Consumer Vulnerability and Welfare in Mortgage Contracts 9781509913398, 9781509913428, 9781509913404

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CONSUMER VULNERABILITY AND WELFARE IN MORTGAGE CONTRACTS This book advocates a new way of thinking about mortgage contracts. This claim is based on the assumption that we currently live in a political economy in which consumer debt fulfils a social function. In the field of housing, this is evidenced by the expansion of mortgage credit through which consumers are to purchase residential property as a means of social inclusion and personal welfare. It is suggested that contract law needs to adjust to this new social function in order to avoid welfare losses in terms of default, overindebtedness, and possibly eviction. To this end, this book analyses theoretical contract law frameworks and makes concrete proposals for contract law in the EU legal order.

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Consumer Vulnerability and Welfare in Mortgage Contracts

Irina Domurath

OXFORD AND PORTLAND, OREGON 2017

Hart Publishing An imprint of Bloomsbury Publishing Plc Hart Publishing Ltd Kemp House Chawley Park Cumnor Hill Oxford OX2 9PH UK

Bloomsbury Publishing Plc 50 Bedford Square London WC1B 3DP UK

www.hartpub.co.uk www.bloomsbury.com Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 920 NE 58th Avenue, Suite 300 Portland, OR 97213-3786 USA www.isbs.com HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published 2017 © Irina Domurath 2017 Irina Domurath has asserted her right under the Copyright, Designs and Patents Act 1988 to be identified as Author of this work. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, e­ lectronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www. nationalarchives.gov.uk/doc/open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2017. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. ISBN: HB: 978-1-50991-339-8 ePDF: 978-1-50991-340-4 ePub: 978-1-50991-341-1 Library of Congress Cataloging-in-Publication Data Names: Domurath, Irina, author. Title: Consumer vulnerability and welfare in mortgage contracts / Irina Domurath. Description: Oxford ; Portland, Oregon : Hart Publishing, an imprint of Bloomsbury Publishing Plc, 2017.  |  Based on author’s thesis (doctoral - Juridiske Fakultet, Københavns Universitet and Háskóli Íslands, 2016) issued under title: Consumer debt & contract law : protection from over-indebtedness in EU mortgage law.  |  Includes bibliographical references and index.  |  Description based on print version record and CIP data provided by publisher; resource not viewed. Identifiers: LCCN 2017036963 (print)  |  LCCN 2017038070 (ebook)  |  ISBN 9781509913411 (Epub)  |  ISBN 9781509913398 (hardback : alk. paper) Subjects: LCSH: Mortgage loans—Law and legislation—Economic aspects—European Union countries.  |  Consumer protect—Law and legislation—European Union countries. Classification: LCC KJE1360 (ebook)  |  LCC KJE1360 .D668 2017 (print)  |  DDC 346.2404/364—dc23 LC record available at https://lccn.loc.gov/2017036963 Typeset by Compuscript Ltd, Shannon To find out more about our authors and books visit www.hartpublishing.co.uk. Here you will find extracts, author information, details of forthcoming events and the option to sign up for our newsletters.

ACKNOWLEDGEMENTS

This book is a revised version of my dissertation at the Universities of Copenhagen and Iceland. My gratitude goes first and foremost to my supervisors, M Elvira Méndez Pinedo and Peter Rott, for their comments and encouragement throughout the years, as well as the University of Iceland and the CEVIA Centre for Enterprise Liability at the University of Copenhagen. The development and completion of this book has benefited from the invaluable suggestions of Iain Ramsay on the first draft of my dissertation. I would also like to thank Hans-W Micklitz, Vanessa Mak, and Vibe Ulfbeck, for their support and challenging criticism. I am also much obliged to Guido Comparato and the late Norbert Reich, who gave very helpful comments on parts of my research on several occasions. Furthermore, I thank the Max-Planck-Institute for International and Comparative Private Law in Hamburg for accepting me as a guest researcher in order to complete the manuscript for this book. I am grateful to everyone at Hart Publishing who was involved in the publication process of this book for their excellent work, but especially Roberta Bassi, Tom Adams, and Nick Allen. Finally, I thank my family and Stefano Palestini for their support and love. Irina Domurath Hamburg, April 2017

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CONTENTS

Acknowledgements������������������������������������������������������������������������������������������������������v Table of Cases������������������������������������������������������������������������������������������������������������ xi Table of Legislation���������������������������������������������������������������������������������������������������xv

Introduction���������������������������������������������������������������������������������������������������������������1 I. Context������������������������������������������������������������������������������������������������������1 II. Themes and Aims��������������������������������������������������������������������������������������6 III. Questions and Structure���������������������������������������������������������������������������8 1. Theoretical Framework������������������������������������������������������������������������������������13 I. Introduction��������������������������������������������������������������������������������������������13 II. Duality of Aims in EU Consumer Law��������������������������������������������������13 III. Normative Preconceptions���������������������������������������������������������������������16 A. Values�����������������������������������������������������������������������������������������������16 (i) Approach: Social Justice and Welfarism in Private Law����������������������������������������������������������������������������16 (ii) Controversy: The Public–Private Distinction���������������������20 B. Method���������������������������������������������������������������������������������������������26 (i) Approach: EU Level��������������������������������������������������������������26 (ii) Controversy: Harmonisation of Contract Law�������������������27 (a) Criticisms���������������������������������������������������������������������29 (b) Alternatives�������������������������������������������������������������������31 (iii) Controversy: Judge-Made Constitutionalisation of Horizontal Relationships������������������������������������������������������33 (a) The Role and Effect of Constitutional Rights and Principles���������������������������������������������������������������33 (b) The Regulation of Private Autonomy�������������������������36 (c) Criticisms���������������������������������������������������������������������37 C. Approach in this Book��������������������������������������������������������������������39 (i) Values�������������������������������������������������������������������������������������39 (ii) Method����������������������������������������������������������������������������������41 IV. Conclusions���������������������������������������������������������������������������������������������43 2. Vulnerability to Welfare Losses through Privatisation�����������������������������������45 I. Introduction��������������������������������������������������������������������������������������������45 II. Privatisation: Credit versus Welfare�������������������������������������������������������46 A. The Emergence and Retreat of the Welfare State���������������������������46

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Contents B. Private Home Ownership as Private Welfare���������������������������������49 (i) Promotion of Private Home Ownership�����������������������������49 (ii) Expansion of Mortgage Credit in the USA and the EU�����������������������������������������������������������������������������50 C. Financial and Social Inclusion��������������������������������������������������������52 (i) The Assumed Logic���������������������������������������������������������������53 (ii) The Political Ideology�����������������������������������������������������������54 (iii) Responsibilisation and Individualisation����������������������������56 III. Welfare Losses������������������������������������������������������������������������������������������57 A. The Fallacy of Financial and Social Inclusion��������������������������������57 B. Welfare Losses in the Housing Sector���������������������������������������������60 IV. Vulnerability to Welfare Losses���������������������������������������������������������������61 A. Definition and Conceptualisation of Vulnerability�����������������������62 B. Vulnerability of Mortgagors�����������������������������������������������������������64 (i) Relational Vulnerability to Internal Risk Factors����������������65 (ii) Event Vulnerability to External Risk Factors�����������������������68 (a) Income Instability and Precarious Workers���������������69 (b) Systemic Risks: Bubble and Foreign-Currency Borrowers���������������������������������������������������������������������70 (iii) Lack of Resilience������������������������������������������������������������������73 (iv) Overview of Vulnerabilities��������������������������������������������������74 V. Conclusions���������������������������������������������������������������������������������������������75

3. Vulnerability in EU Mortgage Contract Law��������������������������������������������������78 I. Introduction��������������������������������������������������������������������������������������������78 II. Vulnerability in EU Mortgage Contract Law�����������������������������������������78 A. Relational Vulnerability�������������������������������������������������������������������78 (i) The European Model Consumer������������������������������������������79 (a) Reasonably Circumspect but Weak Consumer����������79 (b) The Vulnerable Consumer������������������������������������������81 (ii) Weak Consumers������������������������������������������������������������������83 (a) Information Obligations for Lenders�������������������������83 (b) Economic Efficiency and Political Function of Information Provision��������������������������������������������84 (iii) Consumers with Low Levels of Education��������������������������87 (a) Preliminary Remarks on Financial Education�����������87 (b) Fairness of Commercial Practices�������������������������������88 (iv) Marginal Borrowers��������������������������������������������������������������89 (a) Fairness of Contract����������������������������������������������������91 (b) Fairness of Enforcement����������������������������������������������94 (c) Assessment of the Unfairness Regime����������������������100 (v) Summary: Relational Vulnerability in the EU Legal Framework��������������������������������������������������������������������������108

Contents

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B. Event Vulnerability������������������������������������������������������������������������109 (i) Precarious Workers�������������������������������������������������������������110 (ii) Bubble Borrowers����������������������������������������������������������������110 (iii) Foreign-Currency Borrowers���������������������������������������������111 (iv) Assessment��������������������������������������������������������������������������115 C. Lack of Resilience��������������������������������������������������������������������������116 (i) Low-Net-Worth Consumers�����������������������������������������������116 (ii) Assessment��������������������������������������������������������������������������118 III. Conclusions�������������������������������������������������������������������������������������������120 4. A Flexible Mortgage Contract Law����������������������������������������������������������������124 I. Introduction������������������������������������������������������������������������������������������124 II. Relational Vulnerability������������������������������������������������������������������������125 A. A New Benchmark: The Real-Life Mortgagor?����������������������������125 B. Consumers with Low Levels of Education�����������������������������������125 C. Marginal Borrowers����������������������������������������������������������������������127 (i) Price Controls����������������������������������������������������������������������127 (ii) Universal Financial Services�����������������������������������������������129 III. Event Vulnerability��������������������������������������������������������������������������������131 A. Unsuitability of Insurance������������������������������������������������������������132 B. Creditworthiness Assessment�������������������������������������������������������132 (i) Protective Ambit�����������������������������������������������������������������132 (ii) Parameters���������������������������������������������������������������������������133 (iii) Liability��������������������������������������������������������������������������������135 C. Renegotiation of Mortgage Debt��������������������������������������������������136 (i) Proposals after the Financial Crisis������������������������������������137 (ii) The Legal Concept of ‘Change in Circumstances’�������������139 (iii) ‘Change in Circumstances’ in European Legal Orders������140 (a) The ‘Continental’ and English Approaches��������������140 (b) The ‘Nordic’ Approach����������������������������������������������145 (c) Similarities and Divergences�������������������������������������147 (iv) Implications for Renegotiation������������������������������������������149 (a) The Continental Approach����������������������������������������150 (b) The Nordic Approach: Fairness��������������������������������153 (c) Problems���������������������������������������������������������������������154 (d) Exclusion from Credit�����������������������������������������������156 IV. Lack of Resilience����������������������������������������������������������������������������������157 A. Creditworthiness Assessment�������������������������������������������������������158 B. Price Controls��������������������������������������������������������������������������������159 V. Conclusions�������������������������������������������������������������������������������������������159 5. Theoretical Framework Revisited������������������������������������������������������������������161 I. Welfarist EU Mortgage Contract Law?�������������������������������������������������161 A. Market Rationality������������������������������������������������������������������������161 B. Equality and Collectivism�������������������������������������������������������������164

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Contents C. Needs and Further Aims���������������������������������������������������������������165 D. Proceduralisation��������������������������������������������������������������������������168 (i) Balancing: Rights, Autonomy, Power���������������������������������168 (ii) Proceduralised Constitutionalisation��������������������������������172 II. Justice in EU Mortgage Credit Law������������������������������������������������������173 A. Lack of Social Justice���������������������������������������������������������������������174 B. The Features of Access Justice�������������������������������������������������������176

Epilogue������������������������������������������������������������������������������������������������������������������178

References����������������������������������������������������������������������������������������������������������������182 Index�����������������������������������������������������������������������������������������������������������������������201

TABLE OF CASES

C-25/62, Plaumann and Co v. Commission of the European Economic Community, ECLI:EU:C:1963:17�����������������������������������������������������������������������������������������������������������106 C-43/75 Defrenne v Sabena ECLI:EU:C:1976:56������������������������������������������������������������������34 C-33/76 Rewe-Zentralfinanz eG und Rewe-Zentral AG gegen Landwirtschaftskammer für das Saarland, ECLI:EU:C:1976:188����������������������90, 95, 135 C-45/76 Comet BV gegen Produktschap voor Siergewassen, ECLI:EU:C:1976:191���������� 95 C-120/78 Rewe Zentral v Bundesmonopolverwaltung für Branntwein, ECLI:EU:C:1983:202�����������������������������������������������������������������������������������������������������������80 C-148/78 Criminal proceedings against Tullio Ratti, ECLI:EU:C:1979:110����������������������� 34 C-158/80 Rewe-Handelsgesellschaft Nord mbH v Hauptzollamt Kiel, ECLI:EU:C:1981:163���������������������������������������������������������������������������������������������������������� 96 C-32/84 Van Gend and Loos NV mod Inspecteur der Invoerrechten en Accijnzen, Enschede, ECLI:EU:C:1985:104���������������������������������������������������������������������������������������� 34 C-382/87 R. Buet und SARL Educational Business Services v Ministère public, ECLI:EU:C:1989:198�����������������������������������������������������������������������������������������������������������89 C-213/89 The Queen v Secretary of State for Transport, ex parte: Factortame Ltd and others, ECLI:EU:C:1990:257������������������������������������������������������������������������������������ 135 Joined Cases C-6/90 and C-9/90 Andrea Francovich and Danila Bonifaci and others v Italian Republic, ECLI:EU:C:1991:428������������������������������������������������������������������ 34, 135 C-271/91 M. Helen Marshall v Southampton and South-West Hampshire Area Health Authority, ECLI:EU:C:1993:335�������������������������������������������������������������������������� 135 C-470/93 Verein gegen Unwesen in Handel und Gewerbe Köln eV v Mars GmbH, ECLI:EU:C:1995:224�����������������������������������������������������������������������������������������������������������79 Joined Cases Océano Grupo Editorial SA v Rocío Murciano Quintero (C-240/98), Salvat Editores SA v José M. Sánchez Alcón Pradės (C-241/98), José Luis Copano Badillo (C-242/98), Mohammed Berroane (C-243/98), and Emilio Viñas Feliú (C-244/98) (Océano), ECLI:EU:C:2000:346�������������������������������������������������������������91, 103 C-376/98 Federal Republic of Germany v European Parliament and Council of the European Union, ECLI:EU:C:2000:544����������������������������������������������������������� 14, 80 C-168/00 Simone Leitner gegen TUI Deutschland GmbH and Co. KG, ECLI:EU:C:2002:163���������������������������������������������������������������������������������������������������������� 29 C-473/00, Cofidis SA v Jean-Louis Fredout, ECLI:EU:C:2002:705������������������������������������� 97 C-237/02, Freiburger Kommunalbauten GmbH Baugesellschaft and Co. KG v Ludger Hofstetter and Ulrike Hofstetter, ECLI:EU:C:2004:209��������������������������������������������������� 90 C-144/04 Werner Mangold v Rüdiger Helm, ECLI:EU:C:2005:709�������������������������������������34 C-168/05 Elisa María Mostaza Claro v Centro Móvil Milenium SL, ECLI:EU:C:2006:675�����������������������������������������������������������������������������������������������������������94 C-207/05 Commission of the European Communities v Italian Republic, ECLI:EU:C:2006:366���������������������������������������������������������������������������������������������������������� 29

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Table of Cases

C-341/05 Laval un Partneri Ltd v Svenska Byggnadsarbetareförbundet, Svenska Byggnadsarbetareförbundets avdelning 1, Byggettan and Svenska Elektrikerförbundet, ECLI:EU:C:2007:809�����������������������������������������������������������������������34 C-432/05 Unibet (London) Ltd und Unibet (International) Ltd gegen Justitiekanslern, ECLI:EU:C:2007:163���������������������������������������������������������������������� 96, 135 C-438/05 International Transport Workers’ Federation and Finnish Seamen’s Union v Viking Line ABP and OÜ Viking Line Eesti, ECLI:EU:C:2007:772�������������������34 Joined Cases C-261/07, VTB-VAB NV v Total Belgium and Galatea BVBA v Sanoma Magazines Belgium NV (C-299/07), ECLI:EU:C:2009:244��������������������������������������������� 29 C-489/07 Pia Messner v Firma Stefan Krüger, ECLI:EU:C:2009:502�����������������������������������34 C-555/07 Seda Kücükdeveci v Swedex GmbH and Co. KG, ECLI:EU:C:2010:21���������������34 C-40/08 Asturcom Telecomunicaciones SL v Cristina Rodríguez Nogueiras, ECLI:EU:C:2009:615�����������������������������������������������������������������������������������������������94, 95, 97 C-137/08 VB Pezügji Lizing Zrt. v Ferenc Schneider, ECLI:EU:C:2010:659������������������������79 C-243/08 Pannon GSM Zrt. v Erzsébet Sustikné Győrfi, ECLI:EU:C:2009:350������������������97 Joined cases Rosalba Alassini v Telecom Italia SpA (C-317/08, Filomena Califano v Wind SpA (C-318/08), Lucia Anna Giorgia Iacono v Telecom Italia SpA (C-319/08) and Multiservice Srl v Telecom Italia SpA (C-320/08)�������������� 100 C-76/10, Pohotovost’ s.r.o. v. Iveta Korčkovská, ECLI:EU:C:2010:685������������������91, 93, 129 C‑453/10 Jana Pereničová and Vladislav Perenič v SOS financ spol. s r. o., ECLI:EU:C:2012:144���������������������������������������������������������������������������������������������������������163 C-472/10 Nemzeti Fogyasztóvédelmi Hatóság v Invitel Távközlési Zrt., ECLI:EU:C:2012:242��������������������������������������������������������������������79, 91, 92, 93, 97, 98, 106, 107, 129, 163, 171 C-602/10 SC Volksbank România SA v Autoritatea Naţională pentru Protecţia Consumatorilor—Comisariatul Judeţean pentru Protecţia Consumatorilor Călăraşi (CJPC), ECLI:EU:C:2012:443������������������������������������������������������������������������������96 C-618/10 Banco Español de Crédito SA v Joaquín Calderón Camino, ECLI:EU:C:2012:349�����������������������������������������������������������������������������������������������������94, 98 C-92/11 RWE Vertrieb v Verbraucherzentrale NRW, ECLI:EU:C:2013:180��������������� 93, 103 C-415/11 Mohamed Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa (Catalunyacaixa), ECLI:EU:C:2013:164��������������������������������������������������� 5, 91–2, 94, 96–8, 108, 127, 165 C-565/12 LCL Le Crédit Lyonnais SA gegen Fesih Kalhan, ECLI:EU:C:2014:190�������������96, 117, 119 C‑26/13 Árpád Kásler Hajnalka Káslerné Rábai v OTP Jelzálogbank Zrt, ECLI:EU:C:2014:282��������������������������������������������������������������������������������������� 92, 93, 98, 113 C-143/13, Bogdan Matei, Ioana Ofelia Matei v SC Volksbank România SA, ECLI:EU:C:2015:127���������������������������������������������������������������������������������������������������������129 C-280/13 Barclays Bank SA v Sara Sánchez García, Alejandro Chacón Barrera, EU:C:2014:279��������������������������������������������������������������������������������������������������������������������95 Joined Cases C-482/13 Unicaja Banco, SA v José Hidalgo Rueda and Others, C-484/13 Caixabank SA v Manuel María Rueda Ledesma and Others, C-485/13 Caixabank SA v José Labella Crespo and Others, and C-487/13 Caixabank SA v Alberto Galán Luna and Others��������������������������������������������������������������95 C-8/14, BBVA SA v Pedro Peñalva López, Clara López Durán, Diego Fernández Gabarro, ECLI:EU:C:2014:2464�������������������������������������������������������������������������������������5, 97

Table of Cases

 xiii

C‑32/14, ERSTE Bank Hungary Zrt. v Attila Sugár, paras 57–65, ECLI:EU:C:2015:637����99 C-96/14 Jean-Claude Van Hove v CNP Assurances SA, ECLI:EU:C:2015:262����������� 93, 129 C-169/14, Juan Carlos Sánchez Morcillo and María del Carmen Abril García v Banco Bilbao Vizcaya Argentaria SA, ECLI:EU:C:2014:2099���������������� 5, 91, 95, 99, 166 C-312/14 Banif Plus Bank Zrt. v Márton Lantos and Mártonné Lanto���������������������113, 152 German Constitutional Court, judgment of 19 October 1993—1 BvR 567/89����������������170 German Supreme Court, judgment of 24 March 1988, III ZR 30/87������������������������������� 128 Spanish Supreme Court, judgment of 30 June 2015, No. 323/2015���������������������������������� 114 Spanish Supreme Court, judgment of 15 October 2015, No. 563/2015���������������������������� 144 Opinion of AG Trstenjak in C-472/10 (Invitel) delivered on 6 December 2011, ECLI:EU:C:2011:806�������������������������������������������������������������������������������������������������������� 107 Opinion of Advocate General Wahl delivered on 12 February 2014 in Case C‑26/13 Árpád Kásler Hajnalka Káslerné Rábai v OTP Jelzálogbank Zrt, ECLI:EU:C:2014:85�������������������������������������������������������������������������������������������������������������92

xiv 

TABLE OF LEGISLATION

Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts, OJ L 95/29, 21.4.1993, 29�������������������������������������������������������� 10, 28, 91–5, 97–9, 101–4, 106–8 Directive 2002/22/EC of the European Parliament and of the Council of 7 March 2002 on universal service and users’ rights relating to electronic communications networks and services (Universal Service Directive), OJ L 108, 24/04/2002, 51��������������������������������������������������������������������������������������������82, 129 Directive 2005/29/EC of the European Parliament and of the Council of 11 May 2005 concerning unfair business-to-consumer commercial practices in the internal market and amending Council Directive 84/450/EEC, Directives 97/7/EC, 98/27/EC and 2002/65/EC of the European Parliament and of the Council and Regulation (EC) No 2006/2004 of the European Parliament and of the Council, OJ L 149/22, 11.6.2005, 22���������������������������������10, 88–90 Directive 2009/22/EC of 23 April 2009 on injunction for the protection of consumers’ interests OJ L 110, 1.5.2009, 30����������������������������������������������������������������106 Directive 2009/72/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in electricity and repealing Directive 2003/54/EC, OJ L 211, 14.8.2009, 55����������������������������������82, 129 Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC, OJ L 211, 14.8.2009, 94���������������82, 129 Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC (CCD) OJ L 133/66, 22.5.2008���������� 6, 10, 83–4, 110, 117 Directive 2011/83/EU of the European Parliament and of the Council of 25 October 2011 on consumer rights, amending Council Directive 93/13/EEC and Directive 1999/44/EC of the European Parliament and of the Council and repealing Council Directive 85/577/EEC and Directive 97/7/EC of the European Parliament and of the Council, OJ L304/64, 22.11.2011, 64�����������������28 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, OJ L 176, 27.6.2013, 338�������������������������������������������������������� 3, 6, 10, 111 Directive 2014/17 of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, OJ L 60/34, 28.2.2014, 34�������������� 6, 10, 83–4, 87–8, 110–2, 117, 119, 133–5

xvi 

Table of Legislation

Regulation 472/2013 of the European Parliament and the Council of 21 May 2013 on the strengthening of economic and budgetary surveillance of Member States in the euro area experiencing or threatened with serious difficulties with respect to their financial stability, OJ L 140, 27.5.2013, 1���������������������������������������������������1 Regulation 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, OJ L 176, 27.6.2013, 1����������������������3, 158 Directive 2014/92/EU of the European Parliament and of the Council of 23 July 2014 on the comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features, OJ L-257/214, 28.8.2014, 214��������������������������������������� 82, 83, 125, 130

Introduction I. Context Almost ten years into the financial crisis, EU Member States are still struggling with economic slowdown and public budget cuts within a framework of persistent austerity politics. Levels of national debt remain high. Financial markets continue to be volatile, with unstable asset markets and exchange rates, and have come under renewed pressure due to domestic policy uncertainty.1 Notwithstanding regional differences, average economic growth in Europe is declining.2 Approved state aid for financial institutions amounts to almost €5 trillion, around a third of the 2015 GDP of the EU.3 Countries unable to refinance their government debts or to bail out failing banks have obtained assistance from the International Monetary Fund (IMF), the European Central Bank (ECB), the ­European Financial Stabilisation Mechanism/European Financial Stability Facility (EFSF/EFSM) and the European Stability Mechanism (ESM), or bilateral loans.4 At the same time, austerity has imposed harsh public spending cuts in order to comply with the requirements of the lenders and to combat the budget deficits resulting from bailouts. Those measures have had strong social impacts on societies at large. Households continue to be burdened with high debt levels and to rely on social benefits.5 In Portugal, for example, the cuts in wages, healthcare and social benefits were accompanied by an increase in taxes as well as in living and education costs.6 Similar impacts can be detected in Greece and Spain.7 Despite the adoption of different emergency ex-post measures with the aim of helping households in financial difficulties in many countries,8 individuals continue to struggle with high debt levels and the danger of eviction. Spain is undoubtedly one

1 

World Bank Group (2017) 99ff. Regulation 472/2013 of the European Parliament and the Council of 21 May 2013 on the strengthening of economic and budgetary surveillance of Member States in the euro area experiencing or threatened with serious difficulties with respect to their financial stability [2013] OJ L140, 1. 3 www.ec.europa.eu/competition/state_aid/scoreboard/index_en.html#crisis. 4  The EFSM and EFSF were replaced by the permanent rescue funding programme the ESM in 2012. 5  The numbers for social spending have risen almost across the board, OECD (2017), Social spending (indicator). doi: 10.1787/7497563b-en; OECD (2017), Household debt (indicator). doi: 10.1787/ f03b6469-en. 6  See Frade and Pinheiro Almeida (2015). 7  Gutiérrez de Cabiedes and Cantero Gamito (2015); Mentis and Pantazatou (2015); concerning the role of social rights during the crisis, see Kilpatrick and De Witte (2014). 8  See country reports in Micklitz and Domurath (2015); Domurath et al (2014). 2 

2 

Introduction

of the most affected countries: since 2007 the inability of Spanish homeowners to service their mortgage debts has spiralled into a downright social crisis. More than 500,000 repossessions9 have provoked strong societal reactions in Spain as well as international calls for help for evicted homeowners and changes to the strict Spanish mortgage law.10 These developments have prompted harsh criticism which emphasises that austerity measures have exacerbated the impact of the global financial crisis and impaired the ability of individuals to exercise their human rights, especially of vulnerable and marginalised groups who suffer from decreasing access to work and social welfare programmes and reduced affordability of housing and other basic necessities.11 The loss of social and economic rights in times of crisis and in implementation of internationally assumed contractual obligations is regarded highly critically.12 In a similar vein, the discrepancy between economic and social politics is reflected in criticism of bank bailouts borne by taxpayers13 and in emphasising the contrast between individual responsibility for household debt and the limited liability for bank debt. Korzcak argues that private individuals, after becoming over-indebted, enter a long process of insolvency for debts that could be considered insignificant compared to those of banks even though they generally do not engage in high-risk transactions. Banks, in contrast, have been able to rely on governments, without their executive managers being held liable with respect to their private assets and wealth.14 It is well known that the housing market is where the global financial crisis of 2008 started. After a period that saw a credit and housing boom,15 the crisis started in the USA with the fall of Fannie Mae and Freddie Mac and L ­ ehman ­Brothers and the collapse of the subprime mortgage market. Since then, mainstream economics, which assumes a self-regulating market, has been increasingly faced with contrasting theory and evidence. In particular, the expansion of mortgage credit markets is viewed critically. It is considered to have fuelled

9  In 2013, the Financial Times reported more than 400,000 repossessions since 2007, see www. www.ft.com/intl/cms/s/0/16e37aca-8ca5-11e2-8ee0-00144feabdc0.html#axzz3buvOJuPd; in addition, in 2014 alone, more than 100,000 people were newly facing eviction from their homes, see www.ine.es/ en/daco/daco42/eh/eh0414_en.pdf. 10  www.wsj.com/articles/SB10001424127887324339204578173401228910658; www.wsj.com/articles/ SB10001424127887324077704578362693213191094. 11  United Nation Human Rights Office of the High Commissioner (2012) 7. 12  Salomon (2015). 13 From the viewpoint of tax justice: Block (2011); in addition, Shiller (2008) 112 argues that ­bailouts should focus on mortgage borrowers in order to secure economic justice; similarly Mian and Sufi (2014)119 ff, 134. A call tax-funded bail-out while ignoring the household debt problem counterproductive. They also show the connection between the political emphasis on rescuing banks at the expense of overindebted households and the fact that banks create money through liabilities, whereas central banks can only print the money reserves, ibid, 123ff. As for the issue of the creation of money see also McLeay et al (2014). 14  Korczak (2009) 31ff. 15 As regards the credit boom as being the cause for the housing boom, see Mian and Sufi (2014) 82ff.

Context

 3

a housing bubble, exposing the instability inherent in cycles of over-accumulation (boom) and devalorisation (bust).16 The expansion of mortgage markets is also located in the middle of the ‘risk society’, a term coined by Ulrich Beck, in which individuals are supposed to provide for their own welfare as traditional welfare states decline, increasingly leaving the allocation of resources to the markets. With the development of a political economy based on a credit–welfare trade-off, which will be explained in the course of this book, consumer and mortgage credit became of pivotal importance. Therefore, political and legislative frameworks were adopted that facilitated the expansion of credit and mortgage markets. At the same time, it was the massive expansion of household debt in the years before 2008 that not only added to the fragility of the economy but has also been the root of the deep recession ever since.17 The housing and subprime mortgage crisis has not only affected the economic system of the USA but also spread to other parts of the world. Europe, in particular, has been confronted with a decline of national economies and threats to monetary stability. The financial crisis has led to an economic crisis, exposing large amounts of unsustainable sovereign debt in several European countries, with Greece being the most prominent example. The interconnectedness of European countries through the internal market has prompted market and supervisory reforms of the banking sector18 and efforts to enhance surveillance of Member States’ policies with respect to financial stability. The housing situation in many Member States remains a challenge.19 Even though household income is rising again in many Member States, which alleviates housing cost burdens, this is not an even development throughout the EU. In fact, the housing cost overburden rate for households is considered an area with the most substantial deterioration compared to 2008 when the financial crisis started.20 Irrespective of a lack of (publicly) available data, some EU and research institutions have collected data that gives an indication of the financial, economic and social situation of European households. Eurostat provides data that in 2013, more than 23 per cent of European homeowners with mortgages or loans faced a housing cost burden of over 25 per cent of their disposable household income. In the new Member States, this number goes up to more than 45 per cent.21 ­

16 

Gotham (2012) 44ff; also Mian and Sufi (2014) 106ff. Evidence to this end is provided by Mian and Sufi (2014). 18 Regulation 575/2013 of the European Parliament and of the Council of 26 June 2013 on ­prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012; Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/ EC, [2013] OJ L176/338. 19  Social Protection Committee (2016) 31. 20 ibid, 6, 14–15. Also, prices for rented accommodation are not going down: OECD (2017), ­Housing (indicator), doi: 10.1787/63008438-en. 21 www.appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do. 17 

4 

Introduction

Tenants who rent dwellings at market prices face this problem to an even larger extent, with more than 60 per cent being burdened by more than 25 per cent in relation to their disposable income.22 Moreover, material living conditions are declining. The risk-of-poverty, or social exclusion, rate remains high (even though a slight decrease was noticed between 2012 and 2013).23 Overall, in 2013, almost 17 per cent of the EU population were at risk of income poverty and almost 11 per cent lived in households with very low work intensity. Children and elderly people are especially exposed to this type of risk and social exclusion.24 Furthermore, people at risk of poverty are often facing difficult housing conditions and live in overcrowded dwellings.25 Similarly, the inability of EU households to meet unexpected expenses has risen since 2008 (with slight variations).26 Almost 40 per cent of European households are reported to be facing such financial difficulties,27 and tenants in particular spend a high percentage of their disposable income on ­market price rents.28 There is considerable variation among the Member States. Five EU Member States—Bulgaria, Romania, Greece, Latvia and Hungary—rank high in those statistics, with more than a third of their population being at the risk of poverty. But in many other Member States too, especially those that have been hit hardest by the financial crisis—notably Italy, Spain, Lithuania, Ireland, Croatia, Cyprus, Spain and Portugal—the percentage of the population at risk of poverty amounts to almost one-third. The percentage of people who are ‘severely materially deprived’ has also risen since 2008, thus putting emphasis on the importance of social transfers.29 Despite the significant differences between the Member States, the financial, economic and social difficulties of households throughout the EU are a E ­ uropean problem. The economic interdependence of the Member States through the ­internal market of the EU leads to an interconnectedness of policies and strategies.30

22 www.appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do.

23  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion. 24  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion#Main_statistical_findings. 25 www.ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statistics. 26  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion#Main_statistical_findings. 27 www.ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statistics. 28 www.ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statistics. 29  The at-risk-of-poverty rate can be substantially reduced by social transfers, see www.ec.europa. eu/eurostat/statistics-explained/index.php/File:At-risk-of-poverty_rate_before_and_after_social_ transfers_and_at-risk-of-poverty_threshold_(for_a_single_person),_2012_and_2013.png. 30  At the global level, the financial crisis has shown that individual harm poses threats to the wider economy because of systemic risk: see Lamb (2011) 226.

Context

 5

As Mian and Sufi have shown for the USA, large-scale foreclosures also have economic and social impacts beyond their immediate locality because widespread foreclosures and forced sales exacerbate housing downturns, thus affecting all homes in a given region.31 Even households that did not borrow, or regions in which foreclosure rates are low, are affected by economic downturns in other parts, for example through restrictions on lending or rising unemployment.32 It can be argued that societies at large carry the responsibility for the consequences of consumer debt and overindebtedness, including the broad social impacts.33 In this vein, defaulting households and housing problems have ranked high on the policy and research agendas in Europe. In its preparatory 2005 Green Paper on Mortgage Credit in the EU, the Commission acknowledged the ‘huge social and human dimension attached to housing and credit’ as well as the need to take into account the dimension of over-indebtedness,34 and mandated a study on the ­‘worrying’ household over-indebtedness.35 Against this backdrop, an uninterrupted flow of cases has reached the Court of Justice of the European Union (CJEU) and other European courts. In fact, some decisions rendered by the CJEU since the financial crisis have been crucial in assisting consumers to deal with their debt and the resulting severe social consequences. The most prominent case in point is Aziz from Spain, where the CJEU intervened into a contractual agreement between the lender and borrower in order to protect the latter from eviction.36 It did so by interfering with the enforcement procedure, prompting follow-up preliminary references concerning the legality of the amendments to Spanish procedural law.37 Many of the cases that have reached the CJEU concern the claimed unfairness of contract terms in credit and mortgage agreements during enforcement proceedings. The judicial interventions have revived debates on the role of the judiciary in assuming the task of protecting individuals38 in the constitutionalisation process of private law in the EU.

31  Mian and Sufi (2014) 26ff. Because the lender does not want the property and the borrower cannot afford it, the former is forced to sell the property at a lower price, which in turn can lead to a collapse in asset prices. In a vicious circle, depressed asset prices lead to more defaults, which again lead to further depression of asset prices, and so on: see ibid, 29. 32  For the US context, see ibid, 55ff. 33  Reifner et al (2010) 86. 34  European Commission Green Paper Mortgage Credit in the EU, COM(2005) 327 final, Brussels, 19.7.2005, 3–4. 35  Alleweldt et al (2013). 36 C-415/11 Mohamed Aziz v Caixa d’Estalvis de Catalunya, Tarragona i Manresa (Catalunyacaixa), ECLI:EU:C:2013:164. 37  For example, C-8/14 BBVA SA, former Unnim Banc SA v Diego Fernández Gabarro, Pedro Peñalva López, Clara López Durá, ECLI:EU:C:2015:731; C-169/14 Sánchez Morcillo and Abril García v Banco Bilbao, ECLI:EU:C:2014:2099. 38  See Burton (2008) 13ff for the historical role of courts in protecting individuals from unjust commercial practices. The relationship between the legislator and the judiciary is highlighted in the field of contractual adjustment by Rodhe (1959) 196–97.

6 

Introduction

II.  Themes and Aims The causes of the financial crisis are well studied.39 Institutional reforms are being put into place with the aim of guaranteeing better stability of financial markets in the future. In the field of housing, Directive 2014/17 of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property (Mortgage Credit Directive, MCD)40 was adopted. Consumer law literature is replete with analyses. Some themes, however, remain underexplored in the legal literature, especially topics relating to the intersection of welfare state policies, overindebtedness, vulnerability and mortgage contracts. There is manifold literature that describes the replacement of public with private welfare in general,41 and in the field of housing in particular.42 Together with EU policy papers on financial and social inclusion, this literature forms the framework for the position represented in this book that there is evidence of an increasing role of citizens in the provision of their own welfare, which displaces the danger of welfare losses into the private realm.43 What is still missing in this literature is the connection of privatised welfare with an analysis of contract law in order to analyse to what extent contract law—as the vehicle for privatisation—can actually fulfil its welfare role. Moreover, in the scarce literature on overindebtedness, the connection between defaults and welfare losses on the one hand and contracts on the other is neglected. For example, Vandone’s analysis in the field of economics44 is concerned with the implications for contract law theory, but she leaves aside the dimension of­ vulnerability. By adding vulnerability, this book adds another layer to the topic, which allows me to lay down a conceptual framework for legal analysis. Furthermore, this book uses studies and literature from the period after the financial crisis, thus adding a more up-to-date view on the issue of overindebtedness. Even though Reifner et al45 analyse overindebtedness from the viewpoint of contract law, they infer their findings from principles of Member States’ legal orders,

39  For example: Mian and Sufi (2014), Fligstein and Habinek (2014), Mian et al (2010), Mishkin (2010), Ireland (2010), Hellwig (2009), Crouhy and Turnbull (2008), Shiller (2008). 40  Directive 2014/17 of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, [2014] OJ L60/34 (MCD). 41  For example: Prasad (2012), Streeck (2011), Kuhnle and Sander (2010), Castles et al (2010), Nullmeier and Kaufmann (2010). 42 For example: Schwartz (2012b), Harloe (1995a,b), Ansell (2014), Fahey and Norris (2010), ­Conley and Gifford (2006), Doling (1993). 43  For example: Micklitz and Domurath (2015, Mian and Sufi (2014), Wilson (2013a), Ferretti (2015), Korczak (2001) Alleweldt et al (2013), Heuer et al (2005). 44  Vandone (2009, 2012). 45  Reifner et al (2010).

Themes and Aims

 7

whereas this book takes the viewpoint of the EU legislator. In this sense, these two books can be regarded as complementary. More importantly, this book goes beyond the framework of Reifner et al, as it includes the theoretical dimension of how contracts are understood in their role in ordering societies. Vulnerability is not a much-discussed concept in the field of household vulnerability to default and overindebtedness. Even though there are policy papers and discussion on the vulnerability of consumers in general, the concept is more used in environmental studies or sociology.46 In this regard, new attempts to conceptualise vulnerability of consumers47 are welcomed and extended in this book by connecting vulnerability with welfare losses and legal-theoretical implications with direct applicability to the field of mortgage contracts. The main literature used in this book comes from the literature on European private law in the field of consumer law and private law theory. The importance of contracts that consumers conclude in order to obtain credit for the purchase of residential property can hardly be understated. Contracts have been central to the fundamental changes of the twentieth century in terms of privatisation and the globalisation of commercial relations.48 The way in which contract law is designed matters because financial transactions around the world make heavy use of standardised contracts. The standardisation of contracts is also evident in the consumer credit field, as consumers generally take out loans without negotiating the underlying contract terms, which are presented to them by financial institutions. This development is viewed critically in some literature, which regards contracts as replacing parliamentary legislation,49 or forming an ‘informal empire’ marked by a loss of control of sovereign states, thus falling into a zone between international politics and global markets that is free of moral and legal constraints.50 Against this backdrop, discussions have erupted as to the existence of a lex mercatoria beyond the state, meaning that it is detached from state authority or influence.51 To this contract law literature examining the role and effect of contracts in a transnational space beyond the state, this book adds an analysis of mortgage contract law. The theoretical framework of this book is located in the literature on welfare and contract law, which received particular attention in legal scholarship just

46 

Ranci et al (2014a,b), Cook et al (2010). London Economics et al (2016). 48  In this vein Zumbansen (2007) 229; Zumbansen, implicitly, would then concur with the observations of Susan Strange with regard to the erosion of state power in different dimensions (Strange, 2015). For example, a causal link has been found between the contractual design on the one hand and the real estate bubble and subprime expansion on the other: see Bar-Gill (2008) 7ff. 49 See MacNeil and O’Brien (2010) 7ff with further references, criticising the development of standardised securities contracts forming a global law by contract, largely replacing parliamentary legislation. 50  Muir-Watt (2011) 2ff, 20, who also bemoans that states have been deemed very much ‘complicit’ in their loss of control over globalised markets. 51 For a discussion of lex mercatoria and the extent to which it can be considered an entirely new phenomenon, see, for example: Calliess (2010), Jansen and Michaels (2008), Michaels (2007), Teubner (1997). 47 

8 

Introduction

before the millennium, with Thomas Wilhelmsson leading the way, but to the best of my knowledge has never been applied to the analysis of specific policy fields. Thus, the aim of this book is to contribute to filling a research gap that exists in EU law. First of all, it translates the problems involved in privatised welfare into the contractual sphere. For this purpose, I investigate how the current EU legal framework is able to prevent households from defaulting on their mortgage payments as a means to protect them from further welfare losses. This implies an analysis of the extent to which contract law can contribute to the prevention of default. As such, the aim of this book is to show that, on the one hand, contract law can be used to offset the danger of welfare losses that result from the privatisation of welfare and that the EU is not currently using this potential, but on the other hand, that there are important limitations to achieving welfare goals through contractual means. This, of course, is valid only in the light of the current prevailing political economy in which welfare is privatised. It is without prejudice to and even highlights the need for public welfare in the field of housing provision. Second, the book hopes to contribute to a conceptualisation of vulnerability in the legal sphere, showing that vulnerability can be used as an analytical grid for analysing gaps and options in the applicable legal framework. Throughout the book, special regard is given to the temporal dimension of mortgage credit agreements. Such contracts usually span considerable time periods, during which many events can occur that negatively impact the consumer’s ability to repay the loan. This makes the temporal dimension of mortgage credit a pivotal aspect of any analysis in the field. Moreover, the temporality is not only a crucial component in the capitalist order, but specifically also economic crises, if they are understood as the collapse of previously assumed futures.52 Despite this centrality of the issues, the temporal dimension of contracts is often forgotten in the literature.53

III.  Questions and Structure The questions that this inquiry seeks to answer are: can contract be concerned with goals such as the prevention of default and further welfare losses of consumers? Which types of consumers are vulnerable to welfare losses in the field of housing? To what extent are the vulnerabilities of consumers acknowledged in the current EU legal framework on mortgage contracts? What are the gaps and how could they be filled with the help of contract law? What would be the theoretical implications?

52  53 

Beckert (2016) 34; further: Beckert (2012). With the notable exception of Nogler and Reifner (2014b).

Questions and Structure

 9

Underlying this analysis are several hypotheses. First, the protection of mortgagors in the enforcement stage, albeit of pivotal importance, must be complemented with a protective material dimension. The reason for this lies in the premise that the retreat of the welfare state has not only placed the allocation of welfare into the private, contractual realm, but also the danger of welfare losses. In this vein, it is hypothesised that contract law can help to prevent welfare losses even before the enforcement stage. Second, in order to make contract law fit for this welfarist role, the vulnerability of mortgagors needs to be taken into account ex ante and conceptualised on empirical evidence. The concept of vulnerability is multifaceted. This means that it is not only different in different fields of law (consumers buying goods and services online exhibit different vulnerabilities than consumers buying a residential property), but that also within one field different vulnerabilities of consumers can be identified. This complexity of the vulnerability concept, and this is the third hypothesis, prompts the need for a flexible contract law. The analysis proceeds in five chapters. Chapter 1 presents the theoretical framework of this book. It starts with a discussion on the aims of EU law to achieve a ‘competitive social market economy’ (Article 3(3), sentence 2 TEU), and presents the resultant controversies. Against this backdrop, the normative preconceptions for the research in this book are disclosed and set into discussions on values in private law, on EU competences in contract law theory, and on EU law. Without dismissing any diverging opinions and without solving the underlying conceptual and theoretical debates, I hope to adduce good reasons for advocating for a contract law in the field of mortgages that has a welfarist orientation, that is a concern for the needs of mortgagors. Chapter 2 lays out the conceptual framework for the subsequent analysis of legal sources. Based on the pertinent literature in political economy, it provides an explanation of how the retreat of the welfare state has affected the provision of housing and the expansion of mortgage credit. It will become clear that the assumed correlation between financial inclusion and social inclusion is not just ideologically borne, but, more importantly, fallacious, as mortgagors have suffered significant welfare losses. As welfare losses in terms of social exclusion are difficult to define, we will use the proxy of mortgagor default. This acknowledges that default is often the first in a line of welfare losses such as enforcement, eviction, homelessness or another kind of housing deprivation. At the end of the chapter, an understanding of vulnerability for our purposes is established by synthesising different, already existing approaches. We will see that vulnerability in the field of housing is multifaceted and surely distinct from vulnerability in different fields of law. Based on the conceptualisation of three types of vulnerability, we can later on match specific policies that can help to address vulnerability in contract law. Chapter 3 examines the extent to which the current EU legal framework acknowledges the different types of vulnerability in EU mortgage law. The legal

10 

Introduction

framework is mainly made up of the MCD54 and Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts (Unfair Contract Terms Directive, UCT),55 as far as the latter is applicable to financial services (see Annex 2 lit (c) UCT). Directive 2005/29/EC of the European Parliament and of the Council of 11 May 2005 concerning unfair business-to-consumer commercial practices in the internal market (Unfair Commercial Practices Directive, UCP)56 is examined as far as it includes provisions of interest for the themes in this book. Finally, Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers (Consumer Credit Directive, CCD)57 is mentioned to highlight differences or similarities with the approaches taken by the MCD. With the help of policy papers and academic literature, from the fields of law and economics, the pertinent rules are analysed with regard to their suitability to prevent default and further welfare losses. It will become evident that the EU focuses on a certain type of vulnerability while neglecting other, probably more important, ones. The special role of the CJEU and the national courts in their regard for the social dimension of mortgage credit agreements will be highlighted. Despite the undoubted social consciousness of the European courts, it is claimed that the EU legal framework is still ill equipped to address vulnerability and ­prevent welfare losses. In Chapter 4, I propose tools with the help of which the neglected types of ­vulnerability can be addressed in the applicable legal framework on mortgage contracts. The suggestions are matched with the types of vulnerabilities previously identified. We will see that some contractual tools involve only small changes to the current legal framework vulnerabilities, while others would require more substantial changes that go to the core of the theoretical debates on the role of contract law in a political economy in which the welfare states are in retreat. We will also see that some proposals have already been discussed in the legal literature or are in force in some EU Member States. The final Chapter 5 closes the circle to the first chapter by revisiting the theoretical debates. It will be elicited to what extent the current legal framework already has a welfarist dimension and to what extent the gaps could be filled with the suggestions made here. It will become clear that using the concept of vulnerability to

54  Directive 2014/17 of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, [2014] OJ L60/34 (MCD). 55  Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts, [1993] OJ L95/29 (UCT). 56  Directive 2005/29/EC of the European Parliament and of the Council of 11 May 2005 concerning unfair business-to-consumer commercial practices in the internal market and amending Council Directive 84/450/EEC, Directives 97/7/EC, 98/27/EC and 2002/65/EC of the European Parliament and of the Council and Regulation (EC) No 2006/2004 of the European Parliament and of the Council, [2005] OJ L149/22 (UCP). 57  Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC (CCD), [2008] OJ L133/66.

Questions and Structure

 11

welfare losses helps to identify needs of mortgagors with regard to their mortgage agreements and to prevent default. Before beginning with our examination, a few caveats are advisable. First of all, in this book, we will use the terms ‘consumer’ and ‘mortgagor’ interchangeably. This is by no means to be understood as a normative equation of the two terms, but as an acknowledgement that in the EU legal order mortgage credit is understood as part of the legal consumer law framework. While Whitehouse has argued for an equation of ‘mortgagor’ with ‘consumer’, against the backdrop of her analysis that in the UK mortgagors are treated as ‘landowners’, which leads to a lack of fair treatment in comparison with consumers,58 this book highlights the problems associated with equating mortgagors with consumers in the larger political economy. As such, it does not contradict Whitehouse’s claim, but argues that we should go even further. Second, it must be borne in mind that the concept of vulnerability is not understood as a normative category that opposes individual responsibility. In fact, the examination of the multifaceted vulnerabilities of mortgagors in this book should make clear that vulnerability and responsibility are not mutually exclusive. This is because responsibility has a behavioural connotation, whereas the concept of vulnerability goes beyond behavioural conditions by including structural dimensions based on the embeddedness of mortgages in globally interconnected markets. As such, the concept of vulnerability shall also not be used as a means to emphasise the individualisation of problems and as a reflection of individual weakness.59 It is rather used as conceptual lens through which to understand the interactions that can lead to welfare losses in the housing sector in order to grasp the possibilities of legislators to mitigate those welfare losses through contract law. Last but not least, the ex ante focus of this book implies the omission of bankruptcy law from our analysis. As stated, the examination is based on the assumption that there is a need to put into place arrangements for unforeseen events and conflicts that can arise during the period of the contract.60 This holds true especially for mortgage agreements, because of their long-term character and the possibility of adverse events happening during their time span. In addition, the political reluctance to allow debt forgiveness in times of crisis—whether within or outside of bankruptcy procedures61—serves as an argument to put into place ex ante mechanisms that address the renegotiation of debt before the problem of a possible default actually occurs. This is not to deny bankruptcy law a pivotal role in the alleviation of overindebtedness. But much excellent research already exists in the field of bankruptcy,62 which also deals with the political-economic ­framework 58 

Whitehouse (2015). Ramsay has raised awareness of this possible association: Ramsay (2016) 181. 60  Nogler and Reifner (2014a) 3. 61  See the reluctance in the US since 2008 to allow debt forgiveness despite expert opinions to the contrary: Mian and Sufi (2014) 35ff. 62  Ramsay (2017); see also: Ramsay (2012), Anderson et al (2011), Ramsay et al (2009), Niemi-­ Kiesiläinen and Henrikson (2005), Niemi-Kiesiläinen (1999). 59 

12 

Introduction

and the general function of bankruptcy in alleviating ­overindebtedness through discharge of debt. Such work also acknowledges the limits of bankruptcy with regard to addressing more structural issues connected to, for example, the expansion of credit, unemployment and low income.63 The approach of this book is simply different. It may even be complementary in the sense that a contract law with a preventive dimension covers the stages of contract duration that precedes and might help to avoid bankruptcy proceedings. Having effective bankruptcy regimes in place for overindebted individuals does not preclude rules that deal with the protection of debtors at an earlier phase, before they have reached the state of overindebtedness.64 In the end, both contract law and bankruptcy intermesh in fulfilling their economic and social functions.

63  64 

Ramsay (2017) 196. Thus also Wilhelmsson (1996) 240.

1 Theoretical Framework I. Introduction This first chapter seeks to find an answer to the question of the extent to which mortgage law can be concerned with goals such as the prevention of default of consumers. The response depends on the conception of contract law and the role we assign to the regulation of contracts in society. Therefore, we will proceed by presenting the aims of EU law and its inherent contradictions, before laying down the normative assumptions in this book. For this purpose, the debates in the ­literature on contract theory in the EU are described, first, with regard to the values that contract law can incorporate, and second, concerning the method of how these values can be achieved in the EU legal order. The latter encompasses the highly controversial issues of the distribution of competences between the EU and its Member States and the discussion on the role of the judiciary in the broader process of the so-called constitutionalisation of private law.

II.  Duality of Aims in EU Consumer Law EU consumer law mainly pursues two different aims, a dichotomy that is visible both in primary and secondary legislation and the blurred distinction between public and private law. The proclaimed general goals of the EU show that both economic and social goals for the internal market are to be achieved. Article 3(3), sentence 2 TFEU prescribes that the EU shall work for a ‘competitive social market economy’. This wording already shows that competition on the internal market as well as a ‘social Europe’ is one of aims of the EU. Tensions are inherent.1 Article 3(3), sentence 4 TEU makes clear that the goals of the EU comprise not only the internal market, but also full employment and social progress as well as social justice and the combat of social exclusion and discrimination. Similarly, Article 9 TFEU establishes

1  Joerges and Rödl critically discuss the discrepancies in the term “social market economy”, Joerges and Rödl (2004).

14 

Theoretical Framework

that a high level of employment, adequate social protection and the fight against social exclusion should be taken into account in the development and implementation of EU policies. The eradication of poverty and social exclusion is also one of the declared goals of the EU. Under its 2020 Strategy, the European Commission developed the ‘European Platform against Poverty’ as a flagship initiative that aims at raising awareness and recognising the fundamental rights of people who experience poverty and social exclusion in order to enable them to live in dignity and take an active part in society.2 The Commission Communication states that ‘access to affordable accommodation is a fundamental need and right’ and that housing deprivation and homelessness are the most extreme forms of social exclusion.3 This flagship initiative forms part of the EU inclusive growth strategy for high employment and economic, social and territorial cohesion.4 Housing also forms an especially important component of social cohesion.5 This tension between competing aims is especially visible in consumer law, which is concerned with the regulation of both markets and individual transactions. Even though Article 169(2) TFEU stipulates that a high level of consumer protection shall be observed when adopting measures to foster the internal market, using Article 114 TFEU as the legal basis for consumer protection law also influences consumer protection law with a view to achieving market regulation. Since the Tobacco Advertisement judgment of the CJEU,6 any measure that is based on Article 114 TFEU has to have the genuine aim of improving the conditions for the functioning of the internal market. This means that other aims can only be pursued with legislation based on Article 114 TFEU if the measure in question primarily fosters the internal market.7 At the same time, as Weatherill contends, this does not mean that local concerns to promote social justice are not recognised in EU law, but only that measures pursuing those concerns have to be justified.8 The competing aims of the EU certainly find expression in the ‘dual function’ of harmonisation,9 and also in the legal framework under examination in this book. For example, the UCT, in its Preambles 6 and 7, establishes the aims of facilitating the establishment of the internal market and stimulating competition on

2  European Commission ‘Europe 2020—A Strategy for Smart, Sustainable and Inclusive Growth’, 3.3.2010, COM(2010) 2020 final, 19. 3  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions ‘The European Platform against Poverty and Social Exclusion: A European Framework for Social and Territorial Cohesion’, 16.12.2010, COM(2010) 758 final, 10. 4  European Commission ‘Europe 2020—A Strategy for Smart, Sustainable and Inclusive Growth’, 3.3.2010, COM(2010) 2020 final, 7. 5  See SOCOHO (2004), research done for the European Commission. 6 C-376/98 Federal Republic of Germany v European Parliament and Council of the European Union, ECLI:EU:C:2000:544. 7  Weatherill (2006) 143, Weatherill (2016) 95ff. 8  Weatherill (2006) 150. 9  Weatherill (2016) 59.

Duality of Aims in EU Consumer Law

 15

the one hand, and the safeguarding of the ‘citizen in his role as consumer’ on the other. Similarly, Article 1 UCP proclaims the contribution to the proper functioning of the internal market as well as a high level of consumer protection through approximation of laws as aims of the Directive. The CCD, passed after the adoption of the Charter of Fundamental Rights (ChFR),10 refers to the establishment and functioning of the internal market and a high level of consumer protection in Preamble 43, but also mentions respect for fundamental rights and principles in Preamble 45. The MCD, passed after the financial crisis, does not go further than that, as can be been seen from its routine terminology about the ‘genuine’ internal market for credit agreements relating to residential immovable property in Preambles 2 and 7, and the high level of protection afforded to consumers in Preamble 15. The duality of the goals of harmonisation in EU credit regulation reflects two contrasting ideas of consumer credit as a lubricant on the one hand and as a potentially dangerous product on the other—more modern and more traditional ideas, respectively.11 Given the diverging aims of consumer law and the blurred divide between ­public and private law, the tension between goals of market ordering on the one hand and social justice on the other is inherent. The welfare state represents this dual function of law in a social market economy. It implies that a balance has to be found between market forces and private enterprise as the instruments of creating the economic basis of welfare, and solidarity-based interventions in those market forces with a view to achieving other goals.12 This problem becomes amplified when considering the claim that there is a difference between the values of consumer law in the EU on the one hand and national consumer law on the other. The mere idea of consumer protection is one of a (national) welfare state that protects its citizens from being disadvantaged by market transactions, whereas the internal market programme leads to an ‘expulsion’13 of the concept of protection from EU consumer law. This is reflected in a preponderance of ‘common’ rules that relate to the integration of markets at the expense of ‘rules’ that emphasise the quality of the legal regime.14 The MCD does not refer to other, more social goals among its pronounced aims. Even though ensuring ‘minimum living conditions’ and the avoidance of ‘long-term over-indebtedness’ is mentioned in P ­ reamble 27, these aims are specifically considered part of Member State responsibility. Similarly, the Commission’s acknowledgement of the social dimension of mortgage credit as it follows from certain provisions as well as the accompanying Staff Working Document on national measures to avoid foreclosure emphasises the Member States’ role in this respect. The acknowledgement of the social dimension of mortgage credit—which is

10 

Charter of Fundamental Rights of the European Union [2000] OJ C364/1. Ramsay (2016) 162. Wilhelmsson (1996) 8. 13  Micklitz (2012). 14  Terminology from Weatherill (2016) 95. 11  12 

16 

Theoretical Framework

certainly influenced by its adoption some years after the beginning of the financial crisis15—and the problems associated with overindebtedness in the field of housing does not change the observation that consumer law in the EU, including the law on credit for residential property, is ‘stuck’ in its duality of aims on EU level. Be that as it may, the concrete dynamics of diverging aims in the field of housing and mortgage law will be examined later in this book. For now, it suffices to acknowledge that, since EU consumer law aims at compensating for both market failures and imbalances in bargaining power,16 it is a special field of law that transcends traditional boundaries of public and private law.

