Crowdfunding, Crossing Borders
Crowdfunding is a means for a project owner to raise funds from investors (who are generally consumers) with the intermediation of an online platform. Its exponential growth worldwide shows that the market is seriously looking into new financing alternatives.
Crowdfunding platforms pop up all over the place and are expanding rapidly.
Crowdfunding platforms need scalability in order to become profitable. The main means to become scalable is to expand and grow the business on a cross border basis. Due to the lack of a pan-European regulatory framework for the different types of crowdfunding, each Member State maintains its own rules and regulations in respect of crowdfunding. Presumably, the crowdfunding market will be confronted with either takeovers of local platforms by foreign platforms or local platforms will team up and cooperate with foreign platforms. Inherently, the platforms, as well as the investors and the project owners, become confronted with other jurisdictions. Other national laws and regulations, another regulator and another (claims) culture.
The recently published green paper and action plan of the European Commission ‘Building a Capital Markets Union’ evidences that the European regulator acknowledges the potential of cross border crowdfunding activity. Presumably, a European regulatory framework for crowdfunding merely is a matter of time. However, a European wide private law, let alone European liability law, is not something we envisage to be implemented in the near future, if at all. In addition to the regulatory regime, crowdfunding actors will be confronted with numerous different sets of national consumer law and tort law when structuring their business, fundraising or investments on a cross border basis.
Crowdfunding, like any type of investment, involves risks. The applicable risks differ depending on the actor involved in crowdfunding, albeit that – by its nature – the risk of fraud appears to be the biggest risk. The risks involved in crowdfunding can be generally summarized as follows:
the risk of money laundering, resulting in confiscation of assets;
the counterparty risk of a failure or default by either the platform and/or the project owner, resulting in a potential loss of the (partial) investment;
the risk of fraud resulting in embezzlement of the invested funds;
an operational risk of a (temporary) operational failure and/or discontinuity of the platform due to ICT problems and/or a disruption in the (automated) fund flows;
the credit and investment risk resulting in a (partial) loss of investment;
legal risks; and
the risk of information asymmetry, lack of transparency and/or incomplete, inaccurate or misleading information as regards risk/ return profile of the investment and no proper disclosure of the costs involved.
In order to bring the crowdfunding market to the next level, to actually make it a mainstream alternative for bank financing, these main risks should be mitigated as much as possible. From a regulatory perspective, the platform is generally held to be responsible for ensuring that these risks do not materialize, or, in any event, to do its utmost best to prevent such risks from materializing as much as possible. From a civil law perspective, one can ask oneself the question who actually is responsible. An investor who loses his investment will look at other means than the regulator and will generally try to claim monetary damages from either the platform and/or the project owner. Which claims are available to an investor in his capacity as a claimant under local civil law? And what are the defenses a platform and/or project owner can bring against those claims?
Together with the CrowdfundingHub, FG Lawyers initiated a research in 11 Member States with the main research question being: which civil law measures, outside insolvency proceedings, could an investor take against a crowdfunding platform and/or a project owner to hold it liable for damages resulting from investing in a crowdfunding project and what are the main takeaways for a crowdfunding platform and/or a project owner to prevent any such liability risks from materializing?
Regulatory framework versus civil law framework In all eleven Member States where this research was conducted, the regulatory framework is distinguished from the civil law framework. The United Kingdom is the only Member State which legal system is based on a common law approach rather than a civil law approach. As a consequence the United Kingdom does not have a civil code.
Regulatory framework The regulatory framework deals with the license or similar obligations applicable to – generally – the (operating company of an online) platform that intermediates between the investors at the one side and the project owner at the other side. It becomes apparent that the platform has the main responsibilities under the regulatory framework, in all eleven Member States, whilst the project owner generally only becomes confronted with regulatory laws and regulations if it contemplates to issue securities to the public (i.e. investment based crowdfunding). In each Member State, the exact regulatory framework applicable to the platform (and the project owner) depends on the type of crowdfunding (investment based, lending based, rewards based and donations based).
