The Origin of Non- Recourse Mortgage Financing: How

The Origin of Non-Recourse Mortgage Financing: How Ancient Is This Seemingly Modern Financing Technique and Is It Perhaps Sha'ariah and Halachically Compliant?

Leonard Grunstein*

This article explains the modern non-recourse mortgage nancing structure, traces its origins, and suggests that, conceptually, the non-recourse nancing format bears more than a passing resemblance to three nancing forms in use in medieval times, known as the Iska, Qirad, and Commenda. These forms enabled the nancing of trade and business. They also provided for an interest-like return to the nancier, in many cases, without falling astray of the Biblical prohibition against making interest-bearing loans.

It is common practice to nance com- somewhat of a misnomer, however, since it mercial real estate transactions through an does not mean that there is no liability at all. interest-bearing mortgage loan. At its most Rather, the term denotes that there is, gener- basic level, the loan is typically evidenced by ally, no personal liability for repayment of the a note that is secured by a mortgage1 against loan. Instead, the sole recourse is against the the real estate and an assignment of the real estate, encumbered by the mortgage, rents. This structure underlies the nancing which secures repayment of the loan. This of oce, retail, industrial, hotel, multi-family, non-recourse nature of CMBS nancing dis- healthcare and other types of income pro- tinguishes it from other types of mortgage ducing real estate. It is one of the structural nancing, where the borrower is personally components of the nancial product known liable under the note for the debt. as commercial mortgage backed securities (“CMBS”).2 How did non-recourse nancing come into practice? Was it invented as a part of the Introduction CMBS phenomenon or is it an older formulation? Indeed, could it be ancient in origin? The modern CMBS loan is formulated based on a so-called non-recourse mortgage This article suggests that, conceptually, loan structure. The term non-recourse is the non-recourse nancing format bears

*Leonard Grunstein, who was a senior partner at Troutman, Sanders and head of its Real Estate Equity and Capital Markets Group before retiring, is currently a managing member of a private equity rm specializing in health care and real estate. He can be reached at [email protected].

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 9 The Real Estate Finance Journal more than a passing resemblance to three It was after this period that the Islamic form nancing forms in use in medieval times, known as a Qirad (or Mudarabah) likely made known as the Iska,3 Qirad,4 and Commenda.5 its appearance. Christian Europe later ad- These forms enabled the nancing of trade opted a similar format, known as the Com- and business. They also provided for an menda, in the medieval period. The Iska interest-like return to the nancier, in many format also continued to develop. cases, without falling astray of the Biblical prohibition against making interest-bearing In the global economy of the medieval pe- loans. riod, the Iska and Qirad enabled business to be done among lenders and borrowers from This is interesting on a number of levels. dierent countries and seemingly disparate Of course, knowing when and where a useful systems of law and culture. As evidenced by idea was rst formulated is noteworthy from documents found in the Cairo Geniza12 and an historical point of view. But, this analysis elsewhere, there was a commonality of ap- may also yield a result that is most useful, in proach to dealing with lender and borrower terms of modern nancing techniques, as concerns. This was, likely, because of shared well. Understanding why these medieval values and similar supervening religious nancing structures were permitted despite considerations about charging interest, the dominant culture disdaining interest- among individuals of the Jewish, Christian bearing loans might help us adapt existing and Muslim faith. These medieval nancing nancing products to meet similar present forms successfully embraced the purely day concerns. Imagine having a universal nancial demands of the marketplace in a CMBS-like nancial product that permits the manner that also accommodated the religious free ow of capital, through the capital sensitivities of the participants. It is not markets, from sources of capital adhering to suprising then that these nancing forms the Halacha6 and Sha'ariah7 to those in need. were similar in conceptualization; even if not in every detail of execution? There are non-recourse nancing techniques signicantly more ancient in origin The non-recourse and limited recourse than the medieval forms noted above. One of nancing structures noted above were an in- the earliest recorded non-recourse nancing tegral and essential part of medieval structures is reported in the second century commerce. As market conditions have Mishna.8 Limited recourse nancing forms9 changed in the centuries since that time, so are also discussed in the Mishna. Both non- have the terms of nancing. However, it ap- recourse and limited recourse structures are pears we have now come full circle and re- 10 described in the Jerusalem Talmud, which engaged with ancient nancing concepts that was compiled during the fourth century. The ourished in the medieval period. limited recourse model of the Mishna is reected in the form of Iska reported in the The Iska, Qirad, and Commenda address Babylonian Talmud11 of the sixth century. the kind of issues covered by modern nanc- However, there are non-recourse versions of ing forms in similar fashion. Concepts of risk the Iska, as well. There are also other limited of loss, the apportionment of risks, exculpa- or non-recourse nancing models discussed tion from personal liability and carve-outs to in the Jerusalem Talmud and Babylonian exculpation (providing for full or limited li- Talmud, as summarized below. ability), appear to have developed early on.

These forms sought to accommodate and understand the religious principles, which balance both the needs of the lender securely prohibit a loan on interest and yet permit to deploy capital and those of the borrower these nancing forms. In a classical Biblical to obtain funding, without requiring either to loan, the borrower bears all of the risks and take unreasonable risks. As might be ex- must repay the funds advanced under all pected, the terms of nancing appear to have circumstances. The return earned by the changed over time, in response to the ebb lender in this kind of a loan transaction is and ow of demand in the marketplace. deemed prohibited interest. However, if the borrower is not personally liable and lender The religious principles and practices, bears all of the risk of loss, then the nanc- which drove these nancing structures, ing is usually not considered a traditional loan served to enable business, rather than pro- transaction. As a result, the return earned on scribe it. Medieval religious authorities paid a the money advanced by the lender is often great deal of attention to the fundamental not considered prohibited interest. There are concerns of how lenders might employ capital also intermediate positions, where the risk of to make a reasonable and secure return and loss is shared on some agreed upon basis how borrowers might access needed capital by the parties. The details of when and to to nance trade and commerce. What what extent each party bears some of the emerged were nancing forms that were risks of loss are cogent. There are also dif- functional and did not fall astray of religious ferences among and within the body of mandates forbidding the making of interest- religious laws embodied by the Halacha, bearing loans. As noted above, conceptually, Sha'ariah and medieval Christian14 thought. A these forms bear a striking resemblance to careful analysis of what risks may be borne modern non-recourse nancing techniques. by the borrower and the extent of liability This is most refreshing given the absolute can yield insights into the very essence of pronouncements by some denouncing13 the why one type of nancing form may be charging of interest, no matter what the permitted, while another one is deemed a circumstances. These purported religious prohibited interest-bearing loan. A review of spokesmen are often so doctrinaire in their the documentary forms extant, referenced by approach that they fail to address these religious authorities, provides insights into permitted nancing forms used since medi- the nuances of just what is permitted or eval times. While some seek to use religion, prohibited. Thus, a borrower may properly as a divisive force, this article nds that agree to a variety of terms, conditions and shared values and similar nancing concepts obligations. Violating them might convert an were employed to break down barriers and otherwise non-recourse nancing into a re- foster trade and could do so again. Express- course loan. The menu of permitted cove- ing these ancient concepts in modern terms nants in the medieval nancing forms is simi- will hopefully shed light on just what is lar, in many respects, to the carve-outs to prohibited and what is not and will put seem- exculpation in CMBS nancing forms. ingly modern non-recourse nancing in a new The current CMBS non-recourse nancing perspective. structure, like the medieval and more ancient To better appreciate the nature of these forms before it, was designed to accom- medieval nancing forms, it is important to modate prevailing business and nancing

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 11 The Real Estate Finance Journal practices. It is suggested that, conceptually, agreement. When real estate is sold subject much like the antecedent medieval nancing to a mortgage, there is no privity of contract forms, the CMBS format may similarly be between the mortgagee and the new owner, exempt under the Halacha, Sha'ariah and unless there is an assumption by the new Canon law15 from concerns about the charg- owner of the mortgage encumbering the ing of interest (whether termed Ribit,16 Riba17 property.21 Nevertheless, because of the or Usury,18 respectively). concept of privity of estate, the new owner takes title to the real estate, subject to the The CMBS Non-Recourse Financing terms and conditions of the mortgage. This Structure means if the mortgage payments are not The modern CMBS mortgage structure is made, then the mortgagee can foreclose reported to have originated in the late 1980s against the property. However, absent an and the issuance of CMBS began in earnest express assumption of the mortgage and in the early 1990s. However, there were an- underlying debt obligation represented by the tecedents,19 dating back to the beginning of note, the mortgagee cannot sue the new the 1980s, including the syndication of owner personally to enforce the note. It may interests in mortgages, pioneered by the only proceed against the mortgaged property. investment rm Drexel Burnham.20 Functionally, this is the equivalent of a non- recourse mortgage nancing. As noted above, CMBS mortgages are often characterized by the term non- It should also be noted, when it comes to a recourse. The concept of non-recourse mortgage and real estate, contract rights may mortgage nancing was developed before not necessarily be enforceable in quite the CMBS made its debut. However, prior to the same manner as is the case with other 1980s, it was often accomplished using other agreements. In the real world of real estate, formats and techniques that were not as ele- including matters of title, mortgage liens, pos- gant as those used in CMBS nancings. sessory rights, the New York rule of election of remedies22 and the equitable remedy of In 1975, achieving a non-recourse mort- foreclosure,23 there may be intervening or gage was viewed as a structural exercise. It other factors that qualify the kind of relief was not just a matter of drafting an exculpa- that can be obtained.24 In order to access the tion clause; it was more complicated than value of the real estate that is the security that, at the time. for a non-recourse mortgage nancing, the lender is sometimes required to foreclose Real estate is a unique asset category against the property. This is the legal pro- under the law. It has many benets as com- cess whereby the borrower's rights, as the pared to other asset classes; but it is also owner of the real estate (including the so- burdened with certain complications. In deal- called equity of redemption25), as well as, any ing with real estate, there is so called privity other subordinate claims to and liens encum- of estate and privity of contract. These two bering title to the real property, are cut o. existential states can sometimes be in This is also a necessary prelude to obtaining conict. possession of the real estate, subject to the usual non-borrower tenants' rights.26 Being a party to a contract creates privity of contract with the other parties to the The concepts of privity of contract and

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 12 The Origin of Non-Recourse Mortgage Financing privity of estate were used to good eect in to learn that the bank had called and agreed constructing what amounts to a non-recourse to the needed changes. mortgage nancing, prior to the advent of CMBS. Under this structure, title to the real At the time, non-recourse nancing was estate was rst conveyed to a corporation, not a nancial product prevalent at banks, newly formed for that purpose. The corpora- generally; especially, non-money center tion entered into the mortgage loan, which banks. Indeed, in the late 1980s, I was did not contain the exculpatory provisions27 involved in working out non-recourse mort- typically found in a CMBS nancing. The loan gage loans that had been syndicated by was fully recourse against the corporate Drexel Burnham to banks and other nancial borrower. However, the newly formed corpo- institutions, nationwide. Meetings were held ration had only one genuine asset; the real with groups of lenders holding interests in estate encumbered by the mortgage. Next, the morgages to review the status of the title to the property was then usually trans- mortgages and the workout strategy. At one ferred to a limited partnership, owned by the such meeting, with representatives of ap- actual principals in the transaction. A limited proximately two-dozen banks, I was asked partnership entity28 was typically used to to explain the meaning of a non-recourse achieve both limited liability and the benets mortgage. Many in attendance were aston- of a pass-through of income29 and deprecia- ished that the borrowers were not personally tion deductions.30 These are important fea- liable for the debt. The concept was foreign tures that characterize the ownership of to their experience. commercial real estate. The partnership, as While the unique characteristics of the as- the new owner of the real estate did not set class of real estate are sometimes expressly assume the mortgage. It was, in burdensome to a lender, they are generally eect, burdened with responsibility for repay- most benecial. The lender may realize a ment of the mortgage; but only to the extent secure and priority rst mortgage lien on the of the real estate itself. There was no per- real estate and, by extension, the rents sonal obligation because there was no con- derived from the property. Other debts tractual assumption of the mortgage and the incurred by the borrower, with limited excep- underlying debt obligation. The net result was tions,32 are subject and subordinate to the a non-recourse mortgage nancing that lien of the rst mortgage nancing. This de- burdened the real estate; but not the other spite the fact that these very debts33 may assets of the ownership entity or the personal have been incurred in providing services to assets of the principals. tenants needed to yield the rent. Indeed, the ability to compartmentalize the real estate As time went on, borrowers demanded and has powered an entire real estate nance lenders accommodated the need to have an industry. It is not a typical loan to a business, express exculpatory provision in the mort- with all of the attendant underwriting con- gage documents.31 I remember well having to cerns about other intervening creditors and adjourn a closing in the early 1980s, because the complications of running a business. the exculpation language was not quite right. Legally, the real estate asset (and, by exten- As a young attorney, I was concerned that I sion, so too the rents) can be segregated may have made the wrong judgment call. from the business of the tenants at the prop- When I returned to the oce, I was gratied erty paying the rent.

As a corollary to this nancing structure, tionship with the bank. After all, when a bank the need for personal liability of the borrower has a relationship with its customer, then why is diminished. Indeed, it may even complicate not seek to be as secure as possible. Bank what, at its very essence, is a simple nancial culture, therefore, often demands that a model. It is an asset-based loan and the as- personal guarantee of the customer be set is unique because it can continue to obtained, even when it's not necessary, generate its own income, even if the borrower nancially, as credit support for a fully is no longer there. Indeed, if the borrower's secured rst mortgage loan. Why articially personal net worth is needed to support the exculpate the customer from personal liability underwriting of the loan, then it probably is for a loan; it's all part of the overall not the sort of loan that should be pooled relationship. This is unlike an originator in the with others and made a part of a CMBS CMBS market, which is vitally interested in nancing. Each commercial mortgage loan is disentangling the mortgage loan from the required to stand on its own and be under- borrower's other nancial aairs. written based on the real estate securing the loan; not some outside credit. Loans compris- The exculpation from personal liability of ing a CMBS oering are also, generally, sup- the borrower, with the sole recourse being posed to be underwritten in accordance with against the real estate securing the mortgage the same standards. This process of stan- loan, is an essential feature of non-recourse dardization is intended to make these other- nancing. This same conceptual approach wise complex nancial products resemble underlies the the other, more ancient, nanc- commodities. If a personal guaranty is re- ing techniques, noted above. It may also help quired, nancially, to support a mortgage explain why the interest-like return earned loan, then the loan is inconsistent with the by lenders using the Iska or Qirad was not general underwriting standards. Moreover, all viewed as prohibited interest. sorts of entanglements could occur. For The depth, strength and eciency of the example, the guarantor's credit may be capital markets has helped achieve one of impaired for reasons having nothing to do the lowest interest rate environments in with the property encumbered by the history. The CMBS nancing model is a part mortgage. This would violate one of the sac- of the reason for this success. Its re- rosanct principles of CMBS nancing, so emergence as a nancing alternative, after called bankruptcy remoteness. the debacle of 2008, is a testament to its This focus on the asset that is the object resiliency. It remains one of the preferred of the loan, to the exclusion of other sources nancing techniques including for the reasons of credit support, distinguishes the CMBS noted above. However, despite its usefulness format from a typical bank nancing of a re- in making low cost nancing available to so lationship borrower. In essence, when a local many borrowers for the betterment of soci- bank underwrites a loan to one of its custom- ety, is it nevertheless forbidden under the ers, it usually intends to retain the loan as an Halacha or Sha'ariah? The answer may be a asset of the bank.34 Since the bank is not qualied no. It may well be that the CMBS underwriting the loan for resale in the capital format, if properly drafted, yields permitted markets, it is often more concerned about return and not prohibited Ribit or Riba, as entangling the borrower in a nancial rela- more fully discussed below.

The Biblical Prohibition Against the nancier. The borrower cannot bind the Making Interest-Bearing Loans vs. nancier and the liabilities incurred by the Other Financing Techniques borrower are not attributed to the nancier. The nancier's risk on the transaction is The Bible prohibits the making of an limited to the principal advanced. This is un- interest-bearing loan35 by one individual to like a traditional partnership relationship, another. where one partner is responsible for the li- However, nancing structures have since abilities incurred by the other in furtherance been developed that are exempt from the of the partnership business. Whatever the Biblical prohibition, because they dier in one relationship may be between the moneyman or more material respects from the original and the user of the funds advanced, it is not Biblical construct. Of critical importance is a partnership. Religious law views their ar- the fact that the Biblical prohibition involves rangement as a nancing structure. Whether the making of a loan.36 But just what is a it is deemed to be a loan and, hence, any loan? How does it dier from a partnership, prots derived by the lender from the nanc- lease or other nancing device? ing are prohibited as Ribit, is dependent on a number of factors. It is not obvious from the Maimonides37 codied the classical deni- simple fact pattern described above. Further tion of a partnership under the Halacha. At analysis is required to establish whether the its most basic level, it involves two people nancing structure is a loan or something who contribute capital and their services in else. furtherance of a common enterprise.38 The Just what are the dening characteristics sharing of prots and losses is typically that establish a particular nancing form as a based on the relative amounts of their capital loan or not? This is a threshold question. If contributions to the partnership. If both con- the particular nancing structure is not a loan, tribute equally, then they share in the prot then the gain realized by the nancier may and losses equally. But what if only one of not be prohibited Ribit or Riba. the parties contributes capital and, furthermore, that party does not work39 in the It appears that the conceptual basis for venture nanced by his capital. Does that distinguishing a loan from other nancing mean that there is no partnership? The simple structures that do not yield prohibited Ribit answer is yes. or Riba involves, at its most basic level, an apportionment of the risk of loss on the Maimonides expressly deals with this transaction. construct. He posits that if money comes from one party and the other party is desig- At one end of the continuum is a loan nated to deal with the money, then the rela- transaction, where the borrower assumes all tionship is called an “esek.”40 The nancier of the risk of loss and is personally liable to advancing the funds is called the “Baal repay the loan. At the other end of the con- HaMaot” (owner of the money) and the bor- tinuum is a permitted nancing structure, rower is called the “Mit'asek” (businessman where the nancier assumes the risk of loss. or user of the money). This is because the If the borrower has no personal liability to borrower alone is involved in the business repay the funds advanced by the nancier,41 that is nanced with the money advanced by then it is not considered to be a loan. This

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 15 The Real Estate Finance Journal construct has many labels,42 but, at its es- borrower would bear all the risks of loss in sence, it is a nancing. In between are a vari- connection with those subsequent transac- ety of nancing structures, where the risk of tions and the return trip. loss on the transaction is apportioned on some basis that may, or may not, yield There are a number of other permitted prohibited Ribit or Riba. It depends on the non-recourse and limited recourse nancing particulars of the transaction and not every- techniques described in the Mishna, as well one agrees on what does or does not work, as the Jerusalem Talmud and Babylonian as more fully discussed below. Talmud, as summarized below.

Consider, for example, a lease of property It is important to dispense with labels. Call- under a rental arrangement.43 In essence, the ing something a loan, lease or sale does not property is being loaned to the tenant and necessarily make it so, for Riba and Ribit yet the rent paid is not considered Ribit44 or purposes. The reason why one type of trans- Riba. A distinguishing characteristic between action might yield prohibited Ribit or Riba and a Talmudic lease and a loan is that the another similar transaction yield permitted landlord, unlike a lender in a loan transaction, return is primarily a function of how the risk bears some of the risk of loss. At a minimum, of loss is apportioned in the particular the landlord retains the risk of depreciation transaction. of the property, both physically and nancially (in terms of any dimunition in value). The Early Forms of Non-Recourse landlord also typically bears the risk of loss Financing described in the Mishna, Jerusalem Talmud, and Babylonian due to re or other casualty.45 Talmud Consider also one of the permitted nanc- The Jerusalem Talmud49 describes a ing structures discussed in the Jerusalem simple, straightforward, non-recourse ap- Talmud.46 A lender provides a borrower with proach to nancing that solves the problem produce, on credit, for transport to and sale of Ribit. The nancing transaction involves an in a remote locale, where the price is higher. advance of funds to purchase fruits in a place The lender is to be paid the higher price, but where the price is lower and the transport of only upon return by the borrower from the the fruits to another locale for sale, where trading mission. Ostensibly, there is a higher the price is higher. The borrower is the fruit credit price charged for the privilege of dealer and the nancier is known as the deferred payment of the purchase price.47 purchaser. The arrangement provides for a This is, generally, deemed to be prohibited sharing of prots by the borrower and nan- Ribit. Yet in this context, the transaction is cier, equally. The text explicitly provides that permitted, provided that the lender bears the if the nancier bears the risk of loss,50 then risk of loss during the trip to the remote the nancing transaction is permitted. It goes locale.48 The nancing would then convert on to say that if the borrower bears the risk into a straight loan in the total amount of the of loss, then the nancing transaction is higher sales price. The borrower could then prohibited. use the nancing proceeds to buy goods for sale locally and would be entitled to all the Another useful non-recourse nancing prots earned on the return trip. Similarly, the structure discussed in the Jerusalem Tal-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 16 The Origin of Non-Recourse Mortgage Financing mud51 is ascribed to Rav Leyzer.52 Under this case, the text speaks of an assessment be- nancing technique, a sum was advanced to ing made of the value of the calves or colts, the borrower to do business with for a speci- at the inception of the nancing transaction. ed term. All of the prots earned during an This is the distinguishing characteristic be- initial period during the term belonged to the tween the two otherwise identical nancier. The nancier also bore the risk of transactions. The underlying assumption is loss during that initial period. Thereafter, the that the valuation is done in order to x the principal amount plus prots earned, during amount of the principal obligation that the the initial period, was automatically converted borrower undertakes, by entering into the 58 into a loan in that aggregate sum. The bor- prohibited nancing format. rower could then use the loan proceeds to In the prohibited form, the borrower is do further business, for balance of the term, personally liable to the nancier for the value on the conditions agreed to by the parties. of the calves or colts, no matter what Any prots earned during the later part of the happens. If, the ultimate sale of the calves or term belonged to the borrower. Concomi- colts yields less than the amount of the initial tantly, any losses suered during the later value, then the borrower is liable to the nan- period were also borne by the borrower. This cier for the deciency. If the colts or calves 53 non-recourse nancing structure may be die during the course of the transaction, then the basis of the Medieval nancing form the borrower is, nevertheless, liable to pay described by the Tur,54 discussed below. It is the original value. No matter how the trans- also described favorably in an earlier work of action is labeled, in substance, it's a loan. Tannaic literature known as the Tosefta.55 Thus, the Mishna concludes that this type of a nancing structure would yield Ribit59 and, The Mishna56 also describes a form of non- therefore, is prohibited. recourse nancing that does not violate the rules prohibiting Ribit. Under this permitted This is in stark contrast to the virtually structure, a nancier may loan calves or colts identical nancing form previously discussed, to a borrower. The borrower is to raise them where there is no assessment of value of the until an agreed upon time, when they are to calves or colts borrowed at the inception of be sold. Under this nancing arrangement, the nancing transaction. The valuation is not the nancier and borrower split the prots necessary because the borrower is not from the sale, one-half each. It is referred to personally liable to the nancier for the as a “half of the prots” nancing principal amount of the nancing (i.e., the arrangement. original value of the colts or calves).

