Origin of “Iska”, Theme in Talmud | IRR Part IV

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

THE ORIGIN OF THE TERM ISKA AND THE DEVELOPMENT OF THE THEME IN THE TALMUD

In dealing with the issue of how to source capital for use in a business venture without falling astray of the strictures against Ribit, the Talmud discusses using the business vehicle then commonly known as an “Iska”.[1]

The Talmud begins its analysis of the topic as follows:  “The Nehardeans[2] said this Iska.”  The discussion of an Iska relationship appears in the context of a prior analysis of a number of other types of business relationships (such as a sharecropper or lease of a field).

The Talmud digresses at this point in the text to discuss a non-real estate business relationship based on what was then commonly known as an Iska.  It notes that a key element in the Iska relationship is that one party (referred to in the Talmud as the “lender” but sometimes otherwise referred to as the “investor”) has capital or assets (i.e., money or goods).  The other party (referred to in the Talmud as the “borrower” but sometimes otherwise referred to as the “working party” or “managing member”) has sweat, talent and/or contacts and a willingness to devote the same to effectuate the purposes of the Iska.  It is the borrower who is actually to conduct the business of the venture.  The lender has no active role other than providing the money for the Iska venture.

It is important to recognize that the Iska relationship is not a partnership or joint venture.  It is just what the Talmud says it is – an Iska.  The Iska format is to be distinguished from all manner of other relationships.  It is a unique business structure.  Much like a limited liability company and limited partnership are two distinct statutory vehicles, which have certain elements in common and others that are dissimilar; so too an Iska.  Thus, an Iska relationship may be analogous in certain respects to a partnership, but it is at its very essence a lending vehicle.  It is to be distinguished in a number of important ways from a partnership,[3] as outlined below.  The Iska vehicle has its own set of rules.  The Talmud describes the structure used at the time and adapts it to the lender/borrower relationship because of its utility.

It would appear that the origin of the term “Iska” predates the Talmud.  Indeed the Talmud invokes the term as an existing business structure in use at the time.  I have researched the term to determine its origin.  In this regard, I searched various texts in a number of different languages in antiquity in an effort to fix the original use of the term.

The word Iska appears to be one in use in ancient Assyrian.  The particular usage identified below was one in cuneiform on a piece of clay.  It is described[4] as the  “ISKA-LARIM”.  The word “Larim” is said to be a proper noun; the name of an individual, Larim.  The term “Iska”, as used in that context, is defined as an agent or “one in control or possession” of some goods.  As I understand the circumstances, Larim was the manager of a caravan.  He entered into an arrangement, known as an Iska, whereby he was given goods or produce by the owner at the source location.  The purpose was to sell the goods or produce in a destination location. where the prevailing market price was more advantageous.  In this particular Iska, Larim, the manager of the caravan, was to transport the goods or produce and sell them at the destination.  The sales proceeds were to be applied first to pay for the original principal amount of the goods or produce.  The profits earned were then to be split between the caravan manager and the original provider of the goods or produce.  The clay text noted above was an accounting by Larim, the caravan manager, to his Iska compatriot.

This appears to be the Iska structure that the Talmud adapted to the lender/borrower context.  Thus whether it was money or food, the lender (capital source), in effect, loaned the same to the borrower (operator of the Iska).  The borrower was entrusted with the money or goods in the business venture to make a profit.  Upon sale of the goods (i.e., loaned to the venture or purchased with the money loaned to the venture), the profits were then divided up (after repayment of the principal amount to the lender).  Questions of liability for the principal amount at risk were handled by contract, within the context of the overall Iska business structure.

In the Talmudic Iska, the money or goods provided are characterized as one-half loan and one-half investment.  The terms used are “palga milvah” (loan) and “palga pikadon” (investment).  The difference conceptually between a loan and an investment is critical to the understanding of this business vehicle.

In general, when one individual lends another individual money or other assets, there is no right to earn interest or, better said, it violates the Biblical commandment against doing so.  Remember in the Biblical context; one individual lends to another individual a thing of intrinsic value.  Precision is required; because other constructs might not be Biblically proscribed and may not even violate rabbinical enactments, under certain circumstances, as described below.

Getting back to the Talmud’s formulation of the Iska relationship, the portion of the money that is deemed to be a loan must be repaid to the lender even if the business venture fails.  As to the investment portion, in general, there is no right of the lender to receive a return of the capital invested if the venture fails.  Any profits derived from the venture that was funded by the lender (i.e., both the loan part and the investment part) are to be shared by both the lender and the borrower, as the owners of the Iska business venture.

In the example given in the Talmud, the lender supplies merchandise to the borrower.  As Rashi points out, the lender must bear some risk of loss. This is the key to understanding the difference between a loan and an investment.  Thus, as to a loan, the borrower bears the risk of loss, if the principal (or goods purchased with the loan) are lost at sea, in a fire or by reason of other casualty.  However, in an Iska, as to the portion that is an investment, it is the lender who bears the risk of loss.  Unless the lender bears some level of risk of loss as prescribed by the Halacha, in substance, the transaction is nothing more than a loan and is subject to the prohibition against Ribit.

