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بسم الله الرحمن الرحيم
الحمد لله رب العلمين و الصلوة و السلام على سيدالانبياء و المرسلين
In response to recent concerns regarding the difference of opinion in
the Shar’i permissibility of shares, stocks, companies, the
concept of limited liability and other interrelated transactions, we
present this treatise investigating the realities of these modern
business practices and examining how they fare in terms of the
Shariah. We will commence this discourse by providing an
understanding of these commonly misunderstood financial aspects.
Thereafter, we will proceed to mention various points of contention in
regards such misunderstandings between those who permit shares and
those who prohibit them. In conclusion, we will present the reasons of
impermissibility in light of the proofs presented.
CHAPTER ONE
UNDERSTANDING COMPANIES, SHARES AND LIMITED LIABILITY
The majority of information in this chapter has been summarized from
the book, “Islam aur Jadid Ma’ishat wa Tijarat” authored by the
honorable Mufti Taqi Uthmani. The views and understanding of the
workings of shares are of those Ulama who deem shares permissible.
Understanding of a Company:
In a Shirkah (partnership), every individual is deemed to have
his own independent ownership in the business. Depending upon the
amount of capital invested by the partner, proportionately he will be
an owner of the business as well as all of its assets and liabilities.
The assembly of partners in this type of business is known as the
partnership. However, in a company, the collection of these
individuals is established as one “juristic person.” This juristic
person is then referred to as the company.[1]
This company performs all the functions of the business as a separate
legal entity and not as an agent for the partners of the company. It
bears its own rights and responsibilities and accepts and bestows
ownership in its own individual capacity as opposed to playing the
role of a Wakeel (agent). A more detailed explanation of a
juristic person is forthcoming.
The Difference between a Partnership and a Company:
1.
Every individual in a partnership is an owner of the assets and
liabilities of a business in an undivided[2]
manner. Each partner acts as an agent for the other partners. Every
partner shares the same degree of liability in that if one partner
incurs a debt on behalf of the business, all the partners will be
equally liable for it. On the contrary, a company does not function in
this manner. A company is a
“juristic person” and in the eyes of the law, it has its own
independent existence apart from the existence of the shareholders.
The esteemed Ulama who deem shares permissible are of the view
that shareholders own the assets of the company. Because of this
ownership, in the event of dissolution of the company whereby some
residual assets remain, they will share in the assets proportionate to
their investment. However, before the dissolution of the company,
shareholders are by law not able to transact in the assets of the
company. It is for this reason that an indebted shareholder’s personal
assets, including his shares in the company, can be seized to pay off
his debts; however, the company’s assets proportionate to his share
allocation cannot be seized. The laws of the company do not allow
outside transaction in any of its assets. Other Ulama disagree
with this supposition of shares as will be discussed further.
2.
If an indictment is laid by or against any of the partners of the
business, all of the partners will collectively assume the role of the
plaintiff or defendant. On the contrary, a company is an independent
“juristic person” hence; it will in its individual right become the
plaintiff or defendant in a court of law and not the shareholders.
3.
Outside of the partnership, there is no independent existence contrary
to a company which is considered an independent “juristic person.”
4.
If any partner wishes to annul his partnership and reclaim his
capital, he may do so. In a company, a shareholder will not be able to
recover his investment. He can only sell his shares as an alternative.
5.
In a partnership, the liability is generally not limited to its assets
contrary to a company. The partners in their personal capacities and
properties can be sought to fulfill unpaid debts.
Initiation of a Company:
The first step in initiating a company or incorporating an existing
business is obtaining approval for the proposed name of the company.
The second step involves drawing up a Memorandum of Association. This
Memorandum includes the name of the company, the classification of the
company, its
authorized
share capital, and the subscribers (original shareholders
of the company). The next step is drawing up the Articles of
Association. These are the regulations and principles that govern the
relationship between the shareholders and directors of the company.
The Articles of Association coupled with the
Memorandum of
Association makes up the constitution of a company. Once
the legal requirements are met for incorporation, the relevant fees
paid and the corresponding paperwork submitted, permission must be
granted from the government in order for the company to come into
existence as a separate legal entity commonly referred to as a
“juristic person.”
Once the company comes into existence, it will be necessary for it to
issue a prospectus before it can solicit funds through the sale of
shares to the public. In this manner the public will be informed
regarding the inner workings, business and finances of the company in
order to assess whether they deem it profitable to invest in it.