In contrast to this permitted nancing Under the permitted form of the nancing structure, there is a nearly identical nancing structure, the borrower is, generally, not li- form described in a subsequent Mishna in able for any losses (including if the animals the same Chapter of the text;57 but that form perish during the course of the transaction). is prohibited. Both transactions involve a loan The sole recourse is against the property that of calves or colts to a borrower. The nan- is the subject of the nancing (i.e., the calves cier is to receive one-half of the prots in or colts). The borrower would, however, be each case as the return on his investment in personally liable for violating the stipulations the calves or colts. However, in the prohibited made by the parties regarding the use and

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 17 The Real Estate Finance Journal care of the animals. Since, it is the nancier half to the lender and one-half to the who, generally, bears the risk of loss on the borrower.70 transaction, it is not a traditional loan At the same time, as the Talmud points transaction. The Mishna, therefore, raises no out, it favored the interests of borrowers, issue of prohibited Ribit. Said another way, generally, by enabling the freer ow of money the Mishna presents a non-recourse nanc- from capital sources to borrowers. It is sug- ing60 structure with certain carve-outs to gested that this may have been a time when exculpation. lenders were less willing to risk their capital The Mishna61 also reports a limited re- and hence money was tight.71 The Rabbis course structure. Under this nancing tech- formulated this sharing of the risk arrange- nique, the nancier advances funds to a ment to incentivize nanciers to part with storekeeper to purchase goods on the basis their cash because they were better secured. of sharing the prots, equally. Rashi62 and The Iska arrangement encumbered the other commentators63 interpret this structure money advanced and anything purchased as the limited recourse form of Iska, where with the funds.72 When reduced to writing in the risk of loss is apportioned equally be- a document known as a Shtar,73 this innova- tween the parties. Hence, the key proviso tive Iska structure not only encumbered real that the borrower must be compensated for property (because of its debt component), it the work involved in eectuating the nanced 74 transaction. Absent this provision for com- was also able to encumber specied per- pensation, the nancing form would be pro- sonal property. Nevertheless, it was unlike a scribed, as yielding prohibited Ribit, as more pure loan, where the borrower bears all of fully discussed below. the risk of loss. Furthermore, unlike a traditional loan (and despite the borrower bearing This innovative nancing structure is ana- one-half the risk of loss), Rava75 notes in the lyzed in the Babylonian Talmud.64 The text text, all of the monies advanced (including begins by citing a statement of the Nehard- the portion deemed a loan) could only be eans65 to the eect that there is a nancing used for the transaction or business that was structure known as the Iska. It goes on to the object of the nancing.76 Rava goes on to report that the Rabbis reformulated the Iska state that the borrower cannot use the in a manner that beneted both lenders and proceeds of the nancing for drinking beer borrowers. The Iska was a nancing structure (i.e., personal use), as would be the case with in use at the time and prior thereto.66 a traditional loan. Rava also notes that the merchandize purchased with the proceeds of The risk of loss in the basic Iska nancing the nancing stands as security for structure, prior to the Rabbinic intervention, repayment. likely mirrored some of the non-recourse forms67 described in the Mishna and Jerusa- This innovation of the Rabbis analyzed in lem Talmud. The format, however, was the Babylonian Talmud represents one of the restructured.68 As a result, it better protects limits of how much risk of loss may be borne the interests of lenders.69 Thus, instead of by the borrower and still qualify the nancing lenders bearing all the risk of loss (with as a non-loan, for Ribit purposes. This favor- limited exceptions), the risk was divided; one able apportionment of risk of loss is condi-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 18 The Origin of Non-Recourse Mortgage Financing tioned on the borrower receiving some The Talmud explores the nature and extent compensation for his eorts on behalf of the of risk of loss a borrower can assume and venture. The amount that must be paid is the under what circumstances, before the nanc- subject of discussion in another part of the ing transaction is deemed a loan, yielding Talmud.77 It ranges from a nominal amount78 prohibited Ribit. At one end of the equation is to the equivalent of full wages on prevailing the innovation to the Iska reported by the market terms.79 However, this is only required Nehardeans in the Babylonian Talmud noted where the losses and prots are shared above. It is unique among these religiously equally. If the lender bears an appropriately orientated nancing forms. This Iska format, greater percentage of the losses than his adapted to meet the needs of borrowers and share of the prots (for example: 2/3 of the lenders, permits the sharing of the risk of losses vs. 1/2 the prots80), then no separate loss, equally. It is truly a creative restructur- compensation need be provided to the ing of a most useful nancing form. Its borrower. continued use in modern times is a testament to its inherent fairness and functionality. This essential element in the Iska, distin- At the other end of the equation are the non- guishes it both contractually and philosophi- recourse nancing forms that are recorded in cally from other Sha'ariah compliant and the Mishna, Tosefta and Jerusalem Talmud. Christian nancing forms. The Qirad and To be a loan, the borrower must be person- Commenda view the borrower's eorts, acu- ally liable for repayment of the full principal men and contacts, as his or her contribution amount advanced, under all circumstances. to the venture with the nancier. The Halacha However, can a non-recourse loan be con- takes a dierent view. In a pure investment verted into a recourse one under certain cir- context, where the nancier takes all the risk cumstances, without violating the strictures of loss, the borrower is using his labor, talent against Ribit? The answer is a qualied yes, and contacts to achieve prot for both because the borrower must honor the stipu- parties. It is not very dierent from an incen- lations agreed to by the parties and a breach tive compensation arrangement in an employ- results in personal liability by the borrower.84 ment context.81 However, where the borrower What are the kinds of obligations and li- has a personal debt obligation to the nan- abilities that a borrower may undertake and cier, then it might appear that the borrower under what circumstances, without falling was working for the nancier, without com- astray of the prohibition against Ribit? How pensation, as payment in kind to the nancier about the typical carve-outs to exculpation for the loan. This otherwise uncompensated under a CMBS type mortgage loan; would eort82 could then be deemed to be prohibited they be acceptable under the Halacha? The Ribit. Although, this is not a genuine answers to these questions require a deeper employer/employee relationship,83 there is analysis of the relevant Halachic precedent still an appearance issue. The answer of the on the subject. Talmud was to pay the borrower something for these eorts. This served to dispel any There are some risks that the borrower appearance that the borrower contributed can bear without issue. Thus, even an agent these eorts for the benet of the nancier must follow the principal's instructions and solely in order to secure the loan and, hence, would incur liability for defaulting in these any issue of Ribit. duties.85 The Sha'ariah follows a similar path,

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 19 The Real Estate Finance Journal as reected in the Qirad. In essence, the bor- perilous trading missions. Besides the danger rower is liable only if the borrower violates of ships sinking and pirates, crossing the the duties or other stipulations agreed to borders of the many nations along trading under the nancing arrangement. As a result, routes was also no easy feat. Imagine the they are not subject to the strictures against money, eort and contacts it took to mount a Ribit or Riba. successful trading mission from the interior of Germany or France, to the coast of Spain The texts in the Mishna, Tosefta, Jerusa- or Italy and then to India or China and back. lem Talmud, and Babylonian Talmud are With no direct sea route, the trip involved among the earliest recorded discussions of movement on land in Europe, a sea journey the nature of non-recourse nancing. Inter- to the Middle East, a trip over land to the estingly, the Jerusalem Talmud text cited Persian Gulf and then a sea voyage to India above86 also discusses what happens if the and back again, along a similar combination borrower fails to purchase the goods that of sea and overland travel. Few people had are the object of the nancing or sell them. It the means or acumen and contacts to ac- concludes that the nancier cannot hold the complish this kind of international trade.90 The borrower liable for the prots that would have Jews were well placed to do so because of been earned, had the borrower accomplished their presence in many of the locations 91 the purchase and sale of the goods as mentioned above. It is speculated that there intended. The nancier however can recover was a greater supply of money and substan- the unused funds. Similarly, the nancier can tial demand for the products of trade. Entre- recover any goods purchased that are preneurs who could successfully accomplish unsold. these kinds of trade missions were in more limited supply. Moreover, because of the The non-recourse nancing structures inherent risks of sea voyages many entrepre- discussed in the Jerusalem Talmud, as well neurs were unwilling to bear all of the risks as, the earlier presentation of the structure in involved in these ventures.92 The successful the Mishna and Tosefta would appear to entrepreneur, with contacts in far ranging presage, by hundreds of years, a later nanc- places and the apparent ability to accomplish ing form known as a Qirad or Mudaraba protable transactions, was able to obtain under the Sha'ariah. The non-recourse - more favorable terms of nancing. Hence, it nancing form was already in use by the time is believed that borrowers involved in sea of the Mishna.87 trade were able to demand nancing without aording the lender the protection of a full The limited recourse evolution of the Iska recourse loan (or even the more limited re- nancing arrangement, discussed in the course provided under the Babylonian Tal- Talmud, was a standard practice88 until the mud's form of Iska nancing arrangement). 11th century. There appears to have then They could demand and obtain what amounts been a shift back to the earlier form of non- to non-recourse nancing. recourse Iska, reported in the Mishna and Tosefta and discussed in the Jerusalem This was also a time when the Qirad was Talmud. This was a time when trade was in common use and the Commenda nancing international in scope and was conducted arrangement began to appear. Some of the not only on land and by sea.89 These were contemporaneous Halachic discussions of

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 20 The Origin of Non-Recourse Mortgage Financing these various nancing arrangements are This is the grey area in the continuum be- summarized below. Needless to say, there tween full recourse and non-recourse was much business interaction among mem- nancing. The Talmud examines a number of bers of all three major monotheistic religions dierent nancing structures,102 including at the time, in Europe, North Africa and the those summarized below. Middle East. This is documented in the forms of written agreements entered into by the A Technique Akin to the Modern various parties that have survived to our Deed of Trust Mortgage Form 93 times. These nancing structures are also Under this structure,103 the borrower makes the subjects of contemporaneous discus- a conditional sale of a piece of land to the - sions in Rabbinic texts. Thus, for example nancier in connection with a loan. The loan there is the decision rendered by the Ram- amount and purchase price of the land are bam dealing with a Qirad.94 There are also the same. The term of the loan is three years. references by Rabbinic authorities to other The sale is deemed to occur as of the incep- nancing forms then in use. In this regard, I tion of the nancing, provided the loan is not note in passing the reference by Rav Yosef repaid on or prior to the maturity date. The Karo95 in his monumental work, the Bet Yo- fruits derived from the land, in the interim, sef96 on the Tur,97 in which he states that the belong to the nancier, if the sales condition seemingly non-recourse nancing form98 is satised (i.e., the borrower defaults in used in Lombardy99 is not permitted. He notes payment). If the borrower repays the loan that this is because the borrower's liability amount, then the sale is voided and the fruits under that format was too extensive. derived from the land belong to the borrower. The fact that the nancier receives the fruits Other Non-Recourse and Limited derived from the land is not deemed to be Recourse Financing Techniques prohibited Ribit. This was said to be the Discussed in the Talmud nancing device used by Boethus104 ben The Jerusalem Talmud and Babylonian Tal- Zonin, that he used on the advice of the 105 mud100 analyzed a variety of nancing struc- Rabbis. The Jerusalem Talmud reports that 106 tures that were not purely non-recourse and Rav Yuda found this nancing structure to nevertheless did not fall astray of the stric- be permissible. This is because the interest- tures against Ribit. The nature and extent of like yield was, in fact, only earned the limitations on recourse or the conditions conditionally. It was contingent on there be- that might create liability for the borrower, in ing a payment default. Hence, it was deemed an otherwise non-recourse structure, are re- not to be Ribit. The borrower could avoid any corded in various Talmudic texts. The Talmu- such charge merely by making timely pay- dic discussions engendered an entire body ment of the loan. This concept of conditional- of Rabbinic literature, as well as, the creation ity is an underlying theoretical basis ap- of various documents embodying these plicable to many of the permitted springing limited recourse and non-recourse nancing recourse provisions noted below. concepts. How the risk of loss is apportioned A Technique for Financing the Aging between the borrower and lender101 is a key of Wine107 element in distinguishing whether a particular nancing arrangement is prohibited or not. The basic structure is similar to nancing

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 21 The Real Estate Finance Journal techniques used in the liquor business today. that it did not violate the prohibition against A distiller's investment in barrels of scotch Ribit, because the nancier also assumed the left to age over periods of upwards of 18 risk that the wine might, instead, depreciate years or more can be enormous. By entering in value, over the course of the nancing into a buy-sell arrangement with a distributor, transaction,113 as noted above. Thus, while the distiller was able to obtain an immediate the borrower bore some of the risks on the advance of cash, thereby nancing its invest- venture, nevertheless, the nancier took on ment in the scotch. Under this nancing sucient risk to distinguish this nancing program, the distiller kept possession of the structure from a prohibited interest-bearing spirits and had the right to buy back the loan transaction. spirits at the expiration of the term of the nancing. The price yielded a healthy return Another Useful Method of Non- recourse Financing Known as the to the distributer as the nancier. In the mod- Tarsha114 of Rav Hama115 ern nancing form, the distributor also had the right to put the spirits to the distiller at Under this structure the nancier provided the same price. It was a loan in all but name. merchandise to the borrower on credit. The Under the Talmudic structure described by market price for the merchandise in another Abaye108 the nancier similarly advanced a remote locale was higher than the price in sum, denominated as the purchase price, to the local marketplace. The credit price for a wine dealer. It is styled as a purchase, but the goods was based on this higher price. It like the modern form, it is essentially a nanc- was not due and payable until the goods ar- ing device. Unlike, the modern form,109 the rive for sale in the destination marketplace. Talmudic nancier took the risk of a loss that, At that time, the principal amount (represent- when the aging process was completed, the ing the value of the goods in the home mar- price of wine may have declined.110 The - ket) plus interest (representing the agreed nancier also beneted if the wine was worth upon premium over the local price) was more upon completion of the aging process. transformed into a loan. The borrower could The Talmudic wine dealer, as the borrower, then use the monies so advanced to nance similarly kept possession of the wine. The the purchase of goods in the remote locale dealer received the immediate benet of a for sale at a prot in the local home cash advance, instead of tying up capital, marketplace. Why, though, was this Tarsha116 long term, while the wine aged. However, transaction not prohibited by reason of the under the Talmudic form, the dealer, as bor- prohibition against Ribit? Consider, there is rower, bore the risk of loss that the wine the higher credit price that is usually consid- turned into vinegar.111 Rav Sherevya chal- ered Ribit under the Halacha. Then there is lenged this apportionment of risk formulation also the issue of the work done by the bor- of Abaye,112 because he viewed it as being rower in transporting the goods and then sell- akin to a loan. Thus, Rav Sherevya asserted ing them at the higher price. Isn't this uncom- the expected appreciation in the value of the pensated eort also a form of prohibited wine, when fully aged and earned by the - Ribit? It would appear that the only reason nancier, was prohibited Ribit. In response, the borrower exerted all these eorts and Abaye demurred and concluded that the used his contacts and acumen to achieve the nancing form was permitted. He reasoned higher price was the loan that resulted. As to

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 22 The Origin of Non-Recourse Mortgage Financing the former concern, the answer is that the - is returned at the end of the term of a lease. nancier assumed the risk of loss117 on the Said another way, the landlord, in a leasing goods furnished until they were sold in the arrangement, bears the risk of physical (and remote location. Thus, this apparent credit nancial depreciation) of the property leased. sale was not viewed as a loan and, therefore, A Talmudic lease structure also requires that the yield to the nancier derived therefrom the landlord bear some risks, such as re or was not prohibited Ribit. As to the later other casualty. If the landlord bears no risk concern, it appears to be a valid one. Indeed, of loss (as in a triple net bondable lease122) 118 the medieval nancing formats based on then the lease is nothing more than a loan of this Talmudic structure, do require some form the property and the rental prohibited Ribit. In 119 of compensation to the borrower. This is deference to Rav Hama, he apparently be- so, notwithstanding that the Tarsha nancing lieved that if the landlord bore the risk of loss was initially a non-recourse form, as opposed arising out of acts of G-d or other such to a limited recourse structure. The Talmud events outside the control of the borrower,123 responds to the issue by noting that Rav then that was sucient to establish the Hama provided the borrower with the benet nancing arrangement as outside the ambit of his exemption from taxation and a priority of a traditional loan and the prohibition position in the marketplace. These benets, against Ribit. After all, in a true loan the bor- derived from Rav Hama's position, were rower was personally liable no matter what viewed as emolument to the borrower. The the circumstances. However, his colleagues prots made by the borrower on the return disagreed and the form was viewed as noth- trip accrued fully to the borrower. Cor- ing more than a disguised loan.124 respondingly, the borrower was personally liable for payment of the full derivative loan Rav Nachman's Technique125 of amount. This nancing form was expressly Financing Tenant Improvements to recognized by the Rambam as the basis of a Real Estate non-recourse nancing structure of the 12th Under this structure, a storekeeper, who century. It is also believed to be a precedent leased a store, borrowed money from the for a similar form described by the Tur in the landlord for the purpose of painting a mural 13th century. on the wall of the store. The landlord made the loan and increased the rent accordingly. The Leasing of Money Financing It was reasoned that this was a benecial Structure of Rav Hama120 tenant improvement because customers liked A lease can be a nancing tool. In modern to shop in a well-decorated store. Thus, as a nance, a lease of real estate coupled with result, the rental value of the store could be an option to purchase has even been found said to be higher because of the improved to be an equitable mortgage.121 However, the condition. Hence, more rent could be charged. Talmud rejected this leasing of money nanc- Similarly, if a ship owner loaned the lessee of ing technique. The Talmud reports that it is the ship money to install a new mast, then unlike a genuine lease, because money is the rent for the ship could be commensurately fungible. Thus, the original coins leased are increased. The reasoning once again was not returned; rather it is the monetary that, with the improvements to the leasehold, equivalent. In contrast, leased real property the rental value increased. There was, there-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 23 The Real Estate Finance Journal fore, no concern about Ribit. A true rental ar- describing a loan of money. It is believed that rangement is also distinguished from a loan, the use of the term Eshoel in the text is not because there is no personal responsibility accidental and that it is intended to portray a for the value of the property rented. The particular type of nancing structure. Con- physical and nancial depreciation of the sider, a Shoel/borrower does not bear the property, if any, upon expiration of the lease, risk of loss by reason of depreciation, physi- are borne by the landlord. cally or nancially, or use of the borrowed item for the intended purpose. Furthermore, if Increased Rental Rate for Real the lender is present with the Shoel/borrower 126 Estate if Paid Over Time when an event causing a loss occurs, then This is a unique aspect of a Talmudic lease the borrower is not liable for the loss. These of real estate. The guiding principal is that characteristics distinguish the Shoel transac- rent is actually set by the market based on tion from an ordinary loan. The text goes on its being due and payable in full at the end of to provide for a specied amount of compen- 130 the term of the lease. Thus, when rent is pay- sation for the borrower. It concludes with a able up-front or over time in monthly install- statement that the borrower and lender divide ments, it is, in eect, being oered at a the prots; but no mention is made of the discounted rate for early payment. Similarly, precise terms of division. This is unlike the if goods are generally oered for a given other examples of nancing structures de- price set by the market that accounts for scribed in proximity to this form in the text, payment being made on a deferred basis, where the sharing percentage is expressly with no spot price, then the seller is permit- specied as being one-half the prots to the ted to oer a discount for cash. borrower. This does not appear to be a lacuna; rather, it is proposed it is intentional. The Sale of a Borrower's Promissory It is suggested, the Shoel structure described Note at a Discount127 in this text is not an equal sharing arrangement. As a fully non-recourse nanc- The premium earned by the purchaser of 131 ing form, there is no substantive reason to the note is not considered Ribit. limit the parties ability to agree to an unequal prot sharing arrangement. Yet, there may The Eshoel128 Financing Structure still be a problem of appearances. Consider, Described in the Jerusalem Talmud if sharing the prots, equally, is the accepted The entire discussion in the Jerusalem norm, then reducing the prot share of the Talmud of this particular nancing form takes borrower may imply that the work of the bor- all of 16 words.129 It begins with a recitation rower is not fairly compensated. The dier- that an individual who is “Eshoel” (loans) ence may appear to be Ribit.132 Therefore, money to another individual. The use of the the Talmud may be specifying that separate term in this context in the Talmud is unusual. compensation be provided for the borrower The term Eshoel is derived from the word to avoid this issue. This would then be much Shoel (borrow). Generally, the term is used like the formulation of the Tur, discussed to denote a casual loan of a household item below, which was designed, in part, to avoid or tool to a neighbor; not a monetary loan. this very issue of appearances. In any event, The term Loveh is normally used when whether it is a non-recourse or limited re-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 24 The Origin of Non-Recourse Mortgage Financing course form, it is another example of a venture, up to a xed amount agreed to by nancing structure that does not yield prohib- the parties, accrue to the benet of the ited Ribit. nancier.136 Upon paying over the xed sum to the nancier, the borrower has use of the 133 The Surean Pledge original principal amount. Any prots yielded Under this structure, the nancier ad- by the venture thereafter belong to the bor- vances funds to the property owner, as rower and similarly, any risk of loss is borne borrower. In return, the lender receives a so- by the borrower. called Surean Pledge of the real estate and There are two important provisos that is entitled to all the avails from the property animate this nancing form and distinguish it for a term of years. Although, nominally from a prohibited interest-bearing loan. The referred to as a pledge (or mortgage, in mod- rst is that the nancier bears the risk of loss ern terminology), it is, in eect, a lease of real until the xed amount noted above is earned. estate for a term of years. At the maturity Thereafter, the borrower assumes the risk of date, the loan is deemed paid and unencum- loss. The second is that there must be some bered title to the property reverts back to the compensation provided for the borrower until 134 borrower. Conceptually, the principal the xed sum is earned. This is said to deal amount of the loan is viewed as a pre-paid with the appearance issue of Ribit. Otherwise, rent under what is, eectively, a lease of the it would appear that the only reason the bor- mortgaged real estate. In substance, though, rower worked in the venture and used his it is a nancing device, where the borrower is contacts and acumen to achieve realization not personally liable and the sole recourse is of the xed sum of prots due to the nan- against the real estate. Indeed, the real estate cier was the prospect of then obtaining a loan is used to repay the principal sum together of the funds. The payment of some compen- with permitted return over the term of the sation, even nominal,137 is designed to resolve Surean Pledge. The duration of the term of this concern. the Surean Pledge is designed to permit the nancier ample opportunity to earn these The Rambam also considered other non- sums; but the nancier takes the risk that recourse nancing structures.138 In his Re- this result in fact occurs. sponsa,139 he dealt with what he referred to as the Iska in accordance with the form used Maimonides' Consideration of Non- by non-Jews140 or the “Jewish form of con- Recourse Lending Structures in the tract in the format of the Iska of the non- 12th Century, Including the Islamic Jews.141 The Judeo-Arabic text of the Re- Qirad sponsa refers to the Iska as a “Qiratz.”142 The Rambam135 describes a non-recourse The Rambam denes these nancing forms nancing format that is based on the Tarsha by explaining they provide that the borrower of Rav Hama, summarized above. The struc- does not have personal responsibility for ture begins with an advance of funds from losses. The transactions described involved the nancier to the borrower. The terms a variety of locales, including Tunis and India. include a requirement that the borrower use the funds for an investment or presumed In one of the Responsa,143 the Rambam protable activity. All of the prots from the dealt with two types of Iska forms. One form

