The coronavirus crisis has led to a major increase of the number of crowdfunding platforms. But with the development of these platforms, the risk of fraud has also increased, more and more platforms are setting up fictitious projects, often offering investors high interest rates, for example, some platforms will propose the financing of building projects with a high interest rate, investors will participate in the financing but in reality the project does not exist and will never be carried out, it is the platforms that get the money back in order to enrich themselves. How can you, as an investor, build up legal guarantees to protect yourself against these fraudulent platforms??
A weird occurence
These platforms are mainly located in Estonia due to the flexible regulation on the subject. But at the beginning of 2020, many Estonian crowdfunding platforms were no longer able to pay back their investors, initially the Estonian police became interested in the mismanagement of these platforms. The investigations led to the discovery of evidence of fraud.
To understand how this fraud is organised, it is worth recalling how a crowdfunding platform works. The purpose of the platform is to put project owners in touch with investors. When you invest in a project through a crowdfunding platform, you should be aware of the risk inherent in this type of investment: if the project fails, the investment will collapse and be lost. However, there are ways to limit this risk. The investment platforms themselves insure themselves against this risk and this means that they are not accountable to investors for the success or failure of investments. They are only subject to a duty of care which takes the form of verification of the identity of borrowers and their ability to repay. Once this obligation is fulfilled, platforms do not have to guarantee the success of the investment made by the capital providers. Crowdfunding is therefore a platform that is totally conducive to scams: there is no justification for the failure of the investor to repay. In this situation, it is necessary to know how to recognise a fraudulent platform in order to be able to turn against it if you are a victim.
Wisefund is one of the Estonian participatory financing platforms suspected of fraud. It aimed to finance a wide range of projects, from the manufacture of microbiological fertilisers to the purchase of car parts for export. One irregularity drew the attention of investors: the guarantee allowing the platform to buy back bonds from investors in return for a discount was unilaterally deactivated, i.e. Wisefund decided without obtaining the permission of the investors, or even informing them, that it would not buy back their bonds in the future (which now forces the investors to find new buyers). This constitutes a unilateral modification of the contract between the platform and the investors, and this possibility is regulated in the majority of EU Member States’ laws, in this case Estonian law applies: how does it regulate the unilateral modification of the contract by a crowdfunding platform?
The capital providers discovered that this guarantee was provided by a Hong Kong company Best Treasure Limited located in a mailbox building. Despite these irregularities, the platform continued to operate, making numerous late payments and justifying its loss of capital by the risks associated with the investments. The investors decided to file for insolvency in the Estonian civil court (equivalent to a writ of reorganisation) on the basis of alleged fraud.
By a judgment of 14 January 2021, the Estonian civil court rejected the investors’ claim, considering that once fraud is suspected, only the criminal courts have jurisdiction. In this situation, a crowdfunding platform cannot be sued in insolvency, so the creditors must initiate criminal proceedings. This decision was confirmed by the Estonian Court of Appeal on 26 March 2021.
This is a decision that applies the classic division of competences between civil and criminal matters. The civil court denies jurisdiction in all situations where fraud is suspected. This implies that investors can only be reimbursed if they initiate proceedings before the criminal courts. As in French law, the courts considered that the civil judge could not substitute himself for the criminal judge in judging criminal acts.
It is likely that this ruling by the Estonian courts will set a precedent within the European Union. The investors do not have a claim on the platform but on the final borrower, so in case of fraud, they should turn to the criminal courts and not to the civil courts because in theory, the final borrower has not committed any offence. The investors of the Wisefund platform had to pay additional sums to bring this action, which was ultimately unsuccessful. This case shows that it is necessary to determine the best type of action to avoid additional costs and lengthy proceedings.
It is possible to imagine certain hypotheses whereby the investors would engage the civil liability of the participatory financing platform, in particular on the basis of its due diligence obligation, in which case they could have been compensated on civil grounds. In this case with the Wisefund platform, the initiation of this procedure would have forced the platform to provide evidence of fraud or the absence of fraud. Similarly, it would be possible to hold the platform liable before the civil courts if, on reading the contract between it and the investors, it appears that certain clauses are abusive.
