1. Subject matter and purpose
All European jurisdictions provide standardized rules for the basic type of capital procurement transaction (credit) that pertains to the temporary allocation of money or fungible assets. Typically, the lender commits herself to supplying the valuta to the borrower at her unrestricted disposal for a finite period of time. The borrower, upon maturity, has to redeem the loan by repaying its nominal value or by returning goods of equal kind, quality and amount. Moreover, the borrower is usually obliged to pay interest as remuneration for the temporary allocation of money or fungible assets. The term ‘consumption loan’ used for regular loans in some jurisdictions (eg verbruikleening in the Netherlands and prêt de consommation in France) highlights that these contracts generally aim at the allocation of the valuta at the borrower’s unfettered disposal, as opposed to the mere transfer of a right of use and enjoyment under rental or lease agreements. Hence, the borrower may typically expend or dispose of the supplied goods or money at his own discretion.
The law of loan contracts supports the efficient distribution of capital (money or other goods) among market participants. It provides a transaction cost-saving standard-form arrangement for exchanges in which the demand side values the current availability of capital higher than the supply side. As a consequence, by providing default rules the law institutionally secures the market for production factors (procurement of debt financing). At the same time it enhances the satisfaction of consumer preferences (consumer credit).
The importance of loans as a means to facilitate debt financing has been traditionally higher in continental Europe where firms primarily raised funds in a bank-centred system of corporate finance whereas in Anglo-American economies, equal ends have been pursued essentially by issuing corporate bonds in public capital markets. However, the recent readjustment of business strategies observed in many continental European commercial banks has led to a certain decrease in the importance of loans for European firms’ debt financing. Yet, even today loans retain considerable and fundamental relevance in European corporate finance, particularly in those jurisdictions with a preponderance of small and medium-sized businesses. However, the drafting practice has developed a largely independent legal framework for corporate loans on the basis of standard contract terms as well as standardized covenants (banking law). Technically, the supply of capital is generally executed by entries in the borrower’s account. Instead of crediting the valuta, the lender frequently allows the borrower to overdraw his current account up to the agreed amount. Loans relating to fungible goods mostly occur in the form of ‘securities lending’ that is important, for instance, to execute (naked) short sales of securities where stock exchanges require rapid filling of trades or to vote in shareholder meetings without owning the underlying stock (empty voting). The characteristic perils consumers face when they take out a loan induced specific regulations for consumer credit (consumer credit (regulatory principles)) that are comprehensively harmonized on the supranational level.
Depending on the modalities of redemption, loans can be roughly classified depending on whether they are to be repaid in one lump sum or in several instalments over time. With respect to available collateral, personal loans (prêt personnel, Personalkredite) have to be distinguished from real estate loans (prêt réel, Realkredit) as well as from lombard loans (prêt Lombard). The repayment of personal loans is secured by the borrower’s creditworthiness or a third person’s pledge (suretyship (modern law); guarantee, independent), that of real estate loans by mortgages, liens on immovable property etc, and that of lombard loans by liens on movables, particularly securities. Furthermore, the freedom of the borrower to dispose of the capital supplied may be limited by appropriation, eg in case of restructuring credits or subsidies supplied by government entities. Under English law, appropriations assign the lender equitable remedies in rem that may entitle her to reclaim the valuta even in the borrower’s insolvency if the latter disposed of it in a manner inconsistent with the agreement.
In addition to loans, different legal institutes of equal practical importance exist that fulfil an economically comparable credit function. Despite these similarities, from a legal perspective these institutes have to be distinguished from loans. Frequently, the proper classification of the parties agreement may be difficult and highly context dependent. Examples are the credit on goods, the credit letter, or bill-broking and related banking transactions like factoring in particular. The pivotal feature for the relevant legal determination is the fact that loans can be characterized as the allotment of money or fungible goods against the promise of redemption. Hence, many private law systems classify the deposit business of banks as irregular custodianship (dépôt irrégulier; deposito irregulare; unechte Verwahrung) that is subject to the law of loans (expressly eg Germany § 700 Bürgerliches Gesetzbuch (BGB); Italy Art 1782 Codice civile; in other jurisdictions on the basis of case law and prevailing doctrine). Once again, in this context the economic function of the law of loans becomes palpable: it facilitates an allocatively efficient exchange between banks and clients, where the transactions are undertaken because banks put more value on the current availability of capital than their clients.
