A variety of insurance products that is difficult for consumers to understand encourages them to make a choice only after consulting a market observer. However, the involvement of experts in investment decisions raises the question of responsibility for their actions. What possibilities of recourse to liability have those seeking advice or otherwise turned to, what liability risks are such experts subject to?
This question will be examined below using the example of so-called insurance ratings. It is precisely this area that demonstrates the need to protect the consumer from supposedly expert, but often dubious, promotional or false advice.
1. The insurance rating
The rating of an insurance company is an assessment of the probability with which the company will be able to pay its liabilities in the future, in particular the repayment obligations to policyholders. For this purpose, the current economic situation and the viability of future assumptions are largely analysed according to the usual criteria of a company valuation.
2 .Contractual liability of the rating agency
2.1. Basis of liability
Ratings are often merely opinions based on estimates of a probable future development, such as creditworthiness or the certainty with which certain returns can be generated. If the information provided by the rating agency proves to be incorrect, the question of damage and, of course, liability inevitably arises.
The law makes it clear in §675 II BGB that a contractual or tortious legal claim is required, because otherwise there is no liability for “advice, information, recommendation”. The basis for a claim is above all the information or consulting contract.
2.2. Information or consultancy contract
Decisive for the legislator is the question whether the parties show the will to be legally bound.
Case law already links liability to a tacitly concluded advice and information contract if (objectively speaking) the advice or information is of considerable importance for the recipient and it constitutes a basis for essential measures or decisions for the recipient. In particular, the type, reason and purpose of the information or advice, the economic significance for the recipient, the technical and expert knowledge of the person providing the information or advice, the legal or economic interest of the parties to the contract all play a role. A possible deviating inner will of the rating agency not to stand up for advice and information (as often stated on the Internet and in printed editions with the words “Despite conscientious research … without commitment, without liability”) is irrelevant.
What is surprising is that rating agencies have not introduced a procedure for effective limitation of liability along the lines of the individual information contracts of auditors on the occasion of so-called prospectus reports for closed investment funds. This is an effective means for the rating agencies to establish a mutual contractual relationship in their favour and to limit liability within the framework of the legal possibilities.
2.3. Warranty and exemption from liability
The CRA will be required to provide a sufficiently comprehensive, i.e. ‘complete and accurate’, presentation, to make use of existing knowledge, and above all ‘to present an answer to the question of the degree of uncertainty of the outcome of the
own assessment” must be obligatory. However, it is precisely the systematic verifiability of the judgement and the transparency of the assessment system that is a not unproblematic area for ratings. The performance of the rating requires the inclusion of qualitative and quantitative facts in an assessment scheme. If some rating agencies make a great effort to convey their judgement in a comprehensible manner, others close their eyes completely to the outside world. In the event of a judicial review of whether a rating is erroneous in its result or whether it was prepared in an improper manner and thus gives rise to liability, the focus should probably not only be on the complete and incomplete research of the facts, but in particular on the suitability of the methodology used to process and evaluate the data.
A deficient methodological approach is likely to support the rating user who justifiably relies on a scientifically adequate approach in his liability claim.
Rating agencies are also seeking to exempt themselves by means of disclaimers: In individual information contracts this is possible up to the limit of intent, § 276 III BGB. However, if, as is the rule in practice, only general terms and conditions are used for this purpose, the exclusion of liability for intent and gross negligence is regularly ineffective, § 309 No. 7 BGB6. It is only in all other respects that the CRA will be able to benefit in good faith from information provided free of charge’.
It should also be noted that a CRA itself might have problems in excluding only minor negligence. After all, the proper preparation of a rating according to scientific methods will be one of the so-called cardinal obligations of this expert service, for which an exclusion of liability can be ruled out even for slight negligence”.
2.4. Liability for damage to third parties
If the recipient of advice or information or an expert opinion passes this on to a third party who then makes a disposition of assets in confidence that it is correct, the question of liability also arises – even if the third party does not have a contract with the adviser or information provider or the rating agency. This is practical, for example, in a constellation in which an insurer makes the rating available to its (potential) customers via its sales department or other media.
Here, too, only a contractual liability, as it were without a direct contract, is possible. Case law developed from this the legal institution of the “contract with protective effect in favour of third parties” as an initially not legally standardised (partial) basis for claims. The “Federal Court of Justice” (BGH) construes a liability if the information or advice was recognisably of considerable importance for the recipient (third party) from the point of view of the adviser or provider of information (rating agency)! and he (the recipient, i.e. the third party) made it the basis of his decision (in economic, legal or factual terms). The Federal Court of Justice assumes that the person providing the information or adviser was aware that the information would be significant for further circles (third parties) and serve as a basis for asset dispositions.
The decisive factor is that the third party has been included in the so-called protected area of the information or consultancy agreement. This is the case if, according to the intention of the creditor (recipient of the information
or the Council is also intended for that third party. According to the BGH, it is sufficient if the third party “in substance” requires protection. When rating insurance companies as well as insurance products, the results of the information are regularly intended for third parties, namely’ the (possibly potential) policyholders, investors and the sales/intermediary’. This is obvious, at least in the case of ratings commissioned by the insurance company, because – unlike on the Anglo-American capital market – there is no legally founded necessity for insurance ratings, and the use of ratings is therefore limited primarily to sales promotion. The CRA’s own protection obligations vis-à-vis third parties therefore require its own special expertise and the principal’s intention to use the credit rating vis-à-vis third parties. To clarify this question, it will essentially be necessary to refer to the information contained in or underlying the rating itself regarding the purpose and content as well as the circumstances of the contract award. By way of interpretation, it will have to be determined how the valuer understood the mandate given to him and whether and to what extent he expected the rating to be presented to third parties when the rating was published and made by them the basis for a disposition of assets.
