Legal Tech is Shaking up Germany’s Consumer Rights Enforcement: What will new legislation mean for the sector?
Introduction
After many years of obscurity, the legal tech market is now booming and is trying to take over parts of the legal market. The very wide term “legal tech” may not be defined legally yet but commonly denotes the use of software for document management or specialised legal research databases, and the automatic creation of legal documents, smart contracts and online dispute resolution. Although the various fields differ considerably in terms of technical requirements, markets, business models and distribution channels, there must be a regulated market for such legal services within the framework of an orderly administration of justice. In Germany, this scenario must be seen in the light of the development of the debt collection industry, which has changed dramatically in recent years.
In the past, claims, such as compensation demands, from German consumers were collected individually. Now, legal tech debt collection companies have increasingly led a new trend by bundling together many consumer claims in court. Individual claims bundled together carry a completely different weight in court that might be comparable to class actions, a type of legal action not permitted in Germany.[1] Each plaintiff must explain and prove their individual concern, damage and causality. Here, Germany differs from the USA, where class actions are permitted. The legal situation presented in our article has led to a draft of a bill by the German Federal Government to reform the Legal Services Market in January 2021.
Legal tech debt collection companies
This article focuses on legal tech as used by German debt collection companies (Inkassodienstleister). Here legal services are often used for gathering thousands of plaintiffs and are partially automated, thus replacing work ordinarily done by a lawyer. Due to an insufficient legal framework, consequential legal problems have arisen in this sector.
The number of legal-tech debt collection service providers has multiplied in recent years. Originally this term stood for companies who collected unpaid debts from consumers. Nowadays, these companies consider the bundled claims of payment by consumers or small enterprises to be a business opportunity and register as debt collection service providers after appropriate checks.[2] These cases usually concern small sums. Most of these claims would not be pursued one-by-one since the individual claim does not cover the cost risk. Frequently small to medium-sized damages occur with a large number of affected parties, so-called scattered damages (Streuschäden). A study conducted in 2013 showed that more than thirds of German consumers do not mandate a lawyer due to the costs of litigation. Similarly, mandates with low amounts in dispute are unattractive for lawyers too.
When many consumers’ low-value claims are bundled after assignment to the legal-tech debt collection service provider they can be asserted jointly. Lawyers are generally not allowed to do so due to their professional confidentiality restrictions. Now, however, legal tech companies use their bundled claims to first work towards a settlement. If this fails, lawyers are hired to conduct legal proceedings. The company bears the cost risk; only in the event of a successful claim is a fee for the debt collection service owed. The contingency fee is usually about one third of the claim. Some debt collection companies pass on this risk to a litigation finance company in return for a share of the proceeds.
Regardless of whether compensation claims relate to damages like the Volkswagen diesel scandal involving hundreds of thousands of cases, air passengers’ rights or rent reductions, these cases always consist of bundles of many claims where parties are promised that they will pay no costs. Differences exist only in the cost refinancing, in the power to make settlements or the scope of legal advice.
Court rulings in Germany regarding legal tech debt collection in cases involving joint stock companies
Today many consumers visit legal tech companies’ online for convenient dispute resolution. However, these companies have long been operating in a legal grey area. Even today, after several leading court decisions, essential questions of their legal status in Germany remain unclear.
Firstly, whether legal-tech debt collection agencies constitute a legal service and when a debt collection license has been exceeded remain mysteries.[3] Section 1 and 2 of the Legal Services Act (RDG) is intended to protect the public from unqualified legal services. Section 3 prohibits legal services without state permission. Sections 2 as well as 10-12 contain a provision that allows registered debt collection service providers to provide extra-judicial legal services on the basis of special (theoretical and practical) expertise. A violation of the legal prohibition leads, under section 134 of the Bürgerliches Gesetzbuch (German Civil Code, BGB), to the nullity ex tunc of the assignment of the consumer claim to the legal service provider. Germany’s highest civil court, the Bundesgerichtshof (BGH), ruled that such invalidity exists if the collection service provider clearly and substantially exceeds their authority to provide services. In such cases, the assignment in these cases is null and void, the collection service provider has no active legitimacy in court and the action is dismissed as unfounded. As a result there is a risk that a consumer will lose their rights since filing a lawsuit would eliminate the suspension of the claim’s statute of limitations that would normally apply under German law.
However, it has not been conclusively clarified by Germany’s Federal Court of Justice, the Bundesgerichtshof (BGH), when the service authorisation has been exceeded and to what extent legal-tech debt collection fits into the model of the Legal Services Act.
In the case of “wenigermiete.de” the BGH decided that this business model is still covered by the authorisation of the RDG section 10 and that the assignment of consumer claims to the legal services provider Lexfox (now Conny) is effective.[4] According to this, a collection license also includes the authority to advise customers in advance on whether, under what circumstances, and up to which amount a claim exists. A success prognosis of a legal action is also permissible.
