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Ribit Revisited - A Commercial Conundrum: Does Prudence Permit the Jewish "Permissible Venture?"
Prof. Steven H. Resnicoff



1. Partnership features

A number of the features of a permissible venture may lead to its characterization as a partnership rather than as a loan. For example, in a permissible venture the Financier invests in the Recipient's business, and the Financier shares in the profits of the business. Further, the Financier, at least to the extent of his investment, shares in the losses of the business and there is no unconditional obligation on the Recipient to repay the investment. Additionally, in a permissible venture, the Financier may possess certain implicit or explicit powers of control over the business.

Several legal commentators, including law professors, have described the permissible venture as a "partnership"25 without any qualification suggesting that it was a partnership only under Jewish law. Rather, the implication was that it constituted a partnership under secular law as well. One professor has concluded, apparently approvingly, that "the...[permissible venture] has...been recognized by the civil courts as an instrument creating a bona fide partnership..."26

2. Circumstances enhancing the risk

Several factors increase the practical risk that a permissible venture will be treated as a secular partnership. First, permissible venture agreements are often improperly drafted. Not only do they needlessly omit terms which would evidence the parties' intent not to create a partnership, but they frequently contain affirmatively misleading language as well.

As is discussed in Part III, infra, one of the crucial issues a court considers in determining whether a partnership was formed is the intent of the parties. Where the parties agree to provisions uncharacteristic of a partnership, a court would be more inclined to find that the parties did not intend to create a partnership. Thus, for example, by including in the permissible venture agreement the "shutfus" restrictions referred to in Part II, Section D, above, a draftsman could improve the probability that the venture will be treated as a loan.

Unfortunately, the permissible venture agreement is ordinarily prepared by rabbinic scholars whose knowledge of applicable commercial law concepts or rules, and, sometimes even of English, is limited. Attorneys are in most cases excluded from document preparation because the parties believe that the agreement is, at least as a practical matter, of religious significance only, and they advise their attorneys accordingly. In fact, the parties may not even inform their attorneys that a permissible venture agreement will be executed.

Drafting problems often result in the permissible venture agreement. For example, the agreement may neglect to limit the extent of the Financier's liability in the event that the venture sustains net losses. Although under Jewish law a Financier need not be personally liable for such losses, a typical permissible venture form contains the following provision:

"I (we) the undersigned do hereby state that I (we) have received from _________________ the sum of _________________ to be returned _____________________ which shall be used in the form of a joint business venture. All of the profit that I (we) may earn as a result of the said _________________________ which is to be used in the business venture shall be divided equally, i.e. 50% shall inure to the benefit of myself (ourselves) with the other 50% going to the...[Financier]. The same____ shall apply to any losses in the above business venture." [Emphasis added]

The final clause seems to render the Financier personally liable for fifty percent of all partnership losses rather than limiting his liability to the extent of his investment. Yet, this departure from the shutfus approach is usually inadvertent.27

Another example is the use of terms such as "partnership" or, as in the excerpt above, "joint business venture," to characterize the Financier-Recipient relationship. Such phraseology is innocently intended as an approximate translation for the word "shutfus," but not as a technical term of art. Yet use of such terms could be construed as incorporating into the agreement all of the legal baggage attendant to a secular partnership. Triers of fact are likely to be unfamiliar with the intricacies or nuances of Jewish law and may be predisposed to rely on the rules of secular partnership law unless the agreement undeniably evidences a contrary intention.

>3. The "wild-card" of judicial review

Whether a partnership was established is a fact sensitive question requiring a case by case determination. The terms of permissible venture documentation, as well as applicable correspondence or admissible parol evidence, vary from case to case. Consequently, parties must fear that their permissible venture may be construed as a partnership even if agreements in arguably similar situations have been treated as loans.

The vagaries of such judicial review are clear from the relatively few reported United States cases,28 which arguably reach differing conclusions. In any event, the facts of most of these decisions make them unreliable precedents and underscore the risks inherent in case by case adjudication process.

