Chapter 7: Bank Liability for Improper Credit Decisions in the Civil Law

7.1 The number of bankruptcies or corporate reorganisations continues to increase in the aftermath of the recession that marked the early 1990s, while the reorganisation or liquidation of several of the businesses that failed in the 1970s still is underway. In their attempt to recover as much as possible for the creditors, bankruptcy receivers have diversified their attacks and increasingly have sued the directors, managers and auditors of the bankrupt entity. While this cause of action may not encounter insurmountable legal obstacles, the financial benefit it can realise for the creditors is relatively limited. This prompted the receivers to shift their focus to the banks that provided credit to the failed company, since these institutions have virtually unlimited resources.

7.2 Two kinds of actions should clearly be distinguished. On the one hand, there are actions based on an unwarranted or negligent withdrawal of credit by the bank which may have triggered the bankruptcy. On the other hand, third parties have often attempted to have the banks declared liable on the basis that they continued to support the failing company, thus creating an artificial creditworthiness which misled and hence damaged the other creditors. In one case liability will be bilateral and exist only vis-à-vis the beneficiary of the credit: liability will often be based on non-performance of the contract (e.g. undue withdrawal of the credit), more rarely on extra-contractual grounds (pre-contractual liability). Liability may also exist towards third parties, relying on the bank’s credit assessment: co-creditors that have been misled. Here liability will usually be extra-contractual, although in some cases contractual relations between the bank and the third party will be affected (guarantors, or other beneficiaries of the bank’s promises to pay).

7.3 If most legal systems subscribe to liability of the banks towards their clients, the beneficiaries of the credit, some systems also accept liability towards third parties. The conditions of applying the latter type of liability depend on the legal basis on which liability is based. Therefore the law governing the relationship is of prime importance.

7.4 This chapter gives a short overview of the criteria and cases in which such bank liability—more specifically third party liability—for improper credit decisions can attach. It mainly focuses on French and Belgian law, where numerous cases are found, but it also attempts a comparison with Dutch and German law.

7.5 As the overview will mainly deal with continental European systems, the terminology used will be more apt to reflect these legal systems. Therefore, credit institutions will invariably be designated as “banks”, although they may have different regulatory status (including e.g. financial companies, leasing companies, factoring enterprises etc.). Also for the purpose of the present overview, the term “bankruptcy” (“faillite” in Belgium, “règlement judiciaire” and “liquidation de biens” in France) will be used to cover both bankruptcy of individuals as well as bankruptcy of companies or other legal entities. In continental systems, a “receiver” is appointed by the court. In view of the different uses of these words in English law, designating the procedure as “bankruptcy” seemed the more workable solution.

7.6 Published case law in the various Western European jurisdictions shows a varied approach to these actions. Three attitudes can be distinguished. 1

7.7 In several countries, banks have frequently been declared liable for extending excessive, unwarranted or unjustified credit to ailing companies. These countries include France, where the doctrine of bank liability originated, Belgium, where it flourished, and Luxembourg, where a few decisions can be found. 2

7.8 In other jurisdictions, the possible liability of banks for extending credit may be accepted as a principle, but the conditions for liability have been formulated in such a restrictive way that in practice few if any decisions can be found holding the bank liable. This category includes the Netherlands and the Federal Republic of Germany, where some cases exist. In Switzerland, Italy and probably Spain, the legal system would seem to permit such action, but no cases have been found.

7.9 In the common law jurisdictions, including the United States, possible third party liability of banks—as opposed to liability to the creditor itself—is in principle, in these matters, excluded. Only in very specific circumstances, different from our subject, can statutory liability exist. 3

7.10 Two main types of liability can be identified. Between the bank and the borrower, liability may exist whether on contractual or on extra-contractual grounds, especially on the basis of a fault committed by the bank in the pre-contractual stage. So, for example, banks have been held liable for implementing a promise to grant credit on which third parties relied. 4 This type of liability has become more important, particularly in the field of consumer credit where the borrower often argues that the bank has incited him to take up more credit than he could afford.

7.11 The second type relates to third party liability: the bank is held liable against third parties for having failed to meet the standards of prudent banking behaviour. Among third parties, suppliers of the debtor, creditors, 5 guarantors and all other third parties may be entitled to claim against the bank. Creditors of the bankrupt estate, however, cannot claim individually: their claim should be exercised by the insolvency receiver. The basis of this liability may also be two pronged. On the one hand, liability will address the behaviour of the bank before entering into the loan contract: in this case liability will generally be based on the rules of general negligence (art. 1382 Civ. C. in French and Belgian law). Once the contractual relationship has come into being, shortcomings of the bank will be of a contractual nature and give rise to liability according to the rules for breach of contract. General fault liability may also continue to apply. To what extent both types of liability can be applied jointly or cumulatively will depend on the legal system: where French law allows negligence actions even between contractual parties, 6 Belgian law adheres to a strict separation of both types of liability. 7 In a broader context, the conditions for applying liability will differ according to the rules of the jurisdiction involved.

7.12 In addition, the legal systems have developed different attitudes towards the role of the bank in a given economic system: cultural factors relating to the perceived position of the banking system in the economy have an impact on the readiness of the courts to hold the bank to a certain standard of conduct. Increasingly, however, banks are being considered regular commercial enterprises to which general standards of prudent behaviour apply.

7.13 Liability may arise out of other grounds as well. One ground to be mentioned specifically is that based on the bank acting as a de facto director of an insolvent company. The French law on the liability of directors of ailing companies has been scaled down, 8 after the previous legislation led to rather extreme solutions. The Belgian law is based on similar ideas and has been invoked a number of times in bankruptcy cases. 9 Upon the company being declared bankrupt, the receiver may claim damages from the bank for its “gross negligent conduct” as a (shadow) director of that company. Liability will cover all damage caused to the bankrupt company, to the extent to be determined by the court. As a consequence of this legislation, banks are very hesitant to get involved in any way in the actual running of the debtor, and not even be seen to do so. In the UK, the issue of bank liability as a shadow director has been raised, but seems not to have resulted in actual liability, conditions being very strict and the risk of liability quite remote. 10

7.14 Another ground of liability is based on the bank aiding and abetting the negligent conduct of its client: in one case a bank has been held liable for being material in organising a financial mechanism that stripped the creditor of the insolvent company of its main assets. 11

7.15 The main theory of bank liability developed first in France, and was later successfully introduced in Belgium. In both countries, this liability is based on the general rules of tort or negligence liability, that merely require negligence, damage and causation.

7.16 It is sufficient that the damage was caused by the conduct considered negligent, without any further requirement that the rule, the violation of which is alleged, was specifically designed to protect the interests of this victim. Negligence is defined in very broad terms: it is the violation of a specific rule of the law, or of the rule of behaviour that a normally prudent and diligent person would abide by in the same circumstances. It is also generally accepted that non-performance of a contractual obligation, such as the unwarranted withdrawal of an extended credit line, may in specific circumstances be the basis for extra-contractual or tort liability towards third parties, 12 provided the non-execution of the contract also included the violation of a general rule of conduct, to which all normally prudent and diligent persons can be expected to be held. 13 Considering the very broad character of these conditions, it should be no surprise that bank liability for extension of credit is primarily a French–Belgian theory.

7.17 In Germany, however, the criteria for torts are more restrictive. Most importantly, for the existence of a tort based on § 823 of the German Civil Code, 14 the breached duty should be aimed specifically at the protection of the interests of the...