I SIGNIFICANT RECENT CASES
Following the financial crisis, the German Federal Court of Justice (BGH) adjudicated several important cases in the area of banking litigation.
i Contractual close-out netting and statutory insolvency law
In 2016, the BGH rendered a judgment with wide-ranging implications regarding contractual close-out netting.2 It held that contractual close-out netting rules are invalid insofar as they contradict statutory netting claims (Section 104 of the German Insolvency Code). Consequently, the statutory rules are directly applicable, protecting the insolvency estate. This aim was threatened in the court’s view by the possibility of contractual close-out netting claims being calculated differently than under the statutory regime.
The judgment received wide attention and the German Federal Financial Supervisory Authority reacted immediately by a general decree stating that contractual close-out netting clauses continued to be valid. A fast-tracked legislative proposal was passed in December 2016 that provides legal certainty on the requirements for contractual close-out netting rules and updates the statutory provisions on several issues (e.g., valuation methods).
ii Notable cases dealing with conflict of interest scenarios before the German courts
In recent years, two different series of judgments have influenced banking law practice in Germany significantly. On the one hand, the ‘kickback’ proceedings series deals with the important obligation of the investment adviser to disclose kickbacks from the issuer to the investment adviser. This is particularly relevant in the retail customer business.3 Until the most recent judgment in this series, the BGH used to differentiate commission payments by third parties from internal commission payments paid out of the investment capital. These were not subject to a duty of disclosure unless they amounted to 15 per cent or more of the investment capital.4 Following a change in the law, this distinction has now been rendered superfluous: from 1 August 2014, a duty of disclosure applies to all commission payments.
On the other hand, the BGH delivered a series of judgments on the obligation to disclose to the counterparty a negative market value at the beginning of the duration of a derivative. This series of judgments began with the Court’s 2011 Ille judgment and moved on to derivative transactions concluded with German municipalities. In 2015, the Court handed down two decisions that clarified (1) the expression ‘negative market value’ and (2) the scope of applicability of such obligations (i.e., whether the exception of a ‘connected hedging transaction’ exists, which means that no disclosure obligation applies). In 2016, the Court set out the requirements of a ‘connected hedging transaction’.5 The BGH also recently called to mind the prohibition of financial speculation for German municipalities. It lifted the acquittal of a municipal official who was accused of embezzlement because he authorised speculative trades.6
II RECENT LEGISLATIVE DEVELOPMENTS
i European Account Preservation Order – Regulation (EU) No. 655/2014 of the European Parliament and of the Council of 15 May 2014
The European Account Preservation Order (EAPO) is a European instrument similar to an English worldwide freezing order. As an alternative to preservation measures under national law, it aims to ensure the enforcement of an existing or a future judgment. It preserves the status quo.
The EAPO applies to pecuniary claims in civil and commercial matters in cross-border cases that are specified in Article 3(1) of Regulation (EU) No. 655/2014 (the Regulation) (when either the bank account and creditor or the bank account and the court that issues the EAPO are in different Member States of the European Union). It targets debtors who are likely to thwart the enforcement of such judgment by transferring or withdrawing the funds by preserving the debtor’s bank account. The debtor is generally not notified about the EAPO proceedings, therefore an EAPO can make use of the surprise effect – contrary to proceedings with mutual recognition in which the debtor or defendant is necessarily heard. Pursuant to Article 6 of the Regulation, jurisdiction for an EAPO normally lies with the court of the main proceedings.
If no prior judgment exists, the court examines the claim’s chance of success before granting an EAPO. As well as the EAPO, according to Article 14 of the Regulation, there is the possibility to request information about the debtor’s bank accounts in order to find out where funds that could be seized, exist.
ii Markets in Financial Instruments Directive Inducement Rules and Fee-Based Investment Advice Act
Similar to the conflict of interest cases adjudicated by the BGH, the Markets in Financial Instruments Directive (MiFiD) Inducement Rules attempt to reduce conflicts of interests arising out of an advising bank’s double role as adviser and beneficiary of payments by the issuer. According to the MiFID Inducement Rules, investment advisers in banks shall have the right incentive to independently advise their customers and to recommend the most appropriate product to them. This European development was the background to the Fee-Based Investment Advice Act passed by the German legislator. Under the new Act, customers pay for investment advisory services and shall receive independent, tailor-made investment advice in return. While the principle of ‘decent advice for decent money’ has a long tradition in other industries, it is a departure from previous practice in the German financial industries sector.
