Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?
THE ORIGIN OF THE HETER ISKA LOAN STRUCTURE AS A FINANCING MECHANISM THAT AVOIDS PROHIBITED RIBIT
The conceptual framework of the Iska, including the trust fund like terms and conditions noted above, form the basis of a later expansion of the underlying principles. This found expression in a new structure known as the “Heter Iska”.
It was approximately 750 years ago when the Terumat Hadeshen[1] considered the question[2] of how to structure a transaction so that the lender can
(i) earn an interest-like return on the investment;
(ii) be virtually assured of repayment of principal; and
(iii) do so in a manner that is halachically permitted.
The solution provided the Terumat Hadeshen embodies a structure in a Heter Iska.
Under the Heter Iska format of the Trumat Hadeshen (as opposed to the original Iska structure described in the Talmud[3]) the entire amount funded can be deemed to be an investment (kulo pikadon[4]). This as opposed to being a loan in part (chatzie millvah[5]). Nevertheless, the borrower still, in effect, has the personal obligation to repay the entire principal amount of the investment (not just one-half of the principal amount, as is the case in the Talmudic Iska noted above) together with what amounts to interest (a feature not present in the Talmudic Iska). The obligation to pay the principal amount is triggered because of a failure of condition or because of a covenant breach, as more fully described below.
The Heter Iska structure was a dramatic expansion of the original Talmudic Iska structure. It enabled the lender to have the equivalent of an interest like return and loan-like protection as to the entire amount funded (not just half, as was the case in the Talmudic Iska). Its purview is also not necessarily be limited to a wholly business context.[6] Since no part of the amount funded is deemed to be a loan, there is, in effect, no prohibition against receiving or paying what amounts to interest.[7] Given the stringency of the rule against Ribit, having the entire amount funded deemed an investment (as opposed to having any part thereof deemed a loan) is certainly more comforting from the point of view of religious observance. Yet, the lender nevertheless is, in effect, afforded principal protection under the Heter Iska (as well as to the interest equivalent,) a genuine evolution from the original Talmudic Iska structure.)
The borrower’s obligation to repay principal (together with what amounts to interest) arises out of the terms and conditions of the Heter Iska format. The payment obligation is not a function of the amount funded being deemed a loan. There is no direct repayment obligation because all or any part of the amount funded is deemed a loan.
Under the Heter Iska structure, the borrower accepts the lender’s funds and undertakes certain duties and other obligations with respect thereto.[8] Thus, the Heter Iska concept described by the Terumat Hadeshen, provides that the borrower undertakes to use the money only for the specified purpose and to account, on a regular basis (usually monthly), from the time the money is first taken and until it is repaid in full with the agreed upon return (not just after a default), for any income of any kind earned by the borrower (not just the income of the particular venture). There were also security requirements that had to be satisfied, as summarized below. The security and accounting requirement are virtually impossible to satisfy.
The form Heter Iska referred to by the Terumat Hadeshen required that the regular (monthly) accounting be sworn to by both the Rabbi and the Chazan of the community.[9] These were the only two reliable witnesses per agreement of the parties under this form of the Heter Iska. Therefore, in order to defend against the lender’s claim to repayment of principal plus an agreed upon return, the Rabbi and Chazan had to swear,[10] of their own personal knowledge, that the borrower had earned no profit or income of any kind, anywhere in the world, each month. Imagine how impossible it was for the debtor to satisfy this threshold requirement. How could anyone, let alone the Rabbi and Chazan, actually be able to swear of their own personal knowledge as to the world-wide income of the debtor? How could they know that the borrower made no money at all anywhere in the world.
If the borrower could not satisfy this accounting condition as described above, then a liquidated damages formula was set forth in the Heter Iska which made the debtor personally liable to repay the principal amount plus in addition interest thereon.
The form Heter Iska similarly set forth security requirements that were virtually impossible to satisfy. Thus, for example, the form Heter Iska required that the money itself be buried safely in the ground beneath the borrower’s home.[11]
There was also a requirement of complete secrecy. The borrower undertook that no one could know about the money. A breach of the confidentiality conditions also resulted in the debtor being liable as noted above. While complying with these extreme secrecy requirements, the debtor nevertheless had also, at the same time, to comply with very public security measures that were also conditions under the form Heter Iska. The security measures expressly required that the home where the money was buried had to be guarded by three archers and a full complement of other trained security personnel (including a unit of mounted cavalry.) Other additional security measures might be specified.
Consider though the first condition mentioned above; the money itself could not be used. It could only be deposited in a safe place. Therefore, if the borrower actually used the money then it violated an essential trust fund condition and the debtor was then liable personally to repay the principal amount together with the interest like return. If the borrower sought to obtain credit based on the fact that the money was on the deposit then this too would result in personal liability. This is because the debtor would then be disclosing the existence of the deposited funds and thereby perforce violating the secrecy condition noted above. The fact is the borrower could not actually make any practical use of the money without violating one condition or another.
Violating any of the detailed conditions noted above or otherwise specified in the Heter Iska also resulted in personal liability by the debtor as noted above.
The formulation of the Terumat Hadeshen provided a useful structure that enabled funds to flow from lenders to borrowers in need of those funds. The lender was satisfied, because the borrower was, in effect, personally liable for the repayment of principal and the equivalent of an interest like return (the kind of protection associated with a loan). The borrower was satisfied because, as a result, the borrower was able to obtain funding from the lender. This was all accomplished in a context where the prohibition against paying or receiving Ribit was deemed not to be applicable.
