Investment in tangible goods in Germany
(By Verbraucher - Zentrale Hamburg e.V.)

Investment in Tangible Goods: Consumers’ Access to Non-Regulated Markets

I. Introduction

“Are you interested in paying less taxes?” – “Do you think your pension is a reliable retirement arrangement?” By such and similar suggestive questions consumers in Germany are often addressed, involved into a sales talk and finally persuaded to invest money on the non-regulated (“Grey”, see III.) capital market. Companies which are selling these products in many cases have a staff at their command that is psychologically trained and knows how to make systematic use of their customers’ (human) weaknesses for marketing purposes. It is not only many people’s greed which is appealed to, but also and first of all many consumers’ uncertainty and fears about their retirement arrangements. Furthermore, the German legal regulation of taxes, which is famous for being a highly non-transparent copse even to experts, contributes to the fact that it is possible for those marketing staff members appearing as “consultants” to sell virtually lunatic investment products to customers, who are widely inexperienced on the financial market. Quite often during the sales talk the impression is transmitted that for an investment not even a minimum of own capital is necessary, but could be financed by a bank without any problem. This is true as raising of capital, in fact, as far as banks are concerned, hardly ever hits a snag. However, taking a sober look at such investments, one will ask: “Who would take a credit for the purpose of keeping it on a saving banks book?” (lit: Bergk/Strube in: Verbraucher-Zentrale Nordrhein-Westfalen [Ed.], Erwerbermodelle, 3. Edition [2002], p. 8). For consumers such cases are not seldom a question of very much money. And fortunes of those who are affected by a collapsed investment, have to be called tragic in many cases. Sometimes it is only the possibility of consumer insolvency, which has been in existence in Germany for a couple of years now, that contributes to a humane end of a precipitant but momentous decision to invest on the “Grey” capital market. Tragic in some cases – this shall be noted only by the way – are even fortunes of the named “consultants” who are part of the marketing staff and often seem to be not, at least not considerable more experienced on the financial market than their customers. A successful sales(wo)man – this is obviously the unofficial policy of many marketing organisations – has to be convinced of his/her products. With regard to the sale of investment products, which are doomed to failure to begin with, this means: up to a certain extent, the utilised “consultants” have to share their customers intellectual level. Therefore it is not surprising if contracts between marketing organisations and their consultants on the surface first of all provide considerable provision payments which do allow an expensive life-style but lead to a strict dependence, which makes those consultants sell at any costs and abolishes any kind of scruple or doubts concerning the product. There are already cases in which those who were involved as consultants could not find a way out of that dependence and committed suicide.

II. Further Steps of the Presentation

Those scenarios which have been pointed at in the introduction basically take place on a “market place” that is in Germany frequently called “Grey Capital Market”. In the following, first of all on a formal basis, i.e. in comparison to the regulated, organised market, but also on the basis of some examples taken from the field of tangible goods investment, it will be presented what this term generally means (III.). A special investigation with respect to the so-called “Erwerbermodell” will follow afterwards (IV.). On the basis of that, for consumers often ruinous investment model, it will become clear that consumer protection – this is to be presented as a résumé (V.) – in the field of investment in tangible goods on the (non-regulated) Grey Capital Market is not sufficient - respectively starts at the wrong point.

