Civil liability of the financial industry with respect to cum-ex transactions in Germany

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Yorick M Ruland
GÖRG Partnerschaft von Rechtsanwälten, Cologne
yruland@goerg.de

A cum-ex transaction is a complex form of dividend arbitrage or dividend stripping. For the purpose of dividend arbitrage, traders in alternative tax jurisdictions trade shares around dividend dates. Cum-ex trades specifically serve as a mechanism allowing both the buyer and seller of shares to recover capital gains tax (CGT) paid only once on dividend income. The transactions involve acquiring shares ‘cum dividend’ (including dividend right) just before a dividend is due, and then selling ‘ex dividend’ (without dividend right) after the dividend record date. The various steps are processed very quickly, making it difficult to identify the true owner of the shares, thus enabling multiple parties to claim tax credits or tax compensation payments for CGT paid only once. This process often involves the original owner of the shares, the bank or broker that sells them short, and the buyer who purchases them on dividend day. It has been common for the parties to split the proceeds of the tax refunds.

Cum-ex transactions allegedly involve significant sections of the financial industry, with buy-side investors taxable in Germany and short-sellers borrowing the stock in question from pension or investment funds located around the world, all enabled by traders and brokers working for financial institutions around Europe. It is estimated that approximately 100 banks, both German and international, are under investigation for participating in such transactions; all of them are exposed to litigation and enforcement risk.

Two British investment bankers are on trial before a criminal court in Bonn, Germany, accused of defrauding the German state of about €447.5m (£405m) having engaged in cum-ex trading between 2006 and 2011. This is a faction of the €55bn said to be lost by European treasuries through these controversial transactions.

This trial is likely to set the parameters for further cases in Germany and beyond. Indeed, the practices are reported to affect a number of other European states, including Denmark, France, Italy, the Netherlands, Spain and Switzerland.

The trial may prove to be a starting point rather than the end of the scandal. Other reported enforcement actions and litigation arising from the scandal include the following:

• Criminal proceedings are ongoing in charges brought by Frankfurt prosecutors. In this instance, six individuals have been charged (including bankers and a former lawyer) in relation to short sales of securities between 2006 and 2008. The loss suffered by the authorities is said to amount to about €106m.

• A number of financial institutions (including United Kingdom and United States institutions) that lent capital to the schemes are under investigation by the German authorities and are in line for regulatory enforcement fines. To date, one German bank was reported to have repaid €149m plus interest in wrongly claimed tax refunds to the German authorities, and another was said to have paid €19.8m in fines for its role. At the same time, this German bank has sued former managers for about €160m on account of their directors' and officers' responsibility.

• One institution that was reportedly close to settling with the German tax authorities, an Australian bank, has been sued in Germany by investors in relation to transactions which this bank lent money to funds.

• An international law firm was sued in the English High Court by a former client’s creditors, alleging that it gave negligent advice on the lawfulness of cum-ex trades between 2006 and 2010. This claim has, reportedly, recently been settled. Prosecutors have twice raided the same law firm’s offices and, in a considerable development of the Cologne prosecutor’s criminal investigation, on 21 November 2019 the firm’s former head of tax was arrested, held in custody for a number of days and charged with aiding and abetting tax evasion linked to cum-ex transactions.

Insofar as parties formed part of a cum-ex scheme one way or the other, they are joint and several debtors according to section 44 of the German Tax Code (Abgabenordnung or AO). The consequence of this joint and several liability for the tax damage consists in: (1) facilitation recourse by the tax authorities because they can select the party most easily accessible to them; and (2) claims for compensation as among the jointly and severally liable tax debtors. These mutual compensation claims follow the rules of civil law. According to section 426(1) of the German Civil Code (BGB), the joint and several debtors are obliged to equal shares in relation to each other unless other shares can be deduced from the relevant agreements or other circumstances.

According to the jurisprudence, it is possible and necessary to determine a quota by combining several persons responsible into ‘units’ that are treated as one person in relation to the other joint and several debtors with a common liability quota. This aggregation of contributions allows the party entitled to compensation to address one of the debtors in the amount of the aggregated recourse quota if the behaviour of the debtors is to be regarded as a uniform cause. This subgroup formation is possible if the ‘group’ is composed of jointly acting offenders and accomplices whose conduct has essentially resulted in the same causal contribution. It must appear justified that the party jointly and severally liable for payment does not have to address the ‘group members’ on a pro rata basis.

In the agreed cum-ex cases, the parties to the contract of sale and their respective jointly liable auxiliary persons (board members, external advisors or ‘initiators’) can then be regarded as two liability units. The jointly liable custodian banks, which intentionally and in breach of duty failed to pay the tax or issued a false certificate, set their own contributions in this respect, as they violated legal obligations, so that the banks as well as other joint and several debtors on their side (advisers or members of executive bodies) can be regarded as further liability units. If, on the other hand, the cum-ex transactions were only agreed between the buyer and the seller, it is appropriate to treat the contracting parties as a unit vis-à-vis the ‘bona fide’ jointly liable banks. Finally, according to these principles, it seems correct to regard the seller and a deliberately acting domestic custodian bank as a unit liable to the ‘bona fide’ buyer (and his ‘bona fide’ custodian bank).

In addition to the joint and several debtor settlement, there are further bases of recovery claims among the participants of these transactions, for example, frustration of contract, unjust enrichment, gestion rules or contract. Claims can also arise for wrongful advice or misstatement of circumstances when the product was distributed as investment product to other parties.

The civil law review of the cum-ex transactions has only just begun. The inevitability of unbiased questioning in individual cases is already apparent, whether the arrangements were directly or indirectly agreed and coordinated. The civil law recourse proceedings entail risks for all parties involved. A dilemma could arise because any recourse claim includes a threat of loss of reputation and further consequences under criminal law or under the law governing the liability of directors and officers.

The key messages are as follows: (1) under civil law, the parties involved in bad faith are primarily liable; they form a single liability unit vis-à-vis the joint and several debtors who are ‘in good faith’. In all other respects, the rate of recourse is based on the proportion of causation and profit in the individual case; and (2) the short limitation period under sections 195 and 199 of the BGB for recourse claims under section 426 of the BGB, which begins at the end of the year in which the compensation payment is made, has to be closely monitored with respect to the longer period under sections 169 et seq and 228 et seq of the AO.

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