This is Not Interest

Question

Ezriel wishes to borrow a large sum of money from his
elderly uncle Shmelke. The uncle agrees, but since the money will come out
of his pension fund, which constitutes his main source of income, he
wishes to be compensated for loss of earnings. "To avoid ribbis
problems, we will draw up a heter iska document, " says Uncle
Shmelke. How does this work?


Answer

There are two main types of heter iska document
in use, each one based on a different law in Shulchan Oruch. In Yoreh
Deah
(177:2), the standard iska situation is discussed. When a
sum of money is given on iska terms, it is deemed to be half loan
and half deposit, the depositor receiving all or part of the profits. If
the recipient of the deposit invests the money on behalf of the depositor
without receiving payment for his work, this is seen as the equivalent of
payment for the loan section of the iska. Payment for a loan falls
under the prohibition of ribbis. It is therefore necessary for the
depositor to pay the investment manager for his efforts. This need only be
a token sum, if arranged at the time of deposit (see 177:3).

The Kitzur Shulchan Oruch (66:6)and Chochmas
Odom
(143) base their heter iska document on this law. Half the
sum given is deemed to be a straight loan. The sum lent is the sum to be
returned. The other half is a deposit, which remains the property of the
depositor throughout. The recipient agrees to invest this sum and share
both profits and losses equally with the depositor. However, the recipient
has the option of paying the depositor a fixed pre-arranged sum every
month or every year, in which case the depositor waives his right to
further profits. Furthermore, if the recipient returns deposit plus
earnings as per this alternative, no evidence is required as to the actual
performance of the investment. Additionally, in order to avoid the
recipient "paying" for the loan section of the sum, a (nominal)
fee will be paid to him for his work. (The Kitzur Shulchan Oruch
states that it is sufficient if the recipient just declares that he
has been paid for his work, even if no payment has actually been made.)

The Shulchan Oruch (167:1) also describes a
different type of arrangement. Reuven gives Shimon $1000 to invest on his
behalf. Once a certain level of profit has been realised (say, the $1000
investment is now worth $2000), the principal plus profit becomes a loan
to Shimon. This expanded loan is all that Shimon has to pay Reuven. As
long as Shimon is paid for acting as an investment manager, this type of
arrangement is permitted. If no payment were to be made for the investment
work, Shimon would be "paying" for the loan with his free work.
As above, a nominal fee is sufficient if pre-arranged. The Maharam
(quoted in Nachalas Shivah, No.40) bases his heter iska
document on this law. The recipient of the money acts as investment
manager until a pre-arranged level of profit is reached. At that stage,
the original sum plus profit is converted into a loan to him. He repays
this amount at the end of the loan period without any addition. Any
further profits are all his, since they are earned on his money. The
recipient is paid for his work as investment manager, since working for
free is viewed as payment for the loan. The Maharam added a clause
which obligates the recipient to bring witnesses if he claims that the sum
he received was lost. If he claims that he failed to make any profit on
the investment, he must take an oath to that effect. Should he be unable
or unwilling to produce witnesses or take an oath, he can fulfil his
obligation by repaying the principal plus a pre-arranged profit. The Vilna
Gaon is unhappy with this arrangement. He argues that it still looks like ribbis.
Our Sages permitted a genuine iska, where part of the sum remains a
deposit throughout. In this case, at a certain stage the entire sum
becomes a loan. What people will see is that the recipient received a
certain sum at the outset, but made a much larger loan repayment at
the end. The Shach (Note 2) argues that this situation is similar
to pre- or post-loan interest. Therefore, there are those who prefer the
previously described version. Other texts are also available.