Shares of the Company:
Once a specific amount of capital is paid to the company, the company
issues the investor a Certificate stating that the individual has a
certain vested portion of funds in the company. This Certificate is
what is referred to as a “share.”[4]
According to some, the share represents one unit of the equally
divided capital of a company. For example, if a company maintains $10
million of capital and they issue 10 million shares, the value of each
share will be valued at one dollar. There is a difference of opinion
among the Ulama in regards to what a share actually represents.
Does it represent an actual percentage of ownership of the company and
its assets or does it merely represent a percentage of rights to claim
proportionate dividends (profit) without ownership? This issue plays a
pivotal role in the permissibility or impermissibility of shares. This
topic will be discussed in great detail in the subsequent chapters,
insha-Allah.
An Illustration of the Workings of a Company:
The company is technically a “juristic person” which enjoys the legal
rights and responsibilities of transacting given to natural persons.
However, considering the fact that it is not a natural person that can
act and think for itself, a group of shareholders will be designated
as a Board of Directors to represent its interests. The Board is
generally elected by the shareholders of the company. The Board of
Directors will then elect one person as its head known as the Chief
Executive. Once a year, all the shareholders will conduct a meeting to
discuss the various affairs and policies of the company.
Assets:
1.
Current Assets: These are such assets that are either current cash or
easily turned into cash. These are of four types:
a.
Cash
b.
Accounts Receivable
c.
Notes Receivable
d.
Investments
2.
Fixed Assets: These are such assets that are not easily turned into
cash such as property and equipment etc.
3.
Non Tangible Assets: These are such non-monetary assets that cannot be
perceived by the senses that develop over time with effort. Some types
of intangibles are trade secrets, copyrights, patents, the company’s
brand name and goodwill. Despite the fact that these assets are not
physical in nature where by some physical value can be attached to
them, they can have great value to a company and to its profits.
Liabilities:
Current Liabilities: debts or obligations of a company due within one
year. Essentially, these are bills that are due to creditors within a
relatively short period of time.
Long Term Liabilities: liabilities of a company for leases, loans,
bonds and other items not due within one year.
Distribution of Earnings:
Once a year, the company will account for its losses, earnings, assets
and liabilities. If the company yielded earnings higher than its
liabilities, it will distribute the earnings known as “profit”. First,
a specific percent of the earnings will be allocated to its Reserve.
This is a precautionary measure for future unknown expenses and
liabilities. After allocating this reserve amount, the remainder of
the earnings will be termed as “dividends” which are distributed to
the shareholders. The earning of the company as a whole is termed
“profit” whereas the earnings of the shareholders are termed
“dividends.”
Limited Companies:
Limited Liability refers to the company bearing a limited or
restricted liability to its creditors. The company will only be
legally responsible to pay off any debts or liabilities to the amount
of its assets. Additionally, the shareholders of the company are
limited in liability to the extent of their investment. Neither the
company nor its shareholders will be responsible to pay creditors
above and beyond these limitations. If the company suffers any loss,
the most that the shareholder will lose is his capital investment. If
the company incurs a debt, the shareholders cannot be sought to
fulfill that debt. In the event of bankruptcy, only the assets of the
company can be seized and it cannot be sought for anything beyond
that. For this same reason, it is binding upon such companies to affix
words like “Limited Company” etc to their company name. In this
manner, the creditor can be aware that in the event of a debt, there
is a restricted level of liability.
CHAPTER TWO
POINTS OF CONTENTION
We accede to the fact that a company cannot be deemed impermissible
simply because it doesn’t fall under one of these five types of
partnerships. However, by looking at the individual rudiments of each
type of partnership, general all-encompassing principles and
preconditions can be extracted for all partnerships. If the company
adheres to these principles then such a company will be permissible,
otherwise not. One such principle derived by the Fuqaha is that
profits from a Shirkah are derived from one of three avenues;
ownership of the assets, work provided upon the assets as a Mudarib
or by bearing liability of the assets despite not being the owner.
[5]
والأصل أن الربح إنما يستحق عندنا إما بالمال وإما بالعمل وإما بالضمان ،
أما ثبوت الاستحقاق بالمال فظاهر ؛ لأن الربح نماء رأس المال فيكون
لمالكه ، ولهذا استحق رب المال الربح في المضاربة وأما بالعمل ، فإن
المضارب يستحق الربح بعمله فكذا الشريك . وأما بالضمان فإن المال إذا صار
مضمونا على المضارب يستحق جميع الربح ، ويكون ذلك بمقابلة الضمان خراجا
بضمان بقول النبي عليه الصلاة والسلام الخراج بالضمان (بدائع
الصنائع5:82)
"We already know that the law regards a human being as a legal subject
the natural person. But the law also provides for the recognition of
entities, called juristic persons, which may take the form of a
company or close corporation in the commercial world. (An "entity" can
be described as something that exists independently, that is, apart
from the members of which it consists. Note that a partnership is not
a juristic person, because it does not exist as an entity apart from
its members.) It is important for you to realize that a juristic
person is not a human being. The only similarity between a natural
person (human being) and a juristic person is that a juristic person
also has legal capacity and is therefore the bearer of rights and
duties. Furthermore, you must remember that it is not the human beings
within, for example, a company, who are the juristic persons; it is
the company itself that is the juristic person. The company, a
juristic person, exists as an independent entity. It has an identity
that is separate from its shareholders or members and it owns the
assets and incurs the obligations of the undertaking (the company).
