Mayor and her treasurer face prosecution for adverse dealings

How municipal officials can prepare for their defense
Some cities and towns tend to make the budget look more positive than it really is. That’s where fictitious revenue is booked to show a balanced budget. Expenditure already incurred shall be carried forward to the following financial year. The budget thus appears balanced, showing a surplus rather than a deficit. The undisclosed financing gaps are financed, for example, by cash advances taken out with banks without a decision by the city or municipal councils, or by tacit supplier credits, e.g. for the reprinting of out-of-date forms for the municipal bailiffs.

Criminal liability of mayor and treasurer

The Munich Regional Court sentenced a mayor to two years imprisonment with probation, and a treasurer to three years without probation. This decision then went to the Federal Court of Justice and ended up at the Federal Constitutional Court (BVerfG, decision dated 01.11.2012, ref. 2 BvR 1235/11).
Federal Constitutional Court overturns convictions for embezzlement
The Federal Court of Justice (BGH) saw a disadvantage to the detriment of the municipality in the fact that interest on the loan had been incurred. The use of the cash loans for construction measures had been an economic advantage for the municipality. It is decisive, as already repeatedly decided by the BVerfG, that in addition to the breach of duty, the “disadvantage characteristic” must also be examined independently. This means that in the case of a conviction for breach of trust, independent quantified findings on the amount of the economic loss are required (BVerfGE 126, 170 et seq.).

Disadvantages in assets are to be determined economically

If municipal assets are used for “prohibited purposes”, this is not yet sufficient to establish a property disadvantage. In this context, an economic view is imperative, and this must not be supplanted by so-called normative considerations. For otherwise, the result is precisely an “analogous or common law” justification of penalties.

Interest rate disadvantages can be compensated by capital utilisation

The negative interest payments for cash loans can be offset by positive economic values because the municipality can also use the loan amounts – for investments, for example. When determining the benefits of a spot loan, which can compensate for up to 100% of a loss, courts will rarely do without prudent expert witnesses. In case of doubt, it will be necessary to acquit, as the BVerfG has already stated.

Benefits of experts for mayors and treasurers

Rarely will a loan be subjectively worthless to the municipality. It is not only the conditions that are important, but also the specific situation for the respective municipality. In accordance with the so-called prohibition of obfuscation, a breach of duty may not be used to infer abstract damage in order to then assume in the grounds for the judgment that the municipality has suffered economic damage without a concrete figure. The decisive question is then in particular whether the financing of investments is – from an ex ante point of view – economically wrong because it exacerbated the financially strained situation of the municipality or, on the contrary, the investment brought other economic advantages to the municipality or could even be expected to do so, even if they did not materialise in retrospect. Also, bypassing the township or city council does not in and of itself constitute a detriment within the meaning of disloyalty.

Disadvantages due to financial transactions with credit institutions

Complex financial products and transactions are particularly sensitive for local authority officials.
For example, interest rate differential transactions on foreign currencies (known as SWAPs) to allegedly reduce interest rates usually turn out to be a safe income for the bank – and simply speculation with municipal assets. This is not the case if municipal investments are to be prepared in this way and planning security for loans to be taken out in the future is to be achieved by means of such financial transactions.
The fact that planning security is sufficient for the municipal budget even in the case of an average foreseeable loss may be seen from the fact that the conclusion of insurance policies always leaves the insurer and the intermediary as winners on average, and only in the case of accidental major losses is it much rarer for a “return” above the premium expenditure to arise.
It has also been observed that some outsourcing of municipal services in the context of “public-private partnerships” (PPP) turns out to be much more expensive in the end than the municipality would have liked.
In many cases, this includes the de facto disposal of silverware by means of cross-border leasing (known as CBL), which brings money into the coffers in the short term, but in the medium or long term leads to price increases and/or quality losses for the state and citizens.
Admittedly, fiduciary duty will have to be measured against the municipal budget, not the pocketbooks of others, the state including the citizens of the municipality. Paying estate agents to help citizens in need of social assistance to find a better flat beyond the municipal boundary is surely not a waste of money from the municipal budget point of view.
Not to forget other “derivative” financial products, which are used for financing or investment via more or less “secret, rarely read, even more rarely understood contracts”. The responsible bodies regularly first have half-true advantages explained to them with colourful presentations, so that the associated risks recede into the background, and later a liability lawsuit against the financial house threatens at best as a disadvantage for the municipality.

Ban on speculation by local authorities

Speculative financial transactions concluded by municipalities tend to be null and void because they are regularly not within the scope of the tasks assigned to them by law and statute. In many cases, only expert analyses of derivatives, contracts and clauses will bring the risks and side effects to light. The recommendation, for example, to use derivatives unseen in municipal finance is predominantly contrary to the precepts of economic efficiency and thrift. However, this also applies to the packaging in some insurance policies if these offer a higher benefit in the abstract than to cover a loss that has also occurred, e.g. in the form of lost municipal revenue.
It is then realized too late that the weather report for such bets cannot be obtained from the Kachelmann company, unless it is a matter of weather derivatives, for example, to compensate for the lack of income from the municipal swimming pool when there is too little sunshine. Then all those who have bet on rain can also find out from the Offenbach weather service whether they have won this financial bet as a result of sufficient rain. On the other hand, all bettors who want to gain a multiple of the income lost in bad weather would have speculated illegally – here it would be better to consult other experiences of Kachelmann, namely on the service level of the German judicial system.

Expert opinions save costs and risks

The written and documented appraisal of financial contracts prior to their conclusion regularly prevents later accusations, so that criminal investigations will not even continue. At least as unpleasant would be the task of having to train one’s own successor. The extent of the unrecognized risk in the products advertised by financial advisors to municipalities is usually many times greater than the effort involved in conscientious analyses.Dr. Johannes Fiala, Dipl.-Math. Peter A. Schramm

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

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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