21 Sep 2016

Mass Cancelling of Building Loan Saving Contracts Unlawful

SAFE legal scholars warn of tolerating the cancellations of contracts by building societies with reference to the low interest rate environment / Economically “counterproductive”

Building societies are recently cancelling existing contracts on a large scale that guarantee highly attractive interest rates for savers. A wave of lawsuits against these cancellations is currently keeping German courts busy and will reach the Federal Supreme Court (Bundesgerichtshof) shortly. According to Tobias Tröger, Professor at Goethe University Frankfurt and the Research Center SAFE, and his Assistant Thomas Kelm, the cancellations are legally not justified.

As the two legal scholars outline in this week’s issue of the Neue Juristische Wochenschrift (NJW 39/2016, 22 September 2016), building societies cannot claim an exceptional right of termination after §489 I Nr. 2 BGB. It is an original task of credit institutions, which includes building societies, to consider the risk of interest rate changes in their management decisions, they state. If institutions were allowed to terminate contracts in an unfavorable interest rate environment, those that have not met this economically fundamental task would be rewarded. As a consequence, moral hazard would arise taking any incentive from credit institutions to consider interest rate risk at all into in their contracts. Instead, institutions would benefit in good times and cancel unattractive contracts in bad times. As the authors set out, this would be counterproductive because maturity transformation by credit institutions serves a general economic interest. “The enormous threat of a financial sector that is able to refinance itself largely independent from (market price) risk is known not only since the financial crisis.”

A need for action would only arise in the event of a sector-wide mismanagement with a threatening default of a large number of institutions and, thus, a risk for financial stability, the authors explain. In this case, however, supervisory law would apply, not civil law. It is the duty of the Federal Financial Supervisory Authority (BaFin) to assess possible systemic consequences. On the other hand, if only a small number of institutes face problems, they have to bear the consequences of the mismanagement of market price risks themselves.