Introduction
Background
Facts
Decision
Comment
In Dexia Crediop SpA v Province of Pesaro e Urbino,(1) another case linked to the significant Cattolica decision of the Italian Supreme Court, the court granted an Italian bank summary judgment and declaratory relief, finding that interest rate swaps between it and an Italian local authority under an International Swaps and Derivatives Association (ISDA) master agreement were valid and the agreement binding under Italian constitutional law. The court also held that the swaps were not a form of "indebtedness" under Italian law and did not require special approval from the provincial authorities, but it was not content to grant summary judgment in relation to sale of floor options and purchase of caps as neither the expert nor the court could land on a correct interpretation.
Banco Nazionale Del Lavoro SpA v Municipality of Cattolica
In the Cattolica decision of May 2020 the Italian Supreme Court held that derivatives contracts were invalid under Italian law if the derivative could be characterised as speculative or if the swap provider did not give details of mark-to-market valuations and probabilistic scenarios at the time the contract was made.
The issues raised in Cattolica have been addressed several times since in the English courts. In Deutsche Bank v Busto di Arsizio(2) (also considered by the court in Dexia and as to which Dexia tendered notice under section 4 of the Civil Evidence Act 1972), the court decided that Cattolica was primarily concerned with the validity of contracts under Italian law rather than the wider interpretation of the judgment that Italian local authorities did not have the capacity to enter certain derivatives contracts. In the consequentials judgment handed down in February 2022, the court gave declaratory relief to the effect that the Italian local authority had capacity to enter the swaps in question.
In the wake of the decision in Cattolica, the Italian local authority Provincia di Pesaro e Urbino (Pesaro) commenced proceedings in its local courts to unwind or reverse interest rate swaps it had entered into with Dexia Crediop SPA (Dexia) in 2003 and 2005 under an ISDA master agreement (1992 version). Dexia then commenced English proceedings, seeking various declarations that the transactions were valid and binding on the parties. Dexia also applied for summary judgment in relation to several declarations after Pesaro took almost no active part in the proceedings, save for acknowledging service and indicating that it intended to contest jurisdiction (for which an application never emerged). Pesaro did not attend the summary judgment hearing.
The court considered the following issues as to whether summary judgment should be granted:
- the governing law of the ISDA master agreement;
- compliance of the delivery and performance of the swaps documentation with Italian law; and
- whether the transactions were valid and their obligations binding on Pesaro in accordance with the terms of the ISDA master agreement.
Governing law of contract
Dexia argued that the swaps were governed by English law due to the choice of law provision in the ISDA master agreement. In the Italian proceedings, Pesaro argued that the parties had indicated that they considered negotiations on the swaps to be subject to Italian law.
The court considered the EEC Convention on the Law Applicable to Contractual Obligations (the Rome Convention), which was incorporated into English law by the Contracts (Applicable Law) Act 1990. The 1990 Act applies to contracts concluded between 1 April 1990 and 17 December 2009 when the Rome Convention came into force. It applied to the swaps contracts as they were concluded in 2003 and 2005.
Article 3(1) of the Rome Convention provides that parties have freedom to choose the law that will govern their contract, which Dexia argued was the law specified by the ISDA master agreement. Although article 3(3) of the Rome Convention provides that a parties' choice of foreign law cannot displace "mandatory rules" of the country to which the transaction is relevant (ie, Italy in this case), the court agreed with Dexia that the article was not engaged because there was an international element to the contract – back-to-back swaps were made with market participants outside of Italy.
The court held that the ISDA master agreement clearly stated that the swaps were governed by English law and there was insufficient evidence to displace that. The court therefore was content to grant a declaration that the swap contracts were governed by English law.
Compliance with Italian law
Dexia sought a declaration that a representation in the ISDA master agreement meant, or an implied representation existed to the effect that, the execution, delivery and performance of the transactions did not violate or conflict with the following Italians laws or regulations applicable to Pesaro and the transactions:
- article 119(6) of the Italian Constitution, which stipulates that provinces may only indebt themselves as a means of funding investments, and article 30(15) of Law No. 289/2002, which stipulates that a contract entered into under article 119(6) of the Constitution shall be considered null and void. The court held that the swaps were not a form of indebtedness under article 119(6) of the Constitution because their terms did not:
- provide for an upfront payment;
- extinguish pre-existing underlying loans; or
- significantly modify existing loans.
