What is a Heter Iska?
“Heter Iska” is a religious-law term that translates essentially to “Iska Loophole.” It consists of two parts: One, Iska and two, the loophole.
Loans, partnerships and business: the technical differences
To preface: While Torah law prohibits lending at interest, it does not prohibit commerce and the exchange of money. And here’s where details matter. A lot.
In Torah law, a loan is defined as a transaction involving a lender and a borrower—with the borrower bearing full responsibility for the full amount borrowed, even in the case of circumstances beyond his control, like fire or other loss of any part of the money. The borrower remains fully responsible to pay back in full.
In Torah law, a partnership is defined as two individuals investing money in the same single business—for example, each puts down $50,000. All profits generated by the business must be divided evenly between the two partners and likewise, all losses must be evenly absorbed.
In an Iska transaction, however, the terms “lender” and “borrower” are replaced with the terms “giver” and “receiver”—rendering any investor a “giver” and any day-to-day business manager a “receiver.” In Torah law, where there is giver and receiver, not lender and borrower, a receiver is responsible for only 50 percent of any funds lost—the remaining 50 percent is the responsibility of the giver.
For example, Reuben gives Simon $100,000 to invest in a soft-drink company. Simon serves as day-to-day CEO and actually runs the company. Reuben keeps his couch warm. Twelve months later, they review the books. Numbers are crunched, totals tallied, and profits evenly split. No profit? No split—and the business goes on as usual. But if the business fails and that $100,000 is lost, Simon only owes $50,000 to Reuben.
No one likes Iska
Well, Reuben won’t ever open his investor’s wallet again now, will he? And with Iska, who would? The risk of 50-percent loss is too high—never mind the ordinary risk of limited or no profit. Reuben would rather just go to your friendly neighborhood mainstream bank and borrow on interest—so as to lose neither the principal nor the profit.
You can imagine why no one wants to use Iska for business—the Iska law effectively keeps anyone from investing any money in any business.
In European Jewish history, this hesitance really kicked in around 1390—when one of the Jewish halachic leaders of the time, Rabbi Israel Isserlein (the author of the Trumas HaDeshen work on Jewish monetary law), wrote how people resisted lending money under Iska for fear of losing half their money.
Rabbi Isserlein worked on a Torah-complaint loophole to the problem—one that would allow people to provide less-risky loans. They wouldn’t require 100-percent repayment—that would make them full-blown loans, not Iska loans. But they’d still require payback of far more than 50 percent.
Rabbi Isserlein thus created the Heter Iska. In this arrangement, any investor’s claim of loss against any manager would have to be verified by the testimony of two witnesses who are experts in the business in question.
The Heter Iska, explained
So, if the expert witnesses wouldn’t know enough about what happened to the money in question, they would be unable to provide expert testimony. As a result, the manager would then have to repay the investor’s entire principle, including his half. The result was that the investor would be virtually insured for all his investment.
[Despite the fact that the entire goal here is to secure the principal amount, not to declare that the investor and/or manager are not to be believed, it still constitutes interest under Rabbinical law because even the receiver guarantees the principal in full. But since he does not guarantee profits except those that actually materialize, the investor may earn nothing. As such, it’s only interest under Rabbinical law, because Torah law only prohibits interest when both principal and profit are guaranteed. And with the prohibition of Rabbinical interest, one is indeed permitted to find ways of guaranteeing the money.]
But that only takes care of his principal. What about any profit?
So in the early 1600s, the chief justice of the Jewish community court of Cracow, Poland formulated a Heter Iska that covered profits, too. Under his Heter Iska, any receiver testifying that a business produced no profit, or not as much profit as initially projected, is only believed upon taking an oath. The purpose of the oath is to clarify that either he dealt honestly with the money and is telling the truth, or he is not believed until he swears while holding a Torah scroll and testifying before a legitimate Torah court.
And since taking an oath about something already true is highly frowned upon, the result is that if the receiver does not wish to take an oath, he’ll end up paying some specified percent on the money—and thus be exempt from taking any oath. This is because we initially estimate that the receiver’s half can include the sum of the interest.
For example, if the investor gave the receiver $100,000, in the event that the receiver must take an oath regarding any profit and does not wish to do so, he has the option to pay the investor $12,000. This is because, in this particular case, the business was supposed to generate $24,000—which is 24 percent of the $100,000 investment. And of that, half—meaning, $12,000—would have to go to the investor, and the other half, $12,000, would go to the receiver.
But here, where the receiver does not wish to take an oath, even if he is telling the truth, he must pay the investor $12,000 to thus be relieved of his obligation to swear. This mechanism is known as compromise incentive—meaning, that the money incentivizes the compromise of not swearing.
And that is the fundamental definition of the Heter Iska.
For further rules of Heter Iska, see Mishpat HaRibis and Mishnas HaRibis.