The Commercial Court (Financial List) has given a significant judgment in the first of the Italian swaps cases to consider the landmark Italian Supreme Court decision in Banca Nazionale Del Lavoro S.P.A v Municipality of Cattolica, holding that it was open to the English Court to diverge from an authority of the highest Court in a foreign legal system if satisfied on the evidence that the authority does not represent the law.
Busto Arsizio entered into a mirror swap and interest rate swap with Deutsche Bank in 2007 to restructure its existing indebtedness and interest rate hedging arrangements. The ISDA Master Agreement and transactions were governed by English law and subject to the exclusive jurisdiction of the English Courts.
Deutsche Bank brought proceedings in England seeking declarations that, amongst other things, Busto Arsizio had capacity and authority to enter into the swaps, which were valid and binding in accordance with their terms. In its defence, Busto Arsizio argued that it was not bound by the swaps, including because the decision in Cattolica held that Italian public authorities do not have capacity to enter into derivative transactions that (i) do not disclose the mark-to-market, probabilistic scenarios and hidden costs of the derivative and (ii) are ‘speculative’ rather than for the purposes of ‘hedging’. It also argued that the Cattolica decision required the City Council to approve derivative instruments such as the swaps.
Cockerill J held that it was open to the English Court to diverge from an authority of the highest Court in a foreign legal system if satisfied on the evidence that the authority does not represent the law. The Judge found that, absent Cattolica, the Italian Constitution did not limit the capacity of Italian authorities to enter into derivatives, and went on to consider whether the decision in Cattolica had imposed any limits on the capacity of public authorities as alleged by Busto Arsizio.
The Judge rejected Busto Arsizio’s argument that Cattolica had recognised a limit on the capacity of Italian public authorities to enter into derivatives absent disclosure of the mark-to-market, probabilistic scenarios and hidden costs. Insofar as such disclosures were required under Italian law, they imposed limits on the material validity of derivative contracts, which had no application to the transactions between Deutsche Bank and Busto Arsizio as the proper law of those contracts was English law. In any event, the Judge went on to find that, even if the Cattolica decision had introduced limits on capacity by requiring the disclosure of certain matters, those limits were not violated on the facts of this case. The municipality was in a position to make an informed assessment of risk and had available the information required to carry out that assessment, because the bank had clearly disclosed this material prior to the transactions. Further, the municipality had, as a matter of fact, considered this material and carefully made an informed assessment of the risks.
As regards the question of whether the transactions were ‘speculative’, the Judge found that the cash flow swap was a classic form of hedging that sought to manage and contain the interest rate risks to which Busto Arsizio was already exposed on its borrowing. The effect of the mirror swap was simply to neutralise the effect of an earlier swap entered into by Busto Arsizio which exposed it to significant risks if interest rates rose. The transactions were therefore not speculative and had been properly concluded for the purposes of hedging Busto Arsizio’s interest rate risks.
Finally, the Judge also concluded that the transactions did not require City Council approval as they did not significantly modify the municipality’s existing borrowing or incur any expenditure commitments for the future. Even if that were wrong, the Judge found that, to the extent City Council approval was required, it was obtained and, in any event, that the transactions would have been ratified.
Sonia Tolaney QC acted for Deutsche Bank with Rupert Allen, instructed by Allen & Overy LLP. Andrew Lodder acted for Deutsche Bank earlier in the proceedings.
The Judgment can be found here.