Foreign Currency Loans and the Foundations of European Contract Law – A Case for Financial and Contractual Crisis?

2.1 Phenomenon and Core CJEU Decisions

Loans with variable interest rates indexed to foreign currencies are doubly risky, but in a very different and largely unforeseeable way for each single foreign currency separately. In the cases named, the main (foreign) currencies involved – with respect to Polish loans (Polish Zloty being the domestic currency) – were Euros (EUR), Swiss Francs (CHF), much less Japanese Yen (YEN). They indeed developed in dramatically different directions after 2000 – when household mortgage booms kicked in. Indeed, loans indexed in Euros turned out to be mostly neutral after 20 years, those indexed in Swiss Francs were disastrous, those in Yen even a good bargain.^[7] In Poland, unfortunately, Swiss Francs seem to have been the currency chosen most. Typically, loans in foreign currencies are entered into because of lower interest rates – indeed, practice would seem to show that often they were offered (and chosen) when a loan in the domestic currency, because of the higher interest rate, would not have passed the hurdle of ‘responsible lending’ (check of creditworthiness).^[8] In other words, the customer would not have received a loan in Zloty or other domestic (Croatian, Romanian, etc.) currencies. The variable interest rate loans indexed to foreign currencies are, however, doubly risky, because not only is the interest rate 8variable, which carries a fairly high risk of rising interest repayments, but the exchange rate risk is added as a second risk. When foreign currency indexed loans are issued at lower interest rates – especially when the domestic currency is still perceived as being weaker, like the Zloty at the beginning of the Millennium –, this is so because of the index of reference used. All are typically calculated by reference to an interbank offered rate. In the case of CHF, this was often LIBOR, in the case of the Euro typically EURIBOR. Their rates were variable, but almost consistently lower than WIBOR (Warsaw Interbank Offered Rate). Hence, the main bargain was lower interest rates (LIBOR/EURIBOR v WIBOR) v the risk of adverse exchange rate development for the loan principal that has to be repayed at the termination of the loan (EUR or CHF rising as against Zloty).

Given how unforeseeable both developments are, it could, of course, also be argued that disallowing foreign currency indexed loans completely for households would be the soundest consumer law policy.^[9] This, however, was decidedly not the policy of the European Union, not even after the Global Financial Crisis,^[10] nor of the legislature most heavily involved, the Polish Supervisory Authority from whom the association of Polish banks had even asked in vain to introduce such a ban.^[11] Therefore, the issue of such loans cannot in itself be seen as a ‘wrong’ imputable to banks involved – and the CJEU has rather clearly opted for this view, as well in the cases relating to the Romanian practice (see below 2). Thus, all highly affected Eastern European legislatures and the CJEU are unanimous in not imputing any fault to banks issuing such household loans. Exceptions, where such bans have been introduced, like in Austria, just show that this option was open to the legislature, but too seldom taken. For the banks in these countries, it is only a failure in the drafting of the terms of the loans that is at stake, which is associated with improper information.9

If then loans with variable interest rates indexed to foreign currencies are not banned as such, the core question debated today – and also in this article – is how to deal with cases where the mechanism of indexing is further specified via standard contract terms. What is not at stake is ‘naked’ direct referencing just to the foreign currency as such (on this issue see below Section 2 with respect to Romanian cases mainly). With respect to the case law on such loans with variable interest rates indexed to foreign currencies, where the mechanism of indexing is indeed further specified via standard contract terms, the following cases decided by the CJEU so far stand out.

In the case Árpád Kásler,^[12] the CJEU dealt with a Hungarian loan denominated in CHF that contained a standardised clause referencing the monthly instalments in Hungarian Florint to the bank’s own selling rate of exchange. Unsure about the clause’s fairness, the referring court asked the CJEU three core questions: whether the clause was outside the realm of judicial control (‘definition of the main subject-matter of the contract’ or ‘remuneration’), whether the requirement of clear and intelligible drafting also included the economic reasons for using the contractual term under Article 4 para 2 UCTD, and whether it was allowed to cure the contract by replacing the invalid clause with supplementary national law under Article 6 para 1 UCTD. Firstly, the CJEU left it to the referring national court to assess whether the selling rate of exchange of the foreign currency could define the main subject matter, but clarified that the difference between selling and buying rates of exchange cannot be considered as ‘remuneration’.^[13] Secondly, the functioning mechanism had to be transparent so that the consumer could understand the economic consequences for him or her.^[14] Thirdly, where the deletion of an unfair clause would render the continuation of the contract impossible, the CJEU allowed supplementary provisions of national law to fill the gap.^[15]

In Zsuzsanna Dunai,^[16] the CJEU further clarified the consequences of an unfair exchange rate clause of a foreign currency loan. It held that Article 6 para 1 UCTD permits the cancellation of a loan contract on the basis that the exchange difference is unfair when this restores the legal and factual situation in which the consumer would have been without the unfair clause.^[17] This builds on the case Gutiérrez Naranjo and Others, where the CJEU ruled that the restoration of the legal and factual status quo ante required the creation of a right to restitution of advantages wrongly 10obtained.^[18] On a second point in Zsuzsanna Dunai, the CJEU did not allow the cancellation of a loan contract for an unfair term relating to exchange rate risk where the contract cannot continue to exist without that term because such a term defines the main subject-matter of the contract under Article 4 para 2 UCTD.^[19]

In Kamil Dziubak,^[20] the CJEU had to interpret Article 6 para 1 UCTD on several questions deciding the fate of Polish mortgage loans indexed to CHF whose foreign currency exchange clause the referring court deemed unfair. The CJEU ruled that the annulment of certain unfair terms could lead to the annulment of the entire contract if their removal would effectively alter the nature of the main subject matter of the contract.^[21] In addition, the court must assess the consequences of annulling the entire contract in light of the existing or foreseeable circumstances at the time when the dispute arose, with a special consideration of the wishes expressed by the consumer.^[22] When upholding a contract, the national court was not allowed to fill the gaps left by the invalid clauses with national provisions of a general nature, such as equity or established customs.^[23] Where clauses cannot be replaced, they are not to be upheld unless the consumer expressly consents thereto.^[24]

