Keywords: real estate fund, shareholder, loan, counterclaim
BGH (German Federal Court of Justice), ruling dated December 3, 2013 – XI ZR 295/12
In recent years, the Federal Court of Justice (BGH) has repeatedly dealt with various issues related to the liability of banks that finance property funds. The case decided in December 2013 concerned, in particular, the question of the involvement of a financing bank in deliberate unethical prejudice, under Section 826 BGB (German Civil Code), to investors in the fund by a founding shareholder (BGH, judgment of December 3, 2013, case reference XI ZR 295/12), which was denied in this particular case.
Facts
A bank brought claims against the investors as shareholders in a closed real estate fund in the form of a company incorporated under civil law, for the proportional repayment of a loan to the fund. The loan, which was taken out by the fund before the investors joined the fund, served to finance the purchase of property. Due to a fund deficit which had arisen, the bank had terminated the loan for cause. The fund prospectus did not disclose an interim profit, which had been achieved when the fund acquired the fund's real estate from a company whose shareholders were also the fund's managers, for a price around 28% higher than the latter had paid to a third party only three days previously. It subsequently transpired that the fund initiators had adopted this approach in several cases and systematically deceived investors.
Content and subject of the decision
The BGH largely upheld the decision of the Zweibruecken OLG (Higher Regional Court, Zweibruecken), (decision of January 27, 2011 – 7 U 20/11). Initially, the bank was granted a claim against the shareholders as being jointly and severally liable for the proportional repayment of the outstanding indebtedness under the loan, pursuant to Sections 128 and 130 HGB (German Commercial Code), by analogy with the principles of flawed accession by shareholders. To be examined next were any counterclaims by investors submitted in course of the proceedings. In the absence of any direct contractual relationship, the BGH denied a claim by the bank for damages for breach of duty to inform. The substance of the decision lies in the discussion of the question of involvement in unethical damage and hence a counterclaim under Sections 826 and 830 Para. 1 Sentence 1 and Para. 2 BGB. The concealment of the interim profit in the fund's prospectus was classed as an erroneous statement and thus as unethical prejudice by the fund managers to investors. One might also regard the granting of real estate financing by the bank as objective assistance, but it was said that the bank lacked the subjective element of intent to do harm. Although it had known the acquisition and disposal prices, so that it must have noticed the discrepancy in the amounts, the bank could not be accused of knowledge of systematic behaviour on the part of the managers nor of concealing the interim profit in the prospectus as it was unaware of the prospectus. Thus the bank was not liable for involvement in the unethical prejudice to the investors.
At first glance, the decision seems to contradict a 2009 decision of the BHG (BGH, decision of September 29, 2009 – XI ZR 179/07) in which the Senate concluded that a financing bank was at least involved in unethical prejudice to investors. In principle, the case was similar in nature: shareholders in a real estate company incorporated under civil law (investors), the fund manager and the financing bank were arguing over reciprocal claims. In a fund prospectus, investors were led to believe that a subsidiary liability existed, which had not in fact been agreed with the bank. The court found that this constituted a misrepresentation which was crucial to the investors' decision to participate in the fund, which in principle led to the manager's obligation to pay compensation due to deliberate unethical prejudice in which the bank had participated. The key difference compared with the decision of 2013 is that because, in the latter case, the financing bank knew of the representation in the fund prospectus – and this representation contradicted its own loan agreements and it had expressly pointed this out to the manager – the bank could not agree a subsidiary liability provision to repay the real estate finance loans as represented in the fund prospectus with respect to the personal liability of the investors (shareholders in the fund). The bank had, therefore, systematically and knowingly participated in the deception of investors in that, aware of the manager's intended actions, it had gone ahead with funding the real estate, and thereby allowed and intended the deception. The bank's actions were also not justified by its pursuit of its own legitimate interests. Admittedly, the bank was permitted to insist on a direct personal liability but it could not thereby participate in a deception of investors.
This means that the bank should either have refused the real estate financing or insisted on an amendment of the fund's prospectus. However, the extent to which the bank is affected by a supervisory duty remains open. In light of the recent decision, the bank is not liable as long as it did not know of the fund's prospectus or was unaware of a misrepresentation as to the extent of the liability of the investors in the fund. However, where it becomes aware of a statement in the fund prospectus that contradicts its own contractual documentation, it shall, in light of the 2009 decision by the BGH, in its own interest, have an increased duty to insist on a corresponding correction of the prospectus, as otherwise, it shall, where relevant, be liable for corresponding damage or may be subject to such a counterclaim as may oppose its own claim to repayment of the loan. It may seem strange that in a comparison of the decisions a bank which conscientiously keeps itself informed and discusses its customer's fund prospectus bears a higher risk of liability than a bank which finances a property fund without carrying out any more in-depth examination. This is due to the fact that a subjective element is always an intrinsic part of unethical damage, i.e., the knowledge of and intent in relation to – or at least an acceptance of – damage to the investor.
Impact on day-to-day practice
If a bank does not finance the investors' investment, then the bank has no obligation to inform investors, because there is no contractual relationship with the investors. According to the BGH, even in a loanAgreement with the fund, no duty to inform investors is incurred.
When examining a fund prospectus, if a bank notices misinformation that is likely to influence investors in their decision, it should, in order to avoid liability for involvement in deliberate unethical prejudice, go ahead with the financing only upon presentation of a corrected prospectus (for example, by agreeing a corresponding condition precedent to drawdown).
The case law concerning the liability of a bank financing a property fund for deliberate unethical prejudice to investors shows that it often depends on the individual situation and should in general be treated with caution.
Originally published March 27, 2014
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