In the first judgment issued under the new specialist Financial List, the High Court has allowed a Portuguese bank, Banco Santander Totta (BST), to enforce a number of 'snowball' interest rate swaps against four Portuguese public sector transport companies, finding that the swaps should be determined under English law and, on that basis, were valid and enforceable.(1)


Between 2005 and 2007 the transport companies entered into nine different, but broadly similar, interest rate swaps with BST. This followed a request from Portuguese government auditors that they should try to reduce the cost of their debt, which at that time was attracting an interest rate of 4.76%.

The transport companies agreed a structure with BST whereby (in the net position) BST paid them 3% and, following a two-year period with no spread, the transport companies would be liable to pay an additional spread in addition to their fixed rate. The spread fluctuated by reference to certain Euro interbank offered rates (Euribor) and London interbank offered rates. The swaps were structured so that the transport companies would pay:

  • the previous quarter's spread; plus
  • an additional payment based on the amount by which the relevant reference rate fell above or below the specified range; or minus
  • 0.5% if the relevant international reference rate was within the specified range (in most cases the three-month Euribor rate being between 2% and 6%), but never so as to bring the spread below zero.

The swap therefore included a cumulative element (the 'snowball'). This was initially not an issue, as the relevant international reference rates stayed within the specified range and the transport companies succeeded in reducing the cost of their debt by 3%. Of course, the price paid for this benefit was the transport companies' exposure to the "very, very aggressive" and highly risky downside of the swap, including the compounding snowball provision. In contrast to vanilla products, not only did a compound structure apply, but the specific formula used to calculate the spread was also very volatile, meaning that a small variance in the relevant international reference rate had a greater adverse impact on the transport companies.

This was illustrated when, following the 2008 crash, the three-month Euribor rate fell well below 2% and stayed there (and is now in a negative position). This meant that the transport companies became liable for a total compounded rate of over 40% at the time that this dispute was heard at trial in October 2015. At that time, the combined mark-to-market value of the swaps was approximately €1.4 billion – more than three times the value of the loans that the swaps were intended to cover – with total unpaid amounts stated to be €272.5 million.

Transport companies' arguments

The transport companies did not try to defend BST's claim for a declaration as to the validity of the swaps (and to secure payment of sums due under them) with arguments of misrepresentation or negligence. There was also no dispute as to the sums owed. Rather, the court was asked to consider the transport companies' arguments that:

  • BST acted in breach of duties owed to customers under the Portuguese Securities Code in presenting the swaps to the transport companies such that they were therefore entitled to bring a claim in damages which would extinguish their liabilities under the swaps;
  • under Portuguese law, they lacked capacity to enter into the swaps (as the swaps were a speculative 'game of chance'), so the swaps were void; and
  • although the International Swaps and Derivatives Association (ISDA) agreements were subject to English law, this choice of law did not prejudice the application of Article 3(3) of the Rome Convention and the proper application of this provision would mean that certain Portuguese laws would apply to the dispute (ie, those which could not be derogated from by contract (mandatory rules); the swaps contravened those mandatory rules).

As the judgment in this matter runs to some 160 pages and considers a number of alternative and hypothetical issues, this update focuses on the questions of duties owed by BST and the application of Article 3(3) of the Rome Convention.

BST's duties

The transport companies' arguments regarding BST's alleged breach of duty arose from the Portuguese Securities Code, which implemented the EU Markets in Financial Instruments Directive into local law. It was alleged that BST had breached certain duties(2) owed under the code by financial intermediaries, as they suggested swaps to the transport companies which were both incapable of performing the interest rate risk management function that was their purported purpose and which were significantly imbalanced in favour of BST. On this basis, it was said that BST was obliged not to have proposed these instruments to the transport companies, since they were so contrary to their objectives.

BST argued that it was in fact acting on its own account in respect of the swaps, rather than as an intermediary, so it did not have a duty to refrain from proposing or contracting swaps based on an evaluation of their suitability for the client. BST also submitted that if a bank transacts a swap with a client (at least in the absence of deceiving the client), the bank is not thereby put in breach of its conflict of interest duties or its duty to prefer its clients' interests with regard to its own. Properly, it was for the transport companies themselves – not BST – to decide on whether to contract the swaps.

The court accepted that the swaps were "very risky". Because of this risk, there were concerns in Santander Spain (parent company of BST) over the sale of snowball swaps to public sector companies in Portugal. However, Santander Spain was not directly involved with the negotiating or transacting of these swaps, which was handled by officers of BST in Portugal.

While the parties' experts agreed that, at inception, the swaps overall had a probability of 72% of providing a potential benefit to the transport companies over their life, the swaps were long-term instruments and there was clearly a risk (however remote given the historical international reference rates up until that time) that interest rates would breach the upper or lower barriers, and might do so for substantial periods. The effect would be magnified by the leverage and accumulation contained in the snowball structure of the swaps.

The transport companies contended that BST knew the extent (if not the full extent) of the risks that the transport companies would run by entering the swaps and knew – or should have known – that the transport companies, while they might have understood mathematically how the formulae in the swaps worked, did not appreciate the risks that they were running. The transport companies also argued that BST knew or should have known this from the fact that it did not inform the transport companies of the initial mark-to-market position and knew that the transport companies did not have the internal capability to calculate it.

