One is permitted to create a heter iska even when the goal of both parties is only to find a kosher way of creating a transaction that is very similar to an interest- bearing loan (Terumas HaDeshen #302). The words heter iska mean exactly that: performing an allowable business deal that is similar to a prohibited transaction. As we will see, the structure must still allow for an element of risk and loss as accepted by halacha, otherwise it fails the test of being an investment. 

There are several ways of structuring a heter iska, and indeed different situations may call for different types of heter iska. In order to explain how a basic heter iska operates, I must first explain an investment that involves no ribbis, so that we can understand how a heter iska was developed. For the balance of this article, we will no longer refer to “borrowers” and “lenders.” Instead, I will refer to a “managing partner” or “manager” and an “investor.”

THE EARLIEST HETER ISKA

The concept of heter iska is hundreds of years old. The earliest heter iska of which I am aware is suggested by the Terumas HaDeshen (1390- 1460). His case involves Reuven, who wishes to invest in interest-bearing loans to gentile customers, but does not want to take any risk. Shimon, who is an experienced broker of such loans, is willing to take the risk in return for some of the profit on Reuven’s money.

Reuven wants a guarantee that he will receive back all his capital regardless of what actually happens in the business venture. Essentially, this means that Shimon is borrowing money from Reuven and then lending it out to the gentiles; this would result in a straightforward Torah prohibition of ribbis, since Shimon is paying Reuven a return on the loan.

Is there any way that Reuven and Shimon can structure the deal without violating the Torah’s prohibitions against paying and receiving interest?

Actually, all the attempts at creating heter iska are attempts to find a balance whereby the investor is fairly secure that his assets are safe, and yet can generate profit.

PIKADON – INVESTING

Let me explain how a heter iska accomplishes both of these goals, by developing a case: Mr. Sweat has a business idea, but he lacks the capital to implement it. He approaches Mr. Bucks for investment capital. If Bucks has sufficient confidence in Sweat’s acumen to build a business, he might decide to invest even without knowing any details about it in the hope that Sweat’s idea will provide handsome profits. None of this involves any ribbis issues since there is no loan and no one is paying to use the other person’s capital. This business venture is called a pikadon.

GUARANTEEING THE INVESTMENT

Whenever an investor entrusts someone with funds, the Torah permits him to demand an oath afterwards that the manager was not negligent. Therefore, Bucks may insist that Sweat swears an oath that he was not negligent with the money and also that he reported exactly how much money Bucks is due. The heter iska agreement may even require that Sweat swears this oath by using G-d’s name and while holding a Sefer Torah in front of the entire congregation.

Since observant people would rather pay a substantial sum of money to avoid swearing an oath the money is safely secured. The heter iska specifies that the manager has the option of swearing the oath and paying only what the investor is entitled. However, the manager has the option of substituting an agreed upon payment for the oath. Since observant Jews would rather pay the fixed return rather than swear an oath, we accomplish that the investor is reasonably secure, although no loan and no ribbis transpired. The result is not a loan, but a cleverly structured investment.”

I need to explain one other very important detail that people often, unfortunately, overlook. Most forms of heter iska state that the investor paid the manager a specific sum of money, say one dollar, for his time involved in the business venture. It is vitally important that this dollar be actually paid; otherwise there is a ribbis prohibition involved. Yet I know that many people overlook this requirement and do not understand its importance.

STANDARD ISKA – A SILENT PARTNERSHIP

The standard heter iska assumes that the arrangement is half loan and half pikadon. This means that if Mr. Bucks invests $100,000 with Mr. Sweat to open a business, Mr. Bucks and Mr. Sweat become partners in the business because half of the amount is now a $50,000 loan that Mr. Sweat must eventually repay, and the other half is a $50,000 outlay that Mr. Bucks has now invested in a business that Mr. Sweat owns or intends to open. Bucks may receive no profit on the $50,000 loan he extended – if he does, it is prohibited ribbis. However, he may receive as much profit on the investment part of the portfolio as is generated by half the business. As a result, Mr. Bucks and Mr. Sweat are both 50% partners in the business.

