The Effects of negative benchmark interest rates on variable interest clauses in loan agreements


The Effects of negative benchmark interest rates on variable interest clauses in loan agreements

Monday, 25 January, 2016

1. Facts of the Matter

For many years, banks and debtors agreed on interest escalation clauses in loan agreements with variable interest rates. According to such clauses, the debtor had to pay interest in the amount of a benchmark interest rate (such as EURIBOR or LIBOR) and an interest mark-up (margin). The benchmark interest rate represents the general interest level, while the interest mark-up is designed to cover the default risk and yield for financial institutions. It has never been considered that the benchmark interest rate could fall below 0% in loan agreement.

As a result of the financial crisis, benchmark interest rates decreased so much, that the benchmark interest rates EURIBOR and LIBOR went in the negative. An end to this low-interest phase is not in sight. What happens, if the negative value of the benchmark interest rate is higher than the arranged margin in loan agreements? Following the wording of the loan agreements, financial institutions would have to credit negative interest to debtors.

The banks proactively sought to avoid this potential scenario from happening. The debtors were informed by the financial institutions that nobody could foresee a negative benchmark interest rate and that this scenario thus constitutes a contractual gap in the loan agreements. In the case of negative interest rates (benchmark interest rate and margin), the financial institutions want to include a minimum threshold of 0,00001 %, so that the interest rate cannot go below negative. According to the banks, this minimum interest rate is the implicit basis of every loan agreement and is necessary to cover the costs of financial institutions for risk of default, both material and personnel.

2. Legal Arguments of the Banks

An interpretation of loan agreements shows that variable interest rate clauses cannot lead to negative interest rates for loans. When correctly interpreting the loan agreements, the following conclusion is reached when distinguishing two kinds of interest escalation clauses: If a fixed mark-up, in addition to the current benchmark interest rate, has been agreed upon (“absolute calculation method”), the creditor is entitled to at least the fixed mark-up. If the parties do not agree on a fixed mark-up, but instead link the mark-up interest rate to the performance of the benchmark interest rate (“relative calculation method”), the interest rate might reach blank value, but cannot fall below zero.

The financial institutions argue further that according to paragraph 988 of the Austrian Civil Code a loan agreement is a contract for consideration. Therefore, a loan agreement cannot contain a negative interest rate. Years ago, the Austrian Supreme Court ruled that interest rate savings could not fall below zero. This ruling should have also been applied to loan interest rates.

3. Legal arguments of the Austrian Association of Consumer Information

The Austrian Association of Consumer Information (ACI) argues that the bank´s preclusion of negative interest rates for loan agreements is not admissible. On the contrary, negative interest rates can be possible according to the wording of existing loan agreements. Variable interest rates clauses that link interest rates to certain indicators and that can – in case of a negative performance of such indicator – potentially lead to a negative interest rate, is in line with the legislative model of a loan agreement and the typical intention of parties to a loan agreement. According to the ACI, the approach of the financial institutions for unilaterally creating a minimum threshold of loan interest rates by simply informing customers in writing, is unlawful. The ACI argues that a minimum threshold for interest rates without a correlating maximum threshold cannot be bindingly agreed upon in a loan agreement between a financial institution and a customer due to the rule of “two sidedness” contained in paragraph 6 abstract 1 clause 5 of the Austrian Consumer Protection Act.

The interest rates of savings deposits have to be distinguished from loan agreements. A potential negative interest rate for saving deposits without explicit notice thereof by the financial institution would be unexpected and therefore unlawful according to § 864 of the Austrian Civil Code. However, financial institutions do not use their own money in order to facilitate loans, but rather refinance the funds. Thus, dealing differently with savings deposits interest rates and loan interest rates is justified.

Economic strategies of the financial institutions are not perceivable for debtors and hence legally irrelevant.

4. Court decisions

The ACI filed a collective action on behalf of the Austrian Ministry of Social Affairs against the unilateral amendments of the loan agreements by several financial institutions.

The courts of first instance (File number: 27 Cg 32/15x and 57 Cg 10/15v) followed the line of argumentation set forth by the ACI and decided that the financial institutions’ unilateral amendments of loan agreements is unlawful. Financial institutions shall credit and pay out negative interest to debtors if their variable interest rate falls below zero because of the performance of the benchmark interest rate.

The Court of Appeal did not deal with the factual matter at hand, and rejected the appeal on formal grounds (File number: 2 R 187/15g). The case, in which the interest rate falls below 0 % and financial institutions do not credit negative interest to their debtors has not occured as of yet. These notifications from financial institutions does not constitute a unilateral amendment of contracts but a heads-up of the financial institutions to the debtors as to their intentions once the potential scenario becomes a reality. Therefore, the ACI could not legitimately file an action.

All court decisions are not yet legally binding. It remains to be seen how the Austrian Supreme Court will rule in the matter of negative interest. Due to the immense importance and cost intensity for financial institutions, the matter of negative interest will occupy the courts for a long period of time.