The Principle of Limited

Liability
From the Shari’ah point of View

15 August, 1992
By Justice Mohammad Taqi Usman
Supreme Court of Pakistan

1
The Principle of Limited Liability

JUSTICE USMANI tackles head-on

the question of how far, and in
what way, Shari’ah-backed
Limited Liability could, and
perhaps should be introduced into
Islamic ally-run companies. 

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The Principle of Limited Liability
 Limited Liability in modern economic
and legal terminology is a condition
under which a partner or shareholder
of a business secures himself from
bearing a loss greater than the amount
he has invested in a company which is
registered as a Limited Liability
company. If the business incurs a loss,
the maximum loss a shareholder can
suffer is the whole of his original
investment, but his personal assets
3
will not be affected.
 The Principle of Limited Liability

The basic purpose of introducing

this concept was to attract the
maximum number of investors to
large-scale joint ventures, and it
has indeed proved itself to be a
vital force in the mobilization of
large amounts of capital from a
wide range of investors
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The Principle of Limited Liability

 However, at the same time, Limited Liability from

same points of view appears to be injurious to
creditors. When a company goes into liquidation,
creditors can only receive the liquidated value of
the assets of the company, and cannot insist on
shareholders making up the balance owing 10
them. Even the directors of a company cannot be
held responsible and forced to make up money lost
to creditors. It is this aspect of Limited Liability
which requires meticulous Shari’ah consideration
and research.
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The Principle of Limited Liability
 Limited Liability in the modern commercial sense is
a relatively new concept which receives no express
mention in the original sources of Islamic Fiqh.
 However, any Shari’ah ruling could be sought
through reference to principles laid down in the
Quran, in the Sunnah of the Prophet, and in Islamic
Jurisprudence. This is an exercise which would
require some sort of Ijtihad from those qualified to
carry it out, and although it should preferably be
undertaken by Shari’ah scholars at a collective
level, this should not preclude individuals from
doing their share.
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The Principle of Limited Liability

 My own research suggests that Limited Liability

is closely related to the concept of the Juridical
Personality of modern corporate bodies.
According to this latter concept a Joint-Stock
Company itself enjoys the status of a separate
entity as distinguished from the individual
entities of its shareholders. This separate entity
as a fictive person has legal standing, and thus
may sue and be sued, may make contracts, may
hold property in its name, and has the legal
character of a real person in all its transactions.
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The Principle of Limited Liability
 The main question as I see it is whether the
concept of a Juridical Person is acceptable in
Shari’ah. Because once the concept of a Juridical
Person is accepted, and it is admitted that a
Juridical Person CAN be treated as a real person in
respect of the legal consequences of transactions
made in its name, it would then be logical to accept
the concept of Limited Liability.
 The reasoning is this. If a real person dies
insolvent, his creditors have no claim except to the
assets he has left behind. If his liabilities do exceed
his assets, there is no legally enforceable remedy
for the creditors to recover their money from any
other source.
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The Principle of Limited Liability
 Now if we accept that a company in its capacity as a
Juridical Person, has the rights and obligations of a
real person, the same principle would have to apply
to an insolvent company. Every company is bound
to be liquidated after being found insolvent, and
because a company cannot exist anymore after it is
liquidated, the liquidation of a company corresponds
to the death of a person.
 I would further suggest that although this concept of
a Juridical Person is not familiar to the Islamic Fiqh,
there are certain precedents from which the basic
concept of a Juridical Person might be derived.
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Waqf

 The Waqf is a legal and religious

institution wherein a person dedicates
some of his properties to religious or
charitable purposes.
 After being declared Waqf, these
properties no longer belong to the
dedicator, and although the recipients of
a Waqf can benefit from the corpus of
such dedicated property, they are not
the owners. The ownership rests with
10 Allah alone.
 Waqf

 Two rulings of the Fiqa (Muslim jurists) are

relevant.
 First, if a property is purchased with the income
of a Waqf, the purchased property cannot
automatically become a part of the Waqf. The
property shall be treated as a property of the
Waqf, which means that the Waqf can own
property like a real person.
 Second, money donated to a mosque does not
form part of the Waqf, but becomes the
possession of the mosque.
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Waqf

 This principle is also backed up by some scholars of

the Maliki School, who maintain that this Capability
of the mosque is constructive, while the
Capabilities enjoyed by a human being is physical.
A renowned Maliki jurist, Ahmad Al Dardir, extends
this thinking to an inn and a bridge also, provided
they are Waqf.
 So although a Waqf is not a human being, it may
be treated as a human being in the matter of
ownership. It can logically therefore sell and
purchase, may become a debtor and a creditor,
and can sue and be sued, thus showing that it has
all the characteristics of a Juridical Person.
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 Baitulmal

 Another Juridical Person found in our

classical literature of Fiqh is that of
Baitulmal (the exchequer of an Islamic
State).
 Being public property, all the citizens of an
Islamic state have some beneficiary right
over the Batulamal, yet nobody claims to
be its owner. Yet as the well-known Hanafi
jurist Imam Al Sarakhsi says in his work 'AI-
Mabsuf:
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 Baitulmal