Rashi then notes that the borrower has certain duties with respect to the investment portion.[5]  Moreover, those duties extend even to the loan part (not just the investment part), as more fully discussed below.  This is a novel feature of the Talmudic Iska structure.

The transaction described in the Talmud, which was the underlying premise for entering into the Iska relationship, was motivated by a business opportunity.  The value of the goods in one place (where the borrower and lender entered into the Iska relationship) was less than the value in another location.  To take advantage of this arbitrage opportunity, the borrower is to travel to the agreed upon destination with the goods and sell them there.  As an aside, so as to avoid any stricture against Ribit, the borrower is to be paid appropriate compensation for the work the borrower performs as the managing member under the Iska.[6]  In this manner, the efforts expended by the borrower as the working party are not deemed to be Ribit.

The Talmud then comments that the Iska structure as adapted by the Rabbis was good for the borrower and good for the lender.  Notice the language.  The Talmud uses terms that are consistent with a loan, not terms such as “partners” or “investor and “managing member”, which are characteristic of a partnership relationship.  This is because the underlying nature of the parties to the relationship is that of a borrower and lender.  Under the Iska structure, the lender benefits because all of the money furnished to the borrower must be used to generate a profit in the venture.  In addition, the borrower is personally liable for the return of one-half the principal amount furnished.  The borrower similarly benefits because all of the funds needed by the borrower are provided by the lender and the borrower is personally liable for only half of the principal amount.  Given the risks involved in this kind of a transaction, the Talmud concludes that the Iska structure is comforting to both parties.[7]

The Talmud then continues with a discussion by Rava[8] as to the reason why the term Iska is used to describe the goods that are the object of the venture.[9]  He posits a comparison of the term “Iska” with another word, “Easuki,” which in Hebrew is spelled similarly.  The term “Easuki” means for use in business.  Hence, the use of the term Iska to describe the goods loaned (or acquired with the money loaned) for use in the business.

Rava posits[10] that the capital invested in the Iska relationship is for use in the business venture only; not for personal use.  This is another fundamental and distinguishing characteristic of the Iska.  A loan is a personal matter, both in terms of obligation and use.  The borrower does not have to use the proceeds of a loan for any particular purpose.  This is so even if the loan was taken for the sole purpose of using the proceeds in a business to generate profits.  Thus, as the Talmud notes,[11] although the borrower can even drink beer with the proceeds of the loan, generally, (despite the fact that it was characterized as a business loan and not a personal one; or, give the loan proceeds to the borrower’s children as an inheritance), this is not the case with a Iska, where all the proceeds (including the one-half loan portion) must be used in the Iska venture for the intended purpose of generating a profit.

This is not the case with an Iska type loan, as noted above.  Thus, the Talmud rules that the Iska structure mandates use of the entire principal amount (both the investment and the loan portions) furnished in the business venture for the intended business purposes (and for no other purposes).  This in order to fulfill the businesses purposes of the venture (i.e., to earn a profit).

Rashi[12] points out the motivation behind this important and essential condition of the Iska.  He finds that the borrower seeking to profit on his share will therefore earn a profit on the entirety of the principal amount funded by the lender (i.e., both the loan portion and the investment portion).

In line with the foregoing, Rava holds unlike an ordinary loan, which is collectible only as against the real property of the debtor’s estate, in the case of an Iska, the lender can also collect against the merchandise (i.e., personal property) in the Iska relationship.  Moreover, if the debtor were alive at the time, the debtor’s obligation in an Iska relationship may be enforced against all of the debtor’s property, both moveable and real property.

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[1] Tractate Bava Metzia- Chapter 9 ( Hamekabel) on page 104b.

[2] Talmudic scholars from the Town of Nehardea  (i.e. in the area of Bavel) outside of the Land of Israel.

[3] The reference to other comparable structures is as a convenience only, so as to better understand the unique nature of the vehicle.

[4] In the Proceeding of XLV Recontre Assyriologique Internationale (books.google.com)by Tzvi Abusch, Carol Noyes and William Halo (2001) at page 171.

[5] This concept was further developed in the Heter Iska structure  and the effect was to shift all of the risk of loss to the borrower as a practical matter.

[6] Talmud Tractate Bava Metzia at page 68b, where it states that any amount agreed to whether much or little is sufficient. It should be noted however, that Rav Shimon ben Yochai dissents and requires that the full measure of appropriate wages must be paid.

[7] The Talmudic passage cited notes the Iska is beneficial to both parties as noted above.

[8] One of the preeminent Amoras (i.e. Halachic spokesman) in the Talmudic era.

[9] It is the goods themselves and not the venture that is being discussed in terms of the name Iska. Under the Assyrian definition it is the agent who is referred to as the Iska, as noted below.

[10] See in the cited portion of the Talmud noted above

[11] Talmud Tractate Bava Metzia at page 104b.

[12] The Rashi commentary on the passage of the Talmud cited above is printed on the same page of the Talmud alongside the cited text.

Theory vs Practice | IRR Part III

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

THEORY VERSUS PRACTICE – IS THERE A GENUINE PROHIBITION IN OUR TIMES?

