Partnership and Mudarabah Contract Saudi Arabia: Terms, Profits, and Documentation

What Is a Partnership and Mudarabah Contract Saudi Arabia?

The Saudi Civil Transactions Law regulates participation contracts in a separate chapter beginning with Article 528 and addresses both civil partnership agreements and Mudarabah contracts.

Article 529 defines a partnership contract as an agreement under which two or more partners contribute money, work, or both to a project for the purpose of sharing the resulting profits or losses. The provisions of this chapter do not apply to companies governed by specific statutory provisions.

Article 550 defines Mudarabah as a contract under which the capital provider delivers funds to another person who undertakes the investment work in return for a common share of the profit. The party who provides the capital is known as the capital provider, while the party who manages the investment is the Mudarib.

A Mudarabah may suit a project funded by an investor and managed by a person with relevant expertise. A partnership arrangement may instead suit a project in which the parties contribute money, work, or both, depending on the correct legal characterization of the agreement.

For a review of the Sharia and legal implications of these arrangements, Al-Shatiri & Al-Ghamdi Law Firm provides Sharia advisory services for financial transactions, including the drafting of Partnership and Mudarabah agreements and the allocation of related obligations.

What Is the Difference Between Partnership and Mudarabah?

The main difference between Partnership and Mudarabah Contract Saudi Arabia concerns who contributes the capital and work and how losses are allocated. Under a civil partnership agreement, partners may contribute money, work, or both. A Mudarabah, however, is based on one party providing the capital while the other performs the work.

This comparison reflects the general rules governing the two contract types under the Civil Transactions Law. It does not replace the special provisions applicable to companies incorporated and registered under the Companies Law. Financing partnerships offered by financial institutions may also differ depending on the financing product, its agreement, and the regulatory requirements applicable to it.

Requirements for Partnership and Mudarabah Agreements Under Saudi Law

Article 528 of the Civil Transactions Law requires the participation contracts regulated in Chapter Four to be in writing; otherwise, they are void, subject to the specific consequences of invalidity stated in the Article. The writing requirement also applies to amendments made to those agreements.

In addition to the writing requirement, the following matters should be addressed depending on the type of agreement:

• Identification of the parties: State the identity, legal capacity, and authority of each contracting party.
• Capital: Specify the amount, form of contribution, method of contribution, and proper valuation of any non-cash contributions.
• Lawful business activity: The activity must be lawful and must satisfy any licensing requirements applicable to the business.
• Profit entitlement: Specify the agreed profit ratios or valid method of distribution and avoid allocating a fixed amount of profit to one party.
• Management responsibility: Define who manages the funds, the extent of management authority, and any agreed restrictions.
• Termination of the relationship: State the duration, accounting mechanism, return of funds, and settlement of liabilities when the agreement ends.

Article 535 provides that it is invalid to allocate a fixed amount of profit to one partner under a civil partnership agreement. Article 559 similarly prohibits allocating a fixed amount of profit to either party in a Mudarabah. This is distinct from an agreed fixed fee for specific work where Article 559 permits such remuneration in a Mudarabah subject to its conditions.

How Are Profits and Losses Distributed Between the Parties?

The method for distributing profits and losses depends on the type of agreement. It should not be assumed that a person entitled to half of the profits must always bear half of the losses.

Profit and Loss Distribution in a Civil Partnership Agreement

Article 534 of the Civil Transactions Law provides that profits are distributed in proportion to each partner’s share unless the partners agree otherwise, while losses are allocated in proportion to each partner’s contribution to the partnership.

Illustrative example: Two partners contribute SAR 200,000 to a project. The first contributes SAR 120,000, representing 60%, while the second contributes SAR 80,000, representing 40%. They agree to share profits equally.

If the distributable profit is SAR 40,000, each partner receives SAR 20,000 under their agreement. If the capital instead suffers a loss of SAR 20,000, the loss is allocated according to the partners’ capital shares: the first bears SAR 12,000 and the second SAR 8,000.

This example illustrates the general rule governing a civil partnership contract and is not intended to determine the treatment of every case involving a registered company subject to the Companies Law.

Profit and Loss Distribution in a Mudarabah Agreement

Article 558 provides that each party’s share of profit is determined by agreement. Article 559 permits the parties to agree on valid methods under which their respective shares may vary according to the profit actually achieved.

Article 557 provides that the capital provider alone bears any reduction in capital, and any condition providing otherwise is invalid. The Mudarib does not guarantee a loss that occurs without misconduct or negligence, but must compensate for a loss where it is established that the loss resulted from the Mudarib’s misconduct or negligence.

Illustrative example: An investor provides SAR 100,000 to a Mudarib to manage a commercial activity. They agree to distribute profits 60% to the capital provider and 40% to the Mudarib.

If the distributable profit is SAR 30,000, the capital provider receives SAR 18,000 and the Mudarib receives SAR 12,000. If the capital decreases by SAR 15,000 due to an ordinary commercial loss without misconduct or negligence, the capital provider bears that reduction and the Mudarib is not required to compensate for it.