If the undertaking (the company) becomes insolvent, only the assets or
property of the undertaking will be seized, and not the assets of any
shareholder or member, because the undertaking is a separate entity.”[6]
As previously mentioned, Limited Liability is a concept that limits
the amount of accountability for which a shareholder is accountable.
The shareholder cannot be held legally responsible above and beyond
his capital investment. A brief history of limited liability shows
that in and around the middle of the 19th century, various
laws such as the Limited Liability Act of 1855 were enacted legalizing
the concept in numerous western countries. This edict was enacted as a
means of spurring economic growth in certain limited sectors.
Originally, this concept was considered nefarious due to the
inequitable imbalance of risk to gain. In fact, in countries such as
England, a company needed a decree from Parliament before being
registered as a Limited Liability Company. By limiting the
shareholder’s legal responsibility and risk of losing his personal
assets, the shareholder will invest more of his capital. More access
to this capital will increase the productivity and profitability of
the company. Furthermore, the directors and founders of the company,
being practically untouchable in terms of fulfilling the debts of the
creditors, will invest in more precarious, high-profit ventures
without fear of accountability. Charlie Cray states the following,
“Thus, ‘limited liability’ refers to the fact that outside “investors”
(versus active participants) can pool their capital in new ventures
without worrying that they might lose their entire worth. It allows
those with significant wealth to make capital available for research,
innovation and technical progress, without having to oversee the
management of their investment on a daily basis. Thus, the limited
liability corporation has been considered a key feature of economic
progress.”
However, this economic progress comes at a price. The question then
arises, “What is the price? And, Who bears the burden of this price?”
Jacqui Cohen alludes to the answer in her thesis entitled
Externalizing of Risk, and states, “A further
advantage of limited liability is that it allows companies to
externalize the risk involved with modern industrial enterprise and
passes the risk to the creditor.”[10]
Explaining further, Lawrence Mitchell, in Corporate
Irresponsibility presents the following, “Because it shields the
owners and managers from personal liability, limited liability creates
what economists call a moral hazard, an increase in the risk of bad
behavior because the costs of that behavior are shifted onto someone
else (creditors).” Put more blatantly he states, “defining limited
liability is simple. … no matter how much pain it causes, the
corporation is responsible for paying damages (if at all) only in the
amount of assets it has…You can’t go after the stockholders for any
more than they’ve invested. You can’t go after the managers or
employees except in limited and largely irrelevant cases. No matter
what kinds of harms the corporation causes, and no matter what kinds
of judgments a court may levy against it, it must pay only what it
has.”
Summing up the unjust disproportion of Limited Liability, Jacqui Cohen
reiterates, “Accordingly, the most a member in the company can lose is
the amount paid for the shares themselves and thus the value of
his/her investment. As such, creditors who have claims against the
company may look only to the corporate assets for the satisfaction of
their claims as creditors and generally cannot proceed against the
personal (separate) assets of the members. This has the effect of
capping the investors risk whilst, consequently, their potential for
gain is unlimited.”
The concept of Limited Liability where the risk of the investment is
placed on the credulous creditor and the potential of profit rests as
the sole privilege of the investor glaringly contrasts the ethical
economic principles laid down by the Shariah which demand
equity and justice.
Shariah,
not to mention rudimentary ethics, demand that the opportunity for
gain be coupled with the risk of liability.
