Average consumers not expected to conduct legal research - CJEU in Banco Santander (C-265/22)

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On July 13th, the CJEU issued a judgment further clarifying the principle of transparency under the Unfair Contract Terms Directive in variable-rate mortgage loan contracts, in the case Banco Santander (C-265/22). In such contracts the interest rate is variable with time, here: a new rate was to be determined every year for the following 12 months.  

In the Spanish case referred to the CJEU, consumers' interest rate was calculated with reference to the Mortgage Loan Reference Indices (IRPH). Consumers claimed that they were not informed as to the full impact of having such a reference rate, with relevant information either missing from the mortgage loan agreement or not being properly communicated to them. Whilst the Unfair Commercial Practices Directive was not yet applicable at the time the mortgage loan contract was concluded (2006), the Court could not consider whether the bank engaged in a misleading commercial practice. It was, however, able to assess that the UCTD may have been infringed if the bank's practice did not allow for applying to the IRPH a negative margin, in order to align the interest rate with the market rate.

The CJEU reiterates the main points on transparency from the Andriciuc and Others judgment (see our comment): Consumers require sufficient information to take prudent and well-informed decisions; mainly average consumers need to be able to estimate the total cost of the loan (para 53). This translates into an obligation, when variable-rate mortgage loan contracts are concluded, for average consumers to understand: the specific functioning of the method used for calculating that rate (para 55). This requires consumers to have easy access to the main elements relating to the calculation of the reference index (para 56). The national court in the given case needs to check whether the information provided in the agreement (with the index being published by the Bank of Spain and having been described in Annex VIII to the agreement) was sufficient for average consumers to become aware of the method of calculation of the variable interest rate (paras 57-58). Further, the national court should consider whether the lack of information in the loan agreement on a non-binding circular issued by the Bank of Spain could have been detrimental to the average consumer's ability to estimate the total loan cost. This in light of the circular stressing its significance for credit institutions (para 59). The CJEU seems to imply in para 60 that it would go to far to expect average consumers to conduct legal research, that is to try to find other documents of the Bank of Spain that could be applicable to the variable-rate mortgage loans, which have not been referenced in the agreement.

Whilst the CJEU reiterates the finding from the order in Gómez del Moral Guasch that the lack of transparency of a term does not render it, in itself, unfair, it would weigh in on the unfairness test (para 66). Further, the national court, when estimating whether the contract term introduces significant imbalance between parties' rights and obligations, has to look at what rules would apply in the absence of the agreement and assess to what extent the contractual provisions put the consumer at a detriment (Banco Primus - see our comment). With variable-rate mortgage loans this means comparing the interest rate to the statutory interest rate and the interest rates applied on the market at the date of conclusion of the agreement at issue... for a loan of a comparable sum and term (para 65).

UPDATED:

Readers interested in finding out more about the intricacies of the financial indexes used in Spain for calculating variable-rates in mortgage loan contracts, the legal value of circulars issued by the Bank of Spain, and the possible misconstruction of Spanish law by the CJEU - please check the comment of Prof. Ernesto Suárez from ESADE and UPF Law Schools in Spain.

No, Escobedo Cortés does not imply that double interest rates must be secured for traders (but nice try, Prima banka Slovensko)

Earlier this week the Court of Justice delivered a brief, yet noteworthy judgment in case C-192/20 Prima banka Slovensko. The case seems fairly stratightforward and the Court, in fact, proceeded to the judgment without a written opinion from the Advocate General. The judgment, nonetheless, provides a useful clarification of where Directive 93/13/EEC on unfair terms in consumer contracts (UCTD) and the associated CJEU case law do not reach. 

Facts of the case

The case involed a Slovak consumer, who concluded a loan agreement with a local bank for the amount of EUR 5 700 at an interest rate of 7.90%. Several months from the conclusion of the contract, the consumer began to default on his/her payments. After appox. 4 months of non-payment, the bank declared the early termination of the term of the loan and demanded the immediate repayment of outstanding ammount along with a default interest as well as an ordinary interest. 

