German Federal Court of Justice limits banks’ disclosure obligations in connection with swap transactions
20 January 2015
The German Federal Court of Justice handed down an important decision today on banks’ obligations in connection with swap transactions. Further to a landmark decision in March 2011 on a structured interest rate swap, the BGH had to decide to what extent the strict standards of that case also apply to other scenarios. The BGH decided that a bank does not need to disclose the initial negative market value of a swap in all cases.
According to the court’s press release, three-party situations in which the client’s bank and the client’s swap partner are not identical do not necessarily lead to a disclosure duty, at least if the prospects of the client under the swap transaction are not materially impaired by extensive cost and profit elements.
The basis for mis-selling claims in Germany is typically an alleged breach of an advisory agreement. Under the established pattern of German case law, a bank will usually be deemed to have “tacitly concluded” an advisory agreement when presenting investment opportunities to an investor. This agreement results in a duty of the bank to inform the client comprehensively about the prospects and risks of the potential investment. The level of information that is required depends on the complexity of the product and the experience of the investor.
The German Federal Court of Justice (Bundesgerichtshof or BGH) rendered its original decision on banks’ disclosure obligations for swaps in March 2011. It concerned a “CMS spread ladder swap”, a fairly complex derivative relating to interest rates that a bank had entered into with a mid-size German paper company. This judgment confirmed that, as a general rule, a bank does not need to disclose its profits to a customer. At the same time, however, the BGH found that a bank has to disclose an initial negative market value of a structured product under certain circumstances. The court held, in particular, that the existence of an initial negative market value reflected a severe conflict of interest of the bank which it must disclose to its client. The BGH further held that a bank must ensure that the client’s understanding of the risks associated with a complex product is largely identical to the bank’s own level of understanding. Thereby, it introduced a novel and very strict standard.
Since then, many companies, individuals and municipalities have lodged claims for damages against banks in connection with losses incurred from swap transactions. Several appeal courts considered whether the BGH’s findings were also applicable to cases involving a variety of swap transactions, having read the decision in various ways. In particular, it was uncertain whether the BGH’s strict standards applied to all types of swap transactions, or whether this depended on the complexity of the transaction. Further, it was unclear whether a bank must always inform its customer about the initial negative market value or other elements of a product’s cost and profit structure, what information exactly a bank must provide and whether the extent of the information required depends on the purpose of the swap and/or on the customer. The March 2011 decision had effectively raised more questions than it had answered. The new decision rendered today declined to apply these standards and also commented on the much-debated issue of whether a negative market value must be disclosed in all scenarios.
 Judgment dated 22 March 2011, file no. XI ZR 33/10.
Facts of the case
The appeal decision
The new BGH decision
Effects on other disputes
More cases coming up?
Consequences for banks’ disclosures