At present, criminal proceedings are underway and the Estonian police have contacted the investors’ local police. Investigations have led to the discovery of evidence that suggests the setting up of a Ponzi Scheme, a fraudulent financial arrangement that is criminally reprehensible. But how can you, as an investor, identify them? ?
A second case is that of the platforms Envestio and Kuetzal, which offered capital providers to invest in empty companies or in existing companies but did not seek investors on the platform in order to recover the money provided by the investors and not to pay them back by invoking the failure of the project. At the end of 2019, investors on the crowdfunding platforms investigated the projects that Envestio and Kuetzal were offering to fund, revealing the fictitious nature of some of them. These revelations led investors to demand their money back, causing the collapse of the Kuetzal and Envestio platforms. This collapse is explained by the fact that any financial intermediary does not have enough funds to repay all its investors at once, so when they all ask for a refund, the company does not have enough funds and it ends up collapsing, so the question arises of how to obtain the repayment of its investment with the survival of the company so that it can pay off its debts. This is an issue that needs to be considered holistically, from the perspective of all investors. In June 2020, the bankruptcy of the two companies was declared by the Estonian courts.
Faced with this situation, investors organised themselves to form a collective action against the 2 participatory finance platforms. The problem is that the majority of the investors are not Estonian, so a solution had to be found so that people who are not nationals of the state in which the platform is located could join the class action. Faced with this problem, a procedure was implemented at European level to facilitate the process of filing a claim for investors in the platforms. Criminal investigations have been opened and are still ongoing, but the Estonian police suspect that these platforms are fraudulent and organise money laundering activities.
Other platforms such as Monathera or Grupeer have also experienced difficulties in repaying their investors. Initially, this was considered to be caused by mismanagement and default by borrowers, but it now appears that these companies are suspected of embezzlement.
The investors of the Grupee platform have come together to coordinate action against it and the investigations carried out seem to reveal a scam. The Latvian authorities, where the platform is based, have stated that Grupeer has no licence to provide financial services in Latvia. Although the platform was originally established in Latvia, it was legally transferred to Ireland and therefore falls under Irish national regulation and should have obtained a licence to operate in Latvia. The characterisation of the applicable law is fundamental here, as the rules that apply will differ between a Latvian platform and an Irish platform.
It seems that this crisis of the crowdfunding platforms has raised awareness. It has revealed the lack of supervision of equity crowdfunding platforms, for example, there is no supervisory authority for platforms in Estonia to ensure that their projects are genuine. It was noted that it is difficult to engage the civil liability of the platform, but if the bankruptcy of the platform is not due to fraudulent manoeuvres, only the civil courts can be used, and it will therefore be necessary to determine on what grounds to base oneself in order to be compensated. Similarly, no procedure was really provided for to enable collaboration between the national authorities concerned and foreign investors; this was born out of practice, in particular by drawing on existing procedures. There was no European framework for crowdfunding, leading to a disparity of rules within the Member States: but how to determine the law applicable to the platform?
But how to determine the law applicable to the platform?
To address these issues, the European Union has taken steps to create a harmonised regulation between EU countries, the regulation on this issue will be applicable from 10 November 2021. It regulates crowdfunding, in particular by imposing certain obligations on the investment platform, such as information obligations towards the investor. Being aware of the obligations incumbent on a crowdfunding platform is becoming a necessity, as breaches of these obligations have important legal effects.
Additionally, Estonia now wants to strengthen its legislation to regulate the activity of P2P finance platforms more strictly and to prevent such a situation from happening again. In addition to complying with EU regulations, the Estonian legislator wants to create a framework for P2P consumer loans, similar to the one applicable to businesses. It is also intended to regulate crypto-currency services, which are currently very poorly regulated. The Estonian Ministry of Finance’s draft regulation provides that all service provision activities related to virtual currencies will be placed under the jurisdiction of the Financial Supervisory Authority, thus increasing the control over these institutions, which should help limit fraud.
These European and Estonian laws should offer greater protection to investors by ensuring the reliability of the services provided.
Eternoscorp remains at your disposal for any recourse against a company that has acted in fraud of your rights.