Banks’ Interest Rate Swaps with Venice Void Due to Lack of Capacity
Banca Intesa Sanpaolo S.p.A. and another v Comune di Venezia [2022] EWHC 2586 (Comm), is one of several recent English High Court decisions concerning Italian local authorities and the implications of the Italian Supreme Court’s decision in 8770/20 Banca Nazionale Del Lavoro S.p.A. v Municipality of Cattolica (“Cattolica”).1 On the basis of Italian law, certain Italian local authorities have sought to argue that they lacked capacity to enter into transactions which they say are caught by the reasoning in that decision.
In 2007, the Venice local authority entered into transactions with certain banks under an English law governed ISDA Master Agreement. These included an interest rate swap transaction.
Venice challenged the transactions. Several years after the transactions were concluded, the local authority sought to argue that it lacked capacity to enter into the transactions on the basis that:
(a) the transactions were ‘speculative’ for the purposes of Law No 448/2001 (which applies to transactions entered into after 4 February 2004 by local authorities);2
(b) the transactions were ‘indebtedness’ other than for investment expenditure under Article 119 of the Italian Constitution;3 and
(c) the transactions did not receive the requisite approval from the council under Article 42 of the Local Authorities Consolidations Act (Consolidated Code of Local Bodies).4
The Banks sought declarations of validity from the English Court.
Mr Justice Foxton considered the Italian law capacity issues, applying English conflict of laws principles. It was “common ground that issues as to the capacity of Venice (as a legal person) to enter into the Transactions are to be determined by reference to Italian law”, which reflects that “Venice only exists by virtue of, and within the confines imposed by, the municipal legal system which brought it into being”. In accordance with usual conflicts of law principles, the Judge noted that the characterisation of an issue as one of capacity is determined by English law.
The Judge held that Venice did not have capacity. Foxton J observed that the Italian case law “identifies a number of indicia or features which, either individually or in combination, may have the effect that a derivative is… a speculative transaction”. The Judge found, on the evidence, that he was “satisfied that an Italian court would clearly find that the Transactions were speculative for the purpose of the legal restriction under Italian law formulated in Cattolica.” He also found, following his assessment of Cattolica that the transactions involved recourse to indebtedness in contravention of the relevant Italian law.
This finding on the capacity of the local authority led to the conclusion that the derivative transaction was void. Foxton J also made some observations relating to the Banks’ contractual estoppel argument based on representations in the ISDA Master Agreement. In this case, the ISDA Master Agreement was entered into at the same time as, and with a view to concluding, the transactions. Therefore, and despite the presence of an additional “non speculation” representation, Foxton J did not “accept that a local authority which lacks capacity to enter into speculative derivatives can be estopped from contending that the single transaction in issue was speculative. That amounts, in substance, to a promise that it had the capacity it lacked.”
Finally, Foxton J decided that, although Venice was entitled to restitution of amounts paid under the transactions, the Banks could in principle rely on a change of position defence for payments made under the back-to-back hedging swaps: “The outcome which that entails tempers at least some of the consequences which would otherwise flow from a legal development in 2020 leading to a transaction which both parties had treated as binding for nearly 13 years being held to be void from the outset.” In this context, the Judge himself referred to the inevitability of an appeal, so this story is unlikely to be over.
The English High Court’s approach thus far in grappling with Cattolica may lead to further challenges by other Italian local authorities. For example, in both Busto and Venezia, the judges reached the view that, considering specific Italian law provisions post-Cattolica, Italian local authorities could not enter into speculative derivative contracts. However, in neither case did the Court feel able to define what speculation is as a matter of Italian law, leaving some uncertainty as to precisely where the English court will draw the line in these types of cases. Indeed, different conclusions were reached based on the cases’ respective facts, Cockerill J having rejected the local authority’s argument in Busto that the swaps were speculative. This uncertainty is compounded by the fact that Cattolica is widely criticised in Italy, in particular with respect to its findings on the substantive requirements derivative contracts must meet to be valid under Italian law.
Irene Obahiagbon (Associate), and Michael Munk (Managing Associate) in London and Francesco Amatori (Managing Associate) in Milan
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