The first of these cases, Barclay Commerce Corp. v. Finkelstein,29 was decided in 1960. The plaintiff sued, inter alia, individual defendants on their written personal guarantees of moneys due pursuant to a factoring agreement between the plaintiff and the corporate defendant. The individual defendants asserted that a permissible venture agreement that had been executed established a joint venture between them and the plaintiff. The court, however, accepted the plaintiff's argument that the permissible venture agreement was "merely a compliance in form with Hebraic law" and neither created nor intended to create a partnership. Nevertheless, in articulating its ruling, the court curiously stated that "its purpose is not contradicted by the defendants . . ."30

In a 1968 decision, Leibovici v. Rawicki,31 the Recipient refused to repay the Financier the agreed rate of interest, claiming that the interest was usurious.32 The Financier gave the Recipient $5,000 "for the purpose of investing the same in the Real Estate field, Apartment Houses, Office Buildings, Mortgages, Real Estate Improvements, etc."33 The written agreement between the parties provided that the Recipient guaranteed return of the Financier's principal34 and that the Financier would receive profits, if any, up to a maximum of ten percent per annum of the monies advanced. The contract recited that it would be subject to a permissible venture agreement, but there was no explanation of the terms of the agreement other than to state that it forbade the receipt or payment of interest.35 Moreover, no executed permissible venture document was ever submitted to the court.36

At the time of the transaction, the charging of ten percent annual interest on a loan would, under applicable New York law, have been usurious.37 The court stated that an "[i]ntent to overcharge is an essential and necessary element of usury."38 Although the permissible venture agreement was not part of the record, the court found that references to the permissible venture in the parties' agreement and in a subsequent letter were "helpful in arriving at the intention of the parties."39 In concluding that the transaction was not usurious, the court held that an "investment . . . in the nature of a joint venture is not converted into a loan of money, and therefore usurious, by the fact that one party guarantees the other against loss. . . and that his profits shall amount to a certain sum."40 Thus the court, at least arguably, treated the relationship between the parties as a joint venture.41

Although a version of a permissible venture agreement proposed by one of the parties was presented to the court, the court noted that this had not been signed by the other party and treated it as non-binding. The court neither identified, nor addressed the significance of the terms typical of permissible ventures such as the presumption of profits, the elevated substantive and procedural burden of proof required to rebut this presumption and to prove losses, and the Recipient's requirement to repay all monies advanced by the Financier on a specified date, net of any pro rata losses. Yet these are precisely the terms which manifest the parties' intention that the permissible venture be the functional equivalent of a loan. Consequently, the Leibovici result appears to be a poor basis for predictions regarding future cases.

In a 1985 case, Bollag v. Dresdner,42 the court considered a case where the Financier gave the Recipient $15,000 to be used for business purposes.43 Soon thereafter, the parties signed a permissible venture agreement which stipulated the amount, the terms and the conditions of the arrangement.44 The agreement stated that the Recipient received $15,000 for a business investment from which the Recipient would share his profit with the Financier.45 The court concluded that substance, not form, controlled characterization of the venture, noting that "[a] transaction must be considered in its totality and judged by its real character, rather than by the name, color, or form which the parties assign to it." It therefore ruled that the transaction was a loan, not an investment.46

In reaching its conclusion, the Bollag court weighed various complicating factors. For example, the Financier testified at trial that, despite the express terms of the permissible venture to the contrary, he did not agree to share in the Recipient's losses.47 He also maintained that the Recipient was unconditionally obligated to repay the principal amount.48 In addition, a rabbi called as an expert witness as to Jewish law testified for the Financier that the permissible venture did not create a partnership.49 The court concluded, based on an analysis of the substantive terms of the permissible venture "as interpreted by the parties and their witnesses," that the transaction was a loan, not an investment.50 The court may have ruled differently had the testimony supported the explicit content of the permissible venture agreement.

In Arnav Industries Inc. Employee Retirement Trust v. Westside Realty Associates,51 the parties did not assert that any separate permissible venture agreement was executed. Instead, the Hebrew phrase "Al pi heter iska" was inserted above the signature on the promissory note signed by the debtor. This phrase essentially means "Based on a permissible venture agreement." Clause 16 of the promissory note, however, stated that "Nothing herein or in the Mortgage is intended to create a joint venture, partnership, tenancy-in-common, or joint tenancy relationship between Borrower and Lender, . . ." Citing this express language and emphasizing the absence of any separate permissible venture agreement that could be asserted to alter this language, the court ruled that the inserted phrase "Al pi heter iska" created no ambiguity as to the parties' debtor-creditor relationship and granted the plaintiff summary judgment on its foreclosure action.

The most recent case, Heimbinder v. Berkovitz,52 involved a loan from the plaintiff to a corporation. At the closing, one of the borrower's shareholders, Joseph Berkovitz,53 produced a permissible venture document, and insisted that it be executed. The plaintiff could not understand the document, which was written in Hebrew, until Berkovitz translated it into English. The plaintiff later asserted that the document constituted Berkovitz's personal guarantee for the debt. The court rejected this position, finding that the parties did not intend for Berkovitz to be personally liable for the debt. The court emphasized the fact that, prior to the closing, Berkovitz had rejected the plaintiff's request that he personally guarantee the loan. In addition, the court noted that at the closing it was Berkovitz, not the plaintiff, who insisted that the permissible venture agreement be signed.