2. Structures and tendencies of legal development
So far, there are no comprehensive comparative studies on the general questions of the law of loans. However, the publication of extensive research on the subject conducted by the Study Group on a European Civil Code is imminent. In the meantime, the full version of the Draft Common Frame of Reference (DCFR) provides comparative insights on the foundations of its provisions on loans. Apart from that, it can be concluded that European jurisdictions share certain important areas of concern. Beyond the core regulations in contract and trade law, many European countries also provide legislation with immediate relevance for individual loan agreements in the law on financial supervision.
a) Legal nature of loans
It is a fundamental question regarding the private law regulation of loans whether such agreements can doctrinally be classified as consensual or as real contracts. The query is basically if the agreement between the parties to provide capital for a certain time already gives rise to the characteristic contractual duties of a loan or if these are only triggered once the promised capital is actually allotted. If it was only the actual transfer of capital that produced contractual obligations, the contract would in fact be a unilaterally obliging one under which only the borrower would have the duty to redeem the valuta and, as the case may be, to pay interest. According to classic Roman law the mutuum was a real contract and hence only the borrower had the obligation to redeem the valuta under the terms of the condictio once his assets had been increased through the lender’s allocation of funds. Likewise, the depositum generated an obligation to pay back the amount contractually agreed upon only after the actual allocation of funds (datio).
The seminal continental European codifications of the 19th century originally adhered to this concept (eg France Art 1892 Code civil; Italy Art 1813 Codice civile, Spain Art 1753 Código civil; Netherlands Art 7A:1791 Burgerlijk Wetboek (BW) 1838; Austria § 983(1) ABGB; Germany § 607 BGB 1900). The reason for this was mainly to avoid the misapprehension that the lender could claim redemption from the borrower based on the mere contractual consensus without even asserting that the loan had been disbursed in the first place. However, despite explicit regulations in the mentioned civil codes, commentators also argued for the converse position. In some jurisdictions, eg Germany, the latter view became the prevailing opinion over the course of time. More recent codifications, like the Swiss Code of Obligations (OR) (Art 312 OR), the reformed German Bürgerliches Gesetzbuch (BGB) (§§ 488(1), 607(1) BGB) and the proposals for the pertinent parts of the Dutch Burgerlijk Wetboek (BW) forego the allegedly atavistic figure of the real contract and treat loans as regular consensual contracts. These recent developments are consistent with the traditional position of the English common law. Based on its different conception of contractual obligations, the common law at all times classified the borrower’s promise to redeem the loan as consideration for either the lender’s initial allocation of funds or for his promise to disburse the valuta.
Hence, depending on the circumstances, loans are either construed as real contracts or consensual contracts. In fact, the practical importance of the doctrinal division should not be overestimated in any case. Even those continental European legal systems that still follow the traditional doctrine accept that the commitment to give someone credit creates the binding obligation of the prospective lender to disburse the agreed amount. Only the legal nature of the initial commitment is disputed. It is sometimes classified as a mere preliminary agreement (explicitly in Austria § 983(2) ABGB; likewise, the ouverture de credit in France is classified as a promesse de prêt), as an atypical contract sui generis (eg Spain) or as a framework agreement obliging the debtor to disburse individual loans up to the maximum amount stipulated (eg Germany). Under common law, on the other hand, even the commitment to provide credit is subsumed under a broad understanding of loan contracts.
Yet, it is of critical importance in this respect that the common law generally does not acknowledge a right to demand specific performance from a would-be lender promising a loan (Sichel v Mosenthal (1862) 30 Beav 371; South African Territories v Wallington 1898 AC 309). Continental European jurisdictions, although generally hospitable to requests of specific performance, generally allow the lender—regardless of the legal classification of loan promises—to terminate the contract and to decline disbursement if the borrower’s financial situation deteriorates significantly and hence the redemption of the funds seems jeopardized (eg Italy Art 1822 Codice civile; Germany § 490(1) BGB; or the functionally equivalent right to withdraw from the contract based on the objection of an abuse of legal position (abus de droit) under French law).
Just like the question concerning the legal nature of loan contracts, the issue whether these transactions are for remuneration or gratuitous by default can be traced back in legal history. In Roman law the nexum of early times was generally considered gratuitous, just like the mutuum that replaced it in the classic period and the depositum. A remuneration for the allotment of capital was only due if the parties specifically provided for the payment of interest in an independent stipulation. For the sea loan (fenus nauticum) that was subject to specific regulations, it is likely that remuneration was routinely established by disbursing only a sum that was reduced ab initio by the designated interest payment although the loan’s face value had to be redeemed. However, according to current research, for regular loans this practice of disagio can only be documented for the banking sector that developed in northern Italian cities during the late Middle Ages.