عن عائشة : أن رسول الله صلى الله عليه وسلم قضى أن الخراج بالضمان
The circumstance of this judgment was that one person sold a slave to
another person who assigned the slave to work in the market and reaped
proceeds from his labor. Shortly thereafter, the purchaser discovered
defects in the slave which led him to return the slave and demand a
refund. The seller insisted that in exchange of the refund, the
purchaser should return the slave as well as the proceeds earned
through his work. The two presented their case to Rasulullah
صلى الله عليه و سلم
who decreed that the purchaser of the slave was entitled to keep the
proceeds because the proceeds were earned in a period where he was
liable for the slave. Had the slave passed away during that period,
the purchaser would have been liable for the loss thus; he was
entitled to the earnings. Decreeing in favor of the seller would have
sanctioned him receiving profit and proceeds without being liable for
any loss. That would be unfair and unethical, thus Rasulullah
صلى الله عليه و سلم
prohibited it. This concept is more clearly presented in another
Hadith wherein Rasulullah
صلى الله عليه و سلم
stated, “There is no profit without liability.”[13]
قال رسول الله صلى الله عليه وسلم
:ولا
ربح ما لم يضمن
From these Ahadith, it becomes clear that the moral philosophy
of Islamic Finance and Commerce differs from the self-centered
‘dog-eat-dog’ business policies of the modern era. The notion of
Limited Liability pierces the heart of ethical commerce as alluded to
by even non-Muslim western critics such as the following editorial of
The Times of London of 25 May 1824. It declared: “Nothing can be so
unjust as for a few persons bounding in wealth to offer a portion of
their excess for the formation of a company, to play with that excess
to lend the importance of their whole name and credit to the society
and then should the funds prove insufficient to answer all demands, to
retire into the security of their unhazard fortune, and leave the bait
to be devoured by the poor deceived fish.”[14]
Furthermore, Allah Ta’ala states,
يَا أَيُّهَا الَّذِينَ آَمَنُوا لَا تَأْكُلُوا أَمْوَالَكُمْ
بَيْنَكُمْ بِالْبَاطِلِ إِلَّا أَنْ تَكُونَ تِجَارَةً عَنْ تَرَاضٍ
مِنْكُمْ
“O you who believe, do not devour each other‘s property unjustly, save
through trade conducted with your mutual satisfaction.”(4:29)
In the case of limited liability companies, how can it be perceived
that the creditor would be content and complacent to lose his
commodities without being recompensed for them? The company and the
shareholders, protected by the law of the state, merely abdicate the
responsibility to pay their debts after enjoying the profitability and
productivity of the commodities!
أما الشرائط العامة فأنواع منها أهلية الوكالة ؛ لأن الوكالة لازمة في
الكل وهي أن يصير كل واحد منهما وكيل صاحبه في التصرف بالشراء والبيع
وتقبل الأعمال ؛ لأن كل واحد منهما أذن لصاحبه بالشراء والبيع
(بدائع الصنائع 5:77)
In conclusion, the Shariah has stipulated one particular set of
rules for a slave permitted to work and a different set of rules for
partnerships. It is not proper to analogize one to the other
especially in light of clear Ayat and Ahadith as
mentioned above.
Understanding of the Ulama who Prohibit Shares Coupled with
Juridical Corroboration:
If a person holds a share in a company, it does not imply that he owns
the assets of the company. Linguistically, one would assume that the
word ‘share’ denotes a portion or a percentage of ownership in the
assets of a company. However, this is not the case. The definition of
the word “share” has undergone many changes in history resulting in a
departure from its literal meaning to more of a figurative meaning.
The following is a passage of
The Conceptual Foundations of Modern Company Law
describing this metamorphosis of meaning:
“Throughout the eighteenth and early nineteenth centuries, the term
'share' was "used in its natural sense, namely as an appreciable part
of a whole undertaking".
To possess a share in a joint stock company implied ownership of a
share of the totality of the company's assets. "Shareholders", says D.
G. Rice, "were regarded as owners in equity of the company's
property."'
It followed that, as property, shares were directly related to and
co-extensive with the assets of the company and that their legal
nature depended on the nature of those assets. Shares could be either
real or personal estate depending on whether or not the company owned
land. When the courts had to decide whether shares (in both
incorporated and unincorporated companies) were realty and, therefore,
within the Statutes of Mortmain or Frauds, they uniformly held that
the matter turned on the nature of the company's asset.
In the early 1830s it was still consistently being held that company
shares were realty if "the corporation were seized of real estate".
Crucially, while the share was legally perceived as an equitable
interest in the company's assets, shareholders – the equitable
co-owners of those assets - were necessarily closely identified with
their companies. They could not be 'completely separate'. From the
1830s, however, the legal nature of shares began to be re-conceptualised,
and by the mid-nineteenth century the close link between shares and
the assets of companies had been severed. The crucial case,
Bligh v Brent, was decided in 1837 and concerned shares in an
incorporated waterworks company. The issue before the court was
whether the company's shares were realty and within Mortmain. In
accordance with the prevailing view, counsel argued that the nature of
the company's shares as property depended on the nature of the
company's assets. In every joint stock company, he asserted, "the
shareholder has an estate of the same nature as the company". Despite
the overwhelming weight of the authorities, the court rejected this
view. They argued that the case turned on "the nature of the interest
which each shareholder is to have", and in their view shareholders
in incorporated joint stock companies had interests only in the
profits of companies and no interest whatsoever in their assets.