The judgement stated that debt collection is “still” covered by the RDG. The key word here, however, is the word “still” (noch), which is often repeated in the judgment.[5] It is not yet clear which circumstances lead to invalidity. Therefore, each individual case must still be assessed. This BGH ruling led to a number of lower court decisions on the interpretation of when such a legal-tech debt collection is legally allowed. Among these were three judgements of lower courts, namely the district court in Hamburg, the district court in Munich and the district court Braunschweig. An examination by the debt collection company as to whether and how a claim can be brought into existence and asserted was no longer considered to be covered by the collection license.[6] Furthermore, admissibility was denied if the company intended from the outset to seek judicial action, specifically the filing of a class action.[7]
In one of the most extensive proceedings in connection with the 2015 Volkswagen diesel scandal the collection service provider financialright GmbH[8] recently used it‘s Internet platform myright.de to assign the claim of 2,800 Audi[9] buyers.[10] The district court of Braunschweig considered this case regarding purchases of Audi cars modified with illicit software to appear less polluting and meet legal standards of the states where they were sold. The court declared the assignment agreements between financialright GmbH and the Audi consumers null and void as they placed the purchaser at an unreasonable disadvantage if the latter revoked a settlement. If this happened, according to the assignment agreement, the entire legal proceedings would no longer be free of charge for the consumer. The court held that this economic pressure on the consumer and conflict of interest justifies statutory prohibition under section 134 of the Bürgerliches Gesetzbuch. The complaint was dismissed as unfounded due to lack of active legitimation.
It is apparent that there is no consensus in case law or literature as to the extent that these new models are tailored according to the letter of the RDG. Until recently, debt collection in the classical sense was understood as the mass assertion of unchallenged claims by companies against consumers. However, with the recent ruling of the Federal Court of Justice, which uses a broad interpretation, there is a tendency to allow an expansion in this new business model. However, its frequent use of the term “still” (noch)[11] indicates that there was clearly no intention to provide a precise definition of such models.
The fact that the legitimacy of such mass compensation claims needs to be assessed on a case-by-case basis or for each company individually is a limitation to consumers’ rights, which are pretty much in fashion in the EU. Whether or not the claim is null and void can only be clarified in the course of legal proceedings. This represents a considerable legal protection problem. On the other hand, the enforcement of these bundled claims poses a threat to large companies, which now face a significantly larger number of lawsuits.
In any case, it is not certain that judicial development of the law may go much further. This may not go beyond the clearly discernible will of the legislature and the application and interpretation must be in accordance with the rule of law principle of article 20 of the German Constitution (Grundgesetz). Section 2 of the RDG defines legal services, but the special form of legal-tech debt collection companies are not to be found either in the explanatory memorandum or comments to the RDG. It therefore seems to be impossible that the courts can respect the will of the legislator if the latter did not make any considerations regarding the question. The interpretation clearly has limitations here and creates considerable legal uncertainty. It is the task of the legislator to respond to ongoing developments and to regulate them in principle.
Therefore in January 2021 the German Federal Government drafted a bill to reform the Legal Services Market. It includes a definition of the term “debt collection” for the first time. According to this definition, the activities of collection companies are limited to the collection of receivables. If legal tech companies also wish to provide advice, this must be approved by the judicial authorities as an ancillary service. This regulation offers the potential to restore the former separation between lawyers and debt collection service providers. However, it clearly goes against the recent decisions of the BGH and the innovative development of the legal market. It remains to be seen whether the draft will become law before the end of the legislative period in September 2021.
Consumer protection in legal tech vs. joint-stock company cases
Although more and more consumer rights are being created, the enforcement of consumer claims against large companies is always a David versus Goliath scenario. For the first time, this can now be counteracted by debt collection agencies. The advantage these companies have is that due to the large number of similar cases and software technology, they can be decided quickly and reliably whether the enforcement of the claim is promising. In addition, individual claims bundled together experience a completely different weight in court.
In contrast to alternative dispute resolution bodies, consumers do not have to actively participate in the proceedings here because of the assignment of rights. It seems that consumer interests are satisfied despite the high success fee of about one third of the claim. In any case, this model corresponds to today’s expectations of current online user behaviour, where after a few clicks goods or services can be purchased without any action being taken.
Diesel scandals in some of Germany’s biggest joint-stock companies, such as Volkswagen, Audi, Mercedes, BMW have drawn significant attention from the public and the press. The consumer may suffer a loss of rights if his claim is time barred. This might happen if an action is dismissed as unfounded due to the nullity of the assignment and thus the lack of active legitimation. As shown above this has happened in the Audi case. If an action – as in the Audi case – is dismissed as unfounded due to the nullity of the debt collection assignment and, hence, a lack of active legitimation, the consumer suffers a loss of rights if his claim then becomes time-barred.
In the German Parliament the liberal Freie Demokratische Partei (FDP) has pointed out this gap in legal protection and prepared a bill on legal services. The recent bill addressing this deals with the legalisation of legal tech applications: admissibility, expert knowledge requirement, participation of qualified personnel in automated processes, information duties, digital submission of declarations of intent and extension of general terms and conditions as well as the admissibility of contingency fees. The bill is still being discussed in the legislative process.[12]
The political questions that arise as a result of the existence of the legal-tech debt collection model revolve primarily around the importance of judicial legal protection for consumers. The greater weight of these claims is reminiscent of the “claims industry” of US procedural law. The German procedural code does not recognise class actions as such. Since 2018, it has only been possible to file model declaratory actions. In this case, consumer protectionists can bring an action for declaratory judgment against companies on behalf of many affected parties. After the court has determined the claim, however, the individual must assert his or her claim for damages individually in court.