III.  Normative Preconceptions The theoretical framework of this book is based on normative preconceptions, which influence the choice of values and method of adoption of legal rules. These normative assumptions pertain to the values that must underpin mortgage contract law and the role of the EU in the fostering and acknowledgement of these values through its legal framework governing mortgage contracts. In this section, the choice of these normative assumptions is explained by way of outlining the main controversies. The outline is necessarily exemplary. The reader may hopefully forgive the shortened account of the indeed vast discussions and subtleties in argument. The assumptions underlying the analysis in this book should be taken for what they are: a disclosure of preconceptions that influence the choice of sources and interpretations of the law. As such, they offer but one possibility of analysis rather than the conviction that they alone can lead to the desirable outcome.

A. Values (i)  Approach: Social Justice and Welfarism in Private Law This book claims that the values of social justice and welfare need to be taken into account in EU contract law governing mortgages. This is rooted in the understanding that private law not only provides the basic rules that govern economic transactions, but also expresses a broader view of justice and social ordering in a market society.17

15 

Critically with regard to the discrepancy with consumer credit law: Ramsay (2016) 171. Micklitz (1999) 168. 17  Brüggemeier et al (2004) 654. 16 

Normative Preconceptions

 17

With this assumption, the book subscribes to the proactive demand of the Study Group on Social Justice in European Private Law (Study Group),18 which argues—contrary to neoliberal stances—that a unified EU contract law must necessarily be concerned with social justice. In its Manifesto for Social Justice in European Contract Law (Manifesto)19 the Study Group notes that private law expresses a view of justice in a market society, which means that the unification of private law must be based on shared fundamental values:20 A unified law will … have to strike a balance between, on the one hand, the weight attached to individual private autonomy as expressed in the idea of freedom of contract, and on the other hand, principles which respect other equally important demands for social solidarity, which prohibit individuals from taking advantage of superior economic strength or from ignoring the claims of justified reliance upon others. In striking this balance, any system of contract law expresses a set of values, which strives to be coherent, and which is regarded as fundamental to the political morality of each country. European contract law cannot avoid such political judgments.21

Following the Manifesto’s perspective on underlying values, this book’s understanding of social justice goes further than, for example, Rösler’s. For him, the dimension of social justice includes a fair balance between contracting parties, the intervention of society in autonomous private law relationships, and ­collectivism.22 Rösler distinguishes this new social justice from the traditional understanding, in which law should respond to social, economic and social changes, and enshrine the constitutional values of society, thus emphasising the constitutional function of all laws and the incorporation of societal values into the application and interpretation of doctrinal principles and general clauses.23 Without contesting the constitutionlisation of private law and these dimensions of social justice, the normative stance in this book adds the value of consumer welfare in mortgage contract law. The perspective taken in this book might, for some, be in line with the stronger demands of Mattei to rethink the formalistic relationship between public and private law and the basis of private law in competition frameworks (the value of the functioning of markets), while envisioning a legal system that is not ontologically separated from politics and morality.24 But what do welfare and social justice mean, especially in the private law context? The literature in the field of social justice is vast, if not one of the vastest in the field of legal philosophy. Given the concern of this book with the vulnerability of individuals in the field of housing, a deeper analysis of the field has to remain for another time. Instead, exemplary literature, especially in the field of consumer law, is presented and synthesized. 18 ibid. 19 

Brüggemeier et al (2004). ibid, 657. 21  ibid, 656. 22  Rösler (2011) 329–30. 23  ibid, 330. 24  Mattei (2011) 167, 181f. 20 

18 

Theoretical Framework

For centuries, the definition of the terms justice and social justice has occupied much of the legal philosophy. Even though the term ‘social justice’ is one of the terms most often used in ethical and political discourse, it is hard to define with respect to both the ‘social’ and the ‘justice’ elements. There exist many different theories of justice. In its most general form, it can be said that the term justice comprises three elements: ‘other-directedness’, which is concerned with the relations of persons; duty, which involves an understanding of rights and obligations; and equality in the sense of equilibrium or proportionality.25 As for social justice, opinions diverge concerning the role of the individual and the state in achieving social justice, or, in other words, concerning the question of whether social justice is an abstract ideal inherent in society and to be achieved by the state, or a virtue inherent in and practised by individuals.26 Novak demonstrates that the concept of social justice developed over time, based on the idea of a ‘common good’ accompanied by the protection of fundamental rights.27 In ­Aristotle’s time the observation emerged that the ethics of individuals are ­substantially affected by the ethos of the city in which they live and, thus, sacrifices have to be made in order to maintain the ethos of the city and obtain ‘general justice’. Later, it was realised that individual rights needed to be protected if the common good was not to become instrumental to the state.28 The ‘common good’—a rationale of social justice as ‘general’ justice—implies a concern with the distribution of wealth. Similarly, Arnold shows that the conception of justice since Aristotle has always been concerned with distributive justice also in contract law philosophy.29 There is a close relation between distributive justice and social justice. For ­example, according to Rawls, social justice is also distributive justice as it is concerned with questions of just distribution. He states that the primary subject of justice is the ‘way in which social institutions distribute fundamental rights and duties and determine the division of advantages from social cooperation’.30 For Collins, social justice is fairness in the distribution of wealth, power and other goods, with fairness being distribution that is ‘more equal’ than in the case of unfettered market processes.31 Arnold understands distributive justice as a tool to achieve social justice.32 As such, distributive justice obliges the contractual relationship to be embedded into the social, economic and societal context.33 Similarly,

25 

Finnis (1980) 161ff. Novak (1992) 880. 27  ibid, 882–83. 28  ibid, 882. 29  Arnold (2014) 5–190. 30  Rawls (1971) 6. 31  Collins (2011) 133. 32  Arnold (2014) 158; in addition, Hesselink (2015a) 190–91 contends that distributive, interpersonal justice, and social justice are necessarily intertwined. 33  Arnold (2014) 156. 26 

Normative Preconceptions

 19

Wilhelmsson conceives social justice as being concerned with the distribution of entitlements within a social system.34 In his opinion, consumer law is the prime example of social justice as it aims at increasing material equality between members of society.35 Wilhelmsson even equates the term social justice with welfarism and claims that truly welfarist contract law requires measures on different levels. According to Wilhelmsson, a socially just contract law requires:36 —— measures that aim at improving party autonomy and the functioning of ­market mechanisms (market-rational welfarism), as well as corrective measures that aim at rectifying market outcomes; —— internal redistribution in favour of the weaker parties in a contractual relationship, as well as externally redistributive mechanisms that distribute benefits in favour of disadvantaged within a group of contract parties (equality); —— needs-based regulation that takes into account the needs of parties with special needs (ie social force majeure rules), as well as regulation that pursues interests and values that are not related to the parties. Understood in this way, the idea of social justice is inherently connected to that of individual and collective redistribution of wealth from richer to poorer segments of society,37 and thus with welfare in a society. Even though there are differences between the original social welfare states of the nineteenth century and the new welfare states that emerged after the Second World War38 and among contemporary welfare states as such, social justice and welfare share the idea of redistribution beyond individual economic transactions. Conceptualised in this way, contract law that takes account of social justice and welfare concerns refers to the broader aims of societies to achieve a certain common good. To this end, private autonomy needs to be both guaranteed for the enjoyment of individual freedom and limited for the achievement of societal aims (social justice). Within this broader aim, contracts, depending on their design, can play a role in redistributing benefits in favour of the weaker party, taking into account the private autonomy of the contractual parties and their special needs. Thus, welfarism in contract law is concerned with two goals: the material satisfaction of wants and needs, and the protection of freedom and autonomy more generally.39 As such it is concerned with the distribution of resources and power.40 The presented, exemplary definitions have in common their concern with distribution. It is clear that social justice differs from allocative or corrective ­justice: corrective justice is concerned with a just sanction for a specific wrong 34 

Wilhelmsson (1996) 193. ibid, 193, 252ff. 36  Wilhelmsson (2004b) 725–26. 37  Micklitz (2011b) 3–4. 38  ibid, 3, footnote 2. 39  Collins (1994a) 98. 40  ibid; Ramsay (1995) 179. 35 

20 

Theoretical Framework

in an ­individual case, whereas social justice is concerned with the distribution of ­entitlements within a social system. Incorporating the concept of welfare, ­Wilhelmsson goes further by including ‘needs’ into his understanding of social justice in contract law. For the time being, it shall suffice to focus on the commonalities of these ­definitions of social justice. On an abstract level, distributive and social justice concepts concern different widths of different justice-related terms. As a first and smallest unit, the contract between two parties is concerned with commutative and distributive justice between the parties. Contract law, as the second and larger unit, which governs each and every individual contract, is concerned with distributive and social justice, as it aims at distributing goods between groups and members of society. The third unit, the whole society and the legal frameworks it adopts, is in turn concerned with social justice and welfare on the broader societal level.

(ii)  Controversy: The Public–Private Distinction Assuming that social justice and welfare considerations are to inform the contract law rules in the EU legal order also means that an EU contract law in the field of access to housing cannot be politically neutral. Pursuing redistribution in contracts is necessarily informed by public–political goals. This view is not undisputed. Criticism is varied and incremental, but can be located along the lines of a basic formal and material distinction between private law and public regulation.41 Notwithstanding substantial differences in approaches and the varying degrees to which those approaches reject public values in contract, an abridged summary of these views shows that they are based on a formal distinction between private law rules that govern the commutative justice achieved in the specific private relationship between the parties on the one hand, and public law that can be concerned with welfare and social justice as well as other goals on the other. Commentators arguing for the maintenance of this basic distinction between private and public law are often influenced by the ideas of the political liberal ideas of the nineteenth-century nation-states. In the tradition of Hayek’s seminal work Law, Legislation and Liberty, the welfare state is not per se opposed, but it is argued that the law of contracts, which regulates markets in order to maximise wealth, should be disconnected from a second stage in which the welfare state steps in to adjust some of the distributive effects of the markets through taxation. Such a view

41  Jansen and Michaels (2008) show that the debates on the tension between private and public law are embedded in a long historical tradition and cannot just be attributed to the emergence of nation-states in the 19th century. For our purposes it is still useful to begin our account of the debates with a connection to this public–private divide, because we are concerned with the role of welfare and social justice, which was undoubtedly initially connected to emerging welfare states, but is now being ­outsourced into the contractual realm.

Normative Preconceptions

 21

is prominently held by Kaplow and Shavell in their economic analysis of whether legal rules should favour ‘the poor’.42 There is no overarching criterion of fairness that is to be reached through contracting (and contract enforcement for that matter) and the rules of transfers are purely procedural.43 The aim of the law of contract is the facilitation of market transactions by enabling autonomous will to enter into certain contractual relations, whereas the regulations of the welfare state compensates for any wealth loss due to market failures. According to Hayek, social justice is a ‘mirage’: ‘[I]n a free society the general good consists principally in the facilitation of the pursuit of unknown individual purposes.’44 ­Similarly, Rawls’ theory of justice is concerned with fairness based on equal l­iberties.45 A crucial stance of political liberalists is that, first, the values pursued by the state depend on unstable political conditions and, second, that the state necessarily always excludes those who might have different moral values.46 An influential modern view is presented by Weinrib, who argues that the focus of contract law is the direct connection between the two contractual parties, not the achievement of ‘independent goals’.47 The rights and obligations of the contractual parties have to be understood from within the rules of private law; considerations of justice that do not stem from the bipolar relationship between the private subjects must be rejected as an intrusion into the purity of private law.48 According to this view, the only form of justice pursued in private law is corrective, or commutative, justice.49 Any distributive or social aims must be disregarded. Two other views shall be presented here that fall into the rather formalist approach. First, Dagan argues that private law is based on the idea of structural pluralism of contracts concluded between private parties, and thus be should understood as a ‘rich mosaic’ of different value pluralisms, each with its own underlying principles that may or may not differ from each other.50 The role of the state in this account is to provide law that facilitates ‘the coexistence of various social spheres embodying different modes of valuation’.51 This more deliberative approach can be compared to, second, Macneil’s relational contract theory. Macneil considers values in contract as produced by the contracts themselves: the norms that are generated internally in manifold contractual relations are then the most important reflection of the value patterns of the overall s­ ociety.52 Because of

42 

Kaplow and Shavell (2000). in Collins (1992) 54ff with reference to Rawls’s distinction between pure and perfect justice. 44  Hayek (1982) vol 2, 1. 45  Rawls (1971) 11. 46  Account in Hesselink (2013a) 31. 47  Weinrib (2012) 9ff. 48  ibid, 6ff. 49  ibid, 56ff. 50  Dagan (2012) 1411–12, 1413. 51  ibid, 1424. 52  Macneil (1983) 351. 43  Account

22 

Theoretical Framework

horizontal and vertical linkage of all contracts, there is no external matrix or social values external to any contract; he considers all values to be internal.53 Even though he acknowledges external social ‘responses’, the values he considers—private autonomy, consent, reciprocity, the creation and restraint of power, preservation­ of relations, and propriety of means54—are anchored in the contract itself without shaping its content. As regards the propriety of means, they serve the parties themselves, as they are concerned with procedural requirements, rather than the substance of their conduct.55 Thus, he does not regard solidarity as an external value imposed by the welfare state,56 but as generated from within the contract through the interdependence of contractual parties.57 Macneil’s relational-contract theory deals with an internally created solidarity without much external influence upon it. It is probably a more ‘procedural’ contract law that emphasises reflexive law, which is to bring about its own values through procedures.58 As such, this theory highlights that contracts are not only governed by instant utilitarian self-interest but also by long-term motivations. He claims that, over time, exchanges made with such long-term motivations produce norms to which parties expect to adhere, including the preservation of the relation in ‘contractual solidarity’.59 Since the initial competition of spot contracts is replaced with increasing cooperation, this contract model moves away from a static power relation to a dynamic one.60 The formalist view, which emphasises the generation of values from within contracts, can be criticised from different viewpoints (and to varying degrees). ­Arguments against the formalist view concern the assumed superiority of autonomous party will, the supposed existence of such a will, the alleged political neutrality of contract law, and the inherent assumption that there is a clear division between public and private legal spheres. Last, they do not fit with the reality of EU law, which routinely refers to seemingly competing aims in its legislation, especially in consumer law. As for the first objection, one can question the unconditional superiority of autonomous party will. Especially in legal realist writing, the mere existence of litigation before courts has been interpreted as a reflection of a lack of agreement between the parties. That is why the courts are obliged to step in and determine the rights of the parties with reference to unforeseen contingencies (in this way, the essential problem of contract law is viewed in the problem of

53 

ibid, 367. ibid, 367ff. 55  ibid, 378f. 56  Wilhelmsson (2004b) 712–13. 57  Macneil (1986) 577. 58  On procedural contract law, see Wilhelmsson (1993b) 35 with reference to Gunther Teubner. 59  Macneil (1986) 578–79. 60  Macneil (1980). As a consequence, relational contracts also move away from the imposition of strict liability for performance, which Macneil calls the ‘implementation of planning’, towards the adjustment of obligations by waiving strict liabilities: see Campbell (2001) 21 with references to ­Macneil’s works. 54 

Normative Preconceptions

 23

distributing risks).61 In this view, contract law confers sovereignty on one party over the other by putting the state’s forces (ie the apparatus of enforcement) at the disposal of the former and, thus, can even be viewed as a ‘branch of public law’.62 Courts have significant power to test the substantive fairness of contractual terms with doctrines such as frustration, error or unconscionability,63 and the law of contracts often sets limits to the enforceability of agreements that are considered immoral. Second, one can doubt the existence of autonomous party will. The main argument here comes from the spreading phenomenon of standardisation. Standardisation is essentially a product of economic pressures towards uniformity and predictability;64 it became necessary with the rise of big enterprises engaged in mass production, as it enables enterprises to use the same contract in every bargain that concerns the same product or service and thus to exclude risks and deal with unforeseeable uncertainties.65 They also reduce the cost of production and distribution for enterprises.66 Nowadays, standardised contracts are used routinely in internal business practices, leading to a ‘global law by contract’ that has been claimed to replace parliamentary legislation and erode state sovereignty.67 It is questionable whether in this global system of contracts there is any bargaining room left for the contractual parties to negotiate the contract that meets their needs and best reflects their preferences. In fact, standard contracts are used mainly by large enterprises with strong bargaining power and the weaker party, in need of goods and services, often has no choice but to accept the terms proposed to her; they are presented to her on a take-it-or-leave-it basis.68 As a consequence, the parties cannot make an informed and rational decision, so that the market efficiency claimed for by freedom of contract is impaired. The third objection to the formalist approach concerns the political neutrality of contract law. Early legal realist writings claimed that the divide between public and private law disguises the real underlying ideological political choices.69 The mere fact of allowing freedom of contract reflects a larger political agenda of the spread of capitalism; as described above, freedom of contract gives the individual market actors freedom to put into place rules that govern their transactions. The commitment to private autonomy, which is the basis for the liberal-formalist theory of contract, already implicates the political value judgement that private autonomy is part of the liberal market order.70 However, market actors can only 61 

Cohen (1933) 576–77, 584–85. ibid, 586–87. 63  Thus Collins (1992) 66. 64  Horwitz (1975) 261; and see 263–64 for the development away from initially protective and paternalistic mortgage supervision to the ‘triumphs of form over substance’. 65  Kessler (1943) 631. 66  ibid, 632. 67  Referring to standardised securitisation contracts in the years before the latest financial crisis: see MacNeil and O’Brien (2010) 6. 68  This is the reason why Kessler (1943) 632 has termed standardised contract contracts of adhesion. 69  Horwitz (1975) 264. 70  Arnold (2014) 44. 62 

24 

Theoretical Framework

exercise their bargaining power (assuming that this exists) to the extent allowed by the larger regulatory framework. For example, the establishment and protection of property rights as one of the pillars of the capitalist economic system does not only have the dimension of protecting the owner of the property against dispossession, but also against unwanted interference from non-owners.71 Thus, government decisions to support the market as a wealth-enhancing and distributive mechanism incorporate political choices.72 All contract law rules, therefore, necessarily embrace a view about which transfers on the market are considered just, including the choice between procedural and substantive fairness.73 Ius ­commutativa cannot spell out assertions about justice without making political value judgements.74 In this later vein, more modern analyses of private and contract law openly acknowledge its functionalist character in terms of exercising some kind of public or social function beyond the mere management of commutative justice within the contract. From the viewpoint of distributive justice, the law of contracts can also be used to achieve certain goals.75 Such goals can include: the behavioural control of individuals, for example through usury rules; paternalism and the protection of weaker parties, such as minors, employees or consumers; social justice in terms of redistribution; and the achievement of goods of general welfare, for example through the obligation to contract as in the field of insurance.76 Consumer or labour law are the paradigm examples of fields of law in which obligations are put on the contractual parties that target goals outside of the direct contractual relationship. For example, setting up laws against the unjust termination of employment contracts aims at combating the power of employers more directly than a social security system that establishes protection against the adverse effects of unemployment.77 Wilhelmsson even openly acknowledges the imposition of external values (eg solidarity, altruism, the social good, human rights) through content-orientation. According to Wilhelmsson, the ‘contract as a social cooperation’ embraces all the modern tendencies that distinguish it from traditional contract law: it is oriented to content (versus content-neutrality), dynamism (versus being static), cooperation (versus antagonism), collectivism (versus atomism), and to persons (versus being abstract).78 Wilhelmsson also emphasises the importance of defining values with a view to making clear which kind of societal structure is striven for.79

71 

Hale (1923) 471–72. Collins (1992) 52. 73  ibid, 65–66. 74  Arnold (2014) 43; he shows that not only justice, but also distributive justice, is part of contract law, see especially 15ff. 75  ibid, 157–58. 76  Thus ibid, 58ff. 77  Example taken from Collins (1992) 65. 78  Wilhelmsson (1993b) 39. 79  ibid, 46. 72 

Normative Preconceptions

 25

Fourth, the assumption that the public functions of the state are disconnected from the private sphere has been criticised. Based on the claim that there has never been true freedom of contract or a purely private law without a public ­dimension,80 it has been suggested that the distinction between public and private law is an artificial one that conceals the true nature of contracts as a forum of different rationalities in economic exchange, social production and normative promises.81 Terms used in the academic literature, such as ‘hybridization of contracting’,82 ‘hybrid duties’ in ‘regulatory contract law’,83 ‘governance by contract’,84 ‘regulatory private law’85 or the ‘blurred’ public–private divide,86 acknowledge the hybrid character of contract law that gives another dimension to contractual relationships and recognises the different social contexts of that relationship. Already at the time when legal realism first emerged, there was a strong tendency towards ‘the social’ (to be distinguished from Marxist notions), acknowledging existing interdependencies and social need.87 But also in some modern law and economics writings at least the impact of contract design on the society at large is acknowledged, despite perhaps remaining silent on the two-way relationship in the sense that the society at large might in turn have an impact on the contractual design.88 Finally, the reality of EU law is more in line with these modern accounts that deny the division between the public and the private. EU law is concerned with the regulation of the internal market by harmonising rules concerning the free movement of goods, services, persons and capital, while both expanding and limiting private autonomy in order to align it with the goals of the internal ­market.89 ‘Private law has assimilated many characteristics of regulation’,90 which makes EU contract law distinct from the understanding of private law that was developed in the nation-states of the nineteenth century.91 Its regulatory aim is to construct and foster the internal market through a contract law that governs economic transactions within the internal market.92 Weatherill has described this as a ‘dual function’, pointing to provisions in EU law that do, on the one hand, establish rules ‘without prejudice to contract law’, but on the other, affect the way rules of 80 

Zumbansen (2007) 207, 224. ibid, 223. 82  Teubner (2007) 54, arguing in Luhmannian tradition that the economy is structurally coupled with the productive contest and the law. 83 For the field of financial regulation, see Köndgen (2011) 40, referring to standards-setting through mandatory contract provisions and codes of conduct. 84  Zumbansen (2007). 85  Micklitz (2008) for the EU context. 86  Reich (2010a) for the EU context. 87  For an overview of this ‘second globalisation’ of legal consciousness as a response to the ‘first globalisation’ of classical legal thought, see Kennedy (2006) 649ff. 88  See, for example, on the welfare implications of subprime mortgage contracting, Bar-Gill (2008). 89  See Domurath and Comparato (2015). 90  Collins (2006) 226. 91  ibid, 222ff. 92  For example, Micklitz and Patterson (2012) 12. 81 

26 

Theoretical Framework

national contract law are applied.93 This perceived discrepancy can only be understood if we acknowledge that EU law is close to modern private law reasoning that denies the separation of (public) regulation and (private) contract law.94 In other words, EU contract law can be perceived as having two functions: an internal one that is concerned with the interests of the parties and the distribution of risks between them, and an external one that aims at broader goals, such as fostering competition.95 The two of them are inherently connected, as the way in which contract law rules concerned with certain private behaviour are designed reflects and serves the broader goals of the internal market. These remarks show that the claim of the value-neutrality of contract law might rather be of a normative than an empirical nature. The evidence is compelling as to the function of contract law serving more than the immediate contract party’s interest. The political role of contract makes clear that contracts aim at more than commutative justice between the parties. As the main tool for the organisation of market exchange, they do not only have distributive effects, but might also go beyond mere redistribution and be concerned with the achievement of broader social justice. This is in accordance with the aim of the EU to build a ‘social’ market economy (Article 3(3) TEU).

B. Method There are, of course, different ways to incorporate values into legal systems. In a constitutional system, alignment of contract law with constitutional values can be achieved by way of legislative tools or the application and interpretation of contract law rules by the judiciary. In the EU legal system, competences are divided between the EU and the Member States, so naturally many of the problems concerning the method of law-making concern the question whether the EU or the Member States must act to achieve certain goals. If competence is exercised at the EU level, the main process by which to achieve certain goals is the harmonisation of laws. At the same time, value-driven normative processes in Europe are permeated by the judicature of the European courts (CJEU as well as national courts).

(i)  Approach: EU Level As concerns the method of regulation, this book considers that the EU needs to assume its role and competence in the achievement of welfarist goals in its mortgage contract law. A short look at the division of competences between the EU and its Member States reveals arguments that support a competence for the EU to legislate in this matter. 93 

Weatherill (2016) 139–40. Collins (2006) 225–26. 95  Bellantuono (2010) 119. Bellantuono argues, however, for a clear demarcation between regulatory and contract law, giving the latter a gap-filling role. 94 

Normative Preconceptions

 27

In competition matters that concern the internal market the EU has exclusive competence, Article 3(1) lit (b) TFEU, whereas the EU and Member States share competences for social policy, Article 4(2) lit (b) TFEU. At the same time, the EU has only supporting competence to ensure coordination of the Member States’ social policies according to Article 5(3) TFEU. The EU does not have the enumerated competence in the field of private law. This formal division of competences becomes blurred, however, when ­considering the developments in the EU legal order with regard to contract law and social justice. In principle, the harmonisation of contract law is not one of the enumerated competences of the EU in Articles 3 et seq TFEU; hence, according to Articles 4(1) and 5(1) TEU, those competences shall remain with the M ­ ember States. This does not mean, however, that the EU cannot promote its own social policies or have an impact on the private law orders of its Member States. The policy areas for which the EU does have at least shared competence with the ­Member States do touch upon private law matters, among them internal market and consumer protection (Article 4(2) lit a and lit f TFEU). The main legal framework under examination in this book, the MCD and the UCT, are based on (now) Article 114 TFEU. We have seen above that this implies a tension between the achievement of the creation of an internal market for ­mortgage credit (Preamble 2 MCD) and in the case of the UCT the facilitation of the establishment of the internal market (Preamble 6 UCT), on the one hand, and a high level of consumer protection (Article 169 TFEU), on the other. In fact, connecting secondary legislation with the goals of the internal market, the EU exerts considerable influence on Member States’ legal orders. Weatherill, most prominently, routinely deplores the subversion of the subsidiarity principle through a ‘competence creep’ that has led to a ‘spill over’ effect in consumer contract law, for which the EU formally does not have any competence.96 In the end, the principles of subsidiarity and proportionality are not sufficiently conceptualised and rigorously enough applied, especially in view of important political decisions, so that they do not serve as a real barrier to competence creep and make the allocation of competence more of a political issue than a constitutional one.97

(ii)  Controversy: Harmonisation of Contract Law Weatherill’s reservations are echoed in the discussions on the effect of harmonising contract law through secondary EU legislation. Since the review of the consumer acquis,98 which resulted in the publication of the Draft Common Frame 96 

Weatherill (2006) 138ff; also Weatherill (2014) 5ff. (2016) 192ff; Weatherill (2014) 7. Also critical: Harbo (2010); less critical Portuese (2011). 98  The connection between the review of the body of EU legislation on consumer law and the ­harmonisation of contract law is clearly stated in the Communication from the Commission to the European Parliament and the Council ‘European Contract Law and the Revision of the Acquis: The Way Forward’, COM(2004) 651 final. 97  Weatherill

28 

Theoretical Framework

of Reference (DCFR),99 the EU has encroached more and more upon Member State competence in the field of contract law, especially by means of shifting from minimum to maximum harmonisation. Until the Commission Green Paper100 that initiated the review of the consumer acquis, much of EU legislation in the field of consumer law was built on the minimum harmonisation approach, according to which Member States are free to implement higher protection standards than provided for in the underlying EU Directive. For example, the UCT contains a provision in its Article 8 that allows Member States to adopt or retain more stringent provisions than the ones laid down in the Directive. Throughout the review process, however, the Commission argued that the legal fragmentation across the Member States, due to different protection standards, inhibits crossborder trade.101 Thus, it started the full harmonisation of consumer law with a view to prohibiting the imposition of diverging, higher and lower, national protection standards in the Member States.102 Vanessa Mak even argues that in the case law of the CJEU there are two different ways of understanding full harmonisation: one more technical, which focuses on the legal basis of Member State law; and one more functional that prohibits higher protection standards if they run counter to the outcome of the European legislation even if they were adopted on a different legal basis.103 Be that as it may, the move from minimum to maximum harmonisation has encountered heavy criticism on different, often correlated grounds. The common theme of this criticism is grounded in very similar divides to those found in the field of values: the conceptual distinction between private law, on the one hand, which is considered the realm of Member State competence, and public regulation, on the other, which could be a shared responsibility. Hence, the rejection of EU competence is often based on ‘nationalist’ arguments, as thoroughly described by Comparato.104 Those negative arguments usually connect harmonisation to an erosion of economic structures, national preferences, political theories, social justice and culture.105 Many scholars fear that the coherence of national law is jeopardised.106 Oftentimes, they share their basis in a historical view of a slow maturing of national legal orders in accordance with the prevailing political, economic, social and cultural conditions in the nation-state. What these complaints

99 

von Bar et al (2009). Commission Green Paper on the Review of the Consumer Acquis, COM(2006) 744 final. For example, COM(2006) 744, 6. 102  See, for example, Art 4 Directive 2011/83/EU of the European Parliament and of the Council of 25 October 2011 on consumer rights, amending Council Directive 93/13/EEC and Directive 1999/44/ EC of the European Parliament and of the Council and repealing Council Directive 85/577/EEC and Directive 97/7/EC of the European Parliament and of the Council, [2011] OJ L304/64 (Consumer Rights Directive); a more relativised description of harmonisation of EU consumer law is offered by Reich (2010b). 103  Mak (2012b) 216. 104  Comparato (2016). 105  The following remarks are based on ibid, 131ff. 106  For example: Loos (2010) 4–5, Rott and Terryn (2009) 463, Weatherill (2001) 185. 100  101 

Normative Preconceptions

 29

have in common is their observation that the need for the emerging nineteenthcentury nation-states to assert their influence over the claimed national territory led to a national contract law becoming regarded as an expression of a national identity.107 This underlying ‘nationalist’ background results in both formal and material rejections of deepening harmonisation. (a) Criticisms One more formal criticism concerns the observations that a unified legal regime can only entail one idea of justice, which implies that the imposition of that rule on those who do not share this idea can be unjust.108 This argument could be brought forward especially by the Member States whose votes were disregarded in the legislative process because of qualified majority voting in the Council, notwithstanding the—higher or lower—level of social justice in their national legal orders. This problem, which arguably is aggravated by maximum ­harmonisation, leads to a factual transfer of competences and the erosion of ­Member State competence even though this is a shared field of competence.109 The criticisms emphasise the procedural importance of continuous interaction at different levels in order not only to ensure legitimacy but also to leave space for variation, experimentation and innovation.110 The more material rejection is grounded in observations of the level of protection afforded by secondary legislation. Niglia has critically pointed out that ‘­market-oriented’ is replacing ‘rule-based’ contract law.111 In this vein, scholars have criticised that possibly higher national protection standards will be lost.112 More particularly, it has been criticised that the shift from minimum to maximum harmonisation is not accompanied by an increased level of protection at EU level.113 In fact, Reich has shown that in the case of maximum harmonisation the level of protection is decreased, in contrast to an upgrading in the protection level in the case of minimum harmonisation.114 Voices arguing against the broad harmonisation of consumer contract law base their claims also on the perceived lack of a concept of social justice in the EU. A harmonised EU contract law might have other or even no foundations

107 

Comparato (2016) 72ff. ibid, 162–63. For example: Reich (2010b) 17, Rott and Terryn (2009) 459, Howells (2006) 65. 110  Brüggemeier et al (2004) 670ff. 111  Niglia (2003) 190. 112  For example, Poncibó (2007) 5; concerning the difference from the Consumer Credit Directive 2008/48 which is based on ‘targeted’ harmonisation and allows for more excessive (ueberschiessend) German consumer credit rules, see Reich (2010b) 25–26. 113  Schulte-Nölke (2010) 138. 114  Reich (2010b) 26, with reference to cases C-168/00 Simone Leitner gegen TUI Deutschland GmbH and Co KG, ECLI:EU:C:2002:163 concerning upgrading, and Joined Cases C-261/07, VTB-VAB NV v Total Belgium and C-299/07 Galatea BVBA v Sanoma Magazines Belgium NV, ECLI:EU:C:2009:244, and C-207/05 Commission of the European Communities v Italian Republic, ECLI:EU:C:2006:366. 108  109 

30 

Theoretical Framework

in justice concerns as found in many Member States’ private legal systems.115 ­Micklitz has argued that the EU idea of justice is, in fact, a new one, distinct from national concepts; he terms it ‘access justice’.116 It means that the EU grants access to the (internal) market to those who face difficulties in making use of the market freedoms and are excluded from the market. Micklitz also claims that access justice is not exclusive but coexists with differing national models of social justice, covering especially the fields of law where the EU does not have sole legislative responsibility. In turn, social justice ‘re-emerges’ on regulated markets. Be that as it may, the lack of an EU concept of social justice does not necessarily mean that Member States were to rediscover their national ‘haven of social justice’.117 Instead, transnational economic pressures would continue to exist and present maybe even harder challenges for individual Member States. In fact, there is no evidence that Member States promote higher ideals of social justice per se. Even though this might be true for certain Member States—most notably the ­Nordic countries from which some prominent criticism of maximum harmonisation stems118—this is not necessarily true of all Member States. What is known, instead, is that national contract law systems in Europe incorporate ­different approaches to social justice, which might be considered just in their respective tradition and perspective. In France, for example, the more paternalist state occupies a central role in organising the ordre public in private law relationships and solidarity.119 Consequently, private law is considered part of social law (acknowledging its inherent political dimension), and is aimed at the construction of a much more protective welfare state.120 In the Nordic countries too, the idea of a ‘just legal order’ has a long tradition, while being subject to different national conceptions.121 In contrast to the understanding of social justice as redistributive justice based on German idealism or French rationalism, England developed a more utilitarian legal system in which the law, including private law, is endowed with a more economic function.122 English consumer credit law, for example, is less guided by protective aims than by the objective of guaranteeing a functioning capital market.123 In the end, the arguments that perceive a lack of social justice on EU level are, as Comparato shows, highly connected to the historical-nationalist discourse.124 As such they oppose the possibility or feasibility of a more global idea

115 

For example, Mak (2012a) 216. Micklitz (2011a) 2. 117  Weatherill (2006) 151. 118 Wilhelmsson (2004a) 328, 332; Wilhelmsson (2004b) 733. He argues, for example, that a ­European Civil Code would be too static and not allow for continuous development of welfarist rules at national level. 119  Sefton-Green (2011) 237ff. 120  Micklitz (2011a) 9. 121  See analysis by Letto-Vanamo (2011) 257ff. 122  Micklitz (2011a) 6. 123  ibid, 7. 124  Comparato (2016) 181ff. 116 

Normative Preconceptions

 31

of justice and rely on nations as political communities in which universal ideas need to be infused with meaning. Outside of the ‘nationalist’ camp of critics, a few scholars have attacked broad harmonisation based on its logical bases. One criticism, for example, targets the Commission’s lack of substantiation of a supposed link between maximum harmonisation and increased cross-border trade.125 Critics have also stated that full harmonisation cannot create the confident consumer who fosters cross-border trade,126 and that other factors need to be considered, such as language difficulties or technical requirements concerning transactions over the Internet.127 Moreover, scholars have questioned the ability of current Commission initiatives to provide for the coherence it strives for.128 Hence, it is questionable whether coherence can actually be achieved in the way the review of the consumer acquis is approached by the Commission. (b) Alternatives Suggested alternatives to maximum harmonisation are as manifold as the criticisms. One possibility to achieve greater coherence between the Member States’ legal orders is competition between legal systems. For example, the use of optional instruments in private law has been elicited as an alternative. The finished projects of the DCFR, officially treated as a ‘toolbox’ by the Commission,129 and the Common European Sales Law (CESL) must be perceived as offering a possibility to introduce ‘open competition between legal orders’.130 In order to address the resistance to maximum harmonisation through competition, Loos advocates bottom-up harmonisation, pointing out that certain values, such as the solidarity between stronger and weaker parties of private law transactions, are more developed in national systems and could be better maintained at EU level by a voluntary change of national legislation.131 In this vein, harmonisation of social contract law could spontaneously take place through courts that restrict individualistic principles in favour of solidarity and the protection of weaker contractual parties.132

125  Rott and Terryn (2009) 460, Poncibó (2007) 4. For example, the number of businesses who responded to Commission questions in favour of maximum harmonisation was much larger than the number of consumer organisations, who largely favour minimum harmonisation: see Loos (2008) 6. 126  Wilhelmsson (2004a) 325. 127  For example, evidence is produced concerning incoherence of the Consumer Rights Directive 2011/83, especially regarding information duties (Rott and Terryn, 2009, 461), and regarding remedies in consumer sales contracts (Reich 2010b, 28–29; Rott and Terryn, 2009, 467). 128  Reich (2010b) 28–29, Rott and Terryn (2009) 467. 129  von Bar et al (2009) 16. Schulte-Nölke has advocated the implementation of the DCFR as such an optional instrument through the so-called ‘blue button’, which the parties to a private law transaction could click on, especially on e-shop websites, and, thus, determine the applicable law of the transaction: see Schulte-Nölke (2010) 142–43, with reference to Schulte-Nölke et al (2007). 130  Micklitz (2016) 631–32. 131  Loos (2006) 7–8. 132  Comparato (2016) 169ff.

32 

Theoretical Framework

A more deliberative alternative approach to governance is the intergovernmental open method of coordination (OMC)133 in fields of contested competence, such as healthcare, long-term care and social inclusion. Instead of adopting harmonising legislative measures, in this framework Member States have to take steps in order to achieve commonly established goals, which they present in regular reports, while the Commission takes a monitoring and coordinating role.134 The EU has embraced this approach in the field of social policy, where it only has supporting competence, through the Social Protection Committee. This advisory committee for the Employment and Social Affairs Ministers in the Employment and Social Affairs Council was established according to Article 160 TFEU to monitor social conditions in the EU and the development of social protection policies in the EU Member States, and to promote and coordinate national policy approaches. Moreover, in 2008 the Commission launched the ‘Renewed Social Agenda: ­Opportunities, Access and Solidarity in the 21st Century’,135 focusing on opportunities in the employment market, access to education, healthcare, and social protection and services as well as social inclusion and equal opportunities. The European Social Fund (ESF), seeking to improve people’s ‘employability’, co-finances projects for young people seeking employment, for the long-term unemployed, for disadvantaged groups, and for promoting gender equality on the labour market. The discussions on the advantages and disadvantages of the OMC shall not be reproduced here.136 It shall suffice to remark that many proponents value the space for experimentation the OMC brings,137 whereas others criticise ‘­democratic experimentalism’ more generally as a neglect of the rule of law and an attempt to achieve normative synchronisation of legal and political affairs via the logic of contemporary ‘high-speed capitalism’.138 What matters for the purposes of the discussion on harmonisation is that the OMC does not seem to have had the expected converging effect. The 2016 Report of the Social Protection Committee highlights not only several ‘open challenges’, but also existing differences between Member States.139 Furthermore, from a governance point of view, it must be acknowledged that even though joint policy learning and mutual adaption might have some effect on national policies, this is highly dependent on the openness of national governments to policy change.140

133 

Cafaggi (2007) 46ff, Twigg-Flesner (2010) 373. Twigg-Flesner (2010) 373. 135  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions of 2 July 2008, ‘Renewed Social Agenda: Opportunities, Access and Solidarity in 21st Century Europe’, COM(2008) 412 final. 136  For an overview of opinions, see Gatto (2006) 512ff. 137  Twigg-Flesner (2010) 373; Smits (2011), 332ff. 138  Scheuermann (2012) 118–19, 126. 139  Social Protection Committee (2016) 27ff. 140  Falkner (2010) 295–96. 134 

Normative Preconceptions

 33

A position that is less rooted in a nationalist understanding of a division of c­ompetences is proposed by Weatherill and Rott and Terryn, respectively. ­Weatherill argues for minimum harmonisation as the default rule under (now) Article 114 TFEU, even though this might inhibit the creation of an integrated market. He argues that maximum harmonisation should only be pursued where its use been carefully justified in the specific case.141 In any case, he advises caution with regard to the historically determined diversity of contract law in Europe,142 but argues for a ‘residual’ competence of the EU to achieve social justice when Member States are no longer able to do so in the context of integrating markets.143 Comparably, Rott and Terryn argue for minimum harmonisation that aims at a truly ‘high level of consumer protection’ coupled with full harmonisation of specific harmonisation.144

(iii) Controversy: Judge-Made Constitutionalisation of Horizontal Relationships Coherence of European contract law can be achieved not only through the ­harmonisation of legislation, but also through the application and development of principles and fundamental rights in contractual relationships.145 This development is referred to as the constitutionalisation of European contract law.146 It describes not only the relevance of general principles and fundamental rights in the resolution and interpretation of horizontal contractual disputes but also refers to the integrity and coherence of the doctrinal system of law.147 It, thus, provides proof of the blurred public–private divide in the EU legal order. As a consequence, the problem of constitutionalisation reproduces controversies concerning the normative distinctness of private law vis-à-vis public law and concerning the division of competences between the EU and its Member States. (a)  The Role and Effect of Constitutional Rights and Principles The European courts, both the CJEU and national courts, have played a pivotal role in this development.148 Both general principles and fundamental rights were introduced into horizontal relationships by the CJEU. As regards principles, 141 

Weatherill (2006) 155–56. ibid, 241–42. Weatherill (2006) 138ff. 144  Rott and Terryn (2009) 487. However, they consider the so-called blue-button approach could be adopted as a less intrusive option. 145  In order to narrow down this vast topic, I am leaving aside the effects of regulatory and enforcing agencies on the harmonization of private law. 146  Collins (2011) 136. This definition must be distinguished from the discourse on the constitutionalising power of private law, which is discussed with regard to the standardisation of contracts and the consequential loss of parliamentary control of sovereign states. See, for example, MacNeil and O’Brien (2010) and Muir-Watt (2011). 147 Ibid. 148  Colombi Ciacchi (2006). 142  143 

34 

Theoretical Framework

a few seminal, but exemplary, cases shall be mentioned. The first leading case is Defrenne, where the CJEU held that the Treaty provision prohibiting discrimination on grounds of gender in respect of equal pay was applicable in a horizontal ­relationship.149 In a similar vein, in Mangold the CJEU stated that the principle of non-discrimination extends to private law relationships, in that case an employment contract, even though there was no direct effect (because the time period granted for the implementation of the underlying Directive had not yet expired).150 The CJEU confirmed its stance in Kücükdeveci,151 where it connected the principle of non-discrimination to Article 21(1) ChFR and the full effectiveness of EU law.152 In Messner, the CJEU recognised the principle of good faith as one of the ‘principles of civil law’.153 Even though these cases are very different from each other, they have in common the intrusion of public law principles into concrete contractual relationships between individuals. As is well known, the principle of direct effect of individual rights was established by the CJEU in Van Gend en Loos.154 In that case, the Court stated that EU law not only imposes obligations on individuals, but also directly confers ­European rights on them, if the provision under scrutiny is sufficiently clear and the right derives unconditionally from that provision without the need for any further acts of implementation. These rights conferred by EU law can also arise by virtue of obligations contained in the Treaties.155 This direct effect was initially understood as a ‘vertical’ direct effect. However, with proceeding integration and further case law, this vertical direct effect was vested with a horizontal dimension, giving effect to individual rights in horizontal, private relationships as well.156 Most famously, in Viking and Laval, the CJEU granted labour unions the right to collective actions, which were treated as restrictions on economic freedoms in the internal market, namely the right to relocate and the right to employ foreign labour force, respectively.157 The judgments were broadly criticised as reflections of the overriding power of internal market rules over social rights (here the right to collective action in the form of a strike). 149 C-43/75

Defrenne v Sabena ECLI:EU:C:1976:56, paras 33–34, 39.

150 C-144/04 Werner Mangold v Rüdiger Helm, ECLI:EU:C:2005:709. For a critique of

the methodology of the reasoning in this case, see Tridimas (2013). 151 C-555/07 Seda Kücükdeveci v Swedex GmbH and Co KG, ECLI:EU:C:2010:21. 152  ibid, para 55. 153 C-489/07 Pia Messner v Firma Stefan Krüger, ECLI:EU:C:2009:502, para 26. 154 C-32/84 Van Gend and Loos NV mod Inspecteur der Invoerrechten en Accijnzen, Enschede, ECLI:EU:C:1985:104. 155  Joined Cases C-6/90 and C-9/90 Andrea Francovich and Danila Bonifaci and others v Italian Republic, ECLI:EU:C:1991:428, para 31. Direct effect was, as known, subsequently, extended to many other areas of European law, ie environmental product standards, see C-148/78 Criminal proceedings against Tullio Ratti, ECLI:EU:C:1979:110. 156  Concerning the interaction between fundamental rights and contract law, especially the different forms of direct and indirect effect of fundamental rights see Mak (2007), 45ff. 157 C-438/05 International Transport Workers’ Federation and Finnish Seamen’s Union v Viking Line ABP and OÜ Viking Line Eesti, ECLI:EU:C:2007:772; C-341/05 Laval un Partneri Ltd v Svenska ­Byggnadsarbetareförbundet, Svenska Byggnadsarbetareförbundets avdelning 1, Byggettan and Svenska Elektrikerförbundet, ECLI:EU:C:2007:809.

Normative Preconceptions

 35

This influence of constitutional law on private law is not entirely new in the European legal order. In Germany, for example, the so-called Drittwirkung der Grundrechte has been subject to much debate. Regarding fundamental rights not as solely protective rights against the state, but also as participatory and social rights, leads to an infusion of private law principles, such as private autonomy and freedom of contract, with a social and participatory dimension.158 With the growing importance of constitutional law for private law relationships in national legal orders, the ‘constitutionalisation’ of European private law also started, with national courts referring to constitutional rights in private law cases in order to enhance the importance of social rights in private law matters.159 Picking up on that development, the CJEU and European Court of Human Rights (ECtHR) are also starting to use human and fundamental rights as a means to enhance the position of the individual not only vertically vis-à-vis the state, but also horizontally in private law relations. A ‘hybrid legal order’160 is the result. As a consequence of the constitutionalisation process, the principle of proportionality161 or balancing162 of different rights and principles becomes crucial. Even though the role of fundamental rights and principles is not that well established in horizontal relationships, the CJEU has held that individual rights cannot exist in disregard of other interests and rights; an ‘excessive’ use of rights is not permitted.163 Therein lies a novelty in EU law, which brings balancing of fundamental rights into the private realm. It means that the principle of proportionality has a twofold function: it is a means to delineate the powers of the EU and the ­Member States, as well as to determine both the extent of the individual rights and ­obligations.164 Hence, fundamental rights have also served to justify restrictions to market freedoms,165 no matter if the restriction comes from a Member State or a private legal subject. Niglia, critical of this development, highlights that the principle of proportionality, as part of the ‘vocabulary’ of public law, does not grasp the different contextual conditions in which private law matters are enforced.166 Therefore, the Commission should consider possible Member State resistance to further harmonisation that could present itself at the enforcement level.167 Analytically, Kennedy sees the emergence of balancing in EU private law as an insertion into the ‘omnipresent’, albeit ‘highly controversial’, principle of proportionality in EU law, and a continuation of a single, global trend that evolves around 158  See Reich (1974) 189, with further references. In Germany, private law cases can also be reviewed by the Constitutional Court. 159  Micklitz and Patterson (2012) 14. 160  ibid, 14. 161  Cauffman (2015) 69ff. 162  Reich (2014) 131ff. 163  With regard to the doctrine of abuse of rights: Cauffman (2015) 92ff, Reich (2014) 144–45. 164  Cauffman (2015) 84. 165  See Comparato and Micklitz (2013) 133ff. 166  Niglia (2011) 309, 312. 167  ibid, 313ff.

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Theoretical Framework

the different conflicts that emerge involving rights and powers.168 An ­dissenting view is presented by Reich, who argues that the strict proportionality test that the CJEU applies to monitor state action with regard to its interference with free movement law cannot be automatically transplanted into private law and that the matter is rather one of making transparent Vorverständnisse.169 This is not the place to solve the intellectual dispute. What we should keep in mind for our purposes is that, as such, balancing or proportionality implies that it is not a priori clear which values override others.170 Viewed in this way, the constitutional role of individual rights mirrors the indeterminacy of the duality of aims in the EU—the ‘social market economy’—which transcends (supposed) boundaries between public and private law. (b)  The Regulation of Private Autonomy With regard to the right to private autonomy in the EU context as a prominent example of the balancing process, Comparato and Micklitz argue that in the process of constitutionalisation the right to private autonomy in EU law does not have the same character and content as in national laws.171 In order to align private behaviour with the aims of the internal market, private autonomy is both expanded and limited: it is ‘marketised’.172 Its character in terms of expansion and limitation in view of alignment with market goals is also referred to as ‘regulated’173 or ‘framed’.174 This means that private autonomy can also have different meanings and scopes depending on the area of law; in fact, Comparato and Micklitz detect a more proactive role of the CJEU in the development of strong fundamental rights that are applicable also in horizontal relationships when the referred rights can be found also in other provisions of the Treaty.175 These are not areas that pertain to the core areas of contract law, but rather peripheral areas of private law, such as telecommunications.176 In this sense, Safjan finds that autonomy of private parties and freedom of contract are given priority in order to level their position as market participants, whereas—at the same time—he detects ‘pro-social tendencies’ of EU law in accordance with the idea of a social market economy.177 This alignment of individual rights with aims of the EU is possible because the proportionality principle is inherently concerned with the question of whether a certain measure is suitable, necessary and proportional in the strict sense to achieve a certain aim. By applying the proportionality or balancing 168 

Kennedy (2011) 187, 218–19. Reich (2011) 241ff. 170  Kennedy (2011) 215. 171  Comparato and Micklitz (2013) 122ff. 172  ibid, 130, 150. 173  ibid, 150. 174  Reich (2014) 20. 175  Comparato and Micklitz (2013) 141. 176  ibid, 141. 177  Safjan (2013) 165. 169 

Normative Preconceptions

 37

­ rinciple to horizontal relationships, the duality of aims of the EU comes to life p in contract law. Taking a favourable view of the constitutionalisation of private law, social rights provide the foundation for both social regulation and modern contract law, and are thus an integrated body of law rather than autonomous entities.178 Private law is not permitted to subvert constitutional rights. The constitution can even be regarded as a ‘total constitution’, in the sense that it embodies an objective order of values that applies to all areas of law and for all branches of law-making and law enforcement.179 This theory, advanced by Kumm, claims that the constitutionalisation of the relationship between private entities forms part of a broader political context, in which all political and legal conflicts are constitutionalised, while the constitution becomes immune to the possibilities of radical change by entrenching its basic structural features.180 Even though Kumm refers to the theory of indirect effect in the German legal order (mittelbare Drittwirkung), he treats it as direct effect.181 He sees the only difference lying in the question of who is the addressee of the claim, while judges make the exact same assessment when adjudicating directly applicable constitutional claims and when balancing rights and obligations against a constitutional background.182 Consequently, Kumm argues, we might as well just commit to ‘complete constitutional justice’.183 He takes a rather pragmatic stance in positing that the generation of private law rules is already conceived as a political process, which implies that private law is necessarily constitutionalised.184 In this vein, some argue that certain human and fundamental rights should have direct effect also in private law relationships, because the increasing democratisation and secularisation of legal ethics leads to new guidelines that replace ‘outdated moral standards’.185 (c) Criticisms Both the use of general principles and the direct effect of fundamental rights are disputed in academic commentary. As regards principles, it is disputed whether it is desirable to develop general principles at all. Weatherill, for example, argues that the judicial quest for constitutional principles in Mangold stretched beyond the comparative legal heritage of the Member States.186 Turning away from the judge-led development of g­ eneral

178 

Collins (2011) 140, arguing that the Manifesto embraces this, as he calls it, single-house structure. Thus Kumm (2006) 350. 180  ibid, 344–45. 181 Thus Collins (2011) 139–40. Collins also interprets the practice of the German Constitutional Court as giving direct effect, despite the German terminology ‘indirect effect’ being used in the judgment. 182  Kumm (2006) 352ff. 183  ibid, 367ff. 184  ibid, 366 with reference to Habermas. 185  With reference to the right to human dignity, Colombi Ciacchi (2008) 157–58. 186  Weatherill (2016) 44–45. 179 

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Theoretical Framework

principles and emphasising the common legal heritage of the Member States, scholars have embarked on a quest to identify principles of European contract law common to the Member States’ legal orders187 as well as principles that are genuinely derived from EU law.188 However, Hesselink argues that EU and CJEU general principles are ‘particularly vulnerable’ from the perspective of inclusive and deliberate democracy in the Habermasian sense as long as they are not decided in a democratic process.189 At the same time, neither liberal perfectionist nor political liberal critiques and the Habermasian critique exclude per se the project of formulating general principles of private law, but accept their legitimacy under certain conditions.190 Such conditions are, for example, an intermediate level of abstraction; the acknowledgement of principles as sub-constitutional values; and the duty of the CJEU to provide good reasons for adopting and applying general principles of private law.191 Resistance to this constitutionalisation process also stems from the opposition to use individual rights and their direct effect in horizontal relationships. In line with the formalists’ approach to the strict distinction between private law and public regulation, some point to the different role of private law as governing the non-hierarchical relationship between individuals and not between an individual and the state, and to the impasse when both contractual parties can rely on fundamental and human rights.192 It is pointed out that the case law in which the doctrine of direct horizontal effect was developed cannot be automatically transposed into the field of any fundamental freedoms in general.193 Most of all, the formalist critics point to the central principle of freedom of contract and party autonomy, which must be respected in private law,194 as it is the condition sine qua non for exercising fundamental freedoms and the functioning of the internal market.195 A more relativising viewpoint states that constitutional values should play some role in private law, but without subordinating private law rules to such values. Supporters of this approach argue that the horizontal effect should only be ‘weak’196 or ‘indirect’,197 meaning that constitutional rights can only be taken into consideration by the courts without overruling private law norms. In this view, contract law is only influenced by constitutional rights, without being governed by them. Therefore, the courts only take into account the value behind the fundamental rights, without actually balancing competing fundamental rights 187  Lando and Beale (2002) (Commission on European Contract Law); von Bar et al (2009) (Study Group on a European Civil Code). 188  For example: Rutgers and Sirena (2015), Reich (2014). 189  Hesselink (2013) 38–39. 190  ibid, 31ff. 191  ibid, 42. 192  Leible (2008) 65. 193  ibid, 77–78. 194  Pinto Oliveira and MacCrorie (2008) 115ff. 195  Leible (2008) 65. 196  Cherednychenko (2008) 57. 197  Hartkamp (2008).

Normative Preconceptions

 39

against each other.198 These claims are based on the argument that the direct effect of fundamental rights might be disruptive to private law and generate unpredictability: private law, which already provides clear criteria for the validity of contract, has grown over a long period time, mirroring a balance of rights and obligations that might be unsettled by the intrusion of fundamental rights.199 Furthermore, employing only indirect effect instead of direct effect might reduce the risk of a different meaning and interpretation of human and fundamental rights in a horizontal rather than in the classical hierarchical relation, because adjudicating courts are compelled to act within the framework of private law, which attaches greater weight to private autonomy.200 Another argument brought forward against direct effect is that the proportionality test as applied in public law, which balances individual rights with policy considerations, cannot apply in private law, where both rights and policy underpin both sides of the argument.201 Collins argues that a test of double proportionality must therefore be employed by the civil courts in order to assess justifications for interfering with both rights.202 Another argument put forward against the intrusion of human and fundamental rights is their quasi-harmonising effect on private law, for which the EU arguably does not have competence per se. Probably the most convincing argument brought forward by the ‘relative camp’ is an argument about the competence of the CJEU. In the end, what happens with the constitutionalisation of European fundamental rights is that private law would become harmonised top down without any democratic mandate,203 and irrespective of the minimum harmonisation pursued in EU legislation.

C.  Approach in this Book The normative assumptions in this book are, first, that EU contract law in the field of mortgage credit should be concerned with the values of social justice and welfare, and, second, in terms of method, that the EU has a responsibility to deliver these values through legislation. Notwithstanding the mainly normative nature of these preconceptions, a few remarks are indicated for support.

