In Banca Intesa Sanpaolo and Dexia v Comune di Venezia [2023] EWCA Civ 1482, the Court of Appeal decided that the Commercial Court was wrong when it found that the Venice local authority (“Venice”) did not have the capacity to enter into certain swaps, making them void as a matter of English law.  

Background and Commercial Court decision

In 2007, Venice entered into derivative transactions with certain banks (the “Banks”) under an English law governed ISDA Master Agreement, including an interest rate swap. 

In 2019, the Banks applied to the English Commercial Court seeking declarations that the swaps were valid and binding. Venice challenged the transactions on the grounds that they were “speculative” or constituted indebtedness and that, as a matter of Italian law, this meant that Venice lacked the capacity to enter into them. Venice duly counterclaimed in restitution.   

The Commercial Court held that issues as to Venice’s capacity to enter into the transactions should be determined by reference to Italian law and that, under Italian law, Venice had no capacity to enter into transactions which were “speculative” or which constituted “indebtedness.” This conclusion as to capacity under Italian law is in line with the Italian Supreme Court’s decision in the Cattolica 2020 litigation. If Venice had no capacity to enter into the transactions they were, as a matter of English law, void.  

In the Commercial Court, the Judge agreed that the transactions were “predominantly speculative”.  They were “akin to borrowing money but instead of repaying it on predictable terms, entering into a bet with a range of possible outcomes. Venice might never have had to repay [under the transactions] at all, if rates had suddenly risen to well above the cap and stayed there […]. Conversely, Venice might – as has in the event occurred – have to pay it back many times over because its impact on the floor level [has] resulted in Venice paying much more than would otherwise be the case.”  

On Venice’s counterclaim for restitution, the Commercial Court held that the applicable law was English law, as this was the law of the country with the closest connection to the transactions. As such, the Banks were able to rely on a “change of position” defence (which would not have been available in Italian law). 

For more information on the Commercial Court ruling, please see our previous blog post here. 

The Court of Appeal’s judgment

The Banks’ appeal was heard in October 2023. 

The Court of Appeal unanimously overturned the Commercial Court’s decision, holding that the transactions were not “speculative” and did not constitute “indebtedness” in the sense explained in the Cattolica decision. This was primarily on the basis that the pricing of the 2007 swap reflected the negative mark-to-market of the original 2002 swap from which it was restructured. In reaching this conclusion, the Court of Appeal placed weight on the role the swap played in hedging Venice’s risk as to existing exposures and noted that because the Commercial Court did not recognise the swap in question as a hedge, this had led it to mischaracterise the transactions.  

Since the Court of Appeal found that the relevant transactions were not speculative nor did they constitute indebtedness, the foundation for the challenge as to capacity under Italian law fell away and the swaps were valid and binding.   

The decision also considered two significant issues in the conflict of laws and the law of restitution: 

1. the first was whether a claim to recover payments made under a contract which is alleged to be void should be governed by the law applicable to that contract. At first instance, the Commercial Court applied the English common law test and found that English law should be applied since it had the “closest and most real connection” to the claim (so as to meet the relevant Article 8(1) Rome Convention threshold). The Court of Appeal agreed with this conclusion, finding that the Commercial Court’s reasoning “cannot be faulted”.
2. the second concerned whether, in a claim for recovery of payments which were made under a void contract, the defence of “change of position” would be available. The Court of Appeal confirmed that such a defence would be available in principle, as there was no public policy reason to suggest otherwise. 

Comment

Not only has the Cattolica judgment been widely criticised in Italy but, prior to this judgment, the English courts have expressed some uncertainty as to its correct application in English litigation. Whilst the Commercial Court’s decisions both here and in Deutsche Bank v Busto [2021] EWHC 2706 (Comm) were that Italian local authorities had no capacity to enter into speculative contracts, the Commercial Court felt unable to define what counted as “speculative” as a matter of Italian law. Indeed, different conclusions were reached based on the cases’ respective facts. 

The Court of Appeal’s decision in the Venice case is helpful to banks in this regard albeit that all these cases to some extent turn on their own facts. It seems clear that challenges to English law governed swaps on the basis that the Italian counterparty had no capacity to enter into them are not yet over – either in England or indeed in Italy.