Defining the Loan Contract
Case History

Under French law most contracts exist as soon as both parties have expressed their will to be bound. Pursuant to this general principle, no further formalities are required to create a contract.

Defining the Loan Contract

However, certain types of contract do not work on this principle. Their existence and validity are subject to additional formalities. Loan agreements are such a type of contract.

Article 1892 of the French Civil Code defines loan agreements. This article has always been construed as requiring the remittance of the subject matter of the contract as a condition for its existence and validity. Like deposit agreements, loan agreements are therefore considered as agreements over things (in rem). Therefore the remittance of funds by the lender to the borrower does not constitute a contractual obligation. As long as funds have not been transferred, the formal undertaking of a bank to lend money to one of its clients merely constitutes a promise to enter into a loan agreement. If the bank defaults in the transfer of funds it cannot be held accountable, since no loan agreement exists. The would-be borrower is merely, under certain conditions, entitled to damages.

This qualification has been challenged many times. Criticisms state that is unnecessary to refer to the theory of contrats réels (that a contract does not come into existence as soon as the parties agree to be bound, but requires further formalities) in order to demonstrate that the borrower has no obligation to repay the lender, as long as it has not received anything from the latter. One may simply assert that the lender's obligation to transfer funds and the borrower's obligation to reimburse the lender are interdependent. A contract should exist as soon as both parties have expressed their will to be bound, because it is specified that the borrower's obligation only materializes when the lender has executed its obligation.

Case History

The first court decision to question the traditional qualification of loan agreements as contrats réels was the Court of Cassation's judgment of May 27 1998. The court held that credits granted by credit professionals to non-professionals are governed by Article L 311-2 of the French Consumers Code and are not contrats réels. Therefore a contract exists as soon as both parties have expressed their will to be bound. This decision was based on a specific provision in Article L 311-15 of the Consumers Code, which expressly states that such credit agreements exist as soon as the credit offer has been accepted by the non-professional party.

However, the Court of Cassation extended this finding to all loans granted by credit professionals pursuant to its decision of March 28 2000, without referring to any specific statute. In this case the loan was for the purchase of agricultural equipment and was subject to the condition that the purchaser enter into a life-insurance contract. This condition was fulfilled but the purchaser died before the funds were transferred. The bank subsequently refused to execute the loan. This loan was not governed by the Consumers Code but by Article 1892 of the French Civil Code defining loan agreements. This means that the contract was subject to the theory of contrat réels. On this basis the bank claimed that it could not be compelled to transfer the funds since no credit agreement existed. However, the Court of Cassation rejected this argument and without referring to any specific statute stated that loans granted by credit professionals are not contrats réels. The court consequently ruled that the bank was obliged to transfer the funds by virtue of the parties' mutual agreement.

As a result of this decision credit agreements will now exist as soon as they are entered into and give rise to the obligation of the lender to transfer funds to the borrower. If the lender fails to do this the borrower will now be entitled to obtain the transfer of the funds rather than just damages.

This statement is limited to loans granted by credit professionals. It does not completely dismiss the theorythat the existence of a loan agreement is subject to the prior remittance of an object. However, as far as loan agreements are concerned the contrats réels theory has been seriously questioned. If this reasoning is extended to all types of loan agreement, including those between non-professionals, the theory might become obsolete.

For further information on this topic please contact Philippe Portier or Raphaële Navelet at Jeantet & Associés by telephone (+33 1 45 05 81 96) or by fax (+33 1 47 04 87 98) or by e-mail ([email protected] or [email protected]).

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