It would appear that the extremely onerous prohibitions against interest have seemingly been circumvented in practice over the last few thousand years; virtually from the very inception of the prohibition in the Bible, by all three major Religions (Christian, Moslem and Jewish).  They all proclaim to live by the terms and conditions of the Bible.  They all derive their ethical, religious and legal systems from the very same Bible.  Yet all three have found a way to charge interest in practice, despite what appears to be an express prohibition against charging or paying interest.

Rabbi Baruch Halevi Epstein[1] (author of the seminal work on the Bible known as the Torah Temimah[2]) took up the issue in another of his commentaries on the Bible known as, the Tosafot Bracha.[3]  In commenting on the prohibition of Ribit, he noted the world of the exile was very different from that of ancient Biblical Israel.  When the Jewish people lived in the Land of Israel, they functioned within the context of an agrarian economy.  Rabbi Epstein went on to say that in his time, the only occupation available to observant Jews, as a practical matter, was in trade or money lending.  They were not landed gentry, as in days of yore.

Rabbi Epstein analyzed the economy of his day and found that a money lending or banking system[4] was a structural requirement for business and trade to function properly.  Much like the comment made by Rabbi Aaron Solevetchik[5] noted below, the modern economy couldn’t function without banks being available and loaning money.  As we all witnessed recently, a breakdown in the banking system can paralyze the economy generally.  Rabbi Epstein points out, that absent these opportunities to do business, the Jewish people would be without the means to support themselves in the exile.

This is unlike the Biblical economy.  As Rabbi Epstein pointed out, Biblical Israel was a society where owning land, devoted to growing wheat and other foodstuffs, was critical to subsistence.  In that kind of an agrarian economy, there was no real need for money.  As a nation of landowners, inheritance of land and keeping it in the family was a pre-requisite to success.  The wealth was in the land.  Rabbi Epstein points out that those with a surplus might as well loan it without interest to their brethren as a good deed.  This is because there was little else that could be done with surplus money in a subsistence economy.  Indeed, if anyone needed money it was because they were destitute.  They could hardly be expected to pay interest; they might not even be able to repay the principal.  The charging of interest in that kind of a situation is therefore “Neshech” (biting).

In our times, it is often the borrower who prefers to pay a fixed charge for money, instead of making the lender a partner.  The unlimited return potential is reserved to the borrower/entrepreneur.  The lender may want to be a partner, but the borrower is just as likely, or more likely, to insist that only interest be paid for the money, not a profit share.

Today’s world economy is about business and trade.  Money is the lifeblood of the economy.  Land may still have some value for agricultural use, but its highest and best use is usually non-agricultural.  Often, real estate is best used as part of a trade or business.  Commerce (and hence money) is the source of prosperity and in substance the only real source of income (and therefore sustenance) for the Jewish people.

Rabbi Epstein finds that the Heter Iska was the mechanism that the Rabbis enacted to permit businesses to borrow needed capital so as to enable the businesses to function.  He goes on to posit that the Bible itself implicitly provides the basis for the Heter Iska exception.  The Rabbis did not want to undermine the authority of the Bible, generally, by just excising this express prohibition.  Therefore, according to Rabbi Epstein, the Rabbis enacted a mechanism for avoiding the prohibition, as a matter of form, consistent with the philosophy underlying the religious principle of providing money to those in need.[6]

There are similar philosophical underpinnings to the Sha’ariah compliant financing mechanisms noted below.  They similarly provide a mechanism to avoid the prohibition against Riba, as a matter of form, consistent with the philosophy underlying religious principle of providing money to those in need on the most favorable terms.

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[1] A Halachic authority of the early 20^th century.

[2] A commentary on the Bible that cites to texts in the Talmud, which discuss the particular verse in the Bible.

[3] Leviticus: Chapter 25-Verse 36

[4] Rav Epstein uses the term “Ezrat Kessafim” to describe the banking or money lending function that is an integral and vital element of commerce and trade. Otherwise, as he notes, business cannot “take hold”.

[5] A 20^th century Halachic authority. He is the brother of another eminent Halachic authority, Rav Yoshe Baer Solevetchik. Both were also leading professors of Talmud at Yeshiva University.

[6] Lo Tinayl Delet,..(literally, don’t close the door on borrowers) as quoted in the Talmud Tractate Bava Metzia at page 68b. (See also Talmud Tractate Sanhedrin at page 3a.) This concept is also used as the basis for other enactments like Prosbul (a mechanism whereby the biblical requirement that debts be forgiven every 7 years is avoided) that appear, at first blush, to prejudice the borrower; but, in reality enable the borrower to obtain funding. (See Talmud Tractate Gittin at page 36b.)

Definition of “Ribit”, Discussion of Prohibition | IRR Part II

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

THE DEFINITION OF THE TERM “RIBIT” AND A DISCUSSION OF THE ORIGIN AND NATURE OF THE PROHIBITION

The Bible,[1] in Deuteronomy[2] prohibits an individual from charging or paying “Neshech”[3] to another individual.  This includes Neshech as to money, food or other things for which Neshech is [typically] taken.

