Court of Appeal overturns High Court’s high-profile Italian swaps decision

The Court of Appeal has overturned the High Court’s decision that interest rate swaps entered into between the appellant banks and an Italian local authority were void for lack of capacity: Banca Intesa Sanpaolo and Dexia Credit Local SA v Comune di Venezia [2023] EWCA Civ 1482.

The High Court previously found that the swap transactions were void because they were speculative and involved recourse to indebtedness, on the basis of the 2020 Italian Supreme Court judgment in Banca Nazionale del Lavoro SpA v Comune di Cattolica (8770/2020). The Court of Appeal comprehensively rejected the High Court’s reasoning, concluding that structuring the transactions to cover the costs of winding up an existing swap did not amount to speculation or indebtedness.

There has been a wave of disputes relating to swaps entered into by Italian public authorities which the authorities have sought to unwind on the basis of lack of capacity (for example, see our previous blog post here). The High Court’s decision in this case was an outlier as the only decision of an English court to find that the relevant swaps were invalid as a result of Cattolica. Accordingly, the Court of Appeal’s decision is a welcome development for banks both in the context of Italian swaps litigation and for derivatives claims involving allegations of lack of capacity more generally. It has already been considered and followed in Banca Nazionale del Lavoro, Commerzbank and Dexia Credit Local v Provincia di Catanzaro [2023] EWHC 3309 (Comm), with the High Court applying the test identified by the Court of Appeal in this case. The present judgment also includes an interesting analysis of the correct approach to appeals on findings of foreign law.

Further, the Court of Appeal gave some helpful guidance in respect of the defences available in response to the local authority’s counterclaim for restitution of sums paid to the banks under the swap transactions. It confirmed that, in principle, a defence of change of position in respect of payments made under back-to-back hedging arrangements was available to the appellant banks on the basis that they had entered into those arrangements in anticipatory reliance on the payments to be made under the transactions. This finding is of potentially broader significance to banks, who typically hedge their market risk of derivative transactions with clients, meaning that even if those transactions are later found to be void, the liability to repay any sums received under the derivatives may be substantially reduced or extinguished.

We consider the decision in further detail below.

Background

In 2002, the Italian local authority Comune di Venezia (Venice) issued a 20-year floating rate bond (the Rialto Bond). It also entered into an interest rate swap with Bear Stearns (the Bear Stearns Swap) for the same notional amount, in order to hedge Venice’s interest rate exposure under the Rialto Bond. The Bear Stearns Swap was an interest rate collar, which provided a cap on the variable rate payable under the Rialto Bond and a floor below which it would pay a fixed rate.

In 2007, the Rialto Bond was restructured by extending its maturity date to 2037, with an amended coupon (the Amended Rialto Bond). As a consequence of the restructuring, the Bear Stearns Swap was no longer aligned with Venice’s exposure to interest rate risk under the Amended Rialto Bond. However, Bear Stearns was unwilling to amend the Bear Stearns Swap, so Venice agreed to a restructuring with the appellant banks (the Banks), whereby the notional amount of the Bear Stearns Swap was novated to the Banks in return for novation fees paid by the Banks to Bear Stearns. The novation fees reflected the value to Bear Stearns of the Bear Stearns Swap at that time (ie, the mark to market (MTM) in its favour).

The restructuring also involved Venice agreeing the terms of a new interest rate swap with each of the Banks (the Transactions), which together replaced the Bear Stearns Swap. The Transactions were interest rate collars which again provided for a cap and a floor rate to be paid by Venice. The terms of the Transactions matched the Amended Rialto Bond as to termination date, interest rate paid by the Banks, notional amount and amortisation schedule. Separately, the Banks also entered into “back to back” swaps with other banks that hedged their exposure under the Transactions.

Until 2019, Venice did not seek to dispute the validity of the Transactions but continued to pay sums which fell due under them. However, in June 2019, Venice commenced proceedings against the Banks in Italy claiming damages for breach of various alleged advisory duties. In August 2019, the Banks commenced proceedings in England seeking declarations that the Transactions were valid and binding.

In May 2020, the Italian Supreme Court issued its decision in Cattolica, holding that a local authority did not have capacity to enter into speculative derivatives and that certain types of swaps could constitute indebtedness (the Italian constitution does not permit local authorities to incur indebtedness except for the purpose of investment expenditure). This represented a significant change from what Italian law had previously been thought to be. Although the Transactions themselves were governed by English law under the terms of a 1992 ISDA Master Agreement, the question of Venice’s capacity to enter into the Transactions was determined by reference to Italian law (in accordance with the usual conflict of laws analysis).

Venice served its defence in the English proceedings after the Cattolica decision had been issued, relying on the decision to allege that the Transactions were void for lack of capacity. Venice also counterclaimed for restitution from the Banks of the sums it had paid to them under the Transactions (which amounted to more than €70 million), alleging that the Banks were unjustly enriched by receipt of sums paid under contracts which were void.

High Court decision

In its judgment in February 2023, the High Court found in favour of Venice. In its judgment, the Transactions were void because Venice had no power to enter into them under Italian law on the basis that they were speculative and involved recourse to indebtedness in breach of the Italian constitution. As such, Venice lacked capacity to enter the Transactions as a matter of English law.

The High Court also found that Venice’s counterclaim for restitution of sums paid under the Transactions was not time-barred, but that the Banks were in principle entitled to raise a defence of change of position to that counterclaim.

Court of Appeal decision

The Court of Appeal overturned the High Court’s decision. It did so on the basis of the Banks’ first two (of five) grounds of appeal, which concerned whether the Transactions were (1) speculative, and (2) involved recourse to indebtedness.

