Dexia Crediop S.p.A. (Dexia) v Comune di Prato (Prato) [2016] EWHC 2824 (Comm), 10 November 2016
In the second and final part of his judgment, Walker J held that further mandatory provisions of Italian law apply to and invalidate an English law-governed interest rate swap. The decision is a reminder to parties of the risk that the governing law of a contract may not limit the obligations of the parties nor the grounds upon which to challenge its validity. The scope of Article 3(3) of the Rome Convention on the law applicable to contractual obligations (the Rome Convention) in finance transactions is at the top of the Court’s agenda, with the Court of Appeal having recently upheld Blair J’s decision in Banco Santander Totta SA v Companhia de Carris de Ferro de Lisboa SA that it does not apply to a series of swaps.1
Between 2002 and 2006, Dexia (an Italian bank) and Prato (an Italian local public administration) entered into a number of interest rate swaps, including an interest rate collar entered into in 2006 to hedge against rising interest rates by allowing Prato to fix the floating rate of interest payable on its bond debt. Prato would pay an interest rate no higher than the cap rate but no lower than the floor rate. The swap comprised an ISDA Master Agreement and confirmations incorporating an express choice of English law and jurisdiction.
Following the financial crisis and the fall of interest rates to historical lows, the floor payable by Prato exceeded the floating rates prevailing in the market. In 2010, Prato took steps in Italy to set aside the swaps and Dexia brought a claim for payment and declaratory relief in the English Commercial Court. Prato’s defence and counterclaim were based primarily on arguments relating to capacity and provisions of Italian law. In reliance on Article 3(3) of the Rome Convention (Article 3(3)), Prato argued that the swaps should be held invalid or unenforceable by reason of mandatory rules of Italian law.
Article 3(3) of the Rome Convention
Article 3(3) provides that the choice of English law as the governing law of a contract shall not prejudice the application of the “mandatory rules” of the law of the one country with which “all the other elements relevant to the situation at the time of the choice are connected”.
If your contract was entered into after 17 December 2009, the Rome I Regulation will apply. Rome I includes a similar provision to Article 3(3) of the Rome Convention, although it refers to laws that “cannot be derogated from by agreement” rather than “mandatory rules”. Rome I also provides that the “overriding mandatory provisions” of the law of the place of performance (ie those provisions of the law which are regarded as crucial by the relevant state to safeguarding its public interest) can be taken into account by a Member State court when determining a contractual dispute even where the parties have chosen a different governing law for their contract. For more detail on the approach under Rome I, please see our article on the CJEU decision in Hellenic Republic v Nikiforidis.2
All other elements pointed to Italy – so Italian mandatory rules apply
Dexia argued that Article 3(3) did not apply to the swap because it was not the case (as asserted by Prato) that, other than the choice of English law and jurisdiction, “all the other elements relevant to the situation” at the time the parties entered into the contract were connected only with Italy. In particular, Dexia relied on the fact that: (i) the ISDA Master Agreement is an internationally-recognised industry standard form; and (ii) it entered into back to back hedging swaps with banks outside Italy in connection with the swaps, using the same documentation.
Walker J held that neither the international nature of the ISDA Master Agreement, which did not amount to a connection with any specific country other than Italy, nor the back-to-back swaps, which were not within the contemplation of the parties at the time of the choice of governing law, were elements “relevant to the situation”. Accordingly, Prato was permitted to rely on its defences and counterclaims based on ‘mandatory rules’ of Italian law.
The ‘mandatory rules’ defences
Walker J held that Dexia failed to comply with the following ‘mandatory rules’ of Italian law applicable to retail investors, resulting in the nullity of the swaps:
(1) Article 30 of Decree 58/1998 (the Testo Unico della Finanza) (TUF), which requires certain investment contracts placed by so-called “door-to-door selling” to contain a written notice of the investor’s seven day right of withdrawal;
(2) Article 32 of TUF, which requires contracts concluded exclusively by distance marketing techniques to include the same seven-day right of withdrawal; and
(3) Article 23 of TUF and Article 30 of Consob Regulation 11522 of 1998 (the Consob Regulation), which impose a requirement to include certain information and wording in financial contracts.