2.2 Survey on Relevance for Main Affected Jurisdictions

Besides the core decisions reported above that deal with the extent of nullity and raise a question of restitution, both about its foundations and its extent for both contractual parties, there are other important decisions by the CJEU on household loans with variable interests indexed to foreign currencies. The characteristic of these decisions is, however, that the extent of nullity and restitution were not at stake here, because they had already been blocked or avoided at an ‘earlier’ stage. Alternatively, there are jurisdictions that solved core problems ensuing from nullity of such loans via specific national legislation. These developments influence the macro-economic importance of the issue considerably. Among the three most affected jurisdictions – Croatia, Romania and Poland – each has its particular setting.11

Romania, indeed, is the core jurisdiction where the household loan indexed to foreign currencies in large majority were arranged in such a way that the CJEU did not see a case for nullity.^[25] The loans referred directly to the foreign currency and the interest rate index related to it. The court judged that such ‘naked’ direct referencing just to the foreign currency as such fell under Article 4 para 2 UCTD and therefore the substantive scrutiny under the Directive did not apply when the clause was expressed in ‘plain intelligible language’ – all to be assessed at the moment of contract formation.^[26] The same legal outcome – now under Article 1 para 2 UCTD – was given to cases where the arrangement of the conversion mechanism just followed a norm contained in the national background legal regime, the bank just copying the wording, not giving any information and the bank potentially even being conscious of a lack of knowledge of the client.^[27] In case both provisions apply, the court gives preference to Article 1 para 2 UCTD, thereby totally excluding the clause from the ambit of application of the directive and its scrutiny.^[28]

Conversely, in Croatia the adaptation of annulled loan agreements to the changed circumstances was taken care of by the legislature. While this legislation was based on macro-economic reasoning, the consequence was that the weakness of Article 6 UCTD – of being too vague about legal consequences of annulment under the Directive and specifying them too little – was basically cured. The large majority of the loan agreements were based on a new and valid basis balancing the interests of both parties. Moreover, long-term agreements (especially of financial type where only money has to be refunded) raise questions considerably different from those in simple exchange contracts for which the UCTD would seem to be conceived primarily. The main legislative move was to establish a regime of national currency indexed variable (reasonable) interest loans into which consumers could opt and which the banks had to offer them under Consumer Credit Act 2015.^[29] As this constituted a default rule for the consumers (having an option), standard contract terms including such conversion into the new regime were upheld under Article 1 para 2 UCTD by the CJEU.^[30]12

Thus, among the three most affected countries, only in Poland were loans were annulled in large numbers (different from Romania) and there was no legislative solution to the changed circumstances that mandated a compromise solution (different from Croatia). This article hence focuses on the problems raised by such loans issued by Polish banks, a number of which also were referred to the CJEU for preliminary ruling. The solutions proposed here are, of course, of a general kind and would apply also to other jurisdictions – Polish cases just form the main body of case law.

2.3 Macro-Economic Market Considerations and their Relevance for Contract Law^[31]

In its opinion, the Polish Supreme Court requested from the Polish Financial Supervisory Authority on potential systemic risk for the Polish banking sector. The Authority distinguished different scenarios. These relate to the impact of a complete annulment – also of the duty to refund the principal of the loan (in Zloty) – and to the economic consequences a decision would have to bar any payment of interest by the borrower – even interest at low or the lowest available level. According to whether the interest is already paid or remains due, the result may play out in restitution claims of the client or claims of banks to still pay interest. The Authority gives detailed answers for several scenarios (no restitution of loan principal at all, no duty to pay interest at all, or a duty to refund the principal [in Zloty] and pay interest, either according to the [lower] index of LIBOR [related in real markets to CHF loans] or according to that of WIBOR [related in real markets to Zloty loans]).^[32] Depending on the decisions in these contract law questions, and given the volume outstanding, the Authority sees a more or less serious risk not only of losses, but of insolvencies and need for recovery proceedings, potentially also of a bank crisis more generally.

This view raises the question whether courts should take such a risk into account. The traditional view would rather see these questions as being unrelated to the individual justice considerations regarding the contract and its unravelling.^[33] The CJEU already adhered to this traditional view as well.^[34] It does not need to be13 discussed whether there is not a more recent trend to see regulation of the public good and private law considerations as being more closely related to each other -^[35] vigorously supported by the introduction of a private claims regime for antitrust competition law as one of the most paradigmatic areas of public good regulation.^[36]

The establishment of the European Banking Union and its stability regime for the banking sector – probably the dominant legal development in financial law in the last decade, and with respect to the overarching goal of interest here, applicable to EU Member States outside the Eurozone as well – is of core importance here. The reason is that it completely contradicts the traditional approach at least for scenarios where bank insolvencies are potentially at stake. For the banking sector, this stability regime has introduced one overarching principle and benchmark – with superiority over all others. The aim is to avoid bank crises (with their socialisation of costs, namely to taxpayers) by all available means, at least in scenarios where these crises are triggered by private gains or even windfall profits, which is why private burden-sharing via a bail-in mechanism (as opposed to a tax-funded bail-out) was introduced.^[37] No private investors (such as foreign indexed loan borrowers) may make14 their gains at the expense of the public at large (and privatise them). If this is the case already in case of risky investment (speculation), as before the global financial crisis, this has to hold true a maiore for gains that could not have been made anywhere on markets (windfall profits). This rationale of the core legal act and regime in banking law is to be taken seriously in the whole arena (at least) of banking law via systematic interpretation.^[38] It is indeed a prominent (if not the most prominent) method consistently used by the CJEU and also between different legal instruments (‘inter-instrumentally’), with a view to make EU policy considerations consistent.^[39] Therefore, borrowers not properly informed and subjected to (annulled) standard contract terms still have to refund both the loan principal and pay some interest. They profit ‘only’ from a most favourable treatment regime: They may now choose which one of the schemes available on markets at the time of the issue of the loan they prefer, e.g. principal of loan in Zloty tied to WIBOR or principal of loan in CHF tied to LIBOR. Conversely, they have no right to better deals than those that were available on the markets.