About half of the Member States where the research was conducted have specific crowdfunding regulations in place, most of which are from a recent date. The other half of the participating Member States have not yet developed specific crowdfunding regulations, albeit that most of those Member States appear to consider a more tailored regulatory approach. The regulatory framework used by each of the Member States focuses on investment based crowdfunding and lending based crowdfunding. None of the Member States confronts a platform with a regulatory license obligation when a rewards crowdfunding model is used. The same applies to donations based crowdfunding with one exception. Finland requires a money collection permit to be obtained by the project owner who raises funds through a donations crowdfunding project.
However, irrespective of the type of crowdfunding, the money handling by a platform is a concern in all Member States. It may cause the platform to qualify as a payment services provider (PSP) because the receipt and transfer of the funds could qualify as a payment service within the meaning of the Payment Services Directive. In France, crowdlending crowdfunding platforms (only) can opt for a light PSP status France. This is a local and therefore non-passportable regime for these type of crowdlending platforms in France.
Crowdinvesting In the event crowdfunding takes place by means of the issuance of securities, such as equity or negotiable debt instruments such as bonds, the model used qualifies as crowdinvesting. Generally crowdinvesting platforms are confronted with regulatory hurdles, either by requiring the platform to obtain a license under the MiFID regime (such as in Belgium, Finland and the Netherlands) or a comparable local license under specific local crowdfunding regulations (such as in France and Italy).
In some Member States, the regulatory framework applicable to investment based crowdfunding is not yet set in stone (such as in Estonia). Sweden forms an exception: crowdinvesting is not regulated in Sweden. In Germany real equity crowdfunding is no longer possible. The German regime has resulted in hybrid lending based crowdfunding structures being developed, such as subordinated profitparticipating loans.
If the crowdfunding model used qualifies as investment based crowdfunding and therefore involves the issuance of securities, the project owner is generally confronted with the Prospectus Directive as implemented in the respective local laws. Due to the relatively limited offering size, typically a project owner however is exempt from the obligation to publish a Prospectus Directive proof prospectus, approved by the relevant regulator. The threshold for the maximum offering size to rely on the exemption differs in the respective Member States.
In some Member States, such as Germany and Sweden shares in a private liability company do not qualify as negotiable securities. As a result, the project owner – as issuer of the securities – is not considered to offer securities to the public within the scope of the Prospectus Directive. Other limitations apply causing crowdinvesting not being an valuable alternative in those Member States.
Crowdlending The regulatory regime applicable to lendingbased crowdfunding platforms differs subject to the type of project owner/borrower. If the project owner qualifies as a consumer, the platform is generally considered to be the credit provider or credit intermediary, resulting in a license obligation. If the project owner / borrower is considered to be a business (or in any event, not a consumer), the regulatory treatment applicable to the platform differs in the Member States. In some Member States (such as France, the Netherlands, Italy and the United Kingdom), a crowdlending platform does become confronted with a license obligation or another sort of regulatory treatment. In other Member States (such as Belgium, Estonia and Finland), however, merely intermediating between the investors/lenders and the (non consumer) project owner/borrower in respect of a non-negotiable private loan does not trigger a regulatory regime to be applicable.
Non compliance with regulatory framework If a platform or, to the extent applicable, a project owner, does not comply with the regulatory framework applicable to it when operating a crowdfunding platform, structuring a crowdfunding investment project and/or raising funds through a crowdfunding campaign, the platform and/or project owner bears the risk of a regulator taking measures against it. Moreover, the violator risks criminal prosecution. For the purposes of the research conducted, the most important risk is the risk of being held liable in civil law procedures by an individual investor on the basis of breach of law, which forms a ground for liability claims being initiated against the platform or the project owner in each Member State. In some Member States (such as Finland), violating regulatory laws eases down the path to hold the violating party liable for damages in a civil law liability claim by an investor.
