When loans and other financing instruments are granted to consumers, German law provides that consumers must be formally instructed as to their statutory right to revoke the loan contract within two weeks. Under German law, any fault in the form prescribed for such revocation instruction results in preventing the time-limit within which consumers must exercise their right of revocation from running.
In the past, this has led to a borrower of housing loans with a fixed interest rate for a period of generally 10 years having a so-called "revocation joker". He could wait to see how the interest rate for loans would develop: if the interest rate level remained more or less stable as compared with the time of conclusion of the loan contract, he would have no reason to rescind the loan. But if the loan rate sank – as is commonly the case in this current low interest phase – the borrower could play the "revocation joker" and try to rescind his loan contract without having to pay the prepayment penalty which would have been due when terminating the loan before expiry of the fixed-interest period; thus the borrower could restructure the loan at a lower interest rate, to the detriment of the bank.
This article explains the various risks connected with the "revocation joker" as follows:
1. Ruling of OLG Hamburg on the revocation of a loan contract being contrary to good faith
German civil courts have had to deal with such revocation of loan contracts in numerous proceedings. In most of them, the argument of the borrower who exercising his "revocation joker" is the allegation that the bank's instruction on his right of revocation, which in many cases was years ago, was faulty. Therefore, the borrower would argue that, even after many years of servicing his loan in accordance with the contract and even though it would constitute premature repayment within the fixed-interest period, he was still entitled to rescind the loan contract without having to pay a prepayment penalty. On 15 December 2015, the Federal Court of Justice ("BGH" XI ZR 180/15) was due to decide whether – and if so, under which circumstances – the exercise of such a consumer's right of revocation violated the principle of good faith. However, the scheduled oral hearing before the BGH was cancelled as the parties settled the matter shortly before the hearing.
In this case, the plaintiff acquired a shareholding in an investment company in 2005 and financed this acquisition in part with a loan. In 2011, he revoked the loan contract on the ground that the time-limit for revocation – usually two weeks – had not expired for lack of proper instruction. Although the judges at OLG Hamburg (the lower court) had confirmed the right of revocation in this individual case and ruled that the right of revocation had not been forfeited, OLG Hamburg dismissed the plaintiff's action for reverse performance of the loan contract, ruling that his exercise of the revocation right amounted to an unlawful exercise of a right by a borrower. The OLG assumed that in the case at issue, the alleged faults in the revocation instruction were not the reason for the revocation, but that the plaintiff's real aim was to get rid of a speculative and risky financial investment. Therefore, when examining an individual case, the decisive point is whether the borrower, by revoking the loan contract, in the end wants to achieve aims that are not directly related to the contract, and whether reverse performance of the loan contract as the legal consequence of the revocation would actually be minor, since revocation is only a means of achieving such aims.
When assessing comparable cases, the principles developed by OLG Hamburg may be used to argue in favour of the banking industry.
2. The Federal Court of Justice (BGH) strengthens the position of banks and insurance companies; no reverse performance of a life insurance contract linked to a loan
In the case of life insurance contracts linked to loans, the BGH has already blocked the way of simultaneous termination of life insurance in the event of a reverse performance of the loan contract for defective instruction on revocation.
Although life insurance contracts in Germany are frequently used as long-term investments, many customers terminate their contracts prematurely for various reasons; according to estimates from the Hamburg consumer centre, more than 50% of all contracts are affected by such premature termination.
For customers, such termination is financially disadvantageous as in most cases it results in a loss. Therefore, many customers sue the insurance company in order to limit their loss. On this issue, the BGH decided in favour of banks and insurance companies and ruled that where there is such a combination of life insurance and loan contracts, if the customer rescinds his loan contract, he cannot request reverse performance of any life insurance contract taken out simultaneously (file no. XI ZR 406/13).
For many years, banks have recommended non-redeemable loans in connection with life insurance policies instead of traditional redeemable loans. In this model, the loan is repaid at term end using the payout from a capital sum life insurance taken out at the same time as the loan. In addition to coverage in the case of death, this scheme offered tax advantages: while in the case of a bank loan with regular redemption payments the interest amount charged to the borrower decreases from year to year, it does not change if the loan is not redeemed and can be deducted from the tax base – for example if the loan has been used to acquire real property to generate income.