The court hearing the case in first instance upheld the bank's action in part. Specifically, the court considered the claim for default interest to be valid, but dismissed the claim for ordinary interest, on the ground that Slovak law did not allow such accumulation. Indeed, national law appears to have posed certain limits on what creditors can claim in the event of consumer's default and the claims put forward by the bank arguably exceeded those limits. 

Here is where the case get interesting. In the appeal, the bank decided to invoke the previous judgment of the CJEU in joined cases C-96/16 and C-94/97 Banco Santander and Escobedo Cortés (see our earlier comment here). Specifically, the bank argued that the judgment required national legislation to ensure that a borrower who has failed to fulfil his/her contractual obligations should pay not only default interest but also ordinary interest.

Judgment of the Court

The grounds of the judgment essentialy consist of two parts. First, the Court considered the main legal questions in the case at hand. For the Court, these were actually linked not to the provisions of Articles 6(1) and 7(1) of the UCTD, referenced by the national court, but rather to the Directive's scope. Second,  doubts about the consequences of Escobedo Cortés were addressed.

In respect of the Directive's scope, the Court referred to Article 1(2) of the UCTD, which provides that contract terms which reflect mandatory statutory or regulatory provisions shall not be subject to the provisions of the Directive. This may not be immediately inntuitive, since controversy in the case at hand was rather that the terms did not reflect national provisions. The well-established reasoning of the Court in respect of Article 1(2), however, turned out to be useful to make a more general point: that it is not the goal of the UCTD to analyse the content of national mandatory statutory or regulatory provisions, which parties can incorportate into their contracts. It is presumed that national legislature has struck a balance between all of the rights and obligations of the parties to certain contracts, and the UCTD does not intend to interfere with that balance (para. 32). This has to be distinguished from the national provisions relating to the control of unfair terms, whose compliance with the UCTD can be investigated. In the case at hand, however, the contested provisions did not appear to relate to the review of unfair terms and were therefore excluded from the scope of the UCTD (para. 35). Therefore, the Court did not even have to recall that the UCTD is a minimum harmonisation directive.

While this would have sufficed to provide the refering court with useful guidance (that the UCTD was not applicable to the national provisions in question), the Court went on to dispell some doubts related to its previous judgment in Escobedo Cortés. The Court reiterated the context of that case: that it involved an assessment whether national case law that did not prevent the accumulation of interest rates complied with the UCTD. The Court considered that it did; however, it did not follow from that judgment that an accumulation of interests rates must always be ensured under national law (para. 41). It would indeed be rather odd if a directive that seeks to eliminate unfair terms from consumer contracts were to produce such a result.

Interest rate modifications are not separate contracts - CJEU in C-639/18 Sparkasse

On the 18th of June 2020 the CJEU delivered its judgement in C-639/18 KH v Sparkasse Südholstein on the interpretation of Art. 2(a) of Directive 2002/65/EC on Distance Marketing of Financial Services. Unfortunately, the CJEU did not follow AG Sharpston's consumer friendly opinion (on which we reported here).

The facts

To remind us of the facts, KH concluded three contracts with her regional Sparkasse. These contracts were with a fixed interest rate for a fixed period of time after which they would switch to a variable rate in the absence of an agreement between the parties on a new fixed rate (for a newly fixed period). The original contracts were concluded at a branch, but the renegotiated agreement on the interest rates were concluded at a distance, thus KH claimed that Directive 2002/65/EC was applicable giving her a right of withdrawal, which KH intended to use.

The legal question

The legal questions thus arose, whether the newly reached agreements on interest rates were separate contracts (to which the Directive would apply), or as the bank claimed, just 'operations' or amendments of the initial contracts (to which the Directive would not apply). Hence, KH's right of withdrawal depended on the interpretation of Art. 2(a) of Directive, i.e. whether the transactions setting out the new interest rates where covered with the concept of a 'contract concerning financial services' and a contract 'concluded under an organized distance sale or service-provision scheme'.

The ruling

In interpreting the phrase 'contracts concerning financial services' the CJEU concluded that the present agreements on the alteration of the interest rates are not separate contracts, they are not 'contracts concerning financial services' within the meaning of the Art. 2(a) of the Directive because they do no more than to alter the originally agreed rate of interest without changing the duration or the amount of the loan.