As noted above, the conceptual basis of the Heter Iska is derived from a different line of reasoning than the classical Talmudic Iska formulation (of one-half loan). The primary source[12] for this novel Heter Iska is found in the Talmudic discussion reported in Tractate Bava Kama.[13] In that particular section, the Talmud analyzes the situation where a trustee (i.e., a borrower) is entrusted with funds by another party (i.e., a lender[14]). The terms of the trust include the instruction to use the money to purchase wheat. The case posited for discussion concerns a borrower who does not follow the lender’s instructions. Instead of purchasing wheat with the money provided by the lender, the borrower purchases barley (or vice versa). The Talmud goes on to report that there is a disagreement between Tanaim[15] as to how to resolve this matter. However, everyone agrees that if a loss ensues because the borrower does not follow the lender’s instructions, then it is the responsibility of the borrower.
Interestingly, the matter of reported disagreement in the Talmud relates to the situation where the failure to follow the lender’s instructions results in a profit; not a loss. In that case, one Tana[16] holds that profit is earned by the borrower, while the other Tana holds that it is shared 50/50 by borrower and lender (in accordance with the original Iska agreement between the parties[17]).
The Talmud goes on to report that Rav Yohanan[18] attributes this difference of opinion[19] to the argument between Rav Meir[20] and Rav Yehuda[21] to another legal debate dealing with the law of trusts. Rav Meir holds that if the trustee entrusted with goods or money makes a change (i.e., does not follow instructions), then the trustee, in effect, acquires the same (and must pay the value thereof). Therefore, the trustee is liable for any loss and by extension also benefits from any gain. Rav Yehuda disagrees and holds that the trustee is only liable for damages, if any. The dispute as to the underlying basis for imposing liability is cogent; because the case under discussion involves no actual damages and indeed the breach of trust yielded a profit; not a loss.
To better understand this debate, it must be viewed in context. The trust covenant at issue originated under a classic Talmudic Iska arrangement. The question presented is therefore whether the breach of trust by the borrower vitiates the original Iska agreement or not. Unlike Rav Meir, Rav Yehuda does not vitiate the original Iska agreement, just because the borrower breached a trust condition. Rav Yehuda was unwilling to allow the borrower to benefit from his wrongdoing. By not finding that the original Iska relationship was terminated, the terms of the original Iska continue to be in effect. Therefore, any profits are required to be split between the borrower and the lender, equally, as provided in the Iska.
Rashi’s view of the Talmudic discussion is instructive. He explains that a borrower who violates the Iska arrangement transforms it into a loan.[22] The borrower is, therefore, liable to repay the entire principal amount (not just one-half) to the lender.
Tosafot[23] has a somewhat different prospective. Tosafot reasons that if the borrower does not follow the instructions of the lender under the Iska agreement, then, in effect, the borrower is negligent.[24] The borrower (like any “Shomer” or bailee) would therefore be liable for the damages resulting from his tortuous conduct.
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[1] The name of the Halachic work of Rabbi Isserlein ben Petachia, a 15th century Halachic authority
[2] In Section 302
[3] Supra footnote.
[4] Literally, all capital.
[5] Literally, one-half loan
[6] According to many Halachic Authorities.
[7] However, there are some who refuse to permit a Heter Iska where the proceeds are expressly intended to be used solely for personal and not investment purposes. In addition, there was concern about the conditions being so onerous as to render the Heter Iska impossible to perform. See the discussion below about how the Heter Iska text was revised over time to make it well neigh impossible to perform but not actually impossible to perform.
[8] Even under the Talmudic Iska structure there was an obligation by the borrower to use the funds provided by the lender in the business venture which was the subject of the Iska. This duty is an important element in the Iska structure and if violated, the borrower is liable.
[9] The Rabbi (being the chief Halachic decisor of the community and the Chazan being the leader of prayers of the congregation. It would appear that they were chosen because they were of usually figures of absolute integrity and who likely have no knowledge of the borrower’s financial affairs. They also would be unlikely to swear an oath under any circumstances. Thus, the pre-condition to asserting a defense to payment under the Heter Iska could never be satisfied. This therefore assured that the borrower would be personally liable to repay the principal amount plus interest.
[10] Something that most pious Jews are unwilling to do, generally, in any case. This is because of the onerous prohibition against taking G-d’s name in vain set forth in Exodus 20:7.
[11] Talmud Tractate Bava Kama page 102a. Tosafot commenting on the text notes that the money must be hidden in the ground and can only lend it if receives security of gold or silver as collateral.
[13] Chapter 9, page 102.
[14] As will become clearer below, the context of the trust relationship was a Talmudic Iska.
[15] Literally, one who taught. The plural form is Tanaim. These individuals recorded in the Mishna and quoted in the Talmud were the Halachic authorities of the Mishnaic period that ended in the early 3rd century with the codification of the Mishna.
[16] Ibid
[17] The trust fund condition under discussion was embodied in an Iska relationship.
[18] An Amora of the 3rd century,
[19] As to the law of trusts noted above
[20] A Tana of the 2nd century
[21] One of the later Tanaim of the 3rd century (reportedly a contemporary of Rav who is the bridge between the Tannaic and Amoraic periods).
[22] See Rashi commentary on Talmud text cited above.
[23] Commentators on the Talmud following the era of Rashi. Tosafot is a compilation of a number of commentators from the period of the so called First Ones who lived during the period following the Geonic period that ended in approximately the Century in Babylonia through the 15th Century in Europe ending approximately during the period of the great codifier of the law, Rav Yoseph Karo and his contemporaries
[24] See Tosafot commentary on the Talmud text cited.
Leonard Grunstein 