The argument that even redistribution is needed in financial markets into the direction of borrowers^[40] – going still further than ‘only’ re-establishing fair distribution – is problematic in three respects. These borrowers already have profited15 from (legitimate) gains on markets (massive increase of their investment in value).^[41] They would make any further gains (‘use of loan for free’) potentially at the expense of the public at large, also those that could not invest at all. Finally, why should value be redistributed from one group of investors (in shares, for instance needed for retirement schemes) to another group of investors (in houses), disregarding the constitutional guarantees of the former and the second potentially (and probably) even being the richer group? Why should such redistribution not primarily be a public task – supporting investment in housing, i.e. via schemes that do exist in many EU Member States?

3.1 Background Considerations: Partial and Total Nullity and Default Rules

This contribution focuses on a discussion and normative evaluation of the legal consequences of partial or total nullity of standard contract terms – and not of the grounds of nullity and of its extent. However, the main lines found in the case law of the CJEU should at least shortly be mentioned (as has been done already for the [mostly] Romanian banks issued loans that [in principle] escaped nullity because of their pure referral mechanism). This (older) case law (already more extensively discussed in the literature) serves as background to the discussion of the legal consequences and remedies. It is because of the Dziubak case^[42] and its interpretation that the question of restitution is so broadly relevant and hotly debated. The CJEU decision mandated national courts to consider as void standard contract terms that introduced any element of discretion into the reference to a foreign currency or to an index according to which interest was to be calculated (like LIBOR, WIBOR etc.). Moreover, the decision at least allowed national courts to consider also the whole contract as void – and only this would trigger all the questions concerning restitution, constitutional issues and questions relating to how market expectations and systemic risk of bank insolvencies impact. It is, however, disputed whether the court16 also mandated full nullity of the contract,^[43] or left this decision to national courts to decide.^[44] Some authors hold as well that integration of the contract would well have been possible^[45] thus triggering the regular legal consequence of Article 6 para 1 UCTD, namely default rules filling the lacuna created by the nullity of the single clause. In this respect, one further delineation which the court made is that the complementing and filling of such lacunae is possible only via national legal acts, not via rulings by national courts.^[46]

An important consequence of the development triggered namely by the Dziubak case and its understanding in legal academia and practice is an unexpected and impressive new focus on the (EU) law of restitution. The condition was always that the whole contract was seen as void. What ensued was a strange landscape, consisting of two parts, the first one strongly discussed, but with very vague principles. Indeed, it became clear how weak the denominators for legal remedies and consequences are in the Unfair Contract Terms Directive – as the act that triggers the nullity. Also the alternative, common principles derived from national laws on restitution claims for unjust enrichment or resulting from damages and recognised in EU law, remains loaded with considerable uncertainty – because of the need to distil them from Member State law as general principles (for both regimes, see below Sections 2 and 3). These two vague regimes can be complemented by yet another regime that is based mainly on a balancing of open-textured rights, namely the17 constitutional dimension which only lately started to come to the fore (see below Section 4). All these regimes as a larger corpus strongly depend on benchmarks and their interpretation, namely justified expectations, fairness or as well balancing of gains, windfall profits and losses, potentially even losses, which are systematically relevant (see below Sections 3.5 and 5 and also above Section 2.3). The second part of the landscape consists of a rather specific regime, contained in Article 23 of the Mortgage Credit Directive of 2014, so far virtually not discussed for the scenario at hand, for which precision of the rules is not the main concern, but rather its applicability (see below Section 4). Thus, the overall picture of the EU law of restitution is one composed of a set of rules that certainly apply, but whose content is vague, and of a regime that is precise, but whose application remains uncertain and which has been discussed very little so far.

3.2 The Restitution Regime of the Unfair Contract Terms Directive

The Unfair Contract Terms Directive itself does not specify the restitution claims arising from the annulment of a contract. Unfair terms shall ‘not be binding’ on consumers under Article 6 para 1 UCTD and Member States have to ensure ‘adequate and effective means (…) to prevent the continued use of unfair terms’ under Article 7 para 1 UCTD, but the consequences for restitution are not legislated and, in principle, left to national law. In the absence of a European restitution regime, it is the legislative purpose – as expressed in the recitals and the system of the norms – and CJEU jurisprudence that gives important guidance on the relevant principles and criteria for restitution under national law. In case law, these principles can be found both in general CJEU rulings on the Unfair Contract Terms Directive and in specific judgments on foreign currency loans.

The first principle is private autonomy. Like EU consumer law in general, the Unfair Contract Terms Directive builds on the free will of the consumer as a knowledgeable contractual party. As a result, Article 4 para 2 UCTD excludes judicial fairness control of the main contractual obligations where fully autonomous decisions can be assumed even in standardised contracts, i.e. the ‘main subject-matter of the contract’ and the ‘adequacy of the price and remuneration’. In Árpád Kásler, the CJEU confirmed this legislative decision (just as in the cases on Romanian practice) and specified the exact content for foreign currency loans. It left it to national courts to decide whether the selling rate of exchange could define the main subject-matter and clarified that the difference between selling and buying rates of exchange are not ‘remuneration’, especially where the lender does not provide18 foreign exchange services.^[47] It can be further assumed that the amount of the loan principal and its denomination in or indexation to a foreign currency plus the interest rate, e.g. if indexed to LIBOR, EURIBOR or WIBOR are outside judicial fairness control. The parties’ autonomous will ought to be respected also when it comes to unwinding the null contractual relation in form of mutual restitution claims. Restitution shall place the parties in the position where they would have been without the contract, by restituting to each other their respective contributions. It should be clarified already at this point – subject to further explanations later on – that also the (service to provide the) use of the loan principal constitutes such a contribution.^[48]