(i) Values I base my claims on the assumption that social justice and welfare should be underlying values of EU contract law in the field of mortgage credit. For several

198 

Cherednychenko (2008) 58. Thus Collins (2011) 143, Cherednychenko (2008) 47. 200  Collins (2011) 143ff with regard to the right to privacy but also with regard to freedom and autonomy in general. 201  ibid, 145–46. 202  ibid, 155. 203  For example, Cherednychenko (2008); also critical Safjan (2013) 166–67. 199 

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Theoretical Framework

reasons I do not follow the strict division between contract law on the one hand, and ­welfare state regulation on the other. Even some libertarians oppose this formalistic view, arguing that the mere idea of a voluntary agreement is a distributional concept and that taxation is not more neutral or less restrictive than the regulation of contracts.204 In order to solve the ‘inevitable conflict between liberty and fairness’ we cannot only take recourse to a blanket preference for taxation but must also consider that contractual regulation might be a more direct means of redistribution as it causes a direct transfer of wealth without establishing a system of collection and redistribution through the state.205 In fact, contract law and welfare state policies are linked, even though the precise form of linkage is ­complex.206 Moreover, since the EU already exercises much of the competence in the field of the internal market and, through this, has a deep impact on contract law, it is argued that this impact should be taken seriously in terms of ensuring that consumers, when concluding contracts that are also governed by EU legislation, do not suffer social repercussions for which they cannot be held responsible. Focusing on the quality of EU mortgage contract rules, I suggest following the authors who have recognised the importance of material contract rules. For example, the Study Group on Social Justice argues that the abandonment of national legal traditions will only be democratically acceptable if EU law is perceived to offer ‘better principles of social justice’.207 In addition, Micklitz and Reich have pointed at the general need for the EU to decide on a model of fairness deriving from either fully harmonised European consumer law, or a market model, or a social protection model.208 In general, there is no reason why the maintenance of the differences between national private law systems should be needed in order to preserve social justice in the EU.209 Tobacco Advertising merely showed that in harmonisation processes close attention must be paid to the quality of a harmonised regime and that there is no preconception in the European Treaties about market freedoms being given prevalence over social justice.210 More importantly, we must recognise that the role of contract law has increased with the retreat of welfare states and ongoing privatisation of welfare services. Therefore, the normative quality of contract law rules must be taken into ­consideration,211 which does not include in itself an assessment of how far the involvement of the state in private relationships should go. What matters for the perspective taken in this book is that welfare losses should be prevented. Against this backdrop, the suspicion that Member States have lost more control

204 

Kronman (1980) 497, 501ff. ibid, 507ff. 206  Brownsword et al (1994) 2–3. 207  Brüggemeier et al (2004) 669, Weatherill (2006) 136ff. 208  Reich and Micklitz (2007) 130. 209  Collins (2007) 175. 210  Weatherill (2006) 145–46. 211  Thus in principle also Hesselink (2013a) 32. 205 

Normative Preconceptions

 41

over their national welfare policies than the EU has de facto gained in transferred ­authority212 has to be taken seriously. If there is such a gap in welfare policies, this gap should be filled with qualitative EU rules that take into account the social function of a welfarist contract law. This puts a focus on the values in EU contract law applicable to housing and mortgages. In view of these values, the analysis in this book suggests a possible way to contribute to welfare and social justice in the EU. Considering the embeddedness of mortgage contracts in the larger regulatory environment also means that other measures to ensure welfare and social justice must be taken. Last but not least, an approach that takes into account social justice and welfare in private law acknowledges the duality of aims in the EU, namely to achieve a market economy with a social dimension. As such, it is in line with the aim of welfare states that seek to find a balance between the two goals of market-oriented­ efficiency and solidarity-based interventions in markets.213 This balancing is transferred to contract law, not only if we assume that contract law takes on a ­welfarist function but also in view of the already existing distributive effects of contract law rules. A welfarist contract law can thus be equated with the development of limitations to the principle of freedom to contract.214 Here, the principle of proportionality or balancing becomes inherently connected to the welfarist function of contract law assumed here to exist.

(ii) Method As regards the competences of the EU to achieve a socially just, welfarist contract law, a pragmatic attitude is adopted. In the end, the discussion on minimum and maximum harmonisation can be left open for the account in this book, because the main legislation analysed, the MCD and UCT, only pursue minimum harmonisation (see Article 2(1) MCD and Article 8 UCT). According to Article 2(2) MCD, only the rules concerning the provision of information on the European Standardized Information Sheet (ESIS) and the calculation of the annual percentage of rate (APR) are harmonised on a maximum level. This means that there is room for the Member States to employ means to achieve their perception of social justice. At the same time, the EU is free to decide to contribute to an understanding of social justice in the field of mortgage credit and housing and adopt a truly high level of consumer protection in the field, which the Member States can then regard as a mere minimum standard if they want to preserve higher national standards of protection. This pragmatic argument can also respond to the concern that some Member States might oppose an EU concept of justice because it is too high in ­comparison with their national legal order, which they want to preserve, there are a few 212 

For example: Scharpf (2002) 647ff, Scharpf (2009) 7. Wilhelmsson (1996) 8. 214  ibid, 9. 213 

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Theoretical Framework

arguments to counter. Criticising competence creep, however valid that criticism might be, does not change the fact that the EU legislation is in place, adopted according to constitutional processes, and applied by the European courts. If we consider that any private law rule is inherently concerned with the ‘pursuit of some idea of justice’,215 then the question is merely one of choice of the justice standard. In this sense, arguments that claim the lack of competence of the EU tout court to achieve any standard of social justice might neglect the fact that the EU is already engaged in passing rules that directly or indirectly affect contract law based on a specific understanding of justice in the context in question. This means that the question is not one of the ‘if ” of social justice in EU contract law but of the ‘extent’ of social justice in EU contract law. Furthermore, even though constitutionalisation means that ‘equity correction’ in traditional private law is substituted with a pervasion of constitutional values and perceptions of ‘social justice’,216 this is not a process that can be attributed solely to the EU. In fact, the constitutionalisation of contract law is based on developments in national legal orders that increasingly deny the perception of private law as a self-standing legal order rather embedding them in a high legal order that serves as a yardstick for the legality of private law rules.217 The direct effect doctrine is a prominent example. Furthermore, there is a ‘spirit of transformation’ in national legal systems that prove a certain convergence with regard to the incorporation of social justice concerns and the theory of direct effect.218 Thus, in a process of perceived substitution of Member States’ perceptions of social justice, it cannot be assumed tout court that higher or different Member State standards are inevitably lost. Rather, it could be that developments in M ­ ember States’ legal orders influence EU action. This is not subject of this book, but provides a possible antidote to a widespread perception. In this context, not much should be added to Comparato’s comprehensive dissection of the ‘nationalist’ ideologies behind the different claims of Member State competence. Only two points shall be highlighted. First, philosophically and historically, the opposition to harmonisation based on the perceived regional– national conflicts of interest seems to repeat itself: the same reasoning was used to oppose national codification during the nation-state-building processes.219 The term ‘Euronationalism’220 alludes to this replication of nationalist arguments in the context of EU integration. Even though it does not invalidate the concerns to prevent the loss of legal diversity, it adds a broader dimension to the discussion. In view of this broader dimension, second, it can be argued that the historical perspective of these ‘nationalist’ views that describe contract law as a truly national institution might neglect current political, economic, and also social and cultural 215 

Comparato (2016) 164. Safjan (2013) 158–59. 217  Micklitz (2014a) 1. 218  Safjan (2013) 160ff. 219  Comparato (2016) 155. 220  Comparato (2016) 229ff. 216 

Conclusions

 43

developments that not only transcend national borders but might also hint at the need for a new understanding of contract law.221 That being said, I want to disclose a certain ambivalence against the proceduralisation of the constitutionalisation process. While I accept and assume that the EU can and should legislate in contract law in order to achieve social justice, I am not sure that this goal can be achieved through the jurisprudence. This ambivalence does not so much concern the debates of direct and indirect effect of individual rights. In fact, for the rather practical lens of this book, it does not really matter if we accord direct or indirect effect to fundamental rights in contract law, as indirect effect would probably be enough to achieve the goals of a welfarist contract law. But, be that as it may, the ambivalence concerning the proceduralisation rather concerns the nature of adjudication of individual cases. Case law is naturally selective and partial, so that the pursuit of such justice through an activist court is not in line with the assumption that social justice should be a common goal of private law systems in the EU.222 Hence, it is at least debatable whether the pursuit of social justice through a judge-made acknowledgement of such value is at all feasible. We will come back to this issue later; for now it shall be acknowledged that the implications of the constitutionalisation process shall not be underestimated. Finally, I find the modern account of the nature of EU contract law compelling. I accept that a new type of contract law is forming in the EU legal order that cannot be understood in view of the traditional dichotomy between private and private law. The infusion of regulatory goals into private law also means that different subcategories of contracts (consumer, labour) are governed by a diverse set of aims. Against this backdrop, Collins highlights that the task at hand is not the attempt to find common principles that generalise between those subcategories but rather to determine the scope of ‘differentiated contract laws’ according to policy orientation.223 In contrast, Hesselink accepts the search for such principles but emphasises the role of democratic deliberation in the process.224 The stance taken in the book is not a stance in favour or against the search for common principles. It is rather its aim to contribute in one of these subcategories of contract law—mortgage credit—with a view to achieving a socially just and welfarist mortgage credit contract law.

IV. Conclusions This chapter has presented the theoretical framework of this book, which is based on a broad understanding of contract law that incorporates values such as welfare 221 

Thus Collins (2006) 225–26. Thus Safjan (2013) 166–67. He, therefore, argues for the adoption of a European Civil Code. 223  Collins (2006) 226. 224  Hesselink (2013b) 180, Hesselink (2015b) 125–26. 222 

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Theoretical Framework

and social justice. It is further rooted in the premise that these values can and should be achieved through EU legislation. Much of the criticism of such an approach rests on the duality of aims in the EU legal order and its ensuing problems. Consumer law in the EU reflects to a high degree the different aims of the EU: on the one hand, consumers shall be protected (Article 169 TFEU and Article 38 ChFR), and on the other, the internal market shall be fostered. These ensuing problems pertain to perceptions of the role of the EU in fostering social goals, which have traditionally been within the realm of Member State competence. There are two dimensions to the controversies, one concerning the role of private law in achieving social goals that lie outside of the immediate concern of contracting parties (the values of private law) and the other lying in the question whose responsibility it is to achieve those values and aims (the method). While many see this as an insurmountable dichotomy—either because they deem the achievement of social goals as a Member State task outside of EU competence or because, to the extent that consumer law is regulated through contract law, social goals cannot be fostered through private law—this book takes a different approach. It is contended that there is a blurred distinction between public regulation and private contract law, especially not in the highly functionalist EU legal order, which also regulates or frames private autonomy. Moreover, the legal framework under examination here, especially the MCD and UCT, are based on minimum harmonisation, so that much of the criticism against maximum harmonisation can be omitted for our purposes. These normative stances should not be mistaken for being dismissive of other preconceptions and approaches. The aim of this book is merely to contribute to the discussions on how social justice can be achieved in the EU; my proposal is simply that a welfarist orientation of EU legal rules can give impetus to the process of finding a model of social justice in EU contract law. In my view, the approach taken is in line within the constitutional framework of the EU. We have seen that the EU is striving for a social market economy, a goal that involves an inherent duality of aims. At the same time, the constitutionalisation of private law opens the gate for the balancing of those aims. I have expressed reservations concerning the activist role of the CJEU in this regard not necessarily based on grounds of normativity but rather suitability. However, the importance of the proportionality principle for the achievement of a social market economy through the balancing of different rights and obligations in contract law must be acknowledged.

2 Vulnerability to Welfare Losses through Privatisation I. Introduction This chapter is dedicated to the dissection of the relationship between welfare and credit, the retreat of welfare states and the vulnerability to welfare losses. The question to be answered is which types of consumers are vulnerable to welfare losses in the field of housing. Finding the answer to this question requires a description of the general trends of state engagement/disengagement with the provision of welfare (section II). A large part of the research in this field needs to be omitted here as the aim of this book is to look into a specific legal framework. However, it shall become clear how, in general, the retreat of the welfare state went hand in hand with the expansion of credit and how, more specifically, the expansion of private homeownership as a welfare goal is premised on increased access to mortgage credit. This is the logic of social inclusion through financial inclusion. The legal analysis in this book is based on the observation that private home ownership and the privatisation of housing markets do not ensure housing welfare. Housing welfare for our purpose is understood as the access to a residential property in which the mortgagor can live. This welfare goal is not achieved if homeowners who have acquired their residential property with the help of a mortgage default on their payments, become overindebted and are evicted from their homes. Using default as a proxy for these welfare losses, it is described in section III how the occurrence of these welfare losses challenges the assumed connection between financial and social inclusion. Surely, not all mortgagors suffer from welfare losses. Hence, section IV ­establishes an understanding of vulnerability to welfare losses by, first, describing the respective risks consumers are exposed to when taking on financial obligations connected to mortgages, and, second, matching these risks with different types of vulnerabilities of consumers. In the end, vulnerability of mortgagors is conceptualised. This conceptualisation of vulnerability will then be used as an analytical grid for the examination of the EU legal framework in the remaining part of this book.

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Vulnerability to Welfare Losses through Privatisation

II.  Privatisation: Credit versus Welfare In recent decades, a general trend has been observed of states retreating from the provision of welfare services to heavier reliance on personal credit and consumption for individual welfare. The retreat of welfare states and the global expansion of credit are two sides of the same coin: the credit–welfare trade-off.1 Economically, the credit–welfare trade-off is characterised by an inverse correlation between the public provision of welfare services and the expansion of credit. This means that in countries with well-developed welfare systems, demand for credit is generally lower than in those with less-developed welfare systems.2 Hence, the nature of the (welfare) state shapes the role of credit: in states with less-developed welfare ­systems, deregulation allows the credit–welfare trade-off to emerge, because it allows the credit-financed consumption that would otherwise be provided by the welfare state.3 Politically, this is the strive for social inclusion through financial inclusion that takes places within the framework of the retreating welfare state.

A.  The Emergence and Retreat of the Welfare State In general, the Western welfare states have undergone similar developments and transformations since their beginnings in the late nineteenth century. Despite national differences, welfare states grew significantly after World War II until the mid-1970s and have declined since the 1980s. There are, of course, differences in the national markets for both real estate and access to credit. However, the broader developments are very similar, as they are embedded into the same global political context. The modern welfare state started developing in the nineteenth century. At that time, states began to assume a new social role prompted by changes in social structure, population movements, growth of labour and new types of social insecurity.4 Even though different types of welfare states emerged,5 states generally became more involved in the markets, adopting, for example, legislation concerning minimum wages and health in the workplace. Public ownership was also assumed of health and educational services as well as transportation, energy generation and distribution, and water supply. Just like the development of private law, the emergence of the welfare state that dealt with the social needs of populations became

1 

Prasad (2012) 227ff. ibid, 227ff. 3  ibid, 235. 4  Kuhnle and Sander (2010) 62ff. 5  Esping-Andersen (1990). He famously distinguished between three or five ‘worlds of welfare capitalism’, which has been challenged subsequently, but still been used and expanded as a conceptualising approach; see, for example: Ferrera (1996), Arts and Gelissen (2002). 2 

Privatisation: Credit versus Welfare

 47

linked to the project of nation-state-building. By generating links between state and society, promises of social protection served the legitimacy of democratic nation-states.6 Since the 1980s, however, welfare states have been in retreat. The political context informing this retreat is one of globalisation, which poses challenges to state power in general.7 More specifically, the causes of this retreat lie in a general strain on public budgets due to ageing populations and the associated pressures on health and pension systems.8 Continuously high unemployment and slow economic growth have brought into question the link between public spending and economic growth, fuelling the spread of neoliberal ideas,9 which, since the 1980s, have sought to ‘roll back the state’ during the transformation of international political economy.10 Notwithstanding national differences, the retreat of welfare states is reflected in the increased reliance on means-tested benefits, major transfers of responsibility to the private sector, and changes in eligibility rules.11 Privatisation in this sense means a shift of activities or functions from the state to the private sector and a shift from public to private production of goods and services that is governed by legal frameworks.12 In the neoliberal logic, finance plays an important role as a ‘driver of privatisation’:13 the accumulation of private assets creates pressure to find investment opportunities and, as such, offers both relief for public budgets (suffering from high unemployment coupled with low income from taxes and social contributions) and opportunities for private asset owners.14 In the EU, the retreat of the welfare state is especially visible in the privatisation of public services such as energy, postal services or telecommunications.15 Whereas governments invested heavily in, and became the sole provider of, these services in order to rebuild Europe after the war,16 a change in favour of privatisation started in the 1990s after the Single European Act and the establishment of

6 

Pierson (1994) 3. Strange (1996) 3ff, Strange (2015) 25ff. 8  Pierson (1994) 3. 9  ibid, 3. 10  Castles et al (2010) 8ff, Nullmeier and Kaufmann (2010) 81ff. 11  Pierson (1996) 157ff. 12  Starr (1989) 21–22. 13  Huffschmid (2009) 49, 53–54. Huffschmid claims that governments provide financial resources to beneficiaries on the top of the social pyramid and then sell them public assets in exchange for these resources, resulting in the transformation of public welfare into private wealth (54). He also claims that the pressure for privatisation opportunities may even become sharper after the financial crisis of 2008 (58–59). 14  ibid, 49, 53–54. 15  The term public service is used as an overarching term that encompasses services of general economic interest. Sauter (2015) has conceptualised the terms used in the EU legal framework; see 9ff, and figure 1.1 on 16. 16  Sole (2005) 337. This is the reason why a certain protection from competition for such services was still allowed in the Rome Treaty, Art 37 EEC (37 TFEU), Art 90 EEC (106 TFEU), Art 222 EEC (345 TFEU). 7 

48 

Vulnerability to Welfare Losses through Privatisation

the internal market. In its 1993 White Paper on ‘Growth, Competitiveness and Employment’, the European Commission advocated public–private partnerships and the involvement of private investors in ‘projects of European interest’.17 Two years later, the Commission stated that privatisation could further the progress made in terms of reducing the role of the public sector in the telecommunications and energy markets.18 Since then, the EU has systematically planned and enforced a privatisation process by pushing its Member States to expand market and competition mechanisms to cover an ever-widening range of social and economic activities.19 Despite the divergences between countries, there is clear convergent trend from publicsector-based service provision to privatised and marketised provision across EU countries.20 Based on a comparison of childcare, long-term care, healthcare, the provision of electricity and water, and waste management in Germany, Italy, France and the UK, Wollmann and Marcou show that, despite divergences with regard to the role of local governments on the micro level, there is a common macro trend towards privatisation. This trend is viewed in terms of the transfer of public services to still publicly owned organisations, the privatisation of assets, or the contracting of a private or public operator under the responsibility of the state to provide the service.21 The privatisation agenda is broadly in line with ordoliberal thinking, according to which the market is incumbent on government, which enables markets to exist and function free from monopolies and subsidies. According to this political thought, the role of the state is limited to putting into place institutional and legal regulations that free the market from distortions.22 In particular, competitive pressures from the progressing internationalisation of markets have provoked a turn towards individualistic choice and freedom, fuelling neoliberal beliefs in the freedom of the individual and the free operation of market forces.23 State intervention into markets was reduced, welfare expenditure was cut, and former publicsector industries were privatised and subjected to market forces.24 It is based on economic choice theory and principal-agent theory, both claiming increased

17 European Commission, White Paper ‘Growth, Competitiveness and Employment—The ­Challenges and Way Forward into the 21st Century’, COM(93) 700 final, 29ff. 18 European Commission, Broad Economic Policy Guidelines 1995, European Economic Policy, No 60, 9. 19  Hermann and Verhoest (2012) examine the developments in the telecommunications, energy, transportation and healthcare sectors and divide the Member States into ‘early movers’, ‘followers’ and ‘catching up’ countries. 20  Parker (1998) 12ff, observing increased privatisation activity since the 1990s in almost all EU Member States, albeit to varying economically significant degrees; also Wollmann and Marcou (2010) 252. At the same time, Wollmann, and Marcou detect a certain trend to reversing the privatisation, especially in the field of water supply (ie in Germany and Italy), 256–57. 21  Wollmann and Marcou (2010) 253. 22  Rose (1999) 138. 23  Fulcher (2004) 49. 24  ibid, 50.

Privatisation: Credit versus Welfare

 49

efficiency of privatised companies as opposed to those of the public sector.25 This development did not imply a laissez-faire type of liberalism in the sense of freeing the market from social limitations, but a reorganisation of policies to enable markets to exist.

B.  Private Home Ownership as Private Welfare (i)  Promotion of Private Home Ownership With the retreat of the welfare state, private home ownership became increasingly promoted by states. Like other sectors of welfare, housing was subject to similar developments in terms of engagement and disengagement of welfare states. With the flourishing of welfare states after World War II, the housing sector came within the ambit of public policy.26 Welfare states developed public housing policies, albeit with different stances towards owning and renting as reflected in the use of direct and indirect public subsidies and regulation. A stronger welfare role for housing became associated with interventions in rental markets, especially in the form of social housing; a weaker welfare role is reflected in policies to support home ownership and domination by the market.27 In this vein, the US housing market has been largely dominated by private home ownership, whereas European countries after World War II adopted large-scale social housing programmes that coexisted alongside the policies of extension of private home ownership.28 Even after the large-scale building initiatives after World War II had reduced the housing shorting by the 1960s and better-off households had begun to opt for private ownership, the need remained for directly subsidised social housing, especially for low-income households.29 However, this changed in the 1970s. On both sides of the Atlantic, states reduced their interventions in the housing market. Instead of public provision of housing, emphasis was increasingly put on market-led developments with an increased role of private financial institutions.30 Private home ownership numbers rose, sometimes significantly, in the vast majority of the so-called advanced countries.31 Even though differences in the relative level of private homeownership among ­European countries remained—explained by different ideological commitments of the states to ‘welfare collectivism’, with a strong commitment indicating a

25 

For an overview of the two strands of literature, see Parker (1998) 30–31. Fahey and Norris (2010) 479–80, 485 with further references. 27  An overview of government housing interventions in EU Member States can be found in ibid, 486–87. 28  Harloe (1995) 211, Castles (1998) 9, Conley and Gifford (2006) 60. 29  Harloe (1995) 265–66. 30  Edgar et al (2002) 2. 31  Castles (1998) 8. For Europe, see Doling (1993) 70–71. 26 

50 

Vulnerability to Welfare Losses through Privatisation

­ ousing system based on collective, rental housing, and a weaker commitment h emphasising individualised homeownership32—the twentieth century changed the mass of the population in the Western world from renters to homeowners.33 In 2015, almost 75 per cent of the EU population lived in owner occupied­ housing.34 Considerable variation between the Member States exists only concerning the question of whether homeowners have an outstanding or mortgage or housing loan rather than the question of whether home ownership is widespread. Nowadays, private home ownership is considered a welfare goal35 and a substitute for other state-provided welfare.36 It plays a pivotal role in the income redistribution within the lifecycle of individuals from youth to old age,37 reducing the gap between the average incomes of retired people and the average income of the total population.38 As pensioners who own their own dwelling need lower levels of state-provided pensions, public expenditure on old-age welfare also decreases.39 Thus, private wealth acts as a tool of social protection where governmental activity to mitigate inequality (provision of welfare) is scarce.40

(ii)  Expansion of Mortgage Credit in the USA and the EU States have manifold tools available to incentivise private home ownership. Most of these tools concern different financing instruments. Probably the most prominent means for fostering private housing markets is the use of lower interest rates in the mortgage market, creating a boom in construction, rents and land values.41 But states can also provide loans from public funds, guarantees and supplements for mortgage loans, interest-rate subsidies to mortgage associations and banks, rent supplements or housing allowances, tax relief to owner-occupiers or landlords,42 or put into place special facilities for purchasing publicly supplied homes at subsidised prices.43 Or they can grant tax relief on mortgage interest

32  Doling (1993) 74–75. The connection with ideology is especially evident in the Eastern European states where private property ownership was facilitated after the fall of communism. See, for example, Józon (2015) for Hungary, and Andresan-Grigoiu and Moraru (2015) 88, 122. 33  Fahey and Norris (2010) 491. 34 http://ec.europa.eu/eurostat/statistics-explained/index.php/File:Distribution_of_population_ by_tenure_status,_2015_(%25_of_population)_YB17.png. 35  See Conley and Gifford (2006) 58. 36  ibid, 75, without, however, finding evidence for a conscious decision by the state to promote home ownership over welfare programmes. 37  See Kemeny (2004) 2, Castles (1998) 12 with further references. 38  Castles (1998) 16. 39  ibid, 11ff. 40  Conley and Gifford (2006) 71–72. 41  Wilensky (1975) 8. Glaeser (2013) established that, even though interest rates (and thus easy access to credit) do influence housing prices, they do so to a lesser extent than commonly assumed. This is why it is important to take account of the other widespread measures that went hand in hand with a lowering of interest rates in fuelling the housing boom. 42  See Wilensky (1975) 8. 43  Castles (1998) 6.

Privatisation: Credit versus Welfare

 51

for owner-occupiers or keep house purchase taxes low.44 ­Moreover, the state can act as a direct lender of mortgage credit or offer state-backed loan guarantees for private lenders.45 In the USA, where the private housing market has traditionally been larger than in Europe, different measures were taken to deregulate the housing and mortgage markets. In an effort to respond to a decades-long decline as an economic global power46 and to rebuild the national housing and lending industries after the Great Depression, the 1934 Housing Act and the creation of the Federal­ Housing Administration provided insurance to private lenders for the loss on home rehabilitation loans and mortgages for new homes.47 Home-building subsidies and land-planning policies encouraged community developers and large building companies to expand their business.48 The Federal National Mortgage Association (Freddie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Association (Ginnie Mae) introduced the standardised mortgage loan.49 They bought mortgages, packaged them and sold these mortgage-backed securities on the open market, providing guarantees for the promised payments of those securities.50 Mortgages could be sold and bought more easily without the buyers knowing anything about the individual borrowers. This made securitisation one of the key financial innovations underlying the integration of global finance.51 A large and liquid mortgage market came into existence.52 This was possible because of two distinct features. First, securitisation creates liquidity out of ‘spatial fixity’, meaning that a non-exchangeable, immobile and illiquid asset with long turnover times between buying and selling, such as housing, is turned into a predictable and standardised product that can be converted easily and quickly into liquid capital.53 Illiquid commodities (housing mortgages) are turned into liquid assets that serve as a basis for accumulation.54 Second, securitisation thrives on the tension between local social relations and networks of real estate activity that generate knowledge about the property in question, on the one hand, and the global reach of markets that extract this knowledge, reduce its unpredictability

44 

Fahey and NorrisM (2010) 486–87. ibid, 489. Schwartz (2012a) 54ff. 47  Gotham (2012) 32–33. 48  ibid, 35. 49  Aalbers (2012) 10. 50  Hellwig (2009) 146. All this was to enable and incentivise foreigners to buy mortgage assets from the USA, thus generating a revenue flow with which to fund its trade deficit (Schwartz, 2012, 60) and satisfying a global demand for debt denominated in highly rated US dollars (Mian and Sufi, 2014, 97). 51  Fligstein and Habinek (2014) 641. 52  ibid, 641. 53  Gotham (2012) 27, 45. 54  ibid, 45; Aalbers (2012) 1. 45  46 

52 

Vulnerability to Welfare Losses through Privatisation

and standardise and commodify it, on the other.55 In this way, globalised mortgage markets have become disconnected from local housing markets and their vulnerabilities to local risks.56 In contrast to primary mortgage markets, in a system of securitisation the emphasis lies not on the profitability of granting credit to an individual consumer, but on the profitability of the global circulation of pooled mortgages. Even though the EU subprime mortgage market was arguably much smaller than in the USA, EU mortgage markets also expanded significantly. The C ­ ommission for example observes that, despite the diversity of the European mortgage market, mortgage lending has generally been fostered by low interest rates, the growth in housing prices, and increasing liberalisation and integration of EU financial markets.57 The deregulation of the mortgage market allowed more financial ­institutions to offer housing loans.58 Besides traditional financial institutions, different types of lenders entered the increasingly competitive market.59 States allowed practices that enabled the expansion of credit, such as the use of automated credit-scoring through credit bureaus and the move to risk-based pricing, and to this end also prohibited monopolistic practices. Thus, it is not the retreat of the state per se, but the very regulation through which states govern private markets that leads to deregulation and liberalisation. In the EU, the expansion of consumer and mortgage credit markets is part of the larger agenda to foster the internal market. The CCD and the MCD aim at creating a cross-border internal market through the facilitation of available consumer and mortgage credit.60 The EU Commission admits that the integration of EU mortgage markets is ‘essentially supply-driven’, putting emphasis on the freedom of establishment of mortgage suppliers in other Member States.61

C.  Financial and Social Inclusion The privatisation that accompanies the retreat of the welfare state and the promotion and expansion of private home ownership is based on the assumption that citizens are consumers, who satisfy their welfare needs via markets. In order to vest them with the financial resources to do so, especially the poorer segments of society, credit needs to be granted. With the expansion of consumer and mortgage

55 

Gotham (2012) 27. Mian and Sufi (2014) 95–96. 57  European Commission Green Paper Mortgage Credit in the EU, COM(2005) 327 final, Brussels, 19.7.2005, 5. 58  Deregulation in this context is a policy decision that aims at transforming property rights and rules of exchange to enable actors to engage in profitable exchange on the market: see Gotham (2012) 41. 59  Burton (2008) 68. 60  See Preamble 4 CCD, Preamble 2 MCD. 61 European Commission White Paper on the Integration of EU Mortgage Credit Markets, COM(2007) 807 final, Brussels, 18.12.2007, 3. 56 

Privatisation: Credit versus Welfare

 53

credit markets, consumption and private home ownership also expand and, with it, also the market for privatised welfare.

(i)  The Assumed Logic The prevailing political-economic rationale in EU mortgage law is an attempt to bring about social inclusion through financial inclusion.62 If more and more consumers can be included in the financial sector, more and more of those consumers will be enabled to provide for their own welfare and become socially included. This is clearly in line with the EU goal of creating a ‘social market economy’. Since financial inclusion plays a pivotal role in the integration of financial markets, it becomes a prerequisite to the achievement of social inclusion, for which the EU only has supporting competence. Financial inclusion is understood as ‘the capacity to access and use appropriate financial services proposed by mainstream providers’.63 It is to be fostered in four key areas, namely transactions banking, credit, savings and insurance.64 Access to banking is regarded as a (soon-to-be) universal need in the developed EU regions in order to achieve social inclusion through market access, avoidance of stigmatisation, mitigated risk of poverty and procedural streamlining. Savings and insurance, in turn, are considered important with regard to the (in) solvency of the public welfare systems and the privatisation of pension schemes. In contrast, credit plays a significant role in not only smoothing consumption over time and protecting against income shocks, but is also considered as a means of enabling individuals to overcome reimbursement difficulties and preventing overindebtedness. Hence, easier access to credit is granted in order to enable citizens to purchase consumer goods or residential property. On achieving these goals, they can become socially included in an active manner and not through the (passive) provision of state welfare. In this way, the promotion of financial inclusion under non-discriminatory conditions becomes a social ­policy65 and a goal of privatised welfare. This fits neatly with a conception of social rights contributing to market objectives.66 In order to participate in financial markets, consumers of welfare services need to be financially literate.67 This is an ‘essential component’ to ensure that ­consumers can benefit from the internal market.68 As such, financial literacy is a

62 

Reifner et al (2010) 15. Commission, ‘Financial Services Provision and Prevention of Financial Exclusion’ (2008) 10. 64  ibid, 11ff. 65  Comparato (2015) 12. 66  Ramsay (2016) 163 with further references. 67  See Moloney (2010) 376–77 concerning the financial literacy and education of investors in the UK and the (then) EC. 68  European Commission Communication on Financial Education, COM(2007) 808 final, Brussels, 18.12.2007, 2–3. 63 European

54 

Vulnerability to Welfare Losses through Privatisation

­ uch-­advocated policy not only in EU policy but also in the economic l­iterature. m Financial ­ education is considered an efficient tool to ensure the minimum ­knowledge required to make informed choices concerning credit products,69 as it can improve money management skills together with the borrower’s ability to understand financial decisions and create awareness about the impact of spending decisions.70 It provides individuals with the necessary knowledge to help them make informed choices when choosing credit services on the market.71

(ii)  The Political Ideology Politically, the privatisation of welfare, including expansion of credit and private home ownership, are associated with a political strategy to stabilise economies and societies. Credit is regarded as a great ‘democratiser’ that allows the realisation of consumerist desires and to promise a new suburban lifestyle with houses and automobiles for everyone.72 The ideology that regards consumers as members of a universal class with the single and common interest of buying cheap-quality products is informed by the objective of creating a classless consumer-society where everyone has the same access to the same products and services.73 This ‘equal opportunity to consume’ was a response to the social unrest caused by class t­ urmoil, and ­bringing down prices was regarded as the means to bring about social peace. S­ imilarly, owner-occupation of houses is considered to act as a deterrent to social and industrial unrest. According to this argument, individual ownership of property contributes to an overall conservative ideology in capitalist societies,74 helping to resolve one of the contradictions between capitalism and a liberal democracy by emphasising individual (as opposed to social) rights on the free market.75 More generally, terms such as the ‘culture of credit’76 or ‘consumer society’77 are descriptive of the societal developments that account for the role of consumption in social life and the study of consumption as a social phenomenon.78 This shows the intrinsic connection of consumer and mortgage credit to issues of class and social mobility/social inclusion through credit-financed consumption and non-discriminatory access to such credit.79 Extending the benefits of fi ­ nancial innovation to more and more people in society in terms of financial inclusion is

69 

See, for example, Group of Specialist for Legal Solutions to Debt Problems 2007, 22. Atamer, Y 2011a, 187; Vandone, D 2009, 78f. 71  Group of Specialists for Legal Solutions to Debt Problems (2007) 2. 72  Logemann (2012) 206. 73  Whitman (2007) 361–62 with reference to True Story Magazine of 1930 ‘The American Economic Evolution’ 32–34, 67. 74  Kemeny (1980) 372. 75  Conley and Gifford (2006) 58–59 including footnote 7. 76  For example: Olegario (2006). 77  For example: Burton (2008), Logemann (2012) 1. 78  Burton (2008) 27 with further references. 79  Logemann (2012) 4. 70 

Privatisation: Credit versus Welfare

 55

not only a means to foster greater economic stability and prosperity but also to enable citizens to foster a sense of participation and belonging to society through the acquisition of a home.80 In contrast, exclusion from financial markets can mean exclusion from opportunities to meet material needs and from a central means of public expression in society.81 In the EU, this approach is supplemented with an economic role of responsible consumers in the integration of markets. Consumers are supposed to drive the European economy by choosing goods and services on the internal market, thus fostering competition.82 The current Consumer Agenda even considers consumption to be one of the drivers of the European economy in overcoming the economic crisis: Consumer expenditure … is essential to meeting the Europe 2020 objective of smart, inclusive and sustainable growth. Stimulating this demand can play a major role in bringing the EU out of the crisis. To make this possible, the potential of the Single Market must be realised. … Improving consumer confidence in cross-border shopping online by taking appropriate policy action could provide a major boost to economic growth in Europe. Empowered and confident consumers can drive forward the European economy.83

Moreover, in its 2005 Green Paper on Mortgage Credit, the European Commission acknowledged the relationship between the macro-economy and individual mortgage debt.84 This relationship is especially visible on flexible mortgage markets where changes in interest rates can not only have a significant effect on household budgets and spending capacity, but also on their asset levels. A change in ideology is clearly visible in Commission strategy papers. While the Second Action Plan in Consumer Policy was still about ‘Placing the Single Market at the Service of European Consumers’,85 the Commission Strategy for 2007–13 was already stressing the role of empowered consumers who now have ‘greater responsibilities’ especially with regard to protecting ‘vulnerable consumers’ such as children and the elderly.86 Consumers are expected to drive the E ­ uropean economies and exercise this responsibility by fostering competition on the internal market, so that the goods and services offered correspond to consumers’ needs. Credit expansion enables them to fulfil this role. In that way, consumers also contribute to the political European project of market integration.

80 

Thus Shiller (2008) 5, 24. Ramsay (1995) 181. 82  European Commission Communication, ‘Second Action Plan in Consumer Policy’, COM(93) 378 final, 3. 83  European Commission Communication, ‘A European Consumer Agenda—Boosting Confidence and Growth’, COM(2012) 225 final, 22, point 1. 84  European Commission Green Paper, ‘Mortgage Credit in the EU’, COM(2005) 327 final, 4. 85  European Commission, ‘Consumer policy. Placing the Single Market at the Service of European Consumers. Second Commission Three-Year Action Plan 1993–1995’, COM(93) 378 final, 28 July 1993. 86  EU Consumer Policy Strategy 2007–2013, COM(2007) 99 final, 3. 81 

56 

Vulnerability to Welfare Losses through Privatisation

(iii)  Responsibilisation and Individualisation The logic of financial and social inclusion reflects an understanding that­ citizens are regarded as self-reliant and responsible consumers of welfare services. According to the economic rationale, the goal is to enable the consumer to take responsibility for her own choices on the market.87 The EU promotes this entrepreneurialism and responsible consumerism.88 It allots not only important economic and political but also social roles to European consumers. However, if consumers do not fulfil these roles, welfare losses ensue. The logic of reponsibilisation and individualisation implies that consumers are expected to take care of their own welfare using market mechanisms, which also means that consumers become bearers of the risks on those markets. This is connected to the process of individualisation, which describes a societal transformation that puts emphasis on individual agency and regards the individual as the master of her own fate.89 It means, for example, that individuals, groups of individuals (families), or communities, are to take upon themselves the responsibility to secure their property and their persons and to protect themselves from risks.90 People are to become more entrepreneurial and are expected to take uncertain risks that are essential for the creation of wealth and the making of profit.91 And financial markets are the trading venue for risks: risks can be sold to investors who lose the right to a specific payment in the case of a certain event or gain payment in the case of non-occurrence.92 Viewed in this way, risk is the very driving force of the globalising economy93 and ‘chaos and uncertainty’ are market opportunities for those who know how to capitalise on market anomalies.94 Probabilistic

87 For an overview in favour of and opposed to consumer empowerment by information, see H ­ owells (2005). 88  Ramsay (2016) 163. 89  See Zinn (2008) 21, Arnoldi (2009) 27. In this vein, a ‘remarkable story of risk’ unfolds from simple risk-taking in gambling to the ‘mastery of risk’, ie the notion that ‘the future is more than a whim of the gods and that men and women are not passive before nature’ (Bernstein, 1996, 1). 90  Arnoldi (2009) 27. Beck (2007) 302 has taken this argument even further to describe individualisation in terms of a responsibility to civilisation: in a new categorical imperative, the individual is supposed to act as if the future of the whole world depended on her (use solar energy, recycle, etc). 91  Arnoldi (2009) 4, Lupton (2013) 9 with reference to Luhmann; see also Giddens (1999) 23. 92  Arnoldi (2009) 150. 93  Giddens (1999) 3. 94  Peters (1987) xiv. Frank Knight famously introduced the distinction between risk and uncertainty in 1921. He argued that in order to understand the economic system, the meaning and significance of uncertainty must be examined, as we cannot always have complete and perfect information, but only partial knowledge (Knight, 1971, 199). Now, much of the broader risk literature acknowledges that a degree of uncertainty remains, distinguishing this uncertainty from risk in the way that we do not know the odds of an event occurring (Arnoldi, 2009, 34; Adams, 1995, 25). Beck (1986) 95, for example, argues in Risk Society that there is an uncertainty and uncontrollability that surround risks, not only because of the dichotomy between scientific research and opposed public distrust, but also because of conflicting scientific research results. Similarly, Giddens (1999) 28 claims: ‘[W]e simply don’t know what the level of risk is, and in many cases we won’t know for sure until it is too late.’ This puts emphasis on the individual who in times of mistrust is forced to make individual choices; Beck (2007) 107 calls this attempt of individual integrity in the world risk society ‘tragic’.

Welfare Losses

 57

calculations of risks and opportunities become devices to come to terms with an open future.95 The growth of new technologies of credit scoring helps individuals not only to improve their credit rating but also their financial literacy and market confidence.96 Responsible dealing with risks borne by individuals puts emphasis on the internalisation of risks through insurance. A ‘new contract for welfare’ between the citizens and the state assumes that people are to be privately insured against foreseeable risks.97 The insurance industry profits from more probabilistic risk calculations based on new technologies (in order to deal with increased risk), while the uncertainty involved also presents business opportunities in the sense that a new market for private insurance products is created because of the downscaling of state social and health insurance.98 In this way, individuals defy the unforseeability and externality of events and make them subject to an insurance contract.99 In this context, Shiller, prominently, advocates the acquisition of insurance for ­livelihood and home values to cover financial losses from all types of causes.100 He suggests that homeowners can be adequately protected from a reduction in income or losses deriving from a decline in housing prices. Fitting with neoliberal ideology and the role of markets, this individual responsibility might be attractive to many. Individuals are expected to be disciplined and take on responsibility for their financial situation in order to benefit from credit markets. This includes individual responsibility for debt. It does not matter why these debts have occurred or why the individual might not be able to pay them off. The well-known German saying Geld hat man zu haben illustrates the stance that individuals are supposed to be liable for their debts, no matter the circumstances.

III.  Welfare Losses A.  The Fallacy of Financial and Social Inclusion The logic of financial and social inclusion is not infallible, both from ideological and empirical standpoints. Pierson has even described the politics of the

95 

Beckert (2016). Ramsay (2016) 180 with further references. 97  Abbott et al (2006) 229 with reference to Department of Social Security policy in the UK. 98  Arnoldi (2009) 149. In this vein, Knight (1971) 232 had previously stated: ‘It is this true uncertainty which by preventing the theoretically perfect outworking of the tendencies of competition gives the characteristic form of “enterprise” to economic organisation as a whole and accounts for the peculiar income of the entrepreneur.’ 99  It is here that Shiller’s plea for livelihood and home equity insurance has to be understood, with the aim to insure individuals against the aggregate risk over which there is no individual control but that impact financial losses from all causes and the market values of homes, respectively (Shiller, 2003, 111ff). 100  ibid, 111ff. 96 

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Vulnerability to Welfare Losses through Privatisation

r­etrenchment of the welfare state as ‘treacherous’, because it imposes losses on groups of individuals ‘in return for diffuse and uncertain gains’.101 First of all, the democratising effect of privatised welfare and consumption detached from social status through access to credit can be questioned. In fact, there is a tension between states as democracies and markets as the means of resource allocation. Streeck, prominently, has described how the democratic capitalism of today is ruled by two conflicting principles of resource allocation: one operating according to the free play of market forces, and the other based on social need or entitlement.102 This conflict creates problems for governments which have simultaneously to honour both principles: they will be punished politically for neglecting social entitlements and democratic demands; and they will suffer economic repercussions for neglecting the owners of productive resources. This results in inequalities and social exclusion of certain parts of the population.103 Second, it is highly doubtful that individuals are able to protect themselves from the risks they are exposed to in the political economy of the credit–welfare trade-off. As a consequence, they might not be able to fulfil the role that they are assigned—the role of the responsible consumer who shops around on the market to find the welfare services that fit her needs. Even if consumers are financially included by having access to mainstream financial markets, this does not mean that social inclusion necessarily follows. This paradox is manifest in the danger of social exclusion that follows indebtedness, overindebtedness, default, and possible eviction and homelessness.104 As a consequence of overindebtedness, people might withdraw from social (and financial) life because of fear, shame or resignation, a phenomenon termed self-exclusion.105 People can also be excluded from social life through sanctions enforced by their creditors, such as compulsory evictions and consequential homelessness; this is social exclusion in its most prominent sense.106 This problem is highly connected to a possible overestimation of the role of financial education in the process of responsibilisation. Even though it is clear

101 

Pierson (1996) 145. Streeck (2011) 7–8. 103  Social exclusion can be broadly defined as a situation in which an individual does not participate in the key activities of his or her society. Central participation in society relates to the consumption of goods and services, participation in the production of economic or socially valuable activities, political engagement and social interaction. The terminology developed from a term describing a form of social closure to describe those who slipped through the Bismarckian social insurance system, the net of social protection. Nowadays, there are three main schools of thought dealing with social exclusion: one of them debates individual behaviour and moral values in the context of ‘marginalisation’; one focuses on the role of institutions and the provision of welfare; and one puts emphasis on enforceable rights, anti-discrimination, equality and the lack thereof. They all share concern for the relationship between individuals or groups that are inside or outside of social activities (included or excluded) because of their characteristics. See Burchardt (2002) 2–3, 30–31. 104  Comparato (2015) 13–14, Ferretti (2015) 348. 105  Korczak (2004) 7. 106  ibid, 7. 102 

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that low levels of financial literacy are common and widespread, encompassing unfamiliarity with basic concepts of economics and finance,107 it is much less clear to what extent financial education actually influences financial decisions108 and whether financial education does not need to be different for different­ people.109 The effects of financial education are not as straightforward as commonly assumed. Of importance for this book is, moreover, the realisation that the ­educational model is based on the assumption of a learning process. However, in the ­special field of consumer mortgages, there is arguably no learning process. For many ­consumers, acquiring housing and taking on a mortgage obligation is a once-in-a-lifetime transaction rather than one of many investment choices. Many mortgages have a long-term character, which underlines the rarity of this ­economic activity in a consumer’s life. There is hardly ever a ‘second time’ in housing and mortgages. This means that, even if financial education leads to a better initial understanding of the mortgage obligations before signing the contract, the rationale of the educational approach is undermined: consumers are not able to learn from possible mistakes. This might be troubling also from a social perspective. If education of consumers is an important tool for preventing default and overindebtedness, or for achieving any other goal for that matter, access to that education becomes crucial. Here, social inequalities can be mirrored, as some individuals might be excluded from this education. This is even more worrisome because high levels of inequality in educational attainment tend to correlate with higher income inequality.110 Third, more ideologically, responsibilisation and individualism can be criticized because they fuel the ‘debtfare state’: under the ideology of neoliberalism ‘the poor’ are provided with efficient private housing finance in order to manage the housing shortfall.111 In a neo-marxist account, this leads to secondary exploitation through capital–labour relationships.112 In this vein, a social discrepancy can be detected when comparing the personal responsibility of individuals with the responsibility of banks for their debts. ­Korczak has pointed out an incongruity between the responsibility borne by banks as individual actors or by their managers and executives, on the one hand, and of individual consumers and citizens, on the other. While over-indebted private individuals enter a long process of insolvency for debts that are relatively insignificant compared to those of banks, the latter, in contrast, have been able to rely

107 

See for the USA in the context of savings, Lusardi (2008a) 3 with further references therein. financial education in high schools, for example, see Mandell and Schmid Klein (2009). In contrast, other research shows that financial education can foster savings: with regard to families with low education, see Lusardi (2008b). 109  Lusardi (2008). 110  See, for example, Rodríguez-Pose and Tselios (2008). 111  Soederberg (2014) 217ff. 112  Soederberg (2014) 37. 108  For

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on governments with their executive managers not being liable with their private assets and wealth.113 These remarks show the fallacy of the logic between financial and social inclusion. It is the danger of social exclusion that is the inherent consequence of the concept of financial inclusion.

B.  Welfare Losses in the Housing Sector Questioning the logic of social inclusion (ie welfare via the purchase of residential property) through financial inclusion (access to mortgage credit), the claims advanced in this book are based on the assumption that the privatisation of ­welfare leads to social exclusion as a welfare loss. As such welfare losses are difficult to determine, much less to define, a proxy is used to grasp those welfare losses. One possible proxy is the default of mortgagors. The choice of this proxy is based on the observation that larger volumes of lending to a larger number of consumers—combined with an automated and depersonalised credit authorisation system—are associated with an increase of default.114 Even though there is no common definition of default and a lack of publicly accessible and comparable empirical data, some EU and research institutions have collected data that give an indication of the worsening financial situation of ­European households in recent years, which confirms findings in the literature.115 The inability of EU households to meet unexpected expenses has risen since 2008 (with slight variations).116 Almost 40 per cent of European households are reported to be facing such financial difficulties.117 The general context also shows that even though median income has risen in the EU Member States,118 the riskof-poverty, or social-exclusion, rate remains at more than 23 per cent (even though a slight decrease was noticed between 2012 and 2013).119 Overall, in 2013, almost 17 per cent of the EU population were at the risk of income poverty and almost 11 per cent lived in households with very low work intensity. Children and elderly people are particularly affected.120 Also the percentage of people who are ‘severely materially deprived’ has risen since 2008, which emphasises the importance

113 

Korczak (2009) 31ff. (2008) 69–70. In order to handle the growing number of defaults, banks even started outsourcing debt collection; an outright ‘debt sale market’ in personal finance developed. 115  See the country reports in Domurath et al (2014). 116  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion#Main_statistical_findings. 117 www.ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statistics. 118  See www.ec.europa.eu/eurostat/web/gdp-and-beyond/quality-of-life/median-income. 119  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion. 120  www.ec.europa.eu/eurostat/statistics-explained/index.php/People_at_risk_of_poverty_ or_social_exclusion#Main_statistical_findings. 114  Burton

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of social transfers.121 ­Furthermore, people at the risk of poverty are overproportionately represented in statistics related to difficult housing conditions and to overcrowding of dwellings.122 There is a considerable variation among the Member States. Bulgaria, Romania, Greece, Latvia and Hungary rank high in these statistics, with more than a third of their population being at the risk of poverty. But especially in the Member States that have been hit worst by the financial ­crisis, the percentage of the population at the risk of poverty amounts to almost ­one-third, for example Italy, Spain, Lithuania, Ireland, Croatia, Cyprus, Spain and Portugal. Living costs relating to housing are also at a high level. In 2013, more than 23 per cent of European homeowners with mortgages or loans faced a housing cost burden of over 25 per cent of their disposable household income. In the new Member States, it is more than 45 per cent.123 More than 60 per cent of tenants pay more than 25 per cent of their disposable income as rent, and more than 16 per cent facing rents that take up over 50 per cent of their income—these numbers have seen little fluctuation since 2005–06.124 With these high housing cost burdens, it does not come as a surprise that the numbers of default have risen in the last years.125 Considering that default is a prerequisite for enforcement action, it can mark the point in time in which for many consumers their financial situation worsens to an extent that it leads into a spiral of overindebtedness, eviction from their home and possibly homelessness. The proxy of defaulting on a loan is also a welfare loss that precedes many of the social problems involved in access to private housing that can lead to further welfare losses. As an indication of these problems, we can see that the housing deprivation rate has risen on average in the EU.126 In addition, the severe housing deprivation rate for mortgagors has gone up slightly in the last years in many EU countries (with the exception of some Eastern European and Baltic states).127 Housing welfare losses ensue.

IV.  Vulnerability to Welfare Losses Not every mortgagor experiences the welfare loss of default or subsequent welfare losses of overindebtedness, evictions, homelessness or any other form of social 121  The at-risk-of-poverty rate can be substantially reduced by social transfers, see www.ec.europa. eu/eurostat/statistics-explained/index.php/File:At-risk-of-poverty_rate_before_and_after_social_ transfers_and_at-risk-of-poverty_threshold_(for_a_single_person),_2012_and_2013.png. 122 www.ec.europa.eu/eurostat/statistics-explained/index.php/Housing_statistics. 123  www.appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do (last accessed 30 April 2017). 124  www.appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do (last accessed 30 April 2017). 125  Mentis and Pantazatou (2014), 23; Frade and Almeida (2014) 70; Méndez Pinedo and Domurath (2014) 213. 126 www.appsso.eurostat.ec.europa.eu/nui/submitViewTableAction.do. 127 www.appsso.eurostat.ec.europa.eu/nui/show.do?dataset=ilc_mdho06candlang=en.

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exclusion. In general, only those mortgagors who are vulnerable to welfare losses might actually to experience such losses. Since there are no specific empirics concerning the mortgagors who are especially affected by default, housing deprivation and evictions, some parameters are deduced by establishing a conceptual framework for vulnerability to welfare losses.

A.  Definition and Conceptualisation of Vulnerability The concept of vulnerability is not new in the social sciences. However, the literature that deals with vulnerability comes from different fields and uses the term in different ways. However, a synthesis of the approaches shows a convergence towards a definition that relies on the identification of risks and on assessing the capabilities required to cope with the negative consequences of those risks. The definition of the UN Expert Workshop on Ways and Means to Enhance Social Protection and Reduce Vulnerability (UN Report) captures this convergence. Therein, vulnerability is defined as ‘a state of high exposure to certain risks, combined with reduced ability to protect or to defend oneself against those risks and to cope with the negative consequences that ensue when the risks occur’.128 Similarly, a study published by the European Commission in 2016 on consumer vulnerability (Commission Study) defines the concept of vulnerability with reference to ‘an ex-ante assessment of the likelihood of a potential negative outcome in terms of consumer well-being. It is an assessment of risk, rather than a reflection of a negative outcome that has or is certain to materialise.’129 Both the UN Report and the Commission Study see vulnerability as a nonstatic concept. The former links vulnerability with risks that can change in different situations and circumstances, making vulnerability a ‘dynamic and relative’ concept.130 The latter identifies vulnerability not as static, but as dynamic and incremental, because consumers can move in and out of situations in which they experience vulnerability and because their vulnerability can arise from more than one factor.131 There is less synchronicity in conceptualisation as regards the parameters for and types of vulnerability. Both the UN Report and the Commission Study acknowledge that two broad categories of vulnerability emerge from the literature: one that relates to personal characteristics and a broader one that takes account of

128  United Nations Economic and Social Council, Expert Workshop on Ways and Means to Enhance Social Protection and Reduce Vulnerability, 1998, point 5. Another definition including the more refined parameters of the exposure to a risk and the incapability to avoid or to absorb a possible harm is offered by Thomas (2010) 61 with further references therein. The translation is the author’s. 129  London Economics et al (2016) xvii. 130  United Nations Economic and Social Council, Expert Workshop on Ways and Means to Enhance Social Protection and Reduce Vulnerability, 1998, point 6. 131  London Economics et al (2016) 44.

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transactional situations132 or the overall situation of the consumer in general.133 In this vein, the Commission Study also acknowledges the elements of power and control that may, at some point, render all consumers incapable of controlling marketplace interactions.134 The deeper we go into the precise characteristics of vulnerability and its different types, a vast and multidimensional concept emerges.135 As a result of a literature review, the Commission Study, for example defines the ‘vulnerable consumer’ along five ‘core dimensions’: A consumer, who, as a result of socio-demographic characteristics, behavioural characteristics, personal situation, or market environment: —— —— —— —— ——

Is at higher risk of experiencing negative outcomes in the market; Has limited ability to maximise their well-being; Has difficulty in obtaining or assimilating information; Is less able to buy, choose or access suitable products; or Is more susceptible to certain marketing practices.136

Moreover, different fields of research define vulnerability differently. For example, ecological vulnerability is a much-used concept in the literature on disaster management, especially in the context of environmental and rural studies. Therein, the rural poor are considered vulnerable, as they are often directly dependent on local natural resources, but face a number of constraints, such as limited control over those natural resources, limited access to political power, and economic insecurity.137 As another concept, structural vulnerability refers to vulnerability that derives from such attributes as gender, race, occupation or socioeconomic status.138 The economic and sociological literature sheds light on the understanding of these types of vulnerability.139 Therein, the term is often associated with poverty, both in terms of assets (the measurement of poverty and poverty dynamics) and in terms of livelihood stress. In the field of behavioural economics, the less educated, immigrants and individuals with cognitive difficulties are deemed to be ‘vulnerable’ to certain market practices.140 In contrast, sociological literature emphasises that poverty cannot only be captured by money-metric means, thus supplementing economic with social vulnerability.141

132 

ibid, xvii. ibid, 42–43 with further references. 134  ibid, 43. 135  United Nations Economic and Social Council, Expert Workshop on Ways and Means to Enhance Social Protection and Reduce Vulnerability, 1998, point 7. 136  London Economics et al (2016) xx, 46. 137  Thus Stedman-Edwards (2010) 145–46. 138  United Nations Economic and Social Council, Expert Workshop on Ways and Means to Enhance Social Protection and Reduce Vulnerability, 1998, points 7 and 9. 139  For an overview of the literature see Alwang et al (2001). 140  Lissowska (2011) 394. 141  For example, Ranci et al (2014). 133 

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Definitions from the field of financial markets define vulnerability with the help of a clear market dimension. Financial markets play a special role because consumers tend to be less familiar with the very often complex financial products and services and because the impact of financial decision can be life-changing.142 Therefore, Banks, for example, defines vulnerability as the exposure to a loss if a particular event occurs.143 In the context of financial disasters, this definition puts a clear emphasis on exposure to a certain risk, while leaving aside the importance of personal capabilities to maybe absorb the loss. For other authors, in contrast, there seems to be an implicit understanding of vulnerability as being equivalent to low income.144 Also Cartwright offers a definition of vulnerability in the financial field.145 His approach is more comprehensive and incorporates the market dimension. Besides the vulnerability of consumers relating to information, financial pressure, the possibility to choose products and to seek redress, he also considers the relationship between markets and consumers by referring to the difficulties some consumers have in coping with the negative consequences of financial decisions— a concept he calls impact vulnerability. This more holistic view is recognised by the Financial Conduct Authority (FCA) in the UK,146 which acknowledges the importance of both individual characteristics and behaviour and an unexpected change in circumstances for vulnerability on financial markets. Nevertheless, the FCA definition of vulnerability emphasises again the behaviour of market actors, especially of firms that act without appropriate levels of care.147 We can see that definitions of vulnerability converge towards acknowledging the exposure to certain risks and the corresponding characteristics or situations of consumers to respond to those risks. In sum, for our purposes it is appropriate to view vulnerability in the financial sector as the exposure to certain risks (exposure) and the incapability of absorbing losses (lack of resilience). The risks can comprise personal characteristics of the consumers as well as market conditions. The market dimension is especially important for financial vulnerability, because financial products can be very complex and difficult to understand, but also because, more specifically with regard to mortgages, financial obligations can span long periods of time during which the consumer can be exposed to risks.