The shares were personalty, irrespective of the nature of the
company's property.
Bligh v Brent was the turning point, although uncertainties
remained for some years after, particularly in relation to the nature
of shares in unincorporated companies and in companies whose business
activities were closely connected to land. By the mid 1850s, however,
these had largely disappeared. In Watson v Spratley, decided in 1854,
the court had to determine the nature of the shares of an
unincorporated mining company. It held that the matter turned on "the
essential nature and quality of a share in a joint stock company", and
declared its shares to be interests only in profits.
Henceforth, shareholders, even in unincorporated joint stock
companies, had no direct interest in the physical assets of their
companies. Shares were personalty irrespective not only of the
nature of the company's assets but also of its legal status. They were
an entirely separate form of property: legal objects in their own
right. They had been freed from their direct link to the property of
joint stock companies. By 1861 Sir John Romilly was asserting that
"shares in joint stock companies . . . are, in fact, in the nature of
property”.
Critically, as the share became property in its own right, a legal
space emerged between incorporated and unincorporated joint stock
companies -owners of the assets - and their shareholders - owners of
the shares. The recognition of the share as a new form of property was
not, however, without problems. The exact legal nature of this new
form of property eluded and continues to elude company lawyers. As L.
C. B. Gower openly admits, the question "What . . . is the exact
juridical nature of the share?" is more easily asked than answered.
Lawyers know what a share is not - a direct interest in the
company's assets - but not what it is.”
From the above passage, we come to understand that by 1861 the word
‘share’ came to denote something other than a realistic representation
of the assets of a company. However, no one as yet had placed some
definition to a ‘share’. It was only in 1901 that the latest and
current denotation of ‘share’ was defined. In Borland's Trustee v
Steel Farwell J described a share in the following terms:
“A share is the measure of a shareholder in the company measured by a
sum of money, for the purposes of liability in the first place, and of
interest in the second, but also consisting of a series of mutual
covenants entered into by all the shareholders inter se. The
contract contained in the articles is one of the original incidents of
the share. A share is not a sum of money... but is an interest
measured by a sum of money and made up of the various rights contained
in the contract.”
Ellis Faran explains this statement, “This description makes it clear
that a shareholder is an investor: he pays a sum of money in the hope
of earning of return. The shareholder's financial interest is in the
company itself and it does not amount to a direct interest in the
company's assets. These assets belong to the company which
is a separate legal person. Thus in Macaura v Northern Assurance Co
Ltd it was held that a shareholder did
not have an insurable interest in the company's property.”
Furthermore, supporting this definition of ‘shares’ another Judge in
1948, Evershed L J, passed the following ruling in
Short v Treasury Commrs
[1948]:
"Shareholders are not, in the eyes of the law, part owners of the
undertaking (company). The undertaking is something different from
the totality of the shareholdings."
To illustrate that this very denotation is still used today, the
following excerpts of a 2003 appellation in the House of Lords will
prove beneficial. Lord Millet in Opinions of the Lords of Appeal for
Judgment in the Cause - Her Majesty's Commissioners of Inland
Revenue v. Laird Group PLC stated: “The juridical nature of a
share is not easy to describe. It is not a share in the company's
undertaking, for the company owns its property beneficially and not in
trust for its members: "shareholders are not, in the eye of the law,
part owners of the undertaking" (see (Short v Treasury
Commissioners [1948] 1 KB 116, 122, CA). It is classified as a
chose in action, but this merely tells us that it is a species of
intangible personal property. It is customary to describe it as "a
bundle of rights and liabilities", and this is probably the
nearest that one can get to its character, provided that it is
appreciated that it is more than a bundle of contractual rights.” He
further describes what these rights entail by stating, “The rights of
the shareholders in a company are set out in its articles of
association. In the case of ordinary shareholders they are normally
those described by Lord Wilberforce in Joiner at p 1706-7:
"rights to received dividends, if declared, rights to vote, rights in
a liquidation to receive a share of surplus assets after discharge of
liabilities."
