Heter Iska & U.S. Courts | IRR Part VIII

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

 

HETER ISKA AND THE US COURTS

The nature and enforceability of a Heter Iska has been the subject of a number of NY court decisions with varying consequences.  This is problematical in a number of respects.  Of primary concern is the fact that these kinds of anomalous and unpredictable results are the bane of lenders and the capital markets.  Furthermore, as shown below, the treatment of a Heter Iska by a US court may be wholly inconsistent with how the very same document would likely be treated under the Halacha.

To better understand the basis for these concerns, it is important to analyze a number of the seminal decisions under New York law in this area, which affected the way banks structure loans involving a Heter Iska.

One of the more important cases in this area of law is IDB v. Weiss & Wolf,[1] a 1985 NY State Supreme Court[2] decision.  In that case, the Court held that a triable issue existed as to whether a Heter Iska defense was available to the borrower.  As a result of this decision, banks no longer typically sign an individual Heter Iska.  Instead, there is the Heter Iska on the wall, as it were.[3]  Its presence on the wall, instead of in an individual loan file, says much about how serious an issue (i.e., the existence of a Heter Iska signed by the lender and borrower) was presented by the decision in the IDB case.  Ever since then the banks have correctly balked at signing a Heter Iska.  While the case is not reported to have gone to final judgment (presumably it settled), it did establish a precedent in practice.  Thus, given that a properly drawn and executed Heter Iska could be enforced by the courts, banks therefore avoided doing so.  The court’s finding that a triable issue existed was sufficient to case a chilling effect on entering into a Heter Iska on an individual basis.  No bank wants to take the chance of having a borrower interpose a defense, which survives a motion for summary judgment, let alone conceivably lose any portion of the principal amount of the loan.

In 1986, the NY Supreme Court faced another case involving a Heter Iska in Bank Leumi Trust Company of New York v. Morris Spitzer.[4]  In that case, the Court found that Spitzer did not know about the Bank’s Heter Iska, even though it was displayed on the wall, until well after the loan was made.  The Court in the Leumi case granted summary judgment for the benefit of the bank (unlike in the IDB case).  This is because, among other things, the borrower did not rely on the Heter Iska when he entered into the loan.  Indeed, the borrower didn’t even have a copy of the Heter Iska.  Moreover, the US Bank Leumi subsidiary of the Israeli parent bank did not ratify or sign the Israeli parent’s Heter Iska document.  Neither did the borrower (Spitzer) sign a Heter Iska.  The Court found that the bank had never executed and delivered the Heter Iska to the borrower, even though there was a form that was hung on the wall.  On the other hand, the Court found there was a promissory note, which was signed and delivered by the borrower under US law.  The Court weighed this against an unsigned Heter Iska, which the borrower was not even aware of and the bank had disavowed.  The Court therefore granted summary judgment in favor of the bank.  It found that a loan transaction existed, not a Heter Iska relationship.

There have been a number of other unique and interesting cases involving a Heter Iska.  In Bollag v. Dresdner,[5] a civil court case in 1985, the lender sought to use a Heter Iska as a sword instead of a shield.  Thus, the lender sought to collect a usurious rate of interest (in excess of 24% per annum) arguing that the arrangement was truly a profit sharing deal.  The civil court held that substance controlled over form.  It found that notwithstanding the Heter Iska, the arrangement was in fact a loan, which was subject to state usury laws.  The prohibition against usury (excessive interest) could not be avoided by styling the loan as a Heter Iska relationship.

In Heimbinder v. Berkowitz,[6] the lender tried to use the Heter Iska document to assert  personal liability against the shareholder in the corporate borrower, where none existed under US law.  In that case, the borrower was a corporation, notwithstanding that the Heter Iska document was signed by the individual principals.  The court found that the Heter Iska could not change a corporate loan into a personal loan.[7]

Arnav Industries, Inc. v. Westside Realty Associates, et al[8] involved a mortgagee, which sought to foreclose on its mortgage.  The lower court denied summary judgment.  It focused on the insertion of a Hebrew phrase in the mortgage, to wit: “al pi Heter Iska” (in accordance with a Heter Iska)[9] above the signature on the mortgage note and found that there was an issue of fact as to whether it created a partnership agreement between the lender and borrower.  The Appellate Division disagreed and reversed the lower court decision.  It held that the language could not be used by the borrower to vary the terms of the mortgage note.  Among other things, there was no actual Heter Iska signed by the parties.  The note also contained a provision to the effect that nothing contained therein was intended to create a joint venture or partnership.