B.  Vulnerability of Mortgagors We have seen that vulnerability in the field of consumer and mortgage credit has two broader dimensions: the exposure to a risk (of a welfare loss) and the lack

142 

Coppack et al (2015) 22. Banks (2009) 26. 144  For example: Wilson et al (2009), Wilson (2013b) 114; see also: Rott (2014b). 145  Cartwright (2015). 146  Coppack et al (2015) 23ff. 147  ibid, 20. 143 

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of resilience in terms of incapability to absorb (welfare) losses. Since we want to understand the vulnerability of mortgagors to welfare losses, which we approximate with the concept of default, we need to identify risk factors for default and match them with parameters or situations of consumers that make the latter vulnerable to those risks. We must also understand which consumers lack the resilience to absorb welfare losses. Therefore, based on studies and literature that are concerned with the causes for defaults and overindebtedness we can identify risk factors for default that, if coupled with matching personal characteristics, reveal certain patterns of vulnerability of mortgagors.

(i)  Relational Vulnerability to Internal Risk Factors First, the privatisation of welfare has put into the focus the responsibility of private actors; if mortgagee and mortgagor do not act responsibly, the danger of default increases. The emerging vulnerability is relational, as it concerns the relation between the contracting parties. The risks, on which this relational ­vulnerability is based, concern the individual behaviour of the contractual parties. They are ‘internal’ risk factors. The economic literature mentions several such risk factors, such as the inability to process information, evaluate the consequences of indebtedness and deal with financial obligations, as well as irresponsible borrowing and consumption choices.148 This approach gained significant impetus from behavioural economics, which contends that, in contrast to the models used for traditional economics, people do not behave in a rational way but are subject to important cognitive limitations. In the 1970s, Tversky and Kahnemann famously showed that individuals can be subject to systematic errors under conditions of uncertainty, as when they estimate the probability of events.149 In this vein, Gennaioli et al show that even experts neglect risks and that the financial sector amplifies the neglect, such as the risk of house prices falling by more than 10 per cent.150 In addition, Jolls et al explain how ‘bounded rationality’, ie biased forecasts and disregard of utility theory, ‘bounded willpower’, ie the deliberate decision to take actions that are in contrast with one’s own long-term interests, and ‘bounded self-interest’, ie the phenomenon that most people are willing to pay for fairness, influence individual decision-making.151 The cognitive limitations of individuals are reflected in an underestimation of the occurrence of adverse events, so-called overoptimism.152 These cognitive

148  For an overview of the relevant studies, see Vandone (2009) 73–74. Similarly, ‘lack of financial overview’ was one of the three most common factors for bankruptcy in Germany in 2007, together with unemployment and divorce: see Backert et al (2009) 283. 149  Tversky and Kahnemann (1974). 150  Gennaioli et al (2012). 151  Jolls et al (1998) 1476. 152 ibid, 1524, pointing at the role of the overoptimism of humans with regard to negligence assessments.

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biases are generally acknowledged in the economics literature, where it is taken into account that consumers tend to overestimate their capacity to manage financial obligations and to underestimate the likelihood of being affected by adverse events, such as job loss.153 For example, predatory, irresponsible lending with high rates, fees and penalties for non-payment (so-called subprime lending)154 before the 2008 crisis can be explained with such cognitive biases. Even though such practices have arguably been less common in Europe than in the USA, there is evidence from Europe that consumers have been actively approached by financial institutions and encouraged to enter into consumer loans or mortgage agreements advertised with low interest rates, especially, but not only, on the foreign-currency loan market.155 Other incidences were reported of financial institutions pressuring consumers to sign a contract without giving them much chance to reflect on the decision,156 a process fuelled by the trust the bank customers tend to have, especially in their home bank.157 All in all, there is a suspicion that creditworthiness assessments were not undertaken diligently,158 which led to an erosion of lending standards. The vulnerability to these internal risk factors is characteristic of many consumers. In fact, it is an overarching vulnerability pertaining to the contractual relationship. This ‘relational vulnerability’ can derive from unequal bargaining power, a lack of education or knowledge, and financial pressure. These vulnerabilities are well acknowledged in the literature and policy papers. A first type of vulnerability lies in the unequal bargaining power of the consumer vis-à-vis the professional. This weakness is largely acknowledged in the academic literature as the very basis for consumer protection rules.159 The bargaining power of consumers is considered to be diminished160 because professionals rely heavily on the use of standardised contracts.161 As a consequence, the professional dominates the consumer and the latter is not able to negotiate a contract that might fit her needs better than the standard agreement and to shop around for better conditions. Moreover, it is assumed that the professional has more knowledge about the product or service in question than the consumer.162 This is especially true for

153 

So-called overoptimism, ibid, 1524. See also Vandone (2009) 73–74 with further references. Dymski (2012) 157ff. For example in Greece, see Mentis and Pantazatou (2014) 53–54. 156  For example in Spain, see Gutiérrez de Cabiedes and Cantero Gamito (2014) 144–45. 157  In this regard, see Frade and Almeide Pinheiro (2014) 97. 158  See the country reports in Micklitz and Domurath (2015). The reluctance to undertake creditworthiness assessments has also been part of cases heard by the CJEU; see, for example, CJEU Judgment of 18 December 2014 in Case C-449/13 CA Consumer Finance SA v Ingrid Bakkaus and Others. 159  For example: Micklitz (2004), Hartlief (2004), Wilhelmsson (2004a), also Basedow et al (2011) 405, Rösler (2010). 160  With regard to the DCFR, see von Bar et al (2009) 67–68. 161  Kessler (1943) 632, Becher (2008) 726. 162  Becher (2008) 733. 154  155 

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financial services,163 because they tend to be more complex than regular consumer products and services. Cartwright calls this ‘informational vulnerability’.164 Second, a lack of education can inhibit consumers from striking better deals for themselves or understanding the contractual rights and obligations, and thus can exacerbate cognitive biases.165 The FCA also identifies ‘low basic skills’, such as low literacy or numeracy with or without a diagnosed learning difficulty, as ­‘vulnerable circumstances’.166 The complexity of financial products and services and the information relating thereto only adds to misunderstanding and confusion of consumers.167 Third, marginal consumers who are, for various reasons, excluded from access to mainstream credit can be susceptible to high-cost exploitative credit-granting practices. Since the ground-breaking research done by Caplovitz (‘the poor pay more’),168 this type of vulnerability has become the most widely acknowledged both in academic literature169 and policy. The FCA, for example, acknowledges that consumers may be vulnerable if they cannot access products on the market that are affordable for them.170 This includes people with ‘non-mainstream circumstances who do not fit pre-determined criteria’, such as individuals with an impaired credit history, a criminal history or persons of a certain age. Such borrowers are more in need of credit and are less likely to benefit from disclosed information because they feel that they have no alternatives available to them. As a consequence, they are more likely to agree to onerous terms.171 Reich calls this ‘economic disability’,172 while Cartwright defines this as ‘pressure vulnerability’, referring to the pressure felt by consumers based on individual characteristics, such as a possibly clouded judgement because of financial difficulties.173 The vulnerability of marginal borrowers was highly visible the last financial crisis. As we have seen, securitisation in the US mortgage-lending market made it possible to expand credit to so-called subprime segments, and thus to borrowers who were more at risk of defaulting on their loans.174 Compelling evidence shows that lending to these marginal borrowers, who were most likely not able to repay the loans, expanded significantly between 2000 and 2007.175 In Europe too, the

163 

Thus Mak (2012) 3. Cartwright (2015) 121–22; Reich (2015), in turn, distinguishes this ‘weakness‘ from ‘vulnerability’. 165  Reich (2016) 142, who refers more narrowly to ‘intellectual disability’. 166  Coppack et al (2015) 34. 167  ibid, 45ff. 168  Caplovitz (1963). 169  Wilson et al (2009), Wilson (2012) 197; also Rott (2014a), Rott (2013a) 78. 170  Coppack et al (2015) 47ff. 171  See study undertaken by Wilson et al (2009). 172  Reich (2016) 143ff. 173  Cartwright (2015) 122–23. The individual characteristics, however, also include: age or lack of knowledge, temporary individual circumstances such as the loss of a family members, a physical situation such as the presence of the seller in the buyer’s home or other intimidating situations. 174  Mian and Sufi (2014) 95ff. 175  ibid, 76ff. 164 

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emerging housing and credit bubbles supported the expansion of mortgage lending to marginal borrowers. Greece, for example, experienced a consumer credit boom after restrictions on consumer lending were lifted in 1994.176 Favourable macroeconomic conditions, such as low interest rates and the liberalisation of the Greek banking sector, as well as ‘easy lending’ practices by the banks, contributed to the expansion of credit, so that consumers who had previously been barred from access to credit could now borrow money at favourable rates. In Spain, the extension of consumer credit before the financial crisis went hand in hand with a housing bubble.177 Similarly, Iceland experienced both a housing and credit bubble in the years before the crisis: the common overestimation of the sustainability of the credit system based on rising housing prices, low inflation, stable exchange rates (regarding the special case of foreign-currency loans) and low interest rates allowed Icelandic financial institutions and the state-owned Housing Fund to compete also for low-income and credit-constrained households as customers.178 Similar developments took place in other countries.179 These three manifestations of vulnerability have in common their relational character in the sense that they pertain to the weaker position of consumers visà-vis lenders, which makes consumers susceptible to information biases, pressure, unconscionability or further exploitative practices.180 They relate to the exposure to the internal risk factors for default and overindebtedness identified above.

(ii)  Event Vulnerability to External Risk Factors Another risk factor for default lies in unexpected adverse events.181 These events are ‘external’ to the contractual relationship between the lender and the borrower, as they are not directly connected to their behaviour. These critical and adverse events can—alone or in a cumulative way—lead to an escalation of a situation of indebtedness to overindebtedness.182 Mortgagors who are especially exposed to these external risks are also vulnerable to experiencing welfare losses in terms of default, overindebtedness, housing deprivation and eviction. Two types of external risk factors and their respective vulnerability emerge: the vulnerability of precarious workers to the risk of income instability on the one hand, and the vulnerability of mortgagors who borrow ‘into a bubble’ and the vulnerability of foreign-currency borrowers to systemic risks inherent in the financial system on the other.

176 

Mentis and Pantazatou (2015) 43. Gutiérrez de Cabiedes and Cantero Gamito (2015) 135ff. 178  Méndez-Pinedo and Domurath (2015) 235–36. 179  For example in Portugal, Frade and Pinheiro Almeida (2015) 86–87. 180  So implied by Capper (2010) 166ff. See also Coppack et al (2015) 59–60. 181  Vandone (2009) 74. 182  Korczak (2003) 21–22 with further references. 177 

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(a)  Income Instability and Precarious Workers The risk of income instability is strongly associated with default on loans and ­­overindebtedness. Income instability can arise from different situations. For example, changing personal circumstances, such as a divorce or sickness, can cause overindebtedness.183 However, in this book, we focus in this context on market risks, not personal ones. As such, they lie within the ambit of influence of regulators. One of the most common reasons for income instability is loss of ­ employment.184 The unemployed—irrespective of age group—feature high on diverse overindebtedness statistics.185 For example, in Hungary and Romania, unemployment is one of the most common causes of overindebtedness.186 Other ­salary disruptions can also affect income stability. In Portugal, for example, a lot of overindebted consumers have suffered from a salary disruption caused not only by unemployment but also by a decrease in salary or social benefits.187 Precarious workers are the ones who are especially vulnerable to the risk of income instability. Even though there is not much research, to the best of the author’s knowledge, on the extent to which precarious workers are affected by default, we can infer that they are more likely to default on their loans than workers in more secure employment because their source of income is unstable. Precariousness of employment can derive from many different factors. For example, studies in the field of so-called flexicurity have shown that fixed-term labour puts employees at a higher risk of unemployment.188 Also low-skilled and manual workers with lower levels of education experience higher levels of job insecurity. This group of consumers is mainly made up of migrants with a linguistic barrier and a lack of experience in the marketplace, who also undergo stigmatisation and segregation. Similarly, ethnic minorities are faced with difficulties in accessing jobs, even if they have better qualifications than nationals do.189 The European Commission acknowledges that these groups of consumers are vulnerable in its policy paper ‘European Platform against Poverty and Social Exclusion’. It states that the ‘most vulnerable’ have borne much of the impact of the financial and economic crisis, identifying low-income workers as the ones who are confronted with a higher risk of indebtedness and insolvency as well as young people, migrants and the low-skilled, who are often in temporary and low-paid jobs.190 183 

See Heuer et al (2005) table on 4. Reifner et al (2010) 15, Ramsay (2012) 426. et al (2010) 12; also Heuer et al (2005) 3–4, 5. The unemployed are also highly represented in German bankruptcy statistics, see Backert et al (2009) 280. 186  Józon (2015) 176–77; Andresan-Grigorio and Moraru (2015) 287. 187  Frade and Almeida Pinheiro (2015) 71. In Greece, however, the majority of overindebted consumers are actually employed, Mentis and Pantazatou (2015) 45. 188  Gebel (2013) 5 with further references. 189  For this topic see Trade Union Congress (2016). 190 Communication from the Commission, the Council, the European Economic and Social ­Committee and the Committee of the Regions, ‘The European Platform against Poverty and Social Exclusion: A European Framework for Social and Territorial Cohesion’, COM(2010) 758 final, 16.12.2010, 2. 184 

185  Georgarakos

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(b)  Systemic Risks: Bubble and Foreign-Currency Borrowers Another risk factor for default derives from the connection of mortgages to a globalised financial system, exposing mortgagors to the risks on this system; if those risks materialise, the danger of default and further welfare losses increases. In the global financial system, financial transactions are exposed to systemic risks, namely liquidity risk, credit risk and market risk.191 These risk factors are ‘external’ to the contractual relationship. They are systemic, as they can have effects on the entire banking, financial or economic system.192 Their systemic character stems from the global interconnectedness of large banks (through interbank loans, deposits and other financial instruments) and major investors.193 Although research suggests that highly interconnected financial networks can withstand a certain degree of adversity,194 they are also fragile when the shocks cross certain thresholds.195 Moreover, the interconnectedness of banks link the countries in which they ­operate.196 This is what happened during the last financial crisis, when a crisis on the relatively small mortgage markets (relative in comparison with other activities of international banking)197 turned into a financial crisis on a global scale. The vulnerability of consumers to these systemic risks derives from the occurrence of certain events, such as the burst of a market bubble or a risk in interest rates. Therefore, we call the vulnerability to these risks ‘event vulnerability’. The most important systemic risk for our purposes is market risk. It is the risk of a loss or gain based on the movement of a market variable such as interest and currency exchange rates or commodity prices; the adverse systemic effects stem from the liquidation of assets leading to a decline in asset prices. First, the asset market and credit bubbles of the last financial crisis provide an excellent example of this interconnectedness of markets. Before the financial crisis of 2008, the market for real estate assets was highly fuelled by increasing household debt.198 Securitisation had lowered the incentives of banks to screen 191  See Banks (2009) 10ff for the description and definition of these types of risks in the following paragraphs; see Hellwig (2009) 182 for the systemic character of those risks. For another description of liquidity risk, which lies in the instability created by banks ‘borrowing short’ and ‘lending long’, see McCormick (2010) 2 at 1.03, Hendricks et al (2006) 3–4, Pistor (2013) 318; also earlier Minsky (1992, 1980); Carruthers and Babb (2013) 96; Hellwig (2009) 172ff; for a description of the way in which banks make money through liabilities, see McLeay et al (2014). 192  The definitions of systemic risk are summarised in Kaufman and Scott (2003). Even though there is no agreement on the precise definition, nature and causes of systemic risk, all definitions conceptualise systemic risk with regard to the occurrence of shocks and their transmission through financial networks: see Acemoglu et al (2015) 564. 193  Hendricks (2006) 13–14. Systemic risk can be explained mainly by two theories. One focuses on the transmission of common shocks or chain reactions; the other focuses the interconnectedness with other markets: see Kaufman and Scott (2003) 372. 194  For example Allen and Gale (2005) argue that instability can be avoided if the inter-bank obligations are more equally distributed in financial networks. 195  Acemoglu et al (2015) 586 show that when larger shocks occur, the bilateral inter-bank contractual relationships cannot internalise financial network externality anymore. 196  Kaufman and Scott (2003) 375. 197  Hellwig (2009) 130, 168. 198  Mian & Sufi (2014), 82ff, 106ff.

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borrowers more carefully and encouraged irresponsible lending, because, in this way, individual default risk could be outsourced.199 As a consequence, banks could decrease their requirements for down payments (also based on an overly optimistic appreciation of future housing prices, leading to a second boom in housing), with the result that the number of very low, or even zero, down-payment mortgage agreements increased significantly.200 Through securitisation, credit expanded via a higher leverage of the financial system as a whole, which lowered lending standards and, as a consequence, enhanced fragility.201 Thus, securitisation enabled the asset market bubble, but also increased individual default risk. In addition, securitisation had made the banks’ recapitalisation policy dependent on the functioning of asset markets.202 When the first mortgage-borrowers started defaulting on their loans, their assets (the purchased homes) were liquidated. Lost confidence in the housing market lead to a downturn of the housing market, affecting in turn the quality of the mortgage-backed securities. The financial assets of banks and private investors who had purchased the mortgage-backed securities worsened. These events led the market to question the value of the securities and the solvency of the holding institutions. The housing market deteriorated, financial institutions were unable to access liquidity on the markets (liquidity risk), the markets deteriorated still more, and consumers started defaulting on their loans on a large scale (individual credit risk).203 Another example of a market risk concerns, second, the profound impact of a sharp depreciation of the domestic currency on foreign-currency borrowers.204 Foreign-currency loans were a widespread practice especially in eastern non-euro countries such as Hungary, Romania, Bulgaria and Latvia.205 The problem with these types of loans is that, while they provide an escape from high local interest rates, they expose households to significant exchange risk, since households in general do not have income in the foreign currency. Consequently, a sharp ­depreciation in the domestic currency can render borrowers unable to service their foreign-currency loans.206 This is precisely what happened in the last financial crisis,207 with grave consequences for private households. Now, who is vulnerable to these market risks? When looking at these interactions on financial markets, it becomes clear that borrowers who borrowed ‘into the bubble’—usually those with a high loan-to-value (LTV) ratio—and foreigncurrency borrowers are vulnerable to the risks on financial markets.

199 

ibid, 101ff with further references. Immergluck (2009) 69ff, 84ff. 201  Acemoglu et al (2015) 567 with further references. 202  Hellwig (2009) 133. 203  Because of these developments, the banks’ risk management has been criticised: see Hellwig (2009) 195–96. 204  Beckert (2012) 6. 205 Yeşin (2013) 220. See also country reports in Domurath et al (2014). 206 Yeşin (2013) 222. 207  See country reports in Domurath et al (2014). 200 

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First, borrowers who borrow in times of a housing price bubble are the ones especially affected by the interactions between housing and credit bubbles, because they incur the risk of the interactions between housing and credit markets. These bubble borrowers, as we will call them, are borrowers with a high LTV ratio. A high LTV residential real estate loan is a credit secured by owner-occupied property that equals or exceeds 90 per cent of the real estate’s appraised value.208 Bubble borrowers are especially reliant on the appreciation of housing value: during the housing bubble, when the value of their property was considered high, these borrowers can extend their credit accordingly. This also happened in the last financial crisis. In the years before 2008 the LTV ratio increased.209 However, a high LTV ratio is associated with larger numbers of default and increased severity of losses.210 The increase in the numbers of defaulters is caused by a lowering of lending standards, which implies lending to more borrowers who might not have been given a loan previously. The severity of losses is based on inadequate collateral, because, should a borrower default on her loan, the net sales proceeds will most likely not be enough to cover the outstanding amount.211 This means that the vulnerability to welfare losses of consumers with high LTV loans unfolds at two levels: first, it increases the risk of default and overindebtedness; and second, it increases the risk of further welfare losses when ownership of the residential property is lost. Second, foreign-currency borrowers are vulnerable to financial market risks, because they incur the risk of changing exchange rates. Foreign-currency borrowing and lending are both supply- and demand-driven: not only do borrowers try to benefit from lower interest rates, but banks are eager to match the currency structure of their assets and liabilities.212 While this might be a profitable transaction for both contracting parties in times of stable exchange rates, borrowers with little financial means might not be able to cope with a rise in interest rates, finding themselves unable to service their rising debt burdens. Their riskiness for borrowers stems from the mechanism that favours the lender and overcharges the borrower if the foreign currency appreciates relative to the national currency, so that the average value of the former increases.213 Should the foreign currency appreciate, the borrower effectively has to repay a higher amount in national currency than the original amount received. As a consequence, borrowers might be unable to deal with the associated higher costs of credit.214

208 

Rushton et al (1999) 1. See Demyanyk and Van Hemert (2011). 210  Rushton et al (1999) 2. 211 Evidence from Spain, in particular, highlights this problem, see Gutiérrez de Cabiedes and ­Cantero Gamito (2015). 212  Brown et al (2010) have assembled evidence in this regard from an examination of the currency denomination of loans extended to small firms by a Bulgarian bank. 213  Dellacasa (2015) 154. Conversely, the borrower benefits from the mechanisms if the value of the foreign currency decreases relative to the national currency, because in that case the borrower pays a lower amount in national currency than the original amount received. 214  Méndez-Pinedo and Domurath (2015), Józon (2015), Andresan-Grigorio and Moraru (2015). 209 

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The riskiness of this type of loan is evidenced in the observation that, in the aftermath of the financial crisis of 2008, foreign-currency borrowers became more indebted than borrowers with loans in the national currency.215 In 2011, more than 60 per cent of the outstanding loans in Hungary, Romania and Bulgaria were foreign-currency loans. In Iceland, the judicial and regulatory aftermath of the financial crisis concerned almost exclusively the recalculation of both foreign-­currency and, as an Iceland speciality, price-indexed loans.216 Contracting mortgage debt in a foreign currency was a widespread practice before the financial crisis in those countries with small local currencies.

(iii)  Lack of Resilience Third, if borrowers are not able to absorb any changes in their financial capabilities, the danger of default increases. This dimension of consumer vulnerability relates to a lack of resilience to respond to any negative impact on their finances. This vulnerability is largely disregarded in studies and contributions dealing with vulnerability in general and vulnerability on financial markets. By focusing on the behaviour of actors—both consumers and financial service providers— those studies by and large neglect that there are also consumers who could suffer from welfare losses through default and the ensuing spiral of overindebtedness, without being subject to relational or event vulnerability. Even employed consumers might not have enough income or other sources of wealth to navigate their personal finances through times of financial distress. Conversely, unemployed consumers might have enough wealth to absorb possible shocks to their personal finances. In general, low income or poverty is considered to be the main contributor to the lack of resilience—what Cartwright calls impact vulnerability.217 However, what is valid in the field of financial services in general must be qualified in the field of housing. Here, the lack of resilience must be connected with the net worth of the mortgagors.218 Net worth is generally lower for the poorest homeowners, since they are the ones who rely more on home equity. Research from the US mortgage crisis shows that the highly levered poorest households—the ones with very little home equity and no financial assets—were also the ones that were worst hit by the recession.219 This lack of resilience of low-net-worth consumers is not surprising when we consider that the exposure of larger consumer groups to the financial market through the expansion of credit has not only included them in a financial system 215 

Méndez-Pinedo and Domurath (2015), Józon (2015), Andresan-Grigorio and Moraru (2015). For the special Icelandic case, see Méndez-Pinedo (2015). 217  Cartwright (2015) 124. 218  Net worth is made up of an individual’s assets minus her liabilities and the assets can comprise both financial assets such as bonds, stocks or savings accounts as well as housing assets, see www. financial-dictionary.thefreedictionary.com/Net+worth. 219  Mian and Sufi (2014) 22–23. 216 

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but has also exposed them to the risks inherent in that system. While this might not be a problem in times of a stable economy with rising housing prices and low inflation, a chain of adverse events following an economic downtown can lead to the realisation of many different risk factors, such as income instability of precarious workers. In this event, consumers without any or very little net worth are not able to escape from financial difficulties because they do not have a financial nest egg to fall back on in times of reduced income. When they sign the loan agreement, they depend on a stable source of income to cover the monthly instalments.

(iv)  Overview of Vulnerabilities Summarising our findings on vulnerability, the following picture emerges. Relational vulnerability describes the exposure of consumers to internal risk factors for default. More particularly it concerns: the unequal bargaining power of most consumers, which make them vulnerable to unfavourable contract conditions; consumers with low levels of education, who because of their increased cognitive biases, might enter into unfavourable agreements; and marginal consumers, who are under financial pressures because they are excluded from mainstream financial markets. Event vulnerability relates to the vulnerability of precarious workers, bubble borrowers and foreign-currency borrowers to respond to the external risk factors of income instability, systemic risks on housing finance markets, and a rise in exchange rates, respectively. Finally, the lack of resilience is the third category of vulnerability. It reflects how consumers with low net worth have insufficient resilience to withstand any shock to their finances, no matter if those relate to internal or external risk factors for default. Table 2.1 illustrates these three types of vulnerability. These types of vulnerabilities to certain risks are sure to interact, even though different studies point in different directions.220 The internal risk factors for default and overindebtedness, such as irresponsible lending and borrowing practices, tend to correlate with lower-income households, less education and higher rates of unemployment, which in the end links social class with individual characteristics and a higher risk of overindebtedness. A different reason for the correlation between low income and overindebtedness can be found in the lack of margin for error of low-income consumers—due to their lack of time, scarcity of money, unpredictable circumstances and lack of buffers. The former account emphasises behavioural issues; the latter highlights the structural context of vulnerability. We can conclude that default is the result of a complex process and interactions of different factors arising from both the behaviour of the consumer herself (internal risk and relational vulnerability) and the risks involved in financial transactions embedded in global financial markets (external risk factors and event vulnerability). Individuals are not only subject to the ‘traditional’ credit or default

220 

Ramsay (2016) 177–78 with further references.

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Table 2.1:  Vulnerability of mortgagors Risk dimension Internal/ behavioural

Risk factors Lack of information/ understanding

Vulnerable consumers Structuralinformational weakness of all consumers

Type of vulnerability Relational Lack of vulnerability resilience of low-net-worthconsumers

Consumers with low levels of education

External

Irresponsible lending/ borrowing

Marginal borrowers (financially excluded)

Income instability

Precarious workers

Financial market risks

Bubble borrowers (high LTV ratio)

Event vulnerability

Foreign-currency borrowers

risk in their contractual relationship with the bank, but are also exposed to market risks lying beyond the contractual realm. Hence, each individual suffers from the combined effect of different risk elements that interplay as part of the systemic risk on global financial markets. In the increasingly entrepreneurial understanding of risk and uncertainty (individuals assume and are responsible for managing those risks, whether internal or external) we have to consider that even if none of these single risks is alarming, the sum of them may be very well.221 Taking a more macro view, Shiller has claimed: ‘Even if the total risk to a nation could be considered tolerable, if borne individually by all people within a nation, the total risks that each individual faces are much larger.’222

V. Conclusions In this chapter we have constructed the claim that the privatisation of welfare leads to welfare losses for vulnerable mortgagors. We have done this by explaining the decreasing role of public, state-provided welfare vis-à-vis privatised welfare. In the field of housing, we have seen that the disengagement of welfare states

221  222 

Shiller (2003) 61. ibid, 65.

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with ­housing lead to a promotion of private home ownership. Home ownership rates rose accordingly. This development went hand in hand with an expansion of mortgage credit to more and more segments of society. In the USA, ­securitisation enabled a widespread and fallacious outsourcing of risks that incentivised ­irresponsible lending and borrowing practices. To a smaller extent and without a large securitised mortgage market, Europe followed suit by expanding credit to more and more consumers, fuelling asset bubbles in many European countries. The connectedness of global financial markets led to a contagion and transmission of risks throughout these markets. Access to housing plays an important role in the system of privatised welfare, because it lies at the core of the ideology of financial and social inclusion, which is premised on the assumption that including citizens financially as consumers (eg through the expansion of credit) can lead to social inclusion (eg through the acquisition of a private home with that credit). However, we have established that social inclusion (access to housing) does not necessarily result from financial inclusion (access to mortgage credit). The current political economy, in which individuals are supposed to take on more responsibility for their own welfare, implies that consumers take on more of the risks that exist on the markets on which they are supposed to find their welfare services. As a consequence, the risk of welfare losses also becomes individualised and is placed on the shoulders of the individual. As the financial crisis has shown, this is especially true in the field of housing and mortgage borrowing. It is the mortgage borrower, the homeowner, who absorbs the whole loss of a possible drop in housing prices, whereas the mortgage lender is protected. This is because the mortgage borrower has to sell the house at a loss, while the claim of the mortgage lender against the borrower remains the same.223 As a result, this means that consumers cannot fulfil the responsible role they are allotted. Not all mortgagors are equally affected by a materialisation of risks. In line with the ideology of individual responsibility for individual debt, welfare losses are not distributed evenly throughout society. Using the risk of default as a proxy for the risk of a welfare loss, we have seen that a nuanced picture of vulnerability emerges. When we take into account different risk factors for default, both internal and external ones, it becomes clear that the current focus of the literature on the general weakness of consumer vis-à-vis the professional and on the vulnerability of marginal consumers and consumer with low levels of education is indeed correct, but is only one part of the whole picture. The vulnerability of consumers to welfare losses in the field of housing encompasses their exposure to risks on globalised financial markets, such as income instability or the systemic risks that lie in bubble or foreign-currency borrowing. In the end, we can derive an understanding of vulnerability that spans relational vulnerability (structural-­informational weakness, low education, marginality), event vulnerability (vulnerability of ­consumers

223 

This ‘harshness of debt’ is powerfully demonstrated by Mian and Sufi (2014) 18.

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to adverse events external to the contract, such as the vulnerability of precarious workers to income instability, the vulnerability of bubble borrowers to a rise in housing prices, and the vulnerability of foreign-currency borrowers to worsening exchange rates), and lack of resilience in terms of low net worth that inhibits consumers from absorbing financial losses. Each of these dimensions of vulnerability needs to be taken into account if mortgage law is to fulfil not only its double purpose in the EU of serving the internal market and securing a high level of consumer protection but also its function as law in a society. This emphasises another paradox of financial and social inclusion, namely the observation that financial inclusion must necessarily include social protection.224 If vulnerable consumers are in danger of social exclusion because of both their exclusion from and their inclusion into the mainstream financial market by exposing them either to ‘exploitative’ credit or the danger of a spiral of overindebtedness, then ways have to be found to include such vulnerable consumers in the financial market while interrupting the chain of events leading to default, overindebtedness and social exclusion. As Shiller puts it, the ‘democratisation of finance’ does not just imply access to financial products, but access to sound financial products based on an understanding of the risk inherent in real estate, so that the benefits of financial innovation can be extended to more and more consumers.225 The call for sound financial practices for the benefit of a larger sector of society implies the need for a protective design for access to financial products.

224  225 

Micklitz (2010). Shiller (2008) 20ff.

3 Vulnerability in EU Mortgage Contract Law I. Introduction Having established the multifaceted concept of vulnerability in the field of ­housing and mortgage credit, we shall now analyse to what extent the different vulnerabilities of consumers are acknowledged in the EU legal framework. Using the multifaceted concept of vulnerability established in Chapter 2, we will see that there are gaps in the framework that inhibit its protective possibilities, especially with regard to event vulnerability and a lack of resilience. Special attention is given to the case law of the CJEU, which has been confronted with an impressive number of crucial cases, many of them from Spain and countries in which foreign-currency borrowing was widespread. The CJEU frequently shows social awareness when assessing the possible unfairness of credit or mortgage contract terms. This assessment of unfairness will be critically examined from the viewpoint of the prevention of default in order to identify the potentials and pitfalls of such an approach.

II.  Vulnerability in EU Mortgage Contract Law In this section, we will go deeper into the EU legal framework to see how relational vulnerability, event vulnerability, and the lack of resilience are addressed with ­protective rules in the EU legal framework. In order to assess the EU rules, we will first look into the pertinent legislation and case law and identify and describe the provisions that form the legal approach to address relational vulnerability.

A.  Relational Vulnerability We have seen how the relational vulnerability of consumers relates to consumers’ diminished bargaining power as a structural-informational weakness, low levels of education and marginality. This vulnerability, stemming from the relation

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between consumers as borrowers versus professionals as lenders, is the main type of vulnerability acknowledged in the EU legal framework. It is reflected in a triad of sets of rules that aim at remedying these vulnerabilities: information, education and the control of contractual fairness.

(i)  The European Model Consumer EU legislation pertinent to the field of consumer protection proceeds from the assumption that consumers are the weaker parties in contractual relationships with professionals, be it sellers or lenders. At the same time, this weakness is not considered to make consumers generally vulnerable. Vulnerable consumers only form a back-up category of consumers who are not the primary focus of EU legislation. (a)  Reasonably Circumspect but Weak Consumer The ‘weakness’ of consumers vis-à-vis professionals is often referred to in the ­literature and case law.1 The CJEU has made it clear on several occasions that the weak position of consumers derives from both their bargaining power and their level of knowledge.2 Bargaining power is usually inhibited because of the use of standardised contracts3 that are presented to consumers on a take-it-or-leave-it basis and impede their control over the bargaining process, thus depriving the weaker party of its freedom of contract.4 As a consequence, consumers in need of goods and services are not in a position to shop around for better quality or different contract terms.5 In that regard, limitations to the freedom of contract of both the ‘stronger’ professional party and the consumer as the ‘weaker’ party are considered justified.6 EU rules interfere with freedom of contract via information requirements and through the control of standard contract terms with a view to ensuring fairness in the bargaining process. The weakness of the consumer vis-à-vis the professional is embedded in the normative model-view of the reasonably circumspect consumer. Since the famous Mars case,7 the model consumer is supposed to be autonomous, self-reliant and

1 For example: Micklitz (2004), Hartlief (2004), Wilhelmsson (2004a), see also Basedow et al (2011) 405. 2  For example in C-137/08 VB Pezügji Lizing Zrt v Ferenc Schneider, ECLI:EU:C:2010:659, paras 27, 46; C-472/10 Nemzeti Fogyasztóvédelmi Hatóság v Invitel Távközlési Zrt (Invitel), ECLI:EU:C:2012:242, para 33. 3  For the common law system, see Kessler (1943) 632 pointing at the use of standardised terms or the monopolist position of the professional as a source of the consumer’s inability to shop around. 4  Thus concerning the DCFR, von Bar et al (2009) 67–68. Similarly, for the common law system and so-called contracts of adhesion, see Kessler (1943) 632, Becher (2008) 726. 5  Kessler (1943) 632 claims that this inability of the consumers derives from either a monopoly of the professional or because all competitors use the same clauses. 6  In this vein Hondius (2004) 246. 7 C-470/93 Verein gegen Unwesen in Handel und Gewerbe Köln eV v Mars GmbH, ECLI:EU:C:1995:224; the ‘reasonably circumspect consumer’ is mentioned in para 24.

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well informed. This consumer standard is not only the basis for the provision of information about the purchased products and services but also ensures the fairness of the bargaining situation. In addition, it is a normative tool for creating a consumer who needs less protection but is rather an active market participant who can make reasonable choices for and against products and services offered. It fulfils a twofold function: it is the goal and the benchmark for protection.8 The information model and the reasonably circumspect consumer standard are rooted in competition law and the aim of ensuring the free movement of goods.9 Commercial transactions are to be transparent in order to foster deregulation of the internal market because market liberalisation through competition is assumed to allocate production factors in an optimum manner.10 Thus, the EU is to ensure the free flow and transparency of information, a stance held firmly since the seminal Cassis ruling in which the CJEU stated that ‘greater transparency of commercial transactions’ could be achieved by providing suitable information to the purchaser.11 With the help of the information provided, the reasonably circumspect European consumer is then to make her own choice about whether or not to buy the product in question. This reasoning was the starting point for extensive harmonising legislative EU activity in the field of consumer law in order to bring down barriers to trade on the internal market.12 Hence, consumer legislation is largely based on what is now Article 114 TFEU, which is concerned with the establishment and functioning of the internal market. However, connecting consumer law with internal market legislation only produces a side effect13 on consumer protection, since the famous Tobacco Advertising ruling of the CJEU made clear that the measures adopted on the basis of (now) Article 114 TFEU must have the genuine aim of improving the conditions of the internal market.14 In the light of this ruling, it is not surprising that the ‘high level of consumer protection’ as foreseen in ­Article 169(2) lit (a) TFEU for the regulation of the internal market becomes a ‘high and equivalent level’ (Preamble 7 MCP) or a ‘high common level of consumer protection (­Preamble 11 UCP). Preamble 43 MCD mentions the ‘high level of consumer protection’ without a reference or qualification through the words 8  Unberath and Johnston (2007) showed that the benchmark of protection afforded in CJEU case law is different depending on whether the Member States want to maintain or introduce stricter rules of consumer protection (more restrictive) or whether the CJEU interprets EU legislation (more protective). See generally Mak (2012a) 6, who contends that the concept is thus used as a mediating tool between EU law and national law. 9  See discussion Mak (2010) 4ff. 10  See, for example, the Second Commission 3­-year action plan 1993–95, ‘Placing the Single Market at the Service of European consumers’, COM(93) 378 final, Brussels 23.07.1993, points 2 and 5. 11 C-120/78 Rewe Zentral v Bundesmonopolverwaltung für Branntwein, ECLI:EU:C:1983:202 (Cassis de Dijon). 12  Concerning the interplay of negative and positive harmonisation, Unberath and Johnston (2007) 1239ff. 13  Smits (2006) 59. 14  C­-376/98 Federal Republic of Germany v European Parliament and Council of the European Union, ECLI:EU:C:2000:54.

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common or equivalent but bases this level of protection explicitly on the comparability of information. The rationale of competition on the internal market is highly visible here. The reasonably circumspect model-consumer in the EU is a creature of competition. Her protection is based on the assumption that her weakness vis-à-vis the professional derives mainly from two factors: her diminished bargaining power and lack of knowledge. Thus, consumer protection is also based on two main pillars: first, the information model according to which the lack of knowledge of the consumer shall be remedied and second, the unfairness regime that aims at addressing the diminished bargaining power of consumers. (b)  The Vulnerable Consumer Irrespective of the model-consumer who is reasonably well-informed and circumspect, there are a few references to vulnerable consumers in the background of the EU legal consumer framework. For example, the Commission Communication ‘European Consumer Agenda—Boosting Confidence and Growth’ mentions ­vulnerability within the context of social exclusion and the possibility of having access to essential goods and services.15 People with disabilities or reduced mobility, who face difficulties in accessing and understanding information and in finding appropriate products and services on the market, are considered vulnerable. Within the framework of financial and social inclusion, most of the additional references in legislation can be found in the framework for universal services. The reason for the acknowledgement of vulnerability in the field of universal services probably lies in their special nature and history. Universal services are services to which everyone should have access, irrespective of their economic, social or geographical situation, at an affordable price.16 They include services of both general economic interest, such as energy, postal services, transport; and of non-economic interest, such as health, education or social services.17 After World War II, the European states were the sole providers of these services and the receivers of those services were protected through public law principles such as equality, proportionality and the compulsory provision of such services.18 However, this changed with the implementation of the internal market programme. The fostering of competition and freedom of services on the internal market required the privatisation of the provision of universal services, and private companies came to be considered as being able to offer high-quality services at competitive prices. Since public law principles were no longer automatically applicable in this privatised setting,19 the states had to ensure that private operators accomplished 15 Commission Communication, ‘A European Consumer Agenda—Boosting Confidence and Growth’, COM(2012) 225 final, 22, point 3.2. 16  Commission White Paper on Services of General Interest, COM(2004) 374 final, 8. 17  ibid, 5. 18  Rott (2007) 50. 19  Rott (2005) 325.

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their public service mission. In order to compensate for the loss of the collective relationship between state-owned public service providers and citizens through privatisation,20 consumers were given the right to access such services by an obligation to contract for the service providers and the right to adequate prices. The right to access can be found, for example, in Article 20(2) Universal Services ­Directive 2002/22/EC,21 Article 3(3) Natural Gas Directive 2009/73/EC22 and Article 3(3) Electricity Directive 2009/72/EC.23 However, if universal services were unaffordable, access to such services would be merely theoretical.24 ­Therefore, price adequacy requirements are established on the national level—see Article 9(1) Telecommunications Universal Services Directive. Furthermore, universal services shall be supplied in a specified quantity—see Article 11 Telecommunications Universal Services Directive. The rationale of this universality approach lies in the consideration that through the privatisation of such services, certain consumers might be considered undesirable customers for private service companies. Exclusion of those customers must therefore be prevented. In this vein Article 3(3) Natural Gas Directive 2009/73/EC emphasises the protection of end-user customers in remote areas who are connected to the gas system and to appoint a supplier of last resort. Similarly, Directive 2009/72/EC concerning common rules for the internal market in electricity suggests that energy poverty is a parameter for vulnerability in the electricity sector (Preamble (7)). This approach makes prevention of exclusion of ‘vulnerable social groups or regions’ also part of the general EU programme to ensure territorial and social cohesion.25 References to vulnerability can also be found in the new Directive on payment accounts.26 The approach of Directive 2014/92/EU towards vulnerable consumers is based on the idea of financial inclusion. It refers to ‘vulnerable consumers’ on several occasions. For example, Preamble 46 mentions the need to financially include unbanked, vulnerable consumers. To this end, Article 18(4) allows credit institutions to apply different pricing schemes that can be more advantageous

20 

Thus Micklitz (2009b) 12ff. Directive 2002/22/EC of the European Parliament and of the Council of 7 March 2002 on universal service and users’ rights relating to electronic communications networks and services (Universal Service Directive), [2002] OJ L108, 51. 22  Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC, [2009] OJ L211, 94. 23  Directive 2009/72/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in electricity and repealing Directive 2003/54/EC, [2009] OJ L211, 55. 24  Rott (2007) 56. 25  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, White Paper on services of general interest, COM(2004) 374 final, Brussels, 12.5.2004, 8. 26  Directive 2014/92/EU of the European Parliament and of the Council of 23 July 2014 on the comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features, [2014] OJ L257, 214. 21 

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for ‘unbanked vulnerable consumers’. Respective information on the available options is the backbone of this provision. Furthermore, ‘most vulnerable consumers’ in the Member States are to be educated (Preamble 49). Preamble 54 and Article 48(1) lit (j) stipulate that the review of the Directive shall also assess how financial inclusion can be increased and ‘vulnerable members of society’ can be assisted in relation to overindebtedness. It is worth noting that the Directive also refers to refugees and the homeless, acknowledging their difficulties in opening a bank account without legitimate papers or a residential address.27

(ii)  Weak Consumers The main approach of the EU Directives in the field of consumer and mortgage credit for the remedying of relational vulnerability is the provision of information by the lender to the consumer/borrower. Ensuring the fairness of standard terms and the financial education of consumers are supposed to enable the functioning of information obligations. Taken together, these measures primarily aim at fostering competition on the internal market and at fulfilling the normative Leitbild of the reasonably circumspect consumer, but also serve to remedy relational vulnerability in the form of structural-informational weakness of all consumers. (a)  Information Obligations for Lenders Article 11 MCD deals with advertising as the first contact between lender and borrower. In parallel to the provision in Article 4 CCD, suppliers of mortgage credit must provide information of the borrowing rate, the total amount of credit, the annual percentage of rate (APR), the duration of the credit agreement, the total amount payable by the consumer, and the amount and number of instalments. As regards the provision of other general and precontractual information, Article 14 MCD demands the provision of personalised information without undue delay and in good time before the consumer is bound by the agreement. It also refers to the provision of information on the European Standardized Information Sheet (ESIS) in Annex II. The information to be provided goes beyond what is required by Articles 5 and 6 CCD, insofar as it relates to additional information concerning mortgage credit agreements in foreign currencies, requiring the calculation of a loss of 20 per cent of the value of the national currency of the borrower relative to the credit currency, see Point 3(3) and (4) ESIS, and the possibility of changing interest rates, Point 6(3) ESIS. Even after the contract has been signed, Article 27 MCD obliges the lender to inform the consumer about any changes in the borrowing rate before that change enters into force. In addition to the requirement to provide specific information about the credit agreement, the EU legal framework also addresses the issue of the transparency of information. Article 5 CCD and Article 14(3) MCD introduce the requirement of 27 

Concerning this issue in the German implementation of Directive 2014/92/EU, see Rott (2016).

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providing precontractual information in a standardised form, namely the Standard European Consumer Credit Information form (SECCI) in Annex II CCD. Standardisation is to enable consumers to compare different offers more easily. Both the CCD and MCD impose not only information obligations on the lender, but also the obligation to use accessible language when providing that information to the consumer. For example, they demand that the lender gives ‘adequate explanations’ to the consumer on the proposed credit agreement (Articles 5(6) CCD and 16 MCD). Hence, both the SECCI and the ESIS contain simpler language (‘This means …’ in the SECCI; both Forms address the consumer directly in ‘you’-form) than the legal terms in the Directives, acknowledging the difficulty consumers face in understanding financial and legal language.28 Similarly, Article 5 UCT requires that standard contractual terms must be ‘drafted in plain, intelligible language’. In this vein, the provision of information in an unclear, unintelligible, ambiguous or untimely manner is misleading, and thus an unfair commercial practice (Article 7(2) in conjunction with Article 5(4) lit (a) UCP). Coupling the information requirements with intelligibility requirements, the Directives also address the difficulties consumers may have in understanding the information provided. Concerning the inability to evaluate the consequences of indebtedness, the MCD—like the CCD—puts obligations on both the lender and the borrower with a view to achieving responsible lending and borrowing practices. Addressing, albeit incidentally, the consumer’s inability to evaluate the consequences of indebtedness, the CCD and MCD foresee certain warnings to the consumer. For instance, Articles 5(1) lit (m) and 10(2) lit (m) CCD state that both the precontractual and the contractual information, respectively, shall contain a warning regarding the consequences of missing payments. Preamble 26 CCD even states that the promotion of responsible lending practices could comprise warnings about the risks attached to default on payment and to overindebtedness. In terms of general warnings concerning the dangers of indebtedness, the MCD imposes the obligation on the lender to warn the borrower against the possible consequences of non-compliance with the financial commitment under the credit agreement (Article 13(1) lit (n)). Because of the minimum harmonisation character of the MCD, Member States can introduce further warning requirements—see Preamble 43 MCD. (b)  Economic Efficiency and Political Function of Information Provision The provision of information is the most important element of an economic ­justification of consumer policy.29 As is well known, its main goal is to remedy possible asymmetries in information. Different types of such information

28  29 

Preamble 41 MCD. See generally Rischkowsky and Döring (2008) 287, Schwartz and Wilde (1979).

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a­ symmetries are described in the economics literature.30 The asymmetry relevant to our purposes exists between lenders and borrowers: borrowers (eg retail investors or consumers) are less skilled in accessing relevant data and information and need a lot of time to look for these.31 In general, consumers are incapable of appropriately perceiving quality differences and are not willing to pay higher prices, which induces sellers to offer inferior products.32 Consumers might be prevented from making utility-maximising choices because they cannot fully evaluate the information concerning available options or because they are ignorant of elements of the set of options from which they must choose.33 The legal intervention to remedy information asymmetry is based on the wellknown Coase theorem, which holds that an optimal allocation of resources will occur in the absence of transaction costs.34 Thus, the reduction of information acquisition costs is the preferable solution to providing a legislative or judicial determination of the contractual terms, because it allows individuals to make their own informed and utility-maximising choices.35 The logic is that by arming investors with information, thus decreasing the transaction costs involved in obtaining the information, mandatory disclosure promotes informed decision-making, market integrity and efficiency.36 Once they are empowered with information, the argument goes, individuals can protect themselves against abuse, so that there is no need for the government to engage in more substantive regulation.37 In the EU, it is argued that the reasonably circumspect consumer can assess the quality and suitability of the products and services and choose from a range of offers on the internal market the one that satisfies his needs. In line with the information model, the objective is to enable consumers to compare the different offers available and to make an informed decision on whether to conclude a credit agreement or not—see Article 5(1), sentence 1 CCD and Article 14(1) MCD. The provision of specific necessary information and its standardisation is supposed to improve the comparability of information.38 This information model can be criticised from different viewpoints. In particular, research in behavioural economics questions the efficiency of information disclosure based on the rational actor model.39 It has been doubted to what extent 30  For example, there is an asymmetry between two lenders—the ‘home’ bank and other competitive banks—arising from the information monopoly of the home bank borrower’s lending behaviour and history: see Sharpe (1990) 1069–70. 31  Spindler (2011) 318–19 (an analysis for investor protection through the MiFID). 32  In a seminal article with a focus on the car market by Akerlof (1970). 33  Schwartz and Wilde (1979) 633–34. 34  Coase (1960), demonstrating the problem with regard to liability for damages. 35  Schwartz and Wilde (1979) 635. 36  Paredes (2003) 418; see also Spindler (2011) 317. 37  For securities regulation, see Paredes (2003) 418, who, however, criticizes the information model from the viewpoint of information overload for retail investors. 38  See European Commission White Paper on the Integration of EU Mortgage Credit Markets, COM(2007) 807 final, Brussels, 18.12.2007, 6–7. 39  Studies in the field of behavioural economics are not undisputed. The most common criticism concerns the narrow scope of applicability of the very context-specific behavioural economics s­ tudies

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consumers respond to the removal of information asymmetry. The last financial crisis has proven that individuals do not behave in the rational way assumed by classical economic approaches.40 Cognitive limitations lead to individuals overestimating their financial capabilities and underestimating the likelihood of adverse events that affect those capabilities. As a result, the effects of disclosure on consumer behaviour are rather modest, and, what is more, might be limited to higherincome groups.41 Another criticism concerns so-called information overload.42 Because of bounded rationality, people cannot process infinite information, which leads to a diminished quality of decisions when the information level reaches a certain point.43 This even holds true for experts.44 In the end, information overload can lead to increased transaction costs and make the provision of information ­counterproductive.45 One can argue, however, that the standardisation of information in the field of consumer and mortgage credit in the EU legal framework aims at preventing such information overload. The SECCI of the CCD and the ESIS of the MCD focus on 6 and 15 types of information, respectively. This does not amount to the hundreds of pages of information that is usually alluded to when talking about information overload. Thus, consumers might actually be put into a position in which they will be able to compare significant information pertaining to credit. Whether they understand the impact of the agreement on their financial situation in general is another question; but the focus of standardisation on a few crucial points is considered here to be able to counteract information overload. In conclusion, we can say that the provision of information is an important approach to EU consumer legislation and policy. The availability of transparent information is arguably a basic feature of competitive markets. However, it has limitations with regard to how rational actors actually function. This does not

to particular consumer groups (Faure and Luth, 2011). Similarly, Levine (2009) claims that the field of application for behavioural economics is limited (eg to explaining group panics)—and that the ‘bulk of human behaviour’ can be adequately explained by the rational actor model (14)—thus arguing for a strengthened but only supportive role of behavioural economics (15). However, since the field of consumer protection is precisely a ‘limited’ field of application for behavioural economics and since in this field the relevance of behavioural insight is much less disputed, a decision on the suitability of behavioural economics does not have to made for our purposes. Concerning the critique from the field of economic sociology (eg Frerichs, 2011), which favours a contextualisation of different consumer ‘natures’ into a cultural environment, it can be said that this critique does not contradict the use of insights from behavioural economics as such. In general, one can argue that the criticism against behavioural economics can be taken seriously without rejecting its insights altogether (Faure and Luth, 2011). 40 

Most prominently in this regard the above-mentioned Jolls et al (2007). See Whitford (1973). 42  Paredes (2003) 440 in the field of securities regulation in the USA. 43  ibid, 441ff with further references. 44  This is so because of the pressure of accountability and overconfidence. Thus Paredes (2003) 453ff with references to pertinent studies. 45  Spindler (2011) 322. 41 

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mean that information should not be provided, but it should not be the only tool of consumer protection if the aim of preventing default and further welfare losses is to be taken seriously. This puts emphasis on other legal tools in the EU legal framework and their potential for preventing default and welfare losses.

(iii)  Consumers with Low Levels of Education How does the EU legal framework look with regard to the vulnerability of consumers with low levels of education? (a)  Preliminary Remarks on Financial Education The most obvious response would lie in an examination of EU activities in the field of financial education. Given the focus of this book on contract law, we shall not deepen the discussion. Only a few remarks shall be made. The fact that the EU only has supporting competence with regard to education (Article 6 lit (e) TEU). This has not prevented the European institutions from actively promoting financial education of consumers. Even though such education is not explicitly mentioned in the CCD, Article 6 MCD, entitled ‘Financial education of consumers’, obliges Member States to promote the education of consumers in the areas of responsible borrowing and debt management in general and in relation to mortgage credit agreements in particular. In a rather innovative approach, the MCD specifically mentions the role of education of consumers in relation to responsible borrowing and debt management.46 The Commission is committed to identifying best practices among the efforts made by Member States in this respect. Even before the financial crisis, the European Commission in its Communication on Financial Inclusion, which accompanied the White Paper on the Integration of EU Mortgage Markets,47 defined the basic principles of the provision of ‘high-quality financial education schemes’, supporting respective action in the Member States.48 Since the financial crisis, the Expert Group of the European Commission on Financial Education has been active in promoting the financial education of consumers as a key element of consumer protection.49 The initiatives are welcomed in the banking50 and general financial services industry,51 where consumer education is regarded as the necessary corollary to the provision on information requirements. Thus, it is considered that the role of financial literacy

46 

For example, Preamble 29 MCD. Commission White Paper on the Integration of EU Mortgage Credit Markets, COM(2007) 807 final, Brussels, 18.12.2007. 48  European Commission Communication on Financial Education, COM(2007) 808 final, Brussels, 18.12.2007, 7ff. 49  Expert Group on Financial Education (2009) 2. 50  For example, European Banking Federation (2015), which identifies and actively supports good practice among European countries. 51  See Eurofinas (2012). 47 European

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is not to be underestimated with regard to expanding the abilities of certain individuals to prevent (themselves from) overindebtedness. At the same time, criticism reveals the limitations of the informational approach as a whole and of rational and adaptive consumers in particular. ­Learning processes are not as rational as assumed. Furthermore, in the field of mortgages the learning possibilities are limited. More importantly, some groups of consumers may be deprived of the possibility to expand their abilities because of inequalities in access to the educational system. And even if the suitability of the financial literacy approach was accepted, the EU does not have competence in the field of education. (b)  Fairness of Commercial Practices The legal framework might be construed to impose an obligation of the lender to take into account the level of education of the consumer. Article 7 MCD states that lenders should take into account the rights and interests of consumers when ­offering or intermediating mortgage credit. Article 14 MCD talks of the ‘­personalised’ information to be provided to consumers. And Article 22(3) lit (c) MCD mentions as a standard for advisory services that intermediaries shall recommend a agreement ‘suitable’ for the ‘consumer’s needs, financial situation and personal circumstances’. However, neither the wording of the MCD provisions nor the MCD Preambles leave room for the interpretation that the personalisation of information must correspond to the financial literacy of the borrower. Article 14 MCD relates to the personalised information that is needed to compare different offers on the market; Article 22 MCD explicitly mentions only the consumer’s needs coupled with her financial situation and personal circumstances. Inspection of Preamble 44 MCD makes clear that these personalisation efforts must correspond to the ‘preferences expressed by the consumer’. This interpretation is supported by the use of the ESIS. The use of standardised information is premised on the assumption that this information, and the way it is provided, is the information necessary to make a financial decision and is also comprehensible. The consumer who does not understand the standardised information is left alone with her decision. The UCP has a different approach. In its Article 5(3), the UCP refers to ‘­particularly vulnerable’ consumers and establishes that the (un)fairness of commercial practices which (are likely to) materially distort the economic behaviour of a ‘­particularly vulnerable’ and clearly identifiable group of consumers shall be assessed from the perspective of the average member of that group. Article 5(3) UCP also mentions certain parameters for the assessment of the vulnerability, namely mental or physical infirmity, age or credulity. Vulnerability based on these parameters derives from the comparison with the reasonably circumspect consumer in the sense that vulnerability derives from features that inhibit the consumer from acting in a reasonably circumspect way. Mental or physical infirmity, age or credulity makes the consumer in the EU legal order vulnerable to certain

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unfair commercial practices, because they are considered to be unable to understand fully the information or practices. Does vulnerability by virtue of mental and physical infirmity include a low level of education and financial literacy? In Buet, where the CJEU considered the greater risk of ‘ill-considered’ purchases, because the potential buyer with a low level of education was considered especially vulnerable in situations when the seller attempts to persuade her into purchasing by claiming that they might have better employment prospects after the use of the educational material.52 This means that the obligation of the professional to act fairly is higher vis-à-vis such vulnerable consumers53 because, in order to assess the likelihood of materially distorting the economic behaviour of consumers, the benchmark is not the average reasonably circumspect consumer, but the average consumer belonging to this group of vulnerable consumers. The application of this rationale is supported by the consideration that cognitive limitations influence the whole process of financial decision-making of consumers. It could, thus, be argued that consumers with low levels of education are especially vulnerable. This shows that the protection of vulnerable consumers inserts a socially oriented perspective into the legislative rationale. Nevertheless, an analogy between the UCP and the MCD as regards the protection of consumers with low levels of education cannot be supported by this case. Jurisprudence on the issue must be considered highly context specific. Whereas in Buet the CJEU clearly linked the low level of education with the sale of educational material, this link does not exist for vulnerable consumers in the context of a loan application, because access to financial products does not have anything to do with the desire of a consumer to catch up with her education. This mismatch between the product on the one hand and the poorly trained consumer on the other runs counter to the analogous application of the CJEU’s reasoning. There would be a similar mismatch with regard to the MCD and the goal of preventing default, as the latter is not with a direct vulnerability that derives directly from the desire to catch up. Hence, as a consequence, EU law does not (yet) allow a lack of financial literacy to influence the precontractual provision of information.

