Early Loan Repayment and Funding Loss: Background and State of Play

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This article was published in the Forum de l’Immobilier, May 2022 (Anthemis).

For over twenty years, the early repayment of a credit and the amount claimed by the bank in return for that early termination, whether called reinvestment indemnity, break indemnity or funding loss, have kept business people and banking and credit lawyers busy. The indemnity claimed proves significant in a low interest rate environment: it is generally calculated as the difference between the interest that would have accrued on the credit had it run to its agreed term, and the interest the bank expects to earn by reinvesting the funds received on the interbank market or with other borrowers. The lower the reinvestment rate, the higher the indemnity.

A brief history of a long judicial controversy

Many borrowers considered this indemnity to be an abuse of right or an excessive penalty clause, especially since, under Belgian law, article 1907bis of the former Civil Code caps the indemnity a lender may claim at a maximum of six months’ interest. That cap, however, only concerns the loan for interest (pret a interet), which differs from the credit agreement both legally and economically. In 2013 the Constitutional Court held that, given the differences between the two contracts, it was not discriminatory to apply the article 1907bis cap only to the loan for interest.

Against that background, the legislature enacted the Act of 21 December 2013 on the financing of small and medium-sized enterprises (the Laruelle Act). It caps the indemnity at six months’ interest for all loan and credit agreements concluded from 11 January 2014 (depending on the date of conclusion, this cap applies to credits up to EUR 1 or 2 million). The volume of litigation on this issue has fallen appreciably each year since. This did not prevent the Court of Cassation from handing down several judgments between 2019 and 2022.

Characterising a credit or a loan agreement

For professional credits not governed by the Laruelle Act, the legal strategy seen in the courts over the past decade consists, for borrowers, in trying to convince the judge that the contract, despite its title referring to credit, must in fact be re-characterised as a loan agreement, on the ground that it actually has all the features of such a contract. The features of each are now clearly established. The loan (pret) is a nominate, unilateral and real contract, formed by handing over a determined amount to the borrower. It is credited positively to the borrower’s account at the lender’s initiative. Interest is calculated from the handover of the funds and on the whole amount lent. The loan is typically used to finance a single operation, for a determined amount, payable in one go. The credit (ouverture de credit) is an innominate, consensual and synallagmatic contract, consisting of a making available of funds, leaving the borrower free to draw down all, part or none of them under defined terms. Draw-downs are booked negatively. Its advantage is flexibility: the borrower generally pays a reservation commission on undrawn reserved amounts but pays contractual interest only on amounts actually drawn. It is typically used to finance real estate operations where expenditure is incurred in several instalments over time.

Belgian funding loss case law has integrated these differences but generally retains a single criterion to characterise the contract: the freedom to draw down left, or not, to the borrower. In short, a contract titled credit will be re-characterised as a loan if the freedom to draw down proves purely fictitious. In that case, the borrower benefits from article 1907bis, provided it has not waived it by paying the claimed indemnity without reservation.

The recent case law of the Court of Cassation

The recent judgments clarified the criteria a judge may rely on to conclude whether or not the borrower enjoyed sufficient freedom to draw down. The Court above all recalled that calculating a reservation commission or an indemnity for not drawing down the whole credit is not such as to restrict the borrower’s freedom to draw down. The same goes for the credit being drawn down in one go and for the whole amount made available. The Court also recalled that the freedom to draw down amounts under a credit agreement must not be confused with the freedom to use the funds drawn, the latter possibly being very limited for legitimate reasons: the bank must ensure the funds are used for lawful and agreed purposes, the value of the security generally granted to the bank depending directly on the funds being applied to the secured asset.

The Court then validated the legal figure of the promise of loan (promesse de pret), holding that where the borrower had a purely formal freedom to draw down in a credit agreement, the parties should in fact be seen as having promised the later conclusion of a loan agreement, giving rise to article 1907bis. These decisions seemed to relegate to the status of loan only single, determined financing operations for which freedom to draw down was purely theoretical, such as buying a building, refinancing a debt or acquiring shares. Yet in 2022 the Court handed down two further judgments, on 11 February and 3 March, validating the possibility of re-characterising a credit agreement as a promise of loan(s) concluded when the bank and its client agreed on financing operations staggered over time, such as construction works.

Provisional conclusion: a case-by-case approach

The takeaway is that the terms of the contract and the parties’ initial intention will be decisive in re-characterising a credit as a loan or a promise of loan. If the disputed contract confers the right to draw down funds in several tranches up to a determined ceiling, with the freedom not to draw down all or part of them, it is a credit facility. If the freedom to draw down or not is fictitious and does not really exist, re-characterisation follows, with the indemnity capped under article 1907bis of the Civil Code.

This article is a translation and a condensed version. Only the French version is authoritative. It is provided for information purposes and does not constitute legal advice.