The Appellate Division in Arnav also cited its own decision in Barclay Commerce Corp. v. Finkelstein.[10]  In the Barclay case, the Appellate Division noted that the Heter Iska constituted “merely a compliance in form…with Hebraic Law.”[11]  It held a partnership is not created thereby and the issue is devoid of merit.  A similar decision was made by the Federal District Court for Massachusetts in Edelkind, et al v. Fairmont Funding, Ltd., et al.[12]

The Appellate Division in LZG Realty LLC, et  al v. HDW, et  al[13] also dealt with an action for foreclosure of a mortgage.  The defendant borrower failed to raise the matter of a Heter Iska and the binding rabbinical arbitration clause thereunder until 1½ years into the matter.  The court held that it was too late to raise the issue at that point in the case.  The court therefore did not reach the underlying issue of the Heter Iska in the case.

In Koenig v. Middlebury Land Associates, LLC, et al,[14] the court dealt with a Heter Iska that had a rabbinical arbitration clause.  The court found, however, that it was not a binding arbitration clause.

The US Bankruptcy Court for the Southern District of New York In Re Venture Mortgage Fund, L.P., Debtor (and In Re David Schick et al Debtors)[15]  ruled that the Heter Iska could not be used as a means to collect a usurious rate of interest of 27% interest per annum.

A recent noteworthy lower court opinion in the NY Supreme Court of Nassau County (dated January 11, 2012) involved the foreclosure of a mortgage.  The name of the case is VNB New York Corp v. 47 Lynbrook LLC, et al (Index # 018467/2010).  In case the mortgage made reference to the fact that to ensure compliance with Jewish law, the Bank has entered into a Heter Iska.  The defendants sought to amend their answer to interpose a defense against a deficiency judgment based on the Heter Iska.  The court noted that the note and mortgage made it clear that applicable civil law (i.e., NY law) was to govern.  Accordingly, the court found that the existence of the Heter Iska did not alter the clear intent of the parties that NY law governs the enforcement of the mortgage documents.  The Heter Iska was not ground for overturning the foreclosure judgment nor could the defendants defend against a corresponding deficiency judgment based thereon.

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[1] NY State Supreme Court-1984, NYLJ 2/4/85 at page 14.

[2] The court of original jurisdiction in New York. This as distinguished from the US Supreme Court, the highest court of the land. The highest court in New York State is the Court of Appeals.

[3] It is said that when Rav Moshe Feinstein visited an American-Israeli bank, he noticed that there was a framed Heter Iska on the wall.  He is reputed to have said “Kiknah de Heter Iska oif de Vant” (see the Heter Iska on the Wall).

[4] Unreported decision dated 9/18/86 by Judge Leonard N. Cohen in NY Supreme Court New York County under Index # 017734/1986.

[5] 130 Misc.2^nd 221, 495 NYS2nd 560 (NY Civ. Ct. Kings County-1985).

[6] 175 Misc.2^nd 808, 670 NYS2nd 301 (S. Ct. Kings County-1998).

[8] 180 AD2d 463, 579 NYS2d 382 (App Div 1rst Dept.-1992).

[9] An example of this kind of a text may be viewed online at sec.edgar-online.com regarding Allou 10-k annual report (dated 6/30/97)- Exhibit B: Section 1 (iii). The Exhibit is an Amendment to the Guaranty, which adds the following provision to Section 15 of the Guaranty: “Heter Iska: This Guaranty is being provided to BLT in accordance with BLT’s Heter Iska.” BLT is a reference to Bank Leumi Trust Company of NY.

[10] 11 AD2nd 325, 205 NYS2nd 551 (App Div 1rst Dept-1960). See also Leibovic v. Rawicki 64 Misc2nd 858, 316 NYS2nd 181 (NY Sup-App Term-1969).