Iska144 provided for the prots to be shared ing structure is nothing more than a loan and, by the nancier and borrower equally and by extension, the interest-like return payable losses to be borne two-thirds by the nan- to the nancier, prohibited Ribit. cier and one-third by the borrower. The other The Tur also requires that the borrower be form provided for the borrower to receive provided with separate compensation147 dur- only one-third of the prots; but the borrower ing the period until the prot condition is had no personal liability for losses. While the satised. Rav Yosef Karo discusses this Rambam preferred the former nancing requirement of compensation of the format he raised no issue of Ribit as to the borrower.148 He reports that if agreed to at later form. the time of entering into the Iska then the The Tur's 14th Century Structure for a compensation can be nominal. Otherwise, Non-Recourse Financing Rav Karo requires that the borrower be paid the market wage standard for so-called idle Rav Jacob ben Asher describes a permit- laborers.149 This proviso seems to deal ef- ted non-recourse nancing structure, in his fectively with any concern about seminal code of Jewish Law known as the appearances.150 Arba Turim145 or Tur. It is similar to the Rambam's form, based on Rav Hama's Tar- The Trumat Hadeshen's 15th Century 146 sha, summarized above. Non-Recourse Financing Structure Under the Tur's format, the nancier ad- Rabbi Israel Isserlein151 in his seminal work, vances a sum of money to the borrower. The the Trumat Hadeshen,152 begins his discourse borrower agrees to do business with the by setting forth a question of religious law funds so as to yield prot until an amount dealing with lending and Ribit. He posits that equal to double the sum advanced is realized. the lender desires to loan money with a xed The borrower is then to pay over that amount rate of interest that is virtually secure as to to the nancier. The Tur species that the principal. The question posed is how to do risk of loss be borne by the nancier until so, without falling astray of the prohibition this condition is achieved. Thereafter, any against Ribit. further prots earned belong to the borrower The answer provided by the Trumat Ha- and correspondingly, the risk of loss shifts to deshen is most interesting. He begins by the borrower. analyzing the leasing of money arrangement Once again, the critical factor distinguish- posited by Rav Chama153 that was rejected ing this permitted nancing structure from a by the Talmud, as summarized above. He prohibited loan structure seems to center on concludes that it was insucient for the who bears the risk of loss in the nanced lender just to take the risk of loss by reasons venture. If the lender bears the risk of loss of acts of G-d or other such events outside then, subject to the separate compensation the control154 of the borrower. To be exempt provision noted below, the loan structure from the prohibition against Ribit, the lender does not violate the prohibition against Ribit. had to assume the risk of loss,155 generally. On the other hand, if the borrower assumed This included losses incurred by reason of the entire risk of loss of the transaction, from theft or destruction of the property, not just the inception of the nancing, then the nanc- acts of G-d.

However, the Trumat Hadeshen goes on to A Non-Recourse Iska Document,157 note, the lender could agree with the bor- Following the Trumat Hadeshen's rower to certain stipulations, which, if violated, Formulation, with an Amendment to would shift the risk of loss to the borrower. the Terms, Known as the Tikun Maharam, Found in a Documentary Thus, for example, the parties could agree Formbook, Originally Published in that the borrower's own testimony as to the 1625, Entitled Nahalat Shiva occurrence of a loss of principal would not be probative. To establish a loss of principal The Tikun Maharam form of Iska was developed by Rabbi Mendel ben Avigdor158 of would require the testimony of two specied Cracow. It was reportedly adopted by the witnesses, to wit: the Rabbi of the community Council of Four Lands159 at the Kreminitz Fair, and the Cantor. Unless these two specic in the vicinity of Lublin,160 in 1607. witnesses came forward and testied, of their own personal knowledge, to an actual loss of Under this document, the borrower ac- principal, the borrower would be required to knowledges receipt of the money advanced repay the principal amount. With regard to and agrees it is an Iska nancing. The docu- interest, the borrower would have to take a ment provides that as soon as the prots 161 solemn oath that there were no prots. earned reach the xed return amount, the entire principal sum plus the xed return will Otherwise, the specied rate of interest be deemed a pure loan until the maturity date. would be due and payable. From that point forward, the borrower is There could also be other stipulations required to sell all assets acquired with the made by the parties that were dicult or well monies advanced to repay the debt in full. In neigh impossible for the debtor to satisfy. this regard, the document species that even For example, the borrower could agree that if this requires a distress sale at half price, the borrower is still required to do so. the sole use of the funds advanced would be to make secured loans that were fully cash The borrower also agrees that the principal collateralized. If used for any other purpose, amount will be a priority against any prot- then the borrower would be personally liable able venture entered into by the borrower. In to repay the loan. Similarly, extensive secu- essence, money is fungible. If the borrower rity provisions could be made dealing with makes a prot anywhere in the world then it the funds advanced. For example, the bor- is counted for purposes of determining rower could be required to bury the funds whether the lender's principal was lost. This advanced under the oor in his or her home. is not a net income concept, where losses incurred in one venture can be oset against This opinion of the Terumat Hadeshen has a protable one. It is a measuring device for been cited as a source of the non-recourse determining whether the borrower, prima form Iska156 in use today. It is a non-recourse facie, can assert any loss of principal. Thus nancing structure, with carve-outs to the principal is not deemed lost to the extent of any prots earned by the borrower in any exculpation. It is similar in conception to the endeavors, any where in the world. This is modern non-recourse mortgage-nancing also the measure for determining whether format. This Iska format was further devel- the specied xed return has been earned oped over time, as summarized below. on the principal amount.

The document also stipulates that the it may be very dicult for the borrower to testimony of the borrower that there was a assemble the proof needed to meet the loss of principal is not probative. Two kosher burden, the fact is, the borrower can satisfy witnesses are required to establish that there this condition and, therefore, have no per- was a loss of principal. This is the major sonal liability for repayment of the loan. change initiated by Rabbi Mendel to the prior The Tikun Maharam Iska is one of the most version of the Trumat Hadeshen. Hence the prevalent forms still in use to this day. Many term “Tikun,” meaning correction. It modied Iska forms incorporate its terms by reference. the requirement that only the testimony of It represents a milestone in the development the Rabbi and Cantor would be acceptable of the non-recourse form Iska. to evidence a loss of principal; a provision that was viewed as impossible of Trade vs. Loan, a Re-Analysis of performance. After all how could the Rabbi Koranic, Sunnah and other Relevant and Cantor of a community personally know Texts and Denitions and the Qirad all of a borrower's worldwide income and (or Mudarabah) Financing Structure business aairs? Frankly, even the lesser By way of background, it is important to requirement of any two kosher witnesses is note that the Koran163 provides that trade still nearly impossible to satisfy. Indeed, can (Bey) is like Riba. However, trade is permit- anyone know the business of another so ted and Riba is not. The Koran does not intimately and completely, so as to be able to dene these terms or otherwise dierentiate testify of his own personal knowledge? Un- them. Indeed, it is not immediately clear from less the borrower can actually present this the text what distinguishes transactions that testimony, it is presumed there was no loss are prohibited because they yield Riba164 and of principal. As noted above, the borrower those that do not labeled trade. can still assert a prima facie defense to the payment of the xed return, based on the The dierence between the two is not just borrower's own testimony accompanied by a a matter of form or context; it goes to the solemn biblical oath.162 The fact that the doc- substance of two types of nancing ument does not bar the borrower from as- techniques. Riba is associated with a loan serting there was a loss is signicant. The where the borrower is personally liable to borrower cannot covenant there will abso- repay the loan no matter what the lutely be a prot and be personally liable for circumstances. In essence, the borrower as- a braech of this provision. That would be sumes personal responsibility for any risk of nothing more than a disguised loan. Rather, loss, whatever the use of funds or cause of the document provides a precise and exclu- the loss. Another important factor is that the sive mechanism for when and how a defense lender is not actively involved in the venture of loss can be established. The burden of being nanced by the loan. It is the borrower proof is on the borrower. Otherwise it is who does the work. Thus, it is asserted, in presumed that there was sucient prot connection with a loan, it is the money that is earned to warrant payment of both principal working;165 not the lender. Any gain earned and interest. This conditionality feature helps by the lender on money advanced as a loan ameliorate any concern that the non-recourse is viewed as subject to the prohibition against nature of this Iska form is illusory. Although, Riba.166

However, trade can also involve a non- Why was a Qirad that nanced trade and working party who nances the venture. was structured much like a loan transaction, Consider the not unusual situation of a permitted under the Sha'ariah and not person of means who nanced an entrepre- deemed a loan yielding prohibited Riba? Both neur in a trade transaction. Imagine the a loan and trade nancing (under a Qirad,) discussion in a local café in Naples or Cairo, involved an advance of funds by a non- in the 14th century. The entrepreneur pro- working nancier. Yet, in one case, the gain posed chartering and provisioning a ship to earned on the funds advanced was permitted sail to India. The purpose was to acquire and in the other it was prohibited. What spices and to return home to sell them locally. distinguished these two otherwise similar A successful venture of this sort could be transactions? Indeed, in reecting on the very lucrative. The entrepreneur had the acu- Koran verse noted above, there are allusions men and contacts to accomplish the to the fact that there is no genuine dierence transaction. However he was missing the between a loan and what is referred to in the cash to nance the venture. The nancier had Koran as trade. Nevertheless, one is prohib- the money but this was not charity. To induce ited and one is permitted. the nancier to part with his cash required that he too prot from the venture. The The essential distinguishing characteristic simplest way of accomplishing the nancing between a loan earning prohibited Riba and was for the nancier to make a personal loan one earning permitted return involves the to the entrepreneur and receive a return sharing of the risk of loss on an agreed upon called interest on the money advanced. and permitted basis. Thus, notwithstanding However, that was wrong religiously, both in that the lender in a trade transaction does Naples, a part of the Christian world, and not work in the venture (only the borrower Cairo, a part of the Muslim world. Moreover, does) and, furthermore, notwithstanding that the entrepreneur may well have been unwill- the non-working party is the only one ad- ing to borrow the money if he took all of the vancing funds for the venture, the gain earned risks of the venture. It is understandable that on the funds advanced is not prohibited Riba. an entrepeneur might be unwilling to assume The document embodying this permitted form personally liablility to pay principal and inter- of nancing of trade is the Qirad or est, under all circumstances. There were too Mudarabah.168 Under the Qirad, the nan- many genuine risks associated with a sea cier169 advances the money needed by the voyage to so distant a place as India. The borrower to accomplish one or more ship could sink or pirates could attack the transactions. The nancier is not actively ship and steal the money or merchandise. involved; rather, the borrower does all the There was also the risk that the venture work. The borrower also provides the con- might fail because of market conditions. tacts and talent in what is hoped will be a protable venture. Unlike the Iska, the bor- Under these circumstances, the entrepre- rower receives no separate compensation for neur was often able to negotiate a non- his eorts. recourse or limited recourse sharing of risk arrangement.167 These kind of nancing The Qirad is a non-recourse nancing de- structures had names like the Iska, Qirad, or vice, with some carve-outs to exculpation. Commenda. Thus, except for the borrower's negligence

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 29 The Real Estate Finance Journal or failure to fulll his duties, in accordance Commingling of funds with the borrower's with the agreement of the parties, it is the - other activities is also be prohibited. Further- nancier who bears the risk of loss on the more, the borrower is required to provide venture. Borrower's obligations can include a proper management and execution of the variety of covenants, so long as they are not contemplated transansaction intended to otherwise prohibited under the Sha'ariah. yield a prot. This includes the borrower's acumen, contacts and work, which are Prots may be divided as the parties agree. deemed the borrower's contribution to the Unlike the Iska nancing structure, the borrower is not entitled to receive separate venture. The borrower is not supposed to compensation for his eorts. In eect, the - delegate management. If the borrower nancier contributes the capital and the bor- breaches any of these provisions then the rower contributes his time, contacts, skill and borrower is liable for the loss. eorts. At the conclusion of the Qirad transaction, Despite the fact that the money advanced there must be an accounting by the borrower under a Qirad arrangement can be said to be in the presence of the nancier and the working for the nancier, a condition other- principal amount must be repaid rst before wise frowned upon in the Sha'ariah,170 never- any division of prots.177 theless, this nancing structure is permitted. The nancier is not liable for the acts or This is supported by various sources in the Koran,171 Sunnah,172 and Hadith.173 Indeed it is debts of the borrower, including in connec- reported that Mohammed himself entered into tion with the venture being nanced by the a Qirad nancing arrangement with a wealthy nancier. In this regard, it is important to note, Jewish woman nancier, who would later that under the Sha'ariah, the funds advanced become his wife.174 and the property it purchases are technically still owned by the nancier.178 From a legal Under the Qirad, the borrower is liable for point of view, under the Sha'ariah, the bor- losses arising out of the borrower's rower is not deemed to be the agent or negligence. There is a duty of due care and partner of the nancier. Furthermore, neither diligence. There is also a duty to maintain is a joint venture or entity created by virtue condentiality. This would include concealing of the parties entering into a Qirad. The li- material information about the investment or abilities of the borrower are not generally activity to be nanced. Specic stipulations imputed to the lender. The nancier places can also be made. This might include travel- only the monies advanced at risk. In eect, ing by a specic sea route or not traveling they are still considered to be the property of overland through a dangerous valley. The the nancier. Like the Iska, the Qirad has its parties are free to make other stipulations own structure. While it may have some anal- between them. Thus, the parties may also ogous provisions, a Qirad is not a partner- agree the borrower will only do certain ship, agency, lease or loan. It is a nancing 175 transactions with the funds advanced that form that appears to have existed before the are less risky. It would be misconduct by the emergence of Islam.179 borrower to do a prohibited investment or transaction. The parties may also prescribe The basic structure, underlying the Qirad specic security arrangements.176 and the Iska before it, seems to have origi-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 30 The Origin of Non-Recourse Mortgage Financing nated in ancient times. Some of the terms Iska,185 which pre-dates the Qirad and Com- and conditions may have changed over time. menda by many centuries. However, the basic conceptual arrangement, whereby risk of loss is shared, seems to have The particular terms and conditions of the existed in Mishnaic times and perhaps even risk sharing arrangement, qualifying the earlier. This is the essential characteristic nancing form as permitted, dier under 186 systems that distinguishes the Qirad and Iska from a Christian, Sha'ariah and Halachic of law and thought. However, there seems to traditional loan. It is the primary reason why be a common underlying conceptual ap- the return earned by the nancier is permit- proach that distinguishes a prohibited ted as opposed to being prohibited Riba. interest-bearing loan from a permitted nanc- A Comparison of the Commenda, ing under these legal traditions, even if they Qirad and Iska, Including an Analysis dier in detail. Part of the reason for this of the Carve-Outs to Exculpation common approach is shared values, originat- under Each Form ing from the Bible that are venerated by all The Commenda, Qirad, and Iska have three religions. The surviving documents also much in common, conceptually. All three of indicate a prevalence of Jewish parties to the these nancing forms are based on a non- trade transactions, which may also be a com- recourse or limited recourse nancing mon denominator. After all, Jewish merchants structure. They each require that the principal played a signicant role in international trade 187 be paid back to the nancier, rst, before at the time. It is reported that Jewish any sharing of the prots. However, each merchants spoke Arabic, Persian, Roman form also has unique elements that distin- (Greek and Latin), and Frankish, Spanish, and guish one from another. Slavonic languages. They participated in the silk, fur, aloe and spice trade. This involved Scholars have addressed the question of travel to and from the lands of the Franks, the origin of these nancing forms. As to the the Western Sea, ports along the Mediter- western Commenda, some argue that it is ranean (including Italy, Spain, North Africa, based on the Qirad.180 Others argue it may and the Middle East), by camel to the Eastern be based on the Byzantine Chreokoinonia181 Sea and then to and from India, as well as, or the Roman Societas. It is also argued by China. They crossed the countries of the some182 that all of these forms, as well as, Slavs, Khazars, and the Caspian Sea and the Iska may have inuenced the develop- traveled via the overland silk route to China. ment of the Commenda. It is respectfully The dispersal of the Jews throughout the submitted that the earliest such nancing Diaspora created a natural natural network structure was probably the original non- of local contacts necessary to sustain inter- recourse nancing format embodied in the national trade.188 Indeed, it is asserted that Iska. The limited recourse Iska structure because of their presence and contacts in discussed in the Babylonian Talmud was France, Germany, Byzantium, and Muslim ter- described as an innovation183 promulgated by ritories, they had a virtual monopoly on this the Rabbis that beneted lenders. The earlier aspect of international trade at the time. incarnation was, therefore, perforce not as benecial to lenders. The earlier form was This was further enhanced because of the likely the non-recourse184 version of the diculty of safely moving money (in the form

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 31 The Real Estate Finance Journal of gold or specie) over these distances and of the prots or even less. Indeed, Malik especially across borders. The ability to have states that so long as a percentage of prots reliable, trustworthy and proven trading is specied, whether great or small, anything partners was a signicant advantage. Thus, agreed to by the parties is permitted.195 instead of moving money, payments were One of the primary dierences between often made by bills of exchange. This early the Iska, on the one hand, and the Qirad and informal payment by exchange system pre- Commenda on the other hand, relates to saged the modern international banking whether a provision for compensation of the system by centuries. It is no surprise then borrower is required. The Iska mandates that that the nancing structures used to nance the labors of the borrower be separately international commerce, as embodied in the compensated, on some basis, even if the Qirad, Commenda, and Iska, are similar in amount is nominal. This might include award- many respects. Some of the relevant distin- ing the borrower a disproportionately greater guishing characteristics are discussed below. percentage share of the prots as compared The Iska nancing structure can accom- to the losses. This is a key element, in order modate the lender receiving a specied sum to avoid even the appearance of an issue of (whether xed or based on a percentage of Ribit. The Qirad and Commenda do not make the principal amount) under certain such provision because it is antithetical to circumstances.189 Similarly, the Commenda these structures. The labor of the borrower form,190 where the nancier rst receives a is deemed to be a contribution to the venture. Yet all three forms do not view the nancing specied share of the prots and then the structure as a genuine partnership because, remaining share of the prots would go to as discussed above, the nancier only con- the borrower.191 tributes money to the venture; not labor. The Qirad structure, according to Ibn An Iska can accommodate a loan of money Malik,192 appears to prohibit assigning to the or goods. A Qirad can only be based on a nancier a xed amount of prots ahead of loan of money. This is because according to the borrower. His view is that any percent- Malik, if goods are loaned, then there is the age can be specied for the borrower so long problem of uctuation in values before the as there is a sharing of prots and neither intended transaction can be accomplished. In the lender nor the borrower receives a sum addition, there are the costs of sale. In his outside of the sharing of prots arrangement. view, the Qirad does not begin until the goods He explains193 this is because in a Qirad, are converted into cash and the culmination there is no sale, rent, work, advance, or con- of the Qirad is also in cash. venience, which either party can specify he or she receive, without the other party shar- In the Commenda196 the borrower is obli- ing in it. Remember that in a Qirad,194 as op- gated to go through with the venture that is posed to the Iska, the borrower receives no the object of the nancing. This diers from separate compensation for his eorts on an Iska and Qirad, where the borrower can behalf of the venture. However, Malik does elect not to proceed and just return the funds permit the nancier to have more than a one- advanced. The Commenda also limited the half share of the prots. He notes that the risks borne by the lender. Typically, the borrower may receive only a third or a fourth lender assumed only the risk of loss by rea-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 32 The Origin of Non-Recourse Mortgage Financing son of the ship sinking or attack by pirates.197 ported by the Nehardeans in the Talmud,204 is Casualty loss, generally, was borne by the also unique. In essence, the Babylonian borrower. The borrower also assumed per- Talmud permits an apportionment of the risk sonal liability for a breach of the express cov- of loss equally between the borrower and the enants,198 as well as, implied covenants in lender. This limited recourse structure is bril- accordance with custom and usage among liant in its conceptualization. merchants.199 Other provisions might be made, including for personal liability by the Each of the three medieval nancing forms borrower for fraud, as well as, assessing provide for recourse events. Many of the pro- penalties (equal to two times the sum of visions are similar although some are unique principal plus prot200), if the borrower as- to the particular nancing structure. Sum- serted defenses or counterclaims. Once the maried below are some of the typical carve- ship docked, all of the risks of loss were outs to exculpation in each of the forms, borne by the borrower. This is unlike the respectively. Qirad or Iska, where casualty or other mat- The Qirad, may, for example, include the ters outside of the control of the borrower 205 following recourse events: were borne by the lender, whether at sea or 201 on land. E If the borrower takes any of the monies The procedural rules and standard of evi- before a nal accounting, in the pres- dence required to establish a loss, embodied ence of the nancier. Under a Qirad, the in the Tikun Maharam Iska, are unique among principal must rst be repaid and then these three medieval nancing forms The only are the prots to be divided. Iska can also contain a provision that condi- E If the borrower violates a provision that tions any claim of loss by the borrower on only certain goods206 should be pur- there being delivered to the lender periodic chased with the nancing proceeds or accountings, sworn to by the borrower.202 If an express prohibition against buying borrower fails to honor these covenants then certain named goods. the borrower is barred from claiming a loss. The Iska also may provide that, in essence, if E If the borrower uses the principal or the borrower earns prots anywhere in the prots for his own purposes and not in 203 world, then the borrower would be liable to furtherance of the venture. Malik de- pay the principal plus interest. scribes a number of dierent examples of this kind of misconduct, including, us- The security measures required by the Iska ing principal or prots to buy a slave can include provisions dealing with the stor- girl. The borrower is also prohibited from age and use of the funds. The Iska can also entering into a Qirad with another, doing require armed guards, as well as, restrict the other business for himself, buying him- means of transport of the funds. This can self clothing, making charitable contribu- include only traveling by prescribed routes tions, hiring others to do his work or and to specied locations. The Commenda paying for travel and entertainment and Qirad also permit these kinds of security outside of what is necessary, in the covenants. ordinary course and in furtherance of The innovation to the Iska structure, re- the venture.

