Pyramid schemes and the reclaiming of bogus profits

Payments made to investors in a pyramid scheme that are based on profits that do not actually exist can be reclaimed from the investors by way of a challenge under insolvency law. This was decided by the Federal Court of Justice ("BGH").

Facts of the case

The ruling of the BGH is based on the following facts: The later insolvent company ("debtor") raised funds from investors, which the debtor passed on to its founding shareholder L as a loan. The debtor pretended that L was operating a luxury pawnshop. In fact, the business model was based on a pyramid scheme in which the investor funds were used improperly. The insolvency administrator filed a lawsuit and demanded payments back from two investors who had received these payments from the company on the basis of their silent partnership. On the one hand, the payments were based on fictitious profits. On the other hand, the investors received their contributions back, although the contributions were partially used up due to losses; as far as the contributions were used up due to losses, the insolvency administrator is demanding their repayment. The Higher Regional Court upheld the claim. The investors appealed against this decision to the BGH.

The ruling of the BGH from December 14, 2023 (case no. IX ZR 10/23)

The BGH confirmed the ruling of the Higher Regional Court and dismissed the appeal. The BGH ruled that the payments of fictitious profits made to the defendants as well as the repayment of their contributions ( as far as these were used up by losses) can be reclaimed from the insolvency administrator as a gratuitous payment. The defendants had no claim to the payments; the debtor was also aware of this, which is why the payments were gratuitous payments within the meaning of insolvency avoidance.

Practical note

The BGH was again presented with a case in which the meanwhile insolvent company had set up a pyramid scheme at the expense of its investors. Investors receive payments based on fictitious profits or repayments are made on their contributions. In reality, however, no profits were made, but losses. These losses further erode the contributions made. In such situations, the insolvency administrator therefore regularly demands that the investors repay the payments made before filing for insolvency. As far as the payments were based on fictitious profits or repaid contributions had already been used up by losses, the investors were not entitled to these payments.

From a legal point of view, the case of the BGH concerns the so-called "gift contestation". A gift is not to be understood literally in this sense, but rather very broadly, and basically concerns all so-called gratuitous services. A benefit is free of charge if the debtor does not receive any consideration in return. If, as in the case of the BGH, the service is only provided without a legal or contractual basis, i.e. "without legal grounds", the service provider generally acquires a so-called enrichment law claim for repayment, which is regarded as the equivalent of the service and therefore excludes gratuitousness. However, if the performing debtor knows that the creditor has no claim to the performance, the debtor cannot reclaim this performance in accordance with the principles of unjust enrichment law; its performance is therefore "free of charge" in the sense of the avoidance of a gift. In the case of the BGH, the debtor operated a pyramid scheme and thus knew that, on the one hand, there were no profits and, on the other hand, only losses were generated, which had already partially used up the contributions. Such gratuitous payments are contestable if they were made in the period of four years prior to the insolvency application.

At first glance, it may seem unfair that the investor who was unaware of the pyramid scheme has to repay the amounts received. However, the purpose of insolvency law is to treat all creditors of the debtor equally. This so-called principle of equal treatment ensures that a few creditors do not gain unjustified advantages at the expense of many other creditors. This is of course an unsatisfactory situation for the individual investor and shows once again that investment products with "too good returns" must always be examined very carefully in advance.