In its analysis, the CJEU referred to Art. 2(b) of the Directive that defined the concept of 'financial service' as including, among others, contracts of credit. In determining more closely the essence of a credit contract, the CJEU referred to its previous case-law (C-249/16) that clarified that the characteristic obligation of the contract is the granting of the sum lent, whereas the borrowers obligation to repay the sum borrowed is 'merely a consequence of the performance of the the service by the lender'.

In discussing the argument that the newly agreed interest rates are just operations of the initial credit contract, the CJEU disagreed. Having regard to the examples given in Recital 17 (such as opening a bank account as an initial service agreement and withdrawing money from the account as its operation), an amendment that sets a new rate of interest as a result of a renegotiation of a clause in the initial contract (which provides for a variable, 'back-up' rate of interest) is neither an 'operation' of the initial agreement nor an addition to the elements of the initial agreement. 

The CJEU concluded that in order for a contract to qualify for a 'contract concerning financial services' under Art. 2(a) of the Directive it must be for a supply of 'such service' and this condition is not fulfilled here. These were only amendments of the rate of interest payable for the service that was previously agreed.

Finally, although the CJEU noted that one of the objectives of the Directive is to ensure a high level of consumer protection, in order to enhance consumer confidence in distance selling of financial services that would facilitate the free movement of financial services, according to the CJEU, 'such an objective does not necessarily require' that an agreement setting out the new interest rate is  considered as a new contract for financial services.

Given the above conclusion, the CJEU considered unnecessary to answer the other question asking for the interpretation of the meaning of a contract concluded 'under an organized distance sale or service-provision scheme run by the supplier.'

Our evaluation

This judgment deals with an important question in (long term) financial services contracts such as credit, insurance, investment and pensions, where the initial agreement is subject to later changes by way of amendments, ruling that the status of these later agreements are not separate contracts. 

This important and potentially far reaching conclusion (given that the Directive applies to all financial services) is not well supported with analysis. The key line of thinking in this judgement seems to be that the 'contract concerning financial services' must provide for a service, must be for a supply of a financial service, and anything short of this, would not be considered a separate contract. While this argument may have merits, there is very little engagement with what is meant by a 'service.'

One the other hand, one would have expected that there will be a much better analysis of the contractual aspect of the transaction, the meaning of the contract and its formation especially that this was the focus of AG Sharpston's opinion. Apart from the reference to one previous case-law there is no engagement with the meaning of contract and its essential elements. Examples of European solutions would have been useful and they might have lead to a different conclusion. For instance, Section 6:383 of the Hungarian Civil Code defines loan contract by reference to the obligations of the parties under which the creditor is obliged to provide the agreed sum of money, and the debtor is obliged to repay this sum with interest. Interest thus appears as named essential element of the contract and clearly one could argue that changing an essential element of the contract can only be done by way of a new contract?

Finally, there is no mention of power imbalances and the consumers' weaker position in negotiating with the bank, even in this case, where the consumer is likely to engage with the process (by contemplating options and accepting one option offered by the bank). It would have been useful to take into account the way in which these contracts (and their amendments) are concluded in practice.

In addition, the line of reasoning is also weakened by the CJEU's intention to give special status to these amendments (as they are nether separate contracts nor are they the operations of the initial service agreement) without clarifying the details of this special status and what it entails in terms of the rights and obligation of the parties.

Finally, it remains unclear why amendments to (long term) financial contracts are unimportant for the facilitation of a high level of consumer protection and the internal market in financial services. I would argue the contrary, it is indeed important to consider amendments as separate contracts to enhance consumer confidence in concluding (long term) financial contracts and to provide consumers with the protection guaranteed by the Directive, including the important right of withdrawal.

Interest rate modifications in credit contracts should be covered by Directive 2002/65/EC- AG Sharpston in C-639/18 Sparkasse Südholstein

On the 12th of March 2020 Advocate General Sharpston delivered her Opinion in C-639/18 KH v Sparkasse Südholstein on the interpretation of Article 2(a) of Directive 2002/65/EC on Distance Marketing of Financial Services.