E If the goods are sold on credit. If the number of noted experts as to the qual- borrower violates this prohibition then ity of the merchandize purchased and he is liable for any ensuing losses. that an advantageous purchase.209

E If the borrower violates security provi- Halachic literature is replete with examples sions agreed to by the parties. The of these kind of covenants. Rav Moses ben Qirad may require that a particular sea Joseph D'Trani,210 known as the Mabit211 route not be taken or that the money or permitted provisions to the eect that the goods be protected in accordance with money could not be released by the borrower specied procedures while in transport. to anyone except as against a pledge of gold If the borrower does not follow the or silver of at least equal value. Furthermore, agreed upon arrangements, then the either the money or the pledge had to be in borrower is liable for any loss. the exclusive possession and control of the borrower and stored underground in the bor- E If the borrower violates any other cus- rower's house in complete secrecy. No one, tomary provisions designed to protect other than the borrower or his spouse, was the investment against physical loss, to be privy to the location of the funds. The akin to waste. borrower was also required to station guards E If a loss results from the borrower's own at his home if he wasn't there. If the borrower negligence. traveled with the funds, then he was required to have four archers accompany him as se- The Iska, may, for example, include the fol- curity guards. Any violation of these provi- lowing recourse events: sions imposed liability on the borrower for E Failing to account on a regularly pre- any resulting loss. The borrower was also scribed basis.207 charged with responsibility if he delayed in making advantageous trades. Thus, if the E Failing to follow prescribed security market took a downturn and losses were suf- measures. fered because the borrower didn't act im- E Using the proceeds of the nancing for mediately to take best advantage of market a purpose not expressly permitted conditions, then the borrower was liable. The under the particular Iska agreement. Mabit also included other provisions, such as a requirement for an accounting every three E Not obtaining adequate collateral in con- months during the term. His Iska format also nection with the use of the proceeds of specied a xed return payable to the nan- the nancing, in order fully to secure the cier of 10% per year,212 if there were prots, 208 repayment of the funds advanced. consistent with the non-recourse nature of the nancing. E Using means of transport or travel routes that are other than as may pre- The recourse events in a Commenda are scribed in the Iska agreement. more extensive than in a Qirad or Iska, as noted above.213 Thus, the borrower was not E Purchasing goods that are other than liable if, while at sea, the ship sank or was those permitted. attacked by pirates. However, if losses occur E Not obtaining the approval of a given for other reasons, then the borrower was

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 34 The Origin of Non-Recourse Mortgage Financing liable. For example, if the money was stolen There is usually an extensive set of cov- before the purchase of goods was made or enants set forth in the mortgage docu- there was a re that destroyed the money or ments that are designed to limit the pos- goods, then this was the responsibility of the sibility of a bankruptcy by the borrower borrower. The borrower was similarly liable if being triggered by some event outside losses occurred after the ship docked at port of the mortgaged real estate or the or if the venture was unsuccessful nancially, single purpose borrower entity. These because of market conditions. It might be can include provisions limiting the busi- said that the Commenda was a nancing ar- ness of the borrower to owning just the rangements that had two carve-outs to li- mortgaged real estate and no other ability; but was otherwise recourse to the properties or businesses and not enter- borrower. ing into any other debt. This also usually includes entering into any loans An Analysis of Carve-Outs to besides the mortgage loan or precipitat- Exculpation Under the Basic Non- ing a lien against the property, albeit Recourse CMBS Mortgage Form, subordinate to the mortgage. Including from an Halachic and The key is separateness and no outside Sha'ariah Prospective entanglements. In essence, the cove- There are two broad categories of carve- nants are designed to isolate the mort- outs to exculpation. A default in one cate- gaged property and the rents it gener- gory triggers liability for the full amount of ates, so that they are available to service the loan, together with interest (typically at and repay the mortgage loan. Compli- the default rate), plus any costs associated ance with these provisions will hopefully with enforcement. The other category limits avoid substantive consolidation with a liability to the extent the lender suers any bankrupt aliate of the borrower arising actual loss as a result of the borrowers out of nancial issues of an aliate or default. The placement of the carve-out event another property or business. in one category or the other is somewhat ne- The prohibition against entering into gotiable in certain instances. The purpose of other loans, even if not directly secured this article, though, is not to dierentiate by the mortgaged property, is also among the various carve-out events. Rather intended to lessen the possibility of it is to explore them conceptually and com- outside events (such as a default under pare them to the three medieval forms of another loan) triggering a bankruptcy of non-recourse nancing noted above. Thus, the borrower. Sometimes, the mortgage the usual carve-outs to exculpation are sum- lender may permit certain subordinate marized below, without categorization as loans; but only if the holder enters into whether a default there under will result in a complete subordination agreement full recourse for the full loan amount or just with the mortgagee. This kind of an limited recourse as to the actual loss incurred: agreement would typically limit the subordinate lender's right to enforce or E Violating the special purpose entity- even default the subordinate debt, while bankruptcy remote provisions of the the rst mortgage debt is outstanding. mortgage. There is also often a somewhat higher

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 35 The Real Estate Finance Journal cost associated with CMBS mortgage amending the law, in eect, to overrule nancing that permits subordinate debt. the court decisions; as did Ohio. The At rst glance, these kinds of provisions answer for the industry, though, is to would appear to be more detailed ver- negotiate these complicated provisions sions of the categories of covenants of the mortgage documents in a manner discussed below under a Qirad or Iska that delivers genuine non-recourse, as structure. Nevertheless, there have been intended. There is a dierence between some cases in Michigan214 and other intentional bad acts of the sort that were jurisdictions that have interpreted these intended to cause full recourse and mar- types of provisions to mean that a mere ket conditions and circumstances out- payment default could trigger full side the control of a good borrower that recourse. It's one thing to say that not were never intended to cause full paying the debt service under the mort- recourse. gage when there is sucient net cash Clarity is required to distinguish be- ow at the property might trigger a re- tween them. Thus, there are a variety of course event. This is especially so if the so-called pre-bankruptcy defaults cov- borrower is diverting monies earned at ered in the typical covenants and condi- the property for other purposes. It's an- tions in a non-recourse mortgage that other thing to say that the inability to may result in acceleration and foreclo- pay should result in full recourse be- sure against the property. These were cause the borrower thereby violates the designed to enable the lender to access covenant not to be insolvent. The eect the security for the loan in time to avoid an even more serious decline in the of this interpretation would be to trigger value. However, there is a genuine dif- full recourse against the borrower and ference between permitting a foreclo- the guarantors under the so-called good sure and triggering a carve-out to guy215 guaranty. This interpretation is exculpation. All of these nancial issues not only antithetical to the entire concept are not the result of intentional viola- of non-recourse nancing it would also tions of the separateness and isolation undermine any chance that the loan of the real estate that are the conceptual could be deemed to be Sha'ariah and basis for non-recourse nancing. It is Halachically compliant. This is because critical to distinguish among the various it converts what is styled a non- categories of default and the remedies recourse loan into a full recourse one. available under the particular There have been courts in other jurisdic- circumstances. The documents can and tions that have also dealt with the issue should be negotiated accordingly to and the results are not uniform. Frankly avoid the vagaries of court decisions speaking, insolvency should not arbi- that might lead to unintended trarily be deemed to be a recourse consequences. event. Rather, a more nuanced ap- From a Sha'ariah and Halachic point of proach is required, which explores the view, the Michigan cases and similar de- basis for the insolvency. cisions on the subject are problematic. The legislature in Michigan responded It's good the industry216 is responding to the Michigan court decisions by appropriately to mitigate the issue.

E Transferring the mortgaged property or limited to the property itself; not the ownership of the borrowing entity in borrower. It would appear that the Iska violation of the no transfer provisions may contain, conceptually, similar agreed to in the mortgage. provisions. The Qirad, would appear to A CMBS mortgage, typically, is due on be more stringent than either the Iska or sale. It also, generally, prohibits a bor- CMBS structures. Under the Qirad, no rower from doing so without rst obtain- distributions are permitted to the bor- ing the consent of the mortgagee. If rower until the nal accounting at the consented to, then there are usually end of the term of the nancing and then other conditions that must be satised. only after the principal amount has rst For example, the issuance of a new been repaid. The waterfall provisions non-consolidation opinion of counsel under some CMBS mortgages might satisfactory to the lender is usually a represent a more modern iteration of condition to transfer. Needed licensure this Qirad conception of how distributions should be made. or other approvals are usually also conditions. E Committing Fraud or making a material Notwithstanding that the borrower cov- misrepresentation. enants not to transfer, there is no eec- These provisions deal with a variety of tive remedy to prevent the same. In es- issues. They include representations as sence, the only remedy is to accelerate to solvency at the time of the making of the mortgage loan because of this the mortgage loan. This would be an default and foreclose. Hence, the con- exception to the Michigan remedial. cept of using the good guy guaranty as Conceptually, these kinds of provisions a means of deterring such a default appear to be consistent with the require- because it will trigger full recourse under ments of the Halacha and Sha'ariah. the mortgage. However, it should be noted that a rep- These kinds of provisions deal with resentation or warranty that the venture intentional acts of the borrower in con- will be protable is not permitted under travention of obligations that are both either the Halacha or Sha'ariah. This reasonable and customary in the would be wholly inconsistent with the marketplace. They appear to be, con- nature of non-recourse nancing and ceptually, consistent with the kind of the apportionment of risk of loss. The limitations on borrower's use of the borrower cannot assure the nancier funds advanced found in the Qirad and that there will be no losses. It would ef- Iska, as summarized below. fectively convert what is purportedly a non-recourse loan into a full recourse E Failure to provide required periodic ac- loan. As such, the details of the cove- countings and other information or to nants must be examined to determine allow inspections of the property. whether this is the case. These are important because the lender has a genuine interest in monitoring the E Committing waste. performance of the property. After all, This might include specic provisions the ultimate security for the loan is dealing with removal of equipment or

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 37 The Real Estate Finance Journal other property from the premises, un- ferred to as economic or physical waste, less it is replaced with equal or better because the net cash ow derived from property.217 It also includes such notori- the property is insucient to pay for ous acts as unilaterally knocking down debt service on the loan and all of the the building improving the property. costs of operating and improving the While land may have an intrinsic value, property (including, proper maintenance, it usually does not generate the kind of repair and capital improvements so as income or value that a tenanted high- keep the property a rst class facility rise building on the site does. and in compliance with leases with ten- Imagine a situation where a hotel bor- ants at the property,) would be grounds rower starts emptying the rooms of for acceleration of the loan and furniture and sells them privately for foreclosure. However, it would not trig- personal gain. The value of the hotel is ger full recourse. premised in no small measure on being On the other hand, not employing the fully equipped and tted out. Often this net cash ow of the property to pay for is also a requirement of the franchise these items and instead diverting the agreement beneting many hotels. This funds for other purposes, like distribu- kind of action impairs the value of the tions to the principals of borrower or for mortgaged real estate. This concern is other ventures might properly be the amplied in regulated properties like basis for asserting full recourse. Often, skilled nursing facilities, where the spe- these concerns are expressed in detail, cialized patient beds and other equip- as a part of the carve-out to non- ment are an essential part of the recourse, especially after the occur- valuation. rence of a default under the mortgage. It is no wonder that there is a carve-out This is so that there is no question as to exculpation for waste. Of course, in to what is intended, thereby avoiding the properties noted above, there are any theoretical concerns about just particular concerns that are usually what constitutes waste or not. expressed in detail. The concept though With the proviso's noted above, and as- is grounded in waste, where the bor- suming that limited to intentional acts of rower intentionally damages the lenders the borrower and not as a result of re, security in the mortgaged property. casualty or other events outside the While intentional acts that cause physi- control of the borrower, these kinds of cal waste are reasonably included in this provisions would appear to be consis- carve-out to non-recourse, some courts tent, conceptually, with a Qirad or Iska have expanded the provision to include structure. However, it is all about the even non-payment of real estate details. taxes.218 This is another one of the decisions that have yielded surprising E Violation of applicable environmental results to many in the CMBS industry. laws or cleanup requirements. The provision can, however, be These conditions directly aect the negotiated. value and marketability of the property. In essence, experiencing what is re- Imagine if a borrower sought to frustrate

a lender's foreclosure against the prop- against distributions that were made erty by dumping asbestos in the base- prior to any default. These provisions ment of a building on the property. also typically deal with the borrower not Consider also that the intended use of accepting prepayment of more than the property may be materially impaired one-months rent by tenants, without the by environmental contamination. These consent of the lender. kind of intentional or willful acts should There are also sometimes more insidi- trigger personal liability by the wrongdoer. Amelioration of existing ous misapplications of funds. Thus, for adverse physical conditions is a matter example, if the borrower's aliates own of underwriting and assuring other properties and ventures and ex- remediation. On the other hand, there penses of an aliate are paid or improp- are a myriad of environmental regula- erly allocated to the borrower. This tions that are no dierent in concept might also be a problem in terms of from other legal requirements, some are bankruptcy remoteness, because of the genuinely attributable to the tenants, commingling of funds. There are gener- which occupy the premises. Compliance ally express covenants that forbid these with environmental requirements is simi- kinds of activities. lar to compliance with law, generally and Both the Qirad and Iska can contain should not be an automatic exception to conceptually similar provisions, espe- exculpation. Distinguishing among the cially in terms of misapplication of funds. various categories of environmental Under the Qirad, distributions to the concerns is a matter of negotiation and drafting of the particular document. borrower are not permitted until the nal accounting and only after principal is If the matters noted above are not rst repaid. Thus, the concept of recov- caused by the intentional acts of the ering distributions, even prior to any borrower, but, rather, are the result of events outside the control of the bor- default, would be consistent with the rower then that would likely be problem- Sha'ariah. If the agreement permitted atic under the Sha'ariah and the the borrower to obtain interim distribu- Halacha. Similarly, if the net cash ow tions, as is the case in mortgage nanc- from the property was insucient to ings generally, then it might also be deal with these matters, then that would permitted under the Sha'ariah for the also be an issue. lender to receive interim payments of debt service, during the term. On the E Misappropriation, misapplication or other hand, recourse by reason of conversion of rents, security deposits, insolvency of the venture may be a gen- insurance proceeds or condemnation uine issue. However, if the loss arises proceeds. out of the borrower's wrongdoing (in- This provision, in the case of rents, can cluding withdrawing funds for personal often be negotiated to limit it to post- use or use in other businesses or violat- default occurrences. This is important, ing other covenants), then triggering because as discussed lenders might try personal recourse under these circum- to reach back and seek to recover stances would appear to be Sha'ariah

compliant. Once again, it's all about the event. However, this kind of provision details. can be negotiated. Thus, it may be a default; but it would not be a recourse E Failure to maintain required insurance. event. Involuntary bankruptcy might also The failure of the borrower to purchase be included as a recourse event. How- reasonably required third party insur- ever, if it is defended against by the bor- ance coverage against certain appropri- rower, then it typically would not trigger ate risks, out of the rents derived from a recourse event. What is intended is to the real estate, could be an exception avoid a collusive involuntary bankruptcy. to exculpation. The borrower is not li- There have been a number of cases able for the loss, per se; but rather the 221 losses resulting from failure to purchase dealing with this provision. Of particu- the required coverage. lar concern are the ones that appear to impose liability for insolvency even when The Sha'ariah seems to be more ex- it is not directly caused by misconduct ible on this point. Under an Ijara type of nancing arrangement, the lessee/ by the borrower. After all, if the mort- borrower can agree in a separate agree- gage is not paid, because the property ment to reimburse the lessor/nancier does not generate sucient net cash for losses resulting from re or other ow to do so, this inability, in and of casualty. However, under the Halacha, itself, creates a problem of insolvency. the separate agreement and lease - If that is all it takes to trigger recourse, nancing transaction would be integrated. then it may also be a genuine issue in This would result in the lease being terms of compatibility with the Sha'ariah deemed nothing more than a disguised and Halacha. It should be noted how- loan of the property, as noted above. ever, that the Michigan Legislature Nevertheless, it would appear that sep- responded by passing a law that, in ef- arate insurance is permitted to be pur- fect, overturned the court decision.222 chased from a third party insurer.219 To The law prohibits a mortgage lender make this a covenant of the borrower is from seeking recourse (in a non- problematical, unless the obligation is recourse mortgage) against a borrower limited to payment of the insurance or guarantor by reason of the borrower premiums out of available net cash ow becoming insolvent post-closing and and, of course, only if such insurance is, thereby violating a solvency carve-out in fact, available on commercially rea- to non-recourse. Any inconsistent pro- sonable terms and conditions. These vision in the loan documents is deemed are usually negotiated changes to these invalid. Ohio has since passed a similar provisions, in any event. law, entitled the Ohio Legacy Trust Act.223 E Filing of a voluntary bankruptcy.220 This may also include just being E Wrongfully seeking to defeat, impair, insolvent. Thus, if the borrower's assets impede or interfere with the enforce- are less than its debts or the borrower ability of the mortgage or lender's rights is unable to pay its debts as they come or remedies thereunder. due, then that might become a recourse This kind of a provision, like the one

about insolvency, can be problematic. the property, including for the projected The concept of the borrower not assert- cost of tenant improvements and leasing specious defenses is consistent with ing commissions. Interest reserves may the Sha'ariah and the Halacha. A bor- also be established to deal with nega- rower should not be asserting defenses tive cash ow projected during the solely to hinder or delay enforcement of expected rent-up period. There are also the mortgage. Some forms of Qirad and typically personal guaranties associated Iska even provide for penalties in the with the obligation to complete and pay event. However, not having the right to for the work. While these kinds of pro- challenge whether the principal sum is visions are certainly appropriate from an in fact due is an issue. The Iska ad- underwriting and business point of view, dresses this problem by establishing an there may be some diculties with the enhanced level of proof (i.e., only the guaranty provisions. If the guaranties testimony of two kosher witnesses is are limited to the available funds set acceptable on this issue). Both the Qirad aside in reserves for these purposes, and Iska do not permit the borrower to then this might be acceptable. On the challenge the validity of the nancing. other hand, if the guaranties are unlim- The only issue is whether the money ited until the intended results are was lost (due to no fault of the bor- achieved, then this may be problematic rower, as provided under the express under the Sha'ariah and the Halacha. terms and conditions of the document). As is the case with many of the matters Otherwise, the borrower cannot be discussed above, it's ultimately all about heard to say that the nancing amount the details. is not due and payable. Provisions dealing with cooperation by the borrower, in The carve-outs to the exculpation provi- connection with the turn-over of the sion in the mortgage are usually coupled with mortgaged property, after the occur- a so-called good guy guaranty signed by rence of an event of default, and provid- principals of the borrower. Thus individuals ing for liability by the borrower for or other net worth entities would guaranty losses incurred as a result of the bor- the debt or loss, as the case may be, in the rower's failure to cooperate, may also event of a default by the borrower that trig- be consistent, conceptually, with the gers any of the carve-outs to exculpation. It Sha'ariah and the Halacha. Similarly, as is important to note, that these are matters to distributions made after a default, that are, generally, within the control of the while at the same time not paying real borrower. The borrower is fully exculpated estate taxes that would prime the from personal liability unless the borrower mortgage. violates these provisions.

