Challenge to the validity of FX Loans

Retail customers in Hungary are suing banks under FX loan agreements. The financial crisis and the resulting change in FX rates have made these loans more expensive than customers originally expected. This article examines claims that have been made against banks and a recent Supreme Court ruling.

Supreme Court ref No Gfv.VII.30.078/2013/14, 4 July 2013

For several years foreign exchange (in this context, any currency other than HUF, FX) loans had been very popular with customers because the interest rates offered were significantly lower than in the case of HUF loans. FX loan products sold by banks varied in their terms. Some banks simply referred to the FX as a value reference for calculating the HUF amounts due. Other banks sold FX loans structured in a way that the loan amount was fixed in an FX amount and the bank disbursed the loan in HUF at the FX rate offered by the bank for buying the relevant FX. Repayment was to be made by the borrower in HUF at the FX rate offered by the bank but this time for selling the relevant FX. The FX rates offered by each bank fluctuated from day to day.

As a result of the financial crisis which began in 2008, the difference between the sale and buy exchange rates offered by retail banks (or the +/- margin from the bank’s middle exchange rate, the FX gap) in relation to FX loans (approximately 90% of which were denominated in CHF, where both payment and reimbursement occurred in HUF) increased. This meant that customers had to repay considerably more to the banks. Many retail borrowers challenged the validity of FX linked loan agreements on a number of grounds.

This and similar issues have arisen in a number of jurisdictions in CEE.

OTP Judgment

The Curia (the Hungarian Supreme Court) has passed a landmark interim judgment on an FX linked loan agreement (the OTP Judgment).¹

A retail customer sued OTP Bank Nyrt in early 2012, claiming the invalidity of an FX linked loan agreement made in 2006. The customer invoked the absence of any reference in the loan agreement to the FX gap as an ancillary cost of the loan. Under the Banking Act (which implemented Council Directive 87/102/EEC for the approximation of the laws, regulations and administrative provisions of the Member States concerning consumer credit, the Directive) all the costs associated with a loan must be (i) specifically listed in the loan agreement; and (ii) factored into the calculation of the annual percentage rate of charge (APR) which is also a mandatory part of any such loan agreement. Since the difference the consumer had to pay was due to the "hidden FX gap", the consumer claimed that OTP should refund the amount of this difference.

OTP argued that the FX gap was factored in to the APR, which was specifically communicated both in the loan agreement and the general business terms of OTP. According to OTP, the FX gap results from a special method for settlement or calculation but it is not an element of cost. It was not necessary to specifically mention the exact scale of the FX gap in the loan agreement, since it is not a special type of cost, but instead another circumstance that a bank must take into account when calculating the APR. Alternatively, in the event the court had characterised the FX gap as a cost, OTP argued that when the customer transferred the HUF amount to the bank as a repayment, it gave an implied order to OTP to (i) convert the HUF amount into CHF and then (ii) decrease the outstanding amount of the loan with the funds so converted. According to OTP, the conversion occurred under a separate FX sale agreement and so any costs associated with such conversion (including the FX gap) was part of that FX sale agreement and not of the loan agreement. This reasoning was also supported by the General Attorney of Hungary, who provided his opinion upon the request of the Curia.

The Curia, as the last instance judicial forum in Hungary, held in the OTP Judgment that:

• although the loan agreement specified the APR, it was not clear which costs OTP took into account when it calculated the APR; and
• the FX gap qualifies as a cost element from the point of view of consumers and so it should have been specifically mentioned in the loan agreement under s213(1)(c) of the Banking Act (effective as at the date of the loan agreement under review).

The court stated that the definition of the "total cost of the credit" as defined in Article 1(2)(d) of the Directive must be interpreted in a very broad way in favour of the consumers. The conversion was an inevitable mechanism associated with the performance of the loan agreement. Although loan agreements which do not list all the possible costs associated with the loan are null and void by the operation of the Banking Act, the Curia "declared the contract valid" by amending it and specifying the FX gap to be 1% (+/- 0.5% to/from the middle exchange rate applied by OTP) in accordance with the information given by the bank to the borrower at the time of entering into, but not in the text of, the contract.