Status of the findings of foreign law at trial

An important initial question in relation to whether the Transactions were speculative and/or constituted indebtedness was how the Court of Appeal should treat the first instance findings of foreign law in this case.

The Court of Appeal noted that there is a spectrum of circumstances in which a trial judge can use their skill and experience of domestic law/rules of statutory interpretation to ascertain the foreign law and apply it to the case in question, per Perry v Lopag Trust Reg [2023] UKPC 16. At one end of the spectrum there will be considerable scope for the judge to use their experience where the foreign law is a common law system applying the same/analogous principles as English law. At the other end of the spectrum are cases of disputed foreign law, in which the skill/experience of the judge in domestic law has a minimal role, and the court is dependent on expert evidence of foreign law. In the latter type of case, the trial judge’s findings on the content and application of foreign law are akin to other findings of fact and the first appellate court should be slow to intervene in the judge’s assessment.

The Court of Appeal considered that the trial judge’s analysis in the present case did not involve conclusions of Italian law based on the expert evidence, but the judge’s own evaluation of where an Italian court would conclude that the Transactions were speculative and/or constituted indebtedness. This involved, in effect, the judge’s own application of Italian law to the facts. Accordingly, the case was at the end of the Perry spectrum which made the trial judge’s conclusions more amenable to review by the Court of Appeal, provided that some error of principle by the judge could be identified (which the Court of Appeal then went on to consider, as discussed below).

Speculation vs hedging

The Italian Supreme Court in Cattolica found that a local authority did not have capacity to enter into speculative derivatives. However, Cattolica did not provide a definition of what constitutes a speculative derivative.

The key reason why the High Court concluded that the Transactions were speculative was because they were structured to cover the costs of winding-up the Bears Stearns Swap with its substantial negative MTM. To achieve this, the negative MTM was rolled over into the terms of Transactions, with the value to the Banks of the interest rate floor being more than five times the value to Venice of the cap. The High Court agreed with Venice that structuring the Transactions in this way was akin to borrowing money (ie the sum to cover the MTM costs) but instead of repaying it on predictable terms, entering into a bet with a range of possible outcomes depending on what happened to interest rates.

The Court of Appeal disagreed. It considered that the High Court’s “root error” was the failure to factor into its analysis that the Bear Stearns Swap was a valid contract which amounted to hedging. In particular, the Court of Appeal highlighted the following:

  • Validity of original Bear Stearns Swap. Venice did not argue before the High Court that the Bear Stearns Swap was speculative. The High Court should therefore have concluded that the Bear Stearns swap was hedging and was valid, binding Venice at the time of the restructuring of the Rialto Bond.
  • Restructure of Bear Stearns Swap needed to take account of existing negative MTM. In order to align with the new terms and extended maturity date of the Amended Rialto Bond, Venice needed either to renegotiate and restructure the Bear Stearns Swap or enter into a new swap with another bank. If Bear Stearns had agreed to restructure the Bear Stearns Swap to align to the Amended Rialto Bond: (a) it would have been just as much a hedge as the swap it replaced; and (b) any restructuring by Bear Stearns would have necessarily taken account of the existing negative MTM.
  • Restructuring did not convert valid hedging into speculation. The disparity between the value of the cap and the floor in the new Transactions corresponded to the negative MTM as it had been under the Bear Stearns Swap. Contrary to the High Court’s conclusion, that negative MTM was an existing exposure of Venice, not a new exposure or risk which Venice had taken on as a result of the Transactions. If that existing exposure had remained to Bear Stearns, it would not have somehow converted a valid hedging swap into something speculative when the swap was restructured. It was difficult to see how, merely because the same exposure or risk was now to the Banks, what would otherwise have been hedging became speculative. The novation and entering of the Transactions, and rolling over the negative MTM which was a pre-existing non-speculative risk, could not turn what had previously been hedging into speculation.

The Court of Appeal therefore found that the Italian Supreme Court would have concluded that the Transactions were hedging. They gave Venice the benefit of an extended maturity period and other terms to correlate with the Amended Rialto Bond, without altering the economic effect of the Bear Stearns Swap.

Indebtedness

As noted above, under the Italian constitution, a local authority is not permitted to have recourse to indebtedness other than for the purpose of investment. The Italian Supreme Court found in Cattolica that a swap can constitute indebtedness if it amounts to an upfront loan or payment. An upfront payment in the context of derivatives (in Italian law) is an amount of money paid by one party to another to rebalance the financial situation of the parties in “non-par” swaps, ie swaps whose value at inception is not equal to zero.

The Court of Appeal overturned the High Court’s decision that the novation fees paid by the Banks to Bear Stearns and then “embedded” into the terms of the Transactions constituted an “upfront payment” for the purposes of the Cattolica principles. The basis for the High Court’s conclusion was that, although the novation fees were paid to Bear Stearns (rather than to Venice as the other party to the Transactions), those payments had the same economic effect as an upfront payment by the Banks to Venice. That was because Venice benefitted from the payment by the Banks through the Bear Stearns Swap being discharged, but was expected in effect to repay it through the terms of the Transactions.

The Court of Appeal held that this analysis overlooked the fact that the Bear Stearns Swap was valid hedging, under which the negative MTM was an existing exposure which Venice faced. If Bear Stearns had agreed to renegotiate its swap, it could not be said that, in rolling over the negative MTM into a restructured swap, Bear Stearns was making an upfront payment. Similarly, in circumstances where the Banks took over the Bear Stearns Swap and paid the novation fees to stand in its shoes, it could not be said that the novation fees somehow became an upfront payment.

The Court of Appeal also overturned the High Court’s conclusion that the novation fees were not “for the purpose of financing investment expenditure”. This followed from the fact that the High Court was wrong to find that the Transactions were speculative. The restructuring of the Rialto Bond itself was clearly for the purpose of financing Venice’s investment expenditure and so too were the Transactions, given that they were an integral and necessary part of that restructuring.