However, now this type of financing is considered a money-losing deal for the borrower as the tax benefits have been abolished. In addition, the surplus dividends distributed by the insurance are often smaller than expected and the payout does not always suffice to redeem the loan. Customers who had chosen this financing option and then realised that its advantages did not materialise to the extent expected faced the question of whether and how to get out of such contract scheme prematurely.
Action for reverse performance of a life insurance
In the case decided by the BGH, the facts were as follows: in October 2002, the plaintiff had concluded with the defending bank a loan contract on a credit sum of 25,000 euros. In conjunction, the plaintiff took out a capital sum life insurance, the payout of which at final maturity was intended to be used for redeeming the loan. Against this background, the plaintiff assigned her claims under the life insurance to the bank. In April 2011, she revoked both the loan and the insurance contract and, in the first instance, sued the bank for reverse performance of the loan contract. The Regional Court granted the action, and the defending bank appealed against the decision. In the second instance, the plaintiff, in addition to reverse performance of the loan contract, asked the court to declare that the bank was bound to reverse performance of the life insurance contract as well. The plaintiff's application for a declaration that the bank was bound to implement reverse performance of the life insurance contract was rejected by the Higher Regional Court (OLG). The plaintiff appealed this decision on points of law before the BGH without success.
No linked transaction
With this ruling, the BGH blocked the way to simultaneous rescission of the life insurance policy in the event of termination of the loan contract; the life insurance policy is not affected by the revocation of the loan, provided that the insurance premium is not financed from the loan proceeds but saved from other sources.
Pay premiums or maintain cash surrender value
The ruling also strengthens the position of banks and insurance companies. If a consumer is actually entitled to revocation, the bank must ensure reverse performance of the loan contract, i.e. refund any paid interest, fees and other credit costs. According to the ruling of the BGH, however, this rescission does not affect the life insurance contract and the customer remains obliged to continue to pay the agreed premiums until the end of the term. If the customer wants to end this contract too he may terminate it routinely, but in such case will only be refunded the cash surrender value.
Reverse performance of insurance contracts in the event of faulty revocation instruction
What is more critical to banks and insurance companies is the case law on reverse performance of insurance contracts. The BGH ruled (file no. IV ZR 76/11) that insured persons who had not been properly instructed about their revocation right on entering into the life insurance contract may request a refund of the paid premiums and interest on those sums.
Customers who took out a capital sum life insurance or annuity insurance between 1994 and 2007 under the then applicable so-called "Policy Model" could object to the contract if they could evidence that they had not been properly instructed about their right to oppose. Such formal mistakes in the revocation instruction at conclusion of the contract were the prerequisite for its reverse performance.
The time-limit for revocation did not begin to run before the consumer's attention had been drawn to this right of revocation in "highlighted print". If the insurance company failed to comply with this formal requirement, the time-limit for revocation would not commence. As a result, the insured person could still use this "revocation joker" years after conclusion of the insurance contract and demand a refund of all hitherto paid insurance premiums. This practice has now been stopped by the BGH with its ruling issued on 8 April 2015 (file no. IV ZR 103/15).
3. Ruling of the OLG in Schleswig as to the requirements of proper revocation instruction
The Higher Regional Court of Schleswig-Holstein (OLG Schleswig) ruled in its judgment issued on 26 February 2015 (5 U 175/14) for the first time that the text for a revocation instruction used by a savings bank was not objectionable and that the borrower's revocation – declared years after the loan had been paid out – had come too late. This judgment has fundamental importance because no Higher Regional Court had positioned itself so clearly on the extent of permitted deviations in bank instructions on the customers' right of revocation before this ruling.