Moreover, as recent as 2006, the same denotation of a share was
presented in Cambridge Gas Transport Corporation v. The Official
Committee of Unsecured Creditors. Lord Hoffmann stated, “Their
Lordships consider that this argument is based upon a misunderstanding
of the nature of shares in a company. In the classic definition of
Farwell J (Borland's Trustee v Steel Brothers [1901] 1 Ch 279, 288),
‘a share is the interest of a shareholder in the company measured by a
sum of money, for the purpose of liability in the first place, and of
interest in the second’. In the case of fully paid shares, the
question of liability does not of course arise. So a share is the
measure of the shareholder’s interest in the company: a bundle of
rights against the company and the other shareholders. As against the
outside world, that bundle of rights is an item of property, a chose
in action. But as between the shareholder and the company itself, the
shareholder’s rights may be varied or extinguished by the mechanisms
provided by the articles of association or the Companies Act.”
The following is another citation clearly defining who the actual
owner of the assets is and what the shareholders possess:
"Important consequences of the fact that a company is a separate
entity existing apart from its members are the following:
(a) The company estate is assessed apart from the estates of
individual members; consequently the debts of the company are the
company s debts and not those of its members. The sequestration of the
estates of members will not lead to liquidation of the company and,
conversely, the liquidation of the company will not necessarily entail
the sequestration of estates of the members. The position is different
with a partnership which does not exist as a separate person: the
estates of the partners and that of the partnership are sequestrated
simultaneously.
(b) The profits of the company belong not to the members, but to
itself. Only after the company has declared a dividend, may the
members, in accordance with their rights, as defined in the articles
of the company, claim that dividend.
(c) The assets of the company are its exclusive property and the
members have no proportionate proprietary rights therein. Only on
liquidation of the company are members entitled to share in a division
of the assets of the company."
From the above judicial verdicts and legal texts we come to know that
a share has, in our era, come to denote a set of rights rather than
referring to partial ownership of the assets as previously understood.
These rights generally entail voting rights during the Annual General
Meeting, rights to a monetary payout referred to as a dividend in the
event of a profitable fiscal term, and rights to the residual assets
in the rare event of dissolution of the company.
The Fuqaha have codified the following principle that fits
quite aptly in the case at hand,
والحكم قد يتغير بتغير العصر والزمان (ألمحيط البرهانية 12:155)
“The
ruling will, at times, change with the changing of eras.”
As previously explained, the term ‘share’ in the previous era denoted
actual ownership in the assets of a company; therefore, in such an
era, purchasing and investing in shares would have been permissible
according to the Shariah. However, as the times changed, the
meaning of ‘share’ changed whereby a shareholder no longer purchased a
fractional percentage of the company’s assets, therefore, in such an
era, it will not be permissible according to the Shariah to
purchase shares since such a transaction does not fulfill the
Shar’i prerequisites of Shirkah (partnership). It is due to
this reason that some illustrious Ulama of the past issued
verdicts of permissibility regarding shares. However, it will not be
correct for Ulama of the modern era to issue a Fatwa of
permissibility based upon the view of the Ulama of the previous
eras.
From the above passages, this much becomes clear that in the eyes of
the legal and financial sectors, a shareholder is not deemed the owner
of the assets of a company. It is important to bear in mind that it is
the state that brings companies into their metaphysical existence.
Therefore, the state decrees how the directors and shareholders relate
to a company. If the state decrees that the shareholders do not own
assets of the company, then under the authority of the state, the
shareholder cannot own the assets. If the state decrees that the
company, in itself as a juristic entity, owns all of the assets of the
company, then under the authority of the state, only the company will
be regarded as the owner.
We are convinced that if this proper understanding of companies and
shares is presented before the Ulama, they will also issue the
verdict of impermissibility. All of the Ulama agree in regards
to two scenarios, namely, if the shareholder does not own the assets,
his profit will be Riba and if he is the owner of the assets,
then the profit will be permissible as long as the other preconditions
of trade are upheld. The main difference rests upon the perception of
who the owners of the assets are. Presenting the above-mentioned
proofs clearly shows that the shareholder does not own the assets.
Therefore, it is a natural and juristic corollary that all of the
Ulama with this understanding pass the verdict of
impermissibility.
