Usury and the Creative ‘Triple Contracts’

Prior to the commercial revolution of the very late Middle Ages and Renaissance, it was conventional wisdom that money was ‘sterile’ and produced nothing of value by itself. So, most of Europe was skeptical of interest-bearing loans. In those days, the charge of usury could be levelled against anyone charging any interest. However, in the 15th and 16th centuries, investors and businessmen found means of circumventing prohibitions on usury. Various sorts of contracts were devised. One of these was the ‘triple contract’ which, despite its clear intentions, was eventually accepted even by clerical scholars.

Commerce in Renaissance Europe

In medieval and early modern Europe, like today, people formed partnerships, or societas, to split the profit and risk of enterprises. These were often family arrangements; as an example, the estate of a deceased person could be managed by their descendants as an intact unit through such a partnership. This was just one use for societas. Besides inherited property, partners could contribute new money, labor, equipment, or other assets to a partnership. Further, some partnerships were arrangements between principals and agents where a principal left some business to an agent and, in exchange for the agent’s labor, would give the agent a share of the profit. This arrangement was akin to an employment contract but nonetheless occurred within the construct of societas.

Not only has the partnership survived to today, the societas is also a form of organization that dates back to well before the Middle Ages; it was known by that name since Roman times. While the use of partnerships is timeless, the life of any individual partnership was short. The societas were small and short-lived compared to modern corporations because, generally, the death of a partner forced a partnership to be unwound.

Indeed, many were brought to an end far sooner than upon the death of a partner. Partnerships were often tied to a particular venture, like a sea voyage perhaps; so, partnerships would be formed and unwound frequently. Each venture might require both labor and capital from partners but not necessarily in equal proportion among members; one partner might supply the labor and another the capital. As for the profits, partnership contracts could specify unique arrangements for each partner rather than a simple pro-rata split of the profit according to the value of the contribution made.

These partnerships could split the work and risk unevenly. A silent or passive partner might supply capital with the desire for a fixed return with the active partner agreeing to take most of the downside risk if things go wrong but also, potentially, most of the profit if things go well. This could be arranged as long as the gross return on the venture exceeds the minimum desired return of the silent partner by enough to compensate the active partner for his contribution and greater risk. In early modern Europe, profits in trade could easily amount to 10-12% on invested capital but this required substantial work by an industrious merchant. Typically, a silent partner would happily accept a much lower rate of return in exchange for a guaranteed return and no extra work. So, the math worked out and such partnerships were common.

Usury in Commercial Settings

Such an arrangement might seem mutually beneficial but there was no shortage of legal scrutiny for contracts where one partner was perceived as making a riskless return. Even in pre-Christian times, there was skepticism about the right of anyone to a riskless profit. Such an outcome gave rise to accusations of usury and even the Code of Hammurabi in the 18th century BC had something to say about usury, setting a maximum interest rate of 34%. In Roman and Medieval Europe, the legality of partnerships was routinely scrutinized on the basis of the split between the risk and return among partners. According to the Roman jurist Ulpian, active in the early 3rd century AD, an uneven partnership where one partner is exempt from bearing a loss is justifiable but only if that partner is supplying the labor.

“Cassius holds that a partnership can be formed in such a way that, while one of the partners will not be liable for any loss, the profit will be common to all. This, however, will only be valid (as Sabinus says) where the value of the services of the partner will be equal to the loss; for it frequently happens that the industry of one partner is of greater advantage to the partnership than the capital invested.” – Ulpianus, On the Edict, Book XXX, preserved in Digest of Justinian (D. 17,2,29,1)

But what about a partner supplying the capital? A popular assertion of the time was that money was ‘sterile’ (bore no fruit by itself) and therefore, no one had a right to profit merely from investing money. Rather, a risk must be borne to justify a profit; the time value of money was nil so there was no such thing as a just ‘risk free rate [of return]’. Even opportunity cost was not correctly perceived. This was the basis for a strict prohibition of usury, which was entrenched in the 13th century but became increasingly challenged in the 15th and 16th centuries.

A developing economy stimulated demand for more credit. Before long, numerous credit instruments, from bills of exchange to annuities, had been devised to essentially constitute an interest-bearing obligation that would pass muster under the law and be legally enforceable. Capital markets were clearly developing in the Late Middle Ages and Renaissance. Italy was the point of origin of these commercial innovations and it was there that the constraint of usury laws weakened first, events which are obviously related.

Standing to benefit were prospective creditors. These included, whether directly or through intermediaries, widows, orphans, wards, and pensioners. As a sign of the growing legal acceptance of earning interest on money, in Florence, the law required that the guardians investing the inheritances of wards and widows deliver a minimum return of 5% per year. The theologian and jurist Luís de Molina began a work on usury by recounting the practice of widows in Lisbon depositing savings with merchants promising a fixed return. So, there were clearly such endowments in need of being matched with investment opportunities but the beneficiaries of these investments had little interest in maximizing profits by undertaking risky ventures.

