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JURIST's Germany Correspondent is Prof. Dr. Thomas Lundmark, Rechtswissenschaftliche Fakult舩, Westf舁ische Wilhelms-Universit舩, Muenster
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Familial Guarantees of Business Loans

[Editors' Note: our German correspondent writes that for his first report he "chose the topic [of familial guaranties of business loans] because it is one that has received a lot of press recently, in anticipation of a resolution of the issue. The topic illustrates one of a number of areas where German law, which strives to be uniform and predictable, is not. Further, the topic involves both private law and public law, specifically, what is known in German as the Drittwirkung of constitutional rights, sometimes referred to in English as the "horizontal" application of constitutional rights to private transactions. This phenomenon is vaguely similar to the "state action" requirement in American constitutional law."]

[Muenster; Special to JURIST] The business practices and standard contracts of German banks went almost unchallenged for years. But those times have come to an end, thanks to rising consumer awareness and to protective legislation and judicial decisions.

The latest judicial challenge facing German banks concerns the long-standing practice of many if not most banks of requiring spouses, close friends, or even children of would-be borrowers to guarantee repayment of business loans. These are loans for which the spouse etc. would not be liable in the absence of a guaranty. The banks defend their practice as a prudent, even necessary device to deter debtors from sheltering assets with close family members and friends in the event of default on their obligations under the promissory note. According to this reasoning, upon the default of the debtor, the bank should not be required to prove that assets were in fact transferred to the guarantor to evade the bank's collection efforts, since that avenue would be available to the banks even without the guaranty. Rather, to achieve the desired deterrence effect, the guarantor's obligation must be automatically enforceable.

One problem with this line of argument is that it no longer, assuming it ever did, reflects the actual collection practices of banks. Indeed, in years past it seemed that more and more cases were reaching the courts in which banks were mercilessly pursuing collection from gratuitous guarantors who had never received assets from the note's promissor, and who had no prospect whatsoever of ever having the financial wherewithal to make good on their guaranties. Because bankruptcy was not available to them until recently, these well-meaning friends and family members were saddled with debt they could never hope to pay off.

The German Federal Constitutional Court finally stepped into the fray in 1993 in a case in which a 21-year-old unskilled factory worker, with no assets of her own, had guaranteed a 100,000 DM (presently $50,000) loan to her real estate broker father. When her father defaulted on the promissory note, judgment in the civil courts was entered on the guaranty against the woman, who was earning just 1,150 DM (presently $575) monthly, despite her offer of proof that she had been told by an officer of the bank that she would not be incurring any serious financial obligation by signing the guaranty.

Previous challenges to familial guaranties had been rejected by the courts by reference to notions of freedom of contract (Staudinger-Horn ァ 765 No. 162 et seq.). But this time was different. The Federal Constitutional Court granted the petition of the real estate broker's daughter, and reversed on constitutional grounds.

The court based its holding on Article 2 of the German Constitution. Article 2, which literally protects the free unfolding of one's personality (freie Entfaltung der Persnlichkeit), has been construed to protect freedom of contract. According to the Federal Constitutional Court, freedom of contract presupposes relative equality of bargaining position. Absent such equality, the "structurally weaker" party to a contract is not acting freely. Accordingly, it would violate Article 2 of the German Constitution if courts were to sanction the imposition of excessive financial burdens upon people in "structurally weak" bargaining positions.

Because the civil courts do not rule on constitutional issues, the constitutional court ordered that the civil judges in the future inject Article 2 indirectly into their deliberations about familial guaranties by construing the "general clauses" of the German Civil Code in accordance with constitutional rights (89 BVerfGE 214, 237). This technique of exporting constitutional concepts to the civil (non-constitutional) courts is known as Drittwirkung in German. Specifically, the constitutional court decreed in this case that the terms "good morals" (gute Sitten) in section 138 and "good faith" (Treu und Glauben) in section 242 of the German Civil Code must be construed in the context of familial guaranties to protect "structurally weak" relatives and loved ones from exploitation by lending institutions (see generally Zimmermann, Introduction to German Law, Ebke & Finkin eds., at 17).

Unfortunately for both consumers and banks, the civil courts have been unable to reach agreement on what is meant by "structural weakness." Indeed, two divisions of the Federal Supreme Court (Bundesgerichtshof) have, quite independently of each other, developed their own standards. This is possible because appeals involving guaranties are heard by the 9th Senate, and appeals involving bank law by the 11th Senate of the Federal Supreme Court (not to be confused with the Federal Constitutional Court).

