THE RIGHT OF PREFERENTIAL LIEN ON LOAN AGREEMENTS

By: Savvas Savvides, Partner of
Michael Kyprianou & Co LLC

It is commonly accepted
that our modern society requires us to possess a relevant knowledge on bank
accounts and loan agreements.  However, how
feasible is it 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 recuperate 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 plainly 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 it’s 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 at savvides@kyprianou.com.cy