Different view reached by Blair J – an ‘international situation’
In his judgment in the Banco Santander case3, Blair J held that mandatory rules of Portuguese law did not apply where there were other elements that point to an “international situation”. Blair J disagreed with the narrower approach of Walker J to the question of which “elements” were “relevant to the situation”.
In particular, Blair J noted that “the wording of Art. 3(3) focuses on whether the “situation” is linked to one country only”. Applying the interpretation adopted in the Caterpillar case4 that the phrase “‘relevant to the situation’[…] is wider than ‘elements relevant to the contract’”, Blair J held that the court’s “enquiry is not limited to elements that are local to another country, but includes elements that point directly from a purely domestic to an international situation”. In financial transactions, the court may take into account the use of ISDA or other standard documentation used internationally and the fact that “the transactions are part of a back-to-back chain involving other countries” (ie the use of back-to-back swaps in this case).
In upholding Blair J’s judgment, the Court of Appeal expressed support for his reasoning. Sir Terrence Etherton MR noted that Blair had correctly approached Article 3(3) “as a limited exception to the […] starting point of party autonomy and, as such, it is to be construed narrowly”. The Court of Appeal agreed with Blair J’s conclusion that “the enquiry under Article 3(3) includes elements that point directly from a purely domestic to an international situation” and expressly disagreed with Walker J’s approach of “confining ‘elements of the situation’ to those with a connection to a particular country in a conflict of laws sense”.
Further, the Court of Appeal confirmed that Blair J had not committed any error of principle in concluding that the back-to-back swaps with banks outside of Portugal, the use of the multicurrency ISDA and the reliance on Santander’s Spanish banks in the calculation of the credit risk exposure were elements relevant to the situation.
COMMENT
Dexia defeated most of the major defences raised by Prato, including the purported lack of capacity and the alleged existence of hidden costs comprising the negative mark-to-market value of the swap at inception. However, pursuant to Article 3(3), Prato was able to rely and prevail on Italian law ‘mandatory rules’ defences which are arguably of limited relevance to swap contracts.
For example, Prato argued successfully that the ISDA Master Agreement was null and void for breach of the requirement in Article 30.2 of the Consob Regulation to include prescribed wording (including detail of the procedures by which the investor may give orders and instructions and a stipulation of the frequency, type and content of the documentation to be sent to the investor to report on the activity carried out). Dexia had argued that the wording was unnecessary and irrelevant since, among other things, the swaps were the only transactions contemplated between the parties and Dexia did not carry out any “activity” under the swaps on which it could be expected to “report” to Prato. However, the Court interpreted the provision widely given its focus on consumer protection and underlined that the ISDA Master Agreement’s status as an internationally accepted standard form agreement did not remove the need to provide the required protections to retail investors (which was the classification given to Prato by Dexia).
For commercial parties, the long reach of mandatory rules of the jurisdiction where the transaction is performed and their use as a means of contesting the validity of contracts remains a challenge. While parties are advised to thoroughly understand and comply with the mandatory rules which may apply to their transactions, that may not provide complete protection, particularly in the case of long-term contracts. For example, the Court acknowledged that, at the time Dexia and Prato entered into the swaps, Italian case law appeared to indicate that the correct interpretation of Article 30 of TUF was that it did not require the inclusion of a seven-day right of withdrawal in the swaps – but relied on case law subsequent to the contract in finding it to be null for breach of that provision.
The decision of the Court of Appeal in Banco Santander shows that the courts are willing to construe Article 3(3) more narrowly and provides further guidance on the elements which are “relevant to the situation”. It is expected that the evolution of case law in this area will offer parties further clarity on the scope of ‘mandatory rules’ pursuant to Article 3(3) in finance transactions. The Dexia case is listed for appeal later this year.
Footnotes:
1 [2016] EWHC 465 (Comm).
2 Regulation (EC) No 593/2008 on the law applicable to contractual obligations (Rome I).
3 http://www.allenovery.com/publications/en-gb/Pages/Testing-legal-certainty-under-Rome-I.aspx
4 Banco Santander Totta SA v Companhia de Carris de Ferro de Lisboa SA & ors [2016] EWHC 465 (Comm).
5 Caterpillar Financial Services Corporation v SNC Passion [2004] EWHC 569 (Comm)
