Alan, president of an established ladies’ wear corporation, needed a loan to operate his business. He approached his brother-in-law Sam 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 lived up to 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 was once again stable, and the future seemed very promising. Not too long after he finished paying off the loan in full, Alan attended a Torah class in which the topic of the prohibition of 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 of law. Since interest payments are illegal according to Torah law, a lender is required to return collected interest. Alan approached Sam seeking to recover the $120,000 in interest he paid. However, Sam rejected the claim. Sam explained to Alan that he had forfeited earnings from his previous investment, totaling at least the annual percentage he charged Alan, and brought to his attention that he had graciously lent him a very large sum with no guarantee. In Bet Din, Sam expressed that he was insulted by his brother-in-law’s behavior. Nevertheless, 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 not and why?
According to the ruling of the Shulhan Aruch, payment of a loan in excess of the amount borrowed constitutes the Torah prohibition of interest. This prohibition is extended on both the borrower and lender, and is applicable whether the lender requested the interest payment or the borrower offered to pay it. The prohibition is applicable regardless if the interest is a per annum payment or a one-time payment. Various laws with regard to this prohibition are pertinent to our everyday lives, making it our responsibility to set aside time to study this topic. The information covered in this article is limited as it deals primarily with the case at hand.
There is, however, a distinction between the prohibition according to Biblical law and Rabbinical law. According to Biblical law the restriction is only in instances in which the terms of an interest payment were stipulated at the time of the loan. If, however, the borrower delivers a gift to the lender upon return of the loan, the prohibition is of Rabbinical nature. This distinction has halachic ramifications. While interest paid in violation of Biblical law is subject to collection by the borrower claiming its return, interest paid in violation of Rabbinical law is not retrievable.
Nevertheless, our Sages designed an operating agreement based on Talmudic law that enables a lender to receive a return on money he advances to a borrower. This agreement is known as a “heter iska” contract. 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 attributable to his portion of the joint business venture. 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. While redefining half the loan as an investment allows the opportunity for profit, it 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 exposure. The parties further agree that in the event 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 rule in leniency allowing one to collect interest on a loan he 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. Since a borrower is defined by Torah law as someone who has personal liability to repay a debt, in the instance of a corporation, no fitting borrower exists. Although the company’s assets serve as security for its creditors, nevertheless, no individual exists as a suitable borrower. Arguably, another logical reason to waive the prohibition is that a corporation with no personal guarantor for the principal in case of loss makes the loan more resemble an investment in a business venture, thereby enabling the lender to subsequently earn a profit. In instances in which the corporate owner is personally liable, the Biblical prohibition of interest is applicable. Likewise, 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. In this latter case the borrower bears personal liability and all interest laws are applicable.
Although the above leniency with regard to corporations is challenged by various halachic authorities, nearly all agree that collecting interest on such a loan is a rabbinical violation and is not subject to retrieval once paid to the lender.
Nowadays, it is customary to prepare a heter iska even for loans to corporations.
Endnotes: Igrot Moshe Yoreh Deah Bet #63, Halichot Olam Hilchot Ribit, Minhat Yitzhak 4:16, 17, Har Tzvi Yoreh Deah 126, heter iska form revised from “The Laws of Ribbis,” R.Y. Reissman.
Verdict: The Point of No Return
Our Bet Din ruled in favor of Sam, exempting him from returning the interest payments he collected. As mentioned in Torah law, numerous halachic authorities permit collecting interest from a corporation, providing the corporate owner has no personal liability to repay the loan. Upon inquiry, it was apparent that Alan never agreed to any terms of personal liability. Furthermore, the halachic opinions that differ and prohibit lending with interest to a corporation, indeed agree that the prohibition is reduced to a Rabbinical violation. As a general rule, interest collected in violation of Rabbinical law is not subject to return after it is paid to the lender. Hence, even according to the more stringent view, Sam is exempt from returning the earnings he collected. Nevertheless, our Bet Din suggested that for future business loans they use a heter iska.
YOU BE THE JUDGE
A Tunisian Connection
Zelig and Mendel, two prominent members of a well-known Hassidic sect, served as primary distributors of tallitot for their community. As per the specifications established by their Grand Rebbe, only tallitot manufactured in Tunisia were to be sold by the two distributors. This requirement was implemented in order to avoid the prohibition of sha’atnez. Since Tunisia did not grow flax, it was the ideal country for purchasing sha’atnez-free wool tallitot. Rahamin, a Tunisian Sephardic Jew, was their exclusive importer who purchased the tallitot from Arab factories in Tunis, and sold the merchandise to Zelig and Mendel, the retail distributors. After twelve years of successful cooperation, a major crisis arose. Rumors spread through the market that their tallitot were not one hundred percent wool. These rumors prompted Zelig and Mendel to do laboratory testing of their stock. The report determined that although the tallitot did not contain any linen, they nevertheless had an approximate forty percent polyester content.
In Bet Din, Zelig and Mendel claimed nearly $600,000 in damages for their defective stock. They insisted that they were entitled to return the goods and have their money refunded. They explained that they could not sell the defective tallitot to their clients, since they did not meet the religious standards practiced in their circles. In addition, due to the extra-large size and heavy weight of each tallit, they could not be sold elsewhere and were virtually worthless. Rahamim defended his position claiming that although the purchase order was for a hundred percent wool garments, he stipulated at the time of sale that he was not responsible for the quality control of the merchandise. Contrary to standard practice in wholesale transactions, both parties agreed that the inspection of goods for quality control rested with the retailers. Rahamim expressed that he did not at any point come into contact with the merchandise, as it was picked up by the buyers directly from the port. He was therefore unwilling to take back six months of stock that should have been inspected by the retailers upon initial delivery. Rahamim pointed out that their failure to do so in a timely manner caused him to pay the Arabs in Tunis in full. As such, the merchandise is no longer returnable to its original source. Zelig and Mendel persisted that they were sold defective merchandise as per the purchase order signed by Rahamim.