed by the position and powers of the entrepreneur, by means of sufficient monitoring, financial oversight, etc.

Termination

The Sleeping partnership ends when

  • the duration of a temporary sleeping partnership comes to an end
  • one or more of the partners comes to lack legal capacity (including as a result of death)
  • the investor dismisses the entrepreneur whether or not for cause (including violation of agreement, negligence, exceeding powers)
  • the capital is lost or destroyed; if this is a result of the (in)action of the entrepreneur, s/he is personally liable

The Sleeping Partnership is known as the mudaraba.

 

 

Mejelle, 10th Book, Preface-Definitions and Chapter VII.