Court of Appeal clarifies that “mandatory rules” do not override chosen law in contracts with an international element

In two recent decisions, the Court of Appeal has clarified that Article 3(3) of the Rome Convention does not apply to override the chosen law where there is an international element to the contract. In both cases, defendants seeking to set aside interest rate swaps entered into under ISDA master agreements subject to English law were therefore unable to rely on mandatory rules in their home jurisdictions: Banco Santander Totta SA v Companhia de Carris de Ferro De Lisboa SA [2016] EWCA Civ 1267 and Dexia Crediop SPA v Comune di Prato [2017] EWCA Civ 428.

Article 3(3) provides that, where a law is chosen to govern a contract but all the other elements relevant to the situation are connected with another country, the choice of law will not prejudice the application of the mandatory rules of that other country. The Court of Appeal held that it was legitimate, when considering whether all elements were connected with another country, to look to elements pointing to the contract having an international aspect, rather than a purely domestic one.

The decisions provide some comfort for commercial parties regarding the risk of a foreign country’s mandatory laws being applied to contracts governed by English law (whether pursuant to Article 3(3) of the Rome Convention or the equivalent provision of the Rome I Regulation, which is in similar terms).

It remains to be seen what will amount to an “international element” in any given case. These decisions suggest this may include the use of international forms of documentation, the international nature of the market and the existence of related contracts entered into in another jurisdiction.

Background

To determine the law applicable to most contracts, an English court will apply the rules in either the Rome I Regulation (Rome I) (for contracts entered into on or after 17 December 2009) or its predecessor, the Rome Convention (for contracts entered into from 1 April 1991 to 16 December 2009).

The starting position under both is that, where the parties have expressly chosen a particular law to apply to the contract, that law will apply. However, that is subject to various qualifications including under Article 3(3) which provides as follows:

“The fact that the parties have chosen a foreign law, whether or not accompanied by the choice of a foreign tribunal, shall not, where all the other elements relevant to the situation at the time of the choice are connected with one country only, prejudice the application of rules of the law of that country which cannot be derogated from by contract, hereinafter called ‘mandatory rules’.” (emphasis added)

The above is the wording used in the Rome Convention, which was considered in the present decisions. While the corresponding Article 3(3) of Rome I is not in completely identical terms, the Recitals to Rome I make it clear that no substantial change in meaning was intended, and so it is strongly arguable that case law (including the present decisions) interpreting the provision in the context of the Rome Convention should apply equally to Rome I.

Differing approaches at first instance

Both Dexia and Santander involved similar facts – an attempt by a counterparty to (amongst other things) set aside interest rate swap contracts it had entered into with a bank. In each case, the counterparty argued that, apart from the express choice of English law, all other relevant elements of the contract were connected solely with the counterparty’s home jurisdiction (Italy and Portugal respectively) and that Article 3(3) of the Rome Convention therefore applied – with the result that certain mandatory rules of Italian/Portuguese law allowed the swap contracts to be set aside.

Despite the similar facts, the first instance judges reached different conclusions, due to their different approaches to the preliminary question of whether “…all the other elements relevant to the situation … are connected with one country only”, so as to trigger Article 3(3):

  • In Dexia, Mr Justice Walker took a narrow view of the “elements” that were relevant for Article 3(3) and concluded that there were no relevant elements connected with any country other than Italy (so Italian mandatory rules applied and the swaps were set aside).
  • In Santander, decided 9 months later, Mr Justice Blair took a broader approach and looked for elements that suggested an “international” situation as opposed to a purely domestic one. The elements he took into account included the use of the multi-currency cross border form of the ISDA Master Agreement, the international nature of the wider swaps market, and the existence of back-to-back hedging contracts that the bank had entered into outside Portugal. He therefore concluded that not all the relevant elements were connected to Portugal, and refused to allow the Portuguese mandatory rules to be invoked.

Both decisions were appealed.

The Court of Appeal’s approach

Santander was the first of the two cases to be decided by the Court of Appeal, in December 2016. The Master of the Rolls, giving the lead judgment, accepted that, as Article 3(3) is a limited exception to the basic principle of party autonomy, it must be construed narrowly. He agreed with Mr Justice Blair that the elements that would prevent Article 3(3) from being invoked would include any elements that pointed to the contract having an international aspect, rather than a purely domestic one. In particular, relevant elements were not limited to those which had a connection with a particular foreign country (as would be the enquiry in a traditional conflict of laws dispute).

When Dexia was decided in June 2017, the Court of Appeal was of course bound by its previous decision in Santander, accepting that “[o]nce an international element comes into the picture, Article 3(3) with its reference to mandatory rules should have no application.” While the court in Dexia accepted that the international elements in that case were not as obvious as they had been in Santander, it concluded that they were “obvious enough”.

The Court of Appeal in Dexia refused permission to appeal to the Supreme Court.

Commentary

The key clarification provided by the two decisions is that, in order to resist the application of Article 3(3) in any case, it is necessary to establish only that the transaction had some international element, not that it had a connection with any other particular country. That approach appears consistent with the purpose of Article 3(3) – that is, to prevent parties to a wholly domestic transaction from circumventing the relevant jurisdiction’s mandatory rules by choosing a foreign governing law.

Importantly for commercial parties, the Court of Appeal’s reasoning in both decisions was clearly driven by a desire to maximise legal certainty and predictability. As the court observed in Dexia, parties ought to know where they stand in swap contracts regarding the possibility of mandatory rules overriding their chosen law – without them having to closely compare the facts of one case to another. The fact that “an international element” will be sufficient to displace Article 3(3) should provide substantial comfort to commercial parties – although there will clearly still be scope for argument in some cases as to what will qualify as sufficiently “international”. At least in the context of financial services transactions, the elements relied on in these cases suggest a broad approach to that concept.

However, the position remains that, when drafting English law agreements which may come before the English courts (or the courts of another EU member state), parties still need to turn their minds to whether all elements relevant to the transaction point to a particular country other than England and, if so, consider the implications.

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