Civil law framework Irrespective of the potential non applicability of a regulatory framework to the platform and/ or project owner, both the platform and the project owner have obligations under the applicable civil law framework in each Member State. As a consequence, irrespective of the crowdfunding model used (lending, investment, rewards or donations), the platform and/or the project owner is – at all times and in all Member States – subject to a detailed set of rules mainly aimed at protecting consumers’ interests. (2.10)
The absolute majority of the obligations applicable to the platform and/or the project owner are based on EU legislation under the EU Consumer Law Acquis and comparable EU legislation as implemented in the laws of the respective Member States. The implementation of this EU legislation has resulted in local mandatory law provisions that cannot be deviated from if a consumer is involved.
The main duty of the platform and the project owner is to ensure that material information is provided to enable an investor to make an informed investment decision. Such information must at all times be accurate, complete, comprehensible and not misleading (nor misleading by omission). Pursuant to these transparency obligations, the platform and the project owner are subject to a minimum set of specific pre-contractual, contractual and post-contractual requirements which they need to take into account when publishing a project on a crowdfunding platform for investment.
Local law specifics and peculiarities In most Member States, in particular those with specific crowdfunding regulations, the platform is subjected to additional disclosure rules and the platform is required to work diligently, fair and transparent and to avoid conflicts of interest.
In some of the Member States (such as Germany, Italy and the Netherlands) the platform needs to conduct some sort of suitability or appropriateness test before an investor can invest in a specific project listed on the website of the platform. Generally, these investor tests are linked to investment limits being set in the relevant Member States and are aimed at assessing the investor’s knowledge and experience in investing and at determining the investor’s financial soundness.
The consequences attached to the outcome of such investor test differ in the Member States from being barred to invest (Italy) to receiving a non-binding warning (the Netherlands).
Non compliance with the prescribed information and marketing requirements as well as violation of any fiduciary duty could be grounds for holding the responsible party liable. A prejudiced investor can initiate civil proceedings against the platform and/or the project owner if such violations have resulted in losses for the investor or group of investors.
Main grounds for civil liability claim In all Member States, the main legal grounds on the basis of which an investor can initiate legal proceedings against either (the operating company of an online) platform or the project owner are breach of contract (contractual liability) and an unlawful act / tort. In addition, an investor generally also has the possibility to declare (a part of) a legal act annul and void, either with or without court interference, and to terminate or cancel (a part of) a legal act on the basis of, for example, such legal act being contrary to the applicable law, in violation of good morals or public order or on the basis of the legal act being entered into on the basis of vitiated consent (such as deceit or error).
In Finland and France, the principle applies that a claim cannot be based on both breach of contract and unlawful act. In these jurisdictions, the claimant must choose the legal ground on which the liability claim should be made. Presumably the decisive factors will generally be whether or not the claimant is in a contractual relationship with the defendant and whether or not the claimant has the burden of proof when initiating proceedings on the basis of either breach of contract or unlawful act.
Breach of contract In order to be able to bring a successful claim on the basis of breach of contract, several conditions will need to be satisfied in order for the claim to be successful. The exact conditions differ in the participating Member States albeit that in all Member States a claim on the basis of breach of contract requires (i) a defective performance of an obligation under the contract, (ii) damages and (iii) a causal link between the defective performance and the damages. In some Member States (such as in Germany, Italy, the Netherlands and Sweden) it is also required that the defective performance is attributable to the defendant in order for the latter being held accountable.
Unlawful act / Tort It is more difficult to obtain a successful claim on the basis of unlawful act than on the basis of a breach of contract in the Member States. In the relevant tort provisions, one of the prerequisites of a successful tort claim is fault, negligence, wrongful behavior, intent or any other sort of culpability or accountability at the side of the defendant.
Burden of proof Possibly one of the most important factors for an investor to take into account when considering cross border investments is whether or not he, as a potential claimant, has the burden of proof to evidence to the court that the defendant should be held accountable for the damages that the investor incurred. The rules in respect of the burden of proof differ in the Member States where this research was conducted, albeit that generally the burden of proof lies with the claimant. In some Member States (such as Finland and Poland), however, the principle of exculpation liability applies, meaning that the liability of the defendant is presumed resulting in the defendant having the burden of proof that it acted with due care to avoid liability.