 "The Baitulmal has some rights and

obligations which may possibly be
undetermined... and if the head of an
Islamic state needs money to pay his
army's salaries, but finds no money in the
Kharaj Department of the Baitulmal (from
which these salaries are normally paid), he
can proceed to pay the salaries through
the Sadaqah (Zakah) Department.
Nevertheless, the amount so taken from
the Sadakah department shall be deemed
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to be a debt on the Kharaj Department.
 Baitulmal

 It follows from this that not only the

Baitulamal, but also the different
departments therein, can borrow and
advance loans to each other. The
liability of these loans does not lie with
the head of the state, but with the
department concerned. It means that
each department of the baitulamal has
a separate entity, and therefore in that
capacity, can be regarded as a Juridical
Person.
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 Joint Stock

 Another example very close to the

concept of a Juridical Person is that of a
Joint Stock and is found in the Fiqh of
Imam Shafi'i.
 According to a settled principle in the
Shafi'i School, if more than one person
runs their business in a common shop,
where their assets are mixed with each
other, the Zakah will not be levied on
each of them individually, but will be
16 payable on their Joint Stock as a whole.
Joint Stock

 So much so, that even if one of them is not the

owner of the Nisab, but the combined value of the
total exceeds the Nisab, the Zakah will be payable
on the Joint Stock, and the person whose share is
less than the Nisab shall also contribute to the
levy in proportion to his ownership in the total
assets. The same principle - known as Khul-
tatushshugu - is more forcefully applied to the
levy of Zakah on livestock. Consequently, a
person sometimes has to pay more Zakah than he
was liable to in his individual capacity, and
sometimes he has to pay less than that.
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 Joint Stock

 This principle also accepted to some extent by

the Maliki and Hanbali Schools, with some
variations on details, has the basic concept of a
Juridical Person underlying it. It is not the
individual who is liable to Zakah, it is the Joint-
Stock. The Joint-Stock is treated as a separate
entity, and the obligation of Zakah is directed
towards this entity, which is very close to the
concept of a Juridical Person, if not exactly the
same.

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 Joint Stock

 Looked at from this angle, this Inheritance Under

debt has its own entity, which may sell and
purchase, become debtor and creditor, and has
characteristics very similar to those of a Juridical
Person. The abilities of this Juridical Person are
certainly limited to its existing assets, for if the
assets do not suffice to settle all the debts, there
is no remedy left by which its creditors may sue
anybody for the rest of the claims.
 These examples show that the Juridical Person is
not totally foreign to Islamic Jurisprudence.

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 Limited Liability of the Master of a Slave

 In times past, when a master permitted his slave

to trade, he could enter into all commercial
transactions. But the capital invested by the
slave belonged totally to the master, and
whatever the slave earned would also go to the
master. If, in the course of trade, the slave
incurred debts, the same would be set off against
the stock present in the hand of the slave. But if
the amount of such cash and stock were not
sufficient to set off the debts, the creditors had
the right to sell the slave.
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Limited Liability of the Master of a Slave

 If their claims were not satisfied even after selling

the slave, and the slave died indebted, the
original master was not liable for the rest of thief
claims.
 Here, the master was actually the owner of the
whole business, the slave being merely an
intermediary toll to carry out the business
transactions. The slave owned no part of the
business. Nevertheless, the liability of the master
was limited to the capital he invested, including
the value of the slave.
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 No Cheating

 At the same time, it should be emphasized that

the concept of Limited Liability should not be
allowed to work as a device for cheating people
and escaping the natural liabilities consequent
to a profitable trade. So, in my opinion, the
concept should be restricted solely to
companies who issue shares to the general
public, and to the number whose shareholders is
so large that each one of these could not be
held responsible for the day-to-day affairs of the
business, nor for debts exceeding assets.

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 No Cheating

 As for private companies or partnerships, the

principle of Limited Liability should be applied to
these, because it is realistic to claim that each of
their shareholders could easily know the day-to-
day affairs of the business and should therefore
be held responsible for all its liabilities. There may
be an exception in the case of sleeping partners
or shareholders of a private company who do not
take any practical part in the business, whose
liability therefore might be limited by agreement
between partners. If the sleeping partners have a
Limited Liability under an agreement, this means,
in terms of Islamic Jurisprudence, that they have
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not allowed the working partners to incur debts
exceeding the value of the assets of the business.
  In this case, if the debts of the business increase
No Cheating

from the specified limit, it will be the sole

responsibility of the working partners who have
exceeded that limit.
 I would therefore respectfully suggest that this
concept of Limited liability can be justified from
the Shari’ah standpoint only for Joint-Stock
Companies, and those Corporate Bodies who issue
their shares to the general public, although it may
also be extended both to the sleeping partners of
a firm, and to the shareholders of a private
company who take no active part in the business
management.
 The liability of the active partners within a
24 partnership, and the active shareholders of a
private company, however, should always be