High Court upholds validity of derivative transactions and related settlement agreements in latest Italian swaps judgment

The High Court has ruled in favour of the claimant banks in a recent Italian swaps judgment: Deutsche Bank and Dexia v Provincia di Brescia [2024] EWHC 2967 (Ch). In its judgment, the High Court upheld the validity and enforceability of interest rate derivative transactions which the public authority of Brescia was challenging on the basis of the landmark 2020 Italian Supreme Court decision in Banca Nazionale del Lavoro SpA v Comune di Cattolica (8770/2020).

The Cattolica decision has given rise to a new wave of litigation in the English courts involving Italian public authorities. The High Court's judgment follows a number of other recent English judgments which have rejected attempts by public authorities to avoid derivative transactions by relying on Italian law arguments as to capacity, authority and validity (including the Court of Appeal's judgment in Banca Intesa Sanpaolo SpA and Dexia Credit Local SA v Comune di Venezia [2023] EWCA Civ 1482; see our earlier blog post).

The present case is the first in which the High Court has also been required to rule on the enforceability of Italian law settlement agreements that had compromised earlier disputes about the transactions, but which the public authority subsequently sought to have set aside. The judgment provides further reassurance to banks that the English court will take a robust approach to attempts by Italian (and other) public authorities to extricate themselves from their contractual commitments.

Since this judgment was handed down, the English court has heard another similar claim against an Italian public authority, in which it has - once again - granted the claimant bank the relief sought: Dexia SA v Regione Emilia Romagna [2024] EWHC 3236 (Comm).

We consider the present decision in further detail below.

Background

In 2005, Brescia sought to reduce the costs on its existing indebtedness to an Italian bank, which amounted to around €84m under various fixed and floating rate bank loans. Brescia decided to terminate these loans early and issued two floating rate bonds, for €105m and €56m respectively, to refinance its existing indebtedness and to finance new investment (the Bonds). The principal amount of the Bonds was repayable by way of a single bullet repayment in 2036.

The Bonds were underwritten by Deutsche Bank and Dexia (the Banks). Brescia also entered into interest rate swaps with the Banks, to hedge its interest rate exposure under the Bonds (the Transactions). The Transactions with each Bank were entered into pursuant to an ISDA Master Agreement which provided for English law and the exclusive jurisdiction of the English court. The Transactions required Brescia to pay interest on a notional amount equal to the principal amount of the Bonds, but amortising until 2036. Under each Transaction, Brescia was to pay fixed rates until 2010, and thereafter a variable rate subject to a cap and a floor (ie, a "collar").

Both Brescia and the Banks made the relevant payments from inception of the Transactions until the present day. There was no suggestion that the Transactions were unenforceable until Brescia indicated in November 2015 that it intended to seek suspension or cancellation of the Transactions. At that point, the Banks issued claims in England seeking declarations as to the validity of the Transactions, and Brescia commenced proceedings in Italy alleging that the Banks were liable to pay damages for losses suffered under the Transactions. The English and Italian proceedings were resolved by settlement agreements entered into in September 2017 (the Settlement Agreements).  

However, following the Italian Supreme Court's decision in May 2020 that certain swaps with the public authority of Cattolica were void and unenforceable, press reports suggested that Brescia would seek to rely on Cattolica to set aside the Settlement Agreements and further challenge the Transactions in Italy. The Banks therefore issued new claims in England, seeking similar declarations as they had previously (in respect of the settled proceedings), together with further declarations as to the effect of the Settlement Agreements on the Transactions. Brescia subsequently commenced proceedings in Italy challenging the validity and/or enforceability of the Transactions and the Settlement Agreements.

Decision

The High Court found in the Banks' favour on all issues.

The validity of the Transactions

The Banks sought a declaration that Brescia had capacity (or substantive power) to enter into the Transactions. Under conflict of laws rules, the capacity of a legal entity is determined by the law under which it was brought into being as a legal entity, which in the case of Brescia was Italian law. The Cattolica decision suggested that, under Italian law, there are two relevant limits on a public authority's capacity to enter derivative transactions: that is, if the investment: (1) is speculative (as opposed to hedging); or (2) involves a resort to indebtedness other than as a means to fund investment expenditure.

