Fixing credit agreements

Credit agreement is a contract that determines all the different terms and conditions relating to granting and repayment of credit. A credit agreement is subject to rules and principles of contract law unless otherwise agreed. Thus, just like any other contract, credit agreement binds only the parties to the contract (inter partes).

Credit agreements arise in practice when a client requests a bank for a loan and, assuming that the following negotiations are successful, the bank grants the client a loan. The repayment of credit is probably the most important topic in the negotiations: the due dates can be agreed in separate contracts and the banks often use separate payment plans. Such contracts are, of course, equally binding as any other contracts. The debt may be payable in one installment on the agreed date or after the period following the termination of an agreement or when the creditor requires payment. It should be noted that different ways of expiry may be in force at the same time.

It is important to distinguish that the negotiations are not just about agreeing on ways of repayment. Moreover, there are a vast number of different terms and conditions the parties may resort to, even though usually the banks standard terms are applied to credit agreements. Standard terms are commonly used with different kinds of clients. Hence, the standard terms lighten the workload of the banks as the banks will not have to draw up the terms and conditions separately each time. However, the use of standard terms may seem awkward from the other party’s perspective, since the special features of their contractual relationship are easily ignored.  It should be noted that the banks standard terms need to be approved by the Finnish state authority when the other party is a private individual.  The goal is to protect private individuals by ensuring the reasonableness of the standard terms and conditions.

Usually the credit agreement includes terms and conditions that aim to keep the agreement impartial during the contractual relationship, as any possible changes in the economy affect the value of the credit. Therefore, the credit granted by banks includes not only the marginal rate imposed by the banks themselves, but also the reference rate. The reference rate is publicly recognized interest with which the interest of the credit agreement is decided upon. The changes in the reference rate are tied to the key interest rate of the European Central Bank that reflects the economic situation of Europe and the rest of the world. Margin rate on the other hand is the interest with which the bank makes a profit and aims to reduce the risk of lending. As a general rule, the margin rate remains unchanged during the contractual relationship, but by the parties mutual consent the bank may be given a right to unilaterally raise the marginal rate in order secure its financial situation.

Credit relationship is formed by entering into agreement. There are no formal requirements but usually a credit relationship is formed by a written contract. A contract is a legal act which consists of three elements: a person’s will; the expression of a person’s will; and intention to let the other party know about the expression of will. From the point of view of forming a contract, the most important element is the expression of a person’s will. This is shown in the Supreme Court’s decision KKO:2016:10, which dealt with a contractual dispute on a term of a credit agreement.

In the case municipalities and a federation of municipalities had formed a credit agreement with a bank, Svenska Handelsbanken AB. A dispute arose between the parties because Handelsbanken’s standard term, which was included into the agreement, held that the bank had a right to unilaterally raise the marginal rate. The municipalities and the federation of municipalities contended that the parties had not distinctly negotiated about the unclear term and its meaning during their negotiations. The District Court and the Court of Appeal took the bank’s side and held that the bank had a unilateral right to increase the marginal rate. The Supreme Court departed from the lower courts judgments by basing its decision on the general principles of contract law.

According to the Supreme Court, the municipalities and the federation of municipalities had not agreed on the standard term of Handelsbanken because the bank had not specifically negotiated the matter with the parties. In addition, the term was unclear and due to lack of negotiation, it was not possible to identify the common will of the parties. The Supreme Court held that the dispute was essentially about the parties will and expression of will, and hence the matter was to be solved by the general principles of contract law. Thus, an unclear term of a contract is to be interpreted to the detriment of the drafter. In addition, because the term was an exception to general practice, the bank ought to have explicitly negotiated the term with the other party. Therefore, Handelsbanken did not have the right to unilaterally increase the marginal rate, and the municipalities and the federation of municipalities had the right to remuneration on the basis of marginal rate increase.

As can be seen, credit agreements are subject to same rules as any other contracts: the content of the agreement is determined by the will of the parties. However, in some cases there may be confusion on what the parties have actually agreed on. In such cases one of the parties is often, de facto, in a weaker position and hence the stronger party’s opinion is often, de facto, the prevailing one. But, the parties have a right seek justice through legal means as in the case of KKO:2016:10. Yet, this is not beneficial for either party, and hence it is important to draft contracts in mutual understanding. It is advisable to prepare for possible contractual ambiguities beforehand in order to settle the issues quickly and as painlessly as possible. For example, it may have been in the best interest of Handelsbanken to settle the dispute in the Court of Arbitration because then the trial and the verdict would not have been public.