Another similar prohibition is set forth in Exodus.[4]  It provides that when an individual loans money to another then Neshech should not be imposed.

In Leviticus,[5] another term is introduced besides Neshech.  Thus, when helping someone who has suffered diminished circumstances, there is a prohibition against charging Neshech or “Tarbit”.[6]  The Bible[7] then goes on to say that you shall not provide money on the basis of earning Neshech or provide food on the basis of earning “Marbit.[8]

What is “Neshech” and what is “Marbit” is the subject of a discussion in the Talmud[9] in the Tractate of Bava Metzia,[10] aptly entitled “Eizehu Neshech V’Eizehu Marbit” (What is Neshech and What is Marbit).  It would appear that the term Neshech is usually used in the context of earning interest income on money that is loaned.  Marbit is a synonymous concept that is usually employed when dealing with a commodities futures contract for the provision of food as opposed to money.  Nevertheless the conclusion of the Talmudic discussion is that they both have the same meaning and can be used interchangeably.[11]  The more modern term “Ribit” is derived from the root of the Biblical term “Marbit” noted above.

What is and is not prohibited interest (i.e., “Ribit”) is discussed at length in the Talmud and among later Halachic authorities.  In this regard, I note in passing a Tosefta[12] that demonstrates just how abstruse the meaning of the term can be in practice.  Thus, the Tosefta states that there are things, which are Ribit; but are nevertheless held not to be Ribit.  Examples of the principle cited are then provided in the text.  One example given is concerning a loan that is sold at a discount.  Another is about an “Shtar”[13] (likely a commodities future document but possibly a bond) sold at a discount.  Both of these transactions yield what would otherwise be “Ribit” and yet the Tosefta holds they are not Ribit.

Consider, it is prohibited to charge or pay interest; however, it would appear to be permitted to sell, at a discount, the obligation to make payment by a certain date of a fixed sum.  In effect the typical sale of T-Bills at a discount to yield an equivalent rate of return to prevailing market interest rates is permitted.  However, entering into a T-Bond with the same rate of return (albeit, stated as an interest rate instead of a synonymous yield to maturity) is prohibited.[14]

Consider also a variety of items that are Halachically held to be prohibited Ribit; but which in common usage would generally not be considered to be interest, as follows:

1.         A thank-you note or gift;

2.         A service of some kind performed by the borrower for the lender that is not separately remunerated;

3.         A favor done by the borrower for the lender in response to the kindness of making an interest free loan; or

4.         An installment purchase agreement where the deferred purchase price is higher than the all-cash price.

5.         A bond or finance lease, where the Landlord (Lender) bears no risk of loss.[15]

On the other hand, selling one’s own check at a discount[16] is not considered to be Ribit.  Furthermore, while having two different sales prices, one for an all cash purchase and one for a deferred purchase is held to be Ribit; nevertheless, under certain circumstances, a price fixed on the basis of a deferred payment arrangement can be discounted for cash.[17]  Moreover, the Talmud held that a trust for the benefit of orphans could make loans and charge interest, which is exempt from the prohibition against Ribit, under certain circumstances.[18]

Is this all mere sophistry?  For example, is there a genuine difference between the T-Bill discount and the T-Bond stated interest rate noted above?  Under US Law the answer is that, in practice, there is no real distinction between the two concepts; they are in effect the same thing.  Why then prohibit one and permit the other under the Halacha and the Sha’ariah?  Is this really a matter of form over substance? It is suggested that the answer is not that simple.  It requires further analysis to develop an approach that may help answer this fundamental question.

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[1] Tanach an acronym (”TN’K”)- meaning Torah (the Five Books of Moses), Neviim (the Prophets) and the Ketuvim (the Holy Writings) also known as the Septuagint, the original Greek translation of the Bible that the Talmud views as authoritative

[2] Chapter 23-Verse 20

[3] The term “Neshech” is often loosely translated to mean interest but the word literally means a “bite” or “biting”.

[4] Chapter 22-Verse 24

[5] Chapter 25-Verse 36

[6] The term “Tarbit” is also loosely translated to mean interest but the word literally means an “addition”.

[7] Supra 26 . See Verse 37

[8] See definition of the term “Tarbit” above. The term “Marbit” also is loosely translated to mean interest but the word literally means an “increase” or “addition” and is derived  from the same root as Tarbit. See also definition of “Ribit” below, which is derived from the same root.

[9]The Talmud referred to herein is the Bavli. It is an encyclopedic work compiled and edited in about the beginning of the 6^th century in Babylonian by Ravina and Rav Ashi, who were the leading Amoras (Halachic spokesmen) of their generation. It is organized along the lines of a prior compilation of laws known as the Mishna, which was edited by Rav Yehuda, HaNasi (literally the leader) in the beginning of the 3^rd century in the land of Israel. Both works were intended to summarize the body of oral laws and traditions that explain and codify the law and lore sourced in the Bible in detail. Subsequent enactments are also detailed. The Bavli, which was edited in Babylonia, is to be distinguished from a prior version of the Talmud, known as the Yerushalmi (or Jerusalem version), which was edited in the Land of Israel. The printed text of the Talmud Bavli used is known as the Vilna Shas.