A major reason for the relaxing of usury constraints was the growing appreciation of the commercial use of credit rather than use by desperate or careless consumers. The beneficiaries of interest income were not abusers but people in a particular economic situation demanding nothing unreasonable from other sophisticated parties. These were the people identified by intellectuals and chroniclers of the day as the chief beneficiaries of a greater acceptance of interest-bearing contracts. That said, besides orphans and widows, the beneficiaries also included the growing banking interests. Other passive investors of the period were middle class professionals, people like public officials and notaries with enough money to save for the future. All stood to gain from loosening the restrictions on interest.

Triple Contracts

One of the instruments devised to sidestep scrutiny of interest-bearing loans was the ‘triple contract’ (contractus trinus). In this arrangement, one partner guaranteed a fixed return for the other but this was done through a series of different contracts rather than a loan. In a triple contract, a silent partner would make an investment in a partnership and then would affect a guaranteed return of his invested capital, perhaps by purchasing insurance on his investment from the active partner. Alternatively, the active partner may agree to repurchase the silent partner’s interest at some point in the future. In the third leg of the transaction, the silent partner would also sell the right to his share in the excess profits, perhaps back to the active partner.

Thus, the triple contract was comprised of a partnership agreement (societas), an insurance agreement (assecuratio), and a purchase agreement (a specific variety of purchase known as an emptio spei). For simplicity, these could be, though did not have to be, entered into by the same two parties across each of them. The end result was that the silent partner was supplying capital for a fixed return regardless of the related venture’s outcome.

This was a comparatively aggressive workaround to usury prohibitions because the triple contract both relieved the silent partner of investment risk, leaving aside the obvious risk that the active partner would be unable to make good on his promise, yet specified a fixed pre-determined rate of return. Some triple contracts even dispensed with the illusion of a partnership to begin with and the arrangement was often documented by a single contract rather than three separate ones. It is not surprising perhaps that the 15th century theologian Konrad Summenhart likened triple contracts to loans and thought they were unlawful.

Acceptance

What may be more surprising, and reflective of the degree to which the stigma of usury, strictly interpreted, had diminished in Europe, many other religious and legal scholars accepted the triple contracts. Those who had a role in forming the law were interested in commerce and came to understand the contracts’ appeal to all sides of a transaction. Leonardus Lessius was a late-16th century jurist and theologian who also came to understand the markets in Antwerp from frequent discussions with merchants there. His writings on money influenced the development of law in Antwerp, a leading financial center of the era. Lessius went as far as to argue that money was not sterile as, when put to productive use, it produced something of greater value in the future.

The Calvinists, including Jean Calvin and Charles du Moulin, approved of interest-bearing loans so long as the loans were made to sophisticated parties at moderate rates of interest. Catholic scholars like Angelo Carletti di Chivasso in the 15th century and Johann Eck in the 16th century also defended the triple contract.

To some, the fact that the ‘lender’ was entering a partnership made a decisive difference; unlike a moneylender, the partner had a right to a profit because he was an owner in a venture. This formulation may have overemphasized the role of a silent partner, who was largely disinterested in the venture’s exact outcome other than to receive his fixed return, but it did help make triple contracts legally viable.

The credit facilitated by triple contracts and similar instruments had many beneficiaries. Among them were merchants but so too were the investors earning interest on their investments. Indeed, even bishops were leaving their savings in deposit accounts earning interest through means like triple contracts. The bishop of Brixen in Tyrol, Melchior von Meckau, had over 152,000 gulden deposited with the Fugger banking family when he died in 1509. Jacob Fugger, of that famous German banking family, had trained as a clergyman before being needed in the family banking business. He was interested in settling the legal questions surrounding the triple contracts and put in some effort into circulating the opinions of friendly theologians and scholars.

Rates and Evolution

With the acceptance of triple contracts, a going rate of interest could be established in Europe’s financial centers. Triple contracts were sometimes called ‘five-percent contracts’ as that was the going rate on this form of finance, at least in southern Germany. This was the going rate on comparatively ‘safe’ investments generally, though rates would fall lower at times. Even ordinary bank deposits in Germany were characterized as a triple contract, namely as a form of investment by a silent partner in a banking partnership.

After a drop in the going rate of interest during the 15th century, this 5% was also what the Medici Bank in Florence paid on its deposits. In the 16th century though, the implicit rate on triple contracts rose. In Spain, the going rate had been as low as 4% in 1550 but rose to 5% by 1575. Deposit rates offered by the Fugger banking family rose from as low as 2-3% in 1527 to 4.5-5% in 1536.

Lesson

There were numerous means of circumventing prohibitions on usury but as far as things go, triple contracts were particularly obvious in their practical intent. Yet, they came to be accepted. As such, they represent the change in perceptions of interest and credit in this period of history. In a commercial world, in the context of profit seeking ventures among sophisticated parties, arrangements where one person supplied money to a project in exchange for interest income but otherwise had no interest in the venture, seemed innocent. In a rather brief period of time, what was once illicit and done at the edge of the law became commonplace and respectable.

More from the Tontine Coffee-House

Read about usury workarounds in England and how instruments like bills of exchange, used by the Medici Bank in Florence, managed to survive scrutiny. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.