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Supreme Court Decides What Makes a Loan Unfair

Background to the Case

Although the particular case under appeal was not truly a case involving a loan , but rather an example of a consumer credit that could have been arranged over the phone, such that loans are transferred to the borrower’s bank account or by using a card issued by the financial institution, the law was held to apply and, in particular, Article 1 since Article 9 states : ” the provisions of this Act shall apply to an operation substantially equivalent to a loan of money , whatever form the contract may take, and the guarantee of compliance upon which basis the loan has been offered.

The flexibility of the rules contained in the Repression of Usury  Act 1908 has allowed the jurisprudence in this area to adapt the application of that law to new and diverse social and economic circumstances. In the case under appeal , those rules had to be applied to a credit transaction which , by by it’s nature , can be considered to lie within the ambit of ​​consumer credit.

The Civil Chamber of the Supreme Court in its judgment of 25th November 2015 considered that the judgment appealed from the  lower court infringed Article 1 of the Law of Repression of Usury in that the credit agreement must  be considered usurious , as were present the two mentioned legal requirements.

Legal Requirements for a Loan to be ‘Unfair’

A) The interest rate agreed was above the normal price of money.  The interest rate stipulated in the agreement was in the order of 24.6% APR. Since pursuant to Article  315, second paragraph,  of the Commercial Code  “any payments to be made by the borrower shall be considered when calculating the interest rate, the percentage to be taken into consideration in determining whether the interest rate is significantly higher than the normal cost of money is not the nominal rate , but rather the annual percentage rate (APR) , which is calculated taking into account any payments that the borrower has to make to the lender in respect of the loan, according to legally predetermined standards .

This extreme interpretation is essential (but not sufficient by itself) for the clause which  establishes the rate of interest to be considered transparent , because not only does it permit a more clear understanding of the burden that the credit loan supposes to the borrower or creditor , but it also enables a more reliable comparison with loans offered by the competition.

The interest rate with which the comparison is to be made is that  “normal  for money ” . It is not , therefore, compared with the ‘legal’ interest rate , but with that interest rate that is “normal or usual, taking into account the circumstances of the case and the freedom existing in such matters ‘ interest (Case no. 869/2001 of 2nd October) . To establish what is considered “normal interest rates” reference may be made to statistics published by the Bank of Spain , and taking as a basis point  the monthly information provided by credit institutions on the interest rates that are applied to various forms of lending (loans and personal loans up to one year and up to three years, mortgages with a term more than three years, current accounts, savings accounts, hire-purchase agreements, etc. ) .

That obligation held by the financial entities to provide  information on the interest rates they charge has its origins in Article 5.1 of the Statute of the European System of Central Banks and of the European Central Bank ( ECB), which details the obligation of the latter, assisted by the national central banks , to collect information through statistical operators. To this end , the ECB adopted Regulation (EC ) No 63/2002 of 20 December 2001 on statistics relating to interest rates applied by monetary financial institutions to deposits and loans vis households and non-financial companies; and thereafter, the Bank of Spain , through its Circular 4/2002 of 25 June, provided the mandatory content of the Regulation, in order to obtain the information required from the credit institutions. 

In the case under appeal , the judgment being reviewed had found as proven fact that the interest rate of 24.6 % APR – barely over double the normal average interest rate on consumer credit operations at the time when the contract was concluded – could not be criticized as excessive. However, the question is not whether or not it is excessive, but rather if it is ” significantly higher than the normal cost of money and manifestly disproportionate to the circumstances of the case ” and the 1st Chamber of the Supreme Court considered that a difference of this magnitude between the APR applied to this particular loan and the average interest rate on consumer loans on the date on which it was created, made it  possible to consider that the interest should be stipulated as ” significantly higher than the normal cost of money.”

B ) So that the loan could be considered usury it is necessary that, besides being significantly higher than the normal cost of money, the stipulated interest must be “grossly disproportionate when the circumstances of the case are taken into consideration .”     

As a matter of logic, since no test exists to determine that which is considered ‘normal’ it falls to be alleged and proven that there were exceptional circumstances that justified the ‘grossly disproportionate rate of interest’.  The financial institution that granted the “revolving”  loan did not justify the exceptional circumstances that explain the provision of a significantly higher interest than a standard loan in consumer credit.      

Generally, the exceptional circumstances which may justify an abnormally high interest rate are related to the risk of the operation. When the borrower plans to use the loan for a particularly lucrative, but high risk, operation, it is justified that the person who  finances it will , as well as having to run the risk, also benefit from the high profits expected by fixing the interest rate significantly higher than normal.

Consequences Of A Finding That Consumer Credit Has Is Usurious

The consequences of a finding that an offer of credit is usurious are as follows according to the judgment of the Plenary Session of the Supreme Court:  

  1. The usurious “revolving” credit arrangement granted by the Bank entails that the contract is invalid and has been described by the 1st Chamber of TS as “total, absolute and complete”, and permits of no acceptance whatsoever because it is fatally irreparable , nor may the contract be susceptible to  prescription, as a result of expiry of a long period of time, for example.  “( STS no. 539/2009 , of July 14, 2009).
  2. The consequences of such invalidity are those laid down in Article 3 of the Law of Repression of Usury , that is, the borrower is obliged to return only the amount received. In the case under appeal , the defendant (lender) had actually paid the applicant (the borrower) a higher amount than he had received , so the complaint was completely dismissed. The lack of a prepared counterclaim prevented the application of the second part of the provision, according to which , if the borrower had only paid back part of the loan received including principal and interest due , the lender would have to return to the borrower any amount which  exceeds the borrowed capital.
  3. As the defendant had paid an amount greater than that loaned to the applicant, it was not necessary to proceed to the return of interest on arrears, which meant it was unnecessary for the court to have to rule on the second ground of appeal , which raised a question that has already been settled by the jurisprudence of the Supreme Court ( SSTS no. 265/2015 , of April 22 , and 469/2015 , of September 8 ). Moreover, the high court understood that such irresponsible lending practices, providing easy access to consumer loans, without properly studying guarantees provided by the borrower, but at much higher interest rates than normal in order to compensate for late payments, results in those who regularly meet their repayment obligations have to carry the burden for those who are unable to, and this cannot be protected by law”.

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