iii Chambers for international commercial matters
Over the past years, increasing efforts have been made to enable parties in Germany to litigate court proceedings in English. As of today, courts within the districts of the Higher Regional Court of Cologne and the Higher Regional Court of Dusseldorf, as well as the Regional Court of Frankfurt/Main, allow the parties to conduct oral hearings in English, provided the parties have previously agreed thereon and the underlying case has an international dimension. However, as the pleadings as well as the judgment itself must still be in the German language, there have been discussions to establish permanent international court chambers.
In February 2018, a draft bill was submitted to the German Federal Council that would authorise state governments to establish chambers for international commercial matters, allowing the parties to conduct court proceedings completely in English. Although the draft bill contains encouraging proposals, its prospects of success must be met with scepticism: earlier legislative initiatives repeatedly found no support in Parliament.
III CHANGES TO COURT PROCEDURE
i German civil procedure principles
German civil procedure rules differ from common law civil procedure rules (particularly English common law) in several ways (e.g., in Germany there is no discovery). Furthermore, the parties are not allowed to testify as witnesses – they can only be heard in evidence in exceptional circumstances. Though the parties are responsible to present the facts to the court in both jurisdictions, the results vary. While it can only adjudicate on issues according to the claimant’s application, a German court – in contrast to English civil procedure law – is not bound by the legal assessment presented by the parties. Instead, it is free to assess the problem in any way that takes account of the facts. Also, the fee structures are different, with cost recovery rules in the event of winning the action limited to statutory fees in Germany, as opposed to the more flexible English rules.
ii Model Procedure Act
Class actions are not possible under German civil procedure law. In capital markets disputes, however, there is a possibility of filing an application for model proceedings under the Capital Investor Model Procedure Act (KapMuG). This was introduced to address inefficiencies for the claimant in such disputes.
A model procedure is initiated if one investor requests a model procedure and nine other related applications are lodged within six months (‘application proceeding’). The trial court issues an order for reference to the Higher Regional Court and defines the questions the Higher Regional Court needs to answer that are relevant to all proceedings (‘intermediate proceeding’).7 Following this, all trials affected by the model procedure are suspended ex officio8 (‘suction effect’ of the KapMuG).9 Once the Higher Regional Court has ruled on the posed factual and legal questions, the trial courts need to decide the individual cases (‘continuation at trial level’) in accordance with the Higher Regional Court’s findings.10
The necessity of bringing an individual case regardless of KapMuG model proceedings is one of the major detriments to claimants. Only a few KapMuG proceedings have been conducted in over 10 years, without discernible time savings but often added complications because of the KapMuG procedure. Nevertheless, the KapMuG benefits defendants as it bundles the claims against the corporation and gives the defendants the opportunity (and necessity) of obtaining specialist single-source legal advice.
Drawing on the experience of the KapMuG, the German legislator has now introduced a ‘General Model Procedure’ into general civil procedure law, which takes effect in November 2018.11
IV INTERIM MEASURES
See Section II.i, above, with regard to the EAPO.
i Measures under national German law: seizure and injunctions
National German law knows two legal instruments to obtain temporary relief: seizure and injunctions.
Seizure and injunctions are distinguished by the form of claim they aim to secure. While seizure is used to secure the enforcement of a monetary claim by seizing either movable or immovable property,12 injunctions are used to safeguard non-monetary claims. The essential requirements are similar.
