New Case Law on Upfront Fees in German Loan Agreements

by Shearman & Sterling LLP
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On 4 July 2017, the German Federal Court of Justice (BGH)—in two separate cases—held that pre-formulated agreements on work fees that are payable independent from the term of the underlying loan and agreed between a financial institution and an entrepreneur (Unternehmer) are invalid.

The Court Ruling

In both cases, the loan agreements contained boilerplate language based on which the borrower owed a work fee (“Bearbeitungsgebühr,” “Bearbeitungsentgelt”), which was payable in full independent from the actual term of the respective loan (laufzeitunabhängig), i.e. the work fee was not (pro rata temporis) repayable if the loan was terminated or partially prepaid prior to its maturity. The plaintiffs requested and were awarded repayment of such fees pursuant to section 812 para. 1 sentence 1 of the German Civil Code (BGB).

According to the BGH, the relevant work fee arrangements—as part of standard business terms—qualify as “ancillary price provisions” (Preisnebenabrede) which are (other than the agreement on the price itself) subject to the test pursuant to section 307 BGB whether they unreasonably disadvantage the contractual counterparty of the user of the standard business terms. Such unreasonable disadvantage is, inter alia, assumed if a provision is not compatible with essential principles of statutory provisions from which it deviates. The court has ruled that work fees which are not dependent on the term of the loan are incompatible with the key principle of German law set forth in section 488 para. 1 sentence 2 BGB, which provides that the compensation for making available a loan is the payment of interest for the time during which the capital is actually lent to the borrower. Any provision on fees by which a lender seeks to pass on expenses for tasks anyways owed by it by law or contract or conducted in its own interest is considered to cut across such key principle and accordingly invalid if comprised in standard business terms.

The recent rulings follow two decisions of the BGH in 2014 when the BGH decided that such work fees comprised in standard business terms were invalid if provided for in consumer loans (Verbraucherdarlehen). Pursuant to the current decisions, the purpose of section 307 BGB (which is to limit the one-sided power of the user of standard business terms to set the standards for certain contracts or contractual provisions to the detriment of the counterparty) also applies in relation to and in favor of entrepreneurs (Unternehmer). In the BGH’s view, there are no indications that the unilateral power of financial institutions or other lenders would be less distinct vis-à-vis entrepreneurs than vis-à-vis consumers.

Based on the recent rulings, entrepreneurs may be entitled to claim repayment of the relevant fees paid based on standard business terms. The statute of limitation for such repayment claims expires three years after the end of the calendar year in which the claim has arisen and the claimant has or should have had knowledge of the underlying facts and circumstances. Accordingly, any claims for fees paid in 2013 or before can no longer be pursued, whereas a claim for the repayment of fees paid in 2014 will become time-barred by the end of 2017.

Implications for the Industry

Based on the new case law and the pending statutory limitation of claims in relation to fees paid in 2014 by the end of this year, financial institutions should be prepared that borrowers may take steps to claim repayment of upfront fees, and financial institutions will have to carefully analyze in which cases and in relation to which services and fees such repayment claims may have merit. With a view to future agreements, financial institutions and other lenders will have to carefully consider how to design and document fee arrangements going forward.

The following shall highlight a few considerations in relation to the assessment of past fee arrangements and the future design of upfront fees.

Negotiation of Terms — Individual Agreement Versus Standard Business Terms
As the BGH decisions only apply to work fees comprised in standard business terms, no repayment claim can be made where the fee arrangement has been individually agreed by the parties.

As financial institutions often use standard fee clauses or provide draft fee letters based on, e.g. LMA standards or other in-house templates, such terms may prima facie be considered to be standard business terms. An individual agreement requires that the user (Verwender) (see below) of pre-formulated terms has seriously put the pre-formulated clause to the disposition of its counterparty and that the counterparty actually had (and was aware of) the opportunity to provide alternative proposals and had the power to actually assert its alternative proposals vis-á-vis the lender. The hurdle set by the case law of the BGH to actually come to an individual agreement is quite high. Potential repayment claims for fees paid in the past will depend on the facts and circumstances in the individual case and to what extent it has been documented that it was finally an educated and free decision of the borrower to accept the actual fee arrangement instead of alternative arrangements.

Presentation of Standard Business Terms — Who is the User?
Another relevant aspect in the assessment of potential repayment claims is the question of which party in the individual case has to be considered the user of the pre-formulated terms in relation to the work fee. “User” (Verwender) is usually considered to be the party which unilaterally imposes certain contract terms upon the other party. Where the parties use terms pre-formulated by a third party, the user is considered to be the party upon whose initiative a term has been introduced, whereas it is generally not considered relevant in whose favor the specific clause works. Whereas in many cases it will be the lender(s) that have proposed the relevant fees and related provisions, it may be less clear who the “user” is where the borrower has, e.g. initiated a pitch process with several competing financing providers and/or has provided the first drafts of the financing documentation (often based on precedents used by it in other transactions). 