Today, loans without any duty to compensate the lender almost exclusively occur in close relationships between family members or friends. Yet, several legal systems still adhere to the default rule that a loan without express stipulation of remuneration constitutes a gratuitous contract (eg Art 1905 Code civil; Art 1755 Código civil; Art 7A:1804 Burgerlijk Wetboek (BW); Art 313(1) OR; different though eg Art 1815(1) Codice civile and since 2002 § 488(1) 2 BGB). Likewise, the English common law as a basic principle only grants the lender compensation if the contract contains an express stipulation to this effect unless the payment of interest is part of a commercial custom or a usage between the contracting parties (Page v Newman (1829) 9 B & C 378, 381; President of India v La Pintada Compania Navegacion SA 1985 AC 104).
However, multiple exceptions to the basic principle exist in equity, where especially mortgage loans are generally considered to require interest payments even if the parties’ agreement does not contain any express stipulation to this effect (Re Kerr’s Policy (1869) LR 8 Eq 331; Al Wazir v Islamic Press Agency Inc 2002 Lloyd’s Rep 410). The underlying rationale, ie to implement the parties’ manifest concurring intention of granting the lender compensation, is also responsible for reversing the rule in commercial law. As a consequence, in some jurisdictions loans among merchants were treated as agreements for remuneration by default at all times, requiring merchants to expressly waive the obligation to pay interest if gratuity was desired (eg § 354(2) HGB or UGB; Art 313(2) OR). On the other hand, some private law systems still adhere to the default of loans as gratuitous contracts even in trade law (Art 314 Código de comercio even requires remuneration to be expressly stipulated in writing).
Despite these divergences, all European jurisdictions basically grant parties great leeway in negotiating the lender’s remuneration. With regard to money loans in particular, other types of remuneration than the payment of interest can be agreed upon. The latter occurs most notably if the parties agree upon a profit participating loan in which the lender participates in the yields that flow from the investment the valuta was used for. Important limits for the party autonomy are drawn by the law of usury (interest).
c) Allocation of risk
The intrinsic risk allocation in loan contracts provides that the lender bears the risk of value depreciation (inflation) while the borrower will only be discharged of his obligation to redeem the loan if impossibility (impossibility, initial) or other frustrating incidents occur, which constitute a rare exception with regard to monetary obligations. The latter implies that the borrower generally also bears the risk that he is capable of deploying the allocated capital to his benefit as intended. Limited exceptions exist with regard to linked credit agreements in consumer credit regulations (consumer credit (regulatory principles), ie transactions in which the acquisition of goods or services and the loan taken out exclusively to finance this acquisition constitute an economic unity (Art 3(n) Consumer Credit Directive (Dir 2008/48)). Furthermore, the increasing stipulation of disclosure and information obligations (consumer contracts) de facto shift the risk of investing the allocated capital in a utility enhancing manner away from the borrower to the lender. These duties to disclose and inform the consumer about certain credit risks are—where consumer protection law (consumers and consumer protection law) does not explicitly prescribe them anyway—doctrinally moored in either tort (eg France, Italy, Switzerland, England) or quasi-contractual liability (eg Germany). The development described can be rationalized on policy grounds as a generally desirable reduction of informational asymmetries that would otherwise deprive consumers from enjoying the full benefits of the freedom of contract.
In the context of termination of loans which constitute a recurrent obligation (recurring obligations), two main problems are commonly discussed in European legal systems. First, the question is debated whether and, as the case may be, with what consequences the borrower is entitled to redeem the loan before his obligation becomes due, particularly if the agreement was made for a specific time period. Secondly, the modalities are disputed under which the parties may end a loan that was raised for an indefinite time, especially if delay in payment occurs.