At the 72nd German Jurists’ Day, Deutscher Juristentag (DJT) the model of a test case for declaratory relief was found to be inadequate and the introduction of a class action was advocated. In the same year, the EU Commission proposed the introduction of collective actions throughout Europe to strengthen consumer rights. The Directive (EU) 2020/1828 of the European Parliament and of the Council of 25 November 2020 on representative actions for the protection of the collective interests of consumers, which must be transposed into national laws within 24 months and applied within an additional six months by the EU Member States, only allows non-profit-making „qualified entities“ to bring cross-border representative actions if that entity complies with six criteria (Article 4).
The difference to the German model action for declaratory judgement is that consumer protectors can sue for damages directly. In addition, consumers can also enforce their rights in other EU countries.
Conclusion
Consumer rights will only be respected if they can be enforced. On the other hand it is undisputed that many (sometimes minor) claims by consumers, which occur collectively, could have enormous legal and financial impacts on joint-stock companies, such as in the diesel exhaust scandal. Consumers shall – according to the RDG – be protected against unqualified legal services.
These conflicting ideas and goods must be reconciled by legislators. Questions that need to be discussed in this context are: 1. How should we deal with innovation in the legal field? 2. Should profit-oriented, legal-tech services be allowed? 3. Should legal-tech debt collection services take place without any kind of supervision, whereas highly qualified lawyers are strictly controlled? 4. Is it desirable that legal-tech debt collection agencies get the power of making enormous impacts on joint stock companies that are vital for our economies? 5. Will foreign competitors take over the field in Germany and Europe if no legal measures are taken?
Notes
[1] The Directive (EU) 2020/1828 of the European Parliament and of the Council of 25 November 2020 on representative actions for the protection of the collective interests of consumers, which must be transposed into national laws within 24 months and applied within an additional six months by the EU Member States, only allows non-profit-making “qualified entities” to bring cross-border representative actions if that entity complies with six criteria (Article 4). Although the directive resembles the German Musterfeststellungsklage of 2018 (§ 606 ZPO, MFKRegV), it goes beyond it, as far as the entities may sue not only requesting declaratory decisions, but may also request damages.
[2] Under § 10 Rechtsdienstleistungsgesetz (Legal Services Act, RDG).
[3] §§ 10, 2 II 1 RDG.
[4] BGH, decision of 27th of Nov., 2019 , VIII ZR 285/18; accordingly decisions of 8th of Apr. 2020, VIII ZR 130/19 and 6th of May 2020, VIII ZR 120/19.
[5] BGH, decision of 27th of November 2019, VIII ZR 285/18. See among the many examples: Leitsatz f) “Da damit (auch) die in diesemRahmen erfolgte treuhänderische Abtretung der genannten im Zusammenhang mit der “Mietpreisbremse” stehenden Forderungen desMieters (noch) nicht gegen ein gesetzliches Verbot (§3 RDG) verstößt und demzufolge nicht gemäß § 134 BGB nichtig ist, ist der Inkassodienstleister im gerichtlichen Verfahren aktivlegitimiert, diese Ansprüche im Wege der Klage gegen den Vermieter geltend zu machen”.
[6] Landgericht (LG) Hamburg, 26th of March 2020, 327 O 212/19.
[7] LG München, 7th of Feb., 2020, 37 O 18934/17; LG Hannover, 4th May 2020, 18 O 50/16, LG Braunschweig, 30th of April, 2020, Az 11 O 3092/19.
[8] Gesellschaft mit beschränkter Haftung, widely equivalent to the private limited company in the UK and the limited liability company in the US.
[9] Audi AG is a wholly owned subsidiary of the Volkswagen Group.
[10] LG Braunschweig, 30th of April, 2020, Az 11 O 3092/19.
[11] See: BGH, decision of 27th of Nov., 2019 , VIII ZR 285/18: Leitsatz e) “von Inkassodienstleistungsbefugnis … (noch) gedeckt”; Leitsatz f) “(noch) nicht gegen … gesetzliches Verbot (§ 3 RDG) verstößt”; Rn. 19 “durch … Befugnis zur Erbringung von Rechtsdienstleistungen im Bereich der Inkassodienstleistungen (noch) gedeckt”; Rn. 38 “(noch) im Rahmen der Befugnis der Klägerin”; Rn. 97 “(noch) als (zulässige) Inkassodienstleistung … (noch) gedeckt”; Rn. 108, 111 “(noch) als Inkassodienstleistungen gemäß dieser Bestimmung anzusehen”, “(noch) im Rahmen der Inkassodienstleistungsbefugnis”; Rn. 143 “Tätigkeiten (noch) als Inkassodienstleistungen”, (noch) innerhalb des gesteckten Rahmens”; Rn. 146 “Inkassodienstleistungen (noch) gedeckt”.
[12] Bundestag, Drucksache 19/9527.
Photo by orpheus26 from Canva.