However, the court concluded that the swaps, at the time that they were negotiated, were seen as advantageous both to the bank and to the clients, and that despite not being sophisticated financial operators (as BST sought to argue), the transport companies understood the nature of the swaps; while the applicable spread formula was complex, the court considered the concept to be straightforward once understood.

The court concluded that the swaps were entered into as they suited both parties. From the transport companies' perspective, they had extensive debt to manage and were being asked by the Portuguese government to reduce the cost of that debt, and in the early years of the swaps this aim was largely achieved. While there was a price to pay for this benefit (ie, the exposure to risk), the court concluded that the transport companies' officers had no intention of speculating. The transactions were seen, at a time before the 2008 financial crisis, as being a sound management of debt.

While the court made several criticisms of BST by reference to the disclosed contemporary documents,(3) it was satisfied that the officers concerned did not set out to persuade the transport companies to enter into contracts that they thought would be contrary to the companies' interests. In this respect, it was relevant to note that BST offered the transport companies alternative structures in a process in which it was in effect competing for business against various international banks. The court also considered the fact that the transport companies did not allege, and had never alleged, that BST misrepresented the position or gave them negligent advice.

As regards the specific allegation that BST breached its duties by offering the swaps, the court went on to comment:

"when a bank is acting on its own account, its duties to the counterparty under EU legislation (or its national implementation) are commensurate with that relationship. There is no room for applying a rule relating to conflicts of interest in this situation. Where a bank is dealing on its own account, plainly it cannot be expected to give preference to the counterparty's interests over its own. In the case of an interest rate swap, by definition, a movement in interest rates that is positive for one party will be negative for the other."

On this basis, the court concluded that the alleged duties under the Securities Code did not exist and so there was no question of breach to consider.

Article 3(3) of Rome Convention

The issue of the duties owed by BST did not turn on the court's decision regarding Article 3(3) of the Rome Convention. However, many of the remaining arguments in the transport companies' defence became relevant only if Portuguese mandatory rules applied to the swaps.

The transport companies suggested that Article 3(3) acted to enforce the law chosen by the parties to govern their contractual obligations, but could not displace the mandatory rules of the legal system which, but for the choice of law made by the parties, would undoubtedly apply. They also submitted that it was sufficient, for the purposes of Article 3(3), to identify "any element" linking the dispute to the legal system of a country other than Portugal, and that BST had failed to identify any such element; thus, the swaps fell outside of the scope of the conflicts of law altogether.

BST successfully argued that freedom of contract is the cornerstone of the Rome Convention and that to give effect to this principle, any derogation should be strictly necessary and Article 3(3) should be given a narrow interpretation; however, the "elements of the situation" referred to in Article 3(3) should be a wider test, going beyond the elements of the contract itself. BST also persuaded the court that there were strong policy reasons – in particular, commercial certainty – as to why Article 3(3) should not apply to the European over-the-counter interest rate derivatives market.

The court concluded that it was not concerned with the applicable law – there was already a valid choice of law made by the parties, being English law and jurisdiction under the ISDA master agreements. Rather, the relevant question was whether that choice took effect subject to the mandatory rules of Portugal. The court confirmed that where there is an express choice of law, there is no need to enquire as to connecting factors which would indicate the applicable law in the absence of an express choice. The court therefore rejected the arguments of the transport companies and went on to consider the elements of the situation.

In determining whether – choice of law aside – all the elements of the situation were connected with one country only, the court found that the enquiry should not be limited to elements that are local to another country, but includes elements that point directly from a purely domestic to an international situation. In view of this, the court considered the following factors:

  • the right to assign to a bank outside Portugal;
  • the use of standard ISDA master agreements;
  • the practical necessity for the relationship with a bank outside Portugal;
  • the international nature of the swaps market in which the contracts were concluded; and
  • the fact that back-to-back contracts were concluded with a bank outside Portugal (Santander Spain) in circumstances in which such hedging arrangements were routine.(4)

Use of ISDA documentation as a relevant factor is notable, as previous decisions have discounted this as a relevant factor.(5) In expressly confirming this point, the court also identified the line of case law that was preferred to support this element of the judgment.

Having considered each of the factors above, the court concluded that Article 3(3) was not engaged, as all the elements relevant to the situation at the time that the swaps were agreed were not exclusively connected to Portugal. The swaps were not purely domestic contracts and this was inherent in the context of the international capital markets, where the market operates precisely because it is international. The court commented that any other conclusion would undermine legal certainty.


It is clear from the court's judgment that it places value on achieving certainty in international financial transactions, and the decision to uphold the parties' agreed choice of law as set out in the ISDA documentation will further this. It is also notable that this decision cited the use of ISDA documentation as "an element in the situation" to determine this question – a departure from previous decisions. However, the previous decision is subject to an upcoming appeal, which may provide further guidance regarding the extent to which parties can move beyond their choice of law under ISDA documentation.

It is also of interest that if, notwithstanding the parties' choice of law, the court had found that Article 3(3) was engaged and that the Portuguese Civil Code was a mandatory rule that could not be derogated from by contract, the Portuguese Civil Code would have allowed the transport companies to terminate seven of the nine swaps by reason of the abnormal chance in circumstance,(6) as the court accepted that the 2008 global financial crisis was an unprecedented and abnormal change in circumstance. For English law purposes, it remains important to consider financial products in light of the circumstances when they are entered into, rather than after the effects of unprecedented financial crises arise.

For further information on this topic please contact Laura Martin at RPC by telephone (+44 20 3060 6000) or email ( The RPC website can be accessed at

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