III. The So-Called “Grey Capital Market”

1. The Grey Capital Market as Non-Regulated, Non-Organised Market
On the basis of a rather formal understanding, the term “Grey Capital Market” is often used for the purpose of distinguishing products which are offered there from those which are offered on the regulated, organised market (see Zimmer, Der Betrieb [DB] 1998, S.969). In terms of logic, this is a negative definition which is useless unless the regulated, organised market is determined at the same time. Generally it can be said that the regulated, organised market can be determined by the state control. Of course, it has to be taken into consideration that there is no such thing as a market which is comprehensively ruled by the principle of laissez faire and for the purpose of a law-free zone is under no public control at all. Without any doubt, also a claim which is founded on the Grey Capital Market - in Germany this is even guaranteed by the constitution in Art. 19/4 of the German Grundgesetz - can be the basis of a law suit, thus be subject to the control of the courts. However, to the regulated, organised capital market special rules apply. In particular enterprises acting on the regulated, organised market, as well as products they are marketing, require a concession granted by the state and are under the supervision of a special institution which is called “Bundesanstalt für Finanzdienstleistungsaufsicht (BAFin)” (for further details see: Hösch, Gewerbearchiv [GewArch] 1999, S. 135f.). In Germany the scope of the rules which do apply in this connection has recently been extended due to the European directives concerning the harmonisation of the supervision of banks and securities trade in the European Community (6th so-called “Novelle zum Kreditwesengesetz”, 05.06.1997, Bundesgesetzblatt I, S. 2518 – for further details see: Zimmer, Der Betrieb [DB] 1998, S.969ff.).
2. Grey Capital Market in a Wider Sense
With regard to the – just explained - formal distinction of Grey Capital Market on the one hand and regulated, organised Capital Market on other hand those who are concerned with investors’ protection argue that this terminology is hardly proficient. This standpoint is plausible even though it looks like non-regulated, non-organised markets offer an almost unlimited playground especially to enterprises with a certain criminal potential. Nevertheless, it seems important to note that neither companies acting on non-regulated, non-organised markets, nor their products are necessarily unreliable. Furthermore, it has to be taken into consideration that investment models and enterprises, which are formally under particular control of the state, are not necessarily “white” (Bergk/Strube in: Verbraucher-Zentrale Nordrhein-Westfalen [Hrsg.], Rechtsfragen des Grauen Kapitalmarktes, 1. Auflage [2003], S. 9) either. While deciding in favour or against a certain investment model, there is even a certain danger that inexperienced investors misinterpret the feature of the public control as some kind of a guarantee concerning the products quality, which, in fact, can be awarded by the state only up to a very limited extent. And after realising the collapse of an investment, it is hardly to the investor’s advantage if he recognises that the affected product and its seller is under control of the state. Efficient protection against fraudulent offers, finally, can apparently not be reached by state control at all. This is because players on that market typically neither obey general, nor specific rules. Taking this into consideration, it seems more suitable to define the “Grey Capital Market” – as long as a field of consumers’ problems is to be described – in a wider sense as especially risky for the investor.
3. Risky and Fraudulent Offers
On the basis of such an understanding of the Grey Capital Market, with Bergk/Strube (in: Verbraucher-Zentrale Nordrhein-Westfalen [Hrsg.], Rechtsfragen des Grauen Kapitalmarktes, 1. Auflage [2003], S. 9) another distinction can be made to separate those investment models which are profitable under certain circumstances in spite of their speculative character (risky offers), and those that are doomed to failure to begin with (fraudulent offers). In the field of investment in tangible goods, e.g. the sale of diamonds can be qualified as fraudulent by itself. Diamonds might be widely appreciated as a manifestation of richness that endures any inflation (“Diamonds last forever”), but can, in fact - even if they are not just worthless fakes - hardly be sold later, let alone bring any profit. A similar example is the currently (June 2004), on the occasion of the European Football Championship prospering sale of Euro-Coins, which are praised as part of a “limited” edition and sold more than a hundred thousand times, so that an increase in vale is practically impossible (see “Mit Gedenkmünzen in der Abseitsfalle”, www.verbraucherzentrale-nrw.de/em-muenzen). Even after a regulation by law, which has been enacted a couple of years ago, the market for time-sharing-offers, i.e. the sale of permanent rights to use an apartment or house in a holiday resort, still bears quite an amount of criminal potential, too. In such cases the consumers’ special right to withdraw corresponding contracts is useless if a deposit payment or even the whole price has already been cashed in and the other party cannot be traced anymore. Nevertheless, neither referring to time-sharing-offers, nor to other investment models based on the purchase of real estate, can a fraudulent character of the product itself, thus without taking circumstances of a concrete case into consideration, be assumed. By presenting some details about the so-called “Erwerbermodell”, in the following it will be shown that objective risks connected to those offers are also relative. Generally, it can only be said that those offers are usually structured in such a way that without independent, professional help an investor himself can hardly estimate whether the concrete product, with respect to the investor’s individual financial standing, offers a serious possibility of profit or leads almost inevitably into private insolvency.

