Friday, 10 August 2018

Double default: on default interest and default rules

Tuesday 7 August 2018, the last date on the judicial calendar of the CJEU before summer recess, was a busy day. Two of the cases on the dock in which the CJEU gave judgment concerned preliminary references from Spain: Joined Cases C-96/16 and C-94/97 (Escobedo Cortés), discussed earlier on this blog. The judgment relates to, in short, the case law of the Spanish Supreme Court (Tribunal Supremo) on default interest clauses and the Unfair Contract Terms Directive.

Both cases pertained to (mortgage) loan agreements concluded between consumers and banking institutions, containing a default interest clause ("interés moratorio"). This clause entailed that the consumers would have to pay interest rates of 18.50%, 23.50% and 25% respectively in case they were late on meeting their payment obligations. The purpose of this clause was to penalise the debtor's non-compliance, to deter delays in payment and to compensate the creditor in case of such delays.

The Spanish Mortgage Act (Article 114.3) stipulated since 2013 that the maximum default interest rate was three times the statutory interest rate. However, there was still a great degree of divergence in the unfairness assessment of default interest clauses in consumer contracts by Spanish courts, as well as in the determination of the consequences of a finding of unfairness. This resulted in legal uncertainty and arbitrary differences in treatment.
Therefore, the Tribunal Supremo had defined criteria. First, it had examined the national default rules that would be applicable in the absence of agreement between the parties, in order to determine a default rate of interest which could reasonably be agreed to and was not disproportionate. It found that a default interest rate exceeding more than two percentage points of the ordinary interest rate agreed between the parties was unfair. [Note that the criterion is linked to the ordinary interest rate agreed between the parties, not the statutory interest rate.] Secondly, it held that after a finding of unfairness, the increase that the default interest represents (as compared with the ordinary interest) must be eliminated entirely.

The referring courts doubted whether the judicial interpretation given by the Tribunal Supremo was compatible with the Unfair Contract Terms Directive. This had to do with the question whether the judge-made criteria were binding or mandatory on lower courts.
As regards the first criterion, the CJEU concludes that national courts were not deprived of the possibility of considering that terms not exceeding more than two percentage points are still unfair, and have to be set aside; the Tribunal Supremo had merely established an "irrebuttable presumption" (paras 58-59 of the judgment). Yet, as we observed earlier on this blog, there does not seem to be much space for lower courts to deviate from this presumption in an individual case. The CJEU seems to be aware of this, but considers that the Directive is based on the idea that the consumer is in a weak position vis-à-vis her professional counterparty (para 64). The criteria developed by the Tribunal Supremo are consistent with the objective of consumer protection pursued by the Directive. To ensure consistency in the interpretation of law and in the interests of legal certainty, the supreme courts of Member States may elaborate certain criteria for the assessment of the unfairness of contractual terms. The CJEU adds (para 69):

"It follows from Article 3(1) of Directive 93/13 and from the general scheme of the directive that the latter does not so much aim to guarantee an overall contractual balance between the rights and obligations of the parties to the agreement as to prevent an imbalance between those rights and obligations from arising to the detriment of consumers."

As regards the second criterion, the CJEU holds that the Directive intends to restore the balance between the parties by not applying contractual terms declared to be unfair, whilst maintaining, in principle, the validity of the other terms of the agreement at issue. It does not follow that the unfairness of a default interest clause also brings about the unfairness of a clause fixing the ordinary interest (paras 75-76). The case law of the Tribunal Supremo implies that the national court must simply refrain from applying (a) the unfair default interest clause or (b) the increase it represents by comparison with the ordinary interest [NB: there is a significant difference between (a) and (b): a percentage of 0% vs. 8.50%, 11.20% and 4.75% respectively]. The national court cannot substitute supplementary national provisions for an unfair contractual term or revise the term in question (para 78). Thus, the term cannot be replaced by the statutory interest rate that would have applied by default if there had been no agreement.

It could nevertheless be asked whether the criteria formulated by the Tribunal Supremo are sufficiently deterrent. Creditors could be incentivised to increase the ordinary interest rates, with a view to both the 'unfairness' criterion and the 'comparison' criterion, allowing them to claim a higher interest, also in case of default.

Lastly, the CJEU finds the Directive does not apply to business practices consisting in the assignment or purchase of consumer debt, if there is no term in the contract at issue providing for this (para 40). The assignment was made on the basis of a regulatory provision in the Civil Code, which is excluded from the scope of the Directive. Article 1.2 of the Directive extends to national default rules that apply in the absence of other arrangements made by the parties (para 43). The procedural rules in question do not appear to affect the scope of the national court's powers to exercise unfair terms control (para 45). The CJEU does not address the referring court's reference to Article 38 of the EU Charter of Fundamental Rights.
This outcome may be understandable from a purely legal standpoint, but is disappointing from the perspective of consumer protection in respect of the sale of loans; see further our blog on this topic.

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We commented earlier on party names in CJEU case law. It was recently announced that requests for preliminary rulings involving natural persons will be anonymised from 1 July 2018 onwards. This means we will have to refer to this kind of cases in the future as Banco Santander II (C-96/16) or even V (see here, herehere and here for previous cases involving the same bank); or we may need to think of a different system.


  1. Hi Anna,
    from the point of view of the directive's system it is no big problem I think that the credit institutions "could be incentivised to raise the interest rates", because the price of credit per se, as long as it is transparent, is something that the directive is no concerned with. In particular, the assumption is that this price is determined in light of offer and demand, and that consumers are sensitive to it (while they may not be sufficiently attentive when it comes to default interest rates, because everybody assumes they will always pay on time). I am hardly a supporter of predatory credit practices, but going further than nullifying the default interest would, I think, require express legislative intervention as it would be nowhere close to the normal remit of contract law.

  2. Thanks for the clarification Candida, this is also what the CJEU seems to say. It's just that the judgment doesn't shed any light on the relation with Article 114.3 LH, which appears to be an upper limit - set by the Spanish legislator -linked to the statutory interest. From a deterrence perspective, you don't want to give creditors the opportunity to use ordinary interest as a 'concealed' default interest.