The right of preferential lien on loan agreements

Posted on 05 Jul 2016, by Savvas Savvides

It is commonly accepted that our modern society requires us to possess a relevant knowledge on bank accounts and loan agreements. How feasible is it, however, for an average person to understand the dangers of a ‘simple’ loan agreement? The legal system of a democratic country ensures the equal treatment between parties and provides support where it is essential. Specifically, it is vital to emphasise a hidden term contained within loan agreements by which the banks maintain a very powerful right against innocent debtors. This right is namely preferential lien.

In bilateral agreements/contracts, which are distinguishable from those of unilateral agreements, an agreement between two contracting parties is concluded in exchange of mutual promises. In these types of contracts the parties are bound by their mutual contractual obligations.

A loan agreement is the bilateral undertaking of a contractual obligation between the bank (creditor) and the borrower (debtor). With these types of loan agreements and especially those which were provided by the bank during Cyprus’s economic growth period back in 2006 in foreign currencies, there were hidden contractual terms in the agreements which were a “trap” to debtors. This consisted of unfair and/or non-explained legal terms.

Within this framework, a bilateral agreement can be termed as either ‘positive’ or ‘negative’ for the contracting party depending on the power of negotiation standpoint. The Cypriot banks enforced and/or used the needs of a growing construction and real estate period in Cyprus to serve their own purposes. The banks were advertising and offering favourable term loans to persuade innocent purchasers to buy properties in Cyprus.

The loans offered from Cypriot banks at that time were primarily in foreign currencies and especially CHF (Swiss Francs). However, so that the banks could safeguard their own legal interests in a potential failure of payment on loans they included beneficial terms for themselves and adverse terms for the debtor.

What is right of preferential lien? The right of preferential lien is the creditor’s entitlement to retain lawful possession of the debtor’s funds until fulfilment of the obligations of the contract. The right of preference lien in a loan agreement applies when there is reasonable evidence of loss to the creditor due to repayment arrears of the monthly instalments. In addition, the bank retains the right to deny fulfilment of their contractual obligation to the debtor.

The bank retained their entitlement of the general preferential lien against any of the debtor’s assets that related directly to the bank or to any other affiliated company of the bank. When there is non-payment and/or arrears on the payments from the debtor the bank is entitled without notice and/or the receipt of consent from the debtor to recover the unpaid amount from the “relative” funds/assets kept within the bank or its affiliate companies.

The right of preferential lien, when included in the loan agreement, is incorporated within the sphere of unfair contractual terms provided by the bank and in which the debtor is not in reality entitled to amend or include or exclude any contractual legal term within the loan agreement.

In the case of the Arpad Kasler and Hajnalka Kaslerne Rabai V OTP Jelzalogbank Zrt the question arising was as to whether there were unfair terms between the parties in the application of the foreign currency exchange rate of the loan agreement. The European Court of Justice in their consideration that there are debtors that are discriminated against due to lack of information and qualifications must be informed in detail on the consequences of the agreement. Therefore, the loan agreement must be written with transparency and clearly and if there are any doubts in the terms, the most favourable interpretation/conditions should apply to the debtor.

European Law requires its member states to act in the interests of the debtor and to prevent any unfair terms between the professional creditor (banks) and the average debtor. The right of preferential lien it is a very powerful legal weapon for banks and its affiliates in gaining an overall right to the debtor’s assets.

It is important to note that a debtor becomes a bad debtor and/or a loan becomes a non performing loan especially in foreign currency loan agreements where the remaining balances of the loan have increased to almost twice the initial loan due to the exchange rate and the unilateral increase of the interest.

The banks in loan agreements are the strongest contracting party which sets the terms and conditions of the loan. The banks have the responsibility and liability to inform the prospective debtor correctly and lawfully on the terms and conditions of the loan agreement presented for signature. At the same time the debtor should not leave anything in the hands of the bank. The debtor should seek legal advice on the legal terms and consequences of the loan and be informed on the document that will affect their lives and their properties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought on your specific circumstances. For further information, please contact Mr Savvas Savvides.