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Loan markets upside down – are banks to pay interest on loans?

By 1. October 2021No Comments

Loan markets upside down – are banks to pay interest on loans?

1 October 2021

In a nutshell:  Negative base rates were almost incon­ceivable up until a few years ago. However, parties have become accus­tomed to them to the point that now they almost seem the norm. Nevertheless, parties are well advised pay close attention to the drafting of negative base rate provi­sions in loan and credit agree­ments, parti­cu­larly in light of recent diverging decisions of German district courts.

With EURIBOR rates ranging below zero for several years now it was only a question of time when courts had to decide on whether lenders applying floating interest rates would not charge interest but rather have to make a payment to their borrowers.

In commercial loan agree­ments parties frequently agree on floating interest rates, consisting of a (floating) EURIBOR base and a fixed margin. A loan agreement may provide that the base rate can never drop below zero, meaning that the base rate plus the margin can never be negative. Equally, a loan agreement may not expli­citly provide for a “zero floor” for the relevant base rate. This could result in a base rate which is negative to such an extent that the aggregate of that base rate and the margin is still below zero. In that context the question arises whether “negative interest” on a loan would effec­tively result in a payment by the lender to the borrower.

There have been several diverging decisions by German district courts over the past months.

A decision issued by the district court of Düsseldorf in March 2020 (13 O 322/18) was affir­mative to the question and ruled that the lending bank was to pay the borrowers negative interest on the bonded loan outstanding. In the case decided the parties had not expli­citly agreed on a “zero floor” for the EURIBOR. The court concluded that (i) there was no implied floor to any base rate, (ii) the recognition of the negative base rate reflected the fair economic balance of the transaction where the base rate was nothing more than a transitory item and (iii) negative interest would not contradict the character of a loan as being granted in consi­de­ration of interest as interest was still paid, though in this case by the lender.

It was the first decision of a German court confirming the obligation of a lending bank to pay negative interest to a borrower on account of the negative EURIBOR.

Only a few months after this decision a different chamber of the same district court of Düsseldorf decided in June 2020 (2b O 254/18) to the contrary: here the court argued that a bonded loan is generally charac­te­rised as a transaction where a lender provides capital in consi­de­ration of payment of interest, such interest to be paid by the grantee of the capital. This character of a loan would not be upheld if a lender was to pay a consi­de­ration to the borrower. If it was in fact the intention of the parties that the lender was to pay a consi­de­ration to the borrower, the parties should expli­citly agree on this.

This latter decision is currently pending revision by the appellate court of Düsseldorf.

However, the approach taken by the district court of Düsseldorf in June 2020 was taken by the district court of Hamburg in a decision from December 2020 (318 O 367/19) with respect to a bonded loan agreement made in 2006: The court reasoned that at that time neither the lender nor the borrower would have thought of a situation where interest could become negative, resulting in the lenders having to pay borrowers a consi­de­ration for calling for capital. According to the court a contrary inter­pre­tation would require some indication in the agreement that parties took such situation into account and wanted to provide for consi­de­ration to be paid by the lender for placing deposits with the borrower.

In view of these diverging decisions and no decision by the Federal Court being available yet it is advisable for the parties to a loan or credit agreement to draft their agree­ments in a way that expli­citly deals with the situation of a negative base rate. In parti­cular, parties will no longer be able to claim that they just have not thought about the possi­bility of a negative base rate.

In many cases “zero floor”-clauses have been included in loan agree­ments over the past years, by which parties agreed to a “zero floor” for the base rate or a minimum interest rate.

For any new loan or credit agree­ments this practice should be continued. Alter­na­tively, if this is intended, parties should expli­citly provide for the reverse flow of “interest” in the loan agreement as consi­de­ration for the deposit of capital with the borrower.

If you have any further questions, please do not hesitate to contact your contact person at EHLERMANN RINDFLEISCH GADOW or Hendrik Brauns or Dr. Hauke Rittscher.

Your contact persons:

Hendrik Brauns