The Supreme Court Declares Default Interest Which Exceeds Ordinary Interest by Two Percentage Points As Abusive

In its judgment dated 22 April 2015 (the "Judgment"), the Plenary of the Civil Chamber of the Supreme Court declared the provision for default interest included in a general term of personal loans entered into with consumers is abusive when it exceeds ordinary interest of the loan by two percentage points. As a result, it has been established that, from the date of default, the loan will exclusively bear ordinary interest and the percentage surcharge of the default interest will be removed completely.

In the case resolved by the Judgment, the ordinary interest amounted to 11.8 per cent, and the default interest to 21.8 per cent, which exceeded the ordinary interest by ten percentage points.

In short, the bank alleged that this default interest had been individually agreed with the customer and, therefore, it was not possible to replace it for a lower one even if it seemed to be very high. Moreover, it was argued that when a default interest arises, it is because the debtor has shown legally reprehensible behaviour, such as failing to pay the loan amortisation instalments, and this serves to repair the damage caused to the creditor and to make the debtor comply with the contract in a regular way.

The Supreme Court's views

The Supreme Court rejected the arguments of the bank and concluded that, in banking contracts entered into with consumers, it is presumed that the clauses constitute general terms of the agreement which may be controlled by the courts to prevent abuse. For a clause to be excluded from that control, it is necessary for the bank employee (or other negotiator) to explain and justify the exceptional reasons that made him or her negotiate it with that particular customer. This obviously goes against the norm of standard contract terms, which facilitate mass contracting. It is also necessary to prove the existence of such negotiation and the returns that that particular customer obtained as a result of including clauses that favour the position of the bank. In this regard, the mere intervention of the notary public in the formalisation of the loan policy does not imply an individual negotiation.

The limit established by the Judgment for default interest, fixed at two percentage points over ordinary interest, arises from the analysis and comparison that the Supreme Court makes with other rules that regulate how to compensate the creditor proportionally for the delay in the compliance with obligations by the debtor (such as the Spanish Mortgages Act, the Insurance Contract Act, the Consumer Credit Contract Act and the Procedural Civil Act). In addition, the Supreme Court noted that in loan agreements without collateral and concluded through negotiation, the default interest is established by adding a small extra percentage to the agreed ordinary interest because the absence of collateral determines that the ordinary interest is already high. After such analysis, the Supreme Court concluded that the appropriate criterion is the one set out in article 576 of the Spanish Procedural Civil Act, which refers to the procedure arrears that a defendant should pay for a legally declared debt (legal interest of the money plus two percentage points). The Supreme Court deemed this to be proportionate and, at the same time, a deterrent for potential non-compliant parties. It also prevents the default interest from being lower than the ordinary interest.

The remedy applied by the Supreme Court to the nullity of the default interest clause considered abusive was to remove it entirely from the contract (rather than reducing it to a magnitude that excludes its abusiveness) and, therefore, to only maintain the ordinary interest (which had been fixed at 11.8 per cent) as from the date when the breach occurred. Thismeant that the breach by the customer does not result in a dissuasive "sanction" or "punishment". In order to reach such a conclusion, the Supreme Court applied: (i) the Directive 1993/13/CEE, on abusive clauses in agreements entered into by consumers; and (ii) the case law of the High Court of Justice of the European Union which interprets the Directive which indicate that the national judge may not modify the content of the abusive clauses in order to make them proportionate and acceptable, otherwise, banks could be tempted to use abusive clauses based on the fact that, even when declared abusive, the outcome would be most favourable possible to the abusing party.

The relevance of the Judgment is that it constitutes precedent, thus the new criterion shall be applied to other agreements in which the default interest exceeds the ordinary interest by more than two percentage points, which is extremely common in personal loans. Notably, as stated by the Judgment, the court can examine on its own motion whether a clause that has not been individually negotiated in an agreement entered into with a consumer is abusive, with no need for the parties to allege that.

Going forward

Regardless of the fact that banks may decide to modify the general conditions of their new loans or waive the claim for the abusive default interest already agreed, this Judgment also implies that, in principle, consumer customers may claim reimbursement of any excess default interest which has been paid so far. This scenario for the banks follows the recent case law regarding the so-called "floor clause" (cláusula suelo) (i.e. Judgment of the Supreme Court No. 139 dated 25 March, 2015) by which the Supreme Court ordered a bank to reimburse to its customer the interest collected in application of a particular floor clause. It is worth noting that, unlike the position of the Supreme Court in relation to the floor clause, in the case of personal loans entered into with consumers, the court has not set a longstop date which limits the period of time for which the affected parties may claim reimbursement. There is a real risk consumer customers may start to bring legal actions against banks to request reimbursement of these amounts, which makes it essential to seek appropriate advice in order to handle any such potential claims.