A Heter iska is a financing structure that is designed to closely mimic a classic interest-bearing loan while complying with Halacha. It accomplishes this by re-characterizing the transaction as a partnership investment. The “lender” is considered the investor, while the “borrower” is the Recipient. Under the terms of the Iska, the investor and recipient share all profits and losses equally. However, the purpose of the Heter Iska is to minimize the “lender’s” risk, and to allow the “borrower” to retain the bulk of the profits. These goals are accomplished by created a very difficult burden of proof on the recipient of the Heter Iska- he must verify any alleged loss of principal in a Beth Din Arbitration Panel via two witnesses that can directly account for the investment. Any claim regarding the profits generated must be verified with a solemn oath, administered by the Beth Din Panel. For a number of reasons, it is extremely difficult for the recipient/borrower to actually meet these burdens of proof. Because the recipient/borrower generally cannot, or will not, meet his required burden of proof, he is given a second option. He may pay the investor/lender the agreed upon amount (equal to the “interest rate”), and by doing so, he buys out the investor/lender’s share of the Heter Iska investment.
What emerges is a relationship that is nominally a partnership, but, as a matter of practice, virtually always mimics a traditional loan. Indeed, the entire Israeli banking industry operates under the Heter Iska framework, and it is unheard of for a borrower to successfully default on the principal by meeting the Heter Iska burden of proof. Nevertheless, the possibility of it occurring is sufficient to make the transaction permissible from a halachic standpoint.
Parties to a Heter Iska typically execute two sets of documents. A Heter Iska is executed to make the transaction permissible from a halachic viewpoint, while traditional promissory note and mortgage are executed to allow the lender to protect his rights in the event that the borrower defaults, and is unable to meet the burden of proof required under the Iska.
An Iska also contains a nominal ‘management fee’ paid by the Investor to the Recipient for managing the Iska investment. It is typically a one dollar payment, or in the alternative, an extra share of the profits that the Recipient receives for his services. In the typical case that the Recipient does not actually prove the level of profits or losses but rather pays the agreed upon ‘buyout’ fee, the management fee is built in to the settlement amount.