These cases do not provide clear guidance as to how future courts will rule in particular scenarios. However, it is apparent that parties cannot reasonably proceed on the purblind assumption that, irrespective of the precise terms of applicable documentation and the substance of any discussions between parties, a court will treat a permissible venture as a loan.


Treatment of a permissible venture as a partnership rather than a loan would have a number of adverse ramifications for the Financier and Recipient.54

1. Joint and several liability

Partners are jointly and severally liable for partnership obligations.55 This liability attaches even to a person not known by a creditor to have been a partner56 or to a "silent partner" who exercises no control over the partnership business.57 If secular law treats the permissible venture as a partnership, the Financier will be jointly and severally liable for the liabilities of the business conducted by the Recipient.58

In addition, the Financier could not necessarily protect himself from joint and several liability as a partner by simply adding to the permissible venture a clause stating that his liability would be limited to the amount of the Financier's "investment."59 It seems well-established that "[i]f an intent to do those things which constitute a partnership exists, the parties will be considered partners even though they intended to avoid the liability attaching to partners, or expressly stipulated in their agreement that they were not to become partners."60

The Financier could not avoid classification as a partner by obtaining an indemnification and hold harmless agreement from the Recipient for any losses in excess of the Financier's original investment in the partnership.61 The Recipient simply may not have enough money to pay the entire liability, and no such agreement could bar third party claimants from directly pursuing the Financier.62

2. Federal tax consequences

A finding that a permissible venture creates a partnership may lead to unexpectedly large tax liability, denial of tax deductions63 and tax reporting violations.

In 1984, an imputed interest provision was incorporated into the federal tax code.64 Subject to exceptions not here pertinent, this law applies to loans which are nominally "interest-free" and treats them as if interest had been charged and collected by the lender. The lender is therefore treated as having received taxable interest income. In the permissible venture agreement, half of the funds advanced by the Financier are provided as an interest-free loan. If Section 7872 applies, the Financier may be treated as having received imputed payments of taxable interest on that loan.

The periodic payments provided in the permissible venture agreement, on the other hand, are characterized as a return on the Financier's investment. Any excess over the amount invested may be taxable either as investment profits or an payments in lieu of such profits. If a court treated the entire permissible venture as a disguised loan, the Financier's taxable income would probably be limited to the excess of the investment, imputing no additional interest.65

If a permissible venture were treated for tax purposes as a valid partnership, the monies paid by the Recipient to the Financier represent profits or a payment in lieu of profits, not interest. Thus, if a Recipient obtains money from a bank pursuant to a permissible venture agreement, the money paid by the Recipient might not be deductible as a payment of interest.66 Because the ability to deduct interest payments is a critical factor in financial planning, the impact of this possible pitfall would be significant.

Moreover, lending institutions are customarily required to record and report to federal and state taxing authorities regarding the amount of "interest" paid to their customers. A holding that permissible ventures constitute partnerships may mean that many of these institutions have improperly reported partnership profits as interest.

3. Proscribed activities

If permissible ventures are deemed partnerships, lending institutions which participate in them may also be found to have violated various laws or contractual obligations. For example, many banks and savings and loan associations are prohibited, under state law,67 federal law68 and/or agreements entered into with the Federal Deposit Insurance Corporation69 from entering into partnerships or engaging in the types of businesses which are commonly pursued by the Recipients.

4. Deposit insurance

Another potential pitfall arises when a lending institution is the "Recipient" and someone else is the Financier, such as when a person opens a savings account with a bank. It is unclear whether the entire amount "deposited" will be entitled to Federal Deposit Insurance or Federal Savings and Loan Deposit Insurance. When a depositor makes an ordinary deposit, he loans the entire amount to the depositee.70 Under a permissible venture, half of the money "deposited" is an investment by the depositor and not a loan. It is possible that the aforesaid policies of insurance would not protect depositor investments.

5. Securities laws

Various federal and state securities laws and regulations require reporting and disclosure regarding an entity's financial status. A Financier to whom these requirements apply will be obligated to determine how to characterize the moneys advanced to the Recipient. In addition, it must decide whether to disclose its potential exposure as a partner for prospective losses of the venture or to refer to any of the other possible problems discussed in the preceding Sub-sections of this Part II.

6. Fiduciary responsibilities

One commentator has pointed out that state laws customarily impose on partners certain fiduciary responsibilities. He correctly argues that, if a permissible venture arrangement is treated as a partnership, such state laws could cause unanticipated legal complications.71

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