E Completion Guaranties. As discussed above, there are a number Some loans require that certain work be of carve-outs to exculpation permitted under done at the property. The funds needed the Qirad, Iska and Commenda forms. From to accomplish this work are usually set- a Sha'ariah224 and Halachic225 point of view, aside in a reserve. Other reserves may the parties can enter into such business be established to deal with rent up of terms and conditions as they desire, so long

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 41 The Real Estate Finance Journal as they are not expressly prohibited under ment, to access one of the most ecient and the applicable legal system. However, there lowest cost nancing sources in history. are genuine concerns under both these legal systems if the borrower is personally liable NOTES: for events that are outside the control of the 1 borrower. This would likely result in the In some states, instead of a mortgage, there is a deed of trust. nancing instrument being deemed a dis- 2The term CMBS is used to denote a class of se- guised loan and, therefore, being prohibited curities derived from the securitization of a portfolio of mortgages against income producing real estate. This as yielding Ribit or Riba, respectively. Many asset class usually includes multi-family rental apart- in the industry share these concerns about ment buildings, oce buildings, industrial or warehouse buildings, shopping centers, hotels or skilled nursing these kind of provisions, although strictly facilities. The senior mortgage debt is typically placed from a business point of view. The objectional in a trust and various classes (known as tranches) of participation certicates are issued. That's particular provisions can and should be negotiated and portion of the overall debt is then articially segregated adapted to meet these concerns. into classes representing the most senior in priority to the junior-most, within this mortgage pool. The various tranches within this senior mortgage debt are then Conclusion rated by rating agencies and graded in a range that can sometimes reach as high as AAA (the highest The CMBS non-recourse mortgage nanc- grade under the S&P rating system) to as low as BBB (the lowest investment grade rating). Portions of the ing structure may, for the most part, be overall debt that do not merit at least an investment Sha'ariah and Halachically compliant, at least grade rating are separated from the senior mortgage debt included in the trust. This is because this portion conceptually. Details, though, do matter. of the overall oering includes only the tranches of the Thus, some court interpretations of particular overall debt rated investment grade or above. Any portion of the debt that is below investment grade is fur- carve-outs to exculpation may be ther separated into separate tranches, which may also troublesome. However, the applicable provi- be rated. They are often classied as mezzanine or sub debt. The benets of this kind of structured nance sions can be negotiated so that they do not are manifold. On the lenders' side of the equation, those vitiate compliance. The CMBS format is interested in the more secure portion of the debt (i.e., with a lower loan to value ratio and, therefore, more structurally sound and robust enough to ac- coverage) can buy the higher rated securities. However, commodate the foregoing and to make the the interest yield they receive is usually correspondingly lower than that applicable to the lower rated se- adaptations that may be necessary to assure curities and a comparable bank nancing of the entire Sha'ariah and Halachic compliance. debt. On the other hand, the lower rated portions (i.e., with a higher loan to value ratio and, therefore, less coverage) usually yield a higher rate of interest. The The benets of employing the CMBS for- blended rate, though, is generally competitive when mat are manifold. The existing so-called contrasted with comparable bank nancing. The terms of CMBS mortgage nancing may also be more favor- Sha'ariah compliant nancing forms have not able, including that formulated on a non-recourse basis. achieved market acceptance, generally, 3A type of nancing form that if properly structured because they are not compatible with capital does not violate the prohibition against Ribit. It is discussed in the Babylonian Talmud. However, it likely 226 markets requirements. As a result they existed by Mishnaic times and, possibly, well before cost more than competitive capital markets that as well. The terms of the Iska, in its various incarnations, are more fully discussed in this article. products. 4A nancing form in use in the Middle East (including prior to the advent of Islam) and elsewhere that Embracing the CMBS non-recourse nanc- does not violate the prohibition against Riba under the ing form, as outlined above, will permit a Sha'ariah, as more fully discussed in this article. The Qirad is also known as a Mudarabah. whole range of borrowers, now eectively 5A nancing form in use in Europe, during the me- barred by misperceptions of religious impedi- dieval period, that appears not to violate the prohibition

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 42 The Origin of Non-Recourse Mortgage Financing against Usury, under Christian legal traditions and prac- Synagogue in Fustat (Old Cairo), Egypt. It contained a tice. collection of hundreds of thousands of fragments of 6A term used to denote the body of Jewish Law, Jewish manuscripts and documents. In Jewish tradition, derived from the Bible, as elucidated in the Mishna, Je- holy books and documents containing the sacred name rusalem Talmud, Babylonian Talmud and various codes of G-d are not discarded. They are stored in a Geniza of law, as well as, by commentators and later religious (literally, hidden place) until they can be properly buried. authorities. It literally means the way. The Cairo Geniza reportedly contained documents dating back, more than a thousand years, to the ninth 7 A term used to denote the body of Islamic law, century. derived from the Koran and elucidated by later religious 13 authorities and scholars. It too literally means the way. See, for example, the Fatwa of Osama bin Laden, dated August 23, 1996 and reproduced by PBS 8 The Mishna is an authoritative written code of the Newshour online. There are numerous Sha'ariah oral Torah, edited by Rav Yehuda HaNasi (an appella- scholars who disagree with this extremist approach. tion, meaning the leader). It together with the Torah For a fuller discussion, see article by the author entitled: (Five Books of Moses), Neviim (Prophets) and Khetuvim “Interest, Ribit and Riba: Must These Disparate Legal (Writings), comprise a written statement of Jewish law. Concepts Be Integrated or Is a More Nuanced Approach The Torah, Nevium and Chetuvim are also, collectively, Appropriate for the Global Financial Community?” in known by the acronym Tanakh or the Bible, The word the May, June, and September issues of The Banking Mishna may be dened as to study or review. It may Law Journal (2014). also be dened as a recapitulation. The later denition, 14 in contemporary terms, might better be described as Although current Catholic Church Canon Law no the Restatement. longer expressly prohibits the charging of interest, it did proscribe it in the medieval period. However, see 9 Where there is some apportionment of the risk of the discussion below, of Thomas Aquinas' view on non- loss and, hence, limited personal liability, as more fully recourse types of nancing of the sort described in this discussed below. article. Protestant practice is to permit reasonable inter- 10The Talmud is a seminal encyclopedic work of est charges, as noted below. Jewish law, traditions and lore. The word Talmud liter- 15A term used to denote the code of religious law ally means teaching or study. The Talmud contains the of the Catholic Church and aliated Christian Churches. Mishna and additional notes on the Mishna, known as In this regard it should be noted that Protestant Church Gemara (meaning to study or derive logically). It doctrine, as formulated by Calvin, views the matter of provides a critical analysis of the Mishna, including the charging interest dierently. Beginning in 1547, Calvin provenance of the laws reported as a part of the oral spoke of reasonable interest charges for money being tradition. Variant or other texts or reports are examined acceptable. Only excessive interest was wrong. After and inconsistent legal traditions or positions are Henry the VIII broke with Rome, England, in 1545, discussed. Further explanations of and glosses on the passed a law permitting interest to be charged, up to a subject matter of the Mishna or in general may be maximum of 10 percent per annum. In the 19th century, noted. Other materials within the oral tradition are also the Roman Catholic Church acknowledged that moder- included. It represents the next stage in the written ate rates of interest were not to be disturbed. As, noted codication of Jewish Law. The appellation Jerusalem above, Canon Law no longer contains an express pro- Talmud refers to the Talmudic text compiled in Israel hibition against charging interest. during the fourth century. The editing process may not 16 have been fully completed and the version we have The term for prohibited return under a loan as likely represents only a part of the work done. It is proscribed by the Halacha. It literally means increase. distinguished from a later work known as the Babylo- 17The term for prohibited return under a loan as nian Talmud, discussed below. The printed text of the proscribed by the Sha'ariah. Jerusalem Talmud referenced in this article is known 18 as the Zhitomir Edition (1965). The term for prohibited interest under a loan as proscribed by medieval Christian doctrine, as opposed 11The Babylonian Talmud was compiled by Ravina to the modern usage, denoting excessive interest. and Rav Ashi, the leading Amoraim (literally, spokes- 19 man) of their generation, by the beginning of the 6th Referred to as syndications of mortgages, as century. The editing process, though, continued for an- opposed to the term securitization of the CMBS era. other approximately 200 years. The Babylonian 20It is also credited with pioneering the so-called Talmud, like the Jerusalem Talmud, contains both the junk bond. Mishna and a further analysis of the matters covered 21See New York General Obligations Law, Section by the Mishna. It also includes discussions of Biblical 5-705, which requires an executed and acknowledged texts, recitations of other parts of the Oral Torah and assumption of the mortgage, at the time title is subsequent Rabbinical enactments, as well as, a host conveyed subject to the mortgage. Otherwise, the new of other materials. It is a more complete and robust owner of the property encumbered by the mortgage is work than the prior Jerusalem version noted above. not personally liable for the debt and no deciency The printed text of the Babylonian Talmud referred to judgment can be obtained against the new owner. in this article is known as the Vilna Shas. However, this does not aect the liability of the new 12The Cairo Geniza was located at the Ben Ezra owner, if it subsequently enters into an extension or

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 43 The Real Estate Finance Journal modication of the mortgage and assumes the mort- more complicated world of real estate and its taxation. gage debt obligation in connection therewith. This is because the shareholders in the Sub S Corpora- 22See New York Real Property Actions and Pro- tion cannot receive a pass-through of the tax benet of ceedings Law, Section 1301. In New York, a mortgagee, non-recourse mortgage debt in their basis for deprecia- generally, can either sue to enforce the note (and by tion purposes. The fact that non-cash deductions for extension, the guarantors(s) of the note) or foreclose depreciation and amortization can be passed through the mortgage; but not both at the same time. This is to the principals of the Limited Liability Company or known as an election of remedies. This is not a univer- Partnership is a fundamental element of real estate sal requirement and in New Jersey, for example, there investment in income producing properties. It often is no requirement of election of remedies. shields the income of the venture that otherwise might be taxable. In eect, all or part of such income can be 23 Foreclosure is an equitable remedy. Not every said to be tax deferred. This deferral can continue so default under a mortgage will necessarily permit the long as the property is not sold and, even thereafter, if mortgagee to sustain a mortgage foreclosure proceed- there is a tax-free exchange properly eectuated in ing in court. See, for example, Loughery v. Catalano, connection with the sale. 117 Misc. 393, 191 N.Y.S. 436 (Sup 1921), a'd, 207 30 A.D. 895, 201 N.Y.S. 919 (1st Dep't 1923), dealing Non-recourse mortgage debt is an extremely with an attempted foreclosure by the mortgagee important component of the depreciation equation, in that it yields basis that can be depreciated. These tax because of alterations made by the borrower without benets can, in eect, be made available, pro rata, to the consent of the mortgagee. See also Rockaway Park all the partners in a partnership (and members in a Series Corp. v. Hollis Automotive Corp., 206 Misc. 955, limited liability company that elects to be treated as a 135 N.Y.S.2d 588 (Sup 1954), judgment a'd, 285 A.D. partnership), for tax purpose. Recourse debt is not 1140, 142 N.Y.S.2d 364 (1st Dep't 1955), dealing with treated the same way under the tax code. Thus, those an attempted foreclosure by the mortgagee because of partners or members who are not personally liable for building violations in existence at the time the mortgage recourse debt cannot include that debt in basis for was rst entered into and known to the mortgagee. In purposes of depreciation. each of these cases the respective courts denied foreclosure because it was inequitable. 31The substantial increase in transfer taxes due in connection with the multiple transfers of the real estate 24Sometimes, foreclosure is not a genuine option may have been a motivating factor at the time. With the because of inter-creditor, bankruptcy or other con- advent of CMBS, bankruptcy remoteness is a critical cerns. See, for example, In re General Growth Proper- factor, which might militate against the use of interven- ties, Inc., et al, (Bankr. S.D.N.Y., Case No. 09-11977). ing entities and transactions that can complicate the is- 25The right to repay the loan prior to the sale of sue. Moreover, having a uniform exculpation provision, the real estate at a foreclosure sale and thereby, in ef- not subject to the vagaries of local law, is also fect, cancel the foreclosure process. important. Indeed, uniformity of mortgage documents, 26These rights are usually expressly subordinated generally, is a signicant element in the securitization in the lease with the tenant. However, tenants are often process. The fact that the mortgage provisions may protected by a separate subordination and non- not necessarily be uniformly interpreted or enforced lo- disturbance agreement that preserves the tenant's right cally is an emerging concern in the world of CMBS, as to possession in accordance with the terms of the summarized below in this article. lease. As a condition thereto, the tenant is required to 32Real estate tax liens generally prime the mort- attorn and pay rent to the new owner pursuant to the gage lien. foreclosure sale and otherwise perform its obligations 33While not a legal concern in terms of the priority under the lease. of the mortgage, nevertheless the business of running 27At the time, there was a concern that somehow the property is important. If the real estate is not a provision, which exculpated the borrower from li- properly maintained or services are not provided to ability, might somehow impair the note. tenants, as required under the leases, then tenants 28This was before the statutory creation of the may, under certain circumstances, assert defenses to limited liability company (LLC) in common use today. or osets against the payment of rent. Thus, in practice, The limited partnership structure provides for limited li- lenders often make deals with contractors and other ability for the limited partners. However, the general service providers in order to have continuity and no partner is still generally liable for the liabilities of the interruption in the ow of rent. partnership and, hence, the use of a corporate general 34For this reason, the term, portfolio lender is often partner. The LLC form, however, provides for limited li- used to describe these kind of bank lenders. ability for the members and managers, much like a 35See Exodus, Chapter 22, Verse 24; Leviticus, corporation; but with the added benet of permitting an Chapter 25, Verses 35–37; and Deuteronomy, Chapter election to be treated as a partnership for tax purposes. 23, Verse 20. See also Ezekiel, Chapter 18, Verse 13; 29Hence, there is no double taxation, as is typically Psalms, Chapter 15, Verse 5; Nehemiah, Chapter 5 the case in Sub C Corporation under the Internal Reve- Verses 1-13; and Proverbs, Chapter 25, Verse 8. The nue Code. While a Sub S Corporation, at rst glance, Biblical terms for interest are “Neshech (literally, biting; appears to oer the tax eciency of no double taxa- as in the bite of interest) and “Marbit” (literally, increase; tion, nevertheless, it suers from disadvantages in the another synonym for interest). The Halachic term Ribit

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 44 The Origin of Non-Recourse Mortgage Financing is derived from the Biblical term Marbit. explains that the increased rent is not considered 36This article focuses on the nature of the loan prohibited Ribit because rent, under a lease described transaction and not on the distinction between an indi- in the Talmud, is normally due at the end of the term of vidual party and one that is an entity. For a discussion the lease. Hence, what is being oered is a discount of Ribit and Riba and whether it applies when non- for early payment; not a higher deferred rent. In this individuals (i.e., corporations) are a party to the loan regard, it should be noted that, even in the case of a transaction, see article on Interest, Ribit and Riba, by purchase transaction, if the general price is xed based the author, published in The Banking Law Journal,as on a deferred payment arrangement, then it is not noted above. considered Ribit when a discount is oered for immediate payment. On the other hand, if the price is xed 37Rabbi Moshe ben Maimon (known by the acro- based on immediate payment, then a higher credit price, nym Rambam), a 12th century Halachic scholar and charged for a deferred payment arrangement, would be codier of Jewish Law. He is the author of the Mishne considered prohibited Ribit. Torah, a comprehensive code of Jewish law, known as 45 the Mishne Torah (or Yad Chazaka). The Mishne Torah See Babylonian Talmud, Bava Metzia, at page is organized, topically, instead of in the order of the 69b. Talmud from which it is derived. This distinguishes it 46See Jerusalem Talmud, Bava Metzia, at page from prior codes of Jewish law. Subsequent codes of 17a. Jewish law, like the 14th century Arba'ah Turim (liter- 47The Halacha, generally, prohibits charging a ally, the Four Rows, referring to the four categories of premium credit price (for the privilege of deferring the law embodied in the work), authored by Rav Jacob ben payment of the lower purchase price otherwise ap- Asher and the 16th century Shulchan Aruch (literally, plicable for immediate payment,) as Ribit. The Sha'ariah, the Set Table) authored by Rav Yosef Karo, followed however, does not consider a premium price charged the Rambam's format. In modern legal terms, the title of for the benet of deferral of payment to be Riba. This Mishne Torah might be loosely translated as the Re- despite the fact that the premium paid is the equivalent statement of Jewish Law. of interest for the period of the delay in receiving pay- 38Rambam, Mishne Torah — Laws of Agency and ment for the goods. In contrast, Thomas Aquinas, a Partnership — Chapter 6 Section 1, where the Rambam preeminent medieval Christian authority, also objects to notes that if only one of the parties works in the venture charging a higher credit price, as noted below. then it is not a partnership; it is an esek (i.e., Iska rela- 48This reading of the text is in accordance with the tionship). See Chapters 4 and 5 for a discussion of the view of the Pnei Moshe. Rav Margolies corrects the meaning and terms of partnership. This is in contrast to text to read that if the lender (i.e., giver of the fruits) the discussion of the Iska nancing form in Chapter 6, bears responsibility for loss during the trip to the noted above. remote locale, then it is permitted. However, if the bor- 39Ibid. rower (i.e., recipient of the fruit) bears responsibility for 40 the risk of loss during that trip, then it is prohibited. The term literally means a business or com- The text appears to have been corrupted and stated in mercial transaction. See Rambam, Mishne Torah, Book the reverse. As printed, it is also inconsistent with a Of Acquisition-Laws of Agency and Partnership, similar text in the Tosefta (Bava Metzia, Chapter 4, Chapter 6, Section 1. In subsequent sections of this Section 5). The Tosefta (literally, addition) is a body of Chapter, the Rambam makes it clear that he is refer- Tannaic writings that was collected; but which was not ring to the Iska nancing form reported in the Babylo- included in the Mishna, edited by Rav Yehuda HaNasi. nian Talmud, as more fully discussed below. The use of It is helpful, in terms of aiding in the understanding of the term esek appears to be derivative of the term the content of the Mishna (as a contemporary expres- coined by Rava in the Babylonian Talmud in the de- sion on the same subject matter of the Mishna); but it scription of the Iska. See Babylonian Talmud, Bava is not itself as authoritative as the Mishna. Metzia, page 104b, as summarized below. 49 41 Jerusalem Talmud, Bava Metzia, at page 17a. The term nancier is used to distinguish this 50 source of nancing from a lender in a traditional loan The term used in the text to describe the risk of setting, where the borrower is personally liable. loss is “Achrayut.” The term may be dened literally as responsibility. 42 See supra note 40. In the midst of his discussion 51 of the Laws of Agency and Partnership, in Chapter 6, Jerusalem Talmud, Bava Metzia, at page 19b. the Rambam uses the term esek to dene a nancing 52The name “Leyzer” is believed to be a shortened structure. version of Elazar or Eliezer. The Mareh Panim com- 43 mentary adjoining the text of the Jerusalem Talmud Called “Sechirut” in the Talmud and other refers to Rav Leyzer as Rav Eliezer. Rav Leyzer is not Halachic literature and “Ijara” under the Sha'ariah. See otherwise specically identied in this text. However, at the discussion below concerning charging a higher the end of page 19b of the text, there is a reference to rental rate, if the rent is paid over time. Rav Leyzer ben Azaria, who is then subsequently 44Under a Talmudic form lease, it is also permitted referred to as Rav Elazar ben Azaria. Could this be the to charge a higher rent if paid over time. This construct Rav Leyzer referred to in the text? If so then he would is distinguished from a higher deferred purchase price, be a rst century Tanna (literally, teacher). He was not which is deemed to be prohibited Ribit. The Talmud only a preeminent scholar of impeccable lineage; he

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 45 The Real Estate Finance Journal was also reputedly very wealthy. The Tosefta of Avoda ironclad security for the loan, including the borrower's Zarah, Chapter 5, Section 1, reports that he was a personal liability. The reference to “Sheep” may be dealer in wine and oil. Thus, he was likely familiar with because this structure was typically used to nance commercial nancing devices, like the one ascribed to the raising of sheep. The Mishan expressly prohibits Rav Leyzer in the text. He was elevated to the position this nancing structure because of the law against Ribit. of Patriarch by his colleagues at a young age. The Hag- As Rashi (Rav Shlomo Yizchaki, an 11th century, lead- gada of Passover describes an incident where he notes ing Talmudic commentator) explains, this is because, that he was like 70 years old, because in fact he wasn't. under the Tzon Barzel nancing arrangement, the bor- Rather he was a young man who became prematurely rower assumes the entire risk of loss. See also Yoreh grey, as is betting the occupant of so lofty a leader- Deah, Chapter 173 in the seminal code of Jewish Law, ship position. This might help explain his concern with known as the Shulchan Aruch, by Rav Yosef Karo, a appearances, in terms of ultimately refusing to accept 16th century Halachic authority. Rav Karo distinguishes the prot derived from the permitted nancing structure Tzon Barzel from a permitted non-recourse nancing ascribed to him in the text. structure. He notes that if the nancier takes the risk 53Interestingly, the Jerusalem Talmud reports that the livestock may die and also the risk the price, Rav Leyzer balked at using his own lending device. ultimately achieved on sale, may not yield a prot, then Nevertheless, it appears that others accepted it. The the nancing form is permitted. In essence, the live- phraseology in the text is noteworthy. It suggests that stock is deemed to be in the control of the nancier for structure which is said to be close to prot (because of risk of loss purposes. Rav Karo also notes that under the risks borne by the borrower) and close to loss this kind of a nancing form, the sharing of prots (because of the risks assumed by the lender) is ac- formula does not have to be equal. The parties can ceptable. It is respectfully suggested that this means it agree that the borrower would receive a lesser per- is a nancing structure, which has an appropriate ap- centage share, such as one-third or one-quarter the portionment of the risk of loss. This concept is reected prots. In essence, where the lender takes the risk of in the Tosefta, as well. (See Tosefta, Chapter 4, Sec- loss, the sharing of prot arrangement is pretty much tion 9.) It also expresses the conceptual basis of up to the parties. Malik has a similar point of view under Abaye's position, in support of the wine nancing the Sha'ariah, as discussed in this article. structure, described in this article. 59I.e., the one-half of the prots yielded to the - 54See Mareh Panim commentary by Rabbi Moses nancier under the arrangement. Margolit (who also authored the Pnei Moshe), adjoining 60In a parallel text in the Babylonian Talmud, Bava the text of the Jerusalem Talmud, Bava Metzia, on page Metzia, at page 70b, Abaye notes that the nancier 19b, which makes this assertion. See also the Bach takes the risk of loss on “zula” (i.e., a lesser price be- (an acronym for Bayit Chadash), a commentary on the ing achieved on the ultimate sale of the livestock and, Tur, by Rav Joel Sirkis (a late 16th-early 17th century hence, the success of the transaction) or by reason of Halachic authority,) adjoining the text of the Tur, at “Onsin” (i.e., casualty or other events outside the Section 167, noted above. He makes a similar asser- control of the borrower). The Tzon Barzel nancing tion. See further the discussion of the Vilna Gaon, sum- transaction is also discussed in the Babylonian Talmud marized below. at page 69b. It is dened as a loan of an asset. It is 55See Tosefta, Chapter 4, Section 9. The Tosefta distinguished from a lease of the cow. In the case of a is a second century compilation of laws that, as its lease, a rental is paid, but the lessee is not liable for name implies, is composed of additional materials be- depreciation, physically or in the value of the cow. yond that reported in the more authoritative Mishna. Similarly, if the cow dies during the term of the lease, 56 the lessee is not generally liable for the loss. However, Seder Nezikin, Bava Metzia, Chapter 5:4. Also in a Tzon Barzel transaction, the borrower is liable for found in Jerusalem Talmud, Bava Metzia, Chapter 5, the originally assessed value, no matter what happens Law No. 3, at page 16b. Also found in Babylonian to the cow or the price. It is a loan substantively, no Talmud, Bava Metzia at page 68a. Interestingly, the matter how denominated. The borrower is liable Babylonian Talmudic discussion reports the view of personally to the lender for the original value (i.e., the Rabbi Yonatan (A First century Tanna), on an unrelated principal amount). In addition, the borrower is required subject. Rabbi Yonatan's position, though, is grounded to pay to the lender one-half of any prots. Thus, as in the non-recourse nature of the nancing structure noted above, it is deemed to be a prohibited Ribit bear- under discussion. This would seem to establish that ing loan. the non-recourse nancing structure noted in the 61 Mishna dates back at least to the rst century. Jerusalem Talmud, Bava Metzia, at page 16b. 62 57Jerusalem Talmud, Bava Metzia, Chapter 5, Law See Rashi, Babylonian Talmud, Bava Metzia, at No. 5, at page 18a. page 68a. Rashi reports that this is an Iska-Palga 58 Malveh, Palga Pikadon, where the risk of loss is borne Interestingly, a subsequent Mishna, in this equally by the parties. Chapter of the Tractate, speaks of what is referred to 63 as a Tzon Barzel (literally, Iron Sheep) nancing See Pnei Moshe, Jerusalem Talmud, Bava Metzia structure. Under this arrangement, the prots are at page 16b. The Pnei Moshe also reports that this is shared equally. However, the borrower is personally li- an Iska-Palga Malveh, Palga Pikadon, where the risk of able for any losses. It is referred to as “Iron” because loss is borne equally by the parties. the nancier is insulated from loss because of the 64Babylonian Talmud, Bava Metzia at page 104b.