The second principle is consumer equality, not superiority. Well aware of informational and bargaining asymmetries between business and consumers, the Unfair Contract Terms Directive aims to re-establish the equality between them. In other words, market failure is to be cured. There is no indication either in recitals or in the norms that giving windfall profits to the client/consumer constitutes an aim of the directive as well. Ex ante, this means that consumers have to be informed in a clear and intelligible way on the economic consequences of a foreign currency loan, including the difference between the selling and buying rates of exchange and their different impact on the calculation of the total sum due, as the CJEU ruled in Kásler.^[49] Ex post, equality means ‘not to cancel all contracts containing unfair terms but to substitute for the formal balance established by the contract between the rights and obligations of the parties real balance re-establishing equality between them’ – according to the CJEU in Dziubak.^[50] In terms of restitution, the overall idea is not to overprotect consumers, but simply to re-establish the balance through the restitutionary obligations.

The third principle is good faith and fairness, the core aim of the Unfair Contract Terms Directive. This is the principle among the three that is most directly expressed in the directive, namely in Article 3 para 1 UCTD, which constitutes the key norm for the criteria of scrutiny, i.e. the key norm for distinguishing between nullity of terms and validity of terms. In Dunai, the CJEU held that Article 6 para 1 UCTD meant that19 ‘a contractual term held to be unfair must be regarded, in principle, as never having existed, so that it cannot have any effect on the consumer, and that it has the consequence of restoring the consumer to the legal and factual situation that he would have been in the absence of that term’.^[51] For restitution, this means that the parties – both parties, both with respect to loan principal and interest payments – are to be put in the legal and factual situation they would have been in if they had not agreed the contract. In foreign currency loans, the difficulty arises from the difference of the sum due at the original exchange rate when the loan was disbursed and the sum due at the current exchange rate when restitution is claimed. This applies to both the loan principal and the exchange rate. The principle of good faith and fairness requires that all restitution claims from both sides – i.e. the bank claiming back the loan principal and interest and the consumer claiming back all instalments and interest payments – are subjected to the same logic and exchange rate.

The fourth principle is no penalisation. Article 6 para 1 UCTD does not intend to penalise either contractual side. The consumer ought not to be penalised by any solution found, as the CJEU stressed in Dziubak that the nullity of entire contracts could not result in ‘unfavourable consequences’ for consumers and hence, did not ‘penalise’ consumers.^[52] Neither is the business counterpart to be penalised. Of course, the Unfair Contract Terms Directive aims to deter unfair practices in the drafting of contract terms. However, there is no indication either in recitals or in the norms that penalisation of the user of standard contract terms is an aim of the UCTD. In addition, penalising the consumer’s business counterpart is not an objective because – more generally – penalisation is foreign to EU law (see below V 2).

The last principle is procedural autonomy within the boundaries of equivalence and effectiveness. This mainly regards procedural rules, such as prescription or limitation periods for the actions resulting from unfair clauses. Regarding consumer credit agreements, the CJEU ruled in Raiffeisen Bank and BRD Groupe Société Générale that while Articles 6 para 1 and 7 para 1 UCTD allow for time limits of the action seeking restitution on condition that the period is not less favourable than in similar domestic actions (principle of equivalence) and that it does not render practically impossible or excessively difficult the exercise of rights conferred by EU law20 (principle of effectiveness).^[53] The CJEU found a three-year limitation period running from the full contractual performance to infringe these principles, if the consumer’s knowledge was presumed and not proven in the concrete case.^[54] Similarly, it ruled in Profi Credit Slovakia that a limitation period hinders effective enforcement if it starts from a moment in which the consumer is not yet in a position to assess for himself or herself that a contractual term is unfair.^[55]

3.3 The Restitution Regime of General Principles (of EU and National Laws)

There is no clear or common general restitution regime in EU law itself or derived from national laws. However, both sources provide three general principles governing restitution: private autonomy, good faith and fairness, and unjust enrichment.

The general principle of party autonomy can be derived from the Fundamental Freedoms in EU primary law, party autonomy forming their underlying rationale.^[56] Similarly, Members States’ private laws are all based on this principle; thus party autonomy forms a general principle common to the Members States’ private laws. Finally, also for most EU secondary law acts and the bulk of their rules, party autonomy serves as the underlying rationale.^[57] In substance, it is strongly linked to information rules. The reason is that they give a denser basis (namely to consumers) to exercise their party autonomy in a meaningful (and truly autonomous) way (denser form of party autonomy) – a consideration that is paramount also in UCTD law, as has already been explained and the Dziubak case has stressed (material, not only formal equality). Withdrawal rights function in much the same way. Indeed most contract law in the EU is targeted on private autonomy (with enhancing the information basis) or, where autonomous choice seems illusory, alternatively to21 paternalistic protection.^[58] The general thrust of this principle for the law of restitution is that – as already under the UCTD – also as a general principle of EU law, the content of restitution has to come as close to what the affected parties would have had as their expectations when the cause for nullifying the underlying legal relationship occurred.

The general principle of good faith and/or fairness constitutes a principle common to the Member States.^[59] This explains its particular role already in Article 3 para 1 UCTD. It is rooted in common concepts of ancient Roman Law, starting with its importance as key principle under German Law since codification and even more in the course of the 20th century, upgraded to an overarching principle for all aspects of contract law also in the Romance legal orders, namely France in the grand reform of 2016.^[60] It gradually changed from a principle of limited ambit to a truly overarching and omnipresent principle of contract. At least in unfair contract terms law, also UK law makes no exception.^[61] The good faith and fairness principles are omnipresent, however, also throughout harmonisation acts in contract law, be it commercial contracts or consumer contracts, and increasingly have been accepted as one of the most important and indeed overarching principles of EU contract law as well by the Court.^[62] The common thrust is always to foster solutions where the interests and justified expectations of both parties are safeguarded as far as possible, i.e. in a duly balanced way and without giving priority to one party in a one-sided way. For restitution law, this implies that windfall profits (that would not have been available in any market scenario) are to be judged unjustified and hence have to be returned.