7 Essential Clauses for an Agreement Combining Capital and Work

Before signing a partnership agreement involving both capital and work, the document should explain how funds will be transferred, who has decision-making authority, and what happens when profits or losses arise. The following seven clauses help structure the relationship and should be adapted to the specific agreement:

1. Parties and project purpose: Identify the parties, their legal capacities, the activity for which the funds will be used, and the scope of the project.
2. Capital and contributions: Specify each party’s contribution, method and date of delivery, and the value of any in-kind contribution, supported by appropriate documentation.
3. Management and authority: State who manages the business, expenditure and contracting limits, and which transactions require the other party’s consent.
4. Profits and losses: Specify profit-sharing ratios, calculation methods, and payment dates, while distinguishing between the loss rules applicable to a civil partnership and those applicable to a Mudarabah.
5. Accounts and oversight: Define how invoices, supporting documents, and financial reports will be maintained and the parties’ rights to review business results.
6. Duration, withdrawal, and liquidation: Specify the term of the agreement, termination events, asset valuation method, settlement of liabilities, and return of funds.
7. Dispute resolution and documentation: Regulate notices, conciliation, and the competent authority in case of dispute, and identify any documentation or registration procedure required.

Management restrictions are particularly important in a Mudarabah. Article 555 requires the Mudarib to comply with restrictions relating to time, place, type of activity, and other matters where they are expressly stated in the agreement. Where the Mudarabah is unrestricted, the Mudarib may act according to customary commercial practice.

Article 556 also provides that the Mudarib may not mix the Mudarabah capital with personal funds or transfer it to another person under another Mudarabah except in circumstances permitted by the Article, including where this is customary or the capital provider has authorized the Mudarib to act as considered appropriate.

How Is a Partnership and Mudarabah Agreement Documented in Saudi Arabia?

Documentation begins with preparing a written agreement containing the essential terms and then determining whether the relationship is an independent civil agreement or requires the establishment of a company under the Saudi Companies Law.

The writing requirement in Article 528 does not mean that every written agreement becomes a registered company, nor does a signature alone make the agreement an official instrument.

First: Prepare the Partnership or Mudarabah Agreement

Agree on the capital, work, profit and loss allocation, and management authority, then record those provisions in writing. The delivery of capital, transfers, and attachments showing the value of contributions or assets should also be properly documented.

Second: Determine the Appropriate Legal Form of the Activity

If the parties intend to establish a commercial company, they must select one of the company forms permitted by the Companies Law and complete the procedures for the Articles of Incorporation or Bylaws and the required statutory registration.

The Ministry of Commerce provides an electronic service for incorporating a limited liability company through the Saudi Business Center. The incorporation process includes information concerning the partners, management, Articles of Incorporation, and Commercial Registration.

A private civil agreement, however, requires an assessment of the nature of the activity, the parties’ capacity, and any applicable regulatory requirements. It should not automatically be treated as a limited liability company.

Third: Select the Appropriate Documentation Method

You may review the firm’s licensed notary documentation service for information about available procedures for instruments, declarations, company incorporation documents, and amendments, subject to confirming that the notary has jurisdiction over the particular transaction.

Documenting company incorporation documents differs from proving a private investment agreement or financial declaration relating to a partnership. The appropriate procedure should therefore be selected according to the nature of the document, and it should not be assumed that every Mudarabah agreement is documented in the same manner.

Fourth: Retain the Agreement and Performance Documents

After signing or documentation, retain a copy of the agreement, its attachments, evidence of transfers, records showing delivery of assets, and any subsequent amendments. Amendments to participation contracts governed by Article 528 must also be in writing under the specific rule applicable to amendments.

What Are the Rights and Obligations of the Capital Provider and the Mudarib?

Under Article 552 of the Civil Transactions Law, the capital provider must deliver the Mudarabah capital and enable the Mudarib to manage and dispose of it. A promise to provide financing is not sufficient without identifying how and when the capital is to be delivered and how delivery will be evidenced.

Once the capital has been delivered, the Mudarib is authorized to manage and dispose of the funds subject to the agreement and applicable law. The Mudarib’s obligations include:

• Operating within the agreed business activity and contractual restrictions.
• Protecting the Mudarabah capital and exercising the legally required degree of care.
• Not using the capital for personal purposes or exceeding granted authority.
• Providing information and accounts according to the agreement and Article 554.
• Not mixing the Mudarabah capital with personal funds or transferring it under another Mudarabah except where permitted.
• Settling the business and returning the amounts due to the capital provider when the Mudarabah ends.

Article 554 requires the Mudarib to provide information concerning the Mudarabah activities and an account of them at the end of the term. If the agreement is for an indefinite period, the information must be provided at the end of each year unless otherwise agreed.

For this reason, it is useful to specify the frequency of financial reports, the documents the capital provider may request, and the procedure for reviewing income and expenses.

When Do Profits Become Payable Under a Mudarabah Agreement?

Article 560 of the Civil Transactions Law provides that each party’s share of profit becomes due when the Mudarabah ends unless the parties have agreed to value the Mudarabah and determine each party’s entitlement at specified intervals while the business continues.