RECEIVING PROFIT FROM THE LOAN

However, there is an interesting problem that we must resolve. Bucks invested a sum with Sweat, for which he received a profit, and he also loaned Sweat money, for which he may not receive any profit. However, the return on the investment was realized only because Mr. Sweat is investing his know how and labor to generate profit for the partnership – know how and labor that Bucks did not pay for. Why is this investment of services not considered payment for Mr. Bucks’ loan, and therefore a ribbis problem?

Indeed this concern is raised by the Gemara, which presents two methods to resolve the problem.

The first method is that the investor pays the manager a certain amount for his expertise and effort. As long as both parties agree in advance, we are unconcerned how little (or much) this amount is (Bava Metzia 68b). However, there must be an amount, and it must be actually paid. Even if they agree to a sum as paltry as one dollar, this is an acceptable arrangement, similar to Michael Bloomberg’s accepting one dollar as salary to be mayor of New York.

If Mr. Sweat receives no compensation for his hard work on behalf of Mr. Bucks’ investment, it demonstrates that he was working because he received a loan, which would be prohibited as ribbis.

However, there is another way to structure the heter iska so that this is not a problem. This is by having the profit and loss percentages vary. This means that if the business profits, the managing partner makes a larger part of the profit than he loses if there is a loss. For example, in the original deal, let us assume that our silent and managing partners will divide the profits, but in case of loss, our manager is responsible to pay only $30,000. This means that Sweat borrowed only $30,000 and therefore owns only 30% of the business, which should entitle him to only 30% of the profits. The extra 20% of the profits he receives is his salary for managing the business. He is therefore being paid a percentage of Bucks’ profits for his efforts, similar to the way a money manager or financial consultant is often compensated by receiving a percentage of the profits on the funds he manages.

The heter iska I have seen used by the Jewish owned banks in Israel includes this method. The bank invests 45% in a “business” managed by the mortgage borrower, but the borrower is entitled to 50% of the profits. Thus, he is “paid” five per cent of the bank’s profits for his services in managing the investment.

Now I will explain how the Terumas HaDeshen’s money lender would use a heter iska. Actually, his heter iska varied slightly from what we use today. Using today’s accepted heter iska, Shimon the manager accepts the money with the understanding that he is borrowing part and managing the balance for Reuven. He is compensated for his efforts according to one of the approaches mentioned above, and agrees in advance to divide the profits. He also agrees that he will swear an oath guaranteeing that he was not negligent in his responsibilities, and the two parties agree that if he subsequently chooses to pay Reuven a certain amount he is absolved of swearing the oath. Thus, Reuven’s return is not interest on a loan, but the amount Shimon had agreed to pay rather than swear how much he actually owes Reuven.

This approach has been accepted by thousands of halachic authorities as a valid method of receiving a return on one’s investment that looks like interest but is not. The Chofetz Chayim notes that if someone can lend money without compensation, he should certainly do so and not utilize a heter iska, because this is the mitzvah of performing chesed (Ahavas Chesed 2:15). Heter iska is meant for investment situations, and should ideally be limited to them.

I would like to close by sharing with you a thought from Rav Samson Raphael Hirsch about the reason why the Torah prohibited interest. He notes that if the Torah considered charging interest to be inherently immoral, it would have banned charging interest from non-Jews, and also would have prohibited only the lender and not the borrower. Rather, Rav Hirsch notes, the Torah’s prohibition is to demonstrate that the capital we receive from Hashem is so that we donate tzedakah and provide loans, and thereby fulfill our share in building and maintaining a Torah community. The Torah’s goal in banning the use of capital for interest-paying loans is to direct excess funds to chesed and tzedakah.

This was written by Rabbi Yirmiyahu Kaganoff Shlit”a and is being reprinted with his permission. To see more of his articles or for any questions you can visit his website http://rabbikaganoff.com/