Finally, the general principle of unjust enrichment – and duties of restitution deriving from it – is a principle of all Member States’ private laws.^[63] It constitutes, however, a principle less omnipresent in the Court’s case law and EU legal acts than the other two. The Court recognises the concept of unjust enrichment namely as a22 remedy against the EU,^[64] but sees it as well as a remedy of a broader ambit of application in case of nullified contracts when transfers have to be returned.^[65] In this respect, it is flanked by a principle of efficient cure and remedy.^[66] As EU legal acts at least recognise the principle (and do so rather frequently), the lack of a clear structuring of the principle of unjust enrichment in EU legal acts would seem to be mainly due to the fact that EU law turned to regulating remedies for violation only in relatively recent times. In most cases, EU law still is limited to setting the standard as such and leaves the remedies for nullity or breach to the Member States, though within a framework (mandated already by EU law as outer boundaries), in which fairness and efficient honouring of justified expectations is warranted.

3.4 A Constitutional Dimension to the Restitution Regime?

The restitution regime can and should be assessed as well in a constitutional perspective – even if there is only space to do so in broad lines in this contribution.^[67] The Articles in the EU Charter on Fundamental Rights that are most prominently quoted on the side of the borrower are Articles 7, 38 and 47^[68] – respect for private and family life; high level of consumer protection, and fair procedure. A number of contributions contend that these articles create a self-standing right to the private home. While Article 7 EU Charter is sometimes quoted indeed as an additional source in CJEU case law, when the right to fair trial (Article 47 EU Charter) is at stake, the risk involved has to be carefully considered. This fundamental right might potentially be touched by eviction (if there is indeed the risk in the particular case), but not if just a duty to pay interest on a loan is at stake (pure monetary interests). Such cases of eviction were indeed the scenario whenever the CJEU made reference to Article 7. Article 38 EU Charter refers to the high level of consumer protection, which,23 however, is substantiated more in detail in the directives, which refer to the same formula. In any case, the core question remains whether this level of protection should only guarantee that consumers get the full benefit of what markets can offer to duly informed and circumspect consumers or whether it should guarantee consumers windfall profits beyond what markets offer – for instance loans for decades without interest payments. Article 47 EU Charter is on the fairness of the trial and indeed constitutes the provision most quoted – implicitly and explicitly – in CJEU case law on housing and loans, most centrally in any case.^[69] Still, these cases are primarily about procedural fairness – namely the right to be heard and to have sufficient time to react before the final decision is taken – and not about fairness in substantive outcome. The latter is meant to be furthered by having one’s arguments heard. This implies that borrowers (and also lenders, as Article 47 EU Charter protects all private parties) must have had a fair chance to make their case heard – which is paramount for the calculation of the period of limitation in the context of the scenario discussed here.^[70]

One fundamental right rather astonishingly has hardly been discussed until lately. This is the right to property, putting limits to effects of expropriation. This is a right that potentially can be invoked by both parties – by the borrower against eviction, by the lender against expropriation of the loan principal (no refund), but as well against expropriation of the use of the loan principal without remuneration (no interest payments).^[71] More generally, what is often neglected in the discussion about fundamental rights as well is that, in cases of horizontal effect, a balancing of the fundamental rights of both parties is of the essence – namely the right to property on the one hand, and the right to appropriate housing, at least not to be arbitrarily evicted from it, on the other hand (last paragraph, with the seminal decision in the Aziz line of cases).24

3.5 In Particular: The Role of Justified Expectations^[72]

In the cases that are most disputed (and referred to the CJEU), Polish banks offered their clients the alternative of either CHF as the currency of reference and LIBOR as the (variable) interest rate of reference or Zloty as the currency of reference and WIBOR as the (variable) interest rate of reference.^[73] For each of the two variants, periodic adaptation to the chosen interest rate of reference was foreseen. For the latter (periodic adaptation), a scheme was foreseen in standard contract terms including a discretionary decision by the bank on the when and how exactly. In this respect, the UCTD regulation came into play. For one-sidedness, this awarding of a discretionary position to the bank/lender was nullified (and thereby often as well the whole contract).

This raises the foundational question of what scope the regulation is aiming at. Regulation – as it is seen by mainstream economic analysis of law – is about reinstalling market mechanisms where they do not properly function, namely to allow for a properly informed and undistorted equilibrium between demand side and offers available,^[74] not about substituting markets, creating offers that are not available on markets,^[75] even less constructing offers that cannot realistically be made.^[76] Therefore, when information was not properly given or one side had an25 improper unilateral right to discretionary decision-making, this flaw has to be cured and a solution be found that mimics the situation that would have existed without these flaws. What is best is to give the party affected by such flaw the same opportunity (again) as it would have existed without such flaw. If a weaker party needs to be protected against such flaws, it is properly protected (potentially even more than properly protected) if it is empowered to take the decision free of such flaws at a later moment in time – more protected as he/she can now act by hindsight. This ‘advantage’ for the weaker party, if it represents the only feasible way of mimicking a decision made without flaws at the outset, is a necessary precondition for curing the flaw and at the same time still imputable to the other party’s responsibility for the flaw – hence acceptable. Conversely, all solutions reaching beyond this level – to the benefit of the weaker party – would constitute windfall profits for this party, substituting and no longer curing markets. Hence, justified expectations are those expectations that could have been realised at the formation of the loan contract, offers available at that time, with a choice now made with the benefit of hindsight – an option right given to the borrower. Anything reaching beyond this level constitutes over-regulation (or redistribution that requires additional grounds for justification, that cannot be found in the constitutional framework, see above Section 4).