In has been the general practice of the 9th Senate to accept shifting of assets as a sufficient justification for requiring a familial guaranty, but to deny enforcement of the guaranty in cases in which no assets were shifted. For example, in the case of an unemployed woman, with no assets of her own, who had guaranteed a loan for her husband's bar, the 9th Senate held that she could not be forced to make good on her guaranty absent evidence that she was sheltering her insolvent husband's assets (BGHZ 132, 328). The 9th Senate justified its holding as follows. Because no untoward psychological pressure was employed by the bank in securing the wife's guaranty, the taking of the guaranty did not violate good morals under section 138 of the German Civil Code. However, if the fear of shifting assets had indeed been the bank's sole motivation for requiring the guaranty, then enforcement should only be ordered after proof that assets had indeed been shifted to the wife. Failure to require such proof, according to the 9th Senate, would transgress notions of good faith emanating from section 242 of the German Civil Code. Extending its reasoning to divorces, the court went on to state that a bona fide divorce would render the familial guaranty void, since the lender could no longer reasonably fear that the borrower's assets would be sheltered by the ex-spouse. In more recent decisions the 9th Senate has stated in dicta that, for all guaranties executed after January, 1999, it will not uphold the validity of guaranties based on concerns about asset-shifting unless this concern finds explicit mention in the guaranty agreement (BGH NJW 1999, 58, 60).

In June 1999 the 11th Senate issued an opinion critical of the 9th Senate. According to the 11th Senate, a lender's fears of an asset shift should never justify requiring destitute family members to guarantee business loans. Invoking the rarely used provisions of section 132 of the Judicial Procedure Act (GVG), the 11th Senate referred the issue for plenary determination by representative judges from all civil senates of the German Supreme Court.

Section 132 foresees referrals in two circumstances: in cases of fundamental importance, and in cases in which when one senate proposes to depart from the case decisions of another. The reference by the 11th Senate under section 132 cited the first circumstance: determination of a matter of fundamental importance. In an apparently unprecedented move, the 9th Senate in February of this year filed a procedural challenge to the 11th Senate's referral. According to the 9th Senate's challenge, a case may be referred for "fundamental importance" only when no other senate has ruled on the issue. Where, as in this case, another senate has already ruled on the issue, then referral should only be possible under the "permission to depart" provision; and this provision requires that the 9th Senate first be allowed to reconsider its position before a plenary hearing may be set (BGH ZIP 2000, 404).

For better or for worse, the controversy came to an abrupt end recently when the bank withdrew its appeal, leaving the judgment in favor of the guarantor in force (ZIP II/2000 VI). However, the debate goes on. In a recent article in Juristische Schulung Professor Medicus, one of the most eminent authorities on civil law in Germany, argued that talk about the "structural" strength or weakness of parties to a guaranty is misplaced. Absent evidence on the traditional grounds for avoiding contract formation (such as the bank officer's remark that the daughter was not incurring a serious financial obligation), courts in a free society have no business trying to look into men's souls to divine whether otherwise competent adults were somehow psychologically coerced by their "structural weakness" into signing guaranties against their will. Should a familial guarantor be unable to pay in any particular case, then resort to debtor-protection procedures is available. Further, the bankruptcy law now provides relief.

As sympathetic as the authors are to the academic elegance of this approach, we are disinclined to believe that the civil judges will suddenly abandon their newfound constitutional power and refuse to rescue relatives and close friends from what is seen by most as immoral overreaching by banks.

Thomas Lundmark & Holger Hestermeyer
June 28, 2000

ゥ Thomas Lundmark and Holger Hestermeyer

Note on the authors: Holger Hestermeyer is a graduate of the University of Muenster and of Muenster's Foreign Law Program in both Common Law and in French Law. Mr. Hestermeyer will be attending the LL.M. program at UC Berkeley School of Law on a Fulbright fellowship in the fall. Thomas Lundmark, JURIST's German Correspondent, holds the chair in Anglo-American Law at the University of Muenster, where he serves as faculty advisor to the Foreign Law Program. Future reports, as this one, will be filed by Professor Lundmark in cooperation with graduates of the Foreign Law Program (Fachspezifische Fremdsprachenausbildung). A description in English of the Foreign Law Program can be found at http://www.uni-muenster.de/Jura.history/Europa/ffa/info/info.htm.

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