[10] Chapter 5

[11] Ibid.

[12] The Tosefta is a body of Tannaic writings that was collected but which was not included by Rabbi Yehuda, Hanasi in the Mishna, and the authoritative work of Tannaic literature he codified at the beginning of the 3^rd century.  It is thus helpful in terms of helping to understand the Mishna (as a contemporary expression of thoughts on the same subject matter as the Mishna, but is not itself authoritative. The concepts cited are found in  Chapter 4 of the Tosefta on Bava Metzia, in Paragraph 2.

[13] A written document that is witnessed by at least two qualified and competent witnesses. It is not an agreement in the sense understood under US law. Rather, it is what amounts to presumptive evidence as noted below.

[14] See an analogous example of selling one’s own check at a discount that is also not prohibited Ribit, as reported herein.

[15] A form of lease that is based on the so-called triple net form, but, one where the Landlord, in effect,  bears no risk of loss, at all. This concept of a lease being a prohibited Ribit or Riba transaction is more fully discussed below.

[16] As described in Brit Yehuda 15-17 by Rav Blau, provided don’t violate certain conditions.

[17] After the transaction is symbolically consummated by way of a kinyan.

[18] In the Talmud, Tractate  Bava Metzia at page 70a, there is a discussion about how a trust for the benefit of orphans may be permitted to charge what is considered rabbinically proscribed interest. Similarly, a charity may also be permitted to charge such Ribit. See also Tosafot (which posits that since the lender is exempt from the prohibition against  Ribit under these circumstances then so is the borrower) and Ritva on the text cited above.

Abstract & Introduction | IRR Part I

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

ABSTRACT

The Article provides a timely analysis of the recent defaults, bankruptcies and attempts at restructuring of Sha’ariah compliant financial products, including. the spectacular bankruptcy by a Sha’ariah compliant institutional lender, which threatens to undermine the very basis for these products. It discusses the structural issues exposed by these events as well as the inherent incompatibility between existing Sha’ariah products and the requirements of the capital markets.

The success of the capital markets in the US in delivering low cost financing of homes and income producing properties is incomparable.  Among the requirements for accessing the capital markets is the need for a pristine interest payment stream that is fully secured, with a priority lien on the collateral, and which is readily enforceable. Predictability is the key. Financial products, developed under other systems of law and practice that don’t yield the expected results achievable using the model satisfying the requirements of the capital markets are problematical. They may be denied ready access to the capital markets or be priced at a premium to traditional financial products satisfying the requirements of the capital markets.

The Article traces the origin and development of the Sha’ariah prohibition against Riba, and explores relevant sources, including a number of Fatwas. It also discusses the earlier and parallel development of the Halacha prohibiting Ribit . This includes its successful adaptation over time to deal with changing economic conditions, such as permitting borrowers a means of ready access to the capital markets and the benefits of lower cost financing.  There is also a discussion of the unique role banks or other entities play under the Halacha and the Sha’ariah when compared to an individual. It would appear that banks are not necessarily subject to the prohibition against Ribit or Riba, respectively.

A survey of relevant cases under NY law (as well as certain cases in the UK and elsewhere) is also presented. Certain constitutional aspects of applying religious oriented laws are also explored.

The Article suggests that a more nuanced approach is required that both recognizes and respects the traditions of each system of law and practice and yet permits ready access to the US capital markets. The article concludes with a proposed solution that is based on precedent within the Sha’ariah and Halacha. The solution is consistent with the author’s own experience in practice, in structuring such financial products, in a manner that is capital markets’ compliant.

KEY WORDS: Interest, Riba, Ribit, Sha’ariah Compliant, Capital Markets, Heter Iska, Sukuk, Ijara, Murabaha, Fatwa.

 

INTRODUCTION

In a global economy, with lenders and borrowers[1] from different cultures and disparate systems of law and ethics, conflicts can arise.

This article deals with the apparent conflict of laws and ethical traditions between US law,[2] on the one hand and the Halacha[3] and Sha’ariah,[4] on the other hand, as it pertains to loans and the charging of interest.

There are already a number of cases in the US[5] that have dealt with the nature and enforceability of a Heter Iska.[6]  This body of common law has developed over the years and provides us with guidance as to how a US court might view religiously oriented documents and structures under the Sha’ariah.  As noted below, the results are not always predictable and unexpected consequences may occur.  Indeed, it appears the existing religious oriented formats and structures currently used in practice may not always work as intended, as more fully discussed below.  This raises a number of issues, including legally and philosophically.

Furthermore, as a practical matter, it would appear that the capital markets cannot readily accommodate these Sha’ariah and Halachic compliant formats (designed to deal with the apparent prohibition against charging interest[7] in the form of Ribit[8] and Riba,[9] respectively).  This is because they fall astray of the existing legal and other requirements for accessing the capital markets.

Among other things, the following issues are presented:

1.         Do the existing Halachic and Sha’ariah compliant legal structures and documents work as intended under US law? This includes both the concepts of a parallel set of religious oriented documents and the more integrated versions in uses in Sha’ariah compliant banks, as summarized below.  Implicit in this analysis is the question of what documents govern (when dealing with a parallel set of religiously oriented documents) and how to interpret the religiously oriented provisions in the documents.

