The Islamic, non-interest financial system includes a special and vital aspect known as a Modaraba company corporation. It is a monetary arrangement whereby one party, the investor (Rab-ul-Mal), gives cash to another party, the manager (Mudarib), who runs a business enterprise (Modaraba) utilising their expertise and labour. Under the Ordinance, a Modaraba is a commercial arrangement in which one person contributes funds while the other offers skill, labour, or both.

Whatever name they go under, Unit Trusts and Mutual Funds are covered by this definition. From Islamic history, when Hazrat Khadijah (RA) gave funds to the Holy Prophet Muhammad (Sal-Allahu Alaihe Waalahi Wassalam) for business, Modaraba is a well-known example. Under a Modaraba arrangement, earnings and losses are distributed between the manager and the investor based on an agreed ratio.

As part of attempts to transition toward an Islamized economy and encourage Shariah-compliant financial behaviours, Pakistan introduced the notion of Modaraba in 1980.

Explore Different Types of Modaraba Companies in Pakistan

Section 7 of the Ordinance, 1980, explains the different kinds of Modaraba Companies:

Restricted Modaraba: Investor-Controlled Business Investments

In a Restricted Modaraba, the investor sets specific conditions. The investor may limit the business activity or specify a particular location where the funds must be invested. The manager is bound to follow these instructions and invest strictly according to the investor’s directions.

Unrestricted Modaraba: Flexible Management for Maximum Growth

In an Unrestricted Modaraba, the investor gives full freedom to the manager to conduct any business activity they consider suitable. However, the manager cannot appoint another manager, add a partner, or mix personal funds into the Modaraba without the investor’s permission.

Under Unrestricted Modaraba, the manager can carry out all normal business activities. However, if the manager wishes to undertake any unusual or extraordinary activity that goes beyond ordinary business practices, they must first obtain clear approval from the investor.

Duration Options: Fixed vs. Indefinite Modaraba Terms

Depending on the agreement between the parties, a Modaraba company can be set up for an indefinite length or for a fixed period.

Regulations and Laws Governing Modaraba Companies in Pakistan

The following laws and regulations govern Modaraba companies in Pakistan:

• Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980
  
  
• The Modaraba Companies and Modaraba Rules, 1981
  
  
• The Companies Act, 2017
  
  
• The Religious Board
  
  
• Prudential Regulations for Modaraba
  

Step-by-Step Guide to Registering a Modaraba Company in Pakistan

Section 4 of the Ordinance calls for an application to be submitted to the Securities & Exchange Commission of Pakistan (SECP). Once the Modaraba Company is registered with SECP, a different application must be filed to start business the Modaraba’s floatation. This application must include a prospectus explaining the nature of the business, details about Modaraba Certificates, debentures, and other related matters.

The application for floatation must include a prospectus containing important details such as:

• The name and type of Modaraba;
  
  
• The total amount to be raised and its division into Modaraba Certificates of fixed value;
  
  
• The business plan, prospects, and method of profit distribution;
  
  
• The amount the Modaraba Company will invest in its own name, along with proof of its financial capacity.
  
  
• The format of the Modaraba Certificate, and
  
  
• Any other prescribed information.
  
  

All directors of the company must sign and authenticate the application, prospectus, and supporting documents.

To ensure Shariah compliance, the Religious Supervisory Board (RSB) reviews the documents. After approval from the Board, the company applies to the Controller of Capital Issues and the Stock Exchange to proceed with the floatation.

Should the Registrar, following required investigations and more information, be convinced that the candidate fits and registration advances the public good, the Registrar could authorise registration under the right circumstances.

Essential Rules and Guidelines for Operating a Modaraba

All Modarabas must register with the Registrar of Modarabas and meet specific Shariah and operational requirements.

Modaraba funds are raised by issuing Modaraba Certificates. These certificates function as non-voting shares in the Modaraba.

The minimum capital requirement for a multipurpose Modaraba is Rs. 7.5 million, while for a single-purpose Modaraba it ranges between Rs. 2.5 to 5 million.

In both cases, the Modaraba Company must contribute at least 10% of the subscribed capital initially.

The manager (Mudharib) cannot charge more than 10% of the total annual profits as remuneration, in addition to returns on its capital contribution.

Modaraba Companies may issue rights shares, stock dividends, and cash dividends.

They cannot engage in any activity prohibited under Shariah principles.

At least 75% of the Modaraba’s operations must remain within its primary line of business.

A minimum of 15% of the Modaraba’s liabilities must be invested in National Investment Trust (NIT) Units or approved public securities.

Role of State Bank of Pakistan in Modaraba Regulation

The State Bank of Pakistan does not have separate regulations specifically for Modaraba Companies. These companies fall under the category of non-banking financial institutions. The Prudential Regulations applicable to such institutions also apply to Modaraba Companies.

Each Modaraba must establish a reserve fund with the SBP equal to its paid-up capital. This fund is created through an annual contribution of at least 20% of after-tax profits from each Modaraba floated. Once the reserve equals the paid-up capital, the annual contribution may be reduced to 5% of after-tax profits. Stock dividends are treated as part of this allocation.

Before floatation, the prospectus must receive approval from the Registrar of Modarabas at SECP, after obtaining a Shariah compliance certificate from the Religious Board.

Top Reasons to Invest in a Shariah-Compliant Modaraba

• Shariah-compliant (Halal) business model
  
  
• Opportunity to invest in diversified ventures
  
  
• Certain tax advantages
  
  
• High profit distribution potential
  
  
• Access to Shariah-compliant funding and financial facilities
  

Potential Risks You Should Know Before Investing in Modaraba

• Market Risk
  
  
• Operational Risk
  
  
• Credit Risk
  
  
• Regulatory or Shariah Non-Compliance Risk

Let the experienced team at SARDAR KHAN & CO handle the legal process smoothly and in full Shariah compliance. Contact us today to schedule your consultation and get started with confidence.