The concept of limited liability is the foundation stone of the corporate structure. Coming to Islamic Finance/Islamic Banking, there have been various objections from the academic circles as regards the illegitimacy of limited liability in view of the Islamic injunctions.
Here it may be noted that the decisions on Islamic Banking by the Federal Shariat Court in 2022 and 1991 and the decisions of the Shariat Appellate Benches of the Supreme Court in 1999 and 2002 focus the debate largely on the element of Interest/Profit/Riba and the Islamic injunctions relating to it.
Another important concept, however, in Islamic Finance is the legitimacy of the “Limited Liability”. The limited liability concept, according to some conventional Islamic jurists, is not supported by the injunctions of Islam. In other words, the conventional jurists hold that a physical person should always be there to bear the risks and rewards of any monetary transaction. An artificial person with no animate existence created for the purpose of investing money is just a tool of interest/Riba. In other words, such a scenario will result in money creating money which is unwarranted in Islam.
Limited liability concept, therefore, encourages the investment potential of the society as the finances flow from the common men towards the documented corporate sector for safe returns without any future risks of the liabilities. The liability of the shareholders/subscribers remains limited to the extent of the paid-up value of the securities purchased. In other words, the property and person of the investor of the securities is not concerned with the performance of the corporate entity.
There should be a constructive dialogue on such complex issues (between the financial institutions, Islamic jurists, central banks and judiciary) so that further progress in the field of Islamic banking and finance can be achieved
It is interesting to note that in Islamic Financial History there are certain concepts which, although not in toto, but to a larger extent are a replica of Limited Liability Concept.
The first type of such concept is where the state establishes Bait ul Maal, that is, a collective fund which is used for the welfare of the needy citizens of the state. Bait ul Maal in accounting terms is a public asset. Such a fund in Islamic society is a juridical person with the powers to sell, purchase, sue, be sued, sign the binding documents through official stamp or seal, and so on. In every aspect, such a fund is an independent entity and the contributors to such a fund are not liable personally in case such a fund is declared a defaulter.
The second type is a Waqf/Trust. In Islamic jurisprudence, the property which is given in waqf is out of the control of the giver/original owner/donor. When the donor gives a property as waqf, the person(s) who are made managers/trustees of the property to manage its affairs and use the benefit/usufruct of the property are mere custodians of such property. The trustees or beneficiaries cannot be qualified as owners. Accordingly, the waqf property is a separate juristic person with distinct characteristics. In general parlance, waqf is created for religious/ charitable purposes. For example, if a religious institution is created as a waqf, such an institution can open bank accounts, undertake monetary transactions and so on.
Third such type is of zakat-able assets which are jointly owned by a partnership. In such a case, such assets are owned by two or more partners jointly. If each partner calculates the proportionate value of each such asset, then it might be possible that a single partner may not qualify as a sahib e nisab person because of the proportionate value of the asset base. But here the doctrine of severability comes into play whereby the joint zakat-able assets are collectively qualified as a separate entity and that is itself tested for zakat liability. The individual proportionate shares in such assets are disregarded for the fact that the assets are jointly used in furtherance of business and they are not severable.
There are various other examples in Islamic jurisprudence which in their crude forms are reflective of the limited liability concept. If the Islamic jurists endorse the limited liability concept in Islamic banking and finance then a great accommodative window may emerge to consider the legitimacy of Islamic banking.
As discussed in the initial paragraph, the Islamic Banking literature approves the concept of limited liability. Because when the liability becomes limited, it justifies the Islamic banks as competent juristic persons with responsibility for risks and rewards of investment transactions. The allegation of chance money or wagering can therefore be not attached to the financial transactions undertaken by Islamic banks or financial institutions.
The upshot of the above discussion therefore suggests a constructive dialogue on such complex issues (between the financial institutions, Islamic jurists, central banks and judiciary) so that further progress in the field of Islamic banking and finance can be achieved.