65An authoritative group of Talmudic scholars or monumental work on the Talmud, known as the Bet school of thought that originated in Nehardea, a town in HaBechirah (literally Chosen House) also comments on what was once the Babylonian or Persian empire. It the text. He notes in his Bet HaBechirah (Mossad H'Rav was a center of Jewish learning until it was destroyed Kook-Jerusalem-1963) commentary, at page 388, on in the third century. Thereafter, the main centers of this text of the Babylonian Talmud, Bava Metzia, at Jewish learning in this area of the world were said to 104b, that it refers to one-half the sum nanced as be- be Sura and Pumbidita. Some say that the citation in ing deemed a Malveh (loan). This is so as to confer the Babylonian Talmud to “the Nehardeans say” dates personal liability on the borrower for that half of the to the early fourth century period. In any event, the principal sum advanced. He goes on to say that the reports themselves may be of traditions and views rst funds could not be sourced if the borrower's had no expressed during much earlier periods. See The Legal personal liability, at all. On the other hand, if borrowers Methodology of Late Nehardean Sages in Sasanian were required to be fully liable, personally, then no bor- Babylonia by Barak S. Cohen (Brill of Leiden-Boston- rowers would accept money on these terms. The Meiri 2011). then goes on to discuss various aspects of risk of loss 66See Rashi commentary on the text of the Mishna and how it is apportioned among the parties. Thus, he in Babylonian Talmud, Bava Metzia, at page 68a. See notes that the Rambam requires that the risk of loss also discussion of Assyrian Iska-Larim in article by arising out of theft or other loss of the goods purchased author on Interest, Ribit and Riba, published in The with the funds advanced be borne by the nancier and Banking Law Journal, noted above. not the borrower. He goes on to cite the Ra'avad in op- 67 position to this position. He notes the Ra'avad permits See discussion by Rav Betzalel Ashkenazi, a the nancier to shift the risk of loss on these items to 16th century Talmudic scholar, in his work, the Shita the borrower, if the borrower is paid to assume this Mekubetzet (commentary on Babylonia Talmud, Bava risk. However, both agree that the nancier must retain Metzia, page 104b), on the origin of the limited recourse the risk of loss due to Onsin (i.e., casualty or other cir- structure reported by the Nehardeans. He cites the cumstances outside the control of the borrower, teachings of Rav Yehonatan to explain the reasoning sometimes referred to as acts of G-d). The Meiri cites behind this particular limited recourse structure. In es- Rashi for the proposition that if don't expressly stipu- sence, he posited that because of the inherent risks of late otherwise, as a result of the enactment of the Rab- the perilous times and dangers of transporting goods bis reported by the Nehardeans in the Babylonian from place to place, whether by sea or land, the lender Talmud noted above, the presumed agreement between did not want to take on the risk of loss. Thus, nancing the parties is to share the risk of loss equally (i.e., the sources would have dried up if this were required. one-half loan, one-half investment formulation, noted Similarly, borrower/businessman were unwilling to take above). on all the risks. Therefore, the Rabbis instituted the in- 70 novation of apportioning the risk of loss. This limited recourse version of the Iska is com- 68 monly referred to as being Palga (half) Malveh (loan) The language used in the text is interesting. It and Palga (half) Pikadon (investment). The non- states literally that the sages did something that was recourse version of the Iska is commonly referred to as good for the borrowers and good for the lenders. Rav being Kulo (all) Pikodon. Under the Babylonian Talmud's Issac ben Jacob Alfasi, an 11th century Halachic limited recourse version of the Iska, one-half the funds authority. In his work, known as the Rif (an acronym of advanced are deemed to be a loan and there is his name, Rav Issac of Fez), summarizes the Halachic absolute personal liability by the borrower to repay this portions of much of the Babylonian Talmud. In his com- loan amount. The lender is not deemed to earn income mentary on Bava Metzia, at page 62a (corresponding on the loan portion of the nancing. The other half of to the discussion of the Iska in the Babylonian Talmud, the nancing is deemed to be an investment. The bor- Bava Metzia, at page 104b), the Rif describes the in- rower has a number of trust-like duties as to this novation of the Rabbis embodied in the limited recourse investment portion (See Tosafot adjoining text of version of the Iska described above and the underlying Babylonian Talmud, Bava Kama at page 102b). If the reasons for the enactment. He reports it is good for the borrower defaults in any of these duties, he or she is lender because there is at least partial recourse against personally liable. Some, like Tosafot, assert the bor- the borrower personally (for one —half of the principal rower is liable for the whole nancing amount. Others, amount of the nancing). It is good for the borrower, like Rashi assert the borrower is only liable for any because in the event of a total loss, the borrower is losses incurred as a result of borrower's default. The only liable for one-half the principal and not the full net eect of these provisions is to apportion the risk of amount. loss between the lender and borrower. As noted above, 69The Babylonian Talmud makes a conclusory other apportionments may be made, so long as there is statement that it benets the lender; but does not an appropriately proportionate relationship between the explain how it does so. As noted above, the Rif lls in lender's share of prots versus the share of losses. If the blanks. He states that, under this form, the bor- separate compensation is provided for the borrower's rower was personally liable to repay one-half of the work then identical percentages of prots and losses principal amount, under all circumstances. Logically, can be provided to the lender. If, there is no separate then it may be surmised, that, otherwise, the borrower compensation provided to the borrower for the work, would not have been personally liable for repayment of then the borrower is to receive an appropriately any of the principal amount advanced. Rav Menachem disproportionately larger share of the prots, as H'Meiri, a 13th century Halachic authority, in his compared to losses, to compensate the borrower for

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 47 The Real Estate Finance Journal taking on this additional risk. 75A fourth century Amora (literally, one who says) 71See summary of reports of Josephus on the in the Babylonian Talmud. economy of the period, as noted below. It is respect- 76Conceptually, it was viewed as if the nancier fully suggested that the forms used were a functional loaned the borrower one-half the capital to invest in response to the actual business practices, at the time. the deal and charged no interest for the sum loaned. In essence, over time, what may have been a fully non- Therefore, as to this loan amount (i.e., one-half the total recourse nancing structure of the sort recorded in the amount advanced by the nancier), the borrower was Mishna, morphed into the more limited recourse personally liable to repay the loan, under all circum- structures discussed in the Babylonian Talmud, in re- stances. The other half was the lender's investment for sponse to changing nancing conditions. The ebb and which the borrower, generally, had no personal liability. ow of supply and demand of money and good invest- The lender was, therefore, entitled to make a return on ment opportunities may have accounted for the this money, if the transaction was successful. Those changes. For example, in dicult nancial times, when earnings would not constitute Ribit, subject to certain money was tight and demand for money exceeded sup- conditions. While this analogy is useful in terms of ply, lenders had the upper hand. The great innovation analyzing this model, it does not fully explain the of the Babylonian Talmud, discussed above, may have structure. Consider, these are not genuinely two sepa- occurred during this kind of a period, in order to stimu- rate nancing transactions; they are integrated. As late the ow of funds. Indeed, it appears that the Rava points out, all the money advanced by the nan- discussion of a limited recourse nancing structure that cier was required to be used to accomplish the object did not yield prohibited Ribit may have originated in the of the overall nancing. It was, therefore not a purely rst century. This was a time of political, social and separate loan transaction. Moreover, there was also a economic unrest. Even before the actual destruction of disparity between the contributions of each of the two the Temple in Jerusalem in the Year 70 CE, the yoke parties to the transaction. The borrower was the only of Roman domination was particularly heavy on the one actually actively pursuing the transaction for the people of Israel. (See Josephus, Jewish Antiquities, benet of both parties. It might be said that the only Book 20, beginning at Chapter 11, et seq. and also apparent reason the borrower would work for the ben- The Jewish War, Book 2, beginning at Chapter 15, et et of both parties was to recompense the nancier for seq.). After the destruction of the Temple in 70 CE and, providing the loan portion of the nancing noted above. thereafter, at the beginning of the second century, with Why is this nancing form then permitted? Doesn't it the unsuccessful revolt of Bar Kochba, the conditions yield a disguised return to the lender equal to the value were even more dicult. The Rabbi's, in an eort to of the work performed by the borrower, which is incentivize those with money to free up and deploy prohibited Ribit? To address this appearance issue, capital with those who could make use of it and revital- compensation was provided to the borrower to make it ize the local economy, conceived of a way to apportion clear that this was not the case. The amount of the risk in a manner favorable to both, as described above. compensation (be it nominal or otherwise,) is the In good times, when those with money sought prot- subject of much discussion in the Babylonian Talmud able investment opportunities, which were in limited and, elsewhere, as noted above. The Iska nancing supply, borrowers with the right contacts and acumen structure does not require a sweat equity contribution may have had the upper hand. This was not a static by the borrower, as is the case with the Qirad, as more condition; it varied with the interplay of supply and fully discussed below. Indeed, in the limited recourse demand, at the time. The parameters of religious ob- Iska arrangement it is prohibited. It would appear that servance, discussed in the Babylonian Talmud, dened even in the non-recourse Iska format, under certain cir- the upper limits of how risk of loss could be properly cumstances, the absence of some separate compensa- apportioned, without falling astray of the strictures tion for the borrower's work may also constitute an ap- against making a loan on interest. Thus, while making a pearance issue, as more fully discussed in this article. traditional personal loan was also a possibility, earning 77Babylonian Talmud, Bava Metzia, at page 68b. any return on the monies advanced was precluded 78 because it would constitute prohibited Ribit. How to It is sucient that the lender permit the borrower earn a prot on monies advanced, without falling astray to dip into the lender's sh sauce or to share consump- of the applicable strictures against earning prohibited tion of a dried g. (See Babylonian Talmud, Bava interest, was an integral requirement of these transac- Metzia, at page 68b.) tions. 79Interestingly, the Babylonian Talmud (Bava 72See discussion of Rava in the Babylonian Metzia, Page 69a) also discusses the Mishna, noted Talmud, Bava Metzia, at page 104b and the discussion above, that describes a nancier advancing funds to a of Rashi on the text. storekeeper or dealer, as borrower, to buy fruits for 73 sale in the ordinary course. A similar limited recourse A Shtar is a written document attested to by at nancing arrangement is also discussed in the Jerusa- least two witnesses that evidences the agreement be- lem Talmud (Bava Metzia at page 16b). The basis of tween the parties. the nancing arrangement is that the prots derived 74Pledge language could be inserted in support of from this activity are to be shared by the parties, the debt portion of this innovative Iska structure. More- equally. Once again the Talmud notes that this is a over, if a full recourse event were triggered, because permitted nancing arrangement, provided the borrower the borrower violated a nancing covenant, then the is compensated as a worker. Rashi, in commenting on pledge would secure the entire nancing amount. the text, notes that this nancing arrangement de-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 48 The Origin of Non-Recourse Mortgage Financing scribed in the Mishna is an Iska, where prots and 94See discussion of Responsa 26, among others, losses are shared equally. In terms of the compensa- in the Responsa of the Rambam (Blaue edition), sum- tion required for the borrower, Rashi species that the marized below. going rate for workers is divided in half. In essence, as 95A 16th century Halachic Authority, who, among to the so-called loan part, the borrower is, in eect, other things, authored the Code of Jewish Law, known working for his own benet. It's only as to the one-half as the Shulchan Aruch, as well as, a commentary on investment part that there is an issue of the borrower the prior Code of Jewish Law by the Tur and on the working for no apparent compensation. This might cre- Rambam's Mishne Torah Code, before it. ate a substantive issue of Ribit. At the very least, it 96 creates an appearance issue, since, as noted above, Ibid. the only reason the borrower would be doing this work, 97Ibid. for no compensation, is to receive the interest free loan 98Although not specically referred to as a Com- portion of the nancing. Hence, Rashi suggests that, menda, it is likely one, based on the description in the while compensation must be set-aside for the borrower, text of the Bet Yosef. As Rabbi Yosef Karo notes, it only half the going rate is required to avoid the issue of only exculpates the borrower from losses due to the Ribit. ship sinking or the cargo being stolen by pirates. It 80See Babylonian Talmud, Bava Metzia, at page does not exculpate the borrower from all losses due to 68b. Onsin (i.e., casualty or other losses, generally, as a 81It should also be noted the fact that the bor- result of any events outside the control of the borrower bears some of the risk of loss is another factor, rower). This limitated assumption of certain risks by the which distinguishes this sort of a transaction from a nancier is a feature common to Commenda Contracts, typical agency or employment relationship. as more fully discussed below. 99 82The loan nancier made to the borrower is Bet Yosef on the Tur, Yoreh Deah, Section 176, at page 502, in which Rav Karo notes that it is insuf- ostensibly otherwise interest free; hence the appear- cient for the lender to bear just losses occasioned by ance issue. re or theft, as provided in the nancing structure used 83 For example, the nancier is not responsible for in Lombardy. The lender must bear the risk of loss of the acts of the borrower under some theory of respon- Onsin (acts of G-d and other events outside the control deat superior. of the borrower), generally; not just these specic in- 84The extent of this liability is the subject of stances. discussion among the commentators on the Talmud. 100The nancing forms summarized below are for Some argue it is only the damages suered by reason the most part permitted by some, except for Rav of the breach. Many, though, hold the borrower thereby Hama's lease of money structure. This particular incurs liability for repayment of the loan. See discus- example is used in order to dierentiate it from a sion of Trumat Hadeshen and Tikun Maharam below. permitted type of lease nancing transaction. Examples 85See Babylonian Talmud, Bava Kama, at page of nancing structures prohibited by the Talmud, 102a and discussion by Tosafot on the text. See also include the three summarized below. Thus, the Tarsha Tosefta of Bava Metzia, Chapter 4, Section 11. of Rav Papa (Babylonian Talmud, Bava Metzia, at page 86 65a) is prohibited as discussed below. So too are the Jerusalem Talmud, Bava Metzia, at page 17a. so-called Mechozan Documents (Babylonian Talmud, The Talmud notes that although it constitutes wrongful bava Metzia, at page 68a). Under this structure, the - conduct, it is not actionable. nancier accepted a specied sum, in lieu of a half share 87See prior discussion of Mishna above. See also of the projected prots. The Mechozan debt instrument Iska-Larim discussion in article by author on Interest, would set forth a total debt sum equal to the original Ribit and Riba, in The Banking Law Journal, as noted principal amount plus the projected share of the prots above. projected attributable thereto. The borrower waived the 88See the Iska form, attributed to Rav Hai Gaon, right to be believed that less was made than the speci- set forth as Document 15, in the Book of Documents of ed sum. It was viewed, in eect, as a sale by the - Rav Hai son of Shreira Gaon, compiled by Simcha As- nancier of the prot expectation for a lesser xed sum. saf (Jerusalem-1830). The Talmud prohibited this nancing structure. This de- 89 spite the protestations by the nancier's son that his See Medieval Trade in the Mediterranean World, father had orally waived the provision prohibiting Illustrated Documents, translated by Robert S. Lopez testimony by the borrower as to losses actually and Irving W. Raymond (Columbia University Press- incurred. The so-called Narashan Leases are also 1955). mentioned as a prohibited nancing form in the 90Ibid. Babylonian Talmud (Bava Metzia, on page 68a). The 91Ibid, beginning at page 29. structure is congured as a mortgage-leaseback of the 92 property. The rent under the lease of the borrower's See, for example, Shitah Mekubetzet (by Rav property back to the borrower yields an interest like Bezalel ben Abraham Ashkenazi, a leading 16th century return to the nancier on the underlying loan. It is Talmudic Authority,) commentary on Babylonian prohibited because it is nothing more than a disguised Talmud, Bava Metzia, page 104b. loan on interest. The lender does not actually acquire 93Cairo Geniza. title to or even possession of the property; rather, it is

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 49 The Real Estate Finance Journal only a security interest. Contrast this with the immedi- also has a call, at a xed price, so that it can earn any ate sale of the property, in the case of the Boethus ben excess premium in the price. The buy/sell price is Zunin structure summarized in this article. Under that formulated to yield to the nancier an agreed upon structure there is also no lease-back to the borrower. return on its investment. Rashi appears to view the Mechozan Documents as an 111See discussion of Tosafot on the text of integrated transaction that yields actual prohibited Ribit. Babylonian Talmud, Bava Metzia, at page 64a. Tosafot Others though view it as an appearance issue. Interest- views this provision as the equivalent of a warranty of ingly, the Talmud goes on to posit an example of this merchantability or tness for a particular purpose. In nancing structure that was permitted. Thus, the essence, if the warranty is violated, then the nancier is Talmud notes if there was an interval of time (Rashi entitled to rescission (i.e., repayment of principal). The noted for a period of three years), during which the Tosafot (literally, additions) are a collection of the writ- lender took actual possession and operated the real ings of various commentators on the Talmud, following estate and only later leased the eld back to the bor- the era of Rashi. They were among the Halachic rower then this structure was permitted. The Talmud authorities known as the First Ones, who lived during notes that the document then in use recited this state the period beginning with the end of the Geonic Era of facts and was permitted. It goes on to note that this (approximately, the middle of the 11th century) and was important so as not to close the door on borrow- ending in the 16th century, during the time of the great ers. codier of Jewish law, Rav Yosef Karo and his contem- 101There are other permitted nancing forms, which poraries. are based on other considerations. For example, when 112He was a disciple of Rava. Abaye and Rava, interest is not payable by the borrower directly to the were contemporaries, who were often mentioned as lender. This includes the sale of a borrower's interest holding opposing positions in discussions of law in the free note at a discount. The purchaser can collect the Talmud. full amount of the loan, even though a premium is being 113 earned. Thus, notwithstanding that the premium earned See Rambam, Mishna Torah, Laws of Lender is, in eect, interest, it is not deemed Ribit. As the and Borrower, Chapter 8, Section 10. See also Shul- Tosefta states so pithily, there are some things that chan Aruch, Yoreh Deah, Laws of Ribit, Section 173, look like Ribit; but are not. See the Teshuvot Rashi, Sub-Section 13. Section 177. See also Sefer Mitzvot Gedolot, by Rav 114The word in Aramaic reportedly means silent. It Moses ben Jacob of Coucy (a 13th century Halachic is used to describe the nancing technique summa- authority, known as the SM”G, after the initial letters of rized above. the name of this Halachic treatise), Section 193; and 115Babylonian Talmud, Bava Metzia, at page 65a. Tosefta, Chapter 4, Section 2. 116 102 This is in stark contrast to the Tarsha of Rav Not everyone agrees that this is permitted, as Papa discussed in the Babylonian Talmud, Bava Metzia, noted below. at page 65a. The Papaen Tarsha is deemed to be just 103Mishna recorded in the Jerusalem Talmud, Bava a higher credit price under a deferred payment arrange- Metzia, as Halacha 2, on page 16a. See also Babylonian ment. The deferred purchase price was determined Talmud, Bava Metzia, at page 65b, where the same based on an estimate of what the price of beer might Mishna is also set forth in the text. be approximately six months later, in the spring, when the seasonally adjusted price of beer was generally 104A wealthy and respected resident of Lydda in higher. However, the conclusion of the Talmud is that second century Israel, whose home was a meeting this is a credit nancing arrangement yielding prohibited place for scholars. Ribit. This is not intuitively obvious given that the pric- 105See discussion of Mishna, as noted above. See ing was not strictly speaking phrased as being higher also discussion in Gemorah text following the Mishna in because of deferral of payment. However, once again the Jerusalem Talmud, Bava Metzia at page 16b. The the key distinguishing element appears to be whether Pnei Moshe on this text notes that the fruits of the or how the risk of loss is apportioned. In the Papaen three year loan period were held in escrow, with a third Tarsha, the borrower must pay the higher purchase party, during the loan term. They were then turned over price, no matter what happens in the interim. There is to the ultimate recipient, as noted above. no apportionment of risk of loss. The borrower bears 106Jerusalem Talmud, Bava Metzia, at page 16b. the entire risk of loss and it is, therefore, a pure loan 107 transaction. The dierence in the purchase price is Babylonian Talmud, Bava Metzia, at page 64a. thus prohibited Ribit. In the Tarsha of Rav Hama, there 108An early fourth century Amora. is an appropriate apportionment of the risk of loss, as more fully discussed in this article. See discussion of 109The nancing program summarized above this nancing form in Shulchan Aruch, Yoreh Deah, provided for protection against this risk of loss, by way Laws of Ribit, Section 173, Sub-section 15. of a put, under the buy-sell arrangement, as noted 117 above. Ibid. 118 110In the modern form, the nancier has the right to See discussion of the Rambam's Responsa on put the scotch to the distiller/borrower at a xed price. the matter, as well as, the Tur's nancing form, sum- This mitigates against the risk of a loss of value due to marized below. market uctuations in the price. The distiller/borrower 119See also Tur, Yoreh Deah, Chapter 173.