“Work Fees” — To Which Kind of Fees Do the Decisions Apply?
One of the major questions in the context of both potential repayment claims and the design of future fee arrangements is, however, to which kind of fees the recent decisions actually apply. Both of the recent judgments refer to bilateral loans and in both cases the fee was called “work” or “handling fee” (“Bearbeitungsgebühr,” “Bearbeitungsentgelt”). However, according to the BGH, all fees by which the user passes on operating costs or expenditure for the fulfillment of contractual or legal obligations of the user, which it fulfills in its own interest, are subject to court scrutiny and no separate fee is justified unless such fee covers services of the financial institution that are separate from making available the loan (and its legal obligations in its context). Services that according to the BGH do not justify a separate compensation are costs for making available the loan, the costs for determining the credit risk of the borrower (Bonitätsprüfung), costs for the appraisal of collateral and expenditure in relation to collection of client data and client meetings to evaluate the client’s financing requirements. The BGH takes the view that all such costs can—irrespective of the uncertainty in relation to the actual term of the loan—be priced into the calculation of interest at the outset, with the risk of a premature repayment of the loan being covered by way of a mixed calculation (Mischkalkulation). This applies according to the BGH even in case of revolving credit facilities where it is not clear whether and to what extent such facility will be drawn and accordingly how much interest will be paid over the term of the loan. 

How these principles—all of which were stated in relation to bilateral loans—translate into the world of syndicated loans has not yet been decided by the BGH and leaves room for discussion. There is no indication that the BGH would not apply the same principles to syndicated loans; it therefore appears likely that the court would look into whether or not a relevant service is part of the obligations of the lender(s) and is rendered in the interest of the lender(s) rather than the borrower(s). However, in contrast to bilateral loans, it needs to be taken into account that some services are not rendered by all lenders and/or are rendered by legal entities that are not even a lender and could therefore not be compensated for by higher interest payments, and many fees payable in the context of syndicated loans actually cover services not legally or contractually owed by the lenders.

Legal Structuring Options

Alternative Fee Structures
Other than the inclusion of the relevant costs and expenses in the calculation of interest, the BGH in its recent decisions did not provide any specific alternative structuring proposals. Accordingly, all alternative fees comprised in standard business terms and raised in the context of lending money (i.e. not covering separate services) and that are not related to the actual term of the loan would have to pass the test under section 307 BGB as set out above.

Choice of Foreign Law
In order to avoid the applicability of the German law on standard business terms to a fee arrangement, the choice of foreign law may be considered. 

Pursuant to article 3 para. 1 of the Rome I Regulation (EC) No 593/2008 (Rome I) the contractual parties are generally free to choose the law applying to a contract or contractual clause, provided that mandatory provisions of local law cannot be disapplied (i.e. would still overrule the chosen law) where all circumstances of the case at the time of the choice of law point to the law of a member state other than the one whose law has been chosen. Accordingly, the parties cannot deviate from the protections provided by the rules on standard business terms by choosing foreign law where all parties to the financing agreement are based in Germany, the place of performance is located in Germany and there is no other connection to a foreign law.

A connection to foreign law is usually recognized if at least one party to the agreement is located outside of Germany or the place of actual performance of the contract is abroad. The mere foreign nationality of a party, in contrast, is usually not considered to be sufficient, i.e. a non-German bank acting through its German branch will likely not be regarded as providing sufficient foreign connection. Where the borrower group has a non-German group member, it may be an option to conclude the fee arrangements with such foreign entity.

Where a case has a foreign connection, the choice of the foreign law will be fully respected, provided, however, that the choice of law itself could qualify as standard business term which could be defeated by a German borrower under article 10 para. 2 Rome I if the choice of law is considered surprising or ambiguous (section 305c BGB).

Arbitration Clauses Excluding the Laws on Standard Terms and Conditions
Another way to escape the application of the German rules on standard business terms may be to include an arbitration clause in the (German law) loan agreement, instructing the arbitration panel to apply German law excluding the rules on standard business terms. Section 1051 para. 1 of the German Code of Civil Procedure (ZPO) and the relevant provisions of the “Deutsche Institution für Schiedsgerichtsbarkeit” (DIS) and International Chamber of Commerce (ICC) allow the parties to determine the law to be applied by the arbitration panel when deciding on a relevant dispute. Several voices in legal literature argue that this includes the option to not only determine the applicable legal regime (such as German law) but to also specify that individual provisions of such regime shall not be applied. Section 1051 ZPO is thus regarded as a conflict of laws provision insofar overruling the Rome I Regulation. According to other scholars, however, the restrictions of Rome I, notably article 3 para. 3 and article 9, nevertheless apply to section 1051 ZPO and would need to be observed by arbitration panels located in Germany, thereby again applying all mandatory German laws (including the laws on standard business terms) where no foreign connection exists. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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