2.         Are the US courts best suited to decide matters of interpretation of religiously orientated documents? After all, as noted below, the courts, perforce, must rely on religious experts.  Moreover, as noted below, these religious experts may themselves be in conflict because of disputes as to the meaning or applicability of the religious doctrine at issue before the particular court. Furthermore, as discussed below, a US court[10] might decide an issue differently than a religious court would,[11] yielding a contrary result to what was actually intended by the parties.

3.         Can a US court even decide these kinds of issues under the Establishment Clause?[12]

4.         Beyond the legal issues noted above, do the existing religious oriented financial mechanisms work, in terms of enabling access to the capital markets or is there a problem? Moreover, if the current religious oriented structures and documents in use don’t permit a favorable execution within the existing capital markets, and then is there another possible solution?

5.         Is there really a conflict in principle or in practice? Stated another way, is this more a matter of form over substance or are the Western laws and traditions in fatal and irreconcilable conflict with the near Eastern traditions of the Halacha and Sha’ariah.  Furthermore, is there more philosophical coherence conceptually than might superficially appear to be the case? Moreover, is a more nuanced approach in practice a possible solution to the problem?

It is suggested that a resolution of these issues would be helpful in order to permit the free flow of capital through the capital markets, from sources of capital that adhere to the Halacha or Sha’ariah, to those in need, on the favorable terms and conditions that are the hallmark of the capital markets.

To better understand the problem; consider the basic real estate financing structure so prevalent in the US, Europe and throughout Western culture.  It is based on a loan, evidenced by a note and secured by a mortgage that is repayable with interest.  This is a recognized and accepted financing format under the law and traditions of the West.  It has enabled individuals to buy a home with the help of a local bank or other source of funding within the capital markets on very favorable terms and conditions.  It also underlies the financing of office, industrial, multi-family, hospitals and other types of real estate, whether existing or in development.  Indeed, it is one of the essential structural components of the capital markets and the sine quo none of CMBS.[13]  It has been tested in the US courts (including Bankruptcy courts) and through numerous economic cycles of downturn and growth.  It has been refined over time so as to yield consistent and predictable results.  In short, it is a battle-tested format that accounts in no small measure for the success of the capital markets.

As noted above, the essence of the capital markets’ compliant loan structure is predictability.  After all, the lender loaned the money to the borrower and is entitled to receive it back with interest as agreed to by the parties.  There can be no ambiguity when it comes to this basic and essential agreement between the parties.

The underlying problem is that this simple, elegant, efficient and successful financing structure appears to be expressly prohibited under the Halacha and Sha’ariah.  Indeed, the concept of repaying a loan with interest would appear to be an anathema under the Halacha and Sha’ariah.  This is not a matter of style or perception.  It appears to be a genuine conflict between Western culture and law and public expressions of the near Eastern traditions and legal codes of the Halacha and Sha’ariah.  Western legal systems[14] permit the payment and receipt of interest.  The Halacha and Sha’ariah prohibit Ribit and Riba, respectively and thus, would appear to prohibit the payment or receipt of interest.[15]  Any such prohibited acts are deemed sins[16] under the Halacha and Haram[17] under the Sha’ariah.

Nevertheless, for thousands of years under the Halacha and for well over a thousand years under the Sha’ariah, there have been various practices permitted that, at the very least, mimic interest, but are not considered “Ribit”[18] or “Riba”.[19]  What these structures are and how they originated, both conceptually and in practice and developed over time, are subjects of this article.

The broader question though is, in light of the legal and ethical traditions embodied in the Halacha and Sha’ariah, on the one hand and Western law and practices, on the other hand, can East meet West; do these religiously oriented structures and documents work in practice or do they cause unintended consequences?  Is there a gulf so wide that it can’t be bridged or otherwise resolved?

At first blush, it appears well neigh impossible to meld these opposing systems of law and tradition, because of fundamental and irreconcilable theoretical conflicts.  Indeed, as more fully discussed below, a New York court[20] in considering the effect of a Heter Iska found that there was a triable issue as to what the parties intended.  The court was concerned that the transaction at issue might not be an ordinary, simple loan; but rather some kind of an equity or partnership arrangement.  The difference between the two is striking, as more fully discussed below.  Moreover, as shown below, a Bet Din[21] applying the Halacha would likely have determined that the transaction should be enforced as a loan repayable with interest.  This kind of improbable result points to the need to better understand the various religiously oriented formats summarized below.  This so as to avoid these kinds of results that are contrary to the intent of the parties and the very systems of law that created them in the first place.

It is suggested that a nuanced approach, which permits the systems to exist side by side at some level, might be possible.  Developing an approach to enable the free flow of capital worldwide is certainly a worthy object.  Indeed, the Talmud recognizes this as a most worthy goal, citing the legal maxim of “don’t shut the door on borrowers”.[22]  Nevertheless, accomplishing this in practice is no mean achievement.