4.1 The Mortgage Credit Directive as Fully Fledged Restitution Regime

As opposed to the vague restitution principles discussed so far, the Mortgage Credit Directive (MCD) provides a tailored restitution regime based on two pillars: firstly, specific provisions on foreign currency loans in Articles 23 and 24 MCD and, secondly,26 restitution lessons from the consumer creditworthiness assessment under Article 18 MCD in its national transposition. Both give very clear indications of how to deal with restitution claims after foreign currency loans have been annulled.

In the Mortgage Credit Directive, EU legislators clarified their intention to allow foreign currency loans in principle. Article 23 MCD explicitly allows loans denominated in a foreign currency, which Article 4 para 28 MCD defines as a currency other than that of the consumer’s country of residence, income or asset to repay the loan. Loans indexed to a foreign currency are not explicitly regulated, but either covered by the same provision by analogy or at least by Article 24 MCD on variable rate credits as the foreign currency is used as a reference rate. The Mortgage Credit Directive establishes a mechanism to protect consumers from the exchange rate risk in foreign currency loans, a protection grounded in disclosure and party autonomy. In foreign currency denominated loans, Member States have to either grant consumers the right to convert the credit agreement into an alternative currency, especially their home currency, under specified conditions or establish other arrangements to limit the exchange rate risk for the consumer (Article 23 para 1, 2 MCD). In the case of conversion, the market exchange rate applicable on the day of application for conversion has to be used by default (Article 23 para 3 MCD). The lender has to inform the consumer on a regular basis if the exchange rate deteriorates by more than 20% (Article 23 para 4 MCD). Consumers have to be informed about the applicable protection mechanisms in the standardised information sheet ESIS and in the loan contract itself, including an illustrative example of a 20% exchange rate fluctuation (Article 23 para 6 MCD). It makes sense to apply all these provisions by analogy also to loans indexed to a foreign currency as they carry the same exchange rate risk as foreign currency denominated loans. Even if this analogy were denied, Article 24 MCD would still address foreign currency indexed loans and mandate two requirements. Firstly, the applicable exchange rate has to be clear, accessible, objective and verifiable by the parties (Article 24 lit a MCD). Secondly, lenders have to maintain historical records of the exchange rates for calculating the borrowing rates (Article 24 lit b MCD). The same requirements also apply to foreign currency denominated loans with variable interest rates. The rules of Articles 23 and 24 MCD provide clear guidance for how EU legislators conceive a fair agreement between professional lenders and consumer borrowers on a foreign currency loan. While this is about a set of requirements for proper information and performance, the regime also is pertinent to flawed processes.

Specifically on the restitution of a void contract, the consumer creditworthiness assessment under the Mortgage Credit Directive and its national transposition provide further helpful guidance. This duty has evolved from the duty of responsible27 lending to a forceful instrument of public and private law.^[78] Pursuant to Article 18 para 1 MCD, creditors have to thoroughly assess the consumer’s creditworthiness before concluding a loan agreement. In doing so, they have to take into account all relevant factors, not just the value of the residential immovable property (Article 18 para 1, 3 MCD). Errors in the creditworthiness assessment may not lead to the loan’s cancellation or alteration apart from cases of fraudulent consumer behaviour (Article 18 para 4 MCD). The consequences of wrong assessment are mainly spelled out by national law. The EU’s two biggest jurisdictions Germany and France show that the loan is upheld with a mere reduction in interest rates. In France, the interest rate can be reduced by up to 30% if the lender fails to properly inform the consumer about the financial risks or if it does not properly assess the creditworthiness.^[79] Only if no creditworthiness assessment takes place at all can the interest rate be reduced to zero.^[80] In Germany, interest rates are reduced to a market minimum. Fixed interest rates are reduced to the prevailing market rate on capital markets for mortgage bonds and public bonds whose duration corresponds to that of the fixed interest rate.^[81] Variable interest rates are reduced to EURIBOR 3M.^[82] Both national transpositions show that, even where lenders infringe their duty to assess the borrower’s creditworthiness, in principle, there is no credit without interest, but rather interest rates are reduced in proportion (France) or to a market minimum (Germany). This rationale can be transposed to the case of foreign currency loans being partially or totally annulled.

4.2 The Mortgage Credit Model as Paradigm of General Principles

While the Mortgage Credit Directive of 2014 does not directly apply to most of the foreign currency mortgages in Central and Eastern Europe whose restitution claims are of systemic relevance, the CJEU applied the Mortgage Credit Directive already in a case predating its enactment – the case Michel Schyns.^[83] When asked if the consumer creditworthiness assessment under the Consumer Credit Directive obliged creditors to refrain from concluding loan agreements where the assessment is negative, the28 CJEU referred to the creditworthiness assessment under the Mortgage Credit Directive, although neither applicable in time nor in substance, and answered affirmatively.^[84] In line with this ruling, the tailored restitution regime for foreign currency loans under the Mortgage Credit Directive (see above Section 1) can be applied to cases before its national transposition. In the case of a variable interest rate mortgage loan denominated in or indexed to a foreign currency, the contract model is regulated in the Mortgage Credit Directive, which sees these contracts as valid in principle under Articles 23 and 24 MCD. At least the validity of foreign currency as such is unquestioned; under European law, they constitute legitimate transactions.

Moreover, in the parts most relevant, the Mortgage Credit Directive reflects homogeneous practice over decades in the Member States. In substance, two main features of the regime stand out. It provides a blueprint of a fair foreign currency loan whose currency exchange clause cannot be deemed unfair. Moreover, because of that homogeneous practice, the alternative of now a foreign variable interest mortgage loan also constitutes – again – the amount that any borrower would have had to pay and hence is enriched with, in case he did not have to pay it. In content, Article 23 MCD, even though not applicable retroactively, indicates two things. Foreign exchange variable interest mortgage loans can be advantageous for both parties, hence are not void per se. The risks remaining should, however, be contained by conversion rights to the borrower’s own currency and by warning duties, namely when the exchange rate alters to the detriment of the borrower by more than 20%.^[85] Under the model of the Mortgage Credit Directive, the borrower then decides and has to decide whether to choose conversion or to carry on. There is no paternalistic protection for him, but only an informed choice made possible. Article 24 MCD makes clear that a combination with variable interest rates is possible (and indeed even the norm for foreign currency loans), as long as the indices used are clear, neutral and traceable (as LIBOR, EURIBOR and WIBOR are). This reflects the underlying principle of private autonomy in EU consumer law. It also balances the interests of the contracting parties by (re-)establishing informational and decisional equality to the benefit of consumer borrowers, while not overly protecting them or rendering them superior to business lenders. In this sense, it also constitutes an obvious and stringent expression of the overall principle of good faith and fairness.

