At Patron Law, we have worked and continue to work closely with the members of the Rabbinical Court of the Union of Orthodox Hebrew Congregations (UOHC) and a range of lender and borrowers, including short-term finance providers (bridging lenders), to develop specialist Heter Iska documents that are fit for the modern world of commercial secured lending.
We regularly advise clients active in the bridging finance industry on the implementation of a Heter Iska into their suite of lending documents. This includes both traditional lenders, institutional lenders and regulated firms such as peer-2-peer secured lenders specialising in real estate investment and development.
What is a Heter Iska?
A Heter Iska is a Jewish religious compliance document which is used where a lender and borrower are both of the Jewish faith, to achieve compliance with Jewish religious rules against the charging or paying of interest on loans between members of the Jewish faith. It operates as an addendum to any other lending or security documents entered into by the parties (the Loan Documents).
Under the terms of the Heter Iska, the loan relationship between the lender and the borrower established in the Loan Documents is re-cast as an investment partnership relationship. In the investment partnership, the lender adopts the role of investing partner, and the borrower adopts the role of managing partner. The funds advanced by the lender under the Loan Documents are sub-divided so that 50% of the funds are an interest-free loan from the lender to the borrower, and 50% are treated as an investment by the lender in the borrower’s real estate investment business in England & Wales. The interest payment obligations due from the borrower to the lender under the Loan Documents are re-cast as obligations for the borrower to pay to the lender its share of the profits from the investment which the lender has invested in. The fundamental effect of reconstituting 50% of the loan as an investment is that the lender is considered to be participating in the risk of the borrower’s real estate investment portfolio. As such, it circumvents Jewish religious restrictions against interest-bearing loans between a borrower and lender who are both of the Jewish faith. However, as set out below, the Heter Iska also contains numerous safeguards which protect the lender’s position against such risk.
LendCo advances a loan of £100,000 to Mr A Borrows for a 12 month term with interest of 5% per annum. 50% of the loan, or £50,000, is treated as a repayable interest-free loan, and 50%, or £50,000, is an investment into Mr Borrows’s real estate business. Mr Borrows would be required to pay profits from the investments to LendCo at a rate of 10% of the investment portion per annum. This results in Mr Borrows paying £5,000 to the lender per annum, as investment profits, equivalent to paying 5% interest on the loan.
When is a Heter Iska needed?
The Heter Iska is only required for loans between Jewish counterparties, irrespective of whether they are individuals or incorporated entities. A company could be deemed to be Jewish for purposes of the Heter Iska in various scenarios, for example, having a Jewish shareholder, or a Jewish director that is responsible for lending and borrowing. A company with a minority Jewish shareholder with less than 5% of the company’s share capital would generally not need a Heter Iska. If a company had a Jewish shareholder with at least 20% of the shares, that is likely to be significant and a Heter Iska would usually be required. Each scenario needs to be assessed individually, in particular for cases of Jewish shareholders with between 5 – 20% of the shares.
If the lender’s capital is derived from a variety of investors (Funders), not all of whom require a Heter Iska, the Heter Iska stipulates that its application is limited to Relevant Capital. Relevant Capital is defined as the portion of the loan capital that is provided by Jewish Funders. In any case of doubt, a Jewish religious court (Beth Din) is ready to adjudicate whether the Heter Iska has application. Non-Relevant Capital, i.e. funds advanced from a Funder that is not Jewish, falls outside of the application of the Heter Iska, and the Loan Documents between the borrower and the lender are not subject to its provisions in relation to that capital. This applies to company shareholders as well. If a lender company has a Jewish shareholder with 30% of the shares, and no external capital participates in the loan, only 30% of the loan is regarded as Relevant Capital. Relevant Capital and Non-Relevant Capital rank parri passu at all times.
BridgeCo lends £300,000 to DevelopCo, a company that is wholly owned by Jewish shareholders, to purchase and redevelop a property. BridgeCo’s directors and shareholders are not Jewish, but the capital used for the loan to DevelopCo is originated 50%, or £150,000 from external Jewish Funders, i.e. Relevant Capital. The Heter Iska only applies to £150,000 of Relevant Capital. Of the Relevant Capital, only 50%, or £75,000, constitutes an investment under the Heter Iska.