IV. Especially: The So-Called “Erwerbermodell”

Investment models based on the purchase of real estate that is used by a third party and financed by a bank are of extraordinary importance on the Grey Capital Market in Germany. As one reason for that, the investors’ principally correct assumption that, for example, via a rented flat a regular income can be obtained for an unlimited period of time, which proportionally increases with a possible inflation, can be named. In this way such an investment is especially suitable for covering retirement costs which can individually hardly be calculated. Secondly, from the standpoint of a private investor, there is not even a close investment model that is similarly supported by the state. Of course, it is not expressively the so-called “Erwerbermodell” (lit.: “purchase model”) which is supported, but the purchase of real estate in general. And in some cases it is even more-less obvious that the legislator by enacting corresponding provisions, exempting from taxes or being in favour of the buyer in another way, first of all wanted to encourage purchase of real estate for the buyer’s own use. However, on the basis of such provisions, a high number of investment models have been developed on the Grey Capital Market, which can be determined as a “Service-Package containing the real estate’s purchase, financing, renting and administration” (Bergk/Strube in: Verbraucher-Zentrale Nordrhein-Westfalen [Hrsg.], Rechtsfragen des Grauen Kapitalmarktes, 1. Auflage [2003], S. 13). On the other hand, these services appear as a package only in the marketing phase. The investor, in other words, is not served by one and the same person, but closes – at least from a rather formal standpoint – a multitude of contracts with as many different partners. Within such “Erwerbermodell” a distinction can be made between such which provide the purchase of a building that already exists (“Erwerbermodell” [in a more particular sense]), is to be built (“Bauträgermodell”) or to be reconstructed (“Altbausanierungsmodell”). Instead of a direct purchase by the investor, the real estate is also quite often bought via an investment fund (so-called “geschlossene Immobilienfonds”, “Immobiliensparfonds” oder “Eigenkapitalfonds”), of which the investor is to become a share holder.
1. Risks
Even if – as already mentioned – a general judgement concerning the “Erwerbermodell” is not possible, their sale in a considerable number of cases is simply fraudulent. The fact that before the purchase investors are usually neither able to take a look at the corresponding object nor capable to estimate its value offers a great possibility of deception. Without considerable difficulties – in the last years this has been a factor of crucial importance at the sale of flats which are located in the former GDR - it is possible to announce rents that are highly unrealistic with respect to the actual demand. Furthermore, when negotiating a contract far away from the object, substantial building damages can be concealed rather easily and get acknowledged by the new owner in many cases only after any warranty claim became already time-barred. This is also due to the fact that investments’ performances during the first year(s) typically correspond to the consultants’ calculation pattern on the basis of which the “Erwerbermodell” has been sold, so that from the investor’s point of view there is no need to worry. The profitable performance in the beginning usually is obtained by a so-called rent guarantee, which is part of the calculation and means basically a third party’s promise to voucher possible losses of rent. Of course, such a guarantee– this is frequently overlooked by the investors and almost never pointed out by the marketing “consultants” during the sale of an “Erwebermodell” – is only of use as long as the guarantor is solvent. If losses of rent, however, occur not only exceptionally but are more less the normal case, the guarantor’s insolvency is practically preassigned. Then it is especially those investment models which are fully financed by a credit and determine the payments of rent exclusively as a cover to pay off of the credit that can collapse within blink of an eye. The same is true if previously abetting legal acts are changed to the investor’s detriment or unexpected high costs in connection with the maintenance of the building arise. If, finally, it becomes clear that the purchased real estate can be sold only at half price or not at all, the investor has a chance to be released from his duty to pay off the credit only by filing for a private insolvency.
2. Protection of Investors by a Right to Withdraw
Collapsed investments based on the “Erwerbermodell” and fortunes which are connected to such cases have caused an intensive discussion in the German legal literature and among the courts. Within that discussion, in which newly even the Legal Service of the European Commission takes part (see writ of december, 2nd 2003 – JURM(03)12097 – JS/hve [http://www.money-advice.net/media.php?id=1117]), the typical marketing circumstances of the sale is the starting point. Typically, the named “Service-Packages” are sold away from business premises, thus, the European directive 85/577/EEC (implemented in Germany within the so-called “Haustürwiderrufsgesetz” resp. [since 01.01.2002] in § 312 of the German Civil Code [BGB]) applies. Nevertheless, as far as contracts about credits – actually the investors’ primary burden - are concerned, the German Federal Court acknowledged a right to withdraw the contract not before a reproof by the European Court of Justice (“Heininger” [C-481/99]) and has afterwards been applied by the German courts only formally in the widest sense (vgl. BGH - 10.09.2002 - XI ZR 151/99). As a result the withdrawing of a credit contract is even to the consumer’s detriment, because on the basis of a formal standpoint after a withdrawal the credit has to be immediately and fully paid back. Some authors (e.g. Hoffmann, Zeitschrift für Wirtschaftsrecht [ZIP] 2002, S. 1066ff.) argue this result was inadequate as it does not recognise the economical connection of the contract with the collapsed investment. With respect to a couple of literally brand-new decisions (BGH 06.14.2004 - II ZR 392/01 [395/01, 374/02, 385/02, 393/02 and 407/02]) in which a so-called “Einwendungsdurchgriff” (lit.: merge of objections) has been approved, actually it looks like the Federal Court (partly) gives in to that critics. In those cases investors were allowed to hold back further payments towards banks that had financed the purchase of a share of an real estate investment fonds being administrated extremely against the shareholders’ interests. The reasons given were first of all referring to the investors’ (merged) rights to ask for damages from those who were responsible administration of the funds. Secondly the court held that the same legal consequence had to be drawn, as the investors had withdrawn the contract on the basis of § 312 BGB.

IV. Résumé

After all it can be said, that a special protection of consumers on the Grey Capital Market seems to be necessary particularly in such cases in which a credit is to be taken to finance the investment. Concerning that subject matter, the latest development within the judicature of the Federal Court definitely has to be embraced. Nevertheless, it has to be noted, that the withdrawal of contracts in those cases the court had to decide about, had been done only after several years, and was still possible just because – by a legal mistake – there was no special information about the right to withdraw especially in the forms used by the banks. After the named decision of the European Court of Justice such constellations can hardly be expected for the future. Thus, investors’ protection that might be provided by the latest decision of the Federal Court seems to be limited to those cases in which fraud is evident. Finally, it has become clear that especially the sale of “Erwerbermodelle” is problematic not only because investors who are acquired away from business premises are able to make free will decisions only up to limited extent. In those cases investors deserve special protection first and foremost because of the fact, that the marketed products themselves are so non-transparent that a sufficiently reflected decision is hardly possible at all. With respect to the future development of consumer protecting law it seems recommendable to take this into consideration and provide that consumers are informed about concrete individual risks connected to an investment on the Grey Capital Market by an independent party.