The claimant still needs to evidence the damages incurred and the causal link between the damages claimed and the ground for holding the defendant liable but the wrong-doing of the defendant itself is presumed. In Italy and Germany, the burden of proof in crowdfunding investments lies with the defendant. (2.19)
Pursuant to Swedish laws, an investor has an extensive personal responsibility to perform a sufficient due diligence review on the project and the project owner prior to investing in a crowdfunding project.
Statute of limitations Another critical but typical local law issue that should be taken into account by a claimant before commencing legal proceedings against a defendant is the applicable statute of limitations. After all, the grounds for holding a defendant liable should not have been barred by the lapse of time. Not only different statutes of limitations apply in each Member State, but also within each Member State different statutes of limitations apply depending on the type of claim.
Crowdfunding Crossing Borders Due to the absence of a pan-European legal framework or a uniform European legal approach by all Member States applicable to crowdfunding, each of the relevant actors (investors, platforms and project owners) will be confronted with local, unknown, laws when considering crowdfunding crossing borders.
Investors An investor who contemplates to invest in a cross border project listed on a foreign platform and/or related to a foreign project owner, should take into account that generally the underlying legal and/or contractual relationship with the platform and/or project owner will be governed by other laws than the laws of his own Member State because a choice of law clause will generally be included in the underlying contractual terms. Typically, also a choice of forum clause shall be included in the applicable terms referring to another court than the local courts of the Member State of the investor. Subject to not being deprived of mandatory provisions applicable pursuant to the laws of his own Member State, an investor is warned that from a European international private law perspective, a choice of law clause and a choice of forum clause are generally held to be valid. As a consequence, the investor should make himself aware of the relevant laws that apply to his investment.
Platform A platform that contemplates to expand its business into other Member States, at all times, needs to obtain legal advice in the Member State where it wishes to provide its services. Other than mandatory local civil law provisions that the platform should take into account, the platform, in particular crowdinvesting and crowdlending platforms, will need to take into account the local regulatory framework.
Project owner If a project owner wishes to raise funds through a foreign platform and/or from foreign investors, it needs to take notice of the relevant applicable foreign rules and regulations of the host Member States in addition to the legislative framework in his own Member State. In particular, in case of fundraising by means of the offering of securities via a crowdinvesting platform, the project owner not only needs to take into account the laws in relation to a public offering of securities in his own Member State, but also the local laws of the Member States where offerings to the public are contemplated. Pursuant to any of these laws, the project owner may be confronted with the obligation to publish a prospectus. Irrespective of such prospectus obligation, in each Member State, the project owner is held to be the main responsible party for providing any material information to enable an investor to make an informed investment decision. The project owner needs to provide such information on the website of the platform or on its own website in an accurate, complete, comprehensible and not misleading (nor misleading by omission) manner.
Conclusion As mentioned in the introduction of this article, crowdfunding platforms need scalability in order to become profitable. The main means to become scalable is to expand and grow the business on a cross border basis. It is currently still relatively burdensome, inefficient and costly to expand a platform’s business in other Member States. The expanding platform will generally be confronted with a considerable part of new and/or additional local rules to be applicable to it in each host Member State.
If the exponential growth of crowdfunding as an alternative means of financing is continuing in its current pace, this fragmented regulatory approach in the respective Member States will presumably result in multijurisdictional takeovers of local platforms by foreign platforms or in the entering into of other sorts of cross border cooperation or corporate structures like joint ventures in which platforms will team up and cooperate with each other on a cross border basis. After all, why would a foreign platform reinvent the wheel in each Member State where it prefers to become operational while local platforms already have in place all what is needed and have knowledge of the relevant local laws in their Member States?
For further questions or information, please contact the author. Anne Hakvoort, partner FG Lawyers T: 0031 (0)20 760 31 37 M: 0031 (0)6 27 06 32 02 @: hakvoort@fglawyersamsterdam