The third party need not be known by name or in person at the time the rating is issued, but must be able to be individualised. The usual insurance ratings are explicitly geared to the customer. The CRA as debtor (of information, advice, expert opinion) only needs to know that its rating is to be used by the third party as a basis for major decisions.
Contributory negligence on the part of the third party (“injured party”) is usually ruled out if the third party refers to the special expertise and technical knowledge of the debtor (the rating agency).
However, it must be stressed that in this context, the interests of the CRA in good faith must also be taken into account, which cannot be unreasonably burdened with obligations to pay damages to third parties.
The credit rating agency should not be deprived of the possibility to calculate the liability risk and, if necessary, to insure it’. Thus, if a rating agency makes a statement about the creditworthiness of an insurance company or an insurance product, a liability risk will always be considered incalculable if its opinion is taken into account by an unquantifiable number of users and if, as a result of its rating, these users are able to purchase a product that is not limited in terms of quantity. An example may illustrate this: If the rating agency assesses the health insurance product of a provider, it is initially not apparent to the assessor how many readers of his rating are aware of it,
especially since even the insurance company will not set any quantitative limits for this product line. The situation would be different, for example, with the rating for a closed-end fund with a fixed investment volume. In this case, the valuer knows that a limited amount of capital will be raised with the help of his report20. He is liable for this amount – up to this value, decisions are made in confidence in his expertise’. In the case of insurance ratings, however, a restriction of the circle of beneficiary third parties is regularly necessary, as otherwise the liability risk is unduly extended. A liability from “contract with protective effect in favour of third parties” will therefore regularly have to be excluded.
While this result may be dogmatically satisfactory, it seems questionable to privilege a reviewer for being able to influence the decision of an unmanageable number of consumers in full awareness of the scope of his publication without having to bear responsibility for it. Does it make a difference in the end whether capital is to be raised for a closed-end fund with a volume of, for example, EUR 100 million or whether it is a volume – although not limited initially – which is actually limited in terms of volume by the distribution power and existing market shares?
In order to protect the rating agency against a possibly unforeseeable liability, it is therefore advisable to check whether a limitation of the own liability risk is achieved by individual information agreements with the third parties and congruent insurance cover
It would be easier to limit liability in the relationship between the contractor and the contracting authority, i.e. the rating agency with a contractual partner, which would extend to the third party. Such a limitation of liability with third-party effect could be agreed by mutual agreement or introduced into the contractual relationship by means of the Agency’s General Terms and Conditions. Ratings, however, “live” almost from their external impact – they are published, they are used to advertise investment forms or insurance companies and, as is well known, they are passed on to a larger number of unknown persons. The client will refuse to enter into a contractual agreement accordingly, as he is particularly close to the third party, as is usually the case with cooperation partners of insurance companies. It has an interest that the third party can use the rating result for its own work without restriction. The rating is inevitably made public externally. As a result of the foreseeable consequences of liability, neither the client nor the third party wants to be left with the possible damage.
2.5. Standards of due diligence for ratings
The President of BaFin postulates that sophisticated rules of conduct are needed to ensure the verifiability of ratings. It is correct in this finding that there are legally explicit standardised rules in this country only for securities analysis, § 34 b WpHG. In particular, this regulation requires that analyses be performed with care, expertise, conscientiousness and, above all, that conflicts of interest be disclosed (keyword: Chinese Wall). The aim is to create transparency for consumers and investors! While it is disputed whether this is a protective law within the meaning of Section 823 II of the German Civil Code (BGB), it is unanimous that these statutory requirements are only directly applicable to investment service providers, not to rating agencies. De lege ferenda would, however, wish to see the above-mentioned rules also laid down for the area of insurance ratings. The Financial Analysis Ordinance (FinAnV) issued in December 2004 in connection with the Securities Trading Act (WpHG) could provide guidance in this respect. In the BGH’s specific case, the case concerned a price ranking in which the prices had not been determined representatively. The court considered it to trigger liability within the meaning of §824 BGB that the presentation did not appear to be impartial and therefore the investigation of scientific methods was no longer sufficient.
In the opinion of the court, searches must be carried out with great care and information must be sufficiently checked for its accuracy.
Later, the BGH24 also continues to demand that published investigations must be based on neutral, objective and expert execution: It is then sufficient that the type of procedure used in the examination and the conclusions drawn appear justifiable, i.e. debatable. In this respect, considerable discretion is granted for the presentation of the results. It should be noted that in the case of product tests – and thus probably also ratings – “there is considerable discretionary scope for their criticism, which is regularly measured against the right to freedom of expression”, if the underlying aspects of the investigation and their weighting are disclosed for proper assessment by the reader.
Rating agencies may be exposed to considerable legal and thus also economic risks. They should be careful to take this into account in their own risk management and to at least cover a residual risk that always remains. It has been shown that, due to the specific nature of insurance ratings, effective risk management by the rating agency will be achieved primarily by hedging risks. In an effort to cover possible risks through financial loss liability insurance, the rating agency, like any other expert acting as an expert, will have to provide evidence of the quality and “probability of default” of its expert activities. For example, the freedom to act without an effective supervisory or ethical framework is also an obstacle to risk avoidance. On the other hand, the legal obligation to cover liability risks (as is often the case with lawyers, for example), which often goes hand in hand with effective professional supervision, gives the professional groups concerned the privilege of facilitated coverage by the insurance undertakings. The insurance cover thus becomes the reporting of a insurable, i.e. appropriate risk of expert opinion.
By Dr. Johannes Fiala, Christian Kohrs and Sabine Leuschner
Published in Kredit & Rating Praxis, magazine for financial specialists, issue 02/2005
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About the author
Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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