Over the years, I have worked on developing solutions reconciling religious sensibilities with US lending practices, acceptable to a variety of banks, institutional and other lenders, borrowers, religious authorities and governmental regulators.  One example comes to mind because of the diverse composition of the parties involved.  An Egyptian banker acting on behalf of a Saudi-managed fund introduced the matter to me.  They were interested in providing financing to a Pakistani real estate developer.  The security was a development parcel in New Jersey.  It was encumbered by a building loan mortgage provided by a major bank from China, with a branch office in New York City.  I was approached because of my reputation as a real estate finance expert, who also had experience in crafting financing structures that did not violate the law against Ribit under the Halacha.  They hoped I could also craft a financing structure that provided for a secure rate of return that was not prohibited Riba and, hence, was Sha’ariah compliant.  At the same time, the financing structure had to conform to the requirements of the Chinese Bank (and by extension, the capital markets).  This is because the real estate (including the buildings and other improvements to be constructed thereon) was encumbered by the Bank’s Building Loan Agreement and Mortgage.  This very same real estate was also intended to secure the new Sha’ariah compliant financing structure I was charged with creating.

How therefore to craft a Sha’ariah compliant financing vehicle that could be rationalized with the typical US loan structure.  To succeed, it had to be satisfactory to the new financing source (requiring compliance with the Sha’ariah and their financial, legal and religious advisors), as well as, the US bankers (including underwriting, credit, legal and compliance), regulators, rating agencies, traders and investors, who are an integral part of the capital markets.

To better appreciate the relevant issues requires some background.  Therefore, set forth below is a discussion of the meaning of terms such as “Ribit” and “Riba”.  Although the words are loosely translated to mean interest, this would appear to be a misnomer.  The terms Ribit and Riba might be better translated as meaning any addition or increase[23] not strictly speaking just interest.  But a true definition of the terms can only be derived from a rigorous legal analysis of the applicable religious principles that coined the terms in the first place.  Indeed, as shown below, these terms embody all sorts of things that would not ordinarily be defined as interest.  Moreover, there are times when what is commonly understood to be interest is religiously defined not to be Ribit or Riba.  This is particularly relevant when viewed in the context of an analysis of the evolution of the Halacha and Sha’ariah in response to the needs of lenders and borrowers and changing conditions over the years.  A matrix of guiding principles is also outlined below and is used as a tool to show the interplay of these systems of law and practice with the requirements of the capital markets and US law.

I begin with a discussion of Ribit because, among other things, it is first in time historically.  It is also because there is already a well-developed body of case law and business practice dealing with the Halachic prohibition against Ribit and the Heter Iska solution.  As such, we are provided with a source of guidance as to how religious oriented forms and structures have been developed and treated legally by the US courts and in practice by the capital markets.  Having participated personally in developing some of the solutions under the Halacha and in respect of US law and the capital markets, I was privy to discussions about various approaches and considerations that resulted in establishing viable solutions that proved to be acceptable to the capital markets.

Section I of this Article contains a discussion of the definition of the term “Ribit” and the origin and nature of the prohibition.

The article then goes on to deal with a number of Halachic solutions to the problem, beginning in Section II with the original Talmudic Iska format.  Theory versus practice is then analyzed in Section III.  The article then discusses the later development of the Heter Iska structure in Section IV and its evolution over time in Section V.  Section VI continues with a discussion of whether a bank is treated differently from an individual lender under the Halacha.

Section VII deals with the response of the US courts to the Heter Iska.

Section VIII discusses why, in light of applicable US case law, the Heter Iska should not be signed by the parties.

Section! IX discusses the sources of the prohibition against Riba.

Section X analyzes the definition of the term Riba.

Section XI discusses the nature of the prohibition and the rules that developed over time dealing with the practical application of the prohibition. This includes an analysis of whether entities are subject to the same rules as individuals when it comes to the prohibition against Riba. A number of Fatwa and other scholarly positions are discussed dealing with when and under what circumstances the prohibition against Riba does or does not apply.

Section XII outlines a number of Sha’ariah compliant structures in current use.

Section XIII discusses the requirements of the capital markets and analyzes how the existing religious oriented documents and structures outlined in this article are inconsistent with those requirements.  In this regard, it should be noted that the Heter Iska format has been adjusted to conform to the needs of

of the capital markets, as described in this article.  However, the Sha’ariah compliant formats have not made such an accommodation; and, hence, the emergence of some of the problems described in this article.

Section XIV outlines a modern Sukuk structure and analyzes whether it successfully achieves the goal or remaining Sha’ariah compliant while, at the same time, satisfying the requirements of the capital markets.

The integration of religious oriented structures and forms in our society in the US also has a constitutional dimension.  This is discussed in Section XV.

Section XVI discusses the disconnect between the concept of Riba in theory and in practice.

It would appear that efforts being made by proponents of the use of Sha’ariah in the US have encountered a negative reaction.  This blowback is discussed in Section XVII.

A proposed solution is outlined in Section XVIII.  The solution offered is then critically analyzed against the criteria outlined in this article.  The conclusions reached are not just theoretical.  They are often based on insights derived from my own real life experiences in the field.