Seizure exists as personal seizure13 or seizure in rem.14 Seizure is possible if the enforcement of an already existing or future judgment might be obstructed or significantly encumbered. In case the seizure secures the enforcement of a future judgment, the respondent can request the court to set a deadline for initiating the main proceedings. Should the applicant fail to bring the main action within this time frame, the court may set aside the seizure order upon request.15 Personal seizure is only possible if a seizure in rem is not sufficient to protect the applicant (e.g., if it is unclear where the debtor holds domestic assets). Further requirement for a personal seizure is that the debtor has assets liable to attachment.16 Personal seizure can result in the arrest of the debtor.17
Injunctions occur in three different types: they can (1) protect individual claims against change that might frustrate the creditor’s claim; (2) temporarily regulate a legal relationship; or (3), in exceptional circumstances, directly order performance of the claim.18 All injunctions require an injunctive claim (i.e., a substantive claim) and injunctive cause (i.e., the reason for applying for injunctive relief rather than filing main proceedings), which is usually urgency. Deviating from the usual rules of evidence, prima facie evidence by affirmation in lieu of an oath is sufficient.
ii A practical example
A request for writ of seizure can be a dangerous tool because of the lower standard of proof and the fast pace of the proceedings. In 2016, a major German bank was subject to the attempt to seize bank assets amounting to US$97 billion based on hundreds of pages of forged documents alleging a contractual relationship. The request was filed with the court on a Friday afternoon at 3pm. While granting the seizure request does not trigger a necessity to give reasons,19 the dismissal of the request must be accompanied by reasons to enable the applicant to appeal against it.20 Against this background, the applicants might have had speculated – unsuccessfully – that on a Friday afternoon, the court would be more likely to issue the writ rather than closely study the case file and subsequently schedule an oral hearing. In the end, the applicants’ lawyers withdrew the request for a writ of seizure after the defendant had pointed out that the documents produced to justify the application were forged and that no contractual relationship existed between the parties.
V LAWYER–CLIENT PRIVILEGE
Under German law, there is no formal concept of lawyer–client privilege. However, to a certain extent, client information is protected.
i Professional secrecy
German lawyers may not disclose any information they obtain while practising, including the identity of their clients.21 Breaches of this duty can constitute a criminal offence (e.g., disclosure of a trade secret).22
Correspondingly, lawyers and their assistants can refuse to testify in court regarding aspects covered by their duty of professional secrecy.23
ii Seizure of documents
Documents are protected from seizure by law enforcement authorities depending on their content and location. They only cannot be seized in a criminal law context if the client is charged with a crime and the documents refer to his or her defence (e.g., communication from the defence lawyer, notes by the lawyer and notes or correspondence by the client prepared for his or her defence).24 Exceptions apply if the lawyer is under investigation or if he or she holds objects that were instrumentalities.25
With regard to law firms conducting internal investigations, it is much debated whether documents in an internal investigation prepared and held by external lawyers can be seized by law enforcement agencies.26 While the dogmatically correct way of addressing the problem is still uncertain – especially in the absence of a clarification by the BGH – law enforcement agencies, in practice, have searched high-profile law firms and seized internal investigation documents. In March 2017, for example, Jones Day was raided in relation to the VW emissions scandal.27 The question of whether or not such seizures were legitimate is currently the subject of proceedings initiated by Jones Day who filed a constitutional appeal at the Federal Constitutional Court against the seizure of documents. Although the proceedings are still pending, the court has already ordered the public prosecutor by way of an interim measure to refrain from utilising any of the documents seized until its final decision.
Still, Jones Day is not the only law firm that has been subject to on-site searches: Hengeler Mueller and Gleiss Lutz have been raided in connection with the Deutsche Bank/Kirch dispute,28 and Freshfields Bruckhaus Deringer was compelled to hand over an internal investigation report in connection with the HSH Nordbank disaster.29 Against this background, it is not surprising that a common strategy of claimants in banking litigation disputes is to instigate or to wait for the outcome of criminal or regulatory investigations by the authorities and then to participate using the collected evidence by inspecting the files of the authority.