The Law also regulates amounts distributed as profits while the Mudarabah remains ongoing, and a party may not take a profit share before it becomes due without the consent of the other party.

In practice, the agreement should explain how accounts are prepared and distributable profits are determined, taking into account the capital, prior losses, and expenses connected with the business. Revenue entering the project should also be distinguished from profit that has actually become distributable.

Can the Capital Provider Require a Guarantee of the Capital?

The general rule in a Mudarabah is that the capital provider bears any reduction in capital arising from ordinary business loss without misconduct or negligence by the Mudarib. This is expressly provided by Article 557 of the Civil Transactions Law.

If the Mudarib uses the funds contrary to agreed restrictions, exceeds granted authority, or fails to exercise the required care, the Mudarib’s liability for resulting losses and damage must be assessed under Article 557.

The mere fact that the project failed to achieve the expected profit is not sufficient to establish liability. Proving an ordinary commercial loss is different from proving misconduct or negligence. Financial accounts, correspondence, and expenditure records therefore play an important role in determining the cause of the loss if a dispute arises.

How Does a Mudarabah End and Can Either Party Withdraw?

Articles 561–565 of the Civil Transactions Law regulate termination of Mudarabah and its consequences.

Under Article 561, a fixed-term Mudarabah ends when its term expires or when the work for which the Mudarabah was created is completed.

Article 562 distinguishes between fixed-term and indefinite-term Mudarabah agreements:

• Indefinite-term Mudarabah: either party may withdraw after giving the other party reasonable notice, provided the withdrawal is not fraudulent and does not occur at an inappropriate time.
• Fixed-term Mudarabah: a party may not withdraw before the term expires, although the court may be asked to permit withdrawal for acceptable reasons, subject to the compensation rules stated in the Article.

When the agreement ends, Article 563 requires the Mudarib to complete any work already commenced to the extent necessary to prevent the capital or profits from being exposed to loss or deterioration. Article 564 also regulates the Mudarib’s obligation to return the capital provider’s share of the Mudarabah property and the consequences of unjustified delay.

Article 565 addresses termination resulting from the death of a contracting party, legal incapacity, insolvency, or commencement of liquidation proceedings, and includes special provisions intended to protect the capital where the Mudarib dies.

Different termination and withdrawal rules apply to civil partnerships under Articles 544–549. If the dispute concerns a registered company, the Companies Law and the company’s Articles of Incorporation should also be reviewed before deciding on withdrawal or liquidation.

What Should You Do If a Dispute Arises Between the Parties?

A dispute may arise because accounts have not been provided, a manager has acted outside granted authority, the parties disagree over profit or loss amounts, or one party wishes to end the relationship.

Before commencing court proceedings, the following practical steps may be considered:

1. Review the agreement and all amendments and attachments.
2. Collect documents relating to the capital, accounts, invoices, and transfers.
3. Identify the alleged breach or claim precisely.
4. Request an account statement or written clarification from the other party.
5. Consider settlement and conciliation where appropriate to the nature of the dispute.
6. Review any arbitration clause and identify the competent judicial authority before filing a claim.

You may also refer to our guide on shareholder and partner disputes in Saudi Arabia and how they are resolved where the disagreement concerns company management, profits, or valuation of interests upon exit.

Not every commercial loss constitutes wrongdoing by the manager or Mudarib. Determining liability requires an assessment of the agreement, supporting documents, the cause of the loss, and the statutory provisions applicable to the case.

Common Mistakes When Drafting

Partnership and Mudarabah Agreements

Common drafting mistakes that should be avoided include:

• Relying on an oral understanding without a written agreement.
• Allocating a fixed amount of profit to one party without considering the applicable legal rules.
• Failing to distinguish between the capital contribution and the profit-sharing ratio.
• Making the Mudarib responsible for ordinary commercial losses without establishing grounds for liability.
• Failing to define management authority and limits on dealing with the funds.
• Neglecting the accounting mechanism and documentation of expenses.
• Using a general template without adapting it to the actual business activity.
• Treating a civil partnership agreement as a substitute for formally establishing a company where the activity requires incorporation.
• Failing to address withdrawal, liquidation, and return of funds.

Frequently Asked Questions About Partnership and Mudarabah Contract Saudi Arabia

Determining the correct form of a Partnership and Mudarabah Contract Saudi Arabia requires identifying who provides the capital, who performs the work, how the parties share profits, and who bears losses. The agreement must be in writing and should clearly regulate management authority, accounting, reporting, termination, and return of funds.

The parties must then complete the appropriate documentation process or company incorporation procedures depending on the nature of the business activity. Before signing a new agreement or amending an existing arrangement, contact us to review the provisions and identify the applicable legal requirements.

Sources:

• Civil Transactions Law, Articles 528–565 – Umm Al-Qura.
• Civil Transactions Law – Ministry of Justice Legal Portal.
• Saudi Companies Law – Ministry of Commerce.
• Limited Liability Company Incorporation Service – Ministry of Commerce.
• Partnership and Mudarabah definitions – Saudi Central Bank Rulebook.