The issue in dispute was to what extent a revocation instruction may deviate from the model text consistent with the requirements of the Information Ordinance of the German Civil Code (BGB-InfoV). In 2007, the plaintiff had concluded two loan contracts for financing a property with her savings bank and prematurely redeemed them in 2013. Not earlier than after their full performance did she seek to rescind the loan contracts on the ground that she had not been properly instructed about her right of revocation at conclusion of the contracts in 2007 because the revocation instruction used at the time had deviated from the standard model text of BGB-InfoV in an inadmissible way. The savings bank had added the loan numbers and its address to the text of the revocation instruction.
The judges of the 5th civil chamber in Schleswig stated that they could not ascertain any substantive change from the model text of BGB-InfoV; the additions made by the savings bank would not have any detrimental effect. The plaintiff's instruction by the savings bank about her right of revocation complied with the requirements applicable at the time. Therefore, according to the judges, the plaintiff's opposition many years after expiry of the two-week time-limit had not been in time and the reverse performance claimed by the plaintiff could not be allowed.
This judgment has become final and conclusive and the OLG Schleswig has meanwhile confirmed its legal opinion in several other judgments.
4. The Federal Government now intends to put an end to this "perpetual right of revocation" for real estate loans
On 27 January 2016, the Federal Government put forward a draft bill to put an end to this "perpetual right of revocation" for real estate loans taken out between 2002 and 2010. In the Federal Government's opinion, an unlimited "perpetual" right of revocation creates substantial legal uncertainty, especially in the area of real estate consumer loans.
More incentives for banks to grant real estate loans with fixed interest over a long period
|In the Government bill implementing the administrative regulations on real estate loans for dwelling purposes adopted in July 2015, the Federal Government had once before proposed regulations aimed at preventing the creation of perpetual rights of revocation under new real estate consumer loans. The aim of both the 2015 and 2016 bill is to help banks agree real estate loans with a long fixed-interest period with consumers, as such loans are in the consumers' interest because they lead to better foresight of financial burdens when purchasing a property for private purposes.|
Time-limit of three months provided for "ancient cases"
|In addition, the Government plans to introduce a bill according to which still existing "perpetual rights of revocation" linked to ancient cases could finally lapse within a time-limit acceptable to consumers. The rulings of the BGH and the inconsistent case law of the Higher Regional Courts left considerable legal uncertainty, especially in real estate loan contracts entered into with consumers in the years 2002 to 2010. For these contracts it is intended that consumers shall have a three-month period after the law taking effect to decide whether to use any possibly existing right of revocation or not. After expiry of this time-limit, exercise of any such right of revocation would no longer be possible.|
Should the exercise of the right of revocation for loan contracts from 2002 to 2010 be time barred in accordance with the proposal of the Federal Government, the banking industry should expect a wave of declarations of revocation and subsequent litigation about the issue of their legality. Mastering and processing this wave of revocations will not only consume substantial personnel resources at banks, but also generate noticeable costs. In the end, however, the planned time-limit for the right of revocation would substantially restore legal certainty and legal peace between borrowers and banks. Therefore, the Federal Government's draft statute must be expressly welcomed.
*Frank van Alen is partner in the Hamburg office and head of the Banking and Finance Practice Group of SKW Schwarz Rechtsanwälte Wirtschaftsprüfer Partnerschaft mbB. Mr. van Alen is a certified expert in banking and finance law. He can be contacted at email@example.com. Tatjana Schroeder is partner in the Banking and Finance Practice Group in the Frankfurt office of SKW Schwarz Rechtsanwälte Wirtschaftsprüfer Partnerschaft mbB. She has worked for over 15 years as in-house counsel for large international groups (Siemens AG) as well as family offices (DELTON AG, shareholded by Stefan Quandt) and joined SKW Schwarz in 2003. She can be contacted at firstname.lastname@example.org. SKW Schwarz Rechtsanwälte Wirtschaftsprüfer Partnerschaft mbB is an independent German law firm. With more than 120 lawyers and offices at Berlin, Düsseldorf, Frankfurt am Main, Hamburg and Munich we are present in the major German business hubs. Our Banking and Finance Practice Group with nine lawyers includes three certified experts in banking and finance and two certified experts in commercial and corporate law.