English law trumps Italian contractual arguments in swaps litigation

Out-Law News | 21 Oct 2021 | 9:13 am | 3 min. read

The English High Court has ruled that interest rate swaps entered into by an Italian local authority are binding under English law.

The ruling in favour of Deutsche Bank comes after a controversial May 2020 judgment by the Italian Supreme Court in a similar case. The Italian court ruled in favour of the local authority, agreeing the swap contract was unenforceable under Italian law and the local authority in question did not have the legal capacity to enter into it.

The English High Court interpreted the Italian Supreme Court decision as being based on principles of Italian contract law, as opposed to legal capacity. It did not find there was any wide-ranging issue with Italian local authorities’ legal capacity to enter into swaps.

Litigation expert Mike Hawthorne of Pinsent Masons, the law firm behind Out-Law, said the decision meant that English law swaps with Italian local authorities remain enforceable in this jurisdiction despite the Italian Supreme Court decision.

“The Italian law contractual arguments simply do not apply because the swaps were written under English law,” Hawthorne said.

The Italian Supreme Court decision in the dispute between Banca Nazionale Del Lavoro and the municipality of Cattolica was the culmination of a long-running series of cases in Italy in which Italian local authorities had raised various arguments to try to get out of pre-2008 interest rate swaps.

Hawthorne said there had been controversy in Italy about the impact of the Cattolica decision, as it was unclear whether it meant that local authorities generally lacked the capacity to enter into swaps, or that only in some limited factual scenarios could the level of information provided by the bank in the sale render the swap void. This controversy has led to many local authorities in Italy suing their banks to escape swaps that are currently expensive for them.

Hawthorne said there is a two-track litigation strategy typically employed for these cases, with the local authorities suing the bank in Italy and the bank responding with a case before the English courts. That strategy had put the English and Italian courts in a race to determine how Cattolica impacts English law swaps.

“There are a number of pending cases in the English courts in which the Italian law consequences of the Cattolica decision are being hotly contested,” Hawthorne said.

Although in the Deutsche Bank case the High Court provided clarity on the issue of whether swaps governed by English law remained binding, it did not make a ruling on whether Italian local authorities had legal capacity to enter into the swaps. Surprisingly for some Italian scholars, the English court said that, if it had been required to decide the point, it may have decided that the Cattolic decision a is wrong under Italian law.

As a fallback position, Deutsche Bank argued that the local authority, Comune di Busto Arsizio, could not escape its obligations, even if it did not have the capacity to enter into the swap. This was because Busto Arsizio had represented to the bank on entering the swap that it did in fact have the legal capacity to do so.

A previous case in 2014 between Credit Suisse and a Dutch social housing association, Vestia, set precedent relating to capacity. In that case the judge found that Vestia had entered into transactions without having the capacity to do so, but the Master Agreement under which the swaps were transacted remained valid, and in the Master Agreement the association had represented to Credit Suisse that it was able to enter into those contracts.

The judge in the Deutsche Bank case, Mrs Justice Cockerill, said that, if the issue had arisen, she would have been unwilling to follow the Vestia decision. She said: “The doctrine is one which has been established on a very narrow basis and has yet to receive endorsement from the Supreme Court. There are some expressed concerns in the academic commentaries about its principled basis and capacity for uncontrolled growth.”

Hawthorne said he expected the capacity argument to continue in other disputes.

“There are a number of similar pending cases, and the local authorities in those cases will no doubt try to find a way to re-open the capacity argument in some way. It’s an irresistible argument for them because, if they could win the point, it would open up claims to recover all the money they have paid to the banks over the years. At that point we would finally have a route to an appellate judgement on Vestia arguments,” Hawthorne said.