120Babylonian Talmud, Bava Metzia, at page 69b. term to describe a type of borrowing structure that is 121See, for example, United Airlines, Inc. v. HSBC not a pure loan associated with Ribit. We colloquially Bank USA, N.A., 416 F.3d 609, 45 Bankr. Ct. Dec. use the term borrow or loan when referring casually to (CRR) 1, Bankr. L. Rep. (CCH) P 80322 (7th Cir. 2005), lending an item for use by another for no charge. Thus, a relatively recent case that illustrates this point. we might say that a tool was borrowed by a neighbor. In this kind of a transaction, the borrower is generally 122 I.e., that can be the basis of a bond nancing, referred to in the Talmud and Halachic literature as a underwritten wholly on the quality of the rent ow from “Sho'el,” as opposed to a “Loveh.” The distinguishing the tenant. The landlord, generally, has no real respon- characteristic may once again center on how the risk sibilities to the tenant under this type of a leasing of loss is shared by the parties. The lender in the Sho'el structure. To qualify for this kind of nancing, there arrangement bears the risk of loss of depreciation, cannot be any impediments to the payment of rent. The including both physical depreciation and in terms of rent must be paid no matter what the circumstances. dimunition in value. The borrower in the Sho'el arrange- 123See Tosafot adjoining text of Babylonian ment often bears the risks of casualty, theft or other Talmud, Bava Metzia, at page 69b. Tosafot explains loss, but not always. Thus, if the loss occurs while the Rav Hama's view was based on the belief that the Shoel is using the borrowed object for the intended lender taking on the risk of loss of “Onsin” was suf- purpose, then the Shoel is not liable. In that event, it is cient to avoid the prohibition against Ribit. The term the lender who would bear the risk of loss (See Onsin may be dened as acts of G-d or other events Rambam, Mishne Torah, Laws of Borrowing and outside the control of the borrower. This was deemed Entrustment, Chapter 2, Section 1). By implication, it is to be an insucient apportionment of risk of loss to the suggested that (by analogy to the rule of use for the lender so as to constitute the transaction as something intended purpose, noted above) the borrower, in the other than a loan, subject to the prohibition against Shoel nancing arrangement, is not liable for losses, so Ribit. One key distinction between a genuine lease and long as the monies advanced are used for the intended a loan is that the lessor takes the risk of loss of physi- purposes. Furthermore, if the loss occurred in the pres- cal and nancial depreciation of the property that is ence of the lender, the Shoel/borrower would not be li- leased. Rabbi Moshe Isserles (known as the Rema, an able. Rather it is the lender who would bear the risk of acronym of his name), a 16th century Halachic author- loss under these circumstances (See Rambam noted ity and author of the glosses on the text of the above). Rav Yonatan (a rst century Tanna) is cited for Shulchan Aruch of Rav Yosef Karo (generally included the proposition that a lender may be present with the in the text of this monumental code of Jewish law,) borrower by way of an agent. (See Babylonian Talmud, describes how the lessee under a genuine lease can- Bava Metzia at page 96a; See also Exodus, Chapter not assume all of the risk of loss. Thus, he notes, the 22, Verses 13–14.). In this regard, one cannot help but lessee may be required to assume the risk of loss of wonder whether the borrower (who is working for the theft or negligence; but not losses resulting from Onsin. benet of the lender and borrower under this nancing See the discussion below on the treatment of various structure) might not be deemed to be the lender's categories of risk and whether an assumption of those agent, for these purposes. Be that as it may, in a risks by the lessee would recharacterize a lease as a traditional pure loan transaction, the borrower is loan transaction.See Jerusalem Talmud, Bava Metzia, personally liable to return the money loaned and bears at page 19b. all of the risk of loss, as noted above. In line with the 124 foregoing, it is suggested that the reason the Jerusa- See Babylonian Talmud, Bava Metzia, at page lem Talmud uses the term Sho'el is to describe, in 69b. To be a genuine lease and not a loan, the lessor shorthand, a permitted nancing arrangement, where must take the risk of loss of damages due to Onsin, the risk of loss is apportioned dierently than would be physical and nancial depreciation (including reason- the case in a typical pure loan transaction. I propose able wear and tear). Otherwise, the lease is nothing that the Shoel nancing structure discussed in the cited more than a disguised loan, as noted above. The lease, text is a non-recourse (Kulo Pikadon) Iska form. Rav however, may impose certain duties and obligations on Moshe Margolies (an 18th century Talmudic scholar), in the lessee. This would include, for example, liability for the Penei Moshe (a seminal work on the Jerusalem negligence. Talmud he authored, printed alongside the text of the 125Talmud Bava Mezia at page 69b. Jerusalem Talmud noted above) asserts it is a limited 126Talmud Bava Metzia at page 65a. recourse nancing structure. The Pnei Moshe notes 127 that the Jerusalem Talmud text referred to above must Tosefta, Chapter 5, Section 1 and Jerusalem refer to a Palga Malveh (one-half loan), Palga Pikadon Talmud, Bava Metzia, at page 16a, See Babylonian (one-half investment) nancing structure, along the lines Talmud, Tractate Taanit, at page 10b, which describes described in the Babylonian Talmud. He bases this a written document attesting to a debt (Shtar Hov) as thesis on the fact that the nancing device requires merchandise (Prakmatia). See also Shulchan Aruch, that there be provision for compensation for the bor- Section 173. Sub-section 4, which provides that a sale rower's work in the venture. He posits that otherwise of a note at a discount is permitted, so long as the why the need for this separate compensation. In es- seller of the note is not personally liable as guarantor sence, if the lender bore all the risk of loss, as in a of the borrower's obligations under the note. Kulo Pikadon Iska nancing structure, then there would 128The Bible and Talmud (including the Jerusalem not be any requirement, per se, for this kind of a provi- Talmud, Bava Metzia, at page 17a) also use another sion for the borrower. However, this presumes a 50/50

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 51 The Real Estate Finance Journal sharing of prot arrangement. This is not obvious from 52. the text. Indeed, it is arguable that this particular nanc- 136The example of the xed sum given in the ing structure is not necessarily a 50/50 relationship. Responsa of the Rambam is double the original The text merely speaks of the prots being divided be- principal amount. The structure is similar to the one tween the borrower and nancier without specifying described by the Tur, as discussed below. the actual percentage sharing arrangement. In contrast, 137 other examples in the text specically reference the See discussion above of what constitutes ade- fact that they are based on a one-half of the prots ar- quate compensation in the Talmud. The Rambam notes rangement. It is suggested that this is because when in his Responsa (as summarized below) that the the lender has the risk of loss, the sharing arrangement compensation can be nominal. with the borrower does not have to conform to the 138See A Mediterranean Society-The Jewish Com- 50/50 structure of the Neardean Iska. It can be what- munities of the World Portrayed in the Documents of ever is agreed to by the borrower and nancier. Since the Cairo Geniza, by S.D. Gotein, Volume I (University it departs from the customary equal sharing arrange- of California Press-1967). ment, some compensation may be required to avoid an 139 appearance of Ribit issue, as discussed below. Thus, These documents were found in the Cairo the agreement between the parties might also conform Geniza, in Judeo-Arabic print (Arabic written in Hebrew to the non-recourse nancing structures reported by characters). Yehoshua Blaue edited a compilation of the Tur and Rambam, noted above. Under these non- these important documents authored by the Rambam recourse nancing structures, some compensation for (with accompanying Hebrew translation), published the borrower is, nevertheless required. (See the discus- under the title, Teshuvot HaRambam (the Blaue Edition- sion of the Bet Yosef on the Tur text summarized 1948). below.) This approach suggests another possible 140See Volume I, Responsa Number 26 at page 38 understanding of the Jerusalem Talmud text noted of Blaue Edition. above, as an alternative to that of the Pnei Moshe. 141See Volume II, Responsa 276, at page 676 of Under this interpretation, the nancing form reported Blaue Edition. would be a non-recourse structure, rather than a limited 142 recourse one. The provision for separate compensation See Volume I, Responsa 26, at page 38 of Blaue is a matter of appearance; not substance. In essence Edition. It is likely a reference to a Qirad. See also because the nancing structure may appear to yield Responsa 32 at page 45 of Blaue Edition, involving a prohibited Ribit, instead of permitted return, separate voyage to India. Under this nancing structure, the - compensation is set-aside for the borrower to avoid nancier bore all of the risk of loss and was entitled to even the appearance of charging Ribit. This concern is two-thirds of the prots. The borrower was cor- also expressed in the discussion in the Jerusalem respondingly entitled to one-third of the prots. Talmud of the Tarsha of Rav Chama, as more fully 143See Volume I, Responsa 78, at page 120 of discussed below. In this particular case, it is proposed Blaue Edition. that the appearance issue arises because the structure 144 eventually yields a debt, personally owed by the bor- The Rambam, in his response to the question rower to the nancier, even if the structure does not posed, cited with approval the rst Iska structure. This initially begin that way. structure is consistent with the example he provided in the Mishne Torah (Laws of Agency and Partnership, 129 Counting a contraction in the printed text as Chapter 6, Section 2) of methodologies of properly ap- two words. portioning risk of loss. It is also the Iska structure 130By reason of this requirement, the Pnei Moshe described in the Babylonian Talmud, Bava Metzia, at views this as a limited recourse nancing structure (i.e., page 104b, noted above. However, he does not disap- where the borrower receives one-half the prots and prove of the second Iska structure. bears one-half the losses), of the sort described by the 145Literally, the Four Rows, which encompasses Nehardeans in the Babylonian Talmud. See discussion four broad areas of law. One of the areas of law above of this text. See also Babylonian Talmud, Bava covered is entitled Yoreh Deah. The discussion of the Metzia, at page 104b. non-recourse nancing structure referenced above is 131Ibid. set forth in Section 167. 132Inasmuch, as the borrower would presumably 146Unlike the Rambam's Responsa, there is no not work for less, for no reason. Hence, by implication, express citation to the source in the Talmud for this it may appear that the borrower is working, at reduced permitted nancing form. rates so as to recompense the nancier for the loan 147See discussion above of the Teshuvot Maimonit made to the borrower of all the funds needed for the on the subject. See also the discussion below of the venture. Under these circumstances, it may appear that Bet Yosef commentary (authored by Rabbi Yosef Karo) this is a Ribit bearing loan. on the Tur text. Rabbi Yosef Karo distinguishes be- 133BabylonianTalmud, Bava Metzia, at page 67b. tween setting compensation at the very outset of the 134 nancing and doing so thereafter. Thus, the parties can See Shulchan Aruch, Yoreh Deah, Law of Ribit, agree on nominal compensation, as a part of the origi- Section 172, Sub-section 1. nal nancing arrangement. On the other hand, if this is 135Teshuvot Maimonit, Book of Mishpatim, Chapter not initially done, then the compensation must be at the

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 52 The Origin of Non-Recourse Mortgage Financing rate payable to an idle worker and paid daily. It should the funds advanced. Thus, the Tur cites Tosafot for the be noted that this sum is a base measure of compensa- proposition that the Iska may specify that only certain tion. It is not market rate for the kind of talent and ef- merchandise may be purchased with the funds ad- forts expected of the entrepreneur borrower. Rav Karo vanced. If the borrower defaults by varying from this also codied the same nancing structure as the Tur, requirement, the borrower thereby assumes all of the in his Code of Jewish Law, the Shulchan Aruch, in risk of loss. Similarly, the Tur notes, the parties may Yoreh Deah, Laws of Ribit, Section 167. The Vilna Gaon make all manner of stipulations under the Iska, includ- (Rav Eliyahu ben Shlomo Zalman of Vilna), an 18th ing as to security measures to be taken to protect the century Halachic authority, notes (in his commentary, funds advanced. the Biur H'Gra, adjoining the text of the Shulchan 148Interestingly, the Raavad, in his Responsa, Sec- Aruch,) this structure is similar to that of the Tarsha of tion 133, deals with whether it is permitted to convert a Rav Hama. However, The Vilna Gaon goes on to point limited recourse nancing structure into a non-recourse out that it is similarly based on the nancing structure form. Under this sequential Iska structure, a term of of Rav Eliezer (i.e., Rav Leyzer), reported in the Jerusa- two years duration is provided. The rstyear of the lem Talmud, as summarized above. Rav David HaLevi term is structured as a limited recourse Iska. During Segal (the author of the Turei Zahav, known as the this initial period, the borrower and lender share the Taz), a 17th century Halachic authority, explains the prots and losses, equally (i.e., Palga Malveh, Palga dierence between this structure and an ordinary loan. Pikodon, as in the Nehardean Iska). After a year's time His focus is on whether the lender bears the risk of the principal plus prot share due to the nancier would loss or the borrower. Therefore he posits that the then be converted into a non-recourse nancing. The practice of paying the borrower compensation to as- nancier then assumes the risk of loss, generally (i.e., sume all the risk of loss is problematical, because it is, Iska Kulo Pikadon), and reaps any and all prots for in eect, nothing more that a disguised loan. See, the second year of the term (See also the Meiri com- however, the discussion below concerning whether the mentary on Talmud Bava Metzia page 105a. in the Bet parties can agree, in eect, to apportion some of the HaBechirah at page 391). The Raavad concludes that risk of loss (such as re or other casualty) to the bor- this form would be prohibited because it appears like rower, by paying the borrower separate compensation Ribit. He reasons that it appears that the borrower is to do so. The underlying conceptual basis for this kind working for the lender during the second year of the of arrangement is derived from the diering responsi- term for no compensation, in order to pay, in eect, bilities of a paid agent, as compared to an unpaid gent. Ribit for the one-half loan portion of the original nanc- Thus, the theoretical possibility of converting the bor- ing amount that is required to be interest free. The Bet rower from what is referred to as a Shomer Chinum Yosef on the text of the Tur, noted above, cites this (unpaid agent) to a Shomer Socher (paid agent). If this proposition of the Raavad and proposes a solution that were permitted, then the borrower could, in eect, be would enable this particular nancing form to be paid to assume certain risks, such as theft or casualty permissible and avoid any appearance of Ribit concern. loss. However, this practice was frowned upon by the In essence, he suggests, much like the Tur nancing Taz, as noted above. Some would permit this kind of structure, that the Iska stipulate the borrower receive apportionment of some of the risk of loss. Thus, for some compensation for his work. He concludes that example, the Tur, in Yoreh Deah, Laws of Ribit, Section this would dispose of the appearance issue raised by 177, cites the Raavad (Rav Abraham ben David the Raavad. Posquieres), a 12th century Halachic authority, for the 149 proposition that can compensate the borrower to take This is wage rate standard that is, conceptually, on the responsibilities of a paid agent. Thus, the bor- similar to the minimum wage rate in the U.S. It is an rower, in exchange for the payment, would, in eect, objective standard. It is the prevailing wage rate in ef- become the insurer against loss by reason of theft or fect for an unemployed laborer seeking employment. It other casualty. Others though prohibit it. For example, is not a subjective standard. Under this principle of the Tur cites the Rambam for the proposition that even compensation, no assessment is required of the actual if the borrower is paid compensation, he still may not market value of borrower's work. assume the responsibilities of a paid agent. Rather, the 150The Beit Yosef commentary on the text of the borrower remains, for these purposes, an unpaid agent, Tur, Yoreh Deah, Laws of Ribit, Section 167. who is only liable for negligence; but not theft or casu- 151 alty. The Tur, though, also notes that the Rivan (Rav Rabbi Isserlein ben Petachia, a 15th century Yehuda ben Natan, a son-in-law of Rashi), a 12th Halachic authority. century Halachic authority, held that a lender could 152The name of the Halachic work compiled as even shift to the borrower, the risk of loss of Onsin Responsa, authored by Rav Isserlein. See Responsa (i.e., acts of G-d or other events outside the control of 302. the borrower), by agreeing to pay the borrower 153See the discussion of this text in the Babylonian something for this undertaking. However, the Tur goes Talmud, Bava Metzia, at page 69b, noted above, as on to note that the Ri (Rav Yaakov of Orleans), another well as, the commentary of Tosafot on the text sum- 12th century Halachic authority and Tosast, prohibited marized above. this practice. In any event, one of the key risks that 154 had to be borne by the lender under this permitted The term used is Onsin, as discussed above. nancing form, even according to the Rivan, was as to 155See the discussion of the Ritva, Rav Yom Tov the ultimate value of the merchandise purchased with Assevilli (of Seville), a 13th to 14th century commen-

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 53 The Real Estate Finance Journal tary on the Babylonian Talmud, Bava Metzia, page 68a. may, to my knowledge, this specic form is not gener- The Ritva describes how if the lender bears the risk of ally used. The form also does not contain other cove- loss, in what he refers to as “B'Torat Pikudon Gomer” nants and conditions, including as to the kind of proof (literally in the category of an investment, entirely), then that is necessary in order to establish a loss. However, it is not a loan. He concludes the prohibition of Ribit unlike other forms of Iska, this document does not applies only to a loan and not to this type of a non- expressly exclude the testimony of the borrower on recourse nancing structure. the issue of whether there was a loss of principal (c.f. 156Sometimes referred to as the Iska-Kulo Pikadon. the Iska form of the Ri, noted above, as well as, the 157There are other non-recourse (Kulo Pikadon) Tikun Maharam Iska form discussed above). This might help explain why it is that the Tikun Maharam form (or and limited recourse (Palga Malveh, Palga Pikadon) 157 forms extant. A limited recourse form is attributed to a derivative thereof ), based on the formulation of the Rav Hai Gaon, the 11th century head of Acadamey in Trumat Hadeshen, noted above, is the prevailing non- Pumbedita. (See Document 15 in the Book of Docu- recourse form Iska still used to this day. Indeed, many ments, attributed to Rav hai Gaon, compied by Simcha modern forms incorporate the terms of the Tikun Assaf and published in Jerusalem in 1930). An interest- Maharam Iska by reference. ing non-recourse form is attributed to Rav Yackov of 158A 16th century Halachic authority. Orleans, a 12th century Tosast and Halachic author- 159An organization of Rabbis and other representa- ity. It is found in the Glosses of Rav Mordechai ben Hil- tives of Jewry in four lands (inclusive of Poland) that lel HaKohen, a 13th century Halachic authority, who constituted a form of Jewish self-government during wrote the commentary on the Babylonian Talmud the late 16th century and through the mid 18th century, (known as the Mordechai, after his name). It is found at It met from time to time to deal with issues of taxation the back of the Otzar HaSeforim Edition (S. Goldman- and other legal, economic or community issues. It is Ireland-1973) of the Babylonian Talmud, Bava Metzia, reported that it adopted the Tikun Maharam form Iska. on page 172. It provides for a regular payment of a See www.YIVO Encyclopedia.org, subject heading, xed sum, on a weekly basis, until the principal amount Credit. See also Encyclopedia Judaica (second edition), is repaid in full. It states that the testimony of the bor- Volume 20, under the subject heading, Usury, at page rower is not accepted to establish a loss or any other 442. defense to payment of the debt. This form does not, 160 however, provide for an alternative, express means of Ibid. See also Nahalat Shiva, Document 40 at establishing that a loss did in fact occur, as noted in page 592. the formulations of the Trumat Hadeshen and Tikun 161The Tikun Maharam Iska provides for a xed Maharam, described below. Rav Yosef Karo is reported amount of return payable to the nancier, which is con- to have rejected this format, because of a concern that sistent with the Tur's formulation (as well as that of the it appeared like Ribit. Others raised issues concerning Rambam described above). The concept of specifying this form, as well. Another useful non-recourse Iska a priority xed amount of return vs. a share of the form is the non-recourse Iska document, generally fol- prots is not accepted by all Halachic authorities, under lowing the Tur's format, found in a documentary all circumstances. Thus, for example, Rav Yosef Karo formbook, entitled Tikun Shtarot. published in Amster- in his Shulchan Aruch (Section 177 at page 110b) does dam in 1721. This Iska document is most interesting not permit specifying a xed amount of return. However, because it follows neither the earlier formulation Rav Moshe Isserles, a 16th century Halachic authority reported by the Nehardeans in the Babylonian Talmud in his renown glosses on the Shulchan Aruch (set forth (see the form Iska attributed to Rav Hai Gaon noted in the printed text noted above) states that many permit above), nor the later one of the Trumat Hadeshen (see specifying a xed amount of return in a non-recourse the Tikun Maharam form document, based on the nancing structure. Similarly, Rav David HaLevi Segal, formulation of the Trumat Hadeshen, discussed below). a 17th century Halachic authority in his seminal work It appears to be based on the structure set forth in the the Tureh Zahav (known by the acronym Taz), that is Tur, as summarized above. It provides that the bor- printed adjacent to the Shulchan Aruch text cited rower acknowledges receipt of 2,000 gold pieces. It above. The Taz notes that so long as structured as a describes the relationship as an Iska nancing. How- non-recourse nancing, where the xed return would ever, it goes on to say that until there is a prot of 200 only be payable if and to the extent of a prot, then gold pieces earned, the lender shall bear the risk of permitted. Rav Yoel Sirkis, a 16th century Halachic loss. Once the prot of 200 gold pieces is earned, the authority, in his commentary on the Shulchan Aruch, Iska nancing will convert into a pure loan of 2,200 the Bayit Chadash (known by the acronym Bach), that gold pieces (i.e., principal plus interest). From that point is also printed adjacent to the Shulchan Aruch text on, the borrower will have all the risk of loss and cited above, adds a further qualier. He would permit a personal liability for the payment of the stipulated sum specied xed return only if there was no requirement (the principal and interest) of 2,200 gold pieces. The in the Iska that the only acceptable proof of loss was term of the loan is until the specied trade fair occurs. the testimony of two kosher witnesses, as set forth in Once again, the key element of this form that distin- the Tikun Maharam form. Absent removal of that condi- guishes it, from a traditional pure loan on interest that tion, the Bach would only permit a formulation based yields prohibited Ribit, is the provision apportioning the on a sharing of the prots, if any. Rav Moshe Sofer, an risk of loss to the nancier. It should be noted that un- 18th century Halachic authority, in his Responsa, known like the Tur, this form does not specify compensation as the Chatam Sofer (in Volume 5, Choshen Mishpat, for the borrower. Query, is this a lacuna? Be that as it Responsa 63, at page 142) would appear to permit a

