THE 'I-DEAL' LIFE
By: Rabbi Max Sutton
Rich, seeking to expand his wealth, regularly invested in small wholesale corporations that were in need of capital. His latest investment included the purchase of 50 percent of Yoram’s textile company for $1.9 million. Before making the purchase, Rich reviewed the company’s accounting history, and thereafter signed and transferred half the sum as his initial payment. Additionally, as part of the purchase agreement, Rich signed as a personal guarantor for a loan previously extended to the company in the amount of $375,000. Less than a month later, Rich discovered that the transaction was a complete scam. The company’s accounting documents were fraudulent, and the company owed millions of dollars to private investors. Since the company had not generated a profit for many years, Yoram habitually paid the investors their monthly dividends with the money he received from new investors. When the Ponzi scheme could no longer be controlled, Yoram fiendishly sold the company to Rich, and apparently ran off to Argentina with the money. Rich is presently attempting to press criminal charges against Yoram in civil court, and is busy trying to find his whereabouts.
A claim against Rich was brought before our Bet Din by Jack, who had granted the $375,000 loan for which Rich had signed on as a guarantor. Rich responded that since his purchase of the company was retroactively voided, as it was made on the basis of a misunderstanding, he bears no obligation to the creditors. Moreover, Rich claimed, the $375,000 loan was given before his involvement in the company. He argued that just as he was swindled and suffered a financial loss, the creditors were also to sustain their share in the damage. Jack presented to the Bet Din the guarantor document with Rich’s signature fixed to the bottom.
Is Rich obligated to pay Jack his $375,000 loan? How should the Bet Din rule, and why?
According to the ruling of the Shulhan Aruch, a guarantor is responsible to reimburse a lender even if he had secretly warned the lender not to accept him as a guarantor. Since the lender ultimately lent money with the guarantor as his security, full liability is incurred if the borrower defaults on the loan. Addressing the classic case of a lender who returned collateral to a non-Jew in exchange for a Jewish guarantor, the Shulhan Aruch imposes liability even though the guarantor secretly informed the lender that he was not sincere about his commitment. The rationale behind this ruling is that by openly agreeing to his role in front of the borrower and lender, the guarantor in effect authorized the lender to return the collateral. Since the collateral was returned on account of the guarantor’s stated commitment, he is liable if the borrower defaults.
In light of this ruling, it stands to reason that a guarantor is responsible even if at the time of the loan the borrower never intended to repay it. Although the guarantor would certainly not have offered his security had he known that the borrower was fraudulent, nevertheless, since ultimately the loan was extended on account of the guarantor, he is liable for payment. Hence, a guarantor is responsible for a loan extended to a fraudulent corporation operating a Ponzi scheme. Since the lender extended the funds to the corporation relying on the guarantor in case of default, he is entitled to collect the loan from the guarantor.
However, the Shulhan Aruch also rules that a guarantor’s verbal commitment is binding only if it is made prior to, or simultaneously with, the granting of the loan. In such cases, the guarantor is liable even if he only verbally committed to guarantee the loan. This applies also in a case of a lender who returns collateral to a borrower in exchange for a guarantor. Since it is obvious to the parties involved that the loan was forwarded by the lender only because a guarantee was in place, the mere verbal commitment of the guarantor is binding. Hence, the guarantor is liable if the borrower defaults on the loan.
If, however, the loan was previously extended to a borrower, and only thereafter a guarantor steps in to assume responsibility, a verbal commitment is insufficient to impose upon him responsibility. Since the guarantor did not enable the loan, he is not considered the cause of damage when the borrower defaults. Hence, after a loan is already extended to a borrower without any guarantee, a formal contract, prepared according to halachic specifications, is needed to establish a guarantor’s liability.
According to Torah law, a contract signed under completely false pretenses is rendered null and void. While numerous examples of this ruling are listed in the Talmud, every case that arises needs to be carefully evaluated by a staff of knowledgeable rabbinical judges to determine whether the contract in question is indeed invalid. Hence, in situations where somebody signed a contract assuming responsibility for a loan that had already been extended previously, the contract may be declared void if there was vitally important information withheld from the guarantor. Certainly, if the loan was extended to a corporation operating a fraudulent Ponzi scheme, and the guarantor was entirely unaware of the corporation’s fraudulent activity, the contract is null and void and the guarantor is not bound by the commitment written in the contract.
Baba Batra 173b, 176b;
Shulhan Aruch Hoshen Mishpat 131:6, 129:2, 129:4; Tosafot, Kiddushin 49b; Baba Batra 146a;
Pit’heh Teshuva, Hoshen Mishpat 241:3.
Verdict:Null And Void
Our Bet Din absolved Rich, the guarantor, of the $375,000 liability. As discussed, a guarantor who authorizes a loan is liable even if the borrower is fraudulent, but only if he makes his commitment before or at the time the loan is extended. Rich never endorsed Jack’s loan to the corporation, which was extended well over a year prior to Rich’s purchase of the company. Since Rich was not a consideration in Jack’s decision to extend the loan, he is not responsible for the damages caused by a default. Furthermore, upon investigation by our Bet Din, it became evident that Jack’s loan to the corporation was from the onset not retrievable. Prior to Rich’s involvement, the company was borrowing large sums of money on the black market at a 25 percent monthly interest rate, and this cash was used to prolong the Ponzi scheme by paying monthly returns to investors. By the time Rich got involved, Jack’s loan was long gone, as at the time of the loan the company did not have the funds to repay the principal to any of its investors. Therefore, although Rich had signed a document establishing him as a personal guarantor for the loan, nevertheless, since the document was quite obviously signed under false pretenses, it is rendered null and void. Rich’s signature did not affect Jack‘s financial position, and since it was signed by deception, it is invalid. Our Bet Din instructed Jack and Rich to pursue Yoram in civil court and to press criminal charges against him.