VI JURISDICTION AND CONFLICTS OF LAW
Jurisdiction and conflicts of law issues do not play a significant role in German banking law disputes. Occasionally, cases occur that German courts primarily decide on the basis of procedural aspects, such as the cases JPM v. BVG30 and UBS v. Wasserwerke Leipzig GmbH.31 In both cases, the German-resident Wasserwerke Leipzig GmbH and BVG, which both provided services for the public, suffered losses from derivatives. Because of their losses, they suspended payment under the respective derivative, which prompted their contractual counterparties to bring a claim before the High Court of Justice in London. In turn, both Wasserwerke Leipzig and BVG brought an action before German courts, seeking damages and claiming that the derivative was invalid as they had acted ultra vires. Wasserwerke Leipzig GmbH and BVG argued that, as they had acted ultra vires, the German courts enjoyed exclusive jurisdiction under Article 22(2) of the Brussels I Regulation. In a preliminary ruling, the Court of Justice of the European Union denied the applicability of Article 22(2) of the Brussels I Regulation, which led to the lawsuits in Germany being inadmissible.32
VII SOURCES OF LITIGATION
Banking litigation typically arises from claims of mis-selling, prospectus liability or mistrades. However, recently there has been a significant increase in litigation against the decisions of the regulator and discussions in academia regarding banks’ liability in the context of the manipulation of reference indexes.
According to the Bond decision,33 an investment advice contract is concluded by way of implicit conduct whenever information about a financial product is given and the (potential) investor noticeably relies on this information. In principle, this even applies to situations in which the standard terms and conditions used exclude the conclusion of an investment advice contract without prior written consent.34
To comply with legal requirements, investment advice needs to be tailored to the customer and to the product,35 taking into account the personal circumstances of the customer, the customer’s risk appetite, envisaged investment period and personal experience with financial products in general and products of this kind, etc. Although the level and extent of appropriate advice differ in each individual case, a good rule of thumb states that the less experienced the customer and the more complex the suggested product is, the higher the extent and level of advice necessary.
Against this background, it is not surprising that mis-selling cases have become common with regard to retail clients – for instance, in form of the series of kickback decisions by the BGH – and also in respect of institutional clients if an investment product failed.
ii Prospectus liability
As in other countries, prospectus liability claims have been a classic banking litigation theme in Germany as well. German law differentiates between several different types of prospectus liability regimes depending on the product in question.36 However, it is common for all types of prospectus liability that it constitutes a liability not to inform the (potential) investor about facts that are essential to drawing one’s own conclusions in respect of the chances and risks attached to the investment.37
Regarding mistrades, Germany has a whole industry of so-called mistrade hunters – often former traders who lost their jobs in the course of the financial crisis – who look for false prices and try to exploit these situations. Such mistrade hunters often use specialised technology to detect wrong pricing. They know about the limits of the bank that trigger manual double-checking of the appropriateness of the trade. To avoid these checks, they adapt their trading quantity accordingly by splitting trades. After a cancellation or avoidance of such a mistrade, the mistrade hunters allege having acted in bona fides. They claim that the mistrade rules allowing such avoidance are void, and that the statutory avoidance regime does not apply to their case, etc. Usually, such mistrade hunters seek an amicable out-of-court settlement.
iv More proceedings against the supervisory authority
Whereas in the past, there were practically no court proceedings between financial institutions and their supervisory authorities, there has been a significant increase in such court proceedings given the tighter regulation, the authorities’ more aggressive behaviour and the overall more competitive environment for banks. One prominent example of this is the dispute between L Bank and the European Central Bank (ECB) concerning the appropriateness of direct supervision of the ECB, which incurs additional costs to the bank.38
v Impact of the manipulation of reference indexes
There is currently a debate in legal literature as to whether banks that were involved in the manipulation of reference indexes, such as LIBOR, can be held responsible. Three factors are being debated: (1) the calculation of the damage as the ‘fair’ reference index is hardly determinable; (2) the causal link between the specific act and the damage since the highest and the lowest bid are excluded; and (3) the (standard of) fault (at least in cases where the bank’s management did not know about the manipulation).
vi Further trends to be noted
It can be assumed that German civil courts will increasingly have to deal with cases regarding cum-ex transactions. Cum-ex trades involve the acquisition of shares with (cum) dividends due on or just before the dividend record date and delivery of these shares after the dividend record date without (ex) dividends. These transactions typically led to a double credit or refund of dividend withholding tax that was only paid to the German tax authorities once. In January 2012, the German legislator closed the gap in the law that made such multiple credits or refunds possible.
So far, two German court proceedings have become public in which investors in products whose performance relied on making use of cum-ex trades managed to successfully claim more than €48 million in damages against their advising banks; the courts found that the bank failed to properly explain the underlying tax concept and risks.39 In addition, even custodian banks that only executed said trades may also be subject to claims. For instance, investors who were not aware that their investment or trade was part of a cum-ex deal may decide to pursue claims for losses suffered by tax clawbacks.
