Iceland, the EFTA Court and the indexation of credit to inflation: operating in nature ex-post but need to calculate and disclose ex-ante.A law of contradiction?

Author:M. Elvira Mendez Pinedo
Position:School of Social Sciences, Faculty of Law, University of Iceland
Pages:7-39
SUMMARY

Indexation of credit to inflation (ex-post) is a unique legal practice in Iceland based on valorism theory on money vs. nominalism. Two rulings issued in 2014 by the EFTA Court try to clarify the legality and fairness of this particular price-variation clause under the European Economic Area consumer credit acquis. The study summarizes the rulings and analyses critically the interpretation... (see full summary)

 
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STUDIES AND COMMENTS
Iceland, the EFTA Court and the indexation of credit to inflation:
operating in nature ex-post but need to calculate and disclose ex-ante.
A law of contradiction?
Professor M. Elvira MENDEZ-PINEDO
1
Abstract
Indexation of credit to inflation (ex-post) is a unique legal practice in Iceland
based on valorism theory on money vs. nominalism. Two rulings issued in 2014 by the
EFTA Court try to clarify the legality and fairness of this particular price-variation clause
under the European Economic Area consumer credit acqu is. The stud y summarizes the
rulings and analyses critically the interpretation provided by the court. It argues that the
judgements defy the logic of non-contradiction since indexation of credit proves to be an
impossible oxymoron under EU/EEA law. The results are confusing. On one han d, cost of
credit and usury practices tend to fall outside the scope of Europea n harmonisation
(provided disclosure obligation of cost o f credit and transparency ex-ante are respected). A
fairness co ntrol is thus dependent on national and case circumstances to be assessed by
domestic courts. On the other hand, European rules also impose with no derogations that
the cost of indexation of credit to inflation is disclosed in a transp arent way and calculated
ex-ante. The paradox is there. Since indexation of credit operates ex-post on the basis of
real inflation, it is impossible to disclose ex-ante in a transparent way. The findings of the
study help to u nderstand the situation of impasse in Iceland. Without a clear interpretation
from the EFTA Court, the saga has continued at na tional level and will probably head for a
second round of assessment at European level.
Keywords: EFTA Cou rt; Iceland; indexa tion of credit; fairness; information and
transparency; consumer protection.
JEL Classification: K33, K41
1. Introduction
The EFTA Court issued in 2014 two important judgments in the field of
European consumer protection and credit which are probably difficult to
understand in Europe since they deal with a specific Icelandic problem. The cases
Engilbertsson/Íslandsbanki
2
and Gunnarsson/Landsbanki
3
refer to the
1
M. Elvira Mendez-Pinedo - School of Social Sciences, Faculty of Law, University of Iceland,
mep@hi.is.
2
Case C-25/13 Gunnar V. Engilbertsson and Íslandsbanki hf. [2014 ] EFTA Cou rt Reports, not yet
reported (nyr.). Judgment of the EFTA Court of 28 August 2014.
3
Case C-27/13 Sævar Jón Gunnarsson a nd Landsbankinn hf. [2014 ] EFTA Court Reports
nyr. Judgment of the EFTA Court of 24 November 2014.
Volume 6, Special Issue, October 2016 Juridical Tribune
8
compatibility of inflation-indexed secured and unsecured loans (consumer credit
and/or mortgage credit) with European Economic Area (EEA) law.
Indexation of credit is a novel issue in European law although it is related
to price-variation clauses in consumer law. This indexation to real inflation ex-post
(after the signature of credit contract) is a unique practice found in Iceland but also
known in other countries of Latin America
4
. In the field of credit and financial
services, Iceland is an exception to the general theory of debt adopted in Europe
based on nominalism
5
. All EEA countries have adopted a nominalistic approach to
credit and debt. When an obligation/debt keeps its nominal value, inflation erodes
slowly the real value of debt (since it keeps its original nominated or face value
while the salaries tend to follow inflation). In a context of inflation, nominalism
and time help debtors and damages creditors. When creditors are financial
professional institutions and debtors are consumers, nominalism and inflation tend
to compensate the original imbalance of power and asymmetry of information and
education that exists between contracting parties.
In Iceland the opposite occurs since credit is constructed on the basis of
valorism theory. Inflation benefits creditors because the principal of the debt is
directly linked/indexed to the general inflation index and thus keeps its real value
or purchasing power over time. Indexation is thus a practice which operates ex-
post, a sort of semi-automatic price-variation clause embedded in the contract
which deploys its effect during the whole life of the credit and updates the
principal, the interest and other charges on a regular basis. Indexation clauses seem
to be standard terms; they are not individually negotiated (indexation of credit has
been a ―take it or leave it‖ situation for consumers). In practice, the loan agreement
is articulated through a bond (financial instrument) that the consumer issues to the