[11] Ibid at page 328

[12] 539 F. Supp. 2d 449 (2007)

[13] 71 AD3rd 642 (App Div-Second Dept.-2010)

[14] 2008 Conn. Super. Lexis 1816 (July 23,2008)

[15] 245 B.R. 460 (2000) aff’d 282 F3rd 185 (2^d Cir. NY-2002)

Evolution of Heter Iska Structure | IRR Part VI

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 EVOLUTION OF THE HETER ISKA STRUCTURE

The Maharam[1] (approximately 400 years ago) reported a number of amendments[2] to the form Heter Iska.  The primary change involved the stipulation noted above that only the Rabbi[3] and Chazan[4] could testify on the matter of the debtor’s worldwide income from any source.  This seemed to be too contrived and so the Maharam substituted having two kosher witnesses.[5]  However, proof was still required that the managing member did not profit or earn income from any source anywhere in the world.[6]  This was still virtually impossible to satisfy.  After all, how could anyone (of their own personal knowledge) actually know an individual so well as to testify that the individual made no money at all.  The standard is actual knowledge, not circumstantial evidence.  Moreover, only two kosher witnesses with actual knowledge are acceptable.  The Maharam also provides for a “kenas” (a penal amount as liquidated damages) that is due in lieu of the debtor taking an oath.  This then is another means of providing for a return on investment.  The fee can be fixed by formula to mimic interest.

The Shoal u’Mayshiv[7] considered the issue of whether a Heter Iska could properly be used to cover what appears to be a personal loan.  Thus, a teacher wished to obtain funds in order to make a wedding for his daughter and asked whether a Heter Iska mechanism could be employed, in effect, to borrow the funds needed and repay them with what amounts to interest.  The Shoal u’Mayshiv determined that the Heter Iska structure could also be used in this case.  He reasoned that if the teacher could not borrow the funds needed to make a wedding, the teacher would necessarily have to forfeit his job in order to seek charitable donations for this purpose.  He, therefore, concluded that the teacher’s wages could be treated as a source of income or profit under the Heter Iska structure.  The Shoal u’Mayshiv deemed the teacher’s compensation retained as a result of continuing to work as the equivalent of Heter Iska profit.  This is so even though the funds loaned were not invested in a business venture to earn a profit.  The wages earned by the teacher were for work done and were not directly derived from the principal amount of the loan.

The Maharam[8] applied the Heter Iska exception to a mortgage loan against a personal residence.[9]  This was so notwithstanding that the funds were used by the borrower personally to buy a personal residence.  The mortgage loan (covered by the Heter Iska) was against a personal residence; not a pledge of business assets as was originally contemplated when the Heter Iska structure was initiated, as noted above.

The Mabit[10] further developed the form Heter Iska.  He held that there may be various duties and obligations, which the debtor undertakes under the Heter Iska.  The exception though was there could not be an explicit promise that there would only be profits.

There are various forms of Heter Iska in use today.  In general though, they are based on the investment trust funds conceptual arrangement derived from the Talmudic discussion reported in Tractate  Bava Kama,[11] as noted above and crystallized in practice by such halachic authorities as the Terumat Hadeshen and Mabit.  They all have in common the concept of having threshold conditions, which are virtually impossible to fulfill.

This tradition has been further refined over time by extending it to the threshold procedural requirements of Bet Din, as well.  The effect is to assure that the Heter Iska cannot be improperly used to defeat the implicit obligation of the borrower to repay the loan together with what amounts to interest.

Rav Asher Weiss[12] in his discussion of Heter Iska described a modern iteration of the form, which contains a number of very interesting provisions.  The form is premised on kulo pikadon (all investment).  Among the duties set forth in the Heter Iska is the requirement that there be an accounting of worldwide income which is attested to by an oath every month (i.e., from the very inception of the transaction and in good times and bad).  If this condition is not met, then a fixed rate of return must be paid in lieu of a profit share in accordance with a formula agreed to by the parties.  This tracks along the precedent established by the Mabit (which is based on the Talmudic discussion in Bava Kama[13] as described above).

Rabbi Asher Weis also noted that there are threshold procedural requirements of Bet Din that apply to this kind of a case.  Thus, an oath would not be administered to the borrower in support of his claim of no profits, unless the debtor first demonstrated to the Bet Din satisfaction of the pre-conditions to bringing such a claim.  This includes the monthly accounting (of debtor’s worldwide income from any source) requirement that itself had to be sworn to by two competent witnesses each and every month from the inception of the loan and until payment in full with interest.  If this burden was not satisfied first, then the oath of the debtor would not be administered and debtor’s claim would fail before it could even be presented.[14]

Rav Blau,[15] a recognized expert in the area of banking transactions, also dealt with an number of knotty issues in connection with formulating a bank form of Heter Iska.

