On September 10, the Advocate General (AG) issued his opinion on a preliminary ruling to be rendered by the Court of Justice of the European Union (CJEU) regarding a lawsuit in Spain over the validity, under the European directive on unfair terms in consumer contracts (Directive 93/13), of a contractual clause referencing a local interest rate benchmark in floating rate residential mortgage loans. The press has regarded the opinion as unfavorable to the banks. If upheld by the CJEU, it could mark a turning point in the underlying lawsuits. A final negative outcome could provoke massive losses for a number of Spanish banks with the possibility to accelerate a wave of domestic and European bank mergers.

A hypothetical bank defeat, following on a streak of other financial consumer disputes having seriously hit various Spanish lenders in recent years, could also awaken the aggressiveness of consumer associations and plaintiff law firms in other European jurisdictions and make them search for other vulnerable clauses in other bank agreements also on the ground of Directive 93/13.

Therefore, all European financial players and professionals should closely monitor future developments in the IRPH litigation.

A wave of bank consumer litigation

The now virtually defunct Spanish saving banks (Cajas) used to apply the IRPH index as reference rate in their mortgage loans to consumers. IRPH has been yielding rates very much higher than the other commonly used benchmark, EURIBOR, at the cost of borrowers on IRPH. As Cajas converted or were acquired by banks, the contested clause is now on their loan portfolios.

The matter ended up in court in Spain on the ground that consumers were misinformed about the index and its economic results as an essential term in their agreements, in breach of Directive 93/13. The banks argue that IRPH was regulated by the Bank of Spain and was transparent and valid. The Spanish Supreme Court ruled in 2017 in favor of the banks. However, the legal battle continued and a court in Barcelona requested a preliminary ruling from the CJEU and hence the Advocate General’s opinion.

The CJEU will render its judgment in early 2020 and opinions of AGs tend to have weight. The outcome remains uncertain though, and even if the IRPH is set aside, the actual monetary consequences are unclear. Depending on whether the nullity of the provision should result in full disgorgement by the lenders of all interest paid by the borrowers since the agreement was signed, or only the difference between IRPH and EURIBOR, the invoice for the banks could be very different. The potential figures are reported to be as high as 17 billion euros and even 44 billion in the most pessimistic estimates.

Spanish banks have already faced lawsuits based on unfair clauses, especially the so- called “floor clauses”, where a downwards limit on floating rates prevented clients from benefiting fully from the sharp reduction in interest rates. Following a mild ruling by the Spanish Supreme Court in 2013, the CJEU had the last word and ruled that borrowers were to recover all excessive interest, forcing the banks to pay around 2 billion euros.

The consequences of a hypothetical ruling against the banks

If the CJEU heeds the AG’s opinion and, additionally, the nullity decision attracts the most severe consequences, the effect on financial stability can be serious. Some banks would see their capital ratios perilously reduced. This could spark a vicious cycle that could further stigmatize certain institutions to the extent that rescue measures might have to be imposed.

As Governments no longer wish to pay for bank bail-outs, it will be the industry, with or without the intervention of the resolution authorities, which will have to act. Bank mergers and acquisitions may ensue, as this will add to the other multiple factors that call for bank consolidation in Spain and Europe at large. The shock may be such that there may be room for trans-European mergers.

Will similar litigation arise elsewhere in Europe?

While some other countries have also witnessed mass litigation against banks (such as the UK and the PPI disputes), other jurisdictions have not. Although bank contractual terms and practices continue to differ within Europe, Spanish cases are based on a European Directive that establishes principles upon which other different terms could also come under fire if the consumer and legal communities emulate their Spanish peers.

The die is not cast

However, the AG’s opinion is not as bad as the press has reported; it calls for a case-by- case examination and finds that in the instant case, the client received sufficient information although that does not preclude a ruling that the clause is unfair, an appreciation which in any case falls to the national courts. Further, the AG does not conclude on whether the banks should return all the interest or only the excess over EURIBOR. This is not the end of the story and the banks may escape more or less unscathed, including on statute of limitation issues.

Also, Spanish banks are well capitalized now and most could withstand any outcome. If an industry consolidation is to happen, certain Spanish institutions will surely have a leading role. There may be losers and winners but it is likely that the large Spanish banks will weather the storm and come out reinforced.