The facts

This case involves the German Sparkasse Südholstein regional bank. While mortgage contracts are only concluded face to face in its branches, in some cases, in the context of ongoing banker-customer relationship, additions or amendments to these contracts can also be made with the use of distance communication.

In the period of 1994-99 the parties concluded 3 contracts. Two in July 1994 for purchase of immovable property and one in 1999 for personal loan. All three contracts were concluded with an initial fixed interest rate that would switch to a variable rate following the expiry of the period for which the interest rate was initially fixed. As it is usually the case, before the end of this fixed period, the contract was open for negotiation, and a new fixed rate for a newly agreed period could have been agreed between the parties. The present parties negotiated new interest rates in 2008, 2009 and 2010 respectively.

However, in 2015 KH withdraw from the above three contracts setting out the new interest rate claiming that these contracts involved distance selling thus entitling KH for a right to withdrawal under the national provision implementing Directive 2002/65/EC.

The legal problem

The legal issue in this case was whether KH had a right of withdrawal, and this depended on the interpretation of Art. 2(a) of Directive 2002/65/EC, whether the transactions setting out the new interest rates where covered with the concept of a 'contract concerning financial services' and a contract 'concluded under an organized distance sale or service-provision scheme.' In other words, whether the newly agreed interest rates were considered to be new distance contracts or merely 'operations' of the initially concluded credit contracts.

The analysis: a 'contract concerning financial services'

After careful analysis, AG Sharpston answered the first question positively, holding, that a 'contract concerning financial services' in Art. 2(a) of Directive 2002/65/EC indeed includes contracts for the modification of the interest rate that makes no other (substantial) changes to the contract, it neither extends the term of the contract nor modifies the amount of the loan. 

In her interpretation AG Sharpston relaid on the wording of the provision, the purpose of the Directive and the explanations of the aims of the provisions of the Directive contained in the recitals of the Directive. 

First of all, AG Sharpston highlighted the purpose of the Directive to give a number of rights to consumers in distance financial services contacts that is important for the provision of a high level of consumer protection and the increase of consumer confidence in the internal market.

It follows, that the concept of a 'distance contract' must be interpreted broadly, because Art. 2(a) refers to 'any' contract concerning financial services. The same approach would be suggested by recital 14 that suggest the Directive covers 'all' financial services.

Further, AG Sharpston discarded Sparkasse Südholstein's argument that the subsequent contracts for the modification of the interest rate are only 'operations' within the meaning of the Directive that follow the initial service agreement, according to which, the subsequent contracts for the modification of the interest rate are not self-standing, separate contracts, i.e. 'contracts concerning financial services'. Following Article 1(2) of the Directive, a contract that is comprised by an initial service agreement followed by successive operations or series of separate operations of the same nature performed over time, would not fall within the scope of the Directive. Referring to Recitals 15-17 AG Sharpston explained the difference between an 'operation' of an existing contract and a new contract, emphasizing that adding new elements to an existing service agreement is not an operation of the existing contract but a new contract. Relying on Recital 15 that defines distance contracts as those where the offer, negotiation and conclusion are done at distance, AG Sharpston concludes that  constitutive elements of contract formation under the Directive are the offer, the acceptance and the meeting of the minds. While this conclusion seems somewhat unsubstantiated without at least some reference to national jurisdictions where these requirements are applied, her overall analysis seems to be well supported. Thus a key element for a 'contract' to exist under Article 2(a) of the Directive is that there is an agreement between the parties. An 'agreement' can be defined by contrast to an 'operation'. An operation is 'an act of executing agreement without adding elements for which a new meeting of minds would be required' (para. 51). The AG rightly asserts that in the context of a credit contract, an operation would thus cover transactions such as payments reducing the total amount owed to the bank. Further on, an 'agreement' can also be defined by looking at the conclusive elements of a contract. AG Sharpshon explains that a 'characteristic obligation' or essential element of the contract is the granting of the sum borrowed (lenders obligation), the repayment of the sum borrowed (borrowers obligation), agreement on the structure and the duration of the repayment period and the interest rate. The interest rate can be fixed or variable, and as this case also shows, the usual banking practices when concluding contracts with a fixed rate is that this fixed rate is only for  fixed period of time, following which, if no agreement on a new fixed rate is agreed, the banks variable rate will apply. Thus without an agreement on a new fixed rate, the initial contact would not remain unchanged, AG Sharpston emphasizes that it would change substantially, as one of the main elements of the contract would change, i.e. the interest rate. AG Sharpston then concludes that since the importance of this element, an agreement on the new fixed interest rate cannot be a mere operation of the existing contract but it is rather a new contract between the same parties.

