Mr Cohen's textile business is in dire need of $100,000 working capital. So Cohen approaches Mr Mamon, a wealthy Jewish businessman. Mr. Mamon is prepared to lend Mr Cohen the money but would like to earn 10% interest on the loan and receive back $110,000. But this is not possible because Mr Cohen and Mr Mamon would be in violation of the prohibition against paying and receiving interest. Does this mean that Mr Cohen’s business must fail? No, it does not.
The Rabbis, sensitive to the important role of credit in an economy, permit one to structure the transaction as a partnership agreement rather than a loan agreement and to view the 10% as a return on investment rather than interest on a loan. This restructuring of the loan into a partnership agreement is known as “Heter Isko.” And this is how it works.
Mamon tells Cohen that they are setting up a partnership in which Mamon is providing the $100,000 as the investing, sleeping partner and Cohen is to invest the capital in a business venture as the managing partner. The partnership agreement, the “Heter Isko” between Cohen and Mamon further provides that a portion of the money, say $50,000 (it could be a lower or higher portion depending on the deal) is to be considered an equity investment in the business venture. The other $50,000 is to be considered a loan.
The equity portion of the capital is at risk and if it is lost in the business venture, Mamon will not get it back. The loan portion of the capital is not at risk, because, under the terms of the Heter Isko, Mamon will get it back whether the business prospers or fails. Profits and losses in this partnership agreement will be shared equally between the partners. If the business fails and all of the capital is lost, Mamon will be entitled to receive the repayment of the $50,000 loan portion but will lose the $50,000 equity portion.
If the business venture turns a profit of say $20,000, it is shared equally between the partners. Mamon will receive $110,000, being the return of the $50,000 loan, the return of the $50,000 equity investment and the payment of $10,000 profit from the investment. Cohen will keep $10,000 as his cut of the profit on the $50,000 loaned to Cohen by Mamon and invested by Cohen in the business venture.
As a result of restructuring the loan into a partnership agreement and the profit derived from the business venture, Mamon will come out in the same place as if he had loaned $100,000 and taken 10% interest.
But Mamon is still scratching his head. “What if there are no profits from the investment? Or worst still, what if all or part of the capital is lost? In a loan, I am entitled to the return of my money irrespective of the success or failure of the business venture and I want that degree of certainty here too.”
The Rabbis have a solution for this as well. The Heter Isko contains a provision that requires any loss of the principal to be verified by two witnesses. From a practical point of view, it will be extremely difficult for Cohen to produce two eligible witnesses to testify to the exact circumstances of the loss of principal. TheHeter Isko provides that in the absence of such witnesses, Mamon is entitled to the return of the entire $100,000.
The Heter Isko protects the return on the investment as well. It provides that if Cohen claims that the investment did not produce a profit, he must attest to this fact under solemn oath in the presence of a Bet Din. Since observant Jews will refrain from taking an oath under most circumstances, Mamon can be quite confident that Cohen would elect to pay the $10,000 out of his own pocket rather than swear that there were no profits.
The Heter Isko will also provide that Cohen is to receive compensation in exchange for his trouble in managing the partnership’s investment. Cohen’s management services cannot be provided free of charge to Mamon because this benefit would be deemed interest to Mamon on the $50,000 loan. The management fee can be a nominal fee of $1 or it can be in the form of a larger cut (a “carry”) of the partnership profits.
The person drafting the Heter Isko document must take care not to use the words “loan,” “interest,” “lender,” “borrower,” and other such language usually found in loan transactions.
Would-be critics of the Heter Isko will be reminded of the advice they may have received from their accountants or lawyers who structure deals in arcane ways to avoid taxation where the law permits it. The wrong word may cost money. As long as the transaction is conducted in accordance with the law it is legal. As long as the Heter Isko is written in accordance with the Halachah, it is legal too.
Raphael Grunfeld’s new book, “Ner Eyal on Seder Nashim & Nezikin” will be available shortly.