Since OTP changed the sale and buy rates during the term of the loan agreement (which increased the FX gap), the Curia sent the file back to the first instance court to examine whether OTP changed its rates unilaterally without properly notifying its customers of the resulting detrimental effect on the repayment amounts. If the first instance court concludes that OTP did not comply with the strict statutory rules of the Banking Act on unilateral changes of the terms of a loan agreement to the detriment of retail customers, OTP will have to refund the difference based on the grounds of unjust enrichment.

Comment

The Curia made it clear that it could not, in the absence of applications to such effect, examine a number of further issues which may arise in connection with the FX gap or FX linked consumer loans in general (eg unfair terms). In particular, the Curia did not deal with the question as to whether unilateral changes by the bank may be treated as based on unfair terms in consumer contracts – which is a hot topic in other FX loan litigation.

Although there is no obligation to do so, lower courts are expected to follow the OTP Judgment as a precedent and authoritative guidance.

Bad news for banks

The bad news for banks is that the FX gap is now classified as a cost. Therefore, banks can only claim amounts resulting from the FX gap if this was clearly indicated in the loan agreement and only to the extent that it was communicated at the time of the contract.

The outcome of this and similar disputes depend on the interpretation of whether the FX gap is a "cost of the credit to the consumer" (Articles 1(2)(d) and (e) of the Directive). This has been unclear and open to interpretation. Banks could argue that the loan was one agreement and a related, but legally separate, agreement was made for the spot and future sale of FX against HUF. This argument can be supported by the fact that the Banking Act deals separately with lending (s3(1)(b)) and FX sale activity (s3(1)(h), s3(2)(a) and point 14 of schedule 2, part I) which require separate licences and normally require separate agreements.

Against this possible argument, the Curia concluded that from the consumers’ perspective and with a view to protecting their interests in line with the purpose of the Directive and s213 of the Banking Act, the FX sales were part of the loan agreement as all these transactions were offered to the customers as a single, packaged product. It follows that the FX gap is an element of cost in relation to the loan agreement.

The good news for banks

The good news is that the whole structure of FX loans has now been tacitly approved by the Curia. The Curia accepted FX loans structured by using double currencies, ie one calculation currency (kirovó pénznem) in FX and a different payment currency (lerovó pénznem) in HUF. If the Curia had any problem with this structure, it could have found a reason for invalidity ex officio.

It follows that an FX loan or the FX gap is not illegal in itself. It is permitted so long as it has been clearly indicated in the loan contract and its increase has been introduced by a legal (eg not unfair) unilateral amendment by the bank. The banks may now consider whether they wish to officially amend their general terms and conditions and inform existing customers of the application of the current FX gap. It is interesting that the Curia decided to uphold

the loan agreement, albeit with an amendment, rather than render the entire agreement invalid. This perhaps shows that the courts are not willing to release retail customers entirely from repayment obligations as a result of a successful challenge to one aspect of a loan agreement. This is a far better outcome for banks than complete invalidity and restitution.

What happens next − proposed legislative measures and their impact

The government is now considering new legislation to address the socially widespread effects of the widened FX gap and, more significantly, FX losses. Proposed legislative measures vary widely. The narrower approach proposes amending existing contracts by fixing the FX rates to be used at the middle FX rate of the given bank or the official FX rate published by the National Bank of Hungary. The more ambitious and, for banks, damaging proposal is for dividing the risk of HUF depreciation against FX among the banks, the state and possibly consumer borrowers. The latest proposal is for the mandatory conversion of FX loans into HUF loans at current market rates. It is too early to tell which proposal will be passed into law andwhat it will cost banks.

Footnotes

_{1. Ref No Gfv.VII.30.078/2013/14, 4 July 2013.}