VIII EXCLUSION OF LIABILITY
Under German law, it is extremely difficult to effectively exclude liability. Usually, only a balanced reduction of liability is possible. The least strict regime applies to individual agreements. Individually negotiated exclusions of liability must only comply with public policy (contra bonos mores).40 However, most exclusions of liability will be part of standard terms and conditions.41 In these, an exclusion of liability for the main duties under a contract is usually not possible if the exclusion threatens to thwart the objectives of the contract.42 It is generally impossible to limit one’s own liability for grossly negligent or intentional behaviour in standard terms and conditions in relation to consumers. The same applies with regard to entrepreneurs if the contractual counterparty is unreasonably disadvantaged by it (Section 307 Civil Code). A ‘surprising clause’, such as one concerning the investment broker’s liability in a fund joining agreement, does not become part of the contract (Section 305c Civil Code).43
Furthermore, the exclusion of liability must not infringe the principles of bona fides. For instance, a clause excluding the conclusion of an investment advice contract while effectively providing investment advice constitutes a venire contra factum proprium and renders the clause inapplicable.44
IX REGULATORY IMPACT
One result of the crisis has been a marked increase of financial regulation. Alongside the implementation of the European Banking Authority, the MiFID reform and the implementation of the Basel III framework (CRD IV), several new regulatory mechanisms have been introduced (single supervisory and single resolution mechanisms). These all lead to a higher standard of supervision. The emphasis of these new pieces of regulation lies on early intervention.
Under the new regulatory framework, regulators intervene earlier and – as a further lesson learned from the financial crisis – more aggressively. Often, regulators expect an internal investigation of possible regulatory breaches – and threaten to sanction non-compliance with a special audit pursuant to Section 44a of the German Banking Act, which is a particularly expensive tool to investigate a potential issue. Furthermore, regulators place a high emphasis on international coordination. Such increased cooperation by authorities means that regulatory and criminal investigations can overlap.
Banks, on the other hand, are pressured by the increased scrutiny. In some instances, banks have even brought proceedings against their regulators themselves (e.g., L Bank (see Section VII.iv, above)). This shows a drastic shift in culture by banks. Previously, it was deemed prudent not to challenge the regulator but instead to let regulatory authorities proceed with their work. In light of more aggressive regulators, banks increasingly decide on a more confrontational approach. This results in a more litigious environment.
X LOOKING AHEAD: no downturn expected
In recent years, there have been several developments in the banking law sector. One is a strong increase in private investor cases brought to state courts in the wake of the financial crisis. This is helped by widespread legal cost insurance, which makes it less of a risk for private investors to bring an action. Even though German courts have a reputation for being investor-friendly, banks usually prefer litigation in front of state courts to alternative dispute resolution mechanisms. That said, the speed of court proceedings has varied depending on the capacity that the individual courts can free up to manage the rise of investor-brought cases in recent years.
Another development is that banks are more willing to litigate against institutional clients than in the past. This corresponds with legislative pressure on banks and an increasingly competitive environment for financial institutions – especially in a market like the German market, which is considered to be overbanked. Furthermore, in the past three years, more professional process funders have entered the German market,45 which also fosters the trend of more litigation. Given the new aggressive stance adopted by regulators, their international cooperation and law enforcement authorities’ latest focus on banking-related criminal investigations on the one hand, and banks’ determination to take their regulators to court on the other, there is no expectation that the number of banking litigation cases in Germany will drop.
1 Christian Schmitt is a partner at Linklaters LLP. The author would like to thank associates Martin Bär and Tobias Bastian, as well as legal assistant Benedikt Heil, for their invaluable support in the preparation of this chapter.
2 BGH, judgment of 9 June 2016, court reference: IX ZR 314/14.
3 BGH, court order of 29 June 2010, court reference: XI ZR 308/09.
4 BGH, judgment of 23 June 2016, court reference: III ZR 308/15.
5 BGH, judgment of 22 March 2016, court reference: XI ZR 425/14.
6 BGH, judgment of 21 December 2017, court reference: 1 StR 296/16.
7 Section 2, subsection 1, sentence 1; Section 6, subsection 1 KapMuG.
8 Section 8, subsection 1 KapMuG, meaning that no individual trials on the same matter are allowed to proceed.
9 New cases can join the model procedure or be registered to suspend the limitation period without being bound by the model procedure decision, Section 10, subsection 2 KapMuG.
