Chance of multiple profit – but also private bankruptcy risk !
(at the same time with reference to the new BGH ruling on consultant liability, V ZR 402/99)
The original case:
Dr. Peter Fleißig, a physician with a successful practice, 45 years old, one wife, two children, is informed by his financial advisor how he can earn even more money with his unencumbered house (market value 250,000 euros) and even receive an immediate pension.
The property is mortgaged: Bank loans with a mortgage as collateral.
Of course the loan is taken out in YEN or francs, because there the money is “apparently cheaper”. The money (loan) is paid into an immediately starting life annuity insurance (life insurance). The pension should also be used to pay interest on the loan, and the pension should also help to increase the family income.
In addition, a savings plan (further life insurance with investment investment) is concluded: This money is then used to repay the mortgage loan (TILGUNG). The Bank shall have this contract assigned to it as security.
Actually, this model before taxes cannot work out well, because the return on the life annuity is usually lower than the cost of the loan. Under tax law, however, such life annuities are only taxable at the so-called profit share, i.e. only partially. The loan interest is deductible as income-related expenses.
- (a) Is there no supreme court decision on this: a case-by-case decision by the financial – and this is rarely obtained before the contract is signed, to be on the safe side.
- b) There is the question whether an “intention to achieve a profit or total surplus” (before tax!) will be demonstrable: Without the investment investment and a link to the loan and the pension this will hardly succeed. A model which, by the way, often only calculates if the tax burden is constantly (!) high.
Investor Dr. Fleißig only notices the risks after years. Justament when the stock market suffered massive price falls, the bank responded with a request to strengthen the collateral.
Dr. Fleißig has expanded his practice and cannot offer any additional security. The bank sets a deadline and threatens to terminate the agreement. The intermediary helplessly berates the bank, because the credit institution was informed about the model before the loan was signed. Dr. Fleißig has his tax advisor do the calculations: If the contracts are (prematurely) terminated, he will be left with a “loss” of 300,000 euros – his inherited house will then be auctioned off. Dr. Busy thinking about how he’s gonna tell his wife?
The investor was not advised about the following risks.
There is no individual decision by Finanz. The tax office can turn the “calculated profit after tax” into the opposite with the stroke of a pen.
Even if the finance department recognises the model, it can in principle be deleted by the legislator at any time. References to expert opinions of so-called ‘tax experts’ and circulars of the tax authorities do not help here either.
No life annuity insurance gives a guarantee for the total return. The model does not pay off with the minimum interest rate (for German life insurance policies 3.25% – previously 4%). Future profits are uncertain. Only very few companies on the European market can be trusted to actually manage to achieve the “non-binding” projections of a 7% return (and more) over terms of 10 to 20 years.
Numerous freelancers and self-employed persons have bought their investments (funds, real estate, etc.) on credit: Due to the currency exchange rate risk, many a loan customer noticed later that, in addition to the apparently low interest rate, he actually had to pay back much more because the foreign currency had become more expensive for him.
Depending on how the stock market situation has developed when the loan expires, there is a risk that the expected return may not have been achieved by the time the loan matures. Then the loan has to be extended or the investment has to be sold at low prices in a bear market. Dr. Fleißig has the risk that the loan will not be extended, that an option is missing in the loan agreement and, above all, that the bank can demand additional collateral at any time.
Without a fixed interest rate, possibly also for the extension option, rising interest rates can at any time result in an unsustainable additional burden, which leads to the realisation of the collateral by the bank. So the model “bursts” like a soap bubble.
The model calculations assume that the investor has a certain tax situation. If the income is lost over a longer period of time, e.g. due to accident or illness, or if separation and divorce occur, the model is usually no longer profitable.
It is a speculation with various assumptions: This can be called a bundle of risks, because numerous parameters must be met for it to work. Without hedging measures through contractual arrangements (vis-à-vis banks and insurance companies), this can be a time bomb.
The consultant liability:
- (a) documentation.
The mediator’s advice was not documented. Dr. Diligent has not signed any instructions. He is considering suing for inadequate counseling. Dr. Fleißig recalls that he was not informed about currency or leverage risks. The Federal Court of Justice decided such a case, in which the bank had demanded additional collateral for the loan due to a decline in exchange rates: the customer was unable to provide additional collateral and the collateral (including the insurance) was subsequently realised.
Compensation for damages – similar risks await the consultant in the case of the financed immediate annuity, if no instruction is given about conceivable risks (BU, accident, loss of income, tax changes, etc.) or these risks are not covered to the greatest possible extent.
BGH decision 09.07.1998 – III ZR 158/97,
BGH judgement 13.05.1993 – III ZR 25/92,
BGH decision 04.02.1987 – IV a ZR 134/85.
The trade press must be read by the agent: The customer must be given the information: This also applies to incorrect or false information in the trade press. Also with the leverage business the investor can maintain after years that he would have never decided to the investment if he had known the specialized info.
Financed capital investment (rented property, closed property funds, combinations of credit and life insurance, etc.). Here there is the chance for investors to take the agent and/or the financing bank into liability. The seller of an investment (insurer, real estate seller) is also generally responsible if the agent made incorrect calculations that became the basis for the investment decision.
To read up on:
Federal Supreme Court ruling 5 June 2000 – III ZR 305/98
BGH judgement 9 March 1999 – 1 StR 50/99
Federal Court of Justice judgment 6 April 2001 – V ZR 402/99
- (c) Tax advice:
In numerous calculation examples, costs or expenses are not or far too low or tax credits are overstated. The investor can thus invoke a consulting error. In the case of public companies and builder-owner models, prospectus liability comes into consideration.
As soon as the investment intermediary makes his knowledge and experience available to the investor, a consultancy contract is concluded. In this way, the intermediary (also for the partners behind the intermediary) also guarantees the correctness of the “sample calculations” for the individual case in their scope of duties.
BGH judgment 6 April 2001 – V ZR 402/99.
BGH MDR 00, 405.
Dr. Fleißig notes with the receipt of the loan termination:
“First the broker had the experience and I had the money – now it’s the other way around”!
The tip for brokers, consultants, customers:
Many banks like to finance according to the “umbrella principle”: when the sun is shining, the loan is available – when it rains (market price adjustment, reduction of the repurchase value, lowering of the final binification, etc.) the credit institution demands an increase of the loan collateral or “flattens out” the leverage transaction by liquidation.
Agreement of a clause in the credit agreement – e.g. after assignment of the policy to the bank as security, the agreement would be “otherwise as a blank credit” or “without further (further) security”. However, the banker also bears a risk and is exposed to personal responsibility.
This procedure ensures that the banker checks exactly how he assesses the loan collateral, even if the investment develops differently than hoped.
by Dr. Johannes Fiala
published on www.Immopilot.de, 06.2006
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About the author
PhD, MBA, MM
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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