Amending Consumer Finance Contracts at a Distance:  Recent Decision of the Court of Justice of the European Union Prompts Pause for Thought

CJEU Decision – Distance Marketing Directive

The Court of Justice of the European Union’s (“CJEU”) decision in KH v Sparkasse Südholstein¹ will be of particular to interest to lenders amending existing financial contracts with consumers where the amending agreement is offered, negotiated and concluded exclusively by post, phone, online or some other means that is at “a distance”.  This was the first time the CJEU was asked to interpret the meaning of the “distance contract” definition set out in Article 2(a) of the Distance Marketing Directive (2002/65/EC).²

What was the case about?

The borrower (“KH”) had entered into a number of loan agreements with the lender (“Sparkasse”), all of which were signed on the lender’s premises (meaning the Distance Marketing Directive did not apply to the conclusion of the original agreements).  The loan agreements provided for the re-negotiation of the applicable interest rate during the term of the loan, following the expiry of an initial fixed rate period, and, in the absence of agreement, the application of Sparkasse’s default variable rate.  On expiry of the fixed rate periods, new interest rates were agreed between KH and Sparkasse “…using exclusively means of distance communication…”.³  Some years later, KH notified Sparkasse of an intention to retroactively withdraw from the agreed amendments on the basis that those amendments constituted a “distance contract” (for the purposes of the Distance Marketing Directive) and that KH had not been informed of her right of withdrawal (as required by the German legislation transposing Article 3 of the Directive).  KH also sought the return of interest paid and other associated costs and fees.

The question referred to the CJEU

To enable it to rule on the dispute, the German court referred the following question (amongst others) to the CJEU:

The CJEU gave the following decision: 

The CJEU’s reasoning

In reaching this decision, the CJEU decided that the implementation of the interest rate re-negotiation clause in the original agreement was neither a mere “operation” of the original agreement (such that the Distance Marketing Directive would not apply), nor the “addition of elements to the initial agreement” (such that the Directive would apply).  It was something different which required an interpretation of the Directive to determine whether or not the amendment agreements were subject to its requirements.  Making a “…literal and systematic interpretation of Article 2(a)…” of the Directive, the CJEU held that:

The CJEU decided that this interpretation was supported by an analysis of other provisions of the Directive, noting, for example, that the Directive’s requirement in Article 3 for the consumer to be “…fully informed of the identity of the supplier…serves no purpose…” in the “…case of an amendment that relates solely to the interest rate”.  Unfortunately, the CJEU did not elaborate in further detail on how this analysis underpinned its decision. 

What does this mean for lenders?

While the CJEU decided the question in favour of Sparkasse, it should also prompt suppliers of financial services to carefully re-examine how they are dealing with amendments to contracts that may be within the scope of the Distance Marketing Directive.  For example:

• Even where the original agreement was not subject to the Directive, subsequent amending agreements may be.  Are customer management systems designed to capture this scenario?
• Where amendments are being effected by distance means, what criteria are applied to determine whether the Directive applies?   The CJEU’s decision focuses on a specific fact-pattern, which may not be applicable to many of the amendments being affected (particularly in the context of COVID-19 temporary payment breaks and forbearance).  It is also interesting to note that the Advocate General had recommended a different decision (finding against Sparkasse) and the analysis undertaken by the Advocate General could inform future decisions on other types of amendments.
• What is the scale of risk for a lender across its consumer books if its method of amending existing contracts was found to be non-compliant with the Directive (and/or its transposing legislation)?

Comment

In the context of the COVID-19 pandemic, many financial services contracts need to be amended in a manner not contemplated by the original contract, and these amendments will almost all be completed using distance means.  The CJEU’s decision highlights the need for vigilance by the suppliers of any financial service (not just loans) when making such amendments.  While the Court did find in favour of the lender in this instance, this was by reference to a narrow fact-pattern, which is unlikely to reflect the vast majority of amendments currently being effected.  With that in mind, lenders, credit servicing firms, insurers and other suppliers of financial services to consumers will need to carefully consider whether existing processes and documentation meet with the requirements of the Distance Marketing Directive. This can require a close legal analysis of the relevant documentation, parties and processes, which we would be delighted to provide.