Among the many questions I had occasion to discuss with him was the issue of whether the Heter Iska had to be enforceable under the laws of the jurisdiction were it was executed (i.e., US law).  Thus, if for any reason a Heter Iska might not be enforced under the laws of a particular country, then would that affect the Halachic validity of the Heter Iska.  Rav Blau concluded that so long as the Heter Iska was validly created under the Halacha, it did not matter that the document was not enforceable under other laws.  This was an extremely important consideration in drafting the Heter Iska procedures for the IDB Heter Iska, as noted below.

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[1] Rabbi Mendel ben Avigdor of Cracow, a 16^th century Halachic authority.

[2] Volume 2, Section 216

[3] Supra Footnote 66.

[4] Ibid

[5] Ibid

[6] Infra footnote 91

[7] A Halachic work by Rabbi Joseph Saul Nathanson, a 19^th Century Halachic authority (in Volume 3, Section 170).  Rav Shalom Mordechai Schwadron (author of the Tshuvat Maharsham), an early 20^th century halachic authority (in Volume II, Section 216) agrees with the Shoal U’Mayshiv that a Heter Iska may be used for a personal loan.  Others disagree, including Rav Moshe Feinstein (Igrot Moshe-YDII:62), a leading 20^th Century Halachic authority.  See also In re Yosher (Volume I: 108) by Rav Meir Arak, a 20^th Century Halachic authority (who holds that the debtor’s salary is not considered profits from a venture for purposes of justifying the applicability of the Heter Iska exception to the prohibition against Ribit; as well as, Ginat Veradim (YD Section 6:4) by Rav Avraham ben Mordechai Ha Levi, a 17^th Century Halachic authority; Shulcham Aruch Ha Rav (Hilchot Ribit: 42) by Rav Schneur Zalmin of Liady, an 18^th Century Hassidic Master (Lubavich) and Halachic authority (who also authored the Tanya); and the Kitzur Shulchan Aruch (Section 66:10) by Rav Sholom Ganzfried, a 19^th Century Halachic authority.  Also, see The Oxford Handbook of Judaism and Economics by Aaron Levine (Oxford University Press – 2010).

[8] Volume2, Section 216.

[9] I.e., not an investment property.

[10] Rabbi Moses ben Joseph di Trani, a 16^th century Halachic authority, Volume I, section 244.

[11] Page 102a

[12] In oral communication with author.

[13] At page 102a.

[14] We also discussed other possible non-Ribit structures. Of particular interest was the possibility of using a classic bill of exchange kind of construct, where payment was made in another currency. The concept was to use a currency in which there was an implicit inflationary hedge (as the equivalent of an interest factor) when compared to the local currency. This structure was based on a Halachic decision by the Maharsdam (a 16^th century Halachic authority)  in response to a question he received on the subject (See  Maharsdam Y.D. Section 176 at page). This kind of an interest analogue was in vogue in the Middle Ages prior to the Protestant Reformation to mimic what would otherwise be prohibited interest. Thus, back-to-back bills of exchange each specifying a sale of currency transaction. These were used to create the equivalent of a built in interest-like return. In essence, the borrower agreed to pay a price in a selected currency at an agreed upon exchange rate to the local currency of the borrower. A corresponding sale by the lender of the currency the other way locked in the profit with no risk to the lender. If the two transactions in currency were integrated then the borrower was, in effect, paying a higher cost in the local currency, thereby generating an artificial, risk free, profit to the lender, in the very same local currency. See Talmud Tractate Bava Metzia pages 44-45. See also The Valuation of Coins in Medieval Jewish Jurisdiction by Daniel A. Schiffman.

[15] A 21^st century Halachic expert on banking and lending, in oral communications with the author.  Rav Blau is the author of the Bris Yehuda, a seminal Halachic work of our times on matters of Heter Iska and Ribit. He also helped formulate the Heter Iska format and practices adopted at Israel Discount Bank, while I was Chairman of IDB in the US. See also discussion by Rabbi Blau in Brit Yehuda:40 about Heter Iska Klali (as opposed to an  individually signed one for each loan).

Origin of Heter Iska Loan Structure | IRR Part V

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 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 15^th 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 3^rd 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 3^rd 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 15^th 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.

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.)