Regarding the first limit, the High Court held that the Transactions were not speculative. Referring to the Court of Appeal's decision in Venezia, which adopted the test set down by the Italian financial regulator, a derivative will not be speculative when it satisfies the following two conditions:

1. The derivative must be entered into expressly for the purpose of reducing the riskiness of other positions held; and
2. There must be a high degree of correlation between the technical and financial aspects (maturity, interest rate, type, etc) of the exposure being hedged and the financial instrument used for that purpose.

In the present case, the purpose of the Transactions was to amortise the bullet repayment and hedge the interest rate risks arising from the Bonds. Further, there was a high degree of correlation between the derivatives and underlying borrowing being hedged because the Transactions matched the Bonds in respect of notional amounts, maturity and cashflows. The Transactions were "plain vanilla" derivatives that effected a straightforward hedge through an interest rate swap with a collar.

As for the second limit, the Transactions were entered in connection with the refinancing of Brescia's existing debt, and all of the new borrowing under the Bonds (ie the additional sums raised under the Bonds beyond what was needed to refinance) was to finance new investments, namely those listed in the council resolutions by which Brescia had approved the Bonds. Accordingly, the Transactions did not form part of a refinancing that involved Brescia incurring indebtedness for a purpose other than funding investment expenditure.

The High Court also dealt with a number of Italian law arguments about alleged lack of authority and transactional invalidity. The High Court considered that on their true characterisation, these arguments did not concern Brescia's capacity but went to matters governed by English law (as the governing law of the Transactions). As such, these arguments did not affect the validity and enforceability of the Transactions. In addition, the High Court granted declarations in favour of the Banks in respect of some of the Italian law arguments Brescia was advancing in the Italian proceedings.

The validity of the Settlement Agreements

This case represents the first time that the English court has been called upon to determine the effect of Italian law on settlement agreements governed by that law but entered into in respect of English law derivatives alleged to be void or invalid under Italian law.

The Settlement Agreements, entered into in September 2017, were intended to bring an end to all then-existing English and Italian proceedings concerning the Transactions. The Settlement Agreements included agreements that the Transactions were valid, binding and enforceable, as well as representations and warranties that the Transactions complied with relevant Italian laws.

However, in the new proceedings which it had commenced in Italy, Brescia sought to rely on various Italian law arguments to set aside the Settlement Agreements. Brescia argued that the Settlement Agreements were null and void because they related to unlawful underlying contracts (ie the Transactions) and so were contrary to public policy. The Banks accordingly sought declarations in the English proceedings that the Settlement Agreements were valid and enforceable.

As a preliminary matter, the High Court was required to decide the question of jurisdiction. The Settlement Agreements were governed by Italian law and did not have a choice of jurisdiction clause. The issue was whether the choice of Italian law in the Settlement Agreements trumped the jurisdiction clause in the ISDA Master Agreements, which provided for the jurisdiction of the English court "with respect to any suit, action or proceedings relating to this Agreement". The High Court found that it did not. It considered that the declarations sought had "at their heart" the Transactions, and that the provision in the Master Agreements was broad enough to extend to capture any dispute about the Transactions. The English court therefore had jurisdiction to declare invalid any step to challenge or undermine the validity of the Transactions, even if governed by Italian law.

The High Court went on to reject all the substantive Italian law arguments advanced by Brescia. As to whether the Settlement Agreements related to underlying contracts that were null and void, the relevant provision of Italian law applies only where the relevant party was unaware of the reasons for that alleged invalidity at the time of the settlement agreement. In this case, Brescia was aware of the reasons for the alleged invalidity of the Transactions prior to entering into the Settlement Agreements.

The High Court granted the declaratory relief sought by the Banks. Although the declarations concerned the effect of Italian law, the High Court was satisfied it had jurisdiction to make them, given that all of the declarations had the Transactions at their heart. The High Court considered that the declarations would have utility, because Brescia accepted that if the Settlement Agreements were valid, that would dispose of its claims in the Italian proceedings; and in the Italian proceedings Brescia was in effect seeking to undercut the Transactions by which it was bound in English law and to undermine the determinations of the English court in respect of the Transactions.

Interestingly, the Italian Supreme Court issued a decision on 15 July 2024 (following the trial in the English proceedings, but prior to this judgment), confirming that the Italian court lacked jurisdiction to determine the issues concerning the Settlement Agreements in this case.

Conclusion

The High Court noted in conclusion that it was necessary for it to make the declarations sought, in order to ensure as far as possible that Brescia's inappropriate resort to litigation in Italy (in furtherance of its attempts to create uncertainty about the contractual commitments it had freely entered into, when there was none) was brought to an end