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INVESTED INTEREST



The Case

Alan, president of an established ladies’ wear corporation, was in need of a loan to operate his business. He approached his brother-in-law, Sam, and asked for a $750,000 loan, and although Sam was at first reluctant, he eventually transferred the entire sum. The two agreed on a six percent annual interest rate which was to be paid in monthly installments over a five-year period. Alan honored the terms of the agreement and paid back the entire principal, including nearly $120,000 in interest. Taking the loan proved to be a wise decision, as Alan’s business regained stability, and its future seemed very promising.  

Not too long afterward, Alan attended a Torah class in which the Torah prohibition against collecting interest was discussed. The rabbi teaching the class noted that in many instances, a borrower retains the right to recover the interest he paid via a Jewish court. Since interest payments are illegal according to Torah law, a lender who collected interest is required to return it to the borrower.  

Alan thereupon approached Sam, seeking to recover the $120,000 in interest he paid, but Sam refused. Sam explained to Alan that by granting the loan, he had forfeited earnings from his previous investment which totaled at least the annual percentage he charged him. He added that he had graciously lent Alan a very large sum with no guarantee.  

Alan and Sam approached our Bet Din, and Sam expressed that although he felt insulted by his brother-in-law’s behavior, he was willing to comply with Torah law. 

How should the Bet Din rule? Is Alan entitled to recover the $120,000 he paid in interest, or may Sam keep the interest?

Torah Law

According to the ruling of the Shulhan Aruch, payment of a loan in excess of the amount borrowed violates the Torah prohibition of interest. This prohibition is transgressed by both the borrower and lender, and applies regardless of whether the lender requested the interest payment or the borrower offered to pay it, and regardless of whether the interest was paid all at once or on a per annum basis. (It should be noted that various laws associated with this prohibition are relevant to our everyday lives, and it behooves everyone to set aside some time to study this topic. The information covered in this article is very limited, focusing primarily on the particular case at hand.)

The Torah prohibition of ribbit (interest) applies only if the terms of the interest payment were stipulated at the time of the loan, as opposed to a case where the borrower decides to give the lender a gift at the time he returns the loan. Such a gift does not violate the Torah prohibition of ribbit, but it is nevertheless forbidden by force of rabbinic enactment. There is a practical difference between Biblically-proscribed interest and that which is forbidden by rabbinic enactment, with respect to the status of paid interest after the fact. While interest paid in violation of Biblical law may be reclaimed by the borrower, interest paid in violation of rabbinical law is not retrievable. 

Our sages designed, based on Talmudic law, an operating agreement which enables a lender to receive a return on the money he lends. This agreement is known as a “heter iska” contract (as shown on next page). The basic principle of this agreement is that the borrower and lender agree to be partners in a business venture, whereby the lender invests money and the borrower uses his entrepreneurial skills to manage the venture. The investing partner can thereby earn profit by virtue of his portion in the enterprise. In short, the arrangement has the characteristics of both a loan and an investment, as half the money forwarded by the lender is designated as an investment, and the other half is maintained as a loan. Redefining half the loan as an investment allows the opportunity for profit, but also exposes the lender to the risk of loss. In attempt to secure the entire principal for the investing partner, provisions are included in the contract which minimizes his risk exposure. The parties further agree that in the event that the borrower pays a specified annual rate, the lender will waive any claims to additional profit generated by his half of the investment. In addition, a nominal payment is made to the borrower to offset his managing of the business venture so that his labor is not viewed as a gift which would constitute a violation of interest laws.

Leading halachic authorities permit collecting interest on a loan extended to a corporation. The rationale behind this ruling is that since a corporate owner is not personally liable in the event of bankruptcy, the prohibition of interest is not applicable. Torah law defines the term “borrower” as referring to someone who bears personal liability to repay a debt, and a corporation does not meet this definition. Although the company’s assets serve as security for its creditors, nevertheless, no individual bears personal liability, and thus no individual can be considered a halachic “borrower.” It could also be argued that if there is no personal guarantor for the principal in case of loss, the loan resembles an investment, and thus the lender is permitted to earn a profit. However, if the corporate owner is personally liable to repay the loan, then the Biblical prohibition of interest is applicable. Furthermore, although the aforementioned authorities permit a lender to collect interest from a corporation, nevertheless, a corporation is strictly forbidden from collecting interest on a loan extended to an individual, since the borrower bears personal liability for the loan.

Some halachic authorities dispute this ruling and forbid collecting interest even from corporations. Even according to this opinion, however, this is forbidden only by force of rabbinic enactment, and thus once the interest is paid, the corporation may not then reclaim it. 

Nowadays, it is customary to prepare a heter iska even for loans to corporations.

Verdict:The Point Of No Return

Our Bet Din ruled in favor of Sam, exempting him from returning the interest payments he collected. As discussed, numerous halachic authorities permit collecting interest from a corporation if the corporate owner does not bear personal liability to repay the loan. Upon inquiry, it became clear that Alan never agreed to any terms of personal liability, and therefore, according to the aforementioned halachic authorities, the ribbit prohibition was not applicable to his loan. And even those halachic authorities who forbid lending on interest to corporations allow the lender to keep interest that was paid, after the fact. Hence, according to all opinions, Sam was not required to return his earnings from the loan. 

Nevertheless, our Bet Din advised Sam and Alan to use a heter iska form in the future when giving or taking loans, both private and corporate. The heter iska form is appended to this article for the benefit of our readership, revised from the sefer The Laws of Ribbis. A competent halachic authority should be consulted when filling out the form.