While the Mortgage Credit Directive is not applicable in most of the restitution cases, it nevertheless gives valuable insight. In the Schyns case, the Court has used similar insight as well already before the Mortgage Credit Directive formally applied.29 The insight is this: even if a loan contract is totally void – in the Schyns case not for violation of standard contract terms law, but because of the (equally important and perhaps even more directly related in substance) duty of responsible lending –, restitution claims for the loan principal are given. Moreover, according to legislative decision at the Member State level (as the Mortgage Credit Directive is largely mute on this), interest rates are not to be fixed at zero, but at the lowest (‘most favourable’) market rate that borrowers could have got. In the two largest jurisdictions, this spells out as follows. France allows a reduction of the agreed interest rate to up to 30% for virtually all violations (typically, however, intentional), while Germany just reduces the agreed upon interest rate – fixed or variable – to a (low) benchmark rate of the market, e.g. EURIBOR 3M. Increase of interests in case of violation is explicitly excluded under Article 18 para 4 MCD. Comparing violations of the duty to transparently fix exchange rate mechanisms and of the duty to properly assess creditworthiness, the latter would seem even worse given that the borrower is still weaker. Therefore, an a-maiore-argument from the Mortgage Credit Directive context seems appropriate in treating restitution cases of foreign currency mortgages.

5.1 Fairness, Justified Expectations and Consumer Equality as Benchmarks of UCTD and European Law of Restitution

When we introduced the offers de facto available on loan markets in Poland back in the 2000s, we explained the concept of justified expectations. We elaborated on that the aim of regulation is seen in mainstream regulatory theory in reaching these expectations as far as possible by re-installing or mimicking functioning market conditions – not going beyond that level, i.e. not taking the role of a redistributor of assets (above Section 3.5). This should now be tied back to contract law concepts, more concretely the key concepts used in the UCTD discussion. Indeed, we want to specify the relationship between justified expectations, fairness/good faith and consumer/parties’ equality as the three key concepts used with three core aspects in UCTD that can thoroughly be anchored as well in legislation and CJEU case law. The first question is for which shortcomings, according to CJEU case law, the UCTD regulation has been enacted and to which end. The second question is about how the nullity of standard contract terms as the prime legal consequence of the control30 relates to default rules as the prime alternative normative material envisaged in the UCTD. Default rules are so core in the UCTD because they form a prime benchmark for fairness and as well the prime supplementing regime for filling lacunae opened because a standard contract term is annulled. Finally, the third question is about the relationship of the three concepts more generally – justified expectations, consumer/parties’ equality, and good faith/fairness. The last one of the three concepts it the most straightforward to define. In Article 3 para 1 UCTD, when defining the criterion, which decides which standard terms have to be annulled or not, good faith and fairness are singled out as the two core criteria.^[87] They form the guidelines by which proper clauses (binding) are distinguished from abusive clauses (voidable).

The first question is about the purposes of UCTD regulation (grounds and aims of regulation). The answer to the first part of the question was described in the Oceano Grupo case in a seminal way. The Court sees two grounds: ‘the Directive is based on the idea that the consumer is in a weak position vis-à-vis the seller or supplier, as regards both his bargaining power and his level of knowledge.’^[88] Hence, if bargaining power of the whole demand side and of the whole side of offers is taken as benchmark and information is fully given and explained to the consumer again, and the consumer can make his choice on this basis now, the two reasons for regulation are satisfied. This is the core idea of letting consumers/borrowers now choose among the offers that were on the Polish loan markets at the moment when their loan was negotiated – with full information, as a result of hindsight, on full market options. For further supporting this idea, one can as well turn to the aim of regulation. In the Mostaza Claro case, the CJEU established that the prime aim must be to find a mechanism to re-establish the equilibrium that would exist without the two grounds named for regulation and describes the result as ‘equality’ (of parties). The regime (and namely the core legal consequence in Article 6 para 1) ‘aims to replace the formal balance … between the rights and obligations of the parties with an effective balance which re-establishes equality between them.’^[89] Thus, regulation should31 further consumer expectations by also putting them de facto at the same level (equality), not by giving consumer more than he/she could have got with proper information and equal bargaining power (on overall markets). Otherwise, consumer contract law would as well be in fundamental disagreement with overall contract law that is about balancing the affected interests equally, not systematically giving preference to those of one side.

The same result can be reached from another perspective, now looking at the role of default rules in UCTD. When the CJEU in the Kásler case seminally explains why default rules are taken to supplement a standard clause struck-down, the role of the legislature is paramount. The (national) legislatures – not even courts – are seen as the body that (in general) is most clearly constituted in such a way that all interests are fairly balanced, not one is preferred systematically.^[90] It would a maiore be absurd, if a court should then be allowed to fill the whole contract when the whole contract is struck down in a way that systematically preferred consumer interests.