The Fuqaha (Jurists) clearly mention that there is only one of
three ways that a person can receive a profit upon his investment:
-
Growth of his owned assets in a partnership
-
Work conducted on behalf of the partnership as the case with a
Mudarib
-
Bearing complete liability (as in the case of purchased assets on
credit) despite not being the owner
والأصل أن الربح إنما يستحق عندنا إما بالمال وإما بالعمل وإما بالضمان ،
أما ثبوت الاستحقاق بالمال فظاهر ؛ لأن الربح نماء رأس المال فيكون
لمالكه ، ولهذا استحق رب المال الربح في المضاربة وأما بالعمل ، فإن
المضارب يستحق الربح بعمله فكذا الشريك . وأما بالضمان فإن المال إذا صار
مضمونا على المضارب يستحق جميع الربح ، ويكون ذلك بمقابلة الضمان خراجا
بضمان بقول النبي عليه الصلاة والسلام الخراج بالضمان (بدائع الصنائع
5:82)
Bearing the above three pointes in mind, we come to know that the
shareholder is not entitled to receive any amount of profit upon his
purchase of shares. The shareholder neither bears complete
responsibility of the assets of the company, nor provides any service
for the company as a Mudarib, nor owns any percentage of the
assets of the company whereby the profits earned through the shares
could be termed as the growth of his personal assets. Thus,
considering the fact that a shareholder receives dividends and profits
in absence of any exchange, the surplus amount beyond his initial
investment will be considered as interest. This ruling is based on the
juristic definition of Riba, “Riba is any excess amount
free from a reciprocal substitute or exchange.”[35]
لان الربا هو الفضل الخالي عن العوض (رد المحتار 5:169)
The Corporate Veil:
The concept of a company or a corporation existing as a separate
juristic person is frequently referred to as a “Corporate Veil”. The
Corporate Veil refers to an abstract cloak masking the founders,
directors and shareholders of a company from the being held personally
responsible for any action conducted on behalf of the company,
directly or indirectly. All of the affairs of the company are deemed
self existent and attributed directly to the company itself as a
juristic person. The actions of those who run the company will not be
attributed to the individuals in their personal capacities, rather
their actions will be deemed to be the actions of the figurative
organs and limbs of the company as subordinates to the corporation.
However, there are certain rare circumstances where the state decides
to disregard the Corporate Veil and the juristic personality of a
company and regards the fraudulent activities of directors or
shareholders to be actions conducted in their personal capacities. In
such a situation, the shareholder will not be able to mask his
identity behind the Corporate Veil attempting to elude the law.
Section 424(1) of the Companies Act reads:
“Where it appears that the business of the company is being carried on
recklessly or with the intent to defraud creditors of the company, the
Court may, on application, declare that any person who was knowingly a
party to the carrying on of the business in the manner aforesaid,
shall be personally responsible, without limitation of liability for
all or any of the debts or other liabilities of the company as the
Court may direct”.
The general rule is that a company including its directors and
shareholders will be deemed as a legal entity. However, when the
concept of juristic person is misused to commit fraud, defend crime or
any other illicit activity, the law will regard the corporation or a
segment of the corporation, namely the perpetrators of such misdeeds,
as merely a coalition of persons and not as a constituent of the
company.
Jenkinson J, in Dennis Willcox Pty Ltd v Federal Commissioner of
Taxation, stated that:
“The separate legal personality of a company is to be disregarded only
if the court can see that there is, in fact or in law, a partnership
between companies in a group, or that there is a mere sham or facade
in which that company is playing a role, or that the creation or use
of the company was designed to enable a legal or fiduciary obligation
to be evaded or a fraud to be perpetrated.”
One of the most oft cited cases of piercing the Corporate Veil due to
fraudulent activity is the case of Jones v Lipman [1962]. In
this case Lipman agreed to sell land to Jones but before completion of
the contract he changed his mind and sold the land to a company which
he and another were the sole directors and shareholders. The judges
ordered specific performance (fulfilling the promised obligation)
against Lipman and the company. The company was described as a device
and a sham, “a mask which Lipman held before his face in an attempt to
avoid recognition by the eye of equity.”
The court of law will only intervene in clear cases of deception and
fraud. However, the court is very precautious in its approach striving
to maintain the fundamental principles established to protect legal
law-biding companies and its directors and shareholders.
An example of such precaution is the 2006 Supreme Court of Appeal case
of Heneways Freight Services v Klaus Grogor. Mr. Grogor was
the sole director and manager of a company that imported exotic cars.
Heneways were clearing and forwarding agents contracted by Grogor. He
applied to Heneways for credit and after being granted, he incurred a
debt of approximately R300, 000. Grogor sent a post-dated check for
the amount. However, before the date of payment arrived, he stopped
payment on the check. His company filed for bankruptcy and thus was
later liquidated. The Heneways did not receive payment and it seemed
that they were left with no recourse against Mr. Grogor’s company.
