Rich, interested in expanding his wealth, regularly invested in small wholesale corporations that needed capital. His latest investment included buying fifty percent of Yoram’s textile company for 1.9 million dollars. Before purchasing, he reviewed all the accounting history of the company, 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 company he purchased from Yoram was a complete scam. Aside from the company’s accounting, which proved to be fraudulent, the company owed millions of dollars to private investors. Since the company did not generate a profit over the many years, Yoram habitually paid the investors their monthly dividends with the money of each new investor. When the Ponzi scheme became too overwhelming to control, Yoram fiendishly sold the company to Rich, and he presumably ran off to Argentina after being paid. Rich is presently attempting to press criminal charges against Yoram in secular court and is preoccupied in finding his whereabouts. The case brought before our Bet Din was the claim of Jack, the lender of the $375,000, versus Rich, who personally guaranteed the sum. Rich responded to Jack’s claim that since, in retrospect, his purchase of the company was null and void, he has no obligation to the creditors. Furthermore, Rich defended that the $375,000 debt was existent prior to his involvement in the company. He argued that just as he was swindled and suffered a financial loss, the creditors as well were 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?
Torah Law
According to the ruling of the Shulhan Aruch, a guarantor is responsible to reimburse a lender even in instances in which he 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. In a classic case in which a lender returned collateral to a non-Jew in exchange for a Jewish guarantor, the Shulhan Aruch imposed liability even though the guarantor secretly informed the lender that he was not sincere about his commitment for liability. The rationale behind this ruling is that since the guarantor openly agreed to his role in front of the borrower and lender; in doing so he authorized the lender to return the collateral. Since ultimately the collateral was returned on account of the guarantor, he is liable for the damage caused in case of default.
It stands to reason from the above ruling that a guarantor is responsible even if at the time of the loan the borrower never intended to repay it. Although the guarantor would clearly not have offered his security in case of a fraudulent borrower, nevertheless, since ultimately the loan was extended with reliance on 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.
By rule of the Shulhan Aruch, the commitment of a guarantor is binding only if it transpires prior to or simultaneously with the giving of the loan. Since at the behest of the guarantor the loan was extended, he is liable even if he only verbally committed to serve as a guarantor. The same ruling applies in instances in which a lender 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 in consideration of a guarantee in place, the mere verbal commitment of the guarantor is binding. Hence, the guarantor is liable for the damage sustained by the lender in the event the borrower defaults on the loan.
If, however, the loan was previously extended to a borrower, and only thereafter does a guarantor attempt to assume responsibility, a verbal commitment is clearly insufficient. 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, only a specific contract including various halachic provisions, has the power to establish a guarantor’s liability.
By Torah law, a contract signed under false pretenses is rendered null and void. While numerous examples of this ruling are listed in the Babylonian Talmud, a staff of rabbinical judges will generally need to apply their wisdom to determine whether a contract is indeed invalid. Hence, in instances in which a loan was previously extended to a borrower and a contract was signed by a guarantor to establish his liability, the contract may be susceptible to disqualification. Since the guarantor was not a consideration of the lender when he extended the loan, the guarantor may be absolved. Thus, in instances in which a loan was previously extended to a corporation operating a Ponzi scheme, a guarantor unaware of the fraudulent activity is absolved of his contractual obligation.
Endnotes: Baba Batra 173b, 176b, Shulhan Aruch Hoshen Mishpat131:6, 129:2, 129:4, Tosafot Kiddushin 49b, Baba Batra 146a, Pithei Teshuva Hoshen Mishpat 241:3.
VERDICT: Null And Void
Our Bet Din absolved Rich, the guarantor, from the $375,000 liability. As mentioned in Torah law, although a guarantor who authorizes a loan is liable even if a borrower is fraudulent, nevertheless, Rich never endorsed Jack’s loan to the corporation. Jack had extended the loan 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. Furthermore, upon investigation by our Bet Din, it was 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. The cash borrowed was used to prolong the Ponzi scheme by paying monthly returns to investors. Jack’s loan was long gone, as at the time of the loan the company did not have the funds to pay back the principal to any of its investors. Although Rich had signed a document establishing him as a personal guarantor for the loan, nevertheless, since it is beyond the shadow of a doubt that the document was signed under false pretenses, it is rendered null and void. Rich’s signature did not affect Jack‘s monetary position, and since it was signed by deception it is invalid. Jack and Rich were instructed by our Bet Din to pursue Yoram in civil court and to press criminal charges against him.
YOU BE THE JUDGE
To Catch a Thief
Vicky was pushing her child in a stroller while window shopping in Boro Park. She went into a lady’s apparel store, and upon entering she was asked to deposit the stroller and her packages at the far end of the store, to allow free passage for other shoppers. At first Vicky resisted, as her stroller and packages were not obstructing the large passageway, but eventually she complied with store policy and took her child out of the stroller. After selecting several garments, she proceeded to the fitting room to try on her selections. Upon exiting the fitting room, she glimpsed at the far end of the store to check on her stroller and packages, and noticed they were missing. Alarmed, she ran outside the store to catch the thief, but she was unsuccessful. She then attempted to collect her loss from the store owner, claiming that he had assumed responsibility for her belongings, since she deposited it in the corner of his store at his behest. The store owner sympathized with Vicky’s predicament but was unwilling to bear responsibility for the loss. The two presented their dispute to Bet Din to rule on the matter.
How should the Bet Din rule – in favor of Vicky or the store owner?