The Court of Appeal therefore upheld the Banks’ appeal on their first two grounds, finding that Venice did have capacity to enter into the Transactions, which accordingly were valid and binding on it.

Other issues

The Court of Appeal dealt more briefly with the parties’ other grounds of appeal, which were all predicated on the Banks’ first two grounds failing and so were academic given that the first two grounds succeeded. Although obiter, the Court of Appeal made a number of comments which may be important for other derivatives cases. These included the following:

  1. Applicable law. The High Court was right to conclude that Venice’s unjust enrichment claims were governed by English law. The Court of Appeal considered that there is an obvious very close and real connection between the law which determines whether the Transactions are void (which was English law in this case) and the law which determines whether unjust enrichment claims can be brought as a result of finding that they were void. This means that a claim in unjust enrichment to recover payments made under a void contract will usually be governed by the law applicable to the putative contract, a point on which there had previously been some uncertainty.
  2. Limitation. The High Court had misapplied the law in concluding that Venice could not with reasonable diligence have discovered that it had a worthwhile claim prior to the Cattolica decision in May 2020 (such that time did not start running until that date). In fact, Venice should have recognised that it had a worthwhile claim justifying preliminary steps towards issuing proceedings from around 2010 when many Italian local authorities (including Prato) did just that. Although Prato’s claim subsequently failed (see Dexia Crediop SpA v Comune di Prato [2015] EWHC 1746 (Comm)), for limitation purposes this was irrelevant. Venice did not need to know that its claim would succeed, just that it would be able to plead a proper case. Accordingly, the High Court should have concluded that Venice’s claims for payments made more than six years before the issue of the claim form were time barred.
  3. Change of position defence. The High Court was correct to hold that, in principle, a defence of change of position in respect of payments made under back-to-back hedging arrangements was available to the Banks on the basis that the Banks had entered into those arrangements in anticipatory reliance on the payments to be made under the Transactions.
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High Court reaffirms primacy of ISDA Master Agreement jurisdiction clause post-Brexit

The High Court’s judgment in Dexia Crediop SpA v Provincia di Brescia [2023] EWHC 959 (Comm) confirms that an English jurisdiction clause within standard form ISDA documentation will not readily be displaced.

The High Court gave effect to an English jurisdiction clause in an ISDA Master Agreement, finding that the claims related to the validity and enforceability of either the ISDA Master Agreement or the underlying swaps. The court rejected the suggestion that the relevant claims for declaratory relief arose out of a connected settlement agreement between the parties (which did not contain a jurisdiction clause and was governed by Italian law).

This decision is consistent with the trend of the English courts to give effect to ISDA standard form jurisdiction clauses, as set out in the previous decisions of BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2019] EWCA Civ 1740 (read our blog post) and Deutsche Bank AG v Comune di Savona [2018] EWCA Civ 1740 (read our blog post). These judgments were made pursuant to Article 25 of the Recast Brussels Regulation, which governs the question of jurisdiction where there has been an agreement between the parties under EU law. The present case (together with the recent decision in Deutsche Bank v Brescia [2022] EWHC 2859 (Comm)) is one of the first to look at the question of competing jurisdiction clauses in an ISDA context since the UK left the EU, deciding the issue under the UK’s domestic rules on jurisdiction agreements.

Helpfully for financial institutions, the English courts are continuing to demonstrate under the post-Brexit regime that they will give effect to the broad and market standard jurisdiction clauses contained in standard form ISDA documentation. This provides some degree of certainty to parties incorporating such clauses into their transactional documentation, should they need to rely on them at a later stage.

Background

The court considered the standard form ISDA Master Agreement jurisdiction clauses relating to two swap transactions entered into by Dexia and Brescia in 2006 (the Swaps).

The parties were previously involved in litigation in England and Italy concerning the Swaps, which was brought to an end by a settlement agreement. One of the provisions of the settlement agreement purported to confirm the validity of the Swaps. The settlement agreement did not contain a jurisdiction clause, but was governed by Italian law and expressly referred to the fact that the Swaps and the related ISDA Master Agreement were subject to English law and the jurisdiction of the English courts.

Subsequently, the Provincia di Brescia (Brescia) sought to challenge the validity and enforceability of the Swaps and the settlement agreement in a new claim in Italy. In turn, Dexia Crediop SpA (Dexia) brought proceedings in the English court seeking various declarations to the effect that the Swaps were valid and enforceable.

Brescia accepted that the English court had jurisdiction to hear and determine some of the declarations, but applied for an order that it had no jurisdiction in respect of declarations referring to the settlement agreement. Brescia contended that these declarations fell outside the ISDA Master Agreement jurisdiction clause and should be litigated in Italy. Dexia argued that the declarations to which Brescia objected, all related to the Swaps and to the ISDA Master Agreement, and therefore fell within the scope of the jurisdiction clause in the ISDA Master Agreement.

Brescia was not represented at the hearing although the court went on to consider the application anyway, as it had not been withdrawn.

Decision

The court confirmed that no permission to serve out of the jurisdiction was required since the contract contained an English jurisdiction clause (as provided for by CPR 6.33(2B)(b)).

The key question for the court was whether the declarations sought by Dexia related to: (i) the ISDA Master Agreement/Swaps; or (ii) the settlement agreement.

In coming to its decision, the court relied heavily on another recent decision (Deutsche Bank v Brescia [2022] EWHC 2859 (Comm)), where proceedings were brought by Deutsche Bank in relation to two swap transactions entered into by Brescia at the same time as the Swaps. Deutsche Bank sought many of the same declarations as Dexia in the present case, and Brescia took the same position in relation to the ISDA Master Agreement (and related settlement agreement), which were on substantially the same terms. In the Deutsche Bank v Bresica case, the court had held that the ISDA Master Agreement jurisdiction clause:

  • was drawn in “very wide terms” and applied to future disputes; and
  • took precedence over the settlement agreement which expressly preserved the rights of the parties under the ISDA Master jurisdiction clause.

In the present case, the court considered the terms of the relevant declarations sought by Dexia, finding that they each related to the validity and enforceability of either the ISDA Master Agreement or the Swaps.

The court also rejected Brescia’s alternative arguments that: (1) England was not the proper forum, given the irrevocable waiver of any objection on the ground of forum non conveniens set out in the ISDA Master Agreement jurisdiction clause; and (2) service of the claim form had not been properly effected, on the basis that service had been effected in accordance with the notice provisions in the ISDA Master Agreement (which was in accordance with CPR rule 6.11, which requires service to be effected by an agreed contractual method where the claim relates to the contract in question).

As a result, the court dismissed Brescia’s application.

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High Court finds that bank’s notice of event of default under section 5(a)(i) of the 2002 ISDA Master Agreement is valid

The High Court has summarily determined that a bank’s default notice of an event of default to an energy company, for failure to pay monies due under a foreign exchange (FX) swap, was valid under the terms of the 2002 ISDA Master Agreement governing the transaction: Macquarie Bank Limited v Phelan Energy Group Limited [2022] EWHC 2616 (Comm).

The decision will be of interest to financial institutions trading in derivatives based on standard form ISDA documentation. It provides guidance on what constitutes a valid notice of an event of default by a non-defaulting party under section 5(a)(i) of the 2002 ISDA Master Agreement. The decision is also a reassuring one for financial institutions as it highlights that where there is a dispute over the terms of a transaction, such as the amount or currency of a swap, this does not necessarily mean that the default notice is automatically invalid, as long as it complies with the contractual provision in the transaction documentation requiring the notice.

In the present case, the court was satisfied that it was not necessary for the amount stated in the bank’s default notice to be correct for it to be valid. The court emphasised that it was clear that the default notice served by the bank met the requirements of section 5(a)(i) of the 2002 Master Agreement. It would have been immediately and unambiguously clear to the company that: (i) the bank was complaining of a failure to make the payment due to it under the FX swap; (ii) the company had made no payment under the FX swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.

We consider the decision in more detail below.

Background

On 14 May 2021, a bank (Bank) and an energy company (Company), entered into a USD / ZAR FX swap with payment being due by the Company on 28 May 2021 (the FX Swap). The FX Swap was governed by an ISDA 2002 Master Agreement agreed between the Bank and Company in 2019 (the Master Agreement). On 28 May 2021, the Bank emailed the Company stating that it had not yet received the amount due. The Bank used the strike price of ZAR 22.16 to estimate the amount due in its email. The Company disputed that the amount included in the Bank’s email was due or was correct. On 31 May 2021, the Bank served a default notice on the Company requiring it to make a payment of the amount it had estimated (the Default Notice). The Default Notice stated that a failure to make the payment in the time period set out would amount to an event of default under section 5(a)(i) of the Master Agreement. The Company again disputed that the amount was due or correct.

On 3 June 2021, the Bank sent a letter designating 4 June 2021 as the early termination date pursuant to section 6(a) of the Master Agreement (the Early Termination Date Notice). The Company contended that it was not open to the Bank to designate an early termination date as the Company had disputed the Default Notice. Subsequently, on 9 June 2021, the Bank sent the Company a notice of the early termination amount (again determined based on the strike price of ZAR 22.16) (the Early Termination Amount Notice).

The Bank brought a debt claim against the Company. The Bank’s case was that the Company was required under the FX Swap to make certain payments on the settlement dates prescribed in the FX Swap. The Company’s failure to make the payment due in May 2021 constituted an event of default under the Master Agreement. This was a continuing event of default which triggered the early termination provisions under the Master Agreement. The Bank had followed the applicable provisions for early termination, pursuant to which the Company became liable to pay the early termination amount due. The Company denied the claim. The Company contended that it was not liable to pay the sums due given that it disputed the terms of the FX Swap, in particular the strike price for the trade.

The Bank subsequently brought an application for summary judgment on the termination issue, pending the resolution of the issue as to what was the correct strike-out price.

Decision

The High Court found in favour of the Bank on the termination issue.

The court held that it was clear that the Default Notice served by the Bank met the requirements of section 5(a)(i) of the Master Agreement. It would have been immediately and unambiguously clear to the Company that: (i) the Bank was complaining of a failure to make the payment due to it under the FX Swap; (ii) the Company had made no payment under the FX Swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.

The key issues which may be of broader interest to financial institutions are examined below.

1. Was there an Event of Default within section 5(a)(i) of the Master Agreement?

Key terms of the Master Agreement

The court noted that for an event of default to occur under section 5(a)(i) of the Master Agreement, there must be a failure by a party to make payment, which has not been remedied in the grace period after notice of the failure has been given.

Construction of the Master Agreement

The court highlighted that it had regard to the following legal principles when interpreting the Master Agreement:

  • the Master Agreement should as far as possible be interpreted in a way that serves the objectives of clarity, certainty and predictability so that the very large number of parties using it should know where they stand (as per Lomas v JFB Firth Rixson Inc [2010] EWHC 3372).
  • the focus is ultimately on the words used, which should be taken to have been selected after considerable thought and with the benefit of the input and continuing review of users of the standard forms and of the knowledge of the market (as per Lehman Brothers International (Europe) [2016] EWHC 2417 (Ch)).

Requirements for a valid notice under sections 5(a)(i) and 5(a)(ii) of the Master Agreement

The court emphasised that the issue of whether the notice under section 5(a)(i) needed to specify the outstanding amount of payment at all, and what the consequence of including an incorrect figure would be, was ultimately a matter of construction of two documents:

The court also noted that the grace period which service of a valid notice triggers is a relevant consideration when determining what is necessary for a notice to be effective. As per Deutsche Bank AG v Sebastian Holdings Inc [2013] EWHC 3463 (Comm) and Greenclose Ltd v National Westminster Bank plc [2014] EWHC 1156 (Ch), the whole point of section 5 (a)(ii) and section 2(a)(iii) is to provide an opportunity to remedy the failure which gave rise to the event of default or potential event of default.

The court then underlined that a valid notice under section 5(a)(i) must be such as to:

  • communicate clearly, readily, and unambiguously to the reasonable recipient in the context in which it is received the failure to pay or deliver in question, such that the recipient will clearly understand the trade under which the obligation to pay or deliver has arisen and the particular obligation which it is said has not been performed; and
  • thereby enable the recipient to identify what the relevant trade requires it to do in order to cure the alleged failure within the applicable grace period.

The court rejected the Company’s contention that a valid notice required the notice to set out: (i) identification of the confirmation for the relevant transaction, (ii) a precise and accurate statement of the amount due, and (iii) the currency of the payment. In the court’s opinion, this would result in a number of improbable consequences such as very minor mistakes (e.g., in relation to the reference number of the relevant trade or other typing errors) invalidating the notice. The court did not agree that the language or nature of the Master Agreement required such an interpretation.

The court also highlighted that, as per Mannai, the issue of whether the required information had been communicated unambiguously does not solely rely on the language used, and that there can be an unambiguous communication of information even if the communication involves a mistake. This is because the context in which the notice is received will also be relevant to what information the notice communicates to the recipient.

Did the disputed Default Notice meet the requirements of section 5(a)(i)?

The court considered the context in which a reasonable person would have received and read the Default Notice. In the circumstances of the present case, the court highlighted, amongst others, the following factors:

  1. the Default Notice referred to the Company’s failure to make a payment on 28 May 2021 in respect of the FX Swap.
  2. the 28 May 2021 settlement date and the Master Agreement were expressly referred to in the Default Notice.
  3. the transaction reference included in the Default Notice was the same as that included on the confirmation sent by the Bank regarding a trade done on 14 May 2021 for settlement on 28 May 2021.

The court concluded that the Default Notice was valid because it would have been immediately and unambiguously clear to the Company on reading the Default Notice that: (i) the Bank was complaining that the Company had failed to make payment due by the 28 May 2021 settlement date under the FX Swap; (ii) the Company had indeed made no payment under the FX Swap; and (iii) on the face of the documents, it was obliged to pay a certain sum to cure the default to remedy that failure.

2. Was the Early Termination Date Notice valid?

The court said that given it had concluded that the Default Notice was valid (and consequently that there was an event of default as the failure to pay was not remedied in the grace period after the Default Notice was served), the Company’s argument that the Early Termination Date Notice was invalid because there was no event of default failed.

The court then confirmed that the FX Swap had been terminated and that the termination date was 4 June 2021.

Accordingly, the court found in favour of the Bank on the termination issue.

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High Court confirms interest rate swaps entered into with Italian municipal authority were valid, lawful and binding on the parties

The High Court has allowed a summary judgment application by an Italian bank seeking declarations to the effect that certain interest rate swaps entered into with an Italian municipal authority were valid, lawful and binding on the parties: Dexia Crediop SPA v Provincia Di Pesaro E Urbino [2022] EWHC 2410 (Comm).

This is an interesting decision for financial institutions trading in derivatives based on standard form ISDA documentation, particularly given the summary determination. It is the latest in a line of authorities relating to interest rate swap transactions entered into by foreign municipal authorities, in which parties have sought to unwind or set aside the transactions on the basis that they were invalid under certain foreign laws alleged to be applicable to the transactions. The English court has, once again, taken a robust approach to granting declaratory relief and the decision is likely to be welcomed as further evidence of the English court’s emphasis on construing commercial contracts, and in particular standard form ISDA documentation, in order to achieve market certainty and predictability.

In the present case, the court was satisfied that the transactions were governed by English law notwithstanding Article 3(3) of the Rome Convention, which 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. Further, the court held that there was no real prospect of the municipal authority successfully contending that the transactions did not comply with certain Italian laws on the basis that they: (i) were a form of indebtedness; (ii) had not been authorised by the relevant provincial authority; or (iii) did not meet the economic convenience (i.e. they were not “economically advantageous”) requirement.

We consider the decision in more detail below.

Background

In 2003 and 2004, the claimant Italian bank (Bank) entered into two interest rate swap transactions with an Italian municipal authority (Authority). Each of the transactions was subject to a 1992 ISDA Master Agreement, Multi-Currency-Cross Border (the Master Agreement) and associated schedule (Schedule) (together, with the 2003 and 2004 swaps, the Transaction Documents).

In June 2021, the Authority commenced proceedings in Italy seeking to unwind or set aside the transactions (the Transactions), following the Banca Nazionale Del Lavoro SpA v Municipality of Cattolica decision of the Italian Supreme Court, which declared an Italian law governed swap between a bank and local authority invalid. The Bank, in response, commenced proceedings in England seeking a number of declarations to the effect that the Transactions were valid, lawful and binding. The Authority acknowledged service of the English proceedings but subsequently took no active part in the English proceedings.

The Bank applied for summary judgment on its claims for declaratory relief.

Decision

The High Court found in favour of the Bank and allowed the summary judgment application. The key issues which may be of broader interest to financial institutions are examined below.

Governing law of the Transactions

The court held that the Transaction Documents were plainly governed by English law in accordance with Article 3(1) of the EEC Convention on the Law Applicable to Contractual Obligations (the Rome Convention).

In the court’s view, the issue of identifying the applicable law was a matter for the Rome Convention, which was incorporated into UK law by the Contracts (Applicable Law) Act 1990.

The court noted that Article 3 of the Rome Convention provides:

“(1) A contract shall be governed by the law chosen by the parties. The choice must be expressed or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or a part only of the contract.

(2) The parties may at any time agree to subject the contract to a law other than that which previously governed it, whether as a result of an earlier choice under this Article or of other provisions of this Convention. Any variation by the parties of the law to be applied made after the conclusion of the contract shall not prejudice its formal validity under Article 9 or adversely affect the rights of third parties.

(3) 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 at the country which cannot be derogated from by contract, hereinafter called ‘mandatory rules’.”

On the facts, the court said the Master Agreement and Schedule expressly and without any qualification provided that the Master Agreement was to be governed and construed in accordance with English law. Also, the factors relied by the Authority, such as references to certain provisions of Italian law in the Authority’s proposals, were not sufficient to displace the express choice of English law as they were either: (i) not concerned with the terms and performance of the Transaction Documents themselves, but with the circumstances leading up to the conclusion of the relevant contractual arrangements; or (ii) not located in the Transaction Documents at all. Further, even if these references could be said to be concerned with the terms and performance of the Transaction Documents they were not sufficient either to demonstrate with reasonable certainty that Italian law was being chosen as the governing law and they were not sufficient to lead to the conclusion that the parties had overridden their stated choice of English law either expressly or in any other way demonstrable with reasonable certainty.

In addition, if the parties’ intention had been to choose Italian law in the Transactions as the new governing law to replace the choice of English law in the Master Agreement and Schedule, in accordance with Article 3(2) of the Rome Convention, the parties would have used language which was far more explicit to that end, for example by stating that the choice of law in the Master Agreement and Schedule was replaced by the choice of Italian law in the 2004 transaction. However, there was no such provision nor indeed a provision that came arguably close to such a provision. The court underlined that the Master Agreement contemplated – and the Transactions both provided – that the Transactions were entered into under/and or in accordance with the terms of the Master Agreement and Schedule. There was no suggestion of the Transactions being subject to a governing law other than English law.

The court also highlighted that, as per Dexia Crediop SpA v Comune di Prato [2017] EWCA Civ 428, given the nature of the Transaction Documents being based on the ISDA Master Agreement, there was no scope for allowing any mandatory rules of Italian law – should there be such laws – to displace under Article 3(3), the express choice of English law made by the parties in the Master Agreement and Schedule,

Compliance with Italian law

The court held that there was no real prospect of the Authority successfully contending that the Transactions did not comply with certain Italian laws.

Form of indebtedness

For the purpose of the summary judgment application, the court assumed that the Italian Supreme Court’s decision in Cattolica represented the correct position under Italian law. In Cattolica, the Italian Supreme Court held that, although derivative contracts in general do not constitute indebtedness, certain types of derivatives may have the effect of creating indebtedness if they: (i) provide for an upfront payment; (ii) extinguish pre-existing underlying loans; or (iii) significantly modify existing loans.

However, in the court’s view, there was no evidence that the Transactions had any factors which would have rendered them as forms of indebtedness as identified in Cattolica. There was therefore no real prospect of the Transactions being treated as void on this ground.

Authorisation by a provincial council

The court noted, as per Cattolica, that certain interest rate swaps required authorisation by a provincial council under certain Italian legislation if their characteristics were such as to constitute indebtedness.

However, in the court’s opinion, the Transactions were not of the type which required the approval of the provincial council and even if they were, such approval had been obtained by certain resolutions. There was therefore no real prospect of the Transactions being treated as contravening certain Italian legislation.

Economic advantage

The court firmly rejected the Authority’s suggestion that the Transactions did not comply with certain Italian legislation in that they did not meet the economic convenience requirement (i.e. they were not “economically advantageous”) due to the fact that the Transactions included certain “implicit costs” to the Authority.

The court agreed with the Bank that the Transactions did not constitute a refinancing or restructuring of any existing indebtedness, and were therefore not subject to the economic convenience test under certain Italian legislation.

Validity of the Transactions

The court held that the appropriate approvals had been provided. The Authority did not lack capacity and there was no issue undermining the material validity of the Transactions under English law.

The court noted that if this were a matter of English law, being the governing law of the Transactions in accordance with Article 3(1) of the Rome Convention, there was no identified reason why the Transactions or the Transaction Documents should be regarded as invalid.

Accordingly, for all the reasons above, the court found in favour of the Bank and allowed the summary judgment application.

John Corrie
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High Court finds no continuing event of default under ISDA Master Agreements once administration of counterparty terminates

The High Court has allowed an application for directions made by the administrators of an investment bank concerning the construction and effect of various standard form events of default provisions which were included in the 1992 and 2002 versions of the ISDA Master Agreements (multi-currency cross border versions) in relation to certain swaps entered into between the bank and a group of companies: Grant & Ors v FR Acquisitions Corporation (Europe) Ltd & Anor (Re Lehman Brothers International (Europe)) [2022] EWHC 2532 (Ch).

This decision will be of interest to financial institutions trading in derivatives based on standard form ISDA documentation. It appears to be the first case where the court has been involved in a contextual interpretation as to whether there was a continuing event of default under section 2(a)(iii) of the 1992 and 2002 ISDA Master Agreements. The decision is likely to be reassuring for financial institutions as it highlights the court’s willingness to uphold contractual obligations to make payments due under swap agreements where there is no longer any continuing event of default which suspends such contractual obligations, such as the termination of an administration.

In the present case, the court was satisfied that under section 2(a)(iii) the test to be adopted is whether the identified event or state of affairs which constituted the event of default is continuing, rather than whether creditors’ rights have been significantly and permanently altered or continue to be affected. In the court’s view, none of the events of defaults or alleged events of defaults relied on by the group companies were such that it had a substantive adverse effect on them or their rights in relation to the swaps. Further, their credit risk was not increased or adversely affected by any of them, nor would it be.

We consider the decision in more detail below.

Background

In 2007, the claimant group companies entered into two interest rate swap transactions (the Swaps) with an investment bank (the Bank). These Swaps were governed respectively by the 1992 and 2002 ISDA Master Agreements.

In 2008, the Bank entered into administration. The claimants opted against the early termination of the Swaps. The claimants instead relied on section 2(a)(iii) of the ISDA Master Agreements to suspend their payment obligations under the Swaps to the Bank. Section 2(a)(iii) provided that any payment obligations arising under the Swaps were subject to the condition precedent that: “no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing”. There was no dispute that the making of the administration order triggered that suspensory condition.

By 2018, the administration of the Bank was highly successful. Substantial assets remained available in the estate. The administrators’ intention was to bring the Bank’s administration to an end by terminating their appointments and returning the Bank to the control of its directors.

In 2020, the administrators applied to the High Court for directions concerning the construction and effect of various standard form events of default provisions which were included in the 1992 and 2002 versions of the ISDA Master Agreements (multi-currency cross border versions) in relation to the Swaps. The administrators contended that no event of default or potential event of default would be continuing once their appointment terminated and the Bank was placed under the control of its directors. Therefore the suspensory condition provided for by section 2(a)(iii) of the ISDA Master Agreements would fall away and the claimants would become liable to make payment to the Bank of certain sums due under the Swaps.

Decision

The High Court found in favour of the administrators and allowed the application.

The High Court held that if and when all the relevant steps had been taken, no event of default would be continuing under section 2(a)(iii) of the ISDA Master Agreements and the claimants would have a contractual obligation to pay the sums owing to the Bank under the Swaps.

The key issues which may be of broader interest to financial institutions are examined below.

Interpretation

The court noted that, as per Lehman Brothers Finance SA v SAL Oppenheim JR & CIE. KGAA [2014] EWHC 2627, the ISDA Master Agreement is intended to be normative, and to apply in as many situations and with as much straightforward application as possible.

The court said this affected its approach to interpretation. Rather than, as per Wood v Capita Insurance Services Ltd [2017] UKSC 24, ascertaining the objective meaning of the language which the parties have chosen to express their agreement and following the iterative process which each suggested interpretation was checked against the provisions of the contract and its commercial consequences investigated, the court underlined that in the context of a standard form developed by reference to, and to meet the needs of disparate users in a great variety of circumstances, the process must be, in seeking to achieve that objective, ascribe even more than usual deference to the words used, and take as the context not the specific position as between the parties, but its anticipated use by such a variety of intended users in such a variety of circumstances.

Commercial purpose of section 2(a)(iii) of the ISDA Master Agreements

The court highlighted that, as per Pioneer Freight Futures Co Ltd v TMT Asia Ltd [2011] EWHC 778 (Comm) and Lomas v Firth Rixson Inc [2012] 1 CLC 713, the commercial function or purpose of the condition precedent to payment as set out in Section 2(a)(iii) is to mitigate counterparty credit risk during the currency of what may be numerous swap transactions under the umbrella of the 1992 ISDA Master Agreement and while they remain open. It ensures that a non-defaulting party does not have to pay a defaulting party, who may be of doubtful solvency, in circumstances where, under ongoing open swap transactions, a defaulting party may subsequently owe sums to the non-defaulting party. In other words, it prevents any increase in credit risk that might occur if actual payments were made. Its effect is to substitute an accounting procedure whereby debits and credits build up or accrue in an account between the parties, but suspending the obligation of the non-defaulting party to pay any amounts which it may for the time being owe.

Continuing event of default

The court noted that the circumstances in which events of default are continuing, or should be treated as continuing, were not expressly defined or addressed by the ISDA Master Agreements.

The court then highlighted that an admission in writing of a party’s inability generally to pay its debts as they become due is not in the nature of a one-off event: the notice speaks to a continuing ability in that regard unless and until it is corrected. However, the court said that the administrator’s reports and surrounding publicity in the case of the Bank’s administrations, have almost certainly been sufficient to ensure that no creditor would any longer have any regard to the original notice. In the court’s view, the administrators would be justified in publishing or causing the Bank to publish a notice to the effect that the Bank had a surplus of assets over liabilities and now is able to pay its debts as they fall due.

The court also agreed with administrators that in section 2(a)(iii) the test to be adopted is whether the identified event or state of affairs which constituted the event of default is continuing, rather than whether creditors’ rights have been significantly and permanently altered or continue to be affected by the administration. The focus was on the state of coming to be and continuing to be in administration and that state of affairs would no longer be continuing when the administration terminated, whether or not the administration at some earlier point became a distributing administration.

In the court’s view, none of the events of defaults or alleged events of defaults relied on by the claimants were such that it had a substantive adverse effect on them or their rights in relation to the Swaps. Further, their credit risk was not increased or adversely affected by any of them, nor would it be. The claimants were not exposed to any risk of the Bank failing to perform its obligations: the Bank had no such obligations to the claimants.

Accordingly, for all the reasons above, the court found in favour of the administrators and allowed the application.

Andrew Cooke
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High Court confirms no abuse of process or exceptional grounds for partially striking out/staying parallel English proceedings brought by a Bank in relation to a swap claim

The High Court has dismissed an Italian municipal authority’s application to strike out certain parts of the claimant banks’ particulars of claims and/or for a stay (in relation to a declaratory relief claim in connection with two interest rate swap transactions): Banca Intesa Sanpaolo SPA and Dexia Credip SPA v Commune Di Venezia [2020] EWHC 3150 (Comm).

This decision is a noteworthy and reassuring one for financial institutions which may be considering whether to pursue English proceedings, especially where there are existing parallel foreign proceedings in relation to a particular subject matter, or which may be at risk of an application for a stay if parallel foreign proceedings are filed after English proceedings have commenced. The decision highlights the grounds on which the court will decline to strike out part of a claim (insofar as they refer to foreign proceedings or finance documentation which is not directly related to the transaction at the centre of the dispute) or stay proceedings where there are related proceedings in another jurisdiction.

The court found that the definition of a new claim (which would be liable to be struck out) is a new cause of action which changes the essential features of the factual basis of the claim. Interestingly, the court found that references to documentation not directly related to the interest rate swaps at the centre of the dispute in the English proceedings (and which were central to the dispute in Italian proceedings) did not constitute a new claim for the purpose of the English proceedings. Further, the court did not consider that the existence of the Italian proceedings changed the essential features of the factual basis of the English claim. The fact that the relief sought in the English claim form and particulars of claim was the same was significant.

The court also found that exceptionally strong grounds are needed for a stay on case management grounds where the English courts have been granted exclusive jurisdiction. The court confirmed that the risk of parallel proceedings and inconsistent judgments is not sufficient to warrant a stay.

Background

In mid-2007, the defendant Italian municipality authority of Venice engaged the claimant banks (Banks) to restructure €156 million worth of bonds and associated interest rate swaps it had entered into five years earlier with another bank. The parties entered into a Mandate Agreement and Investment Services Agreement (ISA), which were both governed by Italian law and conferred exclusive jurisdiction on the Italian courts. In December 2007, the defendant entered into interest rate swaps (Swaps) with the Banks and signed a suite of associated Swap documentation, including ISDA Master Agreements and schedules which contained an English choice of law and conferred exclusive jurisdiction on the English courts.

In June 2019, the defendant commenced proceedings against the Banks in Italy. The defendant claimed the Banks had failed to comply with the advisory obligations it owed to the defendant under the Mandate, the ISA and certain Italian legislation. Alternatively, the defendant claimed that the Banks’ breaches of duty caused it to enter into the Swap documentation. Two months later, the Banks commenced proceedings in England seeking various declarations in relation to the Swaps. The declarations sought included that the Banks had complied with and/or discharged their obligations arising out of or in connection with the Swaps and were not liable for any claims arising in relation to them (and that such claims were time-barred under the Limitation Act 1980). The Banks also filed applications in Italy challenging the jurisdiction of the Italian courts.

The defendant then applied, in the English proceedings, to strike out parts of the particulars of claim as an abuse of process and/or for a stay until the Italian proceedings had determined the jurisdiction challenge. The disputed paragraphs pleaded details of the Italian proceedings, including the defendant’s allegations that the Banks had failed to comply with their obligations under the Mandate Agreement by advising the defendant to enter into the Swaps.

Decision

The court rejected the defendant’s application to strike out parts of the particulars of claim and for a stay.

Application to strike out

The defendant argued that the disputed paragraphs of the particulars of claim were an abuse of process as they introduced a claim which had not been included in the claim form. The defendant also argued that the claim form was framed solely by reference to the Swap documentation, not the Mandate Agreement or ISA, which were already subject to separate Italian proceedings. In the defendant’s view, the particulars of claim expanded the claim to include matters which were already the subject of the Italian proceedings.

The court accepted that pleadings may be struck out if they raise a new cause of action which is not within the ambit of the claim form. However, in the present case, the court held that the disputed paragraphs did not plead a cause of action distinct from the causes of action in the claim form. In reaching this finding, the court noted it was significant that the relief sought in the particulars of claim was the same as in the claim form. The court also said the disputed paragraphs did not introduce a change to the “essential features of the factual basis of the claim made” (as per the definition of a new cause of action set out in Jalla v Royal Dutch Shell PLC [2020] EWHC 459 (TCC)). The claim in the claim form was based on the terms and effect of the Swap documentation, and those documents referred to the consulting services provided by the Banks prior to entry into the Swaps. Therefore, reference to the Mandate Agreement and ISA in the particulars of claim did not change the essential features or factual basis of the claim, which was based on the terms of the Swaps. The court also considered that reference to the Italian proceedings did not change the essential features of the factual basis of the claim. The existence of the Italian proceedings may have indicated why the declarations were being sought, but did not amount to a factual situation giving rise to an entitlement to a different relief to that being sought in the claim form.

Application for a stay

In seeking a stay on case management grounds until the jurisdictional challenge in the Italian proceedings had been determined, the defendant argued that if the strike out application was not granted, there was a real risk of parallel proceedings and of inconsistent decisions if the Italian proceedings went ahead. If, on the other hand, the Banks’ jurisdictional challenge succeeded in Italy, then England would be the only forum for the defendant to pursue its claims under the Mandate Agreement and ISA. In the view of the defendant, it was in the interests of justice to stay the English proceedings.

The court held in line with previous authority that exceptionally strong grounds are required to grant a stay on case management grounds, especially where the English courts have exclusive jurisdiction, and that there were no such grounds in this case. It noted that in a case where the English court has jurisdiction, especially exclusive jurisdiction, the danger of inconsistent judgments is not a legitimate consideration amounting to exceptional circumstances (as per MAD Atelier International BV v Manes [2020] EWHC 1014 (Comm)).

In this case, the presence of the exclusive jurisdiction clause in the Swap documentation weighed against a stay. Further, a stay would not be consistent with Articles 29 and 30 