The third question is about fairness, justified expectations and consumer equality, thereby also what ‘a high level of consumer protection’ may imply, and how this is related to the overall scope of contract law (and as well of information rules) to establish an equilibrium, i.e. to strike a good balance between the interests of all parties involved. A bit more concretely, would it not be contradictory if contract law indeed was about fair balancing of all affected interests and if nevertheless consumer law was about preferring the interests of consumers beyond a fair balance, even if unfair to their counterparts? In one of the most discussed and most hailed judgments on UCTD of last decade, the CJEU in Aziz, defined the two main criteria of ‘unfairness’. It defined that ‘gross imbalance’ meant gross deviation from the default rule regime (seen as a regime of balanced interests, see above) and that ‘circumstances’ of the formation of contracts referred to justified expectations in that moment.^[91] In literature, this was described as a32 ‘possible agreement test’.^[92] Thus, solutions that could be reached now and to which any properly informed consumer acting in good faith would then have agreed, fully complied with the aim of the regulation. The ‘high level of consumer protection’ then consists in that not only formal equality of information must be reached, but material equality, i.e. the fair possibility for the consumer really to understand the main substance, also of the risk incurred.^[93] ‘High level of consumer protection’ does not imply distribution beyond ‘fairness’, i.e. redistribution. This solution is also in line with the main provision on legal consequences. Article 6 para 1 UCTD is indeed about bringing the adopted (supplementing/alternative) solution as close as possible to what the contract would have brought the consumer if not vitiated by the problem of inequality in information/bargaining power.^[94]

5.2 Penalisation and Redistribution as Aims of European Contract and Restitution Law?

In a last section, the ‘consumer’ equality issue should still be deepened a bit, namely in that it is further explained that neither ‘penalisation’ of lender/banks is an aim of European Contract Law and UCTD nor is redistribution – pointing mostly into the same direction in our scenario. Both approaches propose to bar any duty to refund the loan principal and/or bar any duty to pay interests for the long-term use of the loan principal, i.e. to leave that use to the consumer ‘for free’. Our discussion of this proposal and the approaches behind it is not based on a single theory postulated in literature, but on the legislature’s expressions, on the core rationale of CJEU case law and on general traits to be found in (enacted) European contract law (with constitutional bases) – as only these are seen as the ‘hard bases’ of (democratically posited) law.

We start with European competition law, which forms the first (and the sole primary EU Law) area that was enacted with the aim of consumer protection.^[95] It33 contains as well the most explicit statements on the issue of penalisation, both in CJEU case law and by the European legislature. Compensation is the sole philosophy at EU level, any philosophy of penalisation is explicitly excluded – in the lead decision in Manfredi,^[96] in Recital 13 of the Cartel Damages Directive and in its Article 3 para 3,^[97] which reads as follows: ‘Full compensation under this Directive shall not lead to overcompensation, whether by means of punitive, multiple or other types of damages.’

The same is true, albeit a bit less explicitly, but certainly with enough clarity for the UCTD. When the CJEU makes clear that only default rules may fill lacunae opened up, when a contract term is struck down, not courts, this is because default rules are presumed to balance all interests evenly, not give preference to one side (see above 1) – for instance because economic theory stresses the importance of incentives and penalisation and makes this the sole and completely dominant aspect. If only the legislature is called upon filling gaps, all the more it is only the legislature that can add such an important overall philosophy as penalisation as a main aim of the UCTD (where no indications are given in the directive). Even for the UCTD, the EU legislature has spoken to the opposite (albeit less powerfully and less explicitly than in the Cartel Damages Directive). The UCTD legislature has not imposed fines, and also effective sanctions only for ‘continued’ violation’, not for a first violation and one that was done involuntarily. At least non-fraudulent behaviour, namely when even not yet challenged and struck down in court, would seem to be seen by European mainstream as a flaw that leads (only) to modified amounts of interests. It does not lead at all to cancellation of all duties to pay interest and thereby to a sub-market windfall profit for the consumer/borrower (see discussion of Articles 18, 23 and 24 MCD above Section 4.1). All CJEU judgments quoted above in Section 1 are based on a principle of equality of interests affected – that should be furthered not only formally, but materially. Thus, the aspiration of the UCTD to have deterrent or dissuasive effects,^[98] implies all the instruments developed by the CJEU and/or the34 directive – ex officio statement of unfairness, legal standing for consumer protection associations, no validity conserving reduction of the clause etc. It does, however, not include fines and imposing other sanctions that take away property from the user of standard contract terms that he/she would not have been deprived of had the information and the standard contract term been appropriate – hence no penalisation in the proper sense.

Penalisation would even raise further hurdles. How about nulla poena sine lege and the pertinent case law – for instance on Article 7 of the European Convention on Human Rights – concretising this principle? Would dissolution (a bank’s insolvency) not constitute such penalisation? Would there not need to be ‘continued’ use of the standard contract term incriminated (this is the lex and wording on which the sanction is based according to Article 7 para 1 UCTD), and can penalisation be seen as based in the act when the UCTD does not even foresee fines?^[99] All considerations on penalisation can properly be summarised in three ways. First, all the more recent CJEU case law explicitly runs counter allowing penalisation trends in European contract law, regulation and more specifically within the UCTD. Second, also the most pertinent position-taking by the EU legislature in the last decade in European market regulation explicitly excludes penalisation. Thirdly, not even the constitutional boundaries for penalisation would be respected in this case (see also next paragraph).

The argument that redistribution is needed in financial markets in the direction of borrowers^[100] – going still further than ‘only’ re-establishing fair distribution – is problematic already for the same reasons (because, by necessity, the substance of the proposal implies as well penalisation of the lenders/banks). There are four additional aspects though (see already end of above Section 2.3). Redistribution for their benefit would create windfall-profits to clients that already have made huge gains from speculation by the same transaction anyhow (gained 7% above inflation rate). This additional gain would potentially have to be financed by the public at large (‘taxpayers’), which was not involved with these transactions (a consequence the whole compound of EU Banking Union wanted to combat). Thirdly, one (probably richer) group of investors (in land) would in any case benefit at the cost of another (probably less wealthy) group of investors (in stock) by such windfall profits. Finally, constitutional boundaries are not taken into consideration in an equilibrated, but a one-sided way. What would need to be considered is a balancing of all fundamental rights (all affected parties, obvious in horizontal application), namely also the right to35 property of borrowers which would seem to be infringed if there is no mandatory justification by other fundamental rights (already vested).^[101]