These were the three factors in Cattolica. Therefore, the swaps contracts were not null and void under Law No. 289/2002 article 30(15);
- article 42 of the Local Entities Act (Testo Unico Enti Locali) (TUEL), which requires certain fundamental acts to be approved by the Provincial Council to be valid, including loans. The court held that the swaps did not require approval for the same reason they were not indebtedness for the purposes of the first bullet point above. In any event, the Provincial Council had expressed its intention to use swaps to manage its floating rate debt in several resolutions, which the court held would have satisfied the approval requirement if it was applicable;
- article 41 of Italian Legislative Decree No. 448/2001, which the court held did not impose any restrictions on local authorities at the relevant time because they were not refinancing or restructuring transactions; and
- article 3 of Ministerial Decree No. 389 of 1 December 2003 (Decree 389), which was issued by the Treasury Department of the Italian Ministry of Economy and Finance and published in the Official Gazette No. 28 of 4 February 2004 and the Circular of the Ministry of Economy and Finance of 27 May 2004 (the 2004 circular). This imposed restrictions on local authorities' use of derivatives, including that they are permitted to enter collar swap transactions, but with protection from simultaneous purchase of a cap and sale of a floor. In other words, the authority could only sell a floor option if it funded it by purchasing a cap. It was not clear whether these pieces of legislation required there to be an equivalence of value between the cap and floor elements of a collar swap. Neither the expert nor the court could reach a landing on interpretation. The court considered the issue should be left for trial and it therefore could not grant summary judgment on this declaration.
Validity of transactions
As the transactions were held to be governed by English law under article 3(1) of the Rome Convention, their validity should in theory be determined by English law under article 8(1). However, the court held that if the grounds of invalidity relied upon by Pesaro in the Italian proceedings related to its capacity or power to enter the transactions, it would be a matter for Italian law(3) because matters relating to the capacity of a party (whether corporate or incorporate) are excluded from the scope of Rome I by article 1(c).
The court held that Pesaro's arguments in the Italian proceedings were not concerned with its capacity to enter the transactions. Only one argument came close to touching on capacity issues, which was Pesaro's argument relating article 42 of TUEL, which requires certain "fundamental acts" to be approved by the Provincial Council of the local authority. In Cattolica, the Italian Supreme Court held that interest rate swaps required authorisation if they met certain criteria, including that they significantly modified existing loans so as to give rise to new indebtedness.
The court noted that, in Deutsche Bank AG Ltd v Comune di Busto Arsizio,(4) Cockerill J decided that this provision did not place a limit on capacity of the local authority. However, in any event, the court held that the transactions did not require authorisation because they did not create new indebtedness, and the appropriate approvals had been provided by the Provincial Council of Pesaro anyway, so the argument was ineffective.
The court therefore concluded that the transactions were valid under English law and granted summary judgment accordingly in relation to this declaration.
The decision in Cattolica gave Italian local authorities renewed confidence to challenge pre-2008 swaps contracts and they hoped that the English court would also hold that local authorities lacked capacity to enter similar derivatives contracts. However, Dexia shows that the English courts are still at odds with the Italian Supreme Court's views on the contractual validity of such swaps, even if it considers there is an issue regarding some aspects of their regulatory status in Italy. Dexia also shows that the English courts will not shy away from wide-ranging declaratory relief where it considers it appropriate, even if it arises in the context of a summary judgment application.
For further information on this topic please contact Chris Ross or Becky Bakerat RPC by telephone (+44 20 3060 6000) or email ([email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.
Endnotes
(2) [2021] EWHC 2706 (Comm) (12 October 2021).
(3) See Dicey, Morris & Collins on The Conflict of Laws, rule 187 and paragraphs 30-021 to 30-023.