It is important to recognize that the development of a useful proposal must, first and foremost, be based on a genuine respect for each of the legal systems.  Value judgments about which system may or may not be more appropriate or ethical are exceedingly contra-productive.  Indeed, such pronouncements are often the product of ignorance, not just about one of the systems of law being discussed; but, often all of them.  Each of the systems has withstood the test of time and reflects the majesty of their traditions.  They deserve our respect.

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[1] The terms lender and capital provider, landlord, vendor or investor are used interchangeably. The terms borrower and capital recipient, tenant, vendee, operating member or manager are also used interchangeably. Religiously oriented documents or structure sometimes employ one of these other terms in order to distinguish the transaction in form from a loan; similarly the use of the term borrower.  Interestingly, the Talmud, in Tractate Bava Batra, uses the term “Malveh” (literally, lender) to mean obligee and “Loveh” (literally, borrower) to mean obligor (see Elon: Ha-Mishpat Ha-Ivri – 1:483).

[2] The term US law is used generically to distinguish between Western legal traditions, on the one hand and the Halacha and Sha’ariah, on the other hand. This article is based primarily on New York law (unless otherwise specified) and Federal law where applicable. These are used as representative examples of US law and Western legal and ethical traditions.

[3]  The body of Jewish law derived from the Bible as elucidated in the Talmud and by early codifiers and commentators and later religious authorities, as more fully outlined below.

[4] The body of Islamic law derived from the Koran and as elucidated by later religious authorities and scholars.

[5] See the discussion of Heter Iska cases below and in particular the IDB case.

[6] A document and structure in use under the Halacha that is designed to avoid the prohibition against Ribit, as more fully discussed below.

[7] Plato in the Republic prohibited lending on interest. Aristotle in his Politics (at page 1258) thought it an unnatural mode of producing income (i.e., selling money instead of goods).  According to Aristotle, it was the most hated sort of wealth which makes gain out of money itself. Money according to Aristotle was intended just to be a medium of exchange. Thomas Aquinas in his Summa Theological II (at page 78) thought “it is by very nature unlawful to take payment for the use of money but, which payment is known as interest.” However, this all changed with the advent of a mercantile instead of an agrarian economy.  Thus Calvin beginning in 1547 spoke of reasonable interest charges for money being acceptable. Only excessive interest was wrong. After Henry the VIII broke with Rome, England in 1545 passed a law permitting interest to be charged up to a maximum of 10% per annum. In the 19^th Century, the Roman Catholic Church acknowledged that moderate rates of interest were not to be disturbed.

[8] The terms Ribit and Riba, literally, mean increase.  As more fully discussed below, this is a wholly religious based formulation.  It has no counterpart under US law.

[9]  Ibid.

[10]  See the discussion of the IDB case below.

[11] See the discussion of Heter Iska below and how the pre-conditions to bringing a claim thereunder are virtually impossible to satisfy.

[12]See the discussion of cases under the Establishment Clause of the First Amendment to the US Constitution below.

[13] An acronym, meaning Commercial Mortgage Backed Securities. In a typical CMBS offering, an investment bank pools a portfolio of individual loans secured by first mortgages against real estate (usually rental properties and hence the term “commercial”) and sells certificated interests in the pool to institutional investors, like banks, insurance companies or funds. Often the interests are tranched so that the portion of the aggregate loan amount that represents a lower loan to value ratio (i.e. the most senior interests) are sold to investors for a correspondingly lower yield and the portions that are at the higher end of loan to value within the offering are sold for a higher yield. Often the investment bank making a CMBS offering earns not only fees for the underwriting, banking and placing the CMBS; but, also premiums, if the actual yield at which it is sold is less than the underlying stated contract interest rate of the loans in the pool of mortgages that are being securitized.

[14] New York or Federal law is the primary source of law under discussion in this article, unless otherwise stated.

[15] The Halacha even goes so far as to prohibit scribes from drafting the offensive loan documents and witnesses from affixing their signatures. Under the Halacha, an offending lender or borrower is disqualified as a witness generally because of the odiousness of the sinful practice of paying or receiving prohibited interest. (See Talmud Tractate Bava Metzia Chapter 5, at page 11.) There is also a discussion in Talmud Tractate Sanhedrin (at page 25) concerning how those who collect Ribit are not qualified to be a witness. See also Rambam-Mishna Torah: Hilchot Edut 9:1.

[16]See discussion below as to the fact that viewed as sinful conduct but not necessarily civilly actionable.

[17] Literally, forbidden (i.e. sinful).

[18] Exodus 22:24; Leviticus 25:36-37; Deuteronomy 23:20;  Ezekiel 18:13: Psalms 15,5 ; Nehemiah 5:1-13; and Proverbs 25:8.

[19] Koran 3:130; and 2:275-6

[20] See the discussion of the IDB case and other cases dealing with Heter Iska below.

[21] See the discussion below  of how a Bet Din (or Religious Tribunal) would typically, as a threshold matter, reject a borrower’s claim of defense to payment under a Heter Iska.

[22] Talmud Tractate Bava Metzia at page 68a.

[23] or in the case of Riba, an excess, as more fully discussed below.