10 Section 22 KapMuG.
12 Section 916, subsection 1 Civil Procedure Code.
13 Section 918 Civil Procedure Code.
14 Section 917 Civil Procedure Code.
15 Section 926 Civil Procedure Code.
16 Higher Regional Court Karlsruhe, judgment of 7 May 1996, court reference: 2 UF 59/96.
17 Section 933 Civil Procedure Code.
18 Higher Regional Court Frankfurt, court order of 2 February 2004, court reference: 19 U 240/03.
19 Vollkommer in: Zöller Commentary on the Civil Procedure Code, 31st edition 2016, Section 922, margin No. 10.
20 Drescher in: Munich Commentary on the Civil Procedure Code, 5th edition 2016, Section 922, margin No. 10; Vollkommer in: Zöller Commentary on the Civil Procedure Code, 31st edition 2016, Section 922, margin No. 10.
21 Section 43, subsection 2 German Federal Lawyers’ Act; Section 2 Professional Code for German Lawyers.
22 Section 203 German Criminal Code.
23 See, Section 53 et seq. German Criminal Procedure Code; Section 383, subsection 1, No. 6 Civil Procedure Code.
24 BGH, judgment of 25 February 1998, court reference: 3 StR 490/97.
25 Section 97, subsection 2, sentence 3 Criminal Procedure Code.
26 In favour of seizing documents: Regional Court Hamburg, court order of 15 October 2010, court reference: 608 Qs 18/10. Against seizing documents: Regional Court Mannheim, court order of 3 July 2012, court reference: 24 Qs 1/12, 24 Qs 2/12; Regional Court Braunschweig, court order of 21 July 2015, court reference: 6 Qs 116/15 [affirms freedom of seizure held at the corporation as preparatory measures to a defence in administrative offences trial].
29 Regional Court Hamburg, decision of 15 October 2010, court reference: 608 Qs 18/10.
30 Court of Justice of the European Union, judgment of 12 May 2011, court reference: C-144/10.
31 UBS AG v. Wasserwerke Leipzig GmbH  EWHC 3615 (Comm).
32 Court of Justice of the European Union, judgment of 12 May 2011, court reference: C-144/10.
33 BGH, judgment of 6 July 1993, court reference: XI ZR 12/93.
34 Petra Buck-Heeb, ZIP 2013, pp. 1401-1411; Schmitt in: Zerey (ed.) Financial Derivatives, fourth edition 2016, p. 827.
35 BGH, judgment of 29 April 2014, court reference: XI ZR 130/13.
36 For products in form of a security: German Securities Prospectus Act; for all fund investments: Section 306 German Capital Investment Code; and for all other products: Sections 20 et seq. German Capital Investment Act. This prospectus liability regime is completed by the civil-law prospectus liability in the strict sense, which nowadays has been superseded in the vast majority of cases, BGH, court order of 21 October 2014, court reference XI ZB 12/12, paragraphs 64 et seq.
37 BGH, judgment of 31 May 1990, court reference: VII ZR 340/88.
38 The L Bank lost the action, cf. European General Court, judgment of 16 May 2017, court reference: T-122/15.
39 Regional Court Munich I, court reference: 34 O 680/16 (unpublished); Regional Court Ulm, judgment of 22 May 2017, court reference: 4 O 66/33.
40 Section 138, subsection 1 Civil Code.
41 Sections 305 et seq. Civil Code.
42 BGH, judgment of 14 November 2000, court reference: X ZR 211/98.
43 BGH, judgment of 11 December 2003, court reference: III ZR 118/03.
44 Petra Buck-Heeb, ZIP 2013, pp. 1401–1411; Schmitt in: Zerey (ed.) Financial Derivatives, fourth edition 2016, p. 827.
45 E.g., for claims against Volkswagen, as well as cases concerning JuraXX or Sportgate AG.