Federal Court of Justice confirms relevance of negative interest rates when calculating early repayment compensation

In a long awaited judgment (XI ZR 159/23), the Federal Court of Justice (Bundesgerichtshof) confirmed that the creditor may calculate its losses caused by the termination of a loan agreement secured by a mortgage on the basis of the interest rate applicable to the reinvestment of the repaid loan even if the interest rate is negative.

Background

The starting point of the judgment is section 490 (2) sentence 3 of the German Civil Code. According to this provision, the borrower is obliged to compensate the bank for the loss arising from the premature termination of a loan agreement that is secured by a mortgage (so-called early repayment compensation – Vorfälligkeitsentschädigung).

According to longstanding case law the bank can choose between two methods for calculating its loss: The first method assumes that the prematurely repaid loan amount is reissued as a fixed-interest mortgage loan. The second method, the so-called ‘asset/liability method’ (Aktiv-Passiv-Methode) is based on the principle that the creditor’s loss of profit is calculated by taking into account the notional return that it could expect to obtain if it reinvested the funds released by the early repayment in mortgage bonds with maturities corresponding to the term of the loan.

Prior to the judgment of the Federal Court of Justice, there was no consensus among courts how to deal with the problem that negative reinvestment interest rates had formed on the market for the relevant capital market securities. In some cases, the consideration of negative interest rates was allowed, in others it was rejected.

Arguments of the Federal Court of Justice for relevance of negative interest rates

The Federal Court of Justice agreed with the courts which based the calculation of the early repayment compensation on negative interest rates. The court simply applied the principles already established to the scenario of negative reinvestment interest rates. According to theses principles the creditor may notionally calculate its loss on the basis of a reinvestment in mortgage bonds with matching maturities (paras. 17 et seq. of the judgment). According to the court, this starting point applies irrespective of the relevant interest rate environment (para. 18 of the judgment). This is convincing because the relevant legal principles should indeed apply regardless of actual developments such as the development of market interest rates which cannot be influenced by the contractual parties.

In this respect, the Federal Court of Justice explicitly rejects the idea that the abstract calculation of damages, which is detached from the actual reinvestment, violates the principle under German law that there may not be any overcompensation. Here too, the court emphasised that the already accepted principles apply and that there is no reason to deviate from these principles if the applicable interest rates are negative. According to these principles, the creditor may calculate its loss in the abstract because the successful claim of an early repayment compensation would otherwise be thwarted by practically impossible requirements of proof (paras. 20 et seq. of the judgment).

Implications and outlook

With this judgment, the Federal Court of Justice has created legal clarity and certainty for a large number of past cases in which creditors calculated the early repayment compensation based on negative reinvestment interest rates. The wave of requests for reimbursement that would otherwise be expected will therefore not materialise. As a negative interest rate environment is not to be expected in the foreseeable future, the judgment has no direct significance for loan agreements that will be terminated in the future. However, the judgment underlines the fact that the Federal Court of Justice will continue to adhere to established principles for calculating damages in the future and will not deviate from them lightly.