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 54 The Origin of Non-Recourse Mortgage Financing stated percentage interest rate, if the non-recourse the money, making money. On the other hand, if the Iska format of the Tikun Maharam is used. See also, lender bears at least some or all of the risk of loss, as the Responsa of the Mabit (Rav Moses of Trani, a 16th to the underlying venture's success, in order to get century Halachic authority), Volume I, Responsa No. paid, then money doesn't itself make money, it is the 244 (Grossman Publishing-1961). Reference should underlying venture that yields return or not. How much also be made to the Ginat Veradim, a Halachic work by risk must be assumed by the lender in order to consti- Rav Abraham ben Mordechai HaLevi, a 17th century tute the nancing as trade, as opposed to a pure loan, Halachic authority. The Ginat Veradim (in the Volume is a subject discussed in this article. It varies, depend- on Yoreh Deah-General Rule 6, Section 8) deals with ing on the particular religious law and tradition and the drafting of a form Iska, using the format of the Tikun sometimes on the scholar interpreting the same. Medi- Maharam, including the matter of a xed rate of return eval Church leaders, such as Thomas Aquinas (a 13th payable to the lender. century Christian Theologian) railed against usury 162Rabbi Shabbatai Cohen (known as the Shach), employing arguments advanced by Aristotle. Interest- a17th century Halachic authority, notes in his commen- ingly, unlike the Sha'ariah, but much like the Halacha, tary on the Shulchan Aruch (in the text adjoining the Aquinas objected to a higher credit price. However, Laws of Usury, Section 167,) notes that the practice of even Aquinas distinguished between a loan of money requiring two kosher witnesses so as to establish that and a loan of real property (i.e., a lease), which yielded no prots earned (as opposed to a loss of principal) is rent and not prohibited Usury. Furthermore, Aquinas inappropriate. described a nancing structure that resembled the Iska 163 and Qirad forms described above. See Summa Theo- Koran, Chapter 2:275. See also Koran, Chapter logica, Volume II, part II, Question 78, including Article 3:130, regarding the basic prohibition against Riba. The I-Answer (discussing a lease vs. a loan), Article 2-Reply term Riba is not dened in the Koran. See article by to Objection 5 (discussing an Iska or Qirad type of author on Interest, Ribit and Riba, in The Banking Law nancing structure) and Reply to Objection 7 (discuss- Journal, noted above. ing a higher credit price).The reasoning used by 164Ibid. Aquinas to permit a non-recourse nancing structure, 165The concept of a nancier's money working and is very similar to that of Malik, in his Muwatta, as sum- earning prots, without his personal labor, was also marized below. Thus, if the nancier advanced money condemned in western culture, including by such per- to the borrower for use in a trade transaction, but did sonage as Aristotle. See Aristotle's Politics, Book I, at not convey title to the money, then technically speaking the very end of Chapter 10 (in Vol. 9 of the Britannica the money still belonged to the nancier. He distin- Great Books series, at page 452 referencing page guishes between entrusting the money to the borrower 12589b of the text). He condemns making money on and transferring title to the money to the borrower. money, as opposed to the natural object of it. He goes When title to the money is transferred to the borrower, on to say that money was intended as a means of he deems that a loan of the money. He goes on to say exchange and not to increase at interest. He denes that when title to the money is transferred in a loan interest as the birth of money from money. However, it transaction, the borrower bears the risk of loss of the appears Aristotle also condemned making money on money. On the other hand, when money is advanced trade itself (i.e., by way of a middleman), which he also and is said to be entrusted to the borrower, it is the viewed as unnatural. According to Aristotle, it's one lender who continues to bear the risk of loss on his thing for the producer to sell the product of his or her money. In essence, according to Aquinas, the lender is labor to the consumer, directly. It's another thing, deemed to continue to own the money and a form of though, for an intermediary to make an independent society is formed. The lender bears the risk of loss on market in the goods produced by others, according to his money, even as the merchant/borrower speculates Aristotle. This appears to be a point of departure by with it or the craftsman/borrower uses it in his or her later religious Islamic and Church thinkers. They may craft. According to Aquinas, the lender may therefore have cited Aristotle for the proposition that charging properly demand and receive a share of the prots interest was wrong. However, they distinguished this derived from his money. from trade, which they considered to be a permitted 166Similarly, it may also be considered Ribit under function. The distinction is fundamental. The intermedi- the Halacha, as noted above. ary trade function required both credit (money) and 167Under the Commenda, there was a dierent work to succed. The prots of trade are derived from sharing of risk arrangement. Thus, as more fully the sale of the object purchased with the money. Is discussed below, the entrepreneur, as borrower, took there really a dierence between dividing up the prots the market risk of uctuations in demand and price. of the sale and paying the money-man a return, only if However, the nancier, as lender, took the risk that the there are prots made on the underlying transaction merchandise was lost because the ship sunk or (funded with the money) and out of those prots. This because it was stolen by pirates. might help explain the logic used by Sha'ariah and 168 Christian scholars to permit the nancier make money As noted above, the terms describe similar (without working) in a Qirad or Commenda structure; nancing structures and are used interchangeably. but not in a loan format. The distinction seems to be 169Much like the term used by the Rambam, the - whether the lender bears any risk. If the loan is fully re- nancier is known as the owner or provider of the money course to the borrower, no matter what happens in the or, as the nancier is sometimes colloquially referred to underlying transaction funded by the money, then it is in modern parlance, the money-man.

170See, for example, Koran Chapter 3, Verse 130, fully suggested, as more fully developed in the text of which forbids Riba. See also Chapter 2, Verse 76; this article, that these scholars may not have consid- Chapter 2, Verses 278–9; and Chapter 30, Verse 39. ered the non-recourse nancing forms described in the 171See Koran, Chapter 2 Verse 275, which states: Jerusalem Talmudic and Mishna that predated the “Trade is just like usury, whereas Allah permits trading Baylonian Talmud. They focus only on the limited re- and forbids usury.” Aristotle might disagree; since he course Iska form reported by the Nehardeans and cited apparently considers both trade and interest to be un- in the Babylonian Talmud. Thus, Udovitch analyzed the natural, as noted above. See also Chapter 20, which Palgah Malveh Palga Pikodan innovation by the Rabbis, speaks about traveling throughout the land seeking the reported by the Nehardeans in the Babylonian Talmud. bounty of G-d. This is interpreted to mean traveling to He concluded this could not be the basis of the Qirad buy and sell goods on favorable terms with funds and by extension the Commenda. This is because nei- provided under a Qirad type of trade nancing arrange- ther of these nancing forms contain the unique shar- ment. Similarly, see Koran Chapter 10, which expresses ing of risk formulation embodied in the Nehardean form a similar theme. These are the kind of nancing ar- of Iska. However, as shown in this article, there are rangements that were prevalent in the Arabian penin- earlier texts that discuss a fully non-recourse nancing sula at the time, as well as earlier. See also the format that may be the source of the source of the Mishnaic and Talmudic discussions noted above. Qirad and, by extension, the Commenda. 181 172Sunnah are teachings or practices of Moham- Ibid. med, not expressly set forth in the Koran, as reported 182Ibid. by those in proximity to him. Sunnah are more authori- 183The language in the text is D'Ovid L'Hu Miltze, tative than Hadith. See Sunnah of Abdullah ibn Abbas an Aramaic phrase meaning they did something to it. (i.e., the son of Abbas, who was an uncle of Moham- This phrase may be interpreted, in the context, to mean med) reporting about a Mudarabah. In this case, stipu- they restructured the nancing form known as Iska. lations were made that the moneys advanced under the Mudarabah not be transported by sea or by cross- 184In this regard, the statement, in the text of the ing a valley. The funds were also not to be used to Babylonian Talmud cited above, to the eect that it purchase livestock. It was further stipulated that if these was good for lenders, makes logical sense, if the prior conditions were violated then the borrower would form was non-recourse. The innovation produced an guarantee the loss. It was reported that these condi- acceptable form of limited recourse. It would not be tions were brought to the attention of Mohammed and good for lenders if full recourse were reduced to limited he approved them. recourse. It should also be noted that the Babylonian 173 Talmud in Tractate Bava Metzia at page 104b, also Hadiths are later reports of the deeds or say- discusses that the Iska structure does not necessarily ings of Mohammed. See Ibn Majah, who reported that mandate an equal sharing of prots and losses. Indeed, Mohammed said that a Muqaradhah (another name for in the discussion by Rava of the case of Rav Illush, it a Qirad or Mudarabah) was one of three types of concluded that the Iska arrangement, attributed to Rav blessed transactions. See also Al-Muwattah by Malik Illush, provided for the lender to bear a 2/3 share any ibn Anas (an eighth century compiler of Hadiths and losses and receive a1/2 share of the prots. The what is reputed to be the oldest surviving compendium Rambam (Mishne Torah, Laws of Agents and Partner- of Islamic law), Book 32. ships, Chapter 6) describes how the lender's share of 174See Fatwa on Banking by Umar Ibraham Vadillo prots and losses is a matter of agreement between (October 2006) at page 74. the borrower and lender. So long as the share of losses 175See discussion of the form Qirad described in borne by the lender is inversely proportionate to the Malik's book of laws concerning the Qirad, entitled the share of prots, there is no issue of Ribit. This sug- Muwattah, noted above. gests that if the lender bears all of the risk of loss, then the lender could be entitled to most of the prots. This 176 Ibid. conceptual analysis of the Rambam precedes the 177Ibid. nancing form of the Tur, noted above, which takes 178 this formulation to its logical conclusion. Similarly, the See the discussion above of a similar concept Rambam in his Responsa, discussed above. expressed by Thomas Aquinas. 185Consider, a fully recourse version of this kind of 179See Fatwa of Vadillo noted above. See also text a nancing structure is nothing more than a prohibited cited in the Fatwa, quoting Ibn Rushd, from his work, interest-bearing loan. For example, the Mishnaic textual Bidayat Mujtahid wa Nihayatul-Muqtasid (Cairo, 1329) counterpoint of the iron-clad (Tzon Barzel), fully re- at page 205, on the legality and pre-Islamic origin of course and prohibited nancing form. As discussed the Qirad. Reference should also be made to At the above, it is juxtaposed in the text of Chapter 5 (of the Origins of the Western Commenda: Islam, Israel, Jerusalem Talmud, Bava Metzia,) with the permitted Byzantium? By Abraham L. Udovitch (Spectrum, Vol- non-recourse version of otherwise the same form. ume 37, No. 2 (April, 1962). 186 180See Udovitch, At the Origins of the Western And within each legal tradition, according to some. Commenda, noted above. See also John H. Pryor in The Origins of the Commenda Contract, published in 187In the Book of the Routes and Kingdoms by Spectrum, Vol.52, No.1 (January, 1977). It is respect- Abu al-Qasum (a ninth century work) a document

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 56 The Origin of Non-Recourse Mortgage Financing translated in Gotein, Medieval Trade, at page 31. 205See Book 32 of Malik's Muwatta. 188See discussion in Chapter on Jewish Role in 206However, the nancier cannot specify that the World Trade, in Gotein, Medieval Trade, beginning at goods be purchased solely from a specied supplier. page 29. This is because then, according to Malik, the borrower 189See, for example, the formulations of the Tur, would, in eect, be the nancier's hireling for a wage. Trumat Hadeshen and Mabit, discussed above. This would then not be a genuine Qirad arrangement. 207 190See discussion of Commenda documents, found Accountings can be required weekly and also in Gotien, Medieval Trade. may stipulate that will be sworn to by the borrower, according to Rav Yackov Blaue, a 20th century ac- 191 Ibid. knowledged expert in the area of Ribit and Iska and 192Muwattah, Book 32, Number 32.3.5. author of the Brit Yehudah-Laws of Ribit and Iska 193 (Chapter 37, Section 10, at page 596 of Second Printed Muwattah, Book 32, Number 32.4.6. and Redacted Edition-Jerusalem-1979). See also 194Similarly, in the Commenda arrangement. discussion of Mabit's non-recourse Iska nancing form, 195Some modern Sha'ariah scholars, such as Dr. in this article. Tantawi, the Grand Mufti of Egypt and Shaykh Shaltut, 208See Mabit noted above, as well as, Ginat the Grand Imam of the Al-Azhar University of Egypt, Veradim noted below. See also Tosafot, in Babylonian permit the pre-xing of the share of prots in the case Talmud, Bava Kama, at page 102a. of bank accounts or government bonds, respectively. 209A requirement noted by Rav Abraham ben See The Riba-Interest Equation and Islam: Reexamina- Mordechai HaLevi, a 17th century Halachic authority, in tion of the Traditional Arguments by Dr. Mohammad his Responsa, known as the Ginat Veradim, Yoreh Omar Farooq (2005). See also Part II of Interest Ribit Deah, Rule 6, Section 8. and Riba, by author, in The Banking Law Journal (June- 210 2013), beginning at page 549. Consider also that in a A 16th century Halachic authority. typical CMBS mortgage nancing, the borrower may 211An acronym of his name and the title of his book make distributions of prots monthly, with the payment of responsa. See Responsa No. 244 of the Mabit. of monthly debt service. Furthermore, the borrower, 212 through an aliate, often earns management fees. The formulation used by the Mabit provided that Thus, it may be argued that this criteria of Malik is if there were prots, then $10 for every $100 of satised in a typical CMBS nancing. principal per year would be payable to the lender. See also discussion in Ginat Veradim, noted above, in Sec- 196 See The Commenda Contract, by John H. Pryor tion 8, regarding xing return out of prots. Reference in Speculum, Vol. 52, No. 1 (January, 1977), at pages should also be made to the Shulchan Aruch HaRav 20 and 33. (Yoreh Deah, Laws of Ribit and Laws of Iska, Section 197See The Institutional Dynamics of Early Modern 41), by Rav Shneur Zalmi of Liady, the 18th century Eurasian Trade: The Commenda and the Corporation, Halachic authority, Hassidic Master and founder of by Ron Harris, in the Journal of Economic Behavior and Chabad Hassidism. He was also the author of the Organization (2009). These risks were often separately Tanya, a classic work of Hassidic literature. insured. This may help account for the growth of third 213See the discussion of the Bet Yosef above. party insurers like Lloyd's, which began as a syndica- 214 tion market among investors willing to take on these See, for example, the Cherryland decision, sum- risk of sea voyage for a healthy premium. marized below. 215 198Document 82 (Venetian Commenda-covering a Also referred to as a bad boy guaranty. voyage from Genoa to Thebes), translated in Gotein, 216See, for example, reports in “Carve-outs: Bad- Medieval Trade, at page 176. boy Guarantees have Borrowers Spanked,” by Guelda Voien in the September 8, 2014, edition of the Mortgage 199See Gotien, Medieval Trade, at page 9. Observer. 200 See Document 86, translated in Gotein, Medi- 217This is especially important in hotel or health eval Trade, at page 180. This particular Commenda care facilities, where movable property used in connec- covered a voyage from Pisa to Sicily. tion with the mortgaged real estate, such as the 201See Document 91 (a Marseilles Land Com- furniture, xtures and equipment, is an essential part of menda) translated in Gotein, Medieval Trade, at page the operation of the real estate, so as to generate the 188. This Commenda also included a provision for ac- underwritten net cash ow needed to service the counting by the borrower. mortgage loan. Even computer software, such as an online reservation system in a hotel, can be a valuable 202Ginat Veradim, Yoreh Deah, Principle 6, Section asset. 8. See also Blaue, Brit Yehuda, Chapter 37, Section 10 (discussed below), which notes that can even require 218See The Travelers Ins. Co. v. 633 Third Associ- weekly accountings, sworn to by the borrower. ates, 14 F.3d 114 (2d Cir. 1994). In the Travelers case, 203 the Federal Court was acting based on having diversity See discussion of Tikun Maharam Iska above. jurisdiction. The court therefore was applying New York 204See discussion of the Iska in the Babylonian Law. The Second Circuit noted there was no New York Talmud, Bava Metzia, at page 104b, summarized above. State Court of Appeals decision on point. The court

The Real Estate Finance Journal E Fall/Winter 2014 © 2015 Thomson Reuters 57 The Real Estate Finance Journal went on to hold that a cause of action for waste could Cherryland Mall Ltd. Partnership, 295 Mich. App. 99, lie where there was an intentional failure to pay real 812 N.W.2d 799 (2011) and 51382 Gratiot Ave. estate taxes, despite an obligation to do so or where Holdings, LLC v. Chesterfield Development Co., LLC, the failure was fraudulent. However, as the court 835 F. Supp. 2d 384 (E.D. Mich. 2011). See also “The pointed out this was a narrow ruling. Not every failure Enforcement of Non-Recourse Carveouts in CMBS to comply with a loan obligation would constitute waste. Loans: A Recent History,” by Gary A. Goodman and The failure also had to impair the mortgage. This was Sabrina J. Khble in the May/June 2012 issue of Pratt's axiomatic with real estate taxes in New York, which Journal of Bankruptcy Law for an analysis of these primed the mortgage lien. (See New York State Real cases and the Legislative response in Michigan. See Property Tax Law Section 902.) In the Travelers case, also the Headnote to the issue, entitled “Carveouts, the court was presented with a claim that the borrower Redux,” by Steven A. Meyerowitz, in which he notes willfully failed to pay real estate taxes. Indeed, the bor- that the Cherryland and Chesterfield cases should rower not only defaulted in paying the real estate taxes serve as a wake-up call to negotiate and draft the non- when due, as well as, the mortgage debt service that recourse provisions to reect the parties' exact inten- month (resulting in a payment default under the tions and expectations. mortgage), it, instead, made a substantial distribution to 222The Michigan Nonrecourse Mortgage Act (2012 the principals of borrower. PA 67, MCL 445.1591 et. seq.), passed by the Michi- 219See Blaue, Brit Yehuda, Chapter 37, Section 5 gan Assembly and Senate in March 2012 and signed (at page 583). into law by the Governor of Michigan on March 29, 2012. The Michigan Supreme Court in Wells Fargo 220 See, for example, GCCFC 2006-GG7 Bank, N.A. v. Cherryland Mall Ltd. Partnership, 493 Westheimer Mall, LLC v. Okun, 2008 WL 3891257 Mich. 859, 820 N.W.2d 901 (2012), remanded the (S.D. N.Y. 2008), Memorandum and Order of Judge Cherryland case to the Michigan Court of Appeals, Buchwald, dated August 20, 2008). In this case, which upheld the new law and found it to be Greenwich Capital, as lender, pursued the guarantor constitutional. It then dismissed the Cherryland case under a good-guy guaranty. The basis of the claim was based thereon, in a decision rendered on April 9, 2013, that the borrower had led for bankruptcy, after the under index No. 304682, Grand Traverse Circuit Court lender accelerated the mortgage for a payment default LC No. 2010-028149-CH. and began to foreclose against the mortgaged property. 223 The defendant guarantor caused the borrower to le Chapter 5816: OHIO LEGACY TRUST ACT, for bankruptcy in response to the foreclosure, a clear Added by 129th General Assembly-File No.201, HB violation of an express provision that triggered full re- 479, § 1, e. 3/27/2013. course against the guarantor. The court agreed and 224See Book 32 of Malik's Muwatta. granted summary judgment. This case was cited in 225See Shulchan Aruch, Yoreh Deah, Chapter 167, “Enforceability of Carve-outs to Nonrecourse Loans: Paragraph 5. See also Blaue, Brit Yehuda, Chapter 37, An Update,” by John C. Murray of First American Title Section 8 (at page 585). However, as noted in the Ginat (2011), which also summarizes other cases on the is- Veradim (Yoreh Deah, Principle 6, Section 8), cove- sue in various jurisdictions. See also ING Real Estate nants that no reasonable businessperson would Finance (USA) LLC v. Park Ave. Hotel Acquisition LLC, perform are not permitted. See also discussion of Tikun 26 Misc. 3d 1226(A), 907 N.Y.S.2d 437 (Sup 2010) Maharam above that deals with provisions that are and Branch Banking and Trust Co. v. South Fork impossible of performance. Resources LLC , 32 Misc. 3d 1243(A), 938 N.Y.S.2d 226For a fuller discussion of the subject, see article 225 (Sup 2011). by the author on Interest, Ribit and Riba in The Banking 221See, for example, Wells Fargo Bank, NA v. Law Journal, noted above.