bank promising future payments and pledging guarantees. Empirical research done
by consumer associations has proved that the method of calculation of cost of
credit is never explicitly disclosed to consumers ex-ante, usually there is only a
general referral to indexation to the consumer price index (―CPI‖) in the contract.
The financial sector has traditionally argued that there this indexation is not
a choice but a necessity in Iceland due to the historic inflation
6
and a micro-
4
Ásgeir Jónsson, Sigurður Jóhannesson, Valdimar Árman, Brice Benaben and Stefania Perrucci,
“Nauðsyn eða val? Verðtrygging, vextir og verðbolga‖ (―Necessity or choice? Indexation, interest
and inflation‖), Report for the Association of Financial institutions SFF (Reykjavík, 2012) available
on internet at <http://sff.is/sites/default/files/naudsyn_eda_val-verdtrygging_vextir_og_
verdbolga.pdf> (consulted last time in July 1, 2016). See Chapter 7 ―Inflation Indexation and
Housing Finance‖, at 171- 1 96 which presents a good summary of the problem in English with a
history of indexation to indexation in Latin America for comparison purposes and final policy
suggestions for Iceland. As the report shows, Chile has a similar system of indexing loans to the
consumer price index (using a different currency called Unidad de Fomento UF).
5
On the different theories of debt (nominalism vs. valorism) see Mann, The leg al aspect of money
(OUP, 1938 and 1992) and Kessler, "Book Review: Money in the Law" 40 Columbia Law Review
175 (1940) available on internet at <http://digitalcommons.law.yale.edu/fss_papers/2713>
(consulted last time in July 1, 2016).
6
Jónsson and others, op. cit. supra note 4.
Juridical Tribune Volume 6, Special Issue, October 2016
9
currency. Consumer associations, on the contrary, have consistently argued to the
legislative, executive and judicial powers that credit indexation is extremely
prejudicial not only for consumers but also for the economy since it fuels, in fact,
inflation
7
.
The core of the disputes is whether indexation practices allowed by
Icelandic legislation -as they have been implemented in Iceland during 2001-2013
comply with the requirements of European consumer credit law. From an academic
perspective, the key question is whether loan indexation can pass or not the
European legality and fairness tests that EEA consumer (credit) law requires.
The European legal framework for assessment is given by the EEA
Agreement
8
, the Annex XIX incorporating EU consumer legislation to the EEA
legal order
9
and, in particular, the following secondary law: Directive 87/102/EEC
on consumer credit
10
in force in Iceland at the time (from now on ―1987 Consumer
Credit Directive‖), Directive 93/13 on unfair terms in consumer contracts
11
(from
now on ―1993 Unfair Terms Directive‖) and Directive 2005/29 on unfair
commercial practices
12
(from now on ―2005 Unfair Commercial Practices
Directive‖).
The relevance of the interpretation could not be greater. The current
judicial review on the legality and fairness of indexation of credit under EEA
consumer law by the EFTA Court affects thousands of loan contracts and the
majority of families in Iceland as well as the public sector (Housing Financing
7
Mallet has argued that indexation of loans to the consumer price index (CPI) has failed to address
the economic prob lem and consequences of the hyperinflation and has directly contributed to
increase the inflation rate through creation of secondary monetary sup ply. She summarizes it as a
―positive feedback loop within the banking system‘s monetary regulation―. Mallet, ―An
Examination of the effect on the Icelandic Banking System of Verðtryggð Lán (Indexed-Linked
Loans)―, (2013) IIIM TECH REPORT IIIMTR 2013-01-001 (Icelandic Institute for Intelligent
Machines), available at <www.iiim.is> (consulted last time in July 1, 2016).
8
The EEA Agreement extending the internal market to Iceland, Norway and Lichtenstein entered
into force on 1 January 1994, see O.J. 1994 L 1, p. 3. It has never been formally amended since
the update of all subsequent and relevant legislation is done through the inclusion of new EU/EEA
acts into the an nexes of the Agreement. There is a paralell Aagreement between the EF TA States
on the establishment of a Surveillance Authority and a Court of Justice (ESA/EFTA Court
Agreement) O.J. 1994 L 344, p. 3.
9
EU legislation on consumer p rotection is regularly incorporated to the Annex XIX of the EEA
Agreement by the relevant decisions of the EFTA Joint Committee. Once incorporated to the EEA
legal order, th e Icelandic Parliament adopts it as national domestic law. The new database EEA-
Lex allows to search all EU acts that have been incorporated into the EEA Agreement or are under
consideration for future incorporation
10
Council Directive 87/102/EEC of 22 December 1986 for the approximation of the laws,
regulations and administrative provisions of the Member States concerning consumer credit.
O.J. 1987 L42, p. 48.
11
Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts. O.J. L 09 5,
p. XX.
12
Directive 2005/29/EC of the European Parliament and of the Council of 11 Ma y 2005 concerning
unfair business-to-consumer commercial practices in the internal market. O.J. L 149, p. 29.

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