(iv)  Marginal Borrowers The information model in the MCD is complemented by the fairness regimes in the UCT and the UCP. This fairness regime applies, of course, to all consumers, vulnerable or not. But it can be especially used to target the vulnerability of marginal borrowers to exploitative credit practices. The UCP prohibits unfair commercial practices, misleading actions and omissions of material information, as well as aggressive or coercive practices 52  C­382/87 R Buet und SARL Educational Business Services v Ministère public, ECLI:EU:C:1989:198, para 13. 53  Duivenvoorde (2015) 17.

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(­Articles 5–9 UCP). The rationale of the CJEU in Buet could apply to the vulnerability of marginal borrowers to exploitative credit-granting practices. These consumers could be attempting to achieve a better financial position in order to be included into the financial mainstream market by entering into an exploitative credit agreement. Such practices could fall under Article 5(2) lit (b) UCP, according to which a commercial practice is unfair if it materially distorts or is likely to materially distort the economic behaviour of the average member of the group to which the commercial practice is directed. We can argue that an exploitative credit that is targeted at consumers who are financially excluded from the mainstream market is a commercial practice that is directed at marginal consumers as a particular group of consumers in the meaning of Article 5(2) lit (b) UCP.54 It would then be considered unfair under the UCP if it materially distorted or was likely to materially distort the economic behaviour of the marginal consumer. If there were no such effect, however, for example if the process of credit granting was transparent and the consumer knew what type of contract she was entering into and what the economic consequences for her would be, the practice would not be prohibited under Article 5(2) UCP. This means that in cases in which the consumer does not feel pressured or otherwise influenced by the lender but signs an exploitative credit contract because of another kind of personal pressure to obtain financial resources because there are no other alternatives, Article 5(2) UCP would not apply either. There is considerable uncertainty involved in the assessment of the commercial practice’s effect on the behaviour of the consumer. The UCT, in turn, underlines that the consumer shall not be bound by unfair standard terms, Article 6(1) UCT and that the continued use of unfair terms should be prevented, Article 7(1) UCT. The fairness of contractual terms is assessed through the courts based on Article 3(1) UCT, according to which a standard clause is to be considered unfair if it causes a significant imbalance in the rights and obligations of the contractual parties, to the detriment of the consumer, in violation of good faith. Article 3(3) UCT refers to a non-exhaustive blacklist provided in the Annex. In general, it is for the national courts to decide upon the unfairness of a term.55 The CJEU does not have the competence to decide certain substantive issues directly. Nevertheless, the CJEU has exercised an important regulatory role by, first, applying the non-exhaustive blacklist provided in the Annex of the UCT, Article 3(3), and developing it further, and, second, by encroaching upon the procedural autonomy of the Member States.56 It has done so by focusing on the adequate and effective protection of consumer rights through procedure. It has

54 

Thus Rott (2014a) 689. Freiburger Kommunalbauten GmbH Baugesellschaft and Co KG v Ludger Hofstetter and Ulrike Hofstetter, ECLI:EU:C:2004:209, para 24. 56 Gerstenberg (2015) 602. Procedural autonomy of the Member States in the absence of harmonisation was for example determined in C-33/76 Rewe-Zentralfinanz eG and Rewe-Zentral AG v ­Landwirtschaftskammer für das Saarland, ECLI:EU:C:1976:188, para5. 55 C-237/02

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even connected this procedural consumer protection with procedural equality as enshrined in Article 47 of the Charter of Fundamental Rights.57 (a)  Fairness of Contract First of all, the CJEU has developed criteria for the assessment of unfair terms. Most prominently, in Océano, the CJEU even decided itself on the unfairness, ruling that a standard clause that conferred jurisdiction on the courts at the professional’s place of business was unfair, as it caused a ‘significant imbalance in the parties’ rights and obligation arising under the contract, to the detriment of the consumer.58 However, so far this judgment has remained an anomaly in the jurisprudence of the CJEU, based on the consideration that the jurisdiction clause was evidently unfair as it undermined the effectiveness of the consumer’s rights.59 The Court subsequently reiterated that Article 234 TFEU only confers the competence to interpret general criteria used to define the concept of unfair terms, which excludes the application of these criteria to particular terms, and that it is thus for the national court to rule on the fairness of terms based on the particular facts of case.60 Developing an approach that falls in between full and no control of Océano and Freiburger Kommunalbauten61 respectively, the CJEU has given guidelines to the national courts as to the possible unfairness of terms. In general, a term is deemed unfair, contrary to good faith, if it causes a ‘significant imbalance’ in the rights and obligations of the parties to the detriment of the consumer.62 With regard to the ‘significant imbalance’, the national default rules which would apply in the absence of an agreement must be taken into account in order to assess whether the contract places the consumer into a favourable position or not in comparison with those rules.63 In addition, Article 4(1) UCT requires account be taken of the nature of the goods and services for which the contract was concluded and all the circumstances at the time of the contract conclusion.64 For example, in Aziz, the CJEU also had to decide, inter alia, whether a so-called acceleration clause, according to which the bank can automatically recall the whole outstanding amount of the loan after only one missed monthly instalment, is unfair. In the

57 C-169/14 Sánchez Morcillo and Abril García v Banco Bilbao, paras 48ff, where the CJEU ruled that the post-Aziz Spanish procedural law allowing banks, but not debtors, to appeal the staying of proceedings, gave an unjustified advantage of the bank vis-à-vis the homeowner and thus violated the principle of procedural equality. 58  Joined Cases Océano Grupo Editorial SA v Rocío Murciano Quintero (C-240/98), Salvat ­Editores SA v José M Sánchez Alcón Pradės (C-241/98), José Luis Copano Badillo (C-242/98), Mohammed ­Berroane (C-243/98) and Emilio Viñas Feliú (C-244/98) (Océano), ECLI:EU:C:2000:346, para 24. 59 C-237/03 Freiburger Kommunalbauten, ECLI:EU:C:2004:209, para 23. 60 C-237/03 Freiburger Kommunalbauten, ECLI:EU:C:2004:209, paras 23–25; Case C-472/10 Nemzeti Fogyasztóvédelmi Hatóság v Invitel Távközlési Zrt, ECLI:EU:C:2012:242, paras 25–26; 61  Micklitz (2013a) 643. 62  For example C-415/11 Aziz v Catalunyacaixa, para 73. 63  C-415/11 (Aziz) para 68. For a critique, see Méndez-Pinedo (2015) 85. 64  C-415/11 (Aziz) para 71, based on Pannon, para 39, Pénzygi Lízing, para 42, Freiburger Kommunalbauten, para 21, and C-76/10, Pohotovost’ sro v Iveta Korčkovská, ECLI:EU:C:2010:685, para 59.

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guidance it gave the referring court, the CJEU focused on the balancing of rights and obligations with a view to determining ‘good faith’ and ‘significant imbalance’ of Article 3(1) UCT in two ways: first, the national court would have to establish whether the acceleration clause puts the consumer in a legal situation less favourable than that provided for by the national law in force;65 second, the national court shall then asses whether the imbalance is ‘contrary to the requirement of good faith’ by establishing whether it could be reasonably assumed that the consumer would have agreed to such a term in individual negotiation.66 The CJEU gave more detailed guidance to the national courts, which shows that it demands an overall and contextual assessment and balancing.67 A significant number of cases has reached the CJEU concerning the scope of the exemption in Article 4(2) UCT, according to which the fairness assessment does not cover the ‘main subject matter of the contract’ or the assessment of the price and remuneration. The exclusion of the review of the quality–price ratio of the good or service in question lies in the problems involved in finding legal or mathematical criteria that can provide a guiding framework for such a review.68 In Invitel, the CJEU held that this exemption does not apply to a term setting out a mechanism for price changes.69 The CJEU was more reserved in Kásler, where it delegated the assessment of whether a clause pursuant to which the selling rate of exchange of a foreign currency is applied in order to calculate the repayment ­instalments for the loan lays down an essential obligation of the underlying contract.70 The exemption of Article 4(2) UCT only applies to the extent that the terms in question are in ‘plain intelligible language’. This was confirmed by the CJEU, ruling that the requirement of ‘plain, intelligible language’ applies in all cases, including provisions that deal with the ‘main subject matter’ of the contract.71 This means that as long as contractual core terms are understandable in the broader sense, they are exempted from the unfairness assessment. Thus, from the viewpoint of the UCT it does not matter whether core terms are unfair or not as long as they are transparent. Therefore, the transparency of the information provided on the calculation of price is the factor that justifies the exclusion of the prize (as well as other core terms) from judicial fairness control—see Article 4(2) UCT.72 For example, the CJEU ruled that the lender’s failure to mention the APR in a plain,

65 

ibid, para 68. ibid, para 69. 67  Gerstenberg (2015) 605–06. 68 C‑26/13 Árpád Kásler Hajnalka Káslerné Rábai v OTP Jelzálogbank Zrt, ECLI:EU:C:2014:282, paras 54–55; Opinion of Advocate General Wahl delivered on 12 February 2014 in Case C‑26/13 Árpád Kásler Hajnalka Káslerné Rábai v OTP Jelzálogbank Zrt, ECLI:EU:C:2014:85, para 69. 69  C-472/10 (Invitel) para 23. 70  C-26/13 (Kásler) para 59. 71  ibid. Para 68. 72  Thus Willett (2012) 152ff. 66 

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intelligible language within the meaning of Article 4 UCT can also play a decisive role in the national court’s assessment of the fairness of the clause on the cost of credit.73 The national court must also consider whether the professional could reasonably assume that the consumer would have agreed to such a term in individual contract negotiations.74 Even though the assessment of intelligibility in terms of Article 4(2) UCT lies with the national court, the CJEU case law helps to discern a pattern of good faith that shall guide the fairness review.75 In a case concerning a clause in an insurance contract according to which coverage for the incapability to pay back a loan could be sought only in case the insured person found herself ‘unable to take up any activity paid or otherwise’ (Van Hove), the CJEU decided that a court assessing the unfairness of that clause must ascertain whether the consumer could understand the economic consequences of that clause based on precise, intelligible criteria.76 Similarly, in Invitel, the CJEU doubted the fairness of a unilateral price increase considering the ‘fundamental importance’ of the possibility for the consumer to foresee amendments of business terms regarding service fees because of clear and intelligible criteria.77 In Mattei, which concerned a unilateral price increase clause in a foreign-currency loan agreement, the CJEU connected its assessment to the grey list in paragraph 1 lit (j) of the UCT Annex, according to which unilateral price increase clauses may be declared unfair. Also with regard to foreign-currency loans, the CJEU ruled in Kásler that the requirement of transparency does not only include the intelligibility of the term for the consumer, but also that the specific functioning of the conversion mechanism must be set out in the contract so that the consumer can evaluate the economic consequences for her.78 This shows that the CJEU takes a rather literal view on the wording of Article 4(2) UCT, which states clearly that the exception of Article 4(2) UCT only concerns the adequacy of price and remuneration, but not other parts of the price. This interpretation is in line with the Report from the Commission of 27 April 2000 on the implementation of Council Directive 93/13, which makes clear that the terms laying down the manner of calculation and the procedures for altering the price remain entirely subject to the UCT.79 On the one hand,

73 C-76/10

Pohotovost’ sro v Iveta Korčkovská, ECLI:EU:C:2010:685, para 71. C-415/11 (Aziz) paras 69–70. 75  Micklitz and Reich (2014) 785ff detect elements of this ‘autonomous EU concept of unfairness’: transparency, value judgments taken from other secondary EU law, an indicative list, balancing of interest, and references to national law. 76 C-96/14 Jean-Claude Van Hove v CNP Assurances SA, ECLI:EU:C:2015:262, para 41. 77  C-472/10 (Invitel) para 28. The CJEU has also considered unfair unilateral price increase clauses for household gas supplies, which the supplier used without giving the consumer notice and information about the increase in good time before the increase, so that the consumer could not foresee the consequences of the change, C-92/11 RWE Vertrieb v Verbraucherzentrale NRW, ECLI:EU:C:2013:180, para 56. 78  C-26/13 (Kásler) ECLI:EU:C:2014:282, para 75. 79  Report from the Commission on the implementation of Council Directive 93/13/EEC of 5 April 1993 unfair terms in consumer contracts, COM(2000) 248 final, Brussels, 27.04.2000, 15. 74 

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therefore, transparency is a determining factor for fairness. It is evident that the CJEU considers the transparent and clear information about the consumer’s payment obligations within the meaning of the UCT vital for the consumer to assert his rights. On the other hand, it is notable that, for the CJEU, the consumers’ possibility to understand the economic consequences of a contract forms part of the transparency of its terms. The CJEU uses a narrow interpretation of the exception of Article 4 (2) UCT in order to allow the possibility for consumers to understand the financial implications of the contract. (b)  Fairness of Enforcement Mortgage cases have an especially important procedural dimension as being evicted from residential property leads to significant welfare losses, with default being only the first step down a spiral of overindebtedness. The CJEU has in its case law been sensitive to the social consequences of eviction and connected the possible unfairness of contract terms with the enforcement of mortgage agreements through the principle of effectiveness of EU law and the fundamental right to effective legal protection in Article 47 ChFR. In this way, the case law on the fairness of enforcement of mortgage contracts is located at the centre of the constitutionalisation process of private law. Effectiveness of EU Law Aziz is the most prominent example in a line of cases that have been decided under the influence of the principle of effectiveness. In that case, the CJEU ruled that Spanish procedural law violated the principle of effectiveness, because the borrower did not have a procedural remedy available to escape the consequences of an unfair clause. Because consumers are in a weaker position vis-à-vis the professional, Article 6(1) UCT provides that unfair terms are not binding on the consumer. Thus, its aim is to replace the formal balance between the contracting parties with an ‘effective’ balance.80 This is why national courts have to assert ex officio whether terms are unfair or grant interim relief such as a stay of enforcement procedures. Thus, in Aziz, the CJEU ruled that Spanish procedural law, which did not give courts the power to stay or terminate the mortgage enforcement proceedings, was contrary to the principle of effectiveness insofar as it makes it impossible or excessively difficult to apply the level of protection sought by the UCT.81 In the aftermath of the Aziz ruling, more requests for preliminary references were sent to the CJEU concerning the procedural rules in mortgage enforcement

80 See C-168/05 Elisa María Mostaza Claro v Centro Móvil Milenium SL, ECLI:EU:C:2006:675, para 36; C-40/08 Asturcom Telecomunicaciones SL v Cristina Rodríguez Nogueiras, ECLI:EU:C:2009:615, para 30; C‑137/08 VB Pénzügyi Lízing Zrt v Ferenc Schneider, ECLI:EU:C:2010:659, para 47; and C‑453/10 Jana Pereničová and Vladislav Perenič v SOS financ spol sro, ECLI:EU:C:2012:144, para 28; C-618/10 Banco Español de Crédito SA v Joaquín Calderón Camino, ECLI:EU:C:2012:349, para 40. 81  C-415/11 (Aziz) paras 59ff, 63.

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proceedings.82 For example, the CJEU ruled that a provision in the Spanish Law on Civil Procedure, according to which only the enforcing creditor (and not the debtor) can object to the staying of enforcement proceedings while the judgment on the unfairness of terms is pending, confers an unjustified advantage on the bank because it does not effectively protect the homeowner from unjustified eviction.83 Another provision was contested in Spanish procedural law, according to which a national court is required to adjust the due amounts under a mortgage agreement that provides for default interests at a rate more than three times higher than the statutory rate. The CJEU ruled that Article 6(1) UCT does not preclude such a provision, if it is without prejudice to the assessment by the national court of the unfairness of the term and if it does not prevent the court from removing the term in case it finds it ‘unfair’ within the meaning of Article 3(1) UCT.84 In order to ensure the effective protection of consumer rights, the CJEU has reiterated on many occasions that procedural rules concerning the breach of European rights and obligations must not be less favourable than those applicable to domestic situations (equivalence) and that they cannot in practice render impossible or excessively difficult the exercise of rights conferred by the EU legal order (effectiveness).85 Whereas the principle of equivalence has not been at the centre of attention, mainly because of the expertise and information of national courts making the comparison between European and national procedures and remedies, the principle of effectiveness has served as a gateway for intrusion into Member State autonomy. This is justified by the abuse of procedural autonomy by the Member States when they, for example, enact legislation contrary to EU law, disregard (and do not take steps to achieve) EU objectives, or allow private actors to abuse rights.86 Based on the principle of cooperation in Article 4(3) TFEU,87 the principle of effectiveness comprises a negative and a positive dimension.88 In its negative dimension, the principle of effectiveness prohibits Member State frameworks to

82  See, for example, Joined Cases C-482/13 Unicaja Banco, SA v José Hidalgo Rueda and Others, C-484/13 Caixabank SA v Manuel María Rueda Ledesma and Others, C-485/13 Caixabank SA v José Labella Crespo and Others, and C-487/13 Caixabank SA v Alberto Galán Luna and Others. 83 C-169/14 (Sánchez Morcillo) paras 49–51. 84 Joined Cases C-482/13, C-484/13, C-485/13 and C-487/13 Unicaja Banco and Caixabank, ECLI:EU:C:2014:2099, para 42. 85  See C‑168/05 (Mostaza Claro) para 24; C-40/08 (Asturcom) para 38; C-417/11 (Aziz) para 50; C-280/13 Barclays Bank SA v Sara Sánchez García, Alejandro Chacón Barrera, EU:C:2014:279, para 37. 86  Rott (2013b) 192–93. Rott has shown that the expectations and good faith of the parties matter in this regard: in cases in which parties relied on the possibility of non-enforcement or non-sanction for a breach, this expectation is not protected through the principle of effectiveness; when parties do not expect the existence of remedies or obligations, because the implementation of EU law has already been contested, the principle of legal certainty might limit the principle of effectiveness both for the CJEU and the national court. 87  Rott (2013b) 191 with references to Cases C-33/76 Rewe-Zentralfinanz eG und Rewe-Zentral AG gegen Landwirtschaftskammer für das Saarland, ECLI:EU:C:1976:188; C-45/76 Comet BV gegen ­Produktschap voor Siergewassen, ECLI:EU:C:1976:191; C-432/05 Unibet (London) Ltd und Unibet (International) Ltd gegen Justitiekanslern, ECLI:EU:C:2007:163. 88  Rott (2012) 66.

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render virtually impossible or excessively difficult the enforcement of individual rights. This characteristic has also been termed the ‘eliminatory function’ of the effectiveness principle.89 To that end, even though the CJEU has long held that EU law does not demand that new remedies be introduced into the national legal orders (the remedies provided for by national law for the breach of EU law are, however, subject to the principles of equivalence and effectiveness),90 the CJEU has surely responded to the lack of a harmonised system of EU remedies encroaching upon procedural autonomy of the Member States with regard to both procedural and material remedies. For protective purposes in the field of consumer law, the CJEU tends to intervene in a more invasive manner than in general EU law.91 For example, with regard to material remedies, the CJEU has a long-standing track record of encroaching on Member State competence to establish sanctions for the breach of obligations contained in European legislation. The CJEU has, also in the field of consumer credit law, confirmed that penalties put into place at ­Member State level have to be dissuasive in order to make the penalty efficient.92 The effectiveness of remedies is also the basis for the CJEU to rule on the availability of out-of-court dispute resolution mechanisms to be set up by the Member States. In Volksbank Romania, the CJEU ruled that Article 24(1) CCD obliges Member States to do so, however without making these mechanisms mandatory as long as the effectiveness of the consumer protection sought by the CCD is ensured.93 The protection of consumers through procedural remedies is visible in the case law on the information model and creditworthiness assessments (CWAs) as well as time limits. The CJEU has ruled that the burden of proof for complying with the obligation of the lender to provide information and undertake a CWA lie with the lender and cannot be shifted to the consumer through standard terms either, because it would deprive the consumer of the effectiveness of her rights.94 Even though it was for the national court to interpret provisions of national law, the CJEU submitted for consideration that consumers are not in a position to prove that the bank has not provided her with the necessary information or has not checked her creditworthiness.95 Another case concerned the changes in Spanish procedural law after Aziz, in which a transitional provision was introduced that

89 

Reich (2014) 91–92. Rewe-Handelsgesellschaft Nord mbH v Hauptzollamt Kiel, ECLI:EU:C:1981:163; C-432/05 Unibet Ltd v Justitiekanslern, ECLI:EU:C:2007:163, para 40 (however, in para 41, the CJEU indicated that EU law might intend to create new remedies in cases in which the overall scheme of the national legal protection does not provide a legal remedy in order to ensure respect for individual rights under EU law). 91  Trstenjak and Beysen (2011) 123. 92 C-565/12 LCL Le Crédit Lyonnais SA gegen Fesih Kalhan, ECLI:EU:C:2014:190, paras 52–53. 93 C-602/10 SC Volksbank România SA v Autoritatea Naţională pentru Protecţia Consumatorilor— Comisariatul Judeţean pentru Protecţia Consumatorilor Călăraşi (CJPC), ECLI:EU:C:2012:443, paras 94–95. 94 C-449/13 CA Consumer Finance v Bakkaus and Bonato, para 32. 95  ibid, para 27. 90 C-158/80

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establishes a time limit of one month within which to submit an extraordinary application objecting to enforcement based on the existence of new grounds for such opposition. The CJEU held that the time limit does not render ineffective the exercise of consumer rights, considering that it applies to the extraordinary situation that, in ongoing proceedings, the normal period of ten days has begun to run or has already expired.96 However, taking into account the ‘special features and complexity’ of mortgage enforcement proceedings, the CJEU held that consumers need to be personally informed about the possibility to raise new grounds of objection in enforcement proceedings which were already in progress before the entry into force of transitional law, if the provision is not to infringe the principle of effectiveness.97 Another way of limiting Member States’ procedural autonomy through considerations of effectiveness is to oblige national courts to examine ex officio the fairness of standard terms according to Article 3(1) UCT.98 Limiting the courts’ discretion in that regard,99 the CJEU considers this obligation a matter of the public interest rationale underlying the provisions of the UCT.100 In this way, the CJEU uses effectiveness as a means to put the consumer into a position of being able to exercise her rights under the UCT, irrespective of the fact whether she has, or has not, previously objected to the fairness of contractual terms. The argument holds that it is a matter of the effectiveness of the UCT that the declaration of unfairness of terms does not depend on the knowledge and/or respective activity of the consumer.101 As such, the ex officio doctrine conflicts with the principle of res judicata, because it can lead to the overturn of a previous arbitration award. Therefore, even in cases in which a consumer is in breach of a contractual obligation, the CJEU considers consumer protection and the need for a ‘fair ­market’ to override considerations of legal certainty and procedural justice, because the courts cannot be part of upholding illegality.102 Going beyond, in Aziz, the CJEU used the ex officio control of unfair terms as a (procedural) remedy that linked the enforcement proceedings of a mortgage agreement with the declaratory

96 C-8/14, BBVA SA v Pedro Peñalva López, Clara López Durán, Diego Fernández Gabarro, ECLI:EU:C:2014:2464, paras 30–31. 97  ibid, paras 39ff. 98 This power of the national courts was established in Joined Cases C-240/98 to C-244/98 (­Océano) para 26, but was later narrowed down to a duty to assess the fairness of terms, C-40/08 (Austurcom); also C-243/08 Pannon GSM Zrt v Erzsébet Sustikné Győrfi, ECLI:EU:C:2009:350, para 24. This ex officio obligation does not, however, apply to notaries (which became an issue particularly in Hungary and Spain): see Case C‑32/14, ERSTE Bank Hungary Zrt v Attila Sugár, ECLI:EU:C:2015:637, paras 57–65,. The CJEU has expanded the ex officio doctrine to the expiry of a limitation period, see C-473/00 Cofidis SA v Jean-Louis Fredout, ECLI:EU:C:2002:705. 99  Cafaggi and Law (2013) 671. 100  C‑168/05 (Mostaza Claro) EU:C:2006:675, para 38; C-472/10 (Invitel) para 41. 101  Rott (2013b) 193–94 with reference to Cofidis but also Heininger, in which doorstep credit providers relied on the expiry of the right of withdrawal without informing consumers of that right. 102  Hodges (2013) 622ff.

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proceedings concerning unfairness.103 In effect, the CJEU obliged national courts to grant interim relief as a matter of effectiveness of EU law.104 In its positive dimension, the principle of effectiveness imposes concrete ­obligations on Member States. As a ‘hermeneutical’ principle, effectiveness ensures that Member State courts provide remedies that are ‘sufficient’ to ensure the protection of rights granted by EU law.105 Article 7(1) UCT, for example, reads that Member States must ensure that unfair terms are not continuously used and ­Article 6(1) UCT obliges Member States to ensure that unfair terms are not binding on the consumer. In a line of cases, the CJEU concretised these positive obligations. With regard to Article 6(1) UCT, the CJEU ruled in Banco Espagnol that the national court is competent to exclude the application of the unfair terms,106 while in its Kásler decision it went further by allowing the national court to replace an unfair term with a provision of national law in order to avoid nullity of the whole contract, if the nullity would expose the consumer to ‘particularly unfavourable consequences’, in that case the falling due of the whole outstanding balance of the loan.107 This would amount to a penalisation of the consumer which would ­pre-empt the dissuasiveness of nullity as the legal consequence of unfairness.108 Thus, (only) if it is possible for the contract to continue existing without the unfair provisions, will it continue to be binding on the parties without the court ­replacing it. Irrespective of the Kásler judgment, which shows concern for a material fairness instead of being a purely formalistic interpretation of the UCT, the main reason for, generally, prohibiting the revision of contract terms through courts is that such a revision would disincentivise the drafter of standard terms to draft valid terms because she could count on the courts doing that work in case the terms do not uphold before court.109 In the Invitel case, the CJEU famously decided that the effects of an unfair term can also extend to consumers who were not party to the proceedings.110 The ­judgment thus penetrates into the collective dimension of consumer protection. The action was bought by the national consumer organisation in Hungary against a telephone provider who had inserted into its standard terms a provision ­concerning additional fees for payment through money order, without having set out the reason or method of calculation of those fees. The CJEU argued that the effective implementation of the objective of Article 7(1) UCT to prevent

103 

Micklitz (2013) 641. C-415/11 (Aziz) paras 63–64. 105  Reich (2014) 96–97. 106  C-618/10 (Banco Español) para 71. 107  C-26/13 (Kásler) paras 81ff. 108  ibid, paras 83–84. 109  See Hondius (2013) 629. 110  C-472/10 (Invitel) para 44. 104 

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the continued use of the unfair term requires that it is not binding either on the consumers who are parties to the respective action or on those who have concluded a contract with the same supplier under the same standard terms.111 As for out-of-court enforcement proceedings before a notary, the CJEU ruled that it does not infringe Article 7 UCT if the notary initiates enforcement without a control of fairness of the underlying terms, as it was possible for the consumer in that case to oppose the enforcement before a court.112 However, even though the Hungarian law in question was deemed to be in conformity with Articles 6(1) and 7(1) UCT because of the preventive role of notaries in the initial setting up of the contract, the CJEU also recognised the reluctance of consumers to challenge possibly unfair terms because of the trust that consumers place in notaries in their capacity as impartial advisors.113 The Impact of Fundamental Rights The use of procedural law as a means of asserting the effectiveness of EU law has put into the focus Article 47 ChFR for the resolution of mortgage enforcement conflicts. After the Aziz ruling, the Spanish legislator amended its civil procedure law such that the party opposing the mortgage enforcement proceedings could object to those proceedings on the ground that the contractual clause upon which the enforcement was based was unfair. However, the legislative amendment gave rise to new enforcement problems. In Banco Bilbao,114 the CJEU ruled that Article 695(4) of the Spanish Law on Civil Procedure, according to which a court could stay enforcement proceedings while a judgment on the possible unfairness of terms is pending, conveys an unjustified advantage to the bank at the expense of the homeowner, because the former can appeal against the staying of the proceedings whereas the latter does not have the right to do so. The Spanish Law on Civil Procedure was considered not to offer adequate and effective protection to homeowners in the sense of Article 7(1) UCT in conjunction with Article 47 ChFR, because the imbalance between the procedural rights available to the consumer on the hand and the lender on the other ‘simply accentuates the imbalance existing between the parties’ in terms of bargaining power and level of knowledge.115 This violation of the principle of procedural equality—the balance of arms in the enforcement of rights—jeopardises the effectiveness of the UCT.

111 

ibid, para 38. ERSTE Bank Hungary Zrt v Attila Sugár, para 49, following the opinion of AG Cruz Villalón, paras 65ff and 72. 113  ibid, para 54. 114 C-169/14, Juan Carlos Sánchez Morcillo and María del Carmen Abril García v Banco Bilbao Vizcaya Argentaria SA, ECLI:EU:C:2014:2099. 115  ibid, paras 46, 50–51. 112 C-32/14

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But Aziz also has a constitutional dimension. Even though in its judgment the CJEU did not directly refer to fundamental rights, principles or the ChFR, the Court was not oblivious to the constitutional and social dimension of the case. Without a direct reference to the ChFR and, for example, the right to housing mentioned in Article 34(3) thereof, the Court highlights the importance of a family home when assessing the effectiveness of compensation.116 In this regard, it followed Advocate General Kokott’s observation that: [W]here the mortgaged property is the debtor’s own home, a mere claim for damages … does not constitute effective protection against unfair terms if … a consumer is defenceless in accepting the realisation of a mortgage and thus the judicial auction of his home, the associated loss of ownership and eviction.117

Ramsay calls this an ‘embedding’ of credit markets through minimum ­standards.118 It has also been characterised as a ‘hidden’ constitutional ­weighing.119 The balancing of interests brings to light that losing one’s dwelling and running the risk of eviction is a serious threat that might rank higher than the interest in the repayment of a single loan.120 This approach reflects an impact of fundamental rights, which leads to a proportionality assessment of national procedural rules that restrict the right to effective judicial protection, thus changing from an ‘impossibility’ to a constitutional balancing of different rights and ­interests.121 This leads to a ‘hybridisation’ of remedies, meaning that the remedies rely both on the procedural autonomy of the Member States and the remedies found in national legal orders, on the one hand; and on the effectiveness principle in a broad reading of Article 47 ChFR as well as Article 19(1) TEU, on the other122 In fact, this leads to an upgrading of national remedies via the principle of consistent interpretation if the remedies are considered ‘insufficient’.123 (c)  Assessment of the Unfairness Regime Given the limitations of the information model, it is imperative to analyse the ­suitability of the unfairness regime in the EU legal order with regard to its potential to prevent default and further welfare losses of marginal borrowers in particular, but all mortgagors in general. It emerges that there are considerable limitations of the fairness regime in the EU legal framework, both with regard fairness control of contracts and their enforcement.

116 

C-415/11 (Aziz) paras 60–61. Opinion of AG Kokott delivered on 8 November 2012, ibid, para 52. 118  Ramsay (2016) 172. 119  Micklitz (2013a) 648ff. 120  ibid, 656. 121  Mak (2012) 12, with reference to the Alassini case: Joined Cases Rosalba Alassini v Telecom Italia SpA (C-317/08), Filomena Califano v Wind SpA (C-318/08), Lucia Anna Giorgia Iacono v Telecom Italia SpA (C-319/08) and Multiservice Srl v Telecom Italia SpA (C-320/08). 122  Reich (2014) 98–99. 123 ibid. 117 

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Limitations of the Material Fairness Control An important limitation follows from the rationale of the UCT. The text of the UCT itself and academic commentary make clear that the rationale of legislative intervention into unfair contract terms is based on internal market considerations. To this end, the UCT aims at remedying information asymmetries, unequal bargaining power and abuse of power by the professional. Another justification for the control of standard terms is invoked by behavioural economists: since consumers are cognitively biased and tend not to read contracts, standard terms are of low quality and biased towards the seller.124 As a consequence, consumers do not fulfil their role in terms of disciplining the market.125 Adopted on the basis of now Article 114 TFEU, Preamble 5 UCT makes clear that a lack of knowledge about contract law rules in other Member States may deter consumers from transactions on the internal market. In addition, Preamble 6 UCT clearly states that the goal of the UCT is to facilitate the internal market by removing unfair contract terms, acknowledging that professionals can abuse their power by using standard contracts and even exclude consumer rights—see Preambles 8 and 9 UCT. Consequently, the academic literature claims that the rationale of the unfairness regime lies in information economics and that the unfairness regime forms part of the legal intervention based on economic assumptions to enable consumers not only to make the optimal choice but also to protect them from the consequences of having made uninformed choices.126 The economic assumption lies, for example, in the claim that the costs involved in looking for information are much higher for consumers who sign such a standard contract than for businesses who use those terms on a regular basis. This information asymmetry in the field of standard contracts is considered ‘incurable’.127 The assumption of informed consent as a basis for contract formation is therefore challenged.128 In order to remedy this market failure129 caused by unequal bargaining power, asymmetric information and the transaction costs involved in remedying the asymmetry, legislative intrusion into the general principle of freedom of contract is considered justified and certain terms or practices can be prohibited as ‘unfair’. The Commission proposal for the UCT previously acknowledged this lack of a ‘consensual basis of the law of contract’ as a rationale for legislative intervention.130 The market rationale of the UCT is reflected in its scope, which encompasses standard contractual terms drafted in advance, without any consumer i­nfluence

124 

Faure and Luth (2011) 342, 350. ibid, 350. As for an account of the traditional approach, see Schwartz and Wilde (1979) 633, though they do not agree with it. 127  Grundmann (2002) 275. 128  Becher (2008) 724. 129  Rösler (2010) 741ff. 130  Commission of the European Communities, Proposal for a Council Directive on Unfair Terms in Consumer Contracts, COM(90) 322 final, 14 September 1990, 7. 125 

126 

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on their content—see, for example, Article 3(2) UCT. Individually negotiated terms are outside of the scope of the Directive. Only consumers who do not bargain for their contracts are to be beneficiaries of the assessment of contractual terms under the UCT through the courts. By excluding individually negotiated contracts, it is assumed that consumers who bargain for contracts negotiate terms that meet their needs are aware of the consequences. One can criticise this approach from a philosophical point of view, but from a practical stance this is of not so much importance. In the field of consumer credit and mortgages, the contracts are largely standard contracts and therefore fall under the protective scope of the UCT in large numbers. Even though we can consider the unfairness approach to be substantially ­protective from a consumer perspective because the consumer does not have to refer to mandatory rules, but the judge must take care of consumer interests by his own motion,131 it is clear that the control of unfair terms in the UCT is based on market considerations, and is thus not concerned with the development of a ­European understanding of fairness. A general requirement of fairness is not included in the UCT. Irrespective of the CJEU’s development of a ‘strong ­European procedural fairness test’ that encroaches upon Member States’ procedural autonomy,132 a material fairness test is not developed. Parameters of fairness have to be inferred from the case law. More importantly, the adequacy of price is not subject to judicial review; Article 4(2) UCT, which excludes the subject-matter and the price of the contract from unfairness control, was included after lengthy negotiations on this matter.133 This means that a conscious decision was taken not to extend fairness control to the main subject matter of the contract. While the CJEU has, perhaps in a laudable attempt order to find a protective compensation for this lack of fairness control of the adequacy of price, insisted that the clauses concerning the calculation of prices must meet the requirements of good faith,134 this does not change the fact that the adequacy of prices are outside of the fairness control. From the viewpoint of the prevention of default, this is regrettable, because a widespread reason why marginal borrowers default on their loans lies precisely in the fact that the consumer assumed financial obligations that are beyond her financial capabilities. The same holds true for foreign-currency borrowers. Whether a contract that allows the assumption of such financial obligations is fair or not, is of no concern to the EU legislator. What is more, given the viewpoint of preventing default taken in this book, the unfairness test ex post as employed by the CJEU in Aziz is not of use to consumers when it comes to the prevention of default, and not the alleviation of overindebtedness. As just said, the UCT is not concerned with the prevention of default, 131 

Micklitz (2009a) 16ff. Méndez-Pinedo (2015). 133  On this matter, see Collins (1994) 237–38. 134  Micklitz and Reich (2014) 785ff. 132 

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but with the bargaining and negotiating position of the contractual parties and its protective provisions only apply in circumstances with an element of unfairness that impedes a balanced negotiation position of the parties.135 For the UCT to apply in Aziz, it did not matter why Mr Aziz defaulted to begin with. It is just assumed that the unfairness of his contract derives from the fact that he could not negotiate the terms of his contract. Even if the default occurred as a consequence of unfairness, however, we still face another problem. The assessment of unfairness under the UCT is based on the circumstances prevailing at the time of the conclusion of the contract, Article 4(1) UCT, but not on the circumstances at hand at the time when the contract is to be applied.136 This means that circumstances that occur after the contract has been concluded are not to play any role in the Court’s assessment of whether the terms at hand are unfair, thus neglecting factors that could in effect render contractual clauses unfair after considering the changed situation of the consumer (or professional for that matter). In this way, the UCT, in a formalistic way, aims at the restoration of the balance of negotiating power at the time the contract is concluded. This is not a substantive approach to assess fairness that aims at generating actually balanced outcomes of contracts. The lack of a genuine model of fairness may be a problem of the competence of the CJEU. In general, the CJEU cannot regard particular terms as ‘unfair’ because unfairness depends on the circumstances of each individual case. Even though in Océano it declared the contentious jurisdiction clause designating the courts of the place of the seller’s business as competent to rule as ‘unfair’,137 it rowed back from this judgment in Freiburger Kommunalbauten, clarifying that it did not intend to become the final arbitrator in unfair contractual terms.138 Notwithstanding the clear indications given to national courts by the CJEU with regard to the unfairness of a term, from a formal point of view subsequent case law seems to confirm this latter stance,139 permitting us to conclude that it was the evident unfairness of the jurisdiction clause in Océano that led the CJEU to rule on its unfairness directly.140 While this approach honours the procedural autonomy of the Member State courts as well as the different legal cultures in Member States, the EU legislator might deem it problematic that the same or similar terms might be considered unfair or fair in different Member States. Thus, there are two main gaps in the unfairness regime from the viewpoint of the prevention of defaults and consequent further welfare losses. First, consumers 135 

See Howells (2013) 461. Concerning this issue in Nordic law, see Wilhelmsson (1993a) 440 with further references. 137  Joined Cases C­240/98 to C­244/98, ECLI:EU:C:2000:346 (Océano Grupo) paras 25 and 32. 138  C­237/02 (Freiburger Kommunalbauten) paras 23ff, reasoning that Océano Grupo was different in the way that it concerned a jurisdiction clause that solely benefited the seller, irrespective of the particular circumstances of the case. This later stance was confirmed in Mostaza Claro in which the CJEU ruled that it is the national courts that have to investigate ex officio whether the terms of the transaction in question are unfair: see C‑168/05 (Mostaza Claro) paras 38–39. 139  For example, the Case C-92/11 (RWE), stating that it is the national courts that finally rule on the unfairness of the term in question. 140  C­237/02 (Freiburger Kommunalbauten) paras 23ff. 136 

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who default without an element of unfairness will not come under the protective scope of the UCT. This is a significant gap if we take into account the fact that unfair terms are not among the most common causes of overindebtedness. In fact, as we have shown in Chapter 2, the risk factors for default are to be found not only in irresponsible lending practices, which might or might not include the use of unfair contract terms, but are rather concerned with behavioural limitations and external factors impacting income stability. Despite the important role the UCT has played since the financial crisis with regard to avoiding the eviction of the consumer from the family home, from the viewpoint of the prevention of overindebtedness, we can see a gap in the protective system: defaults are not always the consequence of unfair contract terms. Second, consumers whose circumstances change after the conclusion of the contract, to the extent that after signing it the terms might be rendered unfair, are similarly outside of the scope of the UCT. For this reason, some other commentators have characterised the ex officio control of contract terms with regard to the unfairness as the ‘second-best’ option.141 The case law of the CJEU might provide an emergency brake for consumers about to be evicted from their homes, but with considerable limits and no general aim to prevent defaults. Limitations of the Procedural Fairness Regime We have seen that the case law of the CJEU in the field of consumer protection has a strong procedural dimension. The post-Aziz case law is largely concerned with the enforcement of mortgage agreements and eviction proceedings and thus with the prevention of the possibly dramatic consequences of default, including losing the home (but not with the prevention of overindebtedness as such). But also in cases outside of the field of mortgages, the CJEU adopted a protective stance with regard to the procedures in place. The emphasis on effectiveness that can also have effects on third parties (Invitel) relates to a quasi-regulatory function of courts, which shifts from individual dispute resolution to broader control of market behaviour.142 The CJEU has given weight to judicial procedures as a form of consumer protection by, for example, explicitly combining the UCT with Article 47 ChFR when it referred to the intention of consumer protection that must not be inhibited. This method of adjudication reflects the principle of effective protection, which in turn is justified by the unequal bargaining powers of the parties.143 Thus, Reich observes an ‘upgrading’ of national remedies through the principle of effectiveness of EU law (as enshrined in Article 47 ChFR) and the principle of consistent interpretation (Article 19 TEU).144 At the same time, it can be claimed that the

141 

Thus Micklitz and Reich (2014) 804. Cafaggi and Law (2013) 670; Gerstenberg (2015) 602. 143  Reich (2014) 102. 144  ibid, 98–99. 142 

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declaration of invalidity of an unfair term—especially if coupled with an injunction and ultra partes effect—only indirectly attributes greater bargaining power to consumers by disempowering traders and addressing primarily the market failure of information asymmetry.145 Despite its undeniable evolution in response to the problems of individuals over the years, the references to Article 47 ChFR, as is, are not yet the sign of a new judge-made European law on remedies. The impact and potential of Article 47 ChFR is contended in the literature. Leczykiewicz, for example, claims that these references are neither able to compensate for the limited enforceability of EU rights nor would that be desirable (at least for the fields outside of consumer and internal market legislation).146 In contrast, Chantal Mak argues that Article 47 ChFR can at least support the judicial development of effective EU remedies, even though she agrees that the article did not influence as much the actual outcome of cases as the legal reasoning leading to its adjudication.147 Similarly, Reich argues that reference to Article 47 ChFR does not attach new elements to the substance of the effectiveness principle, but reflects the constitutionalisation of EU civil law.148 From the viewpoint of the protection of vulnerable mortgagors from default, the engagement of the CJEU in the procedural dimension can be viewed both in a positive and critical light. On the one hand, the very role of the CJEU can be to act as the final arbitrator to remedy social and societal deficiencies of the national and European legal order, which are brought about by the opening up of markets for low-income consumers without establishing safeguards against the risks involved.149 The importance of CJEU jurisprudence for consumers in this regard is undisputed.150 The CJEU is still building up its case law, which might in the long run contribute to a ‘phasing out’ of unfair terms that can contribute to or exacerbate a situation of overindebtedness. On the other hand, doubts are bound to arise as to the competence basis of the judicial activism that solves social problems and the problem of giving a private law conflict a constitutional dimension.151 Furthermore, the delayed protection on a procedural stage can be debated from three main viewpoints. First of all, waiting for consumers to bring preliminary references to the CJEU about the fairness of contractual terms, does not serve to avoid the social repercussions in terms of avoiding the eviction from the family home. In the end, Mohammed Aziz, like many others, lost his family home.

145 

Cafaggi and Law (2013) 672. Leczykiewicz (2012) 58, 81. 147  Mak (2012) 17ff. 148  Reich (2014) 121. 149  Thus Micklitz (2014b), here referring to the unresolved paradox of financial and social inclusion; see also Micklitz (2010). 150 The importance of access to preliminary reference procedures to the CJEU has been highlighted by Méndez-Pinedo (2011), who criticises the lack of social justice in cases in which there is no access to judicial review, specifically in the so-called Icesave dispute, which falls into a grey area between EU and EEA law. 151  Thus Micklitz (2014b) 8, 13. 146 

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Second, placing the contractual review of contract terms into the procedural stage, the unfairness regime mirrors the confidence of CJEU in the ‘individual capacity of the consumer to check the legitimacy of the price increase and shop for better offers’, affirming the CJEU’s ‘individualistic concept of protection of weaker parties’.152 The consumer who is able and willing to go before the courts to assert her rights is the one who might benefit from the protection afforded by the courts. In turn, consumers who cannot, for different reasons, go before the courts will not be able to assert their rights. Among the most common reasons are:153 ­unavailability of individual remedies (eg under the UCP), lapse of time and lack of evidence, the cost–benefit weighing of reasonable consumers for low-value claims (reasonable apathy), claims that include high litigation risk (capital market claims, product liability), the availability of successful ADR schemes, and last but not least, psychological barriers which can vary significantly between Member States. ­Consumers, thus, do not always have the individual capacity needed to bring litigation in order to benefit from the protection afforded at a procedural stage. Third, given the individualistic basis of the UCT’s rationale, EU law neglects the collective dimension of consumer law enforcement.154 Class actions, like those pursued in the USA, are not allowed in EU law. This holds true even though the CJEU seems to be supporting EU institutions that have started debates155 about a European framework for collective redress, stating in Invitel that Article 7(2) UCT includes the possibility for collective action.156 The Court qualified this statement with the addition that the organisations taking action must have a legitimate interest under national law in protecting consumers. Moreover, the legal standing of consumer associations in individual cases before the CJEU is difficult to ­establish.157 Within this legislative framework, the CJEU confirmed in Pohotovost, as just one of the latest cases in a long line of strict case law, that consumer associations do not have the right to intervene in individual cases under

152 

Thus Micklitz and Reich (2014) 787. For an overview, see Rott (20120 68ff. 154  Micklitz and Reich (2014) 807–08 with further reference. So far, only Directive 2009/22/EC of 23 April 2009 on injunction for the protection of consumers’ interests, [2009] OJ L110, 30 (Injunctions Directive) allows a qualified entity from one Member State to seek an injunction in another Member State regarding the infringement of consumer rights granted by EU law. Dealing only with cross-border­infringements of rights, the Injunctions Directive is limited in its scope. 155 European Parliament, ‘Towards a Coherent European Approach to Collective Redress’ 2011/2089(INI), 2 February 2012; Commission Recommendation of 11 June 2013 on common principles for injunctive and compensatory collective redress mechanisms in the Member States concerning violations of rights granted under Union Law’, [2013] OJ L201/60; Commission Staff Working Document ‘Public Consultation: Towards a Coherent European Approach to Collective Redress’, SEC(2011)173 final, 4 February 2011. 156  C-472/10 (Invitel) para 36. 157  Since the seminal Plaumann case (C-25/62 Plaumann and Co v Commission of the European ­Economic Community, ECLI:EU:C:1963:17), it is clear that only parties who are individually and directly concerned can challenge the decision in question. This individual and direct concern is difficult, if not impossible, to establish for both regulations and directives on the one hand and groups of consumers on the other. 153 

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Article 7(2) UCT combined with Article 38 ChFR.158 Therefore, the access of collective bodies to judicial proceedings depends on the national legal framework, with considerable variation across Member States.159 Thus, a European approach to collective redress is in its infancy and depends on the national legal frameworks in the ­Member States.160 It must be debated whether the lack of a possibility for collective action on the EU level is mitigated in some way, for example via a quasi-erga omnes effect of judgments in the field of standard terms. In principle, judgments only affect the parties of the dispute, the effect inter partes. While there might be good reasons for assuming an erga omnes effect, for example with regard to the invalidity of a norm of secondary law,161 it is a highly disputed concept, especially in the field of private law. However, there might be a knock-on effect with regard to the contractual design of other consumer credit agreements. If a term in a standard agreement is considered unfair by a national court, other courts might refer to that unfairness in other proceedings, or companies using the same provision might consider removing it from their standard terms. In Invitel the CJEU stated that Article 6(1) UCT in conjunction with Article 7(1) and (2) UCT requires that consumers who have concluded the same standard contract with the same energy supplier (Invitel) shall not be bound by the unfair term.162 This effect has been called the ‘limited erga omnes effect’, as other suppliers shall not be bound because of the right to a fair trial and the right to be heard.163 This can also be considered a formulation of a knock-on effect. Even though Invitel can be considered an anomaly that is concerned with ­standard contracts, it is this anomaly that is the standard case in this field of consumer activity. The overwhelming majority of consumer transactions are nowadays based on standard agreements. And it is precisely this consideration that underlies the national Hungarian provision (Article 209/B(1) of the Hungarian Civil Code) questioned in the Invitel case that the declaration of invalidity of the unfair term also affects all those who have concluded contracts with the supplier of the term. The provisions of the UCT would be rendered ineffective if each individual consumer were obliged to bring her case to the court to declare invalidity yet again. Furthermore, in such a case, the public interest underlying the UCT in the phasing out of unfair terms would not be accounted for. Thus, the Invitel judgment shifts from individual invalidity to invalidity of a plurality of contracts

158 C-153/13 Pohotovost’ sro v Jan Soroka, para 45, ruling that this interpretation does not infringe the right in Art 47 ChFR. 159  Cafaggi and Law (2013) 662. 160  And even if a European approach to collective redress existed, it would have to deal with various obstacles in order to protect consumer rights effectively. Rott (2012) 74, for example, points at issues of distrust towards consumer organisations and general limits of private law. 161  Baudenbacher (2005) 396–97 with further references. 162  C-472/10 (Invitel) paras 38ff. 163  Opinion of AG Trstenjak in C-472/10 (Invitel) delivered on 6 December 2011, paras 59–60.

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concluded with the same defendant,164 whose procedural rights are considered observed by participating in the individual litigation. Thus, in a spillover from a procedural ex officio power to substantial concern of public order and invalidity and from individual to collective action, the national courts are not only vested with considerable regulatory power over market behaviour but are also obliged to exercise it.165 Even though it would be going too far to infer any generalising rules from the Invitel judgment with regard to the binding effect of non-parties to the dispute, it certainly strengthens the collective dimension of consumer protection law to be able to refer to one judgment that extends to the same terms used by the same supplier. The CJEU applied its reasoning to the field of standard terms that is in the focus of this book, which stresses the material character of the unfair term rather than the formal number of the parties to the dispute. Seen in this way, the Invitel judgment makes obsolete the procedural step of invoking unfairness and, consequently, streamlines the protective effect of Articles 6 and 7 UCT.

(v)  Summary: Relational Vulnerability in the EU Legal Framework To summarise the approach of the EU legal framework with regard to relational vulnerability, we can conclude that the information model comprises two dimensions with regard to the internal risk factors for default: the provision of transparent information, in a ‘fair’ way, on the lender side (if standardised contracts are used) and the understanding of that information on the borrower side. I have ­elicited elsewhere that this is how responsible lending and responsible borrowing are conceptualised in the EU legal order.166 To this framework, the CJEU adds limitations of the procedural autonomy of Member States and their courts by requiring the availability of certain remedies—such as interim relief in Aziz. We can conclude that in the EU legal framework the approach to consumer protection is largely based on the provision of information, initiatives for financial literacy and the control of unfair terms. As a consequence of this legislative approach, the reasonably circumspect model consumer in the EU might well benefit from this regime when it comes to the prevention of default through behavioural factors. Armed with transparent information and financial literacy, this model consumer will be able to make an informed choice about the credit agreement that best fits her needs and preferences. If she does not understand the information, she is in the situation to obtain the necessary education and knowledge. Where standard contracts contain unfair clauses, she is able to go before the national and European courts, have the fairness judicially evaluated and achieve a change in contractual terms, respectively. Thus, for this model consumer, the EU legal framework might work well. 164 

Cafaggi and Law (2013) 666. ibid, 673. 166  See Domurath (2015). 165 

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This legal approach to consumer protection fits well the economics literature and with behavioural economics, which emphasises the quality of the information over quantity and the way in which this high-quality information is supplied in addition to a prohibition of business practices that can manipulate the economic behaviour of the consumer.167 Similarly, the approach to warn consumers about the consequences of missing payments or defaulting on the loan finds support in the behavioural economics literature on so-called ‘nudging’.168 Some behavioural economists also argue in favour of regulating unfair terms, because of the evidence that consumers do not cease to buy a product even though the underlying contract contains unfair clauses.169 However, the legal framework examined so far does not help consumers who do not correspond to the EU consumer model. What about the uneducated consumer who is inhibited not only through the normal, human cognitive limitations but also cannot overcome them because she does not have access to the respective educational training or because in her Member State such training does not even exist? This consumer falls through the cracks of the EU legal framework. The CJEU judgments in Invitel, Kásler and Van Hove might prove to open a gateway for acknowledging the actual horizon of understanding of the consumer, but the CJEU approach is limited with regard to including all different kinds of consumers because it is still based on the average consumer model. This is critical from a protective point of view, considering that most consumers do not correspond to the model consumer assumed by the EU law under study. Similarly, the protection of consumers with procedural means is, despite laudable efforts by the CJEU, not enough to ensure protection from welfare losses. In substantive terms regarding the unfairness framework, we have seen that unfairness control is not concerned with the protection from default and other welfare losses and might therefore be limited from a preventive viewpoint. Moreover, there are often practical obstacles for consumers to seek judicial action. The collective dimension of consumer law enforcement thus becomes seminal. The encroachment upon Member State autonomy in the field of consumer law can be seen as a means to diminish the limitations on standing for consumer associations. In addition, the limited erga omnes effect of a declaration of unfair terms is of importance for any field of standard contracts, such as the majority of mortgage agreements concluded by consumers.

B.  Event Vulnerability Besides relational vulnerability, we have identified vulnerability to ­unexpected adverse events (event vulnerability) as probably the principal vulnerability of 167 

Rischkowsky and Döring (2008) 306 with further references. See most prominently Sunstein (2014); Thaler and Sunstein (2003) 175ff. 169  Rischkowsky and Döring (2008), 306f with further references. 168 

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consumers to o ­ verindebtedness. The most prominent of the adverse events to which consumers are vulnerable are income instability, the bursting housing bubble and the deterioration of exchange rates. Respectively, precarious workers, bubble borrowers, and foreign currency borrowers are vulnerable to those events. In this section, we will analyse whether or to what extent the EU legal framework for consumer protection acknowledges these market risks. In this way, we can see whether the EU protects consumers who are vulnerable to these market events.

(i)  Precarious Workers As regards precarious workers and their vulnerability to the risk of income ­instability, a difference should be highlighted between the CCD, adopted just before the financial crisis, and the MCD, adopted under the influence of the ­financial crisis. The CCD does not refer specifically to unexpected, external adverse events. It only obliges the lender to include general warnings with regard to the consequences of missing payments (Articles 5(1) lit (m) and 10(2) lit (m) CCD). Preamble 26 promotes responsible lending practices in the Member States, which ‘may include’, inter alia, warnings about the risks attached to default and to overindebtedness. In contrast, the MCD goes beyond a general warning concerning the possible consequences of non-compliance with the obligations assumed under the agreement, as contained in its Article 13(1) lit (n). The MCD also acknowledges the general risk posed by income instability. ESIS Point 6(1) contains a warning for consumers against the event of a change of income, which states that the consumer shall consider his ability to afford the repayment of the loan in case his income falls. For example, the income-warning contained in Point 6(1) ESIS reads as follows: ‘Your income may change. Please consider whether you will still be able to afford your … repayment instalments if your income falls.’ This wording of ESIS Point 6(1) shows that it is assumed that the responsibility for dealing with the consequences of a change of income falls upon the borrower. Despite these advances in comparison with the CCD, other references to income instability are missing. The risk of unemployment is specifically mentioned only with regard to the right to early repayment of Article 25 MCD. According to ­Article 25(5) MCD, the borrower can exercise her right to early repayment during a period of fixed borrowing rate only if she has a legitimate interest. Such interest can, according to Preamble 66 MCD lie in the event of a divorce or unemployment.

(ii)  Bubble Borrowers Not much can be found in the MCD concerning the event vulnerability of bubble borrowers to the realisation of systemic risks. As regards borrowers with a high LTV ratio, Article 18 MCD states that the CWA shall not be predominantly based on the value of the residential property exceeding the amount of credit or the assumption that its value will increase (if the property is not subject to construction or renovation). In addition, Article 19 MCD demands measures from the

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Member States to ensure that reliable standards for the evaluation of property exist and that those standards are used by lenders. In this regard, Preamble 26 MCD refers to ‘internationally recognised valuation standards’, especially those of the International Valuation Standards Committee, the European Group of Valuers’ Associations or the Royal Institution of Chartered Surveyors: Those internationally recognised valuation standards contain high level principles which require creditors, amongst others, to adopt and adhere to adequate internal risk management and securities management processes, which include sound appraisal processes, to adopt appraisal standards and methods that lead to realistic and substantiated property appraisals in order to ensure that all appraisal reports are prepared with appropriate professional skill and diligence and that appraisers meet certain qualification requirements and to maintain adequate appraisal documentation for securities that is comprehensive and plausible. In this regard it is desirable to ensure appropriate monitoring of residential immovable property markets and for the mechanisms in such provisions to be in line with Directive 2013/36/EU of the European Parliament and the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms. The provisions of this Directive relating to property valuation standards can be complied with for example through law or self-regulation.

