The Commercial Court has ruled that a swap transaction entered into between an Italian regional authority and Deutsche Bank is valid. Busto Arsizio, an Italian regional authority, claimed that it was not bound by interest rate swaps entered into with Deutsche Bank because it lacked capacity to enter into them. It argued that the 2020 decision of the Italian Supreme Court in BNL v Cattolica1, meant that either: i) Busto Arsizio (in common with all Italian regional authorities) had lacked capacity to enter into the swap transactions or ii) that in the absence of sufficient information being provided in relation to the swaps, they were rendered void. The Commercial Court disagreed. In the first English decision following BNL v Cattolica, it ruled that the case could be differentiated on the facts. In a finding which will be welcome to financial institutions, it also interpreted Cattolica as relating to the principles of Italian contract law, not the capacity of public authorities to enter into swap transactions. As the swap transactions were governed by English law, Cattolica therefore had no relevance.
What does this judgment mean for the future of swaps litigation?
Many claims are currently being pursued before the Italian and English courts relating to swap transactions entered into by Italian local authorities prior to the 2008 financial crash. In most cases, the Italian authorities commence proceedings in Italy and the defendant bank brings proceedings for declaratory relief in England, pursuant to an English law and jurisdiction clause in the ISDA Master Agreements. Where the material validity of the contract is in question, the applicable law is the law of the contract (English law). It is only where the capacity of a party to enter into the contract is in question that the laws governing that party's capacity (Italian law) can override the law of the contract.
The Commercial Court's analysis of the meaning of the Cattolica judgment is therefore significant, and may well be followed in future litigation. Its analysis of whether it is open to the English court to depart from decisions of foreign courts on foreign law, including the highest authority on that law, is also of wider interest.
The Cattolica decision
The capacity of local authorities (in England as well as in Italy) to enter into interest rates swaps has been the subject of much litigation and the Cattolica decision represents the highest Italian authority on the point. In essence, in Cattolica (in which the derivatives in question were governed by Italian law) the Italian Supreme Court held that:
- Cattolica (an Italian town) could enter into derivatives contracts if they were for hedging but not if they were speculative;
- Cattolica could enter into hedging derivatives only if a written statement of the mark to market criterion, 'probabilistic scenarios' and the 'hidden costs' of the transactions was included in the contracts; and
- Cattolica could only enter into the type of hedging derivatives in question with authorisation from the City Council authority.
Busto Arsizio argued that these findings applied generally to all local authorities and related to the capacity of public bodies to enter into contracts, rather than the validity of the contracts from a civil law perspective.
The Commercial Court found ("by a clear margin") however, that key aspects of the decision in Cattolica related to the general Italian civil law requirements for a valid swaps contract, and not the capacity of a local authority to enter into that contract. Following a detailed analysis of the expert evidence on Italian law, the court held that the decision in Cattolica was, "at the end of the day, a decision in a specific case, whose facts are not the facts of this case."
In reaching its decision, the court was also informed by the fact that the Italian Constitution did not impose any constraints on the capacity of local authorities to enter into swap transactions. The Commercial Court did acknowledge that, following Cattolica, as a matter of Italian law, local authorities may only enter into derivatives for hedging financial risk, and not if they are speculative. However, the Commercial Court also noted that the Italian Supreme Court had not identified a legal basis for this conclusion and had not provided any guidance as to what would amount to a "speculative" transaction.
The Busto Arsizio decision
Given the court's analysis of the impact of Cattolica, it was not necessary to rule on its application to the present case where the swaps contract was governed by English law. Nevertheless, the court considered the arguments. It found that even if Cattolica did apply to issues of capacity to contract, in this case the transactions in question had been entered into for the purposes of hedging interest rate risks and not for speculative purposes. They were not therefore prohibited as a matter of Italian law in any event. Deutsche Bank had also, the court concluded, provided sufficient information to allow Busto Arsizio to take an informed decision on the risk of the contract it was entering into. Finally, in relation to City Council approval, the court found in this instance it would not have been required. Had it been, it also found such approval would have been provided retrospectively and the transactions ratified in any event. Whilst it was common ground that in conventional cases, the putative law of the contract (English law) would also govern questions of the scope of the agent's authority, Busto Arsizio contended this rule was qualified where the limit on authority is derived from the relevant body's constitution (i.e. "where capacity and authority coincide"). The Commercial Court declined to accept this argument, holding that public law restrictions on an agent's authority were not relevant.
Contractual estoppel and capacity
Deutsche Bank's primary argument (that Italian law did not preclude the entry into the contracts) was accepted by the court. However, it also considered the bank's secondary argument, namely that if the swaps were deemed to be void, Busto Arsizio would be estopped from relying on a lack of capacity. Deutsche Bank relied on the authority in Credit Suisse v Vestia2, in which a Dutch entity was estopped from avoiding liability in a similar scenario because of the warranties it had given under an ISDA Master Agreement about its capacity to enter into the transaction. The court noted that this area of law was "an area of considerable interest which is not replete with authority", and that the doctrine established in Vestia was yet to receive endorsement from the Supreme Court.
Deutsche Bank relied on the contractual representations and warranties in the ISDA Master Agreement, in particular those entitled: "Powers", "No Violation or Conflict", "Consents", "Maintain Authorisations" and "Comply with Laws", contending that Busto Arsizio had represented and warranted that it had capacity to enter the agreements. Deutsche Bank argued that given these representations, Busto Arsizio would be estopped from arguing it could now escape its contractual liabilities due to a lack of capacity. However, the court disagreed, and indicated it would consider departing from the authority in Vestia on the basis that (i) the decision in Vestia related to "Additional Representations" which did not exist in this case; and (ii) as a matter of interpretation, it logically followed that transactions void for lack of capacity could not be 'Transactions' as defined in the ISDA Master Agreement and the subject of the representations and warranties.
Applicable law of restitution claim
Although not deciding the point, the court briefly considered Busto Arzisio's restitution claim that would have arisen if the swaps were void. The court held it would have distinguished Dexia Crediop v Comune di Prato3 and concluded that the "closest and most real connection for the putative transactions was England". In so doing, the court gave weight to the fact that Deutsche Bank acted through its London Branch, and the place of enrichment would therefore have been London, rather than Italy (as was the case in Dexia). The court also noted that the choice of law under the ISDA Master Agreement might militate in favour of English law governing the restitution claim should the putative law of the contract be adopted to determine consequences of lack of capacity on the validity of that contract.
There are many similar claims ongoing in the courts of both Italy and England. This decision should be of comfort to financial institutions, particularly those using ISDA Master Agreements for their swaps transactions. It indicates that the English Courts are likely to confine the decision in Cattolica to its facts, rather than treat it as authority for the proposition that swaps transactions entered into by Italian local authorities are void. It is also striking that the court considered it could depart from a decision of the Italian Supreme Court in any event, if satisfied – on the evidence – that it did not represent the law.
One aspect of the decision which may be less favourable to the banking sector, however, is the interaction between contractual estoppel and warranties as to authority and capacity under the ISDA Master Agreement. The court's reluctance to follow the decision on estoppel in Vestia means that appellate clarification of this issue is likely to be necessary.