High Court confirms interest rate swaps entered into with Italian municipal authority were valid, lawful and binding on the parties

The High Court has allowed a summary judgment application by an Italian bank seeking declarations to the effect that certain interest rate swaps entered into with an Italian municipal authority were valid, lawful and binding on the parties: Dexia Crediop SPA v Provincia Di Pesaro E Urbino [2022] EWHC 2410 (Comm).

This is an interesting decision for financial institutions trading in derivatives based on standard form ISDA documentation, particularly given the summary determination. It is the latest in a line of authorities relating to interest rate swap transactions entered into by foreign municipal authorities, in which parties have sought to unwind or set aside the transactions on the basis that they were invalid under certain foreign laws alleged to be applicable to the transactions. The English court has, once again, taken a robust approach to granting declaratory relief and the decision is likely to be welcomed as further evidence of the English court’s emphasis on construing commercial contracts, and in particular standard form ISDA documentation, in order to achieve market certainty and predictability.

In the present case, the court was satisfied that the transactions were governed by English law notwithstanding Article 3(3) of the Rome Convention, which provides that where a law is chosen to govern a contract but all the other elements relevant to the situation are connected with another country, the choice of law will not prejudice the application of the mandatory rules of that other country. Further, the court held that there was no real prospect of the municipal authority successfully contending that the transactions did not comply with certain Italian laws on the basis that they: (i) were a form of indebtedness; (ii) had not been authorised by the relevant provincial authority; or (iii) did not meet the economic convenience (i.e. they were not "economically advantageous") requirement.

We consider the decision in more detail below.

Background

In 2003 and 2004, the claimant Italian bank (Bank) entered into two interest rate swap transactions with an Italian municipal authority (Authority). Each of the transactions was subject to a 1992 ISDA Master Agreement, Multi-Currency-Cross Border (the Master Agreement) and associated schedule (Schedule) (together, with the 2003 and 2004 swaps, the Transaction Documents).

In June 2021, the Authority commenced proceedings in Italy seeking to unwind or set aside the transactions (the Transactions), following the Banca Nazionale Del Lavoro SpA v Municipality of Cattolica decision of the Italian Supreme Court, which declared an Italian law governed swap between a bank and local authority invalid. The Bank, in response, commenced proceedings in England seeking a number of declarations to the effect that the Transactions were valid, lawful and binding. The Authority acknowledged service of the English proceedings but subsequently took no active part in the English proceedings.

The Bank applied for summary judgment on its claims for declaratory relief.

Decision

The High Court found in favour of the Bank and allowed the summary judgment application. The key issues which may be of broader interest to financial institutions are examined below.

Governing law of the Transactions

The court held that the Transaction Documents were plainly governed by English law in accordance with Article 3(1) of the EEC Convention on the Law Applicable to Contractual Obligations (the Rome Convention).

In the court's view, the issue of identifying the applicable law was a matter for the Rome Convention, which was incorporated into UK law by the Contracts (Applicable Law) Act 1990.

The court noted that Article 3 of the Rome Convention provides:

"(1) A contract shall be governed by the law chosen by the parties. The choice must be expressed or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or a part only of the contract.

(2) The parties may at any time agree to subject the contract to a law other than that which previously governed it, whether as a result of an earlier choice under this Article or of other provisions of this Convention. Any variation by the parties of the law to be applied made after the conclusion of the contract shall not prejudice its formal validity under Article 9 or adversely affect the rights of third parties.

(3) The fact that the parties have chosen a foreign law, whether or not accompanied by the choice of a foreign tribunal, shall not, where all the other elements relevant to the situation at the time of the choice are connected with one country only, prejudice the application of rules of the law at the country which cannot be derogated from by contract, hereinafter called ‘mandatory rules’."

On the facts, the court said the Master Agreement and Schedule expressly and without any qualification provided that the Master Agreement was to be governed and construed in accordance with English law. Also, the factors relied by the Authority, such as references to certain provisions of Italian law in the Authority's proposals, were not sufficient to displace the express choice of English law as they were either: (i) not concerned with the terms and performance of the Transaction Documents themselves, but with the circumstances leading up to the conclusion of the relevant contractual arrangements; or (ii) not located in the Transaction Documents at all. Further, even if these references could be said to be concerned with the terms and performance of the Transaction Documents they were not sufficient either to demonstrate with reasonable certainty that Italian law was being chosen as the governing law and they were not sufficient to lead to the conclusion that the parties had overridden their stated choice of English law either expressly or in any other way demonstrable with reasonable certainty.

In addition, if the parties' intention had been to choose Italian law in the Transactions as the new governing law to replace the choice of English law in the Master Agreement and Schedule, in accordance with Article 3(2) of the Rome Convention, the parties would have used language which was far more explicit to that end, for example by stating that the choice of law in the Master Agreement and Schedule was replaced by the choice of Italian law in the 2004 transaction. However, there was no such provision nor indeed a provision that came arguably close to such a provision. The court underlined that the Master Agreement contemplated – and the Transactions both provided – that the Transactions were entered into under/and or in accordance with the terms of the Master Agreement and Schedule. There was no suggestion of the Transactions being subject to a governing law other than English law.

The court also highlighted that, as per Dexia Crediop SpA v Comune di Prato [2017] EWCA Civ 428, given the nature of the Transaction Documents being based on the ISDA Master Agreement, there was no scope for allowing any mandatory rules of Italian law – should there be such laws – to displace under Article 3(3), the express choice of English law made by the parties in the Master Agreement and Schedule,

Compliance with Italian law

The court held that there was no real prospect of the Authority successfully contending that the Transactions did not comply with certain Italian laws.

Form of indebtedness

For the purpose of the summary judgment application, the court assumed that the Italian Supreme Court's decision in Cattolica represented the correct position under Italian law. In Cattolica, the Italian Supreme Court held that, although derivative contracts in general do not constitute indebtedness, certain types of derivatives may have the effect of creating indebtedness if they: (i) provide for an upfront payment; (ii) extinguish pre-existing underlying loans; or (iii) significantly modify existing loans.

However, in the court's view, there was no evidence that the Transactions had any factors which would have rendered them as forms of indebtedness as identified in Cattolica. There was therefore no real prospect of the Transactions being treated as void on this ground.

Authorisation by a provincial council

The court noted, as per Cattolica, that certain interest rate swaps required authorisation by a provincial council under certain Italian legislation if their characteristics were such as to constitute indebtedness.

However, in the court's opinion, the Transactions were not of the type which required the approval of the provincial council and even if they were, such approval had been obtained by certain resolutions. There was therefore no real prospect of the Transactions being treated as contravening certain Italian legislation.

Economic advantage

The court firmly rejected the Authority's suggestion that the Transactions did not comply with certain Italian legislation in that they did not meet the economic convenience requirement (i.e. they were not "economically advantageous") due to the fact that the Transactions included certain "implicit costs" to the Authority.

The court agreed with the Bank that the Transactions did not constitute a refinancing or restructuring of any existing indebtedness, and were therefore not subject to the economic convenience test under certain Italian legislation.

Validity of the Transactions

The court held that the appropriate approvals had been provided. The Authority did not lack capacity and there was no issue undermining the material validity of the Transactions under English law.

The court noted that if this were a matter of English law, being the governing law of the Transactions in accordance with Article 3(1) of the Rome Convention, there was no identified reason why the Transactions or the Transaction Documents should be regarded as invalid.

Accordingly, for all the reasons above, the court found in favour of the Bank and allowed the summary judgment application.