The analysis: a contract 'concluded under an organized distance sale or service-provision scheme' 

This case also involved the interpretation of a phrase 'concluded under an organized distance sale or service-provision scheme' given that the bank did not solely use distance communication for contract conclusion. The AG concluded again positively, establishing the necessary elements. According to AG Sharpston, contacts are concluded under an organized distance sale or service-provision scheme 'where a supplier, in order to conclude a subsequent interest rate agreement, makes exclusive use of means of distance communication, where the use of those means in exclusive and not strictly occasional but forms part of a framework set by that supplier, in terms of its commercial structure, including staffing and resources, allowing it to conclude contracts without the simultaneous physical presence of the parties'.

In her analysis, AG Sharpston referred back to Article 2(a) and the necessary elements there for a distance contracts. First, that the two parties must not be physically and simultaneously present when the contract is prepared and concluded but rather they exclusively used some means of distance communication such as phone, email, etc. Importantly, the AG asserts that any prior face to face contact between the parties for the purposes other than the conclusion of the contract in question are of no relevance. The second and the more disputed element here is that the transactions much be carried out under an organised distance sale or service provision scheme run by the supplier, who makes exclusive use of distance communication. Apart from Recital 18 that excludes services provided on occasional basis and without a dedicated commercial structure, the Directive does not give any further guidance. However, relying on the wording of Article 2(a) AG Sharpston determined that the scheme must fulfill several criteria. First, it must be an organized scheme, the supplier must have the necessary commercial structure including staffing and resources to conclude contracts at distance. Second, the scheme must be run by the supplier. The supplier must set up the framework to offer the conclusion of distance contracts. Third, running such a scheme must be exclusive for the purpose of the contract in question, that is, it must cover the offer, the negotiation and the conclusion of the contract. Finally, the conclusion of a distance contract should be a normal or regular possibility when concluding contacts. Importantly, the AG clarifies, that once the system is set up, it does not have to be used frequently or systematically, as all the Directive requires is that it is not used 'strictly occasionally'.

Discussing the particular case, AH Sharpston asserted that Sparkasse Südholstein seems equipped both with staffing and resources to run an organized scheme of distance selling, and the fact that Sparkasse Südholstein concludes certain types of contracts exclusively at its branches should not be an obstacle for also running an organized distance selling scheme. Looking at the particular contracts concluded with KH, the AG emphasized that it should be of no relevance for the present analysis that the initial credit contracts were concluded at a branch, as the Directive does not require every single contract to be concluded at distance when there is an ongoing banker customer relationship between the parties. The application of Article 2(a) of the Directive should be observed independently from the rest of the relationship, taking into account only the particular contract, i.e. the contract setting out the new interest rate.

Concluding thoughts

This case involves a 'typical' legal problem in long term contracts where following the initial contact several other agreements are reached throughout the time that raises the question of the status of these new agreements: are they separate, independent contracts or are they just the operation of the initially concluded contract. The AG's conclusion seems to be correct as having these agreements as independent contracts provides a higher level of protection of consumers as if they were not separate contracts. In particular in regard to the right of withdrawal- this important right would not exist if the new agreement on the interest rate is not an independent contract. This case arose in the context of credit contracts. However, AG Sharpston's overall conclusion and the important message on the need to set out the Directive's scope of application broadly for achieving a high level of consumer protection is an important one. It could have far reaching implications, given that the Directive relates to all financial services and similar problems might arise in the context of other long term financial contracts such as life insurance or personal pensions.