When the shareholder becomes the litigation funder: The Federal Court of Justice redraws the boundaries of the duty of loyalty

Judgment of the Federal Court of Justice of 5 May 2026 – Case No. II ZR 2/25

Litigation funding agreements have become a firmly established instrument for enforcing legal claims, particularly where a company itself lacks the liquid funds to pre-finance a costly arbitration or a complex civil action. In such cases, a third party—often a professional litigation funder, but sometimes a shareholder or a company affiliated with one—typically assumes the litigation costs in exchange for a share of the proceeds recovered.

Precisely where the funder and the shareholder are linked by personal or economic ties, the question arises as to how far the shareholder’s fiduciary duty of loyalty extends into such arrangements, and where the line runs between permissible contractual arrangements and impermissible self-dealing.

In its judgment of 5 May 2026, the II Civil Senate of the Federal Court of Justice (Bundesgerichtshof, BGH) addressed this issue and also considered the requirements for convening shareholders’ meetings.

I.    Facts of the case

The decision arose from litigation spanning many years, whose economic origin lay in a share purchase agreement dated 1999. After the buyer ceased making payments, the selling GmbH, together with other parties, initiated arbitration proceedings. To finance these proceedings, the company entered into a litigation funding agreement in February 2011 with a GmbH that was indirectly controlled by the same individual who also served as managing director of the financed company and, through a holding company, held a fifty percent interest in it.

The funder assumed the costs of the proceedings up to an amount of approximately EUR 760,000 and, in return, received a 30 percent share of any proceeds recovered. The arbitration proceedings were ultimately successful and resulted in substantial payments to the company. The parties subsequently disputed whether the litigation funding agreement had been validly concluded at all, and whether the agreed share of proceeds should be reduced following an initial partial success achieved by the company.

The appellate court had, in principle, regarded the agreement as valid, but, relying on the shareholder’s duty of loyalty, made a subsequent adjustment and eliminated the funder’s share of proceeds once a partial success had occurred. The Federal Court of Justice set aside that judgment on two central points.

II.    Legal assessment

Arguably the most significant aspect of the decision concerns the scope of the shareholder’s duty of loyalty in the subsequent correction of third-party transactions. The BGH first clarifies that a litigation funding agreement between a company and a shareholder closely connected to it does not derive its legal basis from the company relationship itself, but instead establishes an independent contractual exchange relationship. Such a third-party transaction is therefore subject to the shareholder’s duty of loyalty only in narrow exceptional cases, for instance where a particular personal or economic connection between the parties involved justifies treating them as equivalent to the shareholder.

Even assuming such an exceptional situation, the BGH held, this does not justify a subsequent substantive correction of the contractually agreed share of proceeds. The parties had expressly provided in their agreement that an improved liquidity position of the company resulting from a partial success should not lead to an early termination or reduction of the funding arrangement. The parties had therefore already considered and deliberately regulated precisely this scenario when concluding the contract. According to the Senate’s reasoning, if a court were, after the fact and with the benefit of hindsight on a success that has since occurred, to substitute a different allocation of risk less favorable to the funder for the contractual arrangement, this would amount to an impermissible ex post assessment that is fundamentally foreign to the law of contract.

The BGH applies a control test in this context. Had the arbitration proceedings been unsuccessful, a proportionate allocation of the costs borne by the funder among the other shareholders would not have been obvious under this contractual structure. It is therefore inconsistent with the structure of the agreement to intervene, in mirror-image fashion, in the agreed profit share where the proceedings succeed. Such a subsequent correction would reduce the role of the litigation funder to bridge financing, under which the other shareholders would participate proportionately in the proceeds in the event of success, while the funder would bear the risk of loss. Such a result would be in tension with the risk allocation chosen by the parties, under which the success fee is structured as compensation for assuming the risk of a total loss.

The shareholder’s duty of loyalty is therefore not a tool for subsequently correcting economic outcomes that result from a contractual allocation of risk made by the parties with knowledge of the relevant circumstances. Freedom of contract is to be taken into account in this respect, even in a company-law context, so long as there is no indication of a violation of public policy or a gross disproportion between performance and consideration. The BGH denied the latter in the case at hand with respect to a market-standard success fee of 30 percent, even taking into account the substantial proceeds generated by the arbitration in absolute terms.

The Federal Court of Justice further clarifies that a company cannot be validly summoned to a shareholders’ meeting merely because its managing director receives the notice of invitation addressed to another company that he likewise represents. The knowledge of a natural person regarding a particular set of facts cannot automatically be attributed to the legal entity that person represents where that knowledge was obtained in a different capacity of representation. The formal duty to give notice serves to protect the participation and information rights of the respective shareholder and cannot therefore be displaced by an economic analysis. Consequently, in line with the Senate’s settled case law, the established defect in the notice renders the shareholder resolution in question void.

Because the company’s articles of association required a prior approving shareholder resolution for transactions of the type at issue that exceeded the ordinary course of business, the void resolution resulted in the pending invalidity of the agreement concluded on its basis. The BGH also took this opportunity to provide clarification of considerable practical significance. The principle under section 37(2) of the German Limited Liability Companies Act (GmbHG) that a GmbH managing director’s power of representation cannot be restricted vis-à-vis third parties does not apply without limitation where the contracting counterparty is a company controlled by the shareholder as sole shareholder and managing director. In such constellations, a restriction of the power of representation under the articles of association also takes effect vis-à-vis third parties, with the result that the contracting party cannot rely on the protection of good faith otherwise afforded by unrestricted powers of representation.

III.    Practical relevance for companies and their shareholders

The decision gives rise to several concrete recommendations for corporate practice. A company entering into a litigation funding agreement with a shareholder, or with a company affiliated with a shareholder, should expressly regulate the allocation of risk from the outset, in particular for the scenario of an interim improvement in liquidity resulting from a partial success. The more clearly such an arrangement is documented, the narrower the scope for a subsequent judicial review of its content on the basis of the duty of loyalty.
At the same time, the judgment makes clear that the formal requirements for convening shareholders’ meetings must be strictly observed in transactions involving a shareholder. In particular, in shareholder structures with changing ownership interests or share transfers, it is advisable to carefully review the current shareholders’ list and to give notice to each registered company separately and in the proper form.

Finally, the clarification regarding the limited scope of section 37(2) GmbHG in transactions with counterparties controlled by a shareholder carries considerable significance for contract drafting within group and affiliate structures. Companies contracting with a counterparty controlled by their own shareholder cannot automatically rely on the protection of reliance that applies in ordinary business dealings with third parties.