The agreement of the parties’ serves as the starting point when it comes to determining the relevant due date. Hence, prepayments are generally not allowed without the lender’s consent if the (typically fixed-interest) loan was taken out for a specified space of time. Important exceptions exist for consumer credit on the basis of Art 16 Consumer Credit Directive. Moreover, in some jurisdictions rather narrowly construed relaxations of the general rule exist for real-estate credits (eg Germany: § 490(2) BGB; France: Art 12 Loi n°78-509 du 13 juillet 1979). In these cases, the borrower who wishes to pay prior to maturity has to indemnify the lender for his loss (of interest) by a compensating payment. If the loan was granted for an unlimited time period some jurisdictions put the issue into the parties hands and allow a regular notice of cancellation (eg § 609 BGB) or a call for redemption (eg the common law by invoking an implied term or mercantile custom to this effect, Joachimson v Swiss Bank Corp 1921 3 KB 110; National Bank of Commerce v National Westminster Bank 1990 2 Lloyd’s Rep 514). Other legislation, on the other hand, requires the judicial termination of loans, thereby granting courts wide discretion not only with respect to the reasons for termination but also concerning the deadline after which repayment becomes due (eg Art 1900 Code civil; Art 1817 Codice civile; Art 7A:1797 Burgerlijk Wetboek (BW)).
The lender, at least de facto, has the capacity, either on statutory or contractual grounds, to call for immediate repayment of an instalment credit if the borrower is substantially in arrears with his amortization instalments. Yet, under common law, the question arises whether the pertinent acceleration clauses in loan agreements have to be considered as penalties and are therefore unenforceable. In this context, the judgment hinges pivotally on whether future interest payments on the amount outstanding also become due automatically. Only if this is the case must the acceleration clause be regarded as an unenforceable penalty.
3. Uniform laws
Uniform laws pertaining to loans as such do not yet exist. The well-established standard contract terms which allow the contracting parties to interact even in cross-border transactions with relative ease despite the absence of a common statutory framework may account for this state. In addition, foreign commerce avails itself of specific credit instruments other than loans, such as, for example, the letter of credit (L/C) (see the Uniform Customs and Practice for Documentary Credit assembled by the International Chamber of Commerce (ICC)).
Both the original and the consolidated Consumer Credit Directive regulate only those aspects of loans that affect consumers. Contrary to the approach the European legislature pursued when promulgating the directive on the sale of consumer goods, the supranational regulation of loans is neither based on a broader concept of the contract type nor does it allow any inferences in this regard.
4. Unification projects
The Principles of European Contract Law (PECL), as well as the Code Européen des Contrats (Avant-projet) and the UNIDROIT Principles of International Commercial Contracts (PICC) pertain only to general contract law. Hence, they do not contain rules for specific types of contracts. Among the general rules of specific relevance for loans are Art 6:109 PECL (Art III.-1:109(2) DCFR) on the termination of contracts concluded for an indefinite period of time by reasonable notice and Art 9:302 c. 2 PECL (Art III.-3:506(3) DCFR) on the cancellation of the entire contract in case of a substantive breach of discrete contractual duties (eg substantive default on instalment payments). In addition, the Draft Common Frame of Reference contains specific provisions regarding loan contracts. The definition of Art IV.F.-1:101(2) DCFR classifies loans as consensual contracts. If none of the parties is a consumer, interest has to be paid even if the parties did not expressly agree on remuneration (Art IV.F.-1:104(2) DCFR). According to the mandatory rule in Art IV.F.-1:106(4) DCFR, redemption prior to maturity is always permitted. The borrower has to indicate his intention three months in advance if the loan was assigned for a period longer than one year (Art IV.F.-1:106(5) DCFR). The lender’s financial losses have to be indemnified by compensation for the premature redemption (Art IV.F.-1:106(6) DCFR). Loans concluded for an indefinite time may be terminated by each party upon reasonable notice (Art IV.F.-1:106(7) DCFR).
Max Kaser, ‘Mutuum und Stipulatio’ in Festschrift Georgios S Maridakis (1963) 155; Aubrey L Diamond (ed), Instalment Credit (1970); UNIDROIT, Sales of Movables by Instalment and on Credit in the Member States of the Council of Europe (1970); Klaus J Hopt and Peter O Mülbert, Kreditrecht (1989); Frank Theisen, ‘Der Darlehensvertrag in seiner historischen Entwicklung’ in Andreas Bauer, Frank Theisen and Karl HL Welker (eds), Studien zur Rechts- und Zeitgeschichte (2005) 11; Hans-Joachim Dübel and Johannes Köndgen, Die vorzeitige Rückzahlung von Festzinskrediten in Europa (2006); Jun Qian and Philip Strahan, ‘How Laws and Institutions Shape Financial Contracts: The Case of Bank Loans’ (2007) 62 Journal of Finance 2803; Philip Wood, Law and Practice of International Finance (2008) 93 ff; Edgar du Perron (ed), Loan Contracts (2009); Denis Philippe (ed), Loan Contracts (2012).