With no other alternative, Heneways sued Grogor personally for
reckless and fraudulent trading under section 424(1) of the Companies
Act. In their claim, Heneways presented evidence that Grogor had a
habit of issuing post-dated checks on behalf of the company which were
later stopped before the date of payment arrived. They claimed that
Grogor was aware of the company’s unstable financial situation when he
applied for credit. They alleged that he knew that his company would
not be able to pay its debts when they became due. They argued that
his business practices were fraudulent and/or reckless. In defense,
Grogor admitted that the company was in financial straights thus he
adopted the method of settling more pressing debts first and making
arrangements to settle the others. He presented that the company was
to be bought out by a large partner shortly after the R300, 000 debt
was incurred. He claimed that debt was to be paid from the proceeds of
that deal. He further stated that in the event that this deal did not
materialize, the company would have been able to settle its debts by
selling some of its assets to revive the company’s cash flow. The
court accepted Grogor’s explanations and held that a reasonable
businessman in his position would have acted in the same way. His
conduct was not found to be reckless or fraudulent.
The central aspect of concern here is that only such members
responsible for the reckless behavior will be held liable and not the
innocent shareholders. When the personal liability is placed upon
certain shareholders or directors, it will be placed upon the
responsible parties directly involved and not upon all the
shareholders as they were not directly involved in the fraud etc thus,
they remain free from liability. Furthermore, in a typical scenario
where no fraud or deception takes place and the company incurs debt
and thereafter files for bankruptcy, the creditor will remain
exploited with no legal recourse. The shareholders are absolved from
any personal financial accountability despite the fact that the level
of profitability is limitless. The above-mentioned Heneways Freight
Services v Klaus Grogor case is a clear example of this injustice.
Despite the fact that the secular law doesn’t consider this act as
deceitful and fraudulent, the Shariah considers it nefarious and
reprehensible. Assuming this company had shareholders, each
shareholder would be proportionately responsible for this oppression,
injustice and usurpation of wealth.
The fact that the state, at times, restrictedly disregards the
juristic person and Corporate Veil does not negate the corruptive and
iniquitous aspects of limited liability, lack of ownership of the
assets and the legal reality of the “legal entity as a whole in
respect to the general shareholders.”
An apt example in the Shariah of a similar type of exemption
from the general rule is the case of a person who gifts away a
considerable amount of his wealth whilst on his death bed. In this
scenario, the dying person is suspected of fraudulent activity by
attempting to deprive some of his heirs from their rightful
inheritance. Thus, the Shariah will restrict the transactions
of such a person looking after the best interest of the public, namely
the heirs who stand to inherit. The Shariah disregards the
intrinsic right of the living person to transact in his own property
in order to circumvent his fraud. However, it would not be proper to
state that the Shariah does not consider a person to possess
the right of disposal in his personal wealth. This case is merely an
exception to the general rule. Similarly, it cannot be said that
shareholders are personally held liable for the company’s debt or that
the juristic person is merely a legal fiction therefore; shareholders
are not participants of the usurpation of wealth and are the
legitimate owners of the company respectively. The seldom cases where
the state pierces the Corporate Veil is an exception to the general
rule and it applies in a very restricted manner to specific
individuals. It does not encompass the normal shareholders of a
company who will still be participants to the injustice of limited
liability and the sin of earning interest upon un-owned assets.
CHAPTER THREE
CONCLUDING SUBSTANTIATIONS
In this chapter, we will discuss various Fiqhi (Juristic)
substantiations for the impermissibility of shares. This chapter is
presented last and it is intended primarily for the consideration of
the Ulama as the majority of substantiations deal with juristic
principles and terminology. The layman will have difficulty in
grasping such terms and concepts; therefore, it should be noted that
this is not intended for the general masses.
We will attempt to dissect the purchase of shares as a compound
contract into its base transactions and thereafter analyze each phase
of the transaction in order to place it in its proper Shar’i
classification for the purpose of deriving an overall ruling.
Firstly, the shareholder has been likened to a partner in a Shirkah;
therefore, since a company or corporation has been likened to a
Shirkah, we will entertain this premise and delve into the various
possibilities therein. As is known to the honorable Ulama, in
order for a person to enter into an existing partnership, he / she
must purchase a certain percentage of the company assets so that he
can become an undivided partner in every portion of all the assets. A
person cannot enter into a Shirkah without this essential
phase. The same concept applies to a new Shirkah in that
Khulta (mere pooling of wealth) will not constitute the Shirkah.
The Shirkah will only convene after purchasing commodity with
that joint wealth. Thus, the very first step of becoming a partner in
the company is purchasing undivided assets from it. This demands that
a Bai’ (contract of sale) take place between the prospective
partner / shareholder and the company. In a Bai’ there must be
a seller and purchaser. In the case at hand, the seller is the company
and the purchaser is the prospective shareholder. In defining both of
the parties on either side of the transaction, there are two
possibilities;
1.
where the Shariah recognizes the concept of a juristic entity
with its own dhimmah (legal financial responsibility)
2.
where it the Shariah does not recognize the juristic entity as
such
In subsequent scenari | 