Moreover, the macroeconomic dimension of mortgages and the housing sector is acknowledged in Article 26(2) MCD, which requires Member States to ensure the appropriate statistical monitoring of the market for residential property, which includes surveillance of the markets. For our purposes, it is not necessary to dive deeper into the politics and problems of standards-setting, especially with regard to their theoretical implications for governance or their reliability. What is important for this book is the acknowledgement that the MCD does take into account the macroeconomic embeddedness of mortgages and attempts to address systemic market risks in the form of overvaluation of property, and, hence, the possible bubble on asset markets that can subsequently also affect financial markets. In this regard, the MCD recognizes that the overoptimistic assessment of property values was an important driver of the events leading to the financial crisis. However, it deals with this problem as a matter of supervision, not as a matter of vulnerabibility of certain consumers.

(iii)  Foreign-Currency Borrowers The special situation of foreign-currency borrowers is taken into account in the MCD in its Preambles 4 and 30. These state that the ‘significant risks attached to borrowing in a foreign currency’ (Preamble 30) are ‘driven by market and regulatory failure as well as other factors such as the general economic climate and low levels of financial literacy’ (Preamble 4). It seems, thus, as if the particular vulnerability of foreign-currency borrowers is put into the context of the embeddedness of mortgage markets into larger asset and financial markets. Concerning the risk of worsening monetary conditions, the MCD sets out obligations about the calculation and use of the APR. Article 17(6) obliges Member

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States to ensure that lenders illustrate the risk linked to significant increases in the borrowing rate (20 per cent for foreign-currency loans, Article 23(4) MCD). For credit agreements with variable interest rates, consumers shall be given an additional APR which ‘illustrates the possible risks linked to a significant increase in the borrowing rate’ (Article 17(6) MCD). This ‘illustrative’ APR shall be calculated on the basis of the highest APR charged in the last 20 years or, in case of insufficient data in this regard, on the highest value of any external reference or benchmark rate—see ESIS Part B, instructions as to the calculation of the APR, section 4, paragraph 2. The approach of the MCD with regard to foreign-currency loans is the prescription of further warnings. The ESIS includes warnings that concern fluctuations in the foreign currency exchange rate (ESIS Point 3), and possible interest rate changes (ESIS Point 6(3)). In addition, Article 23(1) MCD obliges Member States to put regulatory arrangements into place to ensure that consumers have the right to convert foreign-currency loans into alternative-currency loans. This conversion could be an important tool in the protection of consumers from a sudden deterioration in the exchange rate, if the exchange rate for this conversion were not, in general, the market rate on the day of conversion (Article 23(3) MCD). Taking into account consumers’ behavioural biases to foresee and underestimate the occurrence of adverse events, it is questionable whether such a right to conversion based on the exchange rate of the day of conversion is useful to protect the consumer from the market risk of changing exchange rates. At the point in time when the consumer will want to convert his loan, the exchange rate will most likely have already changed to the detriment of the consumer. The market risk will then have already materialized for him. Hence, the protective function of the conversion right is not ensured. Further recognition of market risk connected with foreign exchange rate fluctuations are not dealt with in the provision of the MCD concerning the contract itself. The problems associated with foreign-currency loans have also reached the CJEU. In a line of cases already mentioned above when discussing the framework on the fairness of contractual terms, it became clear that the risks involved in foreign-currency loans are dealt with by the judiciary mainly as a problem of ­Article 4(2) UCT. We have seen that the mere existence of foreign-currency loans is not per se considered unfair in terms of the UCT, but part of an assessment of the national courts as to the essential character of those terms for the contract. In Kásler, the CJEU had to decide whether a contractual provision that stipulated the way in which the Hungarian forints (HUF) lent were to be exchanged for Swiss francs (SWF) for the repayment of a loan falls under the exception of Article 4(2) UCT or whether the national court could examine the fairness of the provision. It ruled that such a provision falls under the scope of the ‘main subject matter of the contract’ (Article 4(2) 1 alternative UCT) only to the extent to which the national court considers it to lay down an essential obligation of the agreement and that the amount that consumers had to repay was not paid in remuneration for a service rendered by the lender under the

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contract (Article 4(2) 2 alternative UCT).170 It, thus, left the delimitation of the ‘main subject matter of the contract’ to the national courts, while making clear that the difference between amount received in HUF and amount to be paid back in SWF merely reflects the risk run with the conclusion of foreign-currency mortgages.171 Instead, the CJEU insisted on the transparency requirements of Article 4(2) UCT. It ruled that the term that lays down the rules for calculation must be grammatically intelligible and that the contract must set out in a transparent way the specific function of the conversion mechanism in order to enable the consumer to evaluate its economic consequences.172 Thus, with regard to foreign-currency loans, the CJEU has rather focused on an assessment of whether and to what extent the respective clauses are worded and framed in an intelligible and transparent way for the consumer (see above). A more proactive attempt to recognise the risks inherent in foreign-currency loans can be observed in national proceedings. In 2014, a Hungarian District Court referred to the CJEU the question of whether a foreign-currency exchange transaction can be legally separated from the underlying foreign-currency-denominated loan (in this case for the purchase of a car), and if so, what the implications for the consumer would be.173 Considering that for every loan instalment the bank sells the foreign currency for the local currency to the client at the exchange rate previously determined in the underlying contract, the national court indicated that this ‘fictitious flow’ of foreign currency amounts to a financial derivative instrument as it constitutes a forward currency transaction between the bank and the client.174 Consequently, the protective provisions of the Markets in Financial Instruments Directive (MiFID) regime would apply, particularly the provision on the suitability test in Article 19(4) and (5) MiFID, which establish substantial information and advice obligations for investment firms that must take into account the specific client’s knowledge concerning the product in question. Thus, the national courts’ stance provides protection that is more functional with regard to risks on financial markets. However, in its judgment, the CJEU followed the Advocate General’s opinion, which emphasised that the purpose of the loan in the underlying case is financing the acquisition of a car, so that the definition of derivative instruments (as those which are used for hedging or speculative purposes because a future price, rate or value of the underlying asset is fixed beforehand) does not apply.175 Instead, the loan agreement for the acquisition of a car is governed by the CCD and the

170 

C-26/13 (Kásler), para 59. Thus Dellacasa (2015) 156. 172  C-26/13 (Kásler), para 75. 173  Request for a preliminary ruling from the Ráckevei Járásbíróság (Hungary) lodged on 1 July 2014—Banif Plus Bank Zrt v Márton Lantos, Mártonné Lantos in C-312/14, ECLI:EU:C:2015:794. 174  Opinion of Advocate General Jääskinen delivered on 17 September 2015 in C-312/14 Banif Plus Bank Zrt V Márton Lantos and Mártonné Lantos, ECLI:EU:C:2015:794, paras 14ff. 175  ibid, paras 37, 41. 171 

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i­ nformation obligations set out therein.176 The CJEU adds that the ‘fictitious’ currency transactions between the bank and the borrower serve no other function than to secure funds with a view to purchasing a consumer good or a service, not, for example, to manage a foreign-exchange risk or speculate on a currency’s exchange rate.177 ‘In fact, these types of foreign exchange transactions serve merely to secure the granting and repayment of the loan’, the Court states.178 Interpreting the foreign-currency loan more narrowly as a loan for consumption purposes leaves the obligations of the lender governed by the less demanding requirements of the CCD. The protection afforded to consumers is thus lower, especially when taking into account the unresolved issue of the fairness of foreign-currency indexation, as the CJEU left it to the national courts to decide whether the respective provisions form part of the ‘main subject matter of the contract’. Whether the CJEU would have arrived at the same conclusion if a mortgage agreement had been the subject of the case is not clear. It is worth to consider that the Spanish Supreme Court decided in 2015 that a ‘multicurrency mortgage’ is a derivative financial instrument as it depends on the value of another underlying asset, namely the foreign currency.179 The assessment of the Spanish Supreme Court might also be guided by the aim to subject foreign-currency loans to the rules of the MiFID, which puts significantly higher information and advising obligations on the bank/investment firm. There might be good reasons for treating foreign-currency mortgages differently from foreign-currency consumer loans, because of the higher and longer exposure to market risks within the duration period of the mortgage contract. The opinion of the Advocate General and the judgment of the CJEU in the Hungarian case is very much influenced by the underlying purpose of the loan as enabling consumption. Argumentum in contrario, the purpose of mortgage agreements as securing the family home could lead the CJEU to rule differently in the context of mortgages. In Aziz the Court had already shown such sensitivity to the different context of mortgages. However, whether this speciality of mortgages means that they should be legally categorised differently from other loans is questionable. The main subject matter of the contract is still the making available of a certain amount of money and the respective repayment obligation. The special nature of mortgages as securing personal welfare and the fact that they usually cover a long period of time can be taken into account when drafting or changing rules that are applicable to mortgages; but this does not require a different characterisation of the loan itself.

176 

ibid, paras 52, 53. ibid, para 57. 178  ibid, para 61. 179  Judgment of the Supreme Court, Madrid, of 30 June 2015, No 323/2015, 16. However, in that case the Spanish Supreme Court denied to declare nullity of the mortgage because the customer was considered a lawyer with expertise in the field of mortgages. The judgment is available in English at www.asufin.com/sentencias/STS_150630_KUTXA_AP9_MADRID_HMD_NO_en_def.pdf. 177 

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(iv) Assessment We have seen as regards event vulnerability that the acknowledgement of external adverse events in EU law is sparse. In the current framework, references to ­external events can only be found in warning requirements. These warnings form part of an explicit political agenda to steer consumer behaviour into a certain direction without restricting consumer choice as such.180 Even though it is contested to what extent warning requirements are an effective legislative tool to achieve certain aims—for example, it has been claimed that such warnings can be part of too much information and thus contribute to information overload,181 the SECCI and ESIS warnings seem to avert that danger. Since they form part of a larger standardised provision of information on a few pages, the danger of information overload can be counterbalanced. A more pertinent criticism is related to the general unresponsiveness of consumers to warnings. The first problem is that consumers generally overlook ­warnings.182 But even if they are not overlooked, the warnings do not seem to overcome the cognitive limitations of consumers.183 Consumers do not only fail to read warnings, they also do not understand or follow them184 because of their manifold cognitive limitations that we have already described above. This holds true at least for purely verbal warnings, as opposed to the use of pictures and graphics, which could improve the consumer’s product beliefs and purchase intentions.185 This might be even more so, if we consider the rather broad terming of the warnings given in the SECCI and ESIS. The warning in Article 13(1) lit (n) MCD is a general one, as is the warning contained in ESIS Point 6(1) regarding change in income. In this regard, the EU legal framework lags behind legislation in some Member States where the warnings are related more directly to the fact that the mortgage is taken in order to purchase a family home.186 Apart from these limitations, the warnings and the illustrative APR clearly put the responsibility on the consumer to understand the extent of not only her financial obligations but also of the effect of an income reduction, of which the consumer does not know whether it will happen at all or by how much her income will drop. The consumer, subject to cognitive limitations, is left alone with the financial decision. Only the reasonably circumspect consumer is able to take an informed decision. Reich might be correct when he claims that these warnings are rather used to exempt the trader from liability187 than to help the consumer in her decision-making.

180 

With regard to health warnings on cigarette packaging, Franck and Purnhagen (2012) 16. Incardona and Poncibó (2007) 32 with further references. 182  Howells (2005), Reich (2004) 43. 183  Concerning health warnings on cigarette packaging, Reich (2009) 9. 184  See study by Latin (1994), who draws conclusions for the design of tort law. 185  Fitzgerald Bone and Russo France (2001). 186  See Reifner et al (2003) 112, 131. 187  Reich (2009) 9. 181 

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It should also be pointed out that the warnings make no provision for the prevention of default and other welfare losses as the primary goal. The wording of the warnings, especially in the ESIS, supports the view that they are rather used as a tool of the information model to address the reasonably circumspect model consumer of the EU. The same holds true for the ‘illustrative’ APR that is to be calculated according to Article 17(6) MCD and the calculation of the APR in s­ ection 4, paragraph 2 of the ESIS. The additional APR is there to illustrate to the consumer any possible difference in the borrowing rate. Preamble 51 MCD makes clear that the guidelines for the calculation of the APR aim to ensure comparability of the APR. In the end, however, the consumer is the one who is supposed to assess the implications of the differences in APRs. This corresponds to the overall individualisation of risks described in Chapter 2, according to which individuals are to master uncertainties and risks on their own. Given the EU agenda of achieving social inclusion through financial inclusion, it is not, however, surprising that the event vulnerability of consumers to the realisation of market risk is not acknowledged in a deeper way. On the contrary, the exposure of consumers to the risks inherent in the financial system is actually enhanced through the financial inclusion agenda. We have seen above that the expansion of credit to consumers is an important tool to achieve social inclusion in a political economy in which the welfare state is increasingly retreating from the provision of public (universal) services and the allocation of resources. This implies that policies that provide an incentive for consumers to participate in credit markets are adopted. As a consequence, in many countries, more and more consumers bought houses expecting to be able to benefit from low interest rates and increasing housing prices. Thus, the EU’s declared goal is to include more and more participants in the financial markets. Arguably, this almost automatically leads to an increase in the number of vulnerable consumers becoming exposed to the risks involved in transactions and activities on financial markets.

C.  Lack of Resilience After having established that the relational vulnerability of mortgagors is addressed more in the EU legal framework than event vulnerability, we shall examine to what extent the EU legal framework takes into account the lack of resilience of low-net-worth consumers.

(i)  Low-Net-Worth Consumers Even though the pertinent legal framework does not explicitly mention the lack of resilience of low-net-worth consumers in the field of mortgage credit, it does not ignore the lack of resilience of borrowers to respond to the danger of overindebtedness. It tackles the issue as a credit risk that can be diminished through CWAs. Both the CCD and the MCD provide the lender with the obligation to assess the creditworthiness of the consumer prior to concluding a credit agreement.

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While the CCD only establishes this obligation through the general rule in Article 8 and the information of the consumer of a possibly negative credit application based on the consultation of a database in Article 9(2) CCD, the MCD dedicates a chapter to CWAs. Article 18(1) MCD states that the lender shall be obliged to make a ‘thorough’ CWA, which shall take into appropriate account the factors relevant ‘to verifying the prospect of the consumer to meet his obligations under the credit agreement’. It is noteworthy that the MCD elaborates on the criteria of the CWA in such a way as to state that it should focus on the consumer’s ability to meet the contractual obligations (Preamble 55 and Article 18(1) MCD). Since CWA is often realised with the consultation of credit bureaus, which collect and store data relating to the financial obligations and liabilities of the consumers, Article 20 makes obligatory the non-discriminatory access to credit bureau databases in order to assess the consumer’s creditworthiness and to monitor her compliance with the credit obligations over the life of the credit agreement. Finally, Article 18(5) lit (a) MCD stipulates that the credit shall only be made available to the consumer if the CWA indicates that the consumer will be able to meet the financial obligations assumed under the credit agreement. Since the CCD does not contain such a provision, it can be assumed that the inclusion of these provisions in the MCD is influenced by the prevalence of overoptimistic practices before the financial crisis. Probably for the same reason, Article 18(3) MCD and Preamble 55 MCD acknowledge the market risk that housing prices may fall. According to Article 18(3) MCD, the CWA shall not predominantly rely on the value of the underlying property and the Member States shall ensure that the standards for property evaluation for mortgage lending purposes are reliable. Similarly, Article 19 MCD ensures that the property evaluation shall be conducted in accordance with reliable standards in the Member States. These provisions are clearly meant to respond to the overoptimistic real-estate evaluations that took place during the housing bubble before the financial crisis. The precise aim of the CWA as designed in this framework is not entirely clear. While it is evident that the objective of any CWA is to ensure that the loan will be repaid, which is in the primary interest of the lender (risk minimisation), it is debatable whether the CWA pursues a further goal. This would be in line with Crédit Lyonnais, in which the CJEU stated that the aim of the creditworthiness assessment is to prevent consumers from the danger of overindebtedness and insolvency and to protect them from being granted loans beyond their financial capacities.188 Furthermore, the references in Preamble 55 and Article 18(3) to the value of the secured property can be interpreted as underlining that the creditworthiness assessment also protects the consumer from the loss of the property acquired with the credit. Similarly, Preamble 3 MCD makes it clear that the prevention of household overindebtedness forms part of the Union’s regulatory

188  See C-565/12 (Crédit Lyonnais) paras 42–43. Thus, it has been claimed that the goal of responsible lending now also comprises the financial stability of the consumer; see Rott (2014).

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framework in the area of mortgage credit. However, that same Preamble considers the prevention of overindebtedness merely as a tool to restore consumer confidence after the financial crisis. It states that irresponsible lending practices have undermined the foundations of the financial system as well as consumer confidence and that it is ‘therefore appropriate to ensure that the Union’s regulatory framework … makes appropriate use of the tools available, … where needed to prevent household over-indebtedness’. Hence, the prevention of overindebtedness is made instrumental in achieving a higher aim: to restore consumer confidence in the internal market.

(ii) Assessment In general, the CWA is considered a cost-effective tool for preventing default. CWAs allow lenders to have a more complete picture of an individual’s total debt exposure.189 Lenders have developed long-standing expertise in screening and monitoring, thus eliminating some of the cognitive biases of consumers when it comes to their borrowing decisions.190 Furthermore, credit bureaus are considered to contribute to the reduction of overindebtedness as they help lenders to reduce adverse selection and detect overcommitted borrowers.191 They gather information on the payment history and consumer borrowers’ accounts, organise and manage the information on the borrowers’ performance, and provide the credit industry with reports issued before the underwriting of a loan agreement.192 Economic theory thus regards them as designed to eliminate the information asymmetries that supposedly exist with regard to both the borrower’s ability and the willingness to repay the loan through information sharing.193 When undertaken diligently, consumers who fall below a certain threshold in terms of income and wealth, ie with too little financial capacity to repay the loan, will not obtain credit. Therefore, in theory, both the provision of transparent, complete and standardised information and creditworthiness assessment are suitable tools to prevent overindebtedness of consumers. However, CWAs and the use of credit bureaus have been criticised from both legal-theoretical and empirical standpoints. First, the efficiency or suitability of the CWA approach remains questionable, even though the MCD goes a bit further than the CCD. Whereas the CCD leaves it open to the lender to grant the credit despite a negative outcome of the CWA194—irrespective of ­Preamble 26 and Articles 8 and 9 CCD, which state that creditors should not engage in irresponsible lending practices or give out credit without prior assessment of ­creditworthiness—the MCD obliges the Member States to ensure that the creditor 189 

Vandone (2009) 77. Atamer (2011) 199. 191  Rona-Tas (2015). 192  Ferretti (2011) 1. 193  See, for example, Jappelli and Pagano (2002). 194  See Atamer (2011) 196, 201. 190 

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only makes the credit available to the consumer if the CWA proves positive (Article 18(5) lit (a) MCD). This implies that credit shall not be granted if the CWA is negative. At the same time, the MCD fails to elaborate on precise criteria or methods of that assessment and leaves further guidance to the Member States. Second, the MCD also lacks a provision on the legal consequences of the ­lender’s failure to deny credit in case of a negative or missing CWA. Article 38 MCD merely provides the almost standard formula (in EU legislation) of obliging Member States to determine ‘effective, proportionate, and dissuasive penalties for the breach of MCD provisions’. The dissuasiveness of penalties was at issue in Crédit Lyonnais, in which the CJEU ruled on a provision in French law that provided for the penalty of forfeiture of entitlement to interest payments should the creditworthiness of the consumer not be assessed by the lender. In that case, the CJEU considered it not dissuasive if the amounts the lender receives if the borrower defaults are not significantly lower than without the default (here the contractual interest rate was replaced with a higher statutory rate, which was in effect more beneficial for the lender).195 The issue is in the hands of national courts, which have to assess the effectiveness, proportionality and dissuasiveness of the national penalties in the light of the MCD. This might not be enough of an incentive for lenders to undertake sound CWAs. In fact, considering that CWA rules have been in place since before the financial crisis of 2008, we can deem that they have largely proven ineffective. The neglect of liability of the lender to undertake CWAs can have a negative impact on the protection of consumers. In this vein, Rott has stated that the protection of consumers from overindebtedness (as the objective of the CWA) is not guaranteed by the sole regulatory oversight and possible imposition of fines through supervisory bodies without an individual enforceable right of the ­consumer.196 The problems entailed by a lack of a provision of legal consequence for a failure to comply with the obligations concerning the CWA are visible from an empirical point of view. Despite the existence of CWA obligations and despite the fact that banks routinely assess the creditworthiness of their customers, evidence suggests that lenders do not always use their knowledge to discourage borrowing. On the contrary, they might even encourage high-risk borrowers to extend their credit.197 Particularly in the years just before the financial crisis, credit was also given to low-net-worth consumers even though it should have been obvious at the time of contract conclusion that they might not be able to repay the loan, which suggests that either CWAs were not undertaken or negative CWA results ignored.198 Even though irresponsible lending practices often came together with irresponsible borrowing choices in a socioeconomic climate in which overoptimism and other cognitive limitations were not effectively counterbalanced, it is 195 

C-565/12 (Crédit Lyonnais) paras 52–53. Rott et al (2011); also Rott (2015) paras 78–79. 197  Atamer (2011) 199 with further references. 198  See the country reports in Domurath et al (2014); for the USA, see Mian and Sufi (2014). 196 

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clear that the incentives for ‘thorough’ CWAs were not in place or did not take function. It remains to be seen whether the MCD will change this.

III. Conclusions In this chapter, we were concerned with the question of how the current EU framework protects the vulnerable from default, our proxy for welfare losses. First of all, we have seen that vulnerability as a concept is absent from the legal framework on mortgage credit. Based on an analysis of EU legislation, policy papers and academic literature, an emphasis was detected on the remedying of relational vulnerability, through information obligations, education of consumers and the fairness control of standard terms, as well as the lack of resilience through CWAs. In contrast, external vulnerability is neglected. We can complete Table 2.1 with this overview of the EU legal tools with regard to the acknowledgement of vulnerability: Table 3.1:  Legal responses to vulnerability Risk dimension

Risk factors

Vulnerable consumers

EU law responses to types of vulnerability Relational vulnerability

Internal/ Lack of All consumers Information behavioural information/ Consumers with low Education understanding levels of education Irresponsible lending/ borrowing

Marginal borrowers (financially excluded)

Fairness control Event vulnerability

External

Income instability

Precarious workers

Warnings

Financial market risks

Bubble borrowers (high LTV ratio)

Housing value not as sole parameter of CWA

Foreign-currency borrowers

Lack of resilience of low-net-worth borrowers CWA

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The information and unfairness approach is rather elaborate in the EU legal framework. Information is provided in a standardised form in order to ease informed decision-making. The CJEU supports this framework, basing its guidance concerning the transparency of the contractual terms on the knowledge and comprehension of the consumer (Invitel, Kásler, Van Hove). This has led commentators to discern a pattern of good faith that should guide the fairness review of the national courts.199 At the same time, this judicial analysis proceeds from the average consumer standard in the EU legal framework, which arguably is the opposite of the approach taken in this book. What is more, very few rules addressing event vulnerability exist. The vulnerability to external risk factors falls through the protective grid. By merely providing warnings in the contracts about possible adverse external events, mentioned as the risk of inability to repay the loan, the market risk for the occurrence of events with adverse consequences for the financial situation of the consumer is effectively passed on to the consumer. On one side, there is the lender, who has to provide reasonably calculated expectations, for example with regard to fluctuations in interest or currency exchange rates; and on the other, there is the consumer, who, equipped with this information, makes the final decision, supposedly in full knowledge of what she is doing. While this responsibility might be considered an appropriate legal responsibility for her own actions, it is doubted that this approach leads to an appropriate balancing of market risk. An acknowledgement of the volatility of the housing markets is not coupled with protective mechanisms in contract law for vulnerable bubble borrowers. The need to monitor residential property markets outlined in Article 26(2) MCD is clearly related to a macroeconomic oversight and the problem of the overappreciation of housing property is tackled as a parameter of the CWA in Articles 18 and 19 MCD. As regards the former, there are no provisions for how this monitoring relates to or has any effect in contract law. As regards the latter, its obvious objective is to make the assessment of the borrower’s ability to repay more sound. While this is certainly useful—together with the reliance on international standards—in order to improve the reliability of the CWA, it has to be acknowledged that the CWA is not a guarantor of repayment capability. Especially in the field of mortgages and housing, where financial obligations are often contracted for many years, even decades, an initial screening cannot possibly incorporate all eventualities encountered throughout the duration of the contract. Heavy reliance on such screening must therefore be regarded critically. Concerning foreign-currency borrowers and their vulnerability to exchangerate risk, the MCD gives them the right to convert their loan into another currency loan according to Article 23 MCD. Even though this is an important right for borrowers, especially with regard to the long duration of the mortgage loan, the 199  Micklitz and Reich (2014) 785ff detect elements of this ‘autonomous EU concept of unfairness’: transparency, value judgements taken from other secondary EU law, an indicative list, balancing of interests, and references to national law.

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remaining provisions dealing with foreign-currency risk, such as the regular warnings in Article 23(4) MCD, aim at informing the borrower and, thus, are subject to the same criticism as other information rules. The EU puts more emphasis on the lack of resilience. With regard to the resilience of, especially, low-net-worth consumers to absorb possible shocks, the obligation to undertake a CWA, which is not to be based primarily on the expectation of a value increase of the property, is an important tool. Despite the obligation not to make the credit available to the consumer unless the result of the CWA is positive, the EU legal framework does not include liability for the undertaking of the CWA. This deserves criticism because the financial crisis brought to light that CWAs were not always (­diligently) undertaken. Lending and borrowing standards had become eroded in the pursuit of expanding credit into more and more segments of society. C ­ onsumers were increasingly encouraged to participate in financial markets and, thus, expose themselves to the risks on those markets (which they are supposed to master individually). CJEU jurisprudence does not make up for this lack of protection. In fact, CJEU jurisprudence seems to hit a wall with regard to the material limits imposed by the wording of the underlying legislation as well as procedural limits with regard to the nature of judicial procedures. The CJEU also seems to be aware of these limitations. For example, with regard to clear wording of Article 4(2) UCT, the Court insists on the impossibility of review of the adequacy of price, on the one hand, while interpreting this exemption in a narrow way and allowing the review of the transparency of clauses setting out the way in which the price is calculated, on the other. However, considering that the amount of credit is, in the end, the reason why vulnerable consumers might default on their financial obligations, this reliance on transparency does not make up for a possible unfairness of the price of credit as such. Another material problem is the clear wording of Article 4(1) UCT, according to which the assessment of unfairness shall be based on the circumstances prevailing when the contract was concluded. This verbatim excludes the taking into account of subsequent changing circumstances that are the basis of event vulnerability. Furthermore, and notwithstanding the importance of CJEU rulings in the context of unfair terms for many consumers (see Aziz, Kásler, Sánchez), the UCT does not apply to cases in which unfair standard terms are not involved. As such, only in situations in which the default of the consumer coincides with the existence of unfair terms can the consumer attempt to seek the cancellation of enforcement. More generally, we can also question the approach to consumer protection through procedural means, as they depend on the individual ability of a consumer to seek enforcement of her rights. It is not yet clear whether the new references to Article 47 ChFR can have a profound impact on the procedures. So far, Article 47 ChFR has rather played a role in judicial reasoning supporting the effectiveness of EU law. Reference to more material fundamental rights, such as Articles 7 or 34(3) ChFR are absent from the rulings. This might be grounded in an awareness of the CJEU about the limited competences of the EU in the field of social policy.

Conclusions

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In the collective dimension, the intrusion of CJEU case law into the collective dimension of consumer enforcement shall, however, be considered advantageous for the preventive and welfarist viewpoint taken in this book. ‘Formalising’ a limited erga omnes effect extending to consumers bound by the same standard terms used by the same supplier, the CJEU has strengthened not only consumers’ individual rights but also the collective dimension of EU consumer law. The reasoning of the CJEU in the pertinent Invitel judgment should also apply to consumer mortgage law because consumers also rely on standard mortgage agreements in this area. All in all, the picture that emerges is that the EU legal framework is not ­flexible enough to take into account different types of vulnerability. It focuses on relational vulnerability, because it coincides with the assumed weakness of the average, reasonably circumspect consumer vis-à-vis the professional lender in terms of information and negotiation power. The multifaceted vulnerabilities of consumers who assume long-term financial obligations on globally connected financial markets in times of employment and social insecurity are not considered in the applicable rules.

4 A Flexible Mortgage Contract Law I. Introduction This chapter shows that certain welfarist elements can be found and included in the legal framework governing mortgage contracts with the help of the concept of vulnerability. The chapter is concerned with the possibility of filling the gaps identified in the EU legal framework on mortgage contracts. It, thus, subscribes to Wilhelmsson’s stance that the dismantling of the welfare state does not necessarily entail a dismantling of solidaric elements in consumer law.1 He supposes that the development of the retreat of the welfare state may on the one hand lead to an erosion of welfarist values in consumer law, but may also increase the pressures to create a private law that safeguards those values.2 The hypothesis is that a more flexible set of rules can help to prevent welfare losses in terms of default and subsequent enforcement, eviction and possibly homelessness. We will use the vulnerabilities as identified in Chapter 2 in order to identify ­contractual mechanisms that can address those vulnerabilities. We shall bear in mind that ‘fixing’ relational vulnerability is certainly laudable, but not the most suitable endeavour to prevent welfare losses for consumers. Hence, in this chapter we shall only briefly look into further measures that could address relational ­vulnerability, but will focus on event vulnerability and the lack of resilience as the more prominent vulnerabilities in the field of mortgage debt. Concerning event vulnerability, different approaches will be presented to address external ­market risks from a contractual perspective. First, attention will be given to CWAs. The existing framework for CWAs will be analysed in order to see how it can be changed in order to incorporate these external risk factors into the calculations of credit risk. Second, we will proceed to discussing the contractual possibilities should the consumer become overindebted, despite a satisfactory CWA. The renegotiation of debt is the focal point of the analysis in this regard.

1  2 

Wilhelmsson (1996) 208. ibid, 208–09.

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II.  Relational Vulnerability A.  A New Benchmark: The Real-Life Mortgagor? We have seen that the EU law approach in the field of consumer law of information, education and fairness control is comprehensive as regards relational vulnerability. This does not mean that the approach is sure to offset relational vulnerability or that it should not be criticised that the main aim of the respective legal tools is not the prevention of default and other welfare losses of consumers, but the fostering of the internal market. If the EU is to improve the legal responses to relational vulnerability, it would have to abandon its underlying assumption of the reasonably circumspect consumer in the field of mortgages. I have argued elsewhere that there are good reasons for making the vulnerable consumer the model consumer in this particular field of law.3 The diverse types of vulnerability described in this book show, on the one hand, the complexities of the concept and, on the other, the need for complexity of rules if the regulatory responses are to be beneficial for consumers. But even if, more likely, the EU continues to adhere to the reasonably circumspect consumer standard in the field of mortgages, a few suggestions can be made as regards the improvement of the current framework. Since we have seen that the starting point for EU legislation is the unequal bargaining power, we will, in what follows, look into the possibility of a higher standard of fairness for contracts with individuals with low levels of education and for marginal borrowers. The basis for this possibility lies in their susceptibility to unfair practices due to their educational and cognitive limitations and their need for credit, respectively.

B.  Consumers with Low Levels of Education Since there are gaps in the EU legal framework with regard to relational vulnerability to internal risk factors, financial counselling or debt counselling measures can be put into place. The importance of such support for consumers is clear in Preamble 49 of Directive 2014/92/EU on payment accounts, which states that Member States should promote education, guidance and assistance in the responsible management of their finances. However, the EU legal framework misses a chance to protect consumers better from defaults and welfare losses because it does not consider these possibilities in the framework applicable to mortgage credit. Even though both the CCD and 3  Domurath (2013). For a critique, see Reich (2016b). While Reich is certainly correct in his observation that not all ‘weak’ consumers are vulnerable, he regards only physical and intellectually ‘disabled’ and economically marginal borrowers as vulnerable and, thus, employs a narrower vision of vulnerability than the one advanced in this book.

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MCD contain provisions on explanations to be provided on behalf of the lender to the consumer so that the latter will be able to assess whether the credit agreement is ‘adapted to his needs and financial situation’ (Articles 5(6) CCD and 16(1) MCD), these contract-specific explanations cannot be equated with advice on the management of household finances in general or consumption decisions. As for impartial, third-party advisory services, the CCD does not address the issue of conflicts of interests when providing advisory services to the consumer. While the MCD, in its Article 6(3) lit (b), speaks of the avoidance of conflicts of interests and sets out standards for financial advice in Article 22, it does not make mandatory the use of non-tied, third advisory parties. A few proposals have been made in order to improve financial decisionmaking­through education.4 In addition, third-party counselling can provide advice to borrowers concerning the management of household finances and decisions regarding consumption, savings and borrowing.5 There is evidence that advice of this sort can help overcome cognitive deficits such as optimism bias or ignorance regarding the complexity of financial products and services.6 Another argument claims that individual consultation and advice can help counterbalance the danger of information overload.7 If financial advice is provided, it is, however, pivotal that it is provided by a third party that is not involved in the financial transactions and has no conflict of interests.8 Moreover, it must be ensured that financial counsellors have the respective technical expertise and the personal ability to convey this expertise to consumers. Be that as it may, the more pertinent question for our purposes is whether the bank can be obliged to take into account low levels of education on the borrower’s side when offering a mortgage loan to her. As we have seen above, Articles 14 and 22 MCD could provide anchorage for such an approach, even though they are not interpreted in that way. Despite a lack of acknowledgement of low levels of education as factors that are to be taken into account in the Preambles or anywhere else in the text, it is not a broad jump from the obligation to provide ‘personalized’ information towards acknowledging the financial

4  In particular, Yoong (2013) 27ff suggests linking financial education to concrete actions, breaking down desirable outcomes into small intermediate steps, the use of knowledge-enhanced actions and commitment devices to ensure follow-up, and social pressure. However, the examples given remain untested and it is unclear to what extent they would have an impact on subsequent financial decisionmaking. Yoong also recognises problems with regard to conflicts of interest. 5  Vandone (2009) 77. 6  Atamer (2011) 187. 7  Ben-Shahar and Schneider (2011) 747. 8  See, for example, Group of Specialists for Legal Solutions to Debt Problems (2007) 8 (no 43). Regarding the issue of commissions, see Reifner (2011); Jackson (2008) 83ff calls the problem of ­neutrality of advice the ‘trilateral dilemma of financial regulation’; he also mentions the dilemma in the field of yield spread premiums to mortgage brokers, investment choices for pension plans, real estate settlement transactions, investment management, or contingent insurance commissions. In the end, he points at the necessity for more studies collecting and disseminating aggregate data on intermediaries and service providers (110).

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l­iteracy of consumers when providing that information in the credit granting process. This would amount to an obligation of the lender to ensure that the borrowers actually understand the terms and conditions of the mortgage agreement as well as its financial implications. This would also be in line with the CJEU case law, in which it was established that consumers must be able to understand, evaluate and foresee the economic consequences of their financial decisions.

C.  Marginal Borrowers In Chapter 2 we have seen that marginal borrowers are especially those who are in need of credit but cannot obtain it on mainstream credit markets, because of certain characteristics such as an impaired credit history. They are susceptible to exploitative credit because they are more likely to agree to onerous terms as they feel that they do not have any alternatives. One possibility to address this vulnerability is to introduce price controls into the legal framework.

(i)  Price Controls Price restrictions should be adopted on two levels, material and procedural. The material dimension refers to the adoption of credit limits or interest-rate ceilings in the MCD. The procedural dimension refers to the possibility of judicial control of the adequacy of price, contrary to what is currently allowed under Article 4(2) UCT. For this purpose, the MCD could determine the maximum amount of credit in relation to monthly disposable income. The same applies to maximum time periods for loans that could be prescribed for consumers in precarious working conditions. For example, it could be determined that for consumers who fall below a certain threshold of wealth and income, the amount of the monthly instalment, after having deducted the average monthly living costs in relation to residence and family situation, cannot exceed half of the monthly disposable income. To give an unfavourable example: the loan agreement concluded between Mohammed Aziz and his bank Catalunyacaixa concerned a credit amount of €138,000, to be reimbursed in 396 monthly instalments.9 Mr Aziz had a fixed monthly income of €1,341, and the monthly instalments amounted to €701.04,10 more than half of his monthly salary, for a period of more than 30 years. Under the approach advocated here, Mr Aziz would not have been eligible for this loan. If the bank, nevertheless, wanted to extend credit to Mr Aziz, it would have been obliged to adhere to certain requirements to minimize the risk of default, for example via a lower credit limit for a shorter period of time.

9 

10 

C-415/11 (Aziz) paras 18–19. Opinion of AG Kokott in C-415/11 (Aziz) para 12.

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Another possible means of price control is the imposition of interest-rate ceilings for marginal borrowers. Such interest-rate ceilings can prove to be an efficient tool to discourage lending to high-risk borrowers because lenders would be deprived of the possibility to mitigate the risk with high interest rates. Hence, interest-rate ceilings are recognised as a form of price control to protect lowerincome consumers from exploitation through, for example, usurious rates and expensive credit.11 Such interest-rate ceilings are implemented in US and Canadian legislation, and in Germany the Supreme Court has set a standard of usury for interests that exceed either the average market by 100 per cent relatively or 12 per cent above the market rate absolutely.12 As such, interest-rate controls can reflect the social disapproval of consumers having to obtain life necessities at a very high price.13 They are based on the claim that distributive issues are not addressed in a more ‘objective’ way through the market, because the market only operates in a competitive way that offers choice and opportunities.14 It would reflect the reality that marginal borrowers do not have access to those opportunities anyway, but are, instead, vulnerable to exploitative practices. One can debate, though, whether interest-rate ceilings would actually be a tool of exclusion from credit, or would enable borrowing but under more favourable conditions. Economists have argued that because of legal maximum limits for interest rates, lenders would be effectively discouraged from lending to low-networth consumers.15 Even though this might be correct, it is precisely this result that the legislator who is concerned with the prevention of default and consequential welfare losses would want to achieve. In the end, they protect consumers from entering into a potentially hazardous situation in a paternalistic way.16 As Ramsay has described, the success of interest-rate ceilings depends very much on the rate at which they are set.17 In his view, a moderate interest-rate ceiling can limit the power of creditors almost single-handedly and empower consumers and enforcement agencies with a low-cost bargaining tool to address problems in high-risk credit markets. Hence, interest rate ceilings might not be a long-term tool to address problems in credit markets, but they cannot be objected to on mere market arguments.18 If we accept the usefulness of price controls, the UCT should be changed with a view to allowing the judicial review of the adequacy of the price. Acknowledging the widespread incapability of consumers to keep up with their monthly

11 

Ramsay (1995) 191. 191, with further references; German Supreme Court, Judgment of 24 March 1988, III ZR 30/87. 13  ibid, 191. 14  Wallace (1976) 456. 15  Vandone (2009) 78. 16  Wallace (1976) 458ff. 17  Ramsay (1995) 192. 18  ibid, 193. 12 ibid,

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payments after the financial crisis, it is possible to argue that price adequacy control could be included into the unfairness assessment. This would imply deletion of the formulation that the assessment of unfairness shall not relate ‘nor to the adequacy of the price and remuneration’ (Article 4(2) UCT). So far, price clauses have been only been subject to judicial review with regard to their transparency.19 The original Commission proposal on the UCT did not contain a restriction of the application of the UCT for the main subject matter or price of the contract.20 A restriction similar to the one in Article 4(2) UCT was later also included in the European Parliament’s amendments to the European Commission Proposal for a Common European Sales law (CESL).21 This shows that there was a deliberate choice in favour of the exemption of price controls from unfairness tests. However, such price adequacy controls might be one of the most effective measures to protect marginal borrowers from default and further welfare losses.

(ii)  Universal Financial Services Requirements concerning the affordability of price are, albeit rare, not an unknown tool in EU law. For example, the EU has been very active in the control of mobile phone roaming charges, setting price limits for charges for voice calls, SMS messaging and data transfers.22 Affordability requirements mainly exist in the law of universal services. They could also, however, be envisaged in other fields of law through a broader fairness control. Apart from requiring access to universal services,23 the pertinent Directives also establish affordability requirements in order to make the right to access operable.24 These affordability control mechanisms are not, however, established on EU, but on Member State level—see, for example, Article 9(1) Universal Services Directive 2002/22/EC. It can be argued that three commonalities between the fields of universal services and financial services law could support an application of a similar approach in both fields.25 In these fields, the privatisation of former state monopolies has 19 C-92/11 RWE Vertrieb v Verbraucherzentrale NRW, ECLI:EU:C:2013:180, para 53; C-96/14 Jean-Claude Van Hove v CNP Assurances SA, ECLI:EU:C:2015:262, para 41; C-472/10 (Invitel) para 28; C-143/13, Bogdan Matei, Ioana Ofelia Matei v SC Volksbank România SA, ECLI:EU:C:2015:127, paras 59–60; C-26/13 (Kásler) para 75; C-76/10 (Pohotovost’) para 71; Case C-415/11 (Aziz), paras 69–70; C-472/10 (Invitel) para 23. 20  Commission of the European Communities, Proposal for a Council Directive on unfair terms in consumer contracts, COM(1990) 322 final, 14. 21  European Parliament, Amendment 185, Proposal for a Regulation, Annex I, Art 100, point g, available at www.europarl.europa.eu/sides/getDoc.do?type=TA&language=EN&reference=P7-TA2014-0159. 22 Since June 2017, roaming charges are prohibited, see European Commission Press Release ­‘Bringing Down Barriers in the Digital Single Market: No Roaming Charges as of June 2017’, available at: www.europa.eu/rapid/press-release_IP-15-5927_en.htm. 23  See, for example, in Art 20(2) Universal Services Directive 2002/22/EC, Art 3(3) Natural Gas Directive 2009/73/EC, and Art 3(3) Electricity Directive 2009/72/EC. 24  Thus Rott (2007) 56. 25  This is the basis of my claim put forward in Domurath (2013).

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led to the loss of the collective relationship between state-owned public service providers and citizens (substitutionalisation), for which the consumer is compensated through individual rights (consumerisation), and the service provider has to adhere to certain obligations (economisation) in order to avoid the social exclusion that can result from privatisation.26 This means that because of the substitution of public with private services, consumers shall be compensated with individual rights and financial service providers have to adhere to certain obligations. As for substitutionalisation, we can observe that, similarly to (current) universal services, public financial services have been increasingly replaced by private financial services. Public savings banks have lost significant market share vis-àvis commercial banks in recent decades.27 This entailed a loss of a public-interest obligation, as savings banks have traditionally promoted savings and engaged in lending to the poor as part of a more charitable business conception and have been, at least initially, reluctant to promote consumer credit.28 With the expansion of commercial banks, consumer credit also expanded at the expense of a more savings-oriented financial culture. Furthermore, in the field of mortgage credit, states have increasingly pushed towards privatisation of the housing after World War II. Obtaining mortgage credit forms an integral part of this broader agenda of the privatisation of welfare. However, even though the universal-service rationale has arrived in the field of financial services with the Directive 2014/92/EU29 regarding universal access to a payment account, it is missing from the framework governing mortgage credit. These developments arguably prompt the need for consumerisation and ­economisation. Taking into account the parallels between universal and financial services, we can see that the current legal framework in the field of mortgage credit lags behind the framework governing access to universal services. Privatisation has taken place with regard to both the housing and the credit market. However, in order to avoid the social exclusion that can follow privatisation, the consumer is not equally compensated through individual rights and respective obligations of the lender. The consumer in a mortgage credit relationship does not have a right to an ‘adequate’ pricing of the credit. The reason for this discrepancy could lie in the duality of the field of mortgage credit: the property is obtained from one party, and the credit is obtained from another. It is, therefore, a legitimate question to ask why, if states have withdrawn from the public provision of housing for their citizens, a creditor bank that merely gives a credit to a consumer for buying a house should compensate for this withdrawal by making sure that the consumer can afford the house.

26 

Thus Micklitz (2009b) 12ff, 27. Bülbül et al (2013). 28  Belvederesi-Kochs (2012) 42. 29  Directive 2014/92/EU of the European Parliament and of the Council of 23 July 2014 on the comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features, [2014] OJ L257/214. 27 

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However, we must see this duality as part of the same phenomenon: the privatisation of welfare, where access to private credit plays the decisive role. Without access to affordable credit, the privatisation of welfare cannot work. So if in most cases ­residential property can only be purchased through the obtaining of credit, this credit must be made affordable for consumers in order to enable the safety of the private dwelling in terms of providing for a family home. Thus, it is possible to justify the imposition of price adequacy controls mechanisms in consumer mortgage credit law with the increasing privatisation of welfare, for which the consumer must be compensated with the right to affordable housing and credit for the financing of such home. This does not mean that mortgage credit should be seen as a universal service within the EU legal framework. But the analogy might serve as a justification for intrusion into the private autonomy of the contractual parties.

III.  Event Vulnerability The approach of the MCD to the acknowledgement of external risk factors, as we have seen above, is largely based on the provision of warnings. In addition, ­Article 18(6) MCD sets out the obligation for Member States to ensure that lenders illustrate ‘the possible risks linked to a significant increase in the borrowing rate’ by means of the illustrative APR. There is considerable room for improvement in this legal framework with regard to event vulnerability. Consumers need flexibility in order to manage their finances when an unexpected event occurs. This is acknowledged by the FCA, even though it focuses on problems of temporary delegation of financial decision to family members or carers especially for individuals who fall sick.30 In addition, the FCA identified inconsistent approaches to temporary forbearance with regard to mortgage lenders’ arrears management, so that consumers with special circumstances could not get appropriate assessment of their needs from their financial services provider.31 Any improvement of the legal framework to protect consumers vulnerable to external events from welfare losses in the field of housing must take into account the complexity of the issue as well as the special nature of mortgage agreements. There is no doubt that it is impossible to foresee all events that might happen in the future with a negative impact on the consumer’s capacity to repay the loan. This is even more so in contracts of a long duration,32 such as mortgage agreements.

30 

Coppack et al (2015) 55–56. ibid, 57–58 with reference to a former study. 32  Thus Nogler and Reifner (2014). 31 

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A.  Unsuitability of Insurance First, we shall refute attempts to deal with external risk factors for default and further welfare losses through insurance. For example, concerning the vulnerability of (bubble) borrowers to the possible devaluation of home value, Shiller has been at the forefront of suggesting compulsory home equity insurance.33 Even though the idea is in itself well targeted to the problem, I am critical of such an approach. It might be that the whole process of purchasing a secured home will be become more complicated if consumers have to sign yet another agreement that affects their personal finances. More importantly, insurance contracts might be subject to the same problems as other securities or financial innovations, because of cognitive limitations of the people designing them. Mian and Sufi have pointed at research which shows that securities usually neglect precisely those risks that are neglected in the financial system: In other words, the securities sold to investors will load heavily on the neglected risk itself. For example, if investors convince themselves that house prices throughout the country cannot fall by more than 10 percent or more, then bankers will create securities that retain their value in every scenario except when house price throughout the country fall by 10 percent or more.34

This sceptical approach to insurance as a way of preventing default and other ­welfare losses would extend to the possibility to insure against exchange-rate risk for foreign-currency borrowers or unemployment insurance for precarious ­workers. It should be noted, in addition, that unemployment insurance is not designed to deal with long-term interruptions of income.35

B.  Creditworthiness Assessment Instead of insurance, we can examine the possibilities of making more robust the framework concerning CWAs in order to allow for a more realistic incorporation of external risk factors and, thus, the development of a suitable response to event vulnerability.

(i)  Protective Ambit The protective scope of CWAs could allow a broadening of the factors considered in the assessment. The ambit of the CWA can be understood as comprising two goals. The immediate goal of the CWA is—according to Article 18(1) MCD—the verification of the prospect that the consumer will be able meet her 33 Shiller (2008). The roots of home equity insurance go back almost 100 years: Caplin et al (2003) 5. 34  Mian and Sufi (2014) 114–15 with further references. 35  See Zywicki (2005) 1505.

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obligations under the credit agreement. To this end, the lender shall take the relevant factors into ‘appropriate account’. Article 20(1) MCD clarifies that such factors include the consumer’s income and expenses as well as other financial and economic circumstances. On the one hand, the CWA protects the lender’s interest in repaying the loan by ensuring that the borrower has sufficient financial capacity to do so. On the other hand, the CWA also protects the borrower from assuming financial obligations she cannot honour. This makes it clear that the interests of both contractual parties shall be protected and that the responsibility for the borrower’s repayment ability shall be shared. This protective purpose of the CWA provisions was confirmed by the CJEU in Credit Lyonnais, when it ruled that consumers shall be protected against the irresponsible granting of credit agreements which are beyond their financial capacities and which may bankrupt them.36 It can be argued that this objective of the CWA also includes the prevention of the loss of the residential property.37 This claim is supported both by the legislative history of the MCD and by concrete provisions in the MCD. As for the legislative history, the Commission Staff Working Paper on ‘National Measures and Practices to Avoid Foreclosure Procedures for Residential Mortgage Loans’, which accompanied the MCD proposal, states that the promotion of responsible lending and borrowing practices through the MCD aims at offering affordable loans which reduce the need for foreclosures of properties.38 This aim of the CWA also informs many provisions in the MCD. For example, Article 28(1) MCD and Preamble 27 MCD acknowledge that creditors should be encouraged to exercise ‘reasonable forbearance’ and to try and resolve issues of emerging credit risk before initiating foreclosure proceedings. Similarly, the objective to prevent the loss of the secured property underlies Article 18(3) MCD on the value of the property. The provision acknowledges the widespread overoptimism about the favourable development of housing prices before the last financial crisis, which led many lenders to extend credit to consumers who did not have large financial resources. These examples show that the MCD is based on an understanding of the far reach of mortgage agreements in terms of their embeddedness in the larger regulatory environment and economic situation and their importance for consumers as a means to secure a crucial part of their living standards.

(ii) Parameters Taking seriously the aim of preventing default and welfare losses would entail a change of responsibility from the borrower to a shared responsibility of both

36 

CJEU C‑565/12 (Crédit Lyonnais) para 43. Rott (2014a) 203, with further references; Rott (2015a) 10. 38 Commission Staff Working Paper, ‘National Measures and Practices to Avoid Foreclosure ­Procedures for Residential Mortgage Loans’ accompanying document to the Proposal for a Directive of the European Parliament and of the Council on credit agreements relating to residential property, SEC(2011) 357 final, 3. 37 

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the lender and the borrower for the repayment of the loan. With its double aim of protecting both parties’ interests in the repayment of the loan, the CWA is the appropriate tool for sharing the responsibility for this repayment, especially when it comes to external risks that are not within the realm of influence of neither party. It can be argued that the loss of employment or other adverse events qualify as circumstances for which the contracting parties should share responsibility. At the moment, such events are only referred to in terms of general warnings in the ESIS (see above), placing the responsibility for the consequences of those risk factors on the consumer. In Article 18(3) MCD, it is already implicitly acknowledged that risk factors outside of the credit relationship for the CWA can have an impact on the financial situation of the consumer and influence the creditgranting process. It would not, thus, be alien to the MCD to include other external factors as well. For example, with regard to the lender’s obligation to base the CWA on not only on the consumer’s income and expenses but also on ‘other financial and economic circumstances’, we could envisage an obligation to take into account other external risk factors and the respective event vulnerability of consumers. As regards precarious workers, it can be argued that the CWA, if it is to be suitable to predict the repayment capacity of the borrower, must factor in the consumer’s working situation. The lender could be required to take into account whether a consumer is in indefinite or fixed-term employment, whether the consumer works (temporarily) in part-time employment, or whether the consumer is at a high risk of being made redundant in certain situations of microeconomic adjustment or general macroeconomic downturn. (For example, work in the construction sector is usually strongly hit in such times.) The higher the risk of losing employment during the long contract period of a mortgage loan, the stronger should be the indication to make the loan unavailable to the consumer, make it dependent on supporting requirements or offer lower credit amounts. One could also envisage to factor into the CWA a buffer of a certain percentage in accordance with the minimum amount of instalments the consumer could still pay even after having lost her job. The social benefits the consumer might be entitled to in such a case could be a guideline for the amount that should be the basis for the CWA calculations. The lender takes an assumed monthly ‘fictive salary’ based on the amount of social benefits as a basis that is approximated to the amount of social benefits the consumer would be entitled to in the event of unemployment. Concerning bubble borrowers, the provisions in the MCD that seek to ensure that the CWA is not solely based on an evaluation of the housing price are to be welcomed. Much depends here on the quality of standards of property value evaluation. However, this topic is outside the scope of this book. Similarly, the CWA can provide a window for the lender to factor in the currency-exchange risk or the risk of rising interest rates that goes beyond the current warning included in Article 23(4) MCD and the guidelines for the calculation of the reference rates in Article 24 MCD. In addition to warning the consumers about the possibly adverse changes in exchange and interest rates, the lender could be obliged to factor those fluctuations into the CWA. This could be done

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through an obligation of the lender not only to calculate and make the illustrative APR accessible to the consumer, but also to make this APR the basis for the actual calculations of the cost of credit. Similarly, with regard to foreign-currency loans, the CWA calculations can also be based on a disadvantageous development of exchange and interest rates. Strengthening the CWA in this way, both the lender and borrower would assume responsibility for the repayment of the loan. The lender assumes responsibility by undertaking a more realistic CWA and the borrower by providing all the information necessary.

(iii) Liability We have seen above that the aim of the CWA is to ensure the interest of both parties in the repayment of the loan. Both parties have obligations with regard to the CWA. It is, hence, natural to assume that this is a shared responsibility of the lender and the borrower for the granting of the credit, which would also entail liability of both parties. The liability of the consumer already exists with regard to the enforcement of the contract. The rationale for including liability of the lender lies in the contributory negligence of the bank in granting credit to consumers who will not be able to repay the loan, for example for the broader purpose of keeping a credit demand high.39 The current EU framework does not, however, impose liability on the lender, in particular not for the breach of the obligation to undertake a CWA or the obligation not to grant credit in case of a negative CWA outcome. Even though, according to Articles 23 CCD and 38 MCD, the Member States shall lay down rules on ‘effective, proportionate, and dissuasive’ penalties and sanctions, respectively, for infringements of the implementing provisions, the provisions do not specify any sanction or penalty. The proportionality or dissuasiveness of a sanction are within the realm of Member State competence and can only be questioned through judicial review. Despite the rich case law on this matter that continuously entrenches the procedural autonomy of the Member States through the principles of equivalence, effectiveness (see Chapter 3) and state liability,40 there exists a considerable divergence in the Member States with regard to sanctions, which questions the extent to which this ex post assessment of the sanction can be an efficient tool for the prevention of default and welfare losses.

39 

Thus Rott (2003). The Queen v Secretary of State for Transport, ex parte: Factortame Ltd and ­others, ECLI:EU:C:1990:257 (Factortame I), C-271/91 M Helen Marshall v Southampton and SouthWest Hampshire Area Health Authority, ECLI:EU:C:1993:335; C-33/76 Rewe-Zentralfinanz eG and Rewe-Zentral AG v Landwirtschaftskammer für das Saarland, ECLI:EU:C:1976:188; C-158/80 Rewe-Handelsgesellschaft Nord mbH v Hauptzollamt Kiel, ECLI:EU:C:1981:163; Joined Cases C-6/90 and C-9/90 Andrea Francovich and Danila Bonifaci and others v Italian Republic, ECLI:EU:C:1991:428; C-432/05 (Unibet) ECLI:EU:C:2007:163. 40 C-213/89

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Specific sanctions are already a feature in several European jurisdictions. For example, the Swiss Federal Law on Consumer Credit (FLCC) imposes clear obligations with regard to the evaluation of the borrower’s financial situation. If a creditor violates ‘seriously’ his obligation to undertake a CWA according to the criteria laid out in Article 28 FLCC, he not only loses the amount of the credit together with the interest and charges but the consumer can also demanded back the amounts already paid (Article 32(1) FLCC). In the case of ‘slight’ violations, the creditor still loses the interest and the charges (Article 32(2) FLCC). Similar sanctions can be found in South African legislation and French jurisprudence.41 In Germany, a lack of liability in the context of consumer credit is now being overturned in the field of mortgage law. The Draft Implementation of the MCD provides in § 505d for the reduction of interest payments to the current interestrate level and a loss of damage claims for breach of contract by the consumer, if that breach is based on a circumstance that would have led to a denial of credit had the CWA been undertaken properly.42 The use of sanctions in those legal orders implies that the creditor would violate his obligations when he grants a credit to a consumer who, according to this definition, will not be able to repay without burdening his unseizable property. The prospect of losing all claims against consumers could have a strong deterrent effect, as it, in effect, strips the contract of any force. In this context, the rationale of the sanction is the fact that credit was granted despite the danger of overindebtedness—it is not the fact that credit was granted under unfavourable conditions.43 The disadvantages of an EU-wide liability is entrenched Member State ­autonomy. Nevertheless, given the EU-wide activity of banks, it can be argued that all Member States should have the same minimum sanctions in place for breaching the obligation to undertake a CWA and make its results fundamental to the subsequent lending decision.

C.  Renegotiation of Mortgage Debt What if a CWA is properly undertaken, however, and the consumer defaults on his mortgage loan anyway, even though external market risks were factored in? This question goes right to the heart of the problem of risks in long-term agreements. There will always be unforeseeable events that impact the payment ability of the borrower during the contract period. While in the case of a foreseeable event the parties can make respective promises to perform even if the event actually happens, not all contingencies can be spelled out ahead of time. In those cases, the

41 

For further reference, see Atamer (2011) 194ff. Concerning France, see Rott (2014b). consumer credit, a subjective right of the consumer can only be construed through a ­damage claim based on the violation of an accessory obligation, §§ 241(2), 280(1) BGB: see Rott (2015b) para 79. 43  Rott (2003). 42 For

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possibility to renegotiate or discharge debt becomes important as a means to ease the debt burden and prevent a spiral of welfare loss, default, overindebtedness, enforcement and eviction. Two specific features of mortgage contracts must be taken into account when eliciting the possibility of re-negotiation. First, we must consider that mortgage credit contracts usually cover a long period of time. It can be assumed that in longterm contracts it is more difficult to anticipate future problems or difficulties.44 As a consequence, parties may prove incapable of making provisions for the occurrence of adverse external events during the contract period. Second, because of the social dimension of mortgage law, the need to be able to adapt contractual terms can also considered to be higher in mortgage credit agreements. A possible spiral of welfare losses can be triggered by unforeseen events, interfering with access to a home as a core necessity of a decent living.45

(i)  Proposals after the Financial Crisis With a substantial impetus since the 2008 global financial crisis, economists view the renegotiation of debt favourably. The International Monetary Fund has accepted the view that ‘bold debt restructuring’ can significantly reduce debt burdens and foreclosures.46 In addition, Mian and Sufi, Shiller, and Pistor have argued for the necessity of flexible contracts that allow the renegotiation of debt according to changed circumstances. In the end, this debt restructuring is a way to share market risk between the contractual partners. Shiller proposes renegotiation of the contractual terms of ‘continuous workout mortgages’, referring to the continuously adjustable terms of mortgage agreements in response to evidence of the changing ability to repay and of changing conditions in the housing market.47 Referring to practices during periods of high inflation, this automatic ‘workout’ is to be made part of the initial contract, so that it can be scheduled every month.48 Pistor also argues for a modification of contractual obligations with a view to taking account of uncertainty in the future as a tool to enhance efficiency.49 She bases this claim on the observation that law is more ‘elastic’ and more discretionary in the core of the financial system, but more ‘binding’ in the periphery, which leads to a higher likelihood of default at the periphery.50 Mian and Sufi claim that the bailout of banks at the expense of taxpayers and instead of mortgage debt relief for households has made the financial crisis and its impact on households worse.51 They provide evidence that debt relief 44 

Momberg Uribe (2011) 7. Nogler and Reifner (2014) 5–6, 43. Leigh et al (2012). 47  Shiller (2008) 157. 48  ibid, 157. 49  Pistor (2013) 329. 50  ibid, 320. The term ‘periphery’ relates to both the relation between countries in the global financial system but also to the hierarchy of the financial system within one country. 51  Mian and Sufi (2014) 119ff. 45  46 

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is a more effective policy than bailout of financial institutions or general financial stimulus52 and that it has positive impacts on the overall economy, because, contrary to traditional views, it provides impetus for employment.53 Making an analogy with the repayment of student loans, which in some countries is contingent upon the income earned after the end of education, they advocate the introduction of a shared-responsibility mortgage (SRM), which protects the borrower from the loss of equity should house prices decline by proportionally reducing mortgage payments if the reference local house-price index falls below the level prevailing at the time of purchase.54 In order to avoid the lender compensating for bearing this downside risk by charging higher interest rates, they propose a 5 per cent capital-gain rule, which provides the lender with a 5 per cent share of the capital gain should the property be sold or refinanced.55 Based on this risksharing principle, the SRM would adequately protect homeowners from a loss of equity and, thus, the economy from a spiral of widespread foreclosures, decreases in household spending and unemployment.56 In this way, Mian and Sufi encourage the absorption of losses through renegotiation under the SRM by the lender, pointing out the benefits for the overall economy prompted by an increase of household spending (boost in demand).57 The legal literature has recently found commentators in favour of renegotiation. Nogler and Reifner describe the rebus sic stantibus principle with regard to what they term ‘life term agreements’. Principle 1.10.10 of their Principles of Life Time Contracts58 states that adaptation of a contract to new social and economic circumstances is indicated if: those circumstances, which have formed the basis of the lifetime contract have changed to the extent that the social nature of the contract is jeopardised; the hypothetical will of the parties is such that the parties would not have entered into the contract, or would have entered only on different terms, had they foreseen the change; it cannot be reasonably assumed that one of the parties continues to comply with the contract. In this vein, Pulgar also advocates the rebus sic stantibus principle as an alternative to bankruptcy procedures.59 The use of unclear concepts such as social nature or reasonably implies the need for further concretisation in the contract law context. But such terms also show the difficult nature of the rebus sic stantibus principle and the difficulties involved in applying it. These difficulties are described on the following pages. 52 

ibid, 119–51, 165. ibid, 149. 54  ibid, 171–72. 55  ibid, 173–74. The 5% gain is based on historical average and thus is considered to compensate adequately for the downside protection of the borrower. 56 ibid. 57  ibid, 177–78. With banks earning a return for the bearing of those risks (through the capital-gain rule) and households being protected when such risks materialise (through reference of payments to the local house-price index), mortgage agreements become equity-like contracts that are contingent on the risks external to the immediate contractual relationship (ibid, 186). 58  Nogler and Reifner (2014) 51. 59  Pulgar (2014). 53 

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Before drawing conclusions for mortgage agreements and the prevention of default and further welfare losses, we will examine the acknowledgement of a change in circumstances in the EU and in Member States’ legal order as well as in other international legal instruments.

(ii)  The Legal Concept of ‘Change in Circumstances’ Some kind of means to deal with a change in circumstances is acknowledged in many legal orders. For example, the UN Convention on Contracts for the International Sale of Goods (CISG), the UNIDROIT Principles of International ­Commercial Contracts (PICC) as well as the Principles of European Contract Law (PECL) and the Draft Common Frame of Reference (DCFR) include provisions on change in circumstances. Article 79 CISG excludes liability for a failure to perform if the failure was due to an impediment beyond the control of the aggrieved party, who cannot be reasonably expected to take the impediment into account at the time the contract was concluded. It applies to impossibility. It is not clear, however, whether Article 79 CISG also applies to cases of hardship. The g­ eneral tendency points at a reluctance to employ the hardship doctrines for examples in cases of price fluctuations (even with variations of more than 100 per cent).60 Articles 6.2.2–6.2.3 PICC allow parties to request renegotiation (and, upon their failure, to bring the matter before court) in cases of hardship, when a reasonably unforeseeable event occurring after the conclusion of the contract (or of which the aggrieved party has knowledge after the conclusion) fundamentally alters the equilibrium of the contractual obligations, beyond the control of and without the assumption of risk by the aggrieved party. Article 6:111 PECL reflects the existence of the concept of change in circumstances in the European legal orders. It allows termination or adaptation of the contract, if the performance has become excessively onerous after a reasonably unforeseeable change of circumstances following the conclusion of the contract, and if the parties are not required to bear the risk of the occurrence of that event. Similarly, Article III.1:110 DCFR establishes an exception to the pacta sunt servanda principle if, after an exceptional change of circumstances, performance of a contractual obligation becomes so onerous that it would be manifestly unjust to hold the debtor to the obligation. It is noteworthy that Article III.1:110 DCFR makes clear in its paragraph 3 that the unforeseeability concerns not only the possibility of the occurrence of the event, but also the scale of the change of circumstance. Despite the acknowledgement of that concept in international legal orders and despite renewed academic interest in the principle in the years since the financial crisis, the potential of the rebus sic stantibus concept is neglected by EU policymakers and jurisprudence alike. On the EU level, there is almost no talk about it, apart from a reference to the ‘modification of loan terms’ in the Commission 60 

Momberg Uribe (2011) 194–95.

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Staff Document accompanying the MDC Proposal on ‘National Measures to Avoid Foreclosure’. Even though therein the Commission identifies a few possibilities for modifying the terms of the loan or its execution in some Member States as a way to avoid foreclosure proceedings, encouraging ‘a dialogue’ between the lender and the borrower,61 actual provisions facilitating this dialogue on modification of contract terms have not been included into the text of the MCD. The CJEU has not dealt much with the rebus sic stantibus either. In RWE, ­however, it had to decide on the fairness of a unilateral price increase by a gas supplier. The CJEU emphasised the two legitimate interests of the contractual parties: on the one hand, the supplier’s interest in guarding against a change in circumstances, and on the other, the consumer’s interest in knowing and being able to foresee the consequences of a unilateral price increase and in having data available to allow her to react most appropriately to the new s­ ituation.62 But this does not amount to a recognition of unforeseen events as possibly altering contractual obligations.

(iii)  ‘Change in Circumstances’ in European Legal Orders In national legislation, the principle of rebus sic stantibus is acknowledged in ­different forms and has increasingly been invoked in a number of national proceedings. However, national judges have been hesitant to allow the adverse effects of the financial crisis on the financial capacity of individuals to serve as a possible basis for allowing the adjustment or change of contractual terms.63 In what follows, the terms rebus sic stantibus and change in circumstances are used as overarching terms to refer to all concepts that deal with some kind of enabler for renegotiation or change of contracts. (a)  The ‘Continental’ and English Approaches A look at the legal orders of Member States and at international legal instruments helps to elucidate the concept and its difficulties. Even though the overview provided here is only exemplary, it will become clear that despite the theoretical and practical difficulties involved, similarities between the different legal instruments can be deduced for further work with this concept in this book. England, Belgium, France In English law, the frustration of contract principle aims at adjusting or renegotiating contractual commitments to take account of a drastic change in circumstances

61 Commission Staff Working Paper, ‘National Measures and Practices to Avoid Foreclosure ­rocedures for Residential Mortgage Loans’, accompanying document to the MCD Proposal, P SEC(2011) 357 final, 5–6, 11. 62  C-92/11 (RWE) ECLI:EU:C:2013:180, para 53. 63  See country reports in Domurath et al (2014).

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since the contract was signed; or at terminating the agreement.64 The doctrine is applied when relief from contractual obligations cannot be derived from the ­parties’ (hypothetical) intentions or from a flaw in the contracting mechanism.65 As a legal consequence, the contract is terminated; English courts do not have the competence to modify the rights and obligations of the parties.66 However, apart from a few consumer cases in which the parties were released from their contractual obligations, English courts have resisted the broad application of the principle.67 It is usually confined to the physical disappearance of the object of the contract. In French civil law, the new Civil Code codified jurisprudence in Article 1196, according to which renegotiation can be demanded upon an unforeseen change of circumstances that make the execution of the contract excessively onerous for one party.68 Historically, the courts have been reluctant to allow any expansion of the doctrine of imprévision, and the impacts of the legal reform are not yet foreseeable. Until a reform in October 2015, no specific rules on changed circumstances existed and the principle of pacta sunt servanda was a much observed principle.69 The concept of imprévision served as a narrowly applied exception and was more established in administrative law.70 In general, therefore, the creditor retained his right to specific performance from the debtor even though such performance might have become very cumbersome.71 Modern case law has recognised i­ mprévision in terms of a duty to renegotiate if performance by one party has become excessively onorous, thereby radically changing the original contractual equilibrium.72 Otherwise, a party could only be exonerated from performance of a contract in case of force majeure, an accident (cas fortuit) or an external cause (cause étrangère)—concepts used interchangeably in the French literature.73 In Belgium, where French law has been influential, the doctrine is applied in a similar way. In an alimony case the Belgian Supreme Court ruled that a husband could be released from paying alimony because of a significant decrease in his salary and because his former wife had established a new household with a new partner.74 64 

Hondius and Grigoleit (2011) 8–9. ibid, 6. 66  Baranauskas and Zapolskis (2009) 203. 67  ibid, 203. Krell v Henry [1903] 2 KB 740 is an example of a judgment in which the Court of Appeal released a party from its contractual obligation to pay the outstanding rent for a flat because of an implied condition in the contract that the defendant would be able to see the coronation procession of King Edward VII, which did not take place on the date set. 68  Text available at www.justice.gouv.fr/publication/j21_projet_ord_reforme_contrats_2015.pdf. 69  Lequette (2015) 110. 70  Momberg Uribe (2011) 50–51. 71  Baranauskas and Zapolskis (2009) 199. This stance is also accepted in the French legal literature, see Lequette (2015) 115ff with further references. 72  Momberg Uribe (2011) 55ff. 73  Baranauskas and Zapolskis (2009) 199. See also Lequette (2015) 111ff for the rejection of the theory of imprévision in French jurisprudence. 74  Philippe (2015) 104. 65 

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Germany, Austria, the Netherlands In Germany and Austria,75 the rebus sic stantibus is dealt with under the concept of Störung der Geschäftsgrundlage. This recognises that the parties conclude a contract based on the assumption that the desired legal effect should only exist under certain circumstances.76 The mutual understanding of the parties’ expectation for the future performance of the contract is seen as the foundation of the contract, which can change fundamentally and thus affect the contractual equilibrium.77 Thus, § 313 of German Civil Code (BGB) establishes that the contract adaptation may be claimed: —— if circumstances upon which a contract was based have changed materially after the conclusion of the contract; —— if the parties would not have concluded the contract (or would have done so upon different terms) had they foreseen that change; and —— if it cannot be reasonably expected that a party would have agreed to be bound by the contract in its unaltered form, especially when taking into account the contractual or statutory allocation of risk.

In such a case, the courts have the right to exonerate the parties from the performance of the contract or change its terms to adapt to the new circumstance.78 The use of the concept of Störung der Geschäftsgrundlage reflects a value judgement according to which the risk of a discrepancy between expectation and reality is to be distributed on both contracting parties. The ‘correction’ of the contract is to be forced upon the resisting party, if and because the parties cannot agree on an adequate compromise between their interests.79 A case of application are long-term contracts in particular.80 Nevertheless, the courts maintain the exceptional character of the doctrine, often relating to times of war and inflation.81 The sanctity of contracts is still the starting point for the adjudication. In this vein, the concept of Störung der Geschäftsgrundlage is only considered a subsidiary legal tool to the concepts of mistake, impossibility and complementary interpretation of the contract.82 With regard to remedies, however, priority is given to the adjustment of terms over the termination of the whole contract, reflecting the rationale of abiding by the initial party’s will to have a contract in the first place.83 Similarly, in Dutch law, the distinction between the concept of unforeseen circumstances, which is enshrined in special provisions of the Dutch Civil Code

75  Hondius and Grigoleit (2011) 55ff; in Austria the concept is not incorporated into the Civil Code, but is accepted by courts and scholars. 76  Baranauskas and Zapolskis (2009) 204 with references to academic thought in the 1920s. 77  ibid, 204–05. 78  ibid; Hondius and Grigoleit (2011) 62–63, 68–69. 79  Finkenauer (2016) 2. 80  ibid. 6. 81  ibid. 23. 82  Hondius and Grigoleit (2011) 55ff. 83  ibid, 63–64.

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and considered lex specialis to the broader principle of good faith,84 and the concept of hardship (force majeure) is a matter of liability: the defaulting party is liable if it should have foreseen the hardship. The invocation of the unforeseen circumstances doctrine requires unforeseen circumstances, which relate to the future and have not become part of the contractual agreement, to be such that the other party cannot expect the agreement to remain unmodified with a view to reasonableness and fairness.85 Former Communist Legal Regimes In Slovenia, Articles 112–115 of the Civil Code enshrines the rebus sic stantibus principle. It allows for dissolution of a contract upon demand of one party or the adjustment of terms with the consent of the counterparty if a significant change in circumstances occurs after the conclusion of a contract, which renders the performance of the obligations more difficult or frustrates the contract’s purpose so that the contract no longer complies with the parties’ expectations. Furthermore, it must be unjust to keep the contract in force as concluded. In the Lithuanian Civil Code, Article 6.20486 allows the parties to modify the contract upon a change of circumstances if the performance of a contract is obstructed under (at the time of conclusion) not reasonably foreseeable circumstances that occur or become known to the aggrieved party after the conclusion of the contract, and that are beyond the control of and the risk of which has not been assumed by the aggrieved party. If the parties fail to reach an agreement about the modification of the contract, they may bring an action before a court, which in turn can either dissolve the contract or modify its conditions with a ‘view to restoring the balance of the contractual obligations of the parties’. The court has the power to interpret a party’s will in order to base its decision on good faith, reasonableness or principles of justice. Interestingly, for the event vulnerability of foreign-currency borrowers, the Lithuanian Supreme Court has approved ‘hardship’ in a case of a lease agreement in which the value of the performance and the money the lessor received had declined because of a significant change in exchange rate between the ­Lithuanian currency and the US dollar since the time it was pegged to the US dollar (time of conclusion of agreement) to the time it was pegged to the euro (time of ­hardship).87 The Lithuanian Supreme Court confirmed that the contract could be modified so as to reflect the changed circumstances and restore the contractual equilibrium.88

84 

ibid, 70. ibid, 71–72 with further references to the Civil Code and jurisprudence. Text available in English at www.wipo.int/wipolex/en/text.jsp?file_id=202088#LinkTarget_10772. 87  Baranauskas and Zapolskis (2009) 211. 88  ibid, 211. 85  86 

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Mediterranean Jurisdictions The Italian Civil Code stipulates in Article 1467 that a party who owes the performance of an obligation within a continuous or periodic contract can demand the termination of the contract should extraordinary and unforeseeable events occur that render the performance excessively onerous.89 It encompasses contracts for continuous or periodic performance, the performance of which has become an excessive burden caused by supervening events that exceed the normal risk of contracts. Aleatory contracts are outside of the scope of this provision (Article 1469 CC). In this context, Italian courts have issued contrasting rulings concerning inflation and deflation as an ‘extraordinary and unforeseeable event’.90 As a consequence of the successful invocation of the eccessiva onerositá, the affected party can ask the court to terminate the contract. The rebus sic stantibus principle was introduced into the Spanish legal order by jurisprudence. The Spanish Supreme Court ruled that, for equity reasons, the clause can be exceptionally applied if there is an extraordinary alteration of the circumstances (unforeseen radical circumstances) between contract conclusion and the performance of the contractual obligation that results in an exorbitant disproportion between the obligations assumed by the parties, which leads to an annihilation of the balance of obligations and, thus, a collapse of contract.91 Nevertheless, in a recent judgment relating to interest-rate swap contracts, the Supreme Court ruled that the aleatory nature of this specific contract leads to the inapplicability of the rebus sic stantibus principle.92 The risk allocation of the parties concerning a possible drop in interest rates is precisely part of the aleas that characterises the contract. In Portugal, change of circumstances is dealt with in a similar way as in Italy and Spain. Article 437, no 1 of the Portuguese Civil Code gives the right to terminate an agreement if a circumstance on which the contract is based on changes ­unexpectedly, if good faith is affected and the change is not covered by risks inherent in the contract.

89 

Cerchia (2015) 122–23. See also Hondius and Grigoleit (2011) 118ff, Momberg Uribe (2011) 71ff. See Momberg Uribe (2011) 76. 91 Text available at www.testolegge.com/codice-civile/articolo-1467; Murga Fernández (2015) 138–39 with further reference to Spanish case law. 92  As explained by Murga Fernández (2015) 144 with reference the Supreme Court judgment STS 29 October 2013 (CENDOJ 5479/2013). Murga Fernández contends that the contract could, however, be terminated not by virtue of the rebus sic stantibus principle, but based on erroneous mutual consent that was based on the disregard of the effects a possible drop in interest rates could cause (146–48). A similar reasoning can be found in Italian jurisprudence and academic discussions: see Cerchia (2015) 126ff with reference to a first-instance court ruling of 2005 and the support for it in Italian academic literature. In October 2015, the Spanish Supreme Court decided the issue of interest-rate swap contracts based on the non-transparency of the respective clauses, see judgment of 15 October 2015, No 563/2015, available at: www.poderjudicial.es/portal/site/cgpj/menuitem.65d2c 4456b6ddb628e635fc1dc432ea0/?lang_choosen_furl=es&vgnextoid=3fa057432c390510VgnVCM100 0006f48ac0aRCRD&vgnextfmt=default&vgnextchannel=45b9fdcc164f0310VgnVCM1000006f48ac0a RCRD&lang_choosen=en. 90 

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A judgment of the Portuguese Supreme Court with regard to a derivative contract, an interest-rate swap,93 has caused a stir in the European legal orders and prompted discussions and a renewed interest in the potential of the rebus sic ­stantibus principle. The underlying loan contract had a variable interest rate linked to the Euribor rate, and the interest-rate swap contract was supposed to mitigate the risks of fluctuations of the Euribor. When the interest rate suddenly dropped, the borrower had to pay significantly higher interest. Before the courts, he argued that the contract had been concluded on the mutual assumption that the interest rates would increase in the future and that the sudden and unforeseeable severe decrease of interest rates was not covered by the contractual distribution of risks.94 The Supreme Court acknowledged the argument of the defendant concerning the aleatory nature of the interest-rate swap contract. But it concluded nevertheless that in the event of a change of circumstances of extraordinary magnitude that causes a major imbalance between the parties’ obligations, it is contrary to good faith to insist on the performance of the contract as initially agreed. This change of circumstances was not considered to be covered by the contractual distribution of risk because the borrower had to bear the consequences of a sharp decline in interest rates, whereas the bank was not obliged to, in turn, bear the responsibility for a sharp increase in the interest rate. The Portuguese Supreme Court sets out two requirements for the application of the change-of-circumstances doctrine of Article 437 of the Portuguese Civil Code, namely: an abnormal and relevant alteration of the circumstances on which the parties have based their decision to conclude the contract; and the gross contradiction of the performance of the obligation to the principle of good faith, which is not covered by the risks of the contract. (b)  The ‘Nordic’ Approach In the Nordic countries, a change of circumstances is dealt with as a matter of fairness of contract. The fairness control is to be found in Articles 36 of the respective contract laws.95 Articles 36 of the respective Contract Acts is considered a more modern approach to the hitherto solely applicable doctrine of frustrated assumptions.96 The legal consequences are similar to the change-in-circumstances approach, with the principal effect being the ineffectiveness of the promise and the cessation of the party’s obligations, but also the modification of those obligations.

93  Decision of the Supremo Tribunal de Justica of 10 October 2013, available at: www.dgsi.pt/jstj.nsf /954f0ce6ad9dd8b980256b5f003fa814/83a1d4ae8a10876180257c0600300716?OpenDocument. 94  The following remarks are based on the summary of the case in Momberg Uribe (2011) 82ff. 95 Sweden: Bernitz (1997) 19, fn 9; Sweden and Denmark: Hondius and Grigoleit (2011) 106; ­Finland: Wilhelmsson (1993a) 439; Iceland: Act No 7/1936 on contracts, agency and void legal instruments, available in English at www.eng.atvinnuvegaraduneyti.is/laws-and-regulations/nr/nr/7429. 96  For the doctrine of frustrated assumptions, see Bruserud (2015) 64ff. The relationship between the doctrine of frustrated assumptions and the various Articles 36 is not yet entirely resolved, due to different perceptions on the matter in the Nordic countries (ibid, 75ff).

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The test of unfairness in the Nordic countries comprises an assessment of the content of the contract, the bargaining position between the parties, the situation at the time the contract was concluded, and of other circumstances including subsequent ones.97 With regard to the content of the contract, a possible point of comparison for unreasonableness is mandatory or default rules. Moreover, the subject of the contract has to be taken into account. Contracts with a more social purpose, such as housing or employment, can be afforded a higher degree of protection than contracts for speculative purposes. The price can also be assessed in terms of reasonableness. Moreover, structural imbalance of negotiation power, for example in consumer or employment contracts, is taken into consideration. The requirement for the court to take into account the situation at the time of the contract conclusion extends to assessing the information provided concerning risks, especially for complex contracts; the demand for the provision of information can be higher for complex contracts. But the courts can also take into account subsequent events and, thus, do not only base their assessment of fairness on the situation when the contract was concluded. Furthermore, those can be external in relation to the content of the contract—even though there has been some resistance to that in the legal doctrine. Based on Articles 36 in the respective contract laws, Wilhelmsson has coined the term social force majeure as a concept to be taken into consideration for the assessment of fairness.98 According to the Finnish Consumer Protection Act, Chapter 7, section 16.2, the creditor shall not have the right to enforce repossession (inter alia), if the delay in payment is due to the illness or unemployment of the consumer or to a similar factor that is not the consumer’s fault, unless it would be unreasonable for the creditor to do so with regard to the length of the delay and other circumstances. In the Norwegian law concerning credit sales, the debtor can be granted relief concerning the repossession of goods if it is probable that the payment difficulties are of a temporary nature and are caused by illness, unemployment and other special circumstances. Danish law contains a similar clause without enumerating the causes of the payment difficulties. Similar provisions exist in the Nordic legal frameworks with regard to the adjustment of interest and the delayed payment of insurance premiums.99 The courts have the power to adjust unfair terms, irrespective of the type of contract.100 In contrast to the situation in the other European jurisdictions and despite variations among the countries, and notwithstanding the high threshold for the application of the respective Articles 36,101 Nordic Supreme Courts (as well as the consumer representatives) habitually apply adjustment clauses.102 97 

The following remarks are based on Hauge (2015) 170ff. Provisions referred to are thus quoted in Wilhelmsson (1990) 3–4. 99  Wilhelmsson (1990) 4–5. 100  Wilhelmsson (1993a) 437. 101  Bruserud (2015) 69. 102  Wilhelmsson (1993a) 438. Hondius and Grigoleit (2011) 643, however, find differences in application between the Nordic countries, characterising Denmark as a ‘closed’ legal system, but Sweden as 98 

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Their assessment of ‘good faith’ entails an assessment based on the contract as a whole, taking into account the status of the parties, deviation from non-mandatory rules, and due care and diligence rules. Exemplary cases concern long-term leases and access to water, in which the Nordic courts have considered changes in monetary value to trigger the application of Articles 36.103 (c)  Similarities and Divergences Despite considerable differences within the EU, commonalities underlying the application of the different forms of the rebus sic stantibus principle can be identified in the ‘continental jurisdictions’ (unless they are confined to situations of impossibility, as in England). As a first common requirement of the ‘continental’ jurisdictions, there needs to be an external event after the conclusion of the contract. Structural imbalances, which already exist at the time of contract conclusion, are not covered. Second, most legal frameworks require that the change in circumstances be unforeseen by the parties (Germany, Austria, the Netherlands, France, Lithuania, Greece). Alternatively, countries operate with terms such as foreseeability (Italy), extraordinary changes (Spain, Italy), exceptional or anomalous (Portugal) in order to make clear the perspective of the parties. Two instruments (ie Lithuanian Civil Code, PICC) also refer to the knowledge of the aggrieved party, thus making relevant the circumstances present when the contract was concluded. The third requirement relates to the effect of the event on the contractual obligations. This means that the event must cause a material change (Germany), an excessive burden or imbalance in the rights and obligations of the parties (excessive onerousness: Italy, Spain, DCFR), or a radical or fundamental change in the contractual equilibrium (France, Belgium, PICC), or has the effect that the contract no longer complies with the parties’ expectations (Slovenia). Fourth, many jurisdictions exclude events for which one party has assumed the risk of its occurrence (literally in the legal frameworks of Portugal, Lithuania, and Spain, as well as the interpretation of the law in the Greek literature, and PECL) or for which the risk of occurrence does not exceed the normal risks of contracts (Italy). The contractual or statutory allocation of risk can be taken into consideration in order to assess the expectation that a party would have agreed to be bound by the contract in its unaltered form (Germany). Fifth, almost all legal frameworks (except England and France) refer to a concept of reason, good faith, or fairness of the alteration or termination of the contract. The elements of good faith (Belgium, Portugal), reason (Germany, Netherlands), justice (Slovenia, PECL) or fairness (Netherlands) are used to assess whether to modify or terminate a contract. ‘open’. In contrast, Hauge (2015) 170 finds differences in the application before Nordic courts, with Denmark using Art 36 most and Norway least. 103 

ibid, 80–81.

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A few countries explicitly acknowledge the importance of the principle for longterm agreements. In Italian law, the concept of excessive onerousness is applicable to contracts covering continuous or periodic performance. Austria and Slovenia have special rules in place for long-term relations. The exceptional nature of the concept of a change in circumstances is evident. Apart from the jurisdictions in which the concept is hardly ever applied anyway (England, France) and with the exception of the Nordic countries in which the courts have been more active in comparison with other countries, the alteration or termination of contracts because of unforeseen circumstances has continuously met with resistance. The preferred legal consequence of the application of the doctrine in all other jurisdictions mentioned above is the modification of the contract rather than its termination. Thus, judicial interference with the contract is to be kept to a minimum. This reflects adherence to the main principle of pacta sunt servanda. In a similar vein, the perspective for the legal assessment is often the hypothetical will or expectations of the contracting parties (Germany, Netherlands, Slovenia), or the priority of complementary interpretation of contract (Germany, Austria, England, also Lithuania with regard to the court’s assessment of the legal consequences). The regime in place in the Nordic countries differs from the ‘continental’ approaches. Articles 36 of the Nordic contract laws do not impose the same ­requirements on the application of a change of circumstances as the ‘continental approaches’, but make an assessment of changed circumstances part of the process of controlling the fairness of terms. Moreover, or maybe as a consequence, the ­Nordic courts are more actively intervening in contractual agreements. The ­Nordic countries have probably the most open-ended provisions, since they empower their courts to alter or terminate agreements as a matter of fairness, after assessing the contract terms and circumstances as a whole, including content, the initial bargaining positions (so it includes structural imbalances), as well as present and future circumstances. The intervention of the courts is based on unfairness, unreasonableness or a finding of a violation of good faith. The concept of change in circumstances as included into the respective legal frameworks is distinguished from other contract law doctrines, such as mistake or impossibility.104 In general, the concept of mistake refers to erroneous information about the circumstances present when the contract was concluded. Rules on mistake assume that the error leads to faults in the contract itself, which do not represent the partys’ will. Errors in motive are not covered. Impossibility does not cover the occurrence of external events that render the performance of contractual obligations too onerous (economic impossibility), but only the vanishing or destruction of the object of contract.

104 This section is based on Hondius and Grigoleit (2011) 55–172, Baranauskas and Zapolskis (2009) and Momberg Uribe (2011) 43ff.

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A few jurisdictions distinguish also the concept of force majeure, which allows for the mitigation of the consequences of overindebtedness if this is caused by unemployment, illness or other similar events. The most prominent use of this concept refers to Wilhelmsson’s social force majeure.105 But references to the concept of force majeure more generally can be found in specific legislation in a number of EU Member States.106 For example, Article 1244 of the French Civil Code allows courts to grant debtors a délai de grâce for due payments, ‘taking into account’ the situation of both debtor and creditor. In most of these jurisdictions, the concept is close to some kind of impossibility, for example in Czech law, where the event must objectively prevent the performance of the obligation, or to the concept of frustration of purpose, as in France.107 In Denmark, force majeure is applied should it become impossible to provide goods.108

(iv)  Implications for Renegotiation Given these suggestions and the existence of the change in circumstances in various forms in many legal orders, the EU could develop a single approach. Implementing this principle—similarly as in the DCFR—into consumer credit and mortgage agreements would have clear advantages, compared with the tools already in place. First of all, the possibility of adapting contractual clauses to a changed financial situation can contribute to protecting consumers who are at the risk of default, as they could adhere to their—albeit changed—obligations under an existing credit agreement, without being exposed to the choice between exclusion from and acceptance of any form of credit.109 The amendment of contractual provisions would thus make enforcement of the contract unnecessary.110 Second, the consumer could avoid resorting to bankruptcy proceedings to achieve a possible discharge of debt or to the judicial review of unfair terms in order to manage overindebtedness ex post. As we have seen above, even though the judicial ex post control of unfair terms has been of pivotal importance for consumers in the aftermath of the financial crisis, its effect is limited with regard to unexpected events that change the context of the financial obligation after the conclusion of the contract, no matter whether it contains unfair clauses or not. Focusing on the

105 

Wilhelmsson (2004b) 730–31. 1244-1, Créé par Loi no 91-650 du 9 juillet 1991—art 83 JORF 14 juillet 1991 en vigueur le 1er août 1992: ‘Toutefois, compte tenu de la situation du débiteur et en considération des besoins du créancier, le juge peut, dans la limite de deux années, reporter ou échelonner le paiement des sommes dues. Par décision spéciale et motivée, le juge peut prescrire que les sommes correspondant aux échéances reportées porteront intérêt à un taux réduit qui ne peut être inférieur au taux légal ou que les paiements s’imputeront d’abord sur le capital. En outre, il peut subordonner ces mesures à l’accomplissement, par le débiteur, d’actes propres à faciliter ou à garantir le paiement de la dette. Les dispositions du présent article ne s’appliquent pas aux dettes d’aliments.’ 107  Hondius and Grigoleit (2011) 91 (Czech Republic), 150 (France). 108  ibid, 115–16. 109  See Reifner et al (2003) 222–23. 110  Implicitly Howells (2013) 461. 106  Art

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initial design of the contract, the unfair terms regime is not designed to address any changes of circumstance. In order to assess the possibility of renegotiation of mortgage debt after the financial crisis we shall now apply the above-mentioned requirements to the mortgage context and the occurrence of external events. Two possibilities exist: we can follow either the Nordic countries’ approach of their Articles 36, or the ‘continental’ approach of the other jurisdictions. (a)  The Continental Approach As regards the requirements for the application of a rebus sic stantibus, the ‘continental’ approach requires: the occurrence of a change in circumstances (external event), its unforeseeability at the time of the contract was concluded, the causation of a material or fundamental change in the contract’s equilibrium, the lack of assumption of risk by the parties, and the imperatives of good faith or fairness to seek adjustment or termination of the contract under the circumstances. The requirement for the occurrence of a change in circumstances is fulfilled by the market risk factors of loss of employment, decline in housing prices and deterioration of exchange rate. It has been discussed whether the financial crisis could constitute such a causal external event that triggers the application the rebus sic stantibus.111 However, that would probably be taking it too far, because—from our viewpoint in this book—the occurrence of a financial crisis does not in itself or directly cause the default or other welfare losses of individuals. Even though the financial crisis might be the anterior trigger for a specific event with an adverse impact on the financial situation of the individual, this is not important from the viewpoint of the prevention of default if the individual does not experience a loss of wealth. As a second requirement, the change in circumstances must be unforeseen by the parties to the contract. On the one hand, it could argue that any circumstance that the parties did not make provision for is unforeseen by them. On the other hand, if we follow the approach in some countries, which require the lack of foreseeability of the event, it can be argued that the loss of employment is foreseeable for a precarious worker, as is a fall in projected house prices over the duration of the contractual period, or a shift in exchange rate that disfavours the foreigncurrency borrower. This problem lies in the centre of behaviour economics, which have brought to light that the contracting parties are often not aware of external events and their possible impact on their financial situation. Cognitive biases lead to an underestimation of risk in general (Chapter 2). Especially before the crisis, financial obligations were assumed based on this underestimation of the risk of high currency fluctuations and the probability of job loss. In fact, most CWAs do not take into account any future salary developments. The assessments are based on the s­ alary received when the contract was concluded. In addition, we have to 111 

Murga Fernández (2015) 141ff.

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take into account the usually long term of mortgage agreements, of even up to 40 years. It is understood that the longer the duration of an agreement, the less likely it is for the contracting parties to be able to foresee any event that can affect the financial capacity of the borrower. Young borrowers might be able to foresee a change in their employment situation in the next year or two, but not in the next 40 years. Acknowledging these problems in the regulation of contracts makes law better equipped to deal with the real-time problems. Hence, the foreseeability of the event should not be a requirement for triggering the change in circumstances. Instead, the actual expectation of the contracting parties should be taken into account. Third, the event must cause a material or excessive burden or imbalance in the parties’ obligations. From the viewpoint of the mortgagor, an excessive burden develops when her financial resources are not enough to fulfil the payment of the monthly instalments. In the case of unemployment it is clear that the financial situation of the individual is negatively affected as a whole because the source of income is discontinued. With regard to a rise in exchange rates, too, there is evidence that high inflation can lead to a much higher total cost of credit.112 Whether these effects are material or place an excessive burden on the borrower must be assessed on a case-by-case basis. For borrowers with high LTV ratio loans we come to a different conclusion. Even though we have established that a high LTV ratio exacerbates the risk of defaulting on mortgage payments, the direct relation between the increase in house prices proper and default is not that clear. A change in house prices does not affect the total price of the loan or the amount of the monthly instalments. As long as a consumer still has a source of income, she can honour her repayment obligations under the mortgage agreements, even though she might be overpaying for the property. This result does not change if we take as a measure an imbalance in the parties’ obligations: neither the obligation of the bank to make available the amount of credit at a specified time nor the repayment obligations of the borrower are affected by a decrease in housing value. The decrease only affects the value of the asset that underlies the contract and becomes relevant when the property is sold, but leaves the contractual obligations intact. This means that a rise in house prices per se is not able to trigger the application of a change-incircumstances approach. Fourth, with regard to the allocation of risk, if there is no contract clause dealing with the distribution of risk, we must take into account the nature of the ­contract. This holds true in terms of the subject matter of the contract and in terms of the duration of the contract. As for the subject matter of the contract, the above-mentioned jurisprudence on swap contracts considered the aleatory nature of the contract when deciding whether to apply the rebus sic stantibus principle or not. But if the aleatory nature of a swap contract, which is a contract about risks and the development of the economy, leads to the assumption that the parties 112 

Méndez-Pinedo (2015) 63.

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could have foreseen more risks than the parties to a normal sales contract,113 a similar logic must be applied for the parties to a mortgage agreement. However, a mortgage agreement is not a risky contract in itself. It primarily serves the purpose of securing the claim of repayment of the lender vis-à-vis the borrower. In this sense it is certainly concerned with a risk, namely the credit risk of the borrower. But it is not concerned with the allocation of external risks in the same way as an interest-rate swap contract, in which the contractual management of external market risks is the main subject. Even though a mortgage agreement can be affected by external market risks, it is not a contract that deals with external market risks per se. Certainly, one of the assumptions is that the income or wealth of the consumer remains at a level necessary to guarantee the her ability to repay the loan throughout the duration of the agreement. This does not, however, mean that the main subject matter of the mortgage agreement is the stability of the source of income or wealth. This merely underlines that external events, such as ­unemployment or the realisation of other market and personal risks, which are not the subject matter of the contract, are the prime cases of application for the rebus sic stantibus principle. Whether the same holds true for foreign-currency mortgages can be debated. In a judgment concerning a foreign-currency consumer loan for the purpose of buying a car, the CJEU held that the purpose of the exchange transactions required under the foreign-currency loan was not the management of foreign-currency risk, but merely to secure funds to purchase another asset.114 The CJEU followed the Advocate General’s opinion on the purpose of the loan and, in the end, is in line with the reluctance of national courts to accept fluctuations in monetary conditions as a trigger for the rebus sic stantibus concept, as a certain degree of fluctuation is to be expected, and thus would form part of the normal risks of a contract.115 It could, however, be discussed whether an extraordinary change in exchange rate could lie outside of those normal risks. Méndez Pinedo provides an example of a price-indexed Icelandic standard mortgage for which the repayment was almost 600 per cent compared to the loan principle.116 In cases of such extreme change, it could be argued that this is not a normal foreseeable ‘fluctuation’, but an excessive change in exchange rates that affects the very foundation of the consensual agreement. The fifth and last requirement for the application of the rebus sic stantibus to mortgage agreements is the element of good faith, reason or fairness. These principles reflect the stance that a modification or even termination of the contract is indicated when the parties cannot be reasonably expected to maintain the agreement after a change of circumstances. It is possible to argue that the fulfilment of

113 

Thus Carlos and Dastis (2015) 96–97. C-312/14 (Plus Bank) para 61. Momberg Uribe (2011) 79–80 (Italy), 195 (with regard to the UN Convention on Contracts for the International Sale of Goods); see also Hondius and Grigoleit (2011) 122–23 (Italy). 116  Méndez-Pinedo (2015) 63. 114 

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all other requirements already indicates the unfairness of maintaining the agreement unchanged, even though this is a case-by-case assessment. Furthermore, the requirements of good faith or fairness can also be applied to the renegotiation of the contract and the decision of whether to modify or uphold the agreement. In sum, we can see that the rebus sic stantibus approach is an adequate tool to accommodate the vulnerability of precarious workers to the eventuality of external risk factors such as unemployment. However, the vulnerability of borrowers with high LTV ratio loans might not be suitably accommodated under this continental approach to a change in circumstances. Foreign-currency mortgages are problematic concerning the assessment of the riskiness inherent in their nature. (b)  The Nordic Approach: Fairness The Nordic approach, in contrast, regulates a change of circumstances in contract law as a matter of fairness or unreasonableness of contractual terms. As stated above, the courts assess the fairness of terms based on the content of the contract, the bargaining position between the parties, and the situation when the contract was concluded as well as supervening circumstances arising after the contract’s conclusion. In this way, it is acknowledged that not only the structural vulnerability of consumer in terms of a weaker bargaining position but also the vulnerability to external risks can become manifest in unfair terms. This open-ended approach to fairness gives the courts considerable room for their assessments. When deciding and evaluating the facts of the case, national judges can take into account not just the structural imbalance of negotiation power, as is already acknowledged in the UCT. For our purposes it is crucial that the Nordic approach also allows the recognition of supervening circumstances. Unemployment of a borrower can be considered as much a supervening event as an unfavourable change in exchange rates for foreign-currency borrowers. Concerning unemployment, courts can take into account the social purpose of residential property and, following Wilhelmsson, even consider unemployment as social force majeure. The Nordic approach to fairness allows for an acknowledgement that a steep rise in exchange rates can alter significantly the balance of rights and obligations under the agreement and, thus, lead to unfairness of the contract. This fairness approach goes further than proposals in the literature, which argue that foreign-currency loans should be subject to higher requirements of transparency.117 The argument is that foreign-currency terms change the objective of the contract and, thus, the character of the loan agreement so that it no longer corresponds to a model loan contract. The bank participates in an indirect but concrete way in an investment in foreign currency and, in addition, receives commission for such transactions. If the lender does not provide sufficient information concerning these risks, the consumer cannot assess the variable risks implied in such a transaction. The legal 117 

Thus Venieris (2015) 367.

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consequence dealing with the change of the objective of the contract is the unfairness of the respective term,118 leaving a gap that needs to be filled in accordance with the hypothetical will of the contracting parties.119 However, again, these proposals rely on the capacity of the consumer to understand information that is provided in a transparent way. The Nordic approach to fairness goes beyond treating foreign-currency mortgages as a problem of transparency, because the courts could consider the increased complexity of such contracts as an indication for higher fairness requirements for the provision of information at the time the contract was concluded. Similarly, controlling whether and to what extent a steep decline in house prices affects the fairness of the underlying mortgage agreement of consumers with a lack of resilience would go further than the continental rebus sic stantibus approach. Here, fairness control could influence the assessment of the contract at the time of contract conclusion or at the time the decline in value occurs. As we have seen, a price cap could be introduced for high LTV ratio loans at the time the contract is concluded; if the contractual parties do not introduce such a cap or it turns out that the cap was inappropriate or too optimistic, the fairness of the contract could be affected. In sum, following the Nordic approach to treating a change in circumstances as a matter of fairness would allow a response to event vulnerability for all three types of consumers: precarious workers, bubble borrowers and foreign-currency borrowers. It also gives the possibility to assess the fairness of mortgage agreements of consumers with a high LTV ratio (lack of resilience). The fairness control is flexible enough to accommodate the needs of those mortgagors because it focuses on the conditions of the contract at the time of the financial difficulties, and not on the circumstances prevailing at the time the contract was concluded, including the riskiness of the contract or the foreseeability of events. (c) Problems Despite the advantages of incorporating a change-in-circumstances approach, the renegotiation process itself, in which a new balance in the adjusted contractual rights and obligations must be found, can prove problematic. The problems concern, for example, the bargaining power of consumers at the time of renegotiation, the replacement of unfair terms, and moral hazard. The bargaining power of the consumer is still diminished at the time of renegotiation, as it was presumably at the time of initial contract conclusion. We would have to take into consideration that the consumer’s bargaining power will probably be as unequal as at the time of the conclusion of the first agreement, if not even more unbalanced to the disadvantage of the consumer who is now in imminent financial difficulties. One option could be the resort to judicial modification of the contractual terms. A disadvantage of this method is the reliance of access to 118  119 

Thus Méndez-Pinedo (2015) 80. Venieris (2015) 368.

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courts as a way to protect consumers. The above-mentioned criticism with regard to the difficulties involved for consumers in starting court proceedings applies here as well. In order to mitigate the problems for consumers in getting access to and voicing their interests in court proceedings, the involvement of consumer organisations or other collective bodies could be mandated, both in court proceedings as well as in out-of-court negotiations. This could strengthen the bargaining position of the consumer and support her with expert knowledge and access to information. In addition, such involvement might have a standardising effect such that many consumers in similar situations could bundle their interests and achieve consent with the common contracting partner more rapidly. Yet another possibility to mitigate the imbalance in negotiating power could be to include a ‘default option’ into the standard mortgage agreements. This default option could establish that the financial obligations for the consumer must be adjusted to the extent that she can adhere to them under the changed circumstances. For example, it could set the maximum amount of monthly instalments that the borrower will have to pay in relation to income minus the average living costs. This would clearly be a highly paternalistic intervention into the substance of the agreement between the parties. At first glance, it seems to be a ‘fixed’ solution that determines the ‘reasonableness’ of the amount of the monthly instalments beforehand. At the same time, by connecting the calculations with the disposable income at the point in time adjustment is sought, this approach becomes flexible because the consumer’s income varies. Last but not least, the problem of moral hazard must be discussed. It could be argued that the existence of the rebus sic stantibus and even a default option in the standard agreements incentivises consumers to take on higher loans as compared to the cases without the possibility of subsequent modification. Knowing that in the event he cannot keep up with the payments, the monthly instalments will be adapted to what he can afford, the consumer could be encouraged to take out loans he might not be able to afford in the end. I have, however, doubts as to consumers’ economic rationality in this regard. We have seen that consumers are not economically rational actors and it is hard to imagine that a legal principle enshrined in a standardised agreement could have a significant impact on consumer behaviour. More importantly, it is reasonable to assume that the vast majority of consumers do not enter into debt lightly. Mortgages are often once-in-a-lifetime occasions and form an essential part of an individual’s or a family’s livelihood. They secure a home to live in. This importance is underlined by evidence that shows that individuals often delay the payment of other bills in order to be able to serve their debt burden resulting from mortgage agreements.120 There are also immediate 120 www.strategicanalytics.com/articles/2005hierarchypayments.php. Overindebted households often have a number of financial commitments that they cannot honour. Payments related to mortgages, car loans, credit card and utility bills are the most common source of financial difficulties. See, for example, the country reports in Domurath et al (2014), Kempson (2015).

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social repercussions that can result from a default on the monthly instalments and the significant negative health effects as a consequence of a forced eviction. Most immanently, overindebtedness has severe effects on surrounding family members, first and foremost children and elderly relatives.121 It heavily affects the quality of life of all individuals living in the overindebted household. Forced eviction from a personal home significantly increases the risk of mental health issues,122 an effect that persists for a significant time after the eviction.123 But even if consumers ignored the possible social repercussion by rationally gambling on safety nets in the form of mandatory default rules or renegotiation, the existing tools should be able to counter the moral hazard involved. Even if a consumer borrows irresponsibly, the lender must still assess his ability to repay the loan. As the CWA must be based on strictly objective criteria, the motivation of consumers to apply for a mortgage loan does not play a role and possible moral hazard should be ruled out if a lender checks thoroughly the repayment ability of the consumer. In sum, it becomes clear that implementing the possibility of renegotiation into the EU legal framework on mortgage agreements would incentivise a mutually beneficial solution for both contractual parties and encourage them to hold on to the contract. With the borrower continuing to pay monthly instalments, albeit diminished, the creditor’s interest in receiving a return will be respected because the contract continues to exist. The procedural problems can be mitigated through out-of-court mechanisms and the involvement of collective consumer organisations. (d)  Exclusion from Credit The tools suggested in this book for a welfarist contract law affect the possibility for consumers to obtain credit. For example, a strengthened CWA and the inclusion of a buffer into the CWA calculations could entail the consequence that some consumers will not pass the assessment, and thus be denied credit. Exclusion from credit might even be exacerbated from an economic point of view. It could be that credit will become more expensive because of the several tools suggested in this book, because banks will outsource the associated cost. In the end, the consumers will have to pay the price for the implementation of more protective contract tools. From the viewpoint of the prevention of default and further welfare losses, exclusion from credit is an acceptable consequence. If consumers do not have the financial resources to pay back the loan, exclusion from credit is considered to

121  Lamb (2011) 227 with further references. See also Niemi-Kiesiläinen and Henrikson (2005) 10–11. 122  Pevalin (2009) 950, Desmond and Kimbro Tolbert (2015). 123  Desmond and Kimbro Tolbert (2015).

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be in the interest of the consumer and the bank as well as the EU legislator who pursues the goal of preventing overindebtedness. This is, after all, the immediate goal of the CWA: to ensure that the loan will be repaid (see above); thus, not granting a loan to a consumer who is unable to repay the loan would be in accordance with the goal of the CWA. In theory, access to credit should already be denied to consumers who are not considered creditworthy under the existing framework. Including liability into the CWA-obligations does not increase the number of consumer who fall below the creditworthiness threshold, but merely supports already existing obligations. In contrast, with regard to the ‘buffer’, the number of consumers falling below the threshold might increase though. It is here that the first paradox of financial and social inclusion is evident. Consumers who are excluded from the mainstream credit market often seek recourse to exploitative credit (Chapter 2).124 In the end, being barred from mainstream financial products can exacerbate social exclusion. However, this paradox cannot be addressed by lowering standards for granting credit. Since exclusion necessarily follows inclusion, the pursuit of social inclusion through financial inclusion is futile. What can be pursued instead is an improved access to credit for those who can afford it. For consumers who are excluded from credit, it might be that contract law cannot bring about the desired social inclusion. This does not mean that low-net-worth consumers cannot strive for social inclusion. Limitations to credit do not necessarily imply a general denial of credit, but can also mean the granting of lower credit amounts. This would restrict the private autonomy to a lesser degree than a blank denial of credit. Even though the consumer might not be able to purchase the property that she initially envisaged, she might find another home that better fits her financial capacity. In the field of housing, this implies a questioning of the credit–welfare trade-off: where credit cannot be securely granted, welfare might have to be provided through other means than market mechanisms.

IV.  Lack of Resilience In this section, we examine how the lack of resilience of consumers can be taken into account in order to strengthen the EU legal framework for the prevention of default. It is suggested that a CWA with targeted parameters and price controls can help to protect low net-worth consumers from welfare losses. Much of the discussions above on event vulnerability apply here as well. Therefore, the section will only highlight the specificities that concern a lack of resilience.

124 

Wilson (2011).

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A.  Creditworthiness Assessment We have seen above that the purpose of the CWA is to ensure that a consumer will be able to repay a loan she has applied for. This procedure arguably serves not only the interest of the bank in achieving repayment of the loan but is also the goal of preventing default and overindebtedness of the consumer. In general, as explained above, the CWA is an appropriate tool for ensuring that individuals with insufficient financial capacity to pay back a loan will not get this credit. However, the large representation of low-net-worth consumers among the overindebted since the start of the financial crisis suggests that either CWAs were undertaken poorly or not at all, or that potentially negative results were ignored. In this regard, Article 18(5) lit (a) MCD is a welcome improvement to the CCD framework as it states that the credit shall only be made available if the CWA reveals that the consumer will be able to repay the loan. However, similarly to dealing with the problem of incorporating external events into the parameters of the CWA, we can debate whether it would be more protective to also introduce lender liability for undertaking a CWA. This is discussed above in the sections on event vulnerability. With a view to ensuring that low-net-worth consumers are granted credit only if they are able to repay the loan, it could be possible to single out high-risk borrowers and include a ‘buffer’ in their CWA. This has actually been proposed by the FSA in the UK. The suggestion is to subtract 20 per cent from the current disposable income of a ‘credit-impaired’ customer in order to allow for arrears on monthly payments up to those 20 per cent.125 This is an additional buffer against financial difficulties arising from unforeseen events and changed circumstances. In the EU, such buffers are currently known only in legal framework on macroprudential supervision. Within this framework, financial institutions are required to hold capital conservation buffers, a countercyclical capital buffer and possibly a systemic risk buffer as well.126 However, including such a buffer into the legal framework on mortgages would vest low net-worth consumers with more financial leeway in order to absorb possible losses. The same holds true, in fact, for precarious workers, bubble borrowers and foreign-currency borrowers with regard to the adverse events to a loss of employment, for example, or any other source of income or wealth. It would also mean that some borrowers, who might have merely passed the lender’s CWA, might then fall below the threshold when a

125 

Financial Services Authority (2010) esp 28. buffers are required under the Capital Requirements Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC and Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012. 126 Such

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certain amount is subtracted from their disposable income. This approach would diminish the pool of possible borrowers, but it would make financial inclusion safer for those who pass the enhanced CWA.

B.  Price Controls Similarly to the price controls for consumers vulnerable to external events, the lender could, instead of rigorously denying credit, propose to low-net-worth consumers with a lack of resilience a lower total amount of credit. If the original amount sought by the consumer is too high for the consumer to be able to keep up with the monthly instalments, she might consider taking a smaller loan. Alternatively, interest-rate ceilings for low-net-worth consumers could be mandated. The advantages and criticisms of price controls have been discussed above. It should just be pointed out that price control mechanisms allow the inclusion of such consumers into the credit market, albeit under different, more favourable, conditions, instead of excluding them. Adequacy requirements are not unknown in EU law, as they can be found in the legal framework on universal services. Such approach would imply an inclusion of the adequacy of price into the fairness assessment under the UCT, in contrast to the current Article 4(2) UCT.

V. Conclusions In this chapter we have elicited contractual tools that address the vulnerabilities of consumers that are neglected in the current EU legal framework: event vulnerability and a lack of resilience. We have identified a strengthened CWA, the application of the change in circumstances doctrine, and price adequacy controls. Both the change in circumstances and price controls should preferably be made part of extended fairness control of contract terms. In support of this claim, we have looked into case law, at proposals that exist in the academic literature as well as at legislation in place in the Member States. It is suggested that a strengthened CWA with new or more realistic parameters could help to prevent default. We have seen that the aim of the CWA is also the financial stability of the consumer in order to ensure that the loan will be repaid. Thus, factoring in the possibility of unemployment for precarious workers and a more realistic assessment of future exchange-rate fluctuations as well as including financial buffers or interest-rate limitations into its calculations could help to prevent default of consumers with different types of vulnerabilities, especially event vulnerability and the lack of resilience. In addition, the lack of consequences from non-compliance with the obligations is to be considered, as they might have well continued to a large-scale disregard of CWA before the crisis. EU-wide liability for granting credit in spite of a negative CWA outcome can support this.

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The strengthened CWA needs to be complemented with broader fairness control. This would not only enhance the chances of preventing default should an event occur that has not been foreseen or the impact of which was underestimated in the CWA. It would also allow a review of price adequacy, which would serve especially marginal borrowers and borrowers with low net-worth. Among the proposals, extended unfairness assessment is probably the most controversial and politically the most difficult to implement. The main problem is that they imply the broadening of fairness control to cover the adequacy of price, which would run counter to Article 4(2) UCT and the will of the EU legislator at the time of its adoption. Hence, a change of legislation would only be feasible against the backdrop of a radical change of thinking.127 At the same time, an extended unfairness assessment would be the most suitable tool to address several vulnerabilities of mortgagors. First of all, it would complement the informational framework currently in place to protect relationally vulnerable consumers with low levels of education, and marginal borrowers. Second, more importantly, it would take into account event vulnerability, which is neglected in EU mortgage contract law. Especially if we follow the Nordic approach to a broader fairness assessment, which includes circumstances subsequent to contract conclusion, we would allow renegotiation of debt should an event occur that significantly alters the financial situation of precarious workers, bubble borrowers or foreign-currency borrowers. The continental approach that works with some kind of change-in-circumstance principle seems to accommodate usual mortgages. In contrast, the broader fairness control as exercised in the Nordic countries also accommodates foreign-currency loans, as it does not require a lack of risk assumption by one of the contract parties. The Nordic approach to controlling the fairness of contracts after supervening events also accommodates the event vulnerability of bubble borrowers, even though their vulnerability is already present when the contract is concluded. Third, unfairness assessment of the price of credit is suitable to respond to the lack of resilience especially of low net-worth mortgagors. Taking into consideration the three broad types of vulnerability identified in this book shows the need for a broadening of the applicable legal framework. The control of prices through fairness, a strengthened CWA and the renegotiation of debt would not only be in accordance with an understanding of responsible lending and responsible borrowing as sharing the responsibility for the repayment ability of the borrower. It also serves the approach of preventing welfare losses which justifies the imposition of further obligations on both parties. Furthermore, it would imply that certain consumers are excluded from private financial markets, which restricts their autonomy considerably. From the viewpoint of the prevention of default, this is an acceptable consequence, especially with a view to the fact the function of the CWA is precisely to avoid giving credit to consumers who are unable to repay the loan. 127 

I have elicited the implications for contractual models elsewhere, Domurath (2016).

5 Theoretical Framework Revisited In this last chapter, we shall revisit the theoretical framework that was established in Chapter 1. What do our findings concerning the protective gaps imply for the type of justice that is reflected in the applicable legal framework in the EU? How do the suggestions in Chapter 4 influence welfarism in contract law and the type of justice pursued? And can a welfarist EU mortgage contract law be achieved?

I.  Welfarist EU Mortgage Contract Law? Before ending the elaborations on vulnerability in this book, we shall revisit the concepts of welfare and justice and the process of the constitutionalisation of private law. What are the implications of our findings for the understanding of justice and welfare in the EU? If we remember Wilhelmsson’s conceptualization of a welfarist, socially just contract law, the following parameters shall be tested: —— Market-rationality: measures that aim at improving party autonomy and the functioning of market mechanisms, and corrective measures that aim at rectifying market outcomes. —— Equality and collectivism: internal redistribution in favour of the weaker parties in a contractual relationship, as well as externally redistributive mechanisms that distribute benefits in favour of the disadvantaged within a group of contract parties. —— Needs: regulation that takes into account the needs of parties with special needs, and rules that pursue interests and values that are not related to the parties.

A.  Market Rationality The traits of market rationality are quite pronounced in the current EU legal framework on mortgage contracts. The pertinent rules improve party autonomy and the functioning of market mechanisms.

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With regard to the weakness of all consumers in their financial transactions, it has long been established that the rules on transparency and information ­disclosure have distributive effects,1 because they reduce the potential advantage the stronger party can derive from information asymmetry.2 The reason for this lies in the widely accepted characteristic of information as an important resource on efficiently operating markets.3 Market failure ensues from information asymmetry between the consumer and the professional—with the latter knowing more about the product or service in question, especially with regard to complex financial services—which is the very reason for imposing market-correcting measures in the form of information obligations.4 In this context, disclosure obligations are a tool to empower consumers. They enable them to make rational choices to improve private autonomy, as they aim at improving consumers’ welfare by choosing goods and services that fit their needs.5 Even though information disclosure duties intrude into the substance of private law contracts by imposing certain obligations on the seller, and even though it could thus be argued that they are rather a form of societal intrusion into private autonomy, these disclosure obligations involve only the smallest deviation from the contractual freedom approach.6 They do not touch the substance of the contract, but emphasise and reinforce contractual freedom. Similarly, financial education aims at enabling consumers to make use of the information in order to make such welfarist choices for themselves. Hence, the education of consumers is a means of increasing private autonomy. At the same time, both disclosure duties and financial education are a means of improving market mechanisms. By enabling rational choices between goods and services on the market, competition is fostered. The information about products is supposed to promote transparency of transactions, and financial education should enable consumers to make use of such information and benefit from and improve a transparent, competitive market. Considering that market transactions are a product of power relations under which one party has trust and confidence in the other to engage in a transaction, the justification for disclosure duties often lies in the protection of the integrity and trustworthiness of the market mechanism in which the transaction is embedded.7 Thus, the MCD and UCP rules on the correctness and absence of misleading information, the (personalised) explanations to be given to the borrower, or demands concerning legibility all distribute information from the lender to the borrower and aim at counteracting information asymmetries. Moreover, by excluding the application of terms that cause a 1 

Collins (1994a) 105ff. ibid, 121–22; Ramsay (1995) 185–86. 3  Collins (1994a) 107. 4  Lamb (2011) 223 with further references; Ben-Shahar and Schneider (2011) 649–50. 5  See Wilhelmsson (2004a) 727. 6  Morgan-Taylor and Willett (2012) 148. 7  Collins (1994a) 111–12. 2 

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‘significant imbalance’ in rights and obligations to the detriment of the consumer (Article 3(1) UCT), the EU framework aims at correcting the market failure of contract terms that do not reflect party will and disadvantage one party vis-à-vis the other. Information duties also improve competition, which is one of the most common justifications for adopting information disclosure rules.8 As such, they are evidence of ‘market rationality’ and of the inherent dimension of redistribution in credit market rules.9 As Collins puts it, they play a small but crucial task in ­welfarist contract law.10 Furthermore, the rules on the CWA can be understood as being in line with market rationality. Their principal aim is to provide transparency on the financial situation of the consumer and, thus, remedy the information asymmetry between the parties (this time with the consumer being in favour) by distributing information about financial capabilites from the consumer to the professional. It is supposed to help lenders to make an informed decision about the risks involved in lending to the prospective borrower. Part of the UCT framework also belongs to the market-rational approach, in as far as these elements are a measure to improve the functioning of market ­mechanisms.11 Considering the structurally weaker bargaining position of consumers and the lack of power they have to influence the content of standard terms, the UCT prohibits certain contractual terms. Its aim is to restore a certain balance of power between the professional and the consumer by ensuring that the stronger party, the professional, does not abuse its position of power in terms of dictating the terms of the agreement in an ‘unfair’ way. The CJEU confirmed that the UCT is based on the idea that the consumer is in a weak position vis-à-vis the seller or supplier as regards both his bargaining power and his level of knowledge. This results in the consumer agreeing to terms drawn up in advance by the seller or supplier without being able to influence the content of those terms.12 Thus, it is considered more effective to control the content of standard terms through substantive review than to control the consent through information duties.13 The market outcome to be rectified is the convergence of practices to use standard contracts, the content of which the consumer does not have influence over. Since there is no room for negotiation, the autonomy of the consumer to choose products and services that fit his needs is limited. In response to this market failure, the equality between the contracting parties is to be restored by phasing out unfair standard terms.

8 

Collins (1994a) 115ff with further references; Bar-Gill and Warren (2008) 197–98. See Ramsay (1995) 193–94. 10  Collin (1994a) 125. 11  Thus Wilhelmsson (2004b) 728. 12  CJEU Case C-453/10 Pereničová and Perenič, ECLI:EU:C:2012:144, para 27; C-472/10 (Invitel), para 33. 13  Thus Hesselink (2011) 10. 9 

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B.  Equality and Collectivism There are traces of material equality in the EU legal framework on mortgage loans, even though they are limited in scope. In general, the measures in question aim at guaranteeing private autonomy of both contracting parties. First of all, the information obligations in the legal framework are not only market-rational measures that aim at rectifying and improving market mechanisms, but also internal redistribution mechanisms that are concerned with equality: they improve party autonomy by distributing the power that enables both contracting parties to take informed decisions. The right of foreign-currency borrowers to switch into a domestic-currency denomination definitely contributes to more equality between the contracting parties. It prevents the consumer being ‘locked into’ an agreement that, even it might have reflected her interests when the contract was originally concluded, is no longer in line with her interests. The right to convert, hence, expands the autonomy of the consumer for the duration of the contract and takes into account that her interests (and needs for that matter) might change. It goes beyond being concerned with market rationality, because it does not hold foreign-currency borrowers to their initial contractual promise but allows them to adjust the contract terms in order to restore a possibly lost contractual equilibrium of rights and obligations. If we take into consideration the prohibition of unfair terms and practices, a broader picture of distributive justice emerges that also reflects equality. For example, the ex officio doctrine according to which national courts must examine the fairness of contract terms by their own motion aims at a more substantive balance between the contracting parties. The consumer’s lack of bargaining power and knowledge with regard to possibly unfair terms is mitigated by the court’s power and knowledge about the legally accepted balance between rights and obligations. The Kásler judgment—according to which the national courts can not only set aside the unfair contract term but also replace it with a rule of national law, if the legal consequence of nullity would lead to ‘particularly unfavourable’ consequences for the consumer—itself is a sign of a different approach towards a more material equality. In fact, the CJEU stated that the substitution of an unfair term for a provision of national law would be consistent with Article 6(1) UCT, which is concerned with the substitution of a formal balance with a material equality between the contracting parties.14 Here, the CJEU demonstrates a social awareness and gives national courts the power to intrude significantly into party autonomy, because it can deprive them of the possibility to renegotiate. Taking stock with regard to the collective dimension of a welfarist contract law shows that the legal framework still has gaps. Apart from the Invitel ­judgment, where the CJEU ruled that a contract term that has been deemed unfair in 14 

CJEU C-26/13 (Kásler) para 82.

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i­njunction proceedings must be set aside ex officio for all consumers who have concluded a contract with the same provision, there is not much to be found in the legal framework on the collectivism that is deemed crucial for a welfarist approach to contract law. Even though the CJEU here acknowledged the plurality of contracts and the considerable regulatory power over market behaviour,15 there is no possibility of collective redress on EU level.

C.  Needs and Further Aims With regard to needs of consumers and further aims in the EU legal framework on mortgage credit, a differentiated picture emerges. Even though the legal framework, especially when taking into account CJEU jurisprudence, has a welfarist concern, the suggestions made in Chapter 4 go beyond that by suggesting tools that could integrate the needs of consumers. This is the case especially with regard to fairness controls and the CWA. We have seen that the needs of consumers who are at the risk of default due to their event vulnerability are not much acknowledged. As stated above, warnings are largely ineffective and are merely regarded a tool for financial product providers to escape liability. The CWA rules do not acknowledge the changing employment situations, for example, that can arise for precarious workers and might make an adjustment of terms necessary in order for the worker not to default. There are no rules on social force majeure or provisions that otherwise acknowledge change in circumstances in the applicable provisions. If the MCD makes reference to the needs of consumers at all, this must be understood against the backdrop of market rationality. For example, the ‘needs, financial situation, and personal circumstances’ of the consumer are referred to in the context of advising consumers on financial products—see, for example, ­Article 22 MCD, Preamble 64 MCD. This does not apply to situations in which no financial consultation or advice is sought. Furthermore, the dimension of personal circumstances is dropped when it comes to the needs of the consumer in terms of choosing the right financial product with the help of precontractual ­information—see Article 16(1) MCD. The CJEU has intervened into disputes concerning unfair terms by taking into account special needs of consumers. Aziz and Sánchez are the most prominent examples of cases in which the court has taken into account the broader social context beyond the terms of the underlying mortgage agreements. In Aziz, the CJEU clearly stated that the importance of the purchased property as a family home must play a role in the assessment of unfairness of terms.16 Similarly, the Court was aware in its order in Sánchez of the significant consequences of its ruling in

15  16 

Cafaggi and Law (2013) 666. C-415/11 (Aziz) paras 60–61.

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Spain, where many people have in recent years been subject to foreclosure proceedings in respect of their private dwellings.17 ­Moreover, the CJEU noted that the risk of losing the main dwelling puts the consumer and his family in a ‘particularly fragile situation’.18 These interventions show that the Court acknowledges the needs of the consumers in particular circumstances. In this way, the CJEU takes into account concerns of social justice in terms of need in the interpretation of unfair terms. In doing so, it does not alter the limits imposed by the wordings of the legal texts, but focuses on controlling a high number of contractual provisions, for example under the fairness control, by interpreting the exemption of Article 4(2) UCT narrowly (Chapter 3). The suggestions made in Chapter 4 would go beyond this ‘social consciousness’ of the CJEU and potentially increase the welfarist orientation of EU law. The demand for a fair price rule, either already included in the legislative framework or through renegotiation of the contractual parties, would find support either in welfarist approaches to contract law such as found in Nordic law or in the view that allows price control if the lender takes advantage of the consumer’s need for access to credit. Furthermore, it finds support in the functionalist viewpoint to prevent default and other welfare losses. As regards renegotiation, it is claimed here that incorporating a concept dealing with a change in circumstances into the EU legal order would not only be beneficial both for lenders and borrowers, but also allow the incorporation of welfarist concerns. Concerning the interests of the contracting parties: the consumer has an interest in adjusting or terminating the now too onerous agreement, whereas the creditor’s interest lies in having struck a deal and receiving a return on it.19 However, if the consumer is not financially able to honour the agreement after a change in circumstances, the creditor cannot receive the performance owed to her anyway. Recourse to bankruptcy, foreclosure and forced sale of the property do not necessarily satisfy the creditor’s claims. Urgent sales of illiquid markets (eg property) tend to lower prices.20 Thus, it should also be in the interest of the lender to adjust the contractual terms rather than enforcing the agreement with probable financial loss. More importantly, the adjustment of contract terms can help to prevent recourse to anti-welfarist practices, like those in Spain, which give the creditor the right to claim from the borrower the outstanding amount even after an auctioning off of the property at market price. These practices have been criticised for their anti-social effects and scrutinised by courts as an abuse of rights.21 Nevertheless, the extent to which price controls are ‘just’ is disputed. Many commentators assume that the market price is the fair price. In this vein, an approach

17 

C-169/14 (Sánchez) para 7. C-169/14 (Banco Bilbao) para 11. Howells (2013) 461. 20  Campbell et al (2011) 2108–09, 2129–30. 21  Gutièrrez de Cabiedes and Cantero Gamito (2014) 117–18; C-415/11 (Aziz). 18  19 

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that is based more on economics regards the price that the parties agree on to be a reflection of the market price, which should not be subject to judicial review.22 Article 4(2) UCT incorporates this view. One could also take a more restrictive view and allow the judicial control of price if one party took advantage of the other’s ignorance or necessity.23 Others, especially commentators on the Nordic legal framework, go further and accept a fair price rule, which allows the judicial control and adjustment of price terms (Chapter 4). From a viewpoint of achieving a ‘just’ society, Hesselink has claimed that both the presence and absence of a fair price rule would be compatible with a just contract law regime. In his view, even the libertarian approach, which rejects state interference into contract prices, does not prohibit a price rule, because parties would still be allowed to enter into an ‘unfair’ price agreement—all the state would do is to refuse enforcement of that unfair pricing; conversely, it is not imperative from a viewpoint of corrective justice either, because it is not concerned with distribution.24 Hesselink, thus, sees the question of whether or not to introduce a fair price rule as lying in the hands of the democratic legislator.25 However, assuming that the prevention of default should be a welfarist concern of contract law, the democratic equilibrium could tilt towards the adoption of fair price rules. With regard to CWAs too, the CJEU has recognised the needs of consumers. We have seen above that the objective of the CWA is not only the minimisation of credit risk to ensure that the loan will be repaid, but also, according to the CJEU, to protect consumers from the danger of overindebtedness by accepting loans beyond their financial capacities.26 From Preamble 55 and Article 3 MCD we have inferred that the CWA also protects consumers from the loss of the secured property. This broader, social goal of the CWA can be interpreted as comprising the financial stability of the consumer.27 Interpreting the objective of the CWA in this way is a commitment to a goal beyond the minimisation of credit risk inherent in the immediate contractual relationship between lender and borrower, as it acknowledges the personal and social importance of housing. In this regard, the objective of the financial stability of the consumer and the loss of the secured property could be framed in Wilhelmsson’s need-based interpretation of societal intervention. In particular, low-net-worth consumers, who due to their lack of resilience do not have a lot of financial flexibility to shop around for many different housing options, are in need of affordable housing. Therefore, if we see the goal of CWAs for mortgage agreements as achieving housing stability for consumers, we can infer a concern for consumers’ needs in the obligation to conduct a CWA. 22  For example, Eidenmüller (2015) 226ff. He argues that a fair-price rule would be inefficient, lead to legal uncertainty and high associated costs, and would not foster cross-border trade. 23  For example, Gordley (2015) 209–10. 24  Hesselink (2015), 192–94. 25  ibid, 195–96. 26  See C‑565/12 (Crédit Lyonnais) paras 42–43. 27  Rott (2014a).

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The mortgage contract framework is also sensitive to the other welfare losses that can follow from default. The social problems entailed by eviction has surely appeared on the policy agenda, with the Commission presenting a Staff Working Document concerning national measures to avoid foreclosure, which accompanied the MCD proposal and in which the reduction of the need for foreclosure of property is included as an aim of responsible lending and borrowing practices.28 Furthermore, Preamble 15 MCD states that it applies to all credit agreements that help an owner to continue to retain rights in the property, because it aims at a high level of protection. This implies that the avoidance of eviction is one of the aims of the MCD. In this regard, Article 28 stipulates that Member States must ensure that lenders exercise ‘reasonable forbearance’ before initiating enforcement. These considerations have led some commentators to identify a paradigm shift in the regulation of consumer debt and credit by incorporating external values into the contractual relationship. Ramsay has identified a change in underlying aims and rationales in the regulatory framework for mortgages since the financial crisis, because it now also includes the aim of greater stability on financial markets (see Preambles 3, 17 MCD) and the importance of avoiding foreclosures.29 A similar shift with regard to private law in general has been observed by Micklitz30 and Köndgen for the regulation of financial markets in general (‘de-privatisation’).31 In addition, Fairweather et al have found changing policy paradigms in the legal framework on consumer credit in Australia with a turn towards paternalism.32

D. Proceduralisation (i)  Balancing: Rights, Autonomy, Power All in all, it appears to be true for the field of mortgage contract law that autonomy in EU law is ‘framed’33 or ‘regulated’.34 It is both expanded and limited with a view to achieving not only the goals of an integrated financial market35 or financial stability, but also material equality between the contracting parties. Information requirements restrict the autonomy of one contracting party, while expanding the autonomy of the other. The CWA rules of the MCD restrict the private autonomy

28  Commission Staff Working Paper, ‘National Measures and Practices to Avoid Foreclosure Procedures for Residential Mortgage Loans’, accompanying document to the Proposal for a Directive of the European Parliament and of the Council on credit agreements relating to residential property, SEC(2011) 357 final, 3. 29  Ramsay (2016) 169. Ramsay also contends that this has lead to an unjustified distinction between mortgage and consumer credit in the EU (171). 30  Micklitz (2016) 639ff. 31  Köndgen (2014) 296ff. 32  Fairweather et al (2017) 4ff. 33  Reich (2014) 20. 34  Comparato and Micklitz (2013) 150. 35  Comparato and Domurath (2015) 232ff.

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of both parties should the outcome of the CWA be negative. Notwithstanding the lack of liability for breach of this obligation, the autonomy of the lender to grant credit as well as the autonomy of the consumer to receive credit is limited. Whether this automatically leads to a more socially just EU law in this field is questionable, but it should be acknowledged that the CJEU has shown sensitivity to the social dimension of mortgages. It should be considered that the reason for the rather drastic restriction of private autonomy may be rooted in a concern for the embeddedness of mortgages in the financial system and their economic and social importance for the very livelihood of consumers. This would mean that private autonomy is restricted because of the intrusion of external values into the contract. The welfarist mechanisms suggested in this book fall into the centre of an elaborate interplay of the different goals, limitations and extensions of private autonomy. Taking into account the needs of consumers and changes in private autonomy, the suggested tools distribute power from lenders to borrowers, with consequences for the exercise of rights and obligations, especially private autonomy. This power relates first and foremost to the legal power of financial institutions. As explained above, the professional lender, who is giving loans routinely, has more bargaining power vis-à-vis the consumer, who generally enters into a mortgage agreement only once in a lifetime. The legal power of the lender is manifest in the use of standardised contracts, in which she can—within the legal framework—dictate the content of the rules applicable to the credit relationship. A bargaining process to achieve more or less favourable rules does not usually take place in consumer transactions. Consumers are often not even aware of the effects different rules in the contract can have. They tend to accept standardised contracts as a viable default option that is legal and giving them all rights they need. This opens the door for abusive terms, especially with regard to matters that are outside of the scope of the unfairness control. This view on power is also discussed by Azoulai with regard to the Viking and Laval judgments; he conceives the possibility of subjecting private parties to certain obligations on the internal market because of their ‘social power’, which comes close to the normative power of states to define regulatory tasks.36 In this regard, we have to distinguish at least two, if not three, developments. First, it has been already mentioned that private companies have an increasing law-making power through the widespread use of standard terms. Even though this law-making power is not limitless—due to legislative intrusions and the control of unfair terms—it does have substantial scope because the main subject of the contract (typically price) is excluded from judicial control. This relates to the structurally unequal bargaining power in the context of contract formation in line with the Bürgschaftsentscheidung of the German Constitutional Court (GCC). This structural vulnerability can influence the broader self-determination of the

36 

Azoulai (2008) 1344ff.

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consumer as it can lead to a certain susceptibility to ‘hetero-determination’.37 The extended view of private autonomy as broader self-determination helps to identify the power issues structurally embedded into lender–consumer relationships. Furthermore, going beyond the GCC’s Bürgschaftsentscheidung, the power of the lender also extends to a broader, social power. This power of lenders can also lie in their control of access to credit. By marking the bar between having and not having access to a mortgage, banks exercise considerable social power. The screening function they take on must not only be seen in terms of allowing consumers access to credit, but also denying this access. After all, this is the very aim of the CWA. But with this power also comes the power to determine who can buy residential property for personal welfare. Here, we can pick up the analogy to universal services. As explained before, there are similarities between the field of traditional universal services and financial services with a caveat of a state–bank duality: states have increasingly withdrawn from the public provision of housing, hand-in-hand with an extension of activities of private financial institutions in offering mortgage credit for consumers in order to enable them to buy their own dwelling and, thus, avoid the necessity of having recourse to the shrinking public provision of welfare. As a consequence, the imposition of certain socially aware practices on credit-granting institutions might be justified. It could even be argued that lenders have a broader systemic power, or even responsibility, in terms of the creation of risk. As described in Chapter 2, banks have been at the centre of a global financial system in which risks can be transferred from one market to another, from one bank to another, from one country to another and even from one continent to another. While these risks are mainly addressed through regulatory supervision of the market activities of banks, the involvement of financial institutions in this system of contagion—which is powerful enough to spark economic crises in vulnerable countries, with significant economic and social consequences (e.g. unemployment)—can also be used as a justification to regard financial institutions as powerful players vis-à-vis consumers, who for their part do not have any influence on the processes in the international financial system, but whose economic and financial abilities can certainly be influenced by those processes. These considerations do not amount to a construction of liability of lenders for the worsening financial situation of certain consumers, but can serve as an argument to buttress the redistribution of power in the lender–consumer relationship. As a result of cases in which private parties have become the addressee of individual rights in a sort of framing of power on the internal market,38 private relationships can appear more vertical and hierarchical than assumed.

37  38 

German Constitutional Court, judgment of 19 October 1993, 1 BvR 567/89. Azoulai (2008) 1343ff.

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The provision on lender forbearance in Article 28(1) MCD can already be seen as a mirror of a certain social responsibility of banks when enforcing a mortgage agreement. According to Article 28(1) MCD, the lender shall exercise forbearance before initiating foreclosure proceedings, while leaving open the precise obligations of the lender in this regard. Moreover, Preamble 27 last sentence MCD states that Member States’ legislation shall not prevent the parties to the mortgage ­contract from agreeing that the transfer of the security to the creditor shall be sufficient to repay the loan. If consumers were allowed debt relief by transferring the mortgage property to the lender, the risk of a devaluation of the property would be borne by the lender. Even though Preamble 27 MCD does not lead to a respective obligation of the lender, it can be understood as an acknowledgement of the greater negative effects of foreclosure on the consumer compared with the positive effect for the lender who is enforcing the contract. In this sense, it mirrors a concern for larger social issues, placing more social duties on lenders who are in possession of an enforcement title against the consumer, because of their larger power. The economic, social and normative power of lenders sheds light not only their possible obligations vis-à-vis individual consumers, but also on the inferior position of consumers as a whole. Considering the connectedness of banks on global markets and their widespread use of standardised contracts, it becomes clear that consumers worldwide are not equally connected and do not possess a similar normative power. Consumers face financial institutions as individuals and not as a network of consumers. This highlights the collective dimension of consumer protection in the redistribution of power. Consumer associations could play a bigger role in the negotiation and enforcement of standard contracts with financial institutions. So far, as we have seen in Chapter 3, the collective dimension of both consumer bargaining and enforcement is neglected in the EU legal framework. Cases such as the RWE39 or Invitel40 only rarely reach the CJEU. One reason for this could be lack of standing before the CJEU and the dependence of consumer associations on the rules of the respective Member States. In addition, collective bargaining in the financial sector is not existent as in the field of employment, where collective bargaining has become a strong social institution. Notwithstanding the problems involved in collective bargaining and ­enforcement,41 it is submitted that in the context of financial markets, an ­empowerment of collective consumer interest groups can help to balance the power of financial institutions vis-à-vis their customers. Collective consumer associations could be involved in the design of standard terms, the renegotiation of debt and enforcement.

39 

C-92/11 (RWE). C-472/10 (Invitel). 41  For an overview of advantages and disadvantages of collective enforcement see Rott (2012) 72ff. 40 

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(ii)  Proceduralised Constitutionalisation The framing or regulation of autonomy under the parameters of market rationality, equality and collectivism, and needs and further aims, and the fact that much of this framing is done through the case law of the CJEU and the national courts reflects the prominence of a procedural approach to consumer protection in the EU in general, and in the field of mortgagor protection in particular. We can even claim that there is a kind of threefold proceduralisation taking place in EU mortgage contract law: first, regarding procedural dimension of affording mortgagors protection at the very delayed stage of contract enforcement (which is problematic from the viewpoint of preventing default as a matter of welfare); second, regarding the importance of procedural law and procedural individual rights in the disputes themselves; and third, regarding the possible attempt by the CJEU to improve the discursive character of EU law. First, we have seen that consumer protection in the field of EU mortgage contract law so far ‘kicks in’ at a very late stage of the contractual relationship: enforcement. This is problematic from the viewpoint of preventing default and further welfare losses, because, at this stage, the loss of the home is often imminent and not preventable (Chapter 3). Second, there is a curious absence of literal references to material fundamental rights from adjudication. Even though, in theory, the direct effect of individual and fundamental rights in private law has arguably led to a materialisation of law, constitutionalisation in the field of EU mortgage contract law is rather procedural. This is connected to the observation that despite the judicial technique of balancing of rights having a potential materialising effect, the principal right that is being used in EU mortgage contract law is the right to effective legal protection in ­Article 47 ChFR. It is not Article 7 ChFR with its right to respect of a family home, the freedom to conduct a business in Article 16 ChFR, the right to property in Article 17 ChFR, the right to a high level of consumer protection in Article 38 ChFR, or even private autonomy as part of the relevant constitutional values.42 None of these rights are referred to much in the case law pertinent to mortgage credit. Instead, national remedies are being upgraded in procedural law43 with the help of the (procedural) fundamental rights. Third, I consider it plausible to interpret the case law in a way that the CJEU shows awareness to the division of competences. Even though the opposite is often claimed, some limitations in the jurisprudence we have examined could be attributed to competence sensitivity. For example, the precise assessment of the unfairness of the term in question is left to the national courts. Against this backdrop, many have noted that the EU has not developed its own model of fairness, even though the CJEU gives considerable guidance to the national courts. Another example is the assumption that national legislation is just and fair, which underlies 42  43 

Hager (2008). Reich (2014) 98–99.

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the CJEU ruling (Kásler) that an unfair term can be replaced by a national provision. So, without the intention to downplay the immense importance and the social dimension of CJEU jurisprudence in this regard, commentators have highlighted that this approach is not enough to give new elements to the substance of the effectiveness principle44 or to remedy the limited enforceability of EU rights.45 A more optimistic view is held by Gerstenberg, who argues that the understanding of the fairness principle will gradually crystallise as more and more experience derives from the open discursive space between the CJEU and national courts.46 In his view, the proportionality principle applied to private law contract disputes allows the European courts to become active regulators in the EU’s ‘living constitution’, in which a high level of consumer protection is aimed for while softening ‘judicial finality’ in an inclusive process of stakeholder discussions on the meanings of unfairness and proportionality.47 In the latter view, the CJEU is not the final arbitrator of unfairness, as it also claimed of itself in Freiburger Kommunalbauten, but sensitive to different national legal contexts, as well as to the circumstances of different individual cases. Gerstenberg is, despite the CJEU’s definite intrusions into Member State autonomy over the decades, inclined to see the proportionality principle in private law as a reflection of the Court’s awareness of its limited competence and of the procedural autonomy of the Member States. The social dimension that is added by references to the hardship involved in losing the family home—as in Aziz—does not amount to a judicially postulated concept of fairness; Gerstenberg is optimistic that such a concept will, however, be brought about by a deliberative-discursive process. In this context, the European courts all become social engineers. Notwithstanding my sympathy for Gerstenberg’s optimism, we must come to the conclusion that, at least for the time being, the EU approach relies heavily on individual disputes seeking to determine the fairness of the mortgage contract terms involved. I am doubtful whether this could lead to social justice, especially when we take into account the limitations of the procedural fairness control, including the belated response to welfare losses and the missing collective dimension outlined above. What is more, the interplay of legislation and interpretation by the CJEU and national courts makes it difficult to discern a specific model of justice, at least at this point in time.

II.  Justice in EU Mortgage Credit Law So what type of justice can be found in the rules on EU mortgage contracts? 44 

ibid, 121. Leczykiewicz (2012) 58, 81. 46  Gerstenberg (2015) 609. 47  ibid, 603. 45 

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A.  Lack of Social Justice Putting together our findings brings to light the gaps in the EU legal framework with regard to social justice. We have seen that both legislation, especially the MCD, and CJEU jurisprudence, especially with regard to the UCT, recognise the social dimension of housing, especially its importance for the welfare of consumers and the stability of the financial system in general. However, despite this general concern with social justice in the EU approach and the respective ‘framing’ of private autonomy, there are also limitations with regard to the achievement of social justice. We can see that the emphasis lies on the improvement of private autonomy through the provision of information and in its restriction through CWA obligations and fairness control. And even though this emphasis is relatively strong, we can see in the sections above that the end goal, the distribution of power away from the lender to the consumer-borrower, is inhibited. For example, as regards the approach to the provision of information, we have seen that, in practice, consumers often do not make rational use of the information provided. In the end, the redistribution of information, and thus power in favour of the consumer as the structurally weaker party of the transaction, is futile. The fair and social balance between the contracting parties is not actually restored. Even though the obligation to provide information can be regarded as having its basis in welfare considerations, because private autonomy as part of welfare requires the opportunity to make choices between different ways of life, it is not enough to guarantee full private autonomy either. In order to ensure that each person has the chance to lead a meaningful life, the welfare state has to ensure that individuals have sufficient resources as well.48 Furthermore, needs-based regulation that is concerned with the special needs of the parties is neglected in the legislative framework and acknowledged only in recent CJEU case law, with the limitations of the procedural approach outlined. The control of standard terms through the UCT and of unfair commercial practices through the UCP, while aiming at protecting the structurally weaker party, is not a radical break away from the traditional opinion concerning the role and nature of contract as providing a just balance of rights and obligations based on autonomous party will. Abstract fairness rules merely draw the boundaries within which private autonomy may play freely.49 Evidence is provided by the lack of applicability of the UCT to individually negotiated contracts and the main subject matter of the contract, such as adequacy of price and remuneration, and the emphasis on the circumstances that prevailed at the time the contract was formed. In addition, consideration is also given to the limitations of the current creditworthiness approach in terms of a lack of obligation to deny credit and a lack of

48  49 

Thus Collins (1994a) 101–02, 124–25. Thus, concerning the UCT, Wilhelmsson (1993a) 441.

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liability. We can therefore conclude that the mere concern for the economic and social welfare of mortgagors is not matched with clear enforceable obligations. Academics have criticised the lack of social justice concerns in the EU legal framework. The overarching concern of EU legislation is not social justice, notwithstanding the consideration of social justice in the CJEU case law. The Manifesto for Social Justice has also emphasised that even though principles of social justice—such as notions of good faith, rules on insolvency or environmental law—are included in the EU legal order, those principles derive from a narrow, functionalist view of the competence of the EU and embrace a narrow conception of social justice that is applicable to a competitive internal market.50 With its focus on information duties and the enabling of autonomous choices on the market, the emphasis of EU consumer law is on market-rational welfarism,51 neglecting both internally redistributive mechanisms, such as price controls, and externally redistributive measures that aim at improving access for less advantaged persons.52 This leads to low protection standards, instrumentalising them to prevent market distortion.53 This is connected to the observation that there is no coherent set of values behind the present welfarism in the contract laws in Europe.54 In the same vein, Hesselink has bemoaned the connection between citizenship and consumer protection, which leads to a reduction of citizens to consumers and is instrumental in market building and full harmonisation, while stepping further away from social justice in private law.55 What is missing from the EU model of justice in consumer credit and mortgage law is the concern for larger distributive issues beyond the distribution of information and the concern for the bargaining power at the stage of contract formation. Since a private dwelling fulfils two roles, as a private asset and a means of social protection, the legal framework governing the allocation of housing, whether public or private, necessarily touches upon larger distributive issues and approaches to welfare. This becomes even more evident when reminding ourselves of the social and societal impact of mass evictions as evidenced in Spain and other parts of Europe. Even if we took the (limited) point of view of the EU with its basis of legislation in competition law, the current legal framework in the field of mortgage credit neither produces the desired social inclusion nor fosters a functioning internal market. From a preventive point of view, a pronounced commitment to social justice would include stronger ex ante control of contract terms that are specifically designed to take into account the causes of overindebtedness. Such an approach would go beyond the reliance on fairness control of standard terms in individual

50 

Brüggemeier et al (2004) 665ff. Wilhelmsson (2004b) 732. 52  ibid, 732. 53  Brüggemeier et al (2004) 661. 54  Thus Wilhelmsson (2004b) 733. 55  Hesselink (2006) 41. 51 

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court proceedings, which is, besides its ex post character, not concerned with the causes of default and further welfare losses.

B.  The Features of Access Justice It has been claimed that a new concept of ‘access justice’ has emerged in the EU, which can be located between social distributive and libertarian ­allocative justice.56 The term was coined by Micklitz, and is based on the German term Zugangsgerechtigkeit. This model of access justice aims at securing opportunities on the internal market for the benefit of the well-informed and sovereign consumer-citizen who corresponds to the normative consumer Leitbild of the reasonably circumspect consumer. The consumer who is considered vulnerable in certain fields, such as in the UCP, in the field of universal services, or in more protective case law of the CJEU, appears only as a backup category.57 Similarly, the rules on unfairness control do not constitute a departure from traditional market rationale contract values.58 When looking at the parameters for access justice, we come to the conclusion that traits of this type of justice are employed in the field of mortgage contracts. As such, I do not mean to confirm access justice as a full theory of justice in EU private law,59 but rather to show that the elements of access justice can be found in this field of law. Access justice comprises two elements: the breaking down of barriers that limit participation and access, and the strengthening of enforcement of consumer rights.60 Concerning the removal of access barriers, we have seen that the regulatory framework on consumer credit in Europe is geared towards enabling access for more and more consumers to the credit market. As for the strengthened enforcement of consumer rights, we have also seen that the CJEU has used the fundamental right to effective procedural protection of Article 47 ChFR to underpin consumer protection. These tools are aimed at improving the private autonomy of consumers in order to enable them to profit from the competition mechanisms on the internal market. Of course, this confinement of access justice is connected to a lack of competence of the EU to legislate in the field of private law and the consequential recourse to sectoral, fragmented legislation that incidentally touches upon private law issues together with the regulation of the internal market. As we have seen in Chapter 1, there is no general mandate for the EU to deliver social justice in the current legal framework; social justice can only be advanced through EU measures if those measures themselves are adequate tools to improve the functioning of

56 

Micklitz (2011a) 21–22. Micklitz (2013b) 274. Thus Wilhelmsson (1993a) 440. 59  For a powerful critique, see Hesselink (2016) 688ff. 60  Micklitz (2011a) 23; see also Micklitz (2011b) 37. 57  58 

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the internal market.61 It should not come as a surprise, therefore, that concerns of market failure underlie much of EU consumer legislation instead of distributive or social justice.62 The persistence of the dual provision of welfare through state institutions and market mechanisms reveals that the central goal of welfare provision is not the establishment of an egalitarian society, but the achievement of autonomy for each citizen.63 If it were the enjoyment of equal resources and opportunities, the goal of regulation would be to prevent anyone from gaining better opportunities by the use of market mechanisms.64 Instead, it is the fostering of formally equal bargaining positions, to be achieved through the provision of information and the control of unfair standard terms. Micklitz claims that the European model of access justice is distinct from other ideas of justice in two ways.65 First, in contrast to consumer law in the Member States, which supposedly reflects welfare state concerns for the weaker parts of society and thus aims at social justice, it does not aim at social protection in a redistributive perspective, because it is designed for the reasonably circumspect consumer who can seek the best opportunities on the market. Second, it is different from allocative libertarian justice, because it restricts the exercise of market freedoms and the private autonomy of contractual parties. It rather lies in between libertarian justice and social justice as it aims at materialising the doctrine of equity so that the theoretical chance of participation is transformed into a realistic opportunity of access (access justice), without, however, incorporating welfarist concerns as such. The theoretical chance of participation is the focus of the traditional, more formalistic contract law model, whereas the realistic opportunities for such participation are to be achieved through information, education and fairness control. In sum, it can be stated that the EU legal framework is not primarily concerned with the achievement of social justice, mainly because of competence restrictions and market bias. The model of justice manifest in the legal framework comprises features of access justice, which is concerned with participation both in terms of access to the credit market and in terms of enforcement of rights. The at times more activist stance of the CJEU, which takes into account the larger social context of the socially sensitive issue of adequate living conditions and access to housing, fails to make up for the general lack of social justice. Whether Gerstenberg’s ­deliberative approach of the dialogue between European courts is true, which could then lead to a framework more aligned with social justice, is for the future to tell.

61 

Weatherill (2006) 143. Collins (1994b) 237–38. Collins (1994a) 103. 64  ibid, 103. 65  Micklitz (2011b) 34ff. 62  63 

Epilogue This book is concerned with the potential of contract law to prevent welfare losses in the field of housing. We have seen that contract law can help to prevent default—as the proxy used in this book for welfare losses. We have arrived at this conclusion by examining a set of questions that fall into the heart of discussions on the role and values of contract law. In Chapter 1, we established the general possibility that contract law can be ­concerned with values such as welfare and social justice. Presenting contract theory, we have been able to adduce good reasons for such a concern in private law even though it arguably belongs to the realm of public law. First of all, there is no clear division between public and private law, as often assumed by formalist contract lawyers. This is especially true for EU contract law, in which we can find routine references to competing aims in its legislation, including aims that lie outside of the immediate contractual relationship. Second, the formalist view is often premised on the assumption of an autonomous party will, according to which the parties negotiate what they deem ‘just’ in their contractual relation. We have, however, seen that this assumption is overly optimistic at best. In contrast, contract law with an ex ante view that incorporates concerns of welfare and social justice can at least complement the procedural ex post approach currently taken by the EU to the protection of mortgagors. Furthermore, I hope to have supported the normative preconception that social justice should be achieved on the EU level. The prevention of default through EU instruments should be an EU concern. Moreover, much of the controversies on maximum and minimum harmonisation could be left open for our purposes, because the legal framework under examination here is based on minimum harmonisation. Chapter 2 explained the retreat of the welfare state in the political economy of the credit–welfare trade-off and the assumed logic of financial and social inclusion. We have seen that this logic is fallacious, as the expansion of mortgage credit to more and segments of society has not led to more (privatised) welfare. On the contrary, social problems, including forced evictions from homes acquired with mortgage credit, have been widespread in recent years. Acknowledging that not all mortgagors are affected by those welfare losses, we have also conceptualised vulnerability in this field. Three types of vulnerability must be distinguished: relational vulnerability, referring to the structural-informational vulnerability of weak consumer vis-à-vis the professional lender in terms of negotiating power and knowledge, the vulnerability of consumers with low levels of education, and

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the vulnerability of marginal borrowers to exploitative practices; event vulnerability, describing the vulnerability especially of precarious workers, bubble borrowers and consumers with foreign-currency loans to adverse events that are external to the immediate contractual relationship; and, lastly, the lack of resilience of lownet-worth consumers to absorb possible losses should their financial situation change for the worse. Thus, we have seen that the concept of vulnerability is multifaceted in the field of housing. As such, it might share similarities with vulnerability of consumers in other fields of law, but might also be distinct from it. In Chapter 3, we then analysed to what extent the three types of vulnerability are acknowledged in the protective mechanisms of the applicable EU legal framework. The answer is: partly. Relational vulnerability is clearly part of the legal framework in terms of the weakness of consumers vis-à-vis the professional. This is the very rationale of consumer law, which aims at remedying information asymmetries through the obligation of lenders to provide certain information to the consumer as well as power asymmetries through the judicial control of unfair terms. However, using the concept of vulnerability, we have seen that this approach is insufficient if we are to acknowledge the important role that contract law assumes in the political economy of the credit–welfare trade-off: event vulnerability and a lack of resilience are neglected in the framework. The former is acknowledged in general but legal tools that could remedy event vulnerability specifically are missing. The latter is assumed to be remedied by the CWA; despite improved rules since the financial crisis, we can deem the current approach not suitable because of a lack of liability and lack of strong parameters. In Chapter 4, I propose tools with the help of which the neglected types of vulnerability can be addressed in the applicable legal framework on mortgage contracts. The suggestions are matched with the types of vulnerabilities previously identified. Apart from a strengthened CWA, with more robust parameters of assessment, such as buffers for low-net-worth consumers or the incorporation of external events into the probability assessments, an extended unfairness control is the most important tool identified. More specifically, I suggest deleting the exception of Article 4(2) UCT from the wording of the Directive with a view to enabling control of the adequacy of price. In this way, all types of vulnerability could be better addressed in the legal framework. Relational vulnerability, especially of marginal borrowers, and the lack of resilience of consumers with low net worth, could benefit from interest-rate ceilings or buffers in the CWA, respectively. Interest-rate ceilings would make it harder for lenders to pass on the higher cost of lending to marginal borrowers on to consumers. In turn, buffers would make it harder to borrowers to obtain credit. This is accepted from the viewpoint of preventing defaults and further welfare losses. In the end, it becomes clear that some contractual tools involve only small changes to the current legal framework—such as the inclusion of buffers or interest-rate limits—while others imply substantial changes that go to the core of the theoretical debates on the role and values of contract law.

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Epilogue

In the final chapter, we revisited the theoretical debates started in Chapter 1 by eliciting the implications of the suggested contract law tools for the understanding of social justice in the EU and the development of a welfarist contract law. Based on Wilhelmsson’s characterisation of a socially just contract law, which includes needs-based concerns as a welfarist parameter, we have seen that, as it stands, EU contract law is largely rooted in market rationality. It focuses on remedying information asymmetries and empowering consumers to care for their own welfare on private markets. Intruding deeper into private autonomy, we have also seen that there are traces of concerns in the legal framework with the material equality of the contracting parties. In particular, the proactive jurisprudence of the CJEU has added to this dimension by ruling that national courts must assess ex officio the possible unfairness of contract terms and that the national court could even replace the unfair term in question with a default provision of national law. At the same time, the judicial approach to mortgagor protection was criticised because it is not possible to review the adequacy of price and because it relies on individuals bringing cases before the courts. A radical rethinking must take place if the EU is to take seriously the welfare losses brought about by a privatisation of welfare. We have seen that the rationales of universal services already have this welfarist orientation and that judicial practice in the Nordic Member States has a significant welfarist outlook. This shows that such different thinking is not unknown in the legal order. Finally, even though the CJEU has undisputedly shown concern for the social dimension of mortgagors losing their home in enforcement procedures and thus their social need, this concern is not matched with a substantive approach to material fairness. Instead, the actual assessment of fairness is left to national courts. I claim that this deficiency in terms of achieving a socially just contract law on the EU level is rooted in a conscious attempt by the CJEU to not overstep the competence limits of EU action. The Court appears to be actively engaging in an open dialogue with national courts, which might lead to further elaborations on social justice in the EU. As things stand, however, this has not been achieved and the constitutionalisation of contract law in the EU might be highly procedural. This shows the dilemma of the dual aims of achieving both a competitive EU based on market economy and an EU that comprises a social model. The existing European social model is not easy to characterise. If we define a social model as society’s mode of managing the risks to human life that are specifically created by modern capitalism,1 then it becomes clear that a social model on the EU level has not been achieved. In this vein, it must be acknowledged that an economy dependent on consumer debt, coupled with the need constantly to reintegrate consumers into the credit market, might be not be sustainable.2 This, however, would go

1  2 

Somek (2011) 28. Ramsay (2016) 182.

Epilogue

 181

beyond the realisation that privatised welfare can only work if welfarist contractual tools are included into the legal framework. It would imply an abandonment of the fallacious logic between financial and social inclusion and a re-emergence of the welfare state. In order to address the problems of financial exclusion and possibly social exclusion in terms of a restricted access to housing, which is brought about by higher lending and fairness standards, welfare states would have to reassume their role as the providers of social housing and counteract the credit– welfare trade-off.

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INDEX

Acceleration clause  94 access justice  30, 176–7 access to financial products need for a protective design for  77 Aristotle  18 Arnold, S  18 austerity  1, 2 autonomous party will  22–3, 178 Aziz, M  105, 127 Azoulai, L  169 bank bailouts  2 Banks, E  64 Beck, U  3 ‘behavioural economics’  65 bubble borrowers creditworthiness assessments  134 systemic risks  70–2 vulnerability in EU mortgage contract law  110–11, 121 Caplovitz, D  67 Cartwright, P  64, 67, 73 CESL  31, 129 change in circumstances see renegotiation of mortgage debt collective bargaining  171 Collins, H  18, 39, 43, 163 Common European Sales Law (CESL)  31, 129 Comparato, G  28, 30, 36, 42 ‘competence creep’  27 constitutional dimension of Aziz  100 constitutionalisation of contract law  33, 42, 43 criticisms of  37–9 ‘regulation’ of private autonomy  36–7 role and effect of principles and fundamental rights  33–6 proceduralization  172 consumer associations  106–107, 171 consumers with low levels of education EU mortgage contract law fairness of commercial practices  88–9 provision of financial education  87–8

flexible mortgage contract law banks to be obliged to take into account low levels of education  126–7 financial counselling  125–6 vulnerability, of  66–7 ‘continuous workout mortgages’  137 contracts importance of  7 corrective justice  19–20 credit–welfare trade-off  46, 157, 181 creditworthiness assessments (CWAs)  116–9, 120–2, 163 bubble borrowers  134 exchange and interest rates  134–5 flexible mortgage contract law  132, 159 lack of resilience, and  158–9 liability  135–6 needs of consumers  167 precarious workers  134 protective ambit  132–3 shared responsibility  133–5 Dagan, H  21 ‘debtfare state’  59 ‘democratisation of finance’  77 direct effect of individual rights  34 distributive justice  18–20 division of competences EU and Member States  27 ecological vulnerability  63 ‘economic disability’  67 economic interdependence of EU Member States  4–5 effectiveness of EU law  94–9 equivalence, and  95 principle of cooperation  96 ex officio control of standard terms  97, 104, 108, 164–5, 181 equality and collectivism  164–5 information obligations  164 prohibition of unfair contract terms  164 right to convert currency  164 ESF  32 EU consumer law aims of  13–16, 44, 178

202  eradication of poverty and social exclusion  14 functioning of the internal market  14–5 harmonisation  14–5 national consumer law, and  15 European model consumer EU mortgage contract law  79 reasonably circumspect but weak consumer  79–81 vulnerable consumer  81–3 ‘European Platform against Poverty’  14 European Social Fund (ESF)  32 European Standardized Information Sheet (ESIS)  83–4, 86, 88, 112, 115–6, 134 event vulnerability external risk factors  68, 74, 179 income instability: precarious workers  69 systemic risks: bubble and foreign-currency borrowers  70–73 event vulnerability and flexible mortgage contract law  131 insurance, unsuitability of  132 renegotiation of mortgage debt  136–7, 160 change in circumstances  139–56 proposals for  137–8 see also credit worthiness assessments (CWAs) event vulnerability bubble borrowers  110–11, 121 in EU mortgage contract law  109–10, 115–16, 121 foreign-currency borrowers  111–14, 121–2 precarious workers and income instability  110 Ex officio doctrine, see effectiveness of EU law Fairness Consumers with low levels of education  88–9 Marginal borrowers Fairness of contract  91–3 Fairness of enforcement and effectiveness of EU law  94–9 in Nordic countries  148–9, 153–4 financial counselling consumers with low levels of education  125–6 financial education  effects of  58–9 private autonomy  162 provision of, and access to  59, 87–8 financial inclusion  53 social inclusion, and  52–5, 76–7, 116, 157, 178, 181 financial literacy  53–4, 87–8

Index flexible mortgage contract law  124, 159–60, 179 event vulnerability  131 creditworthiness assessments  132–6 insurance, unsuitability of  132 renegotiation of mortgage debt  136–56, 160 exclusion from credit  156–7, 160 extended fairness control  159, 160 lack of resilience  157, 179 creditworthiness assessments  158–9 price controls  159 relational vulnerability  179 consumers with low levels of education  125–7 marginal borrowers  127–31 vulnerable consumer as model consumer  125 foreclosures, avoiding  168 foreign currency borrowers creditworthiness assessments  134–5 right to convert currency  164 systemic risks  70–3 event vulnerability in EU mortgage contract law  111–14, 121–2 Gennaioli, N  65 Gerstenberg, O  173, 177 global financial crisis  1–3 housing market  2–3 Green Paper, Mortgage Credit in the EU  5 harmonisation of contract law  27–31, 41 alternatives to maximum harmonisation  31–3 Hayek, F  20, 21 Hesselink, M  38, 43, 167, 175 household debt levels  1, 2 housing promotion, of  49–50 situation and conditions in EU  3–4 welfare losses in  60–1 housing cost burden  3–4, 61 impact vulnerability  64, 73 information obligations  83–7, 162, 163, 164 information overload  86, 115 ‘informational vulnerability’  66–7 insurance unsuitability of  132 International Monetary Fund  1, 137 Jolls, C  65 Judicial activism  105 CJEU, of the  177, 180 Nordic courts  148 European courts as active regulators  173

Index judiciary, role of unfairness of contract terms  5 Kahnemann, D  65 Kaplow, L  21 Kennedy, D  35 Kokott, Advocate General  100 Köndgen, J  168 Korzcak, D  2, 59 Kumm, M  37 lack of resilience  73–4, 179 EU mortgage contract law  118–20, 122 low-net-worth consumers  116–18 flexible mortgage contract law  157, 179 creditworthiness assessments  158–9 price controls  159 Leczykiewicz, D  105 lex mercatoria  7 Loos, M  31 Macneil, I  21, 22 Mak, C  105 Mak, V  28 Manifesto for Social Justice  17, 175 Marcou, G  48 marginal borrowers  fairness of contracts  91–4 fairness of enforcement  94 effectiveness of EU law  94–9 fundamental right to effective legal protection  99–100 fairness regime  89–91, 100 limitations of  101–8 flexible mortgage contract law  127 price controls  127–9 universal financial services  129–31 market rationality  161–3, 180 creditworthiness assessments  163 financial education  162 information obligations  162, 163 unfair standard terms  163 Mattei, U  17 Méndez-Pinedo, M  152 method of law-making  26 EU level  26–7, 41–3 constitutionalisation of contract law  33–9, 42, 43 division of competences  27 harmonisation of contract law  27–33, 41 Mian, A and Sufi, A  5, 132, 137–8 Micklitz, H  30, 36, 40, 168, 176, 177 Mortgage Credit Directive (MCD)  6 Needs-based regulation  19, 161, 174 needs of consumers  164–8 avoiding foreclosures  168 change-in-circumstances principle  166

 203

creditworthiness assessments  167 in CJEU case law  176 price controls  166–7 Niglia, L  29, 35 Nogler, L  138 Novak, M  18 open method of coordination (OMC)  32 overoptimism  65 Pierson, P  57–8 Pistor, K  137 political neutrality of contract law  23–4, 26 precarious workers creditworthiness assessments  134 income instability  69 vulnerability in EU mortgage contract law  110 ‘pressure vulnerability’  67 price controls lack of resilience, and  159 marginal borrowers  127–9 needs of consumers  166, 167 private home ownership deterrent to social and industrial unrest  54 financial measures for fostering private housing markets  50–51 mortgage markets, expansion of  51–2 promotion of  49–50, 76 welfare role of  50 private law/public regulation distinction  20–26 Pulgar, J  138 Ramsay, I  100, 128, 168 Rawls, J  18, 21 rebus sic stantibus principle  138 see also renegotiation of mortgage debt Reich, N  29, 36, 40, 67, 104, 105, 115 Reifner, U  6–7, 138 relational contract theory  21–2 relational vulnerability internal risk factors  65–8, 74, 178–9 relational vulnerability and flexible mortgage contract law consumers with low levels of education banks to be obliged to take into account of  126–7 financial counselling  125–6 marginal borrowers  127 price controls  127–9 universal financial services  129–31 vulnerable consumer as model consumer  125 relational vulnerability in EU mortgage contract law  78–9, 108–9, 121 consumers with low levels of education fairness of commercial practices  88–9 provision of financial education  87–8

204 

Index

European model consumer  79 reasonably circumspect but weak consumer  79–81 vulnerable consumer  81–3 marginal borrowers  fairness of contracts  91–4 fairness of enforcement  94–100 fairness regime  89–91, 100–108 weak consumers economic efficiency and political function of information provision  84–6 information obligations for lenders  83–4 information provision  83, 86–7 renegotiation of mortgage debt  136–7, 160 change in circumstances  140 acknowledgment of, in international legal orders  139 conditions for application of the principle  147–9 ‘Continental’ and English approaches to  140–45, 150–53 implementing principle into mortgage agreements  149–54 Nordic approach to  145–7, 153–4 problems of incorporating a change-in-circumstances approach  154–6 welfarist EU mortgage contract law  166 proposals for  137–8 responsibilisation and individualisation  56–7 risk of poverty  4, 60–61 eradication of poverty and social exclusion  14 ‘risk society’  3 Rösler, H  17 Rott, P  33, 119 Safjan, M  36 self-exclusion  58 shared responsibility creditworthiness assessments  133, 134, 135 shared-responsibility mortgage (SRM)  138 Shavell, S  21 Shiller, R  57, 75, 77, 132, 137 social exclusion  4, 58, 59, 60, 77 eradication of poverty and social exclusion  14 social force majeure  146, 149, 153, 165 social inclusion through financial inclusion  52, 53, 54, 55, 76, 77, 116, 157, 178, 181 social justice and welfare lack of social justice concerns in the EU legal framework  174–6, 180 need to be taken into account in contract law  16–17, 19–20, 39–41 social justice, concept of  18, 19, 20 see also access justice

SRM  138 Standard European Consumer Credit Information (SECCI)  84, 86, 115 standardisation of contracts  23 Streeck, W  58 structural vulnerability  63 Study Group on Social Justice in European Private Law  17, 40 Sufi, A and Mian, A  5, 132, 137, 138 temporal dimension of mortgage credit agreements  8 Terryn, E  33 theoretical framework  7–8, 13, 16 Tversky, A  65 unequal bargaining power of the consumer  66–7 unfair contract terms judiciary, role of  5 prohibition of  163, 164 universal financial services marginal borrowers  129–31 universal services  81–2 Vandone, D  6 vulnerability in EU mortgage contract law  78, 120, 120, 122–3 event vulnerability  109–10, 115–16, 121, 179 bubble borrowers  110–11, 121 foreign-currency borrowers  111–14, 121–2 precarious workers and income instability  110 lack of resilience  118–20, 122, 179 low-net-worth consumers  116–18 relational vulnerability  78–9, 108–9, 121, 179 consumers with low levels of education  87–9 European Model Consumer  79–83 marginal borrowers  89–108 weak consumers and information provision  83–7 vulnerability to welfare losses  7, 9, 61–2 categories of vulnerability  62–3 concept of vulnerability  62–4 mortgagors  64–5, 74, 75, 75, 76, 77 event vulnerability to external risk factors  68–73, 74, 179 lack of resilience  73–4, 179 relational vulnerability to internal risk factors  65–8, 74, 178–9 weak consumers EU mortgage contract law

Index economic efficiency and political function of information provision  84–6 information obligations for lenders  83–4 information provision  83, 86–7 Weatherill, S  14, 25, 27, 33, 37 Weinrib, E  21 welfare losses  60 credit-welfare trade-off, and  46 default of mortgagors  60–1, 76 privatisation, and  60 see also vulnerability to welfare losses welfare provision  46 credit–welfare trade-off  46, 157, 181 privatisation  47–9 responsibilisation and individualisation  56–7 see also private home ownership; social inclusion welfarist EU mortgage contract law equality and collectivism  164–5 information obligations  164 prohibition of unfair contract terms  164 right to convert currency  164

 205

features of  19, 161 market rationality  161–3, 180 creditworthiness assessments  163 financial education  162 information obligations  162–3 prohibition of unfair contract terms  163 needs of consumers  165–8 avoiding foreclosures  168 change-in-circumstances principle  166 creditworthiness assessments  167 price controls  166–7 proceduralisation balancing rights, autonomy, and power  168–71 proceduralised constitutionalisation  172–3 welfare states developments and transformations  46–9, 75 need for  181 Whitehouse, L  11 Wilhelmsson, T  8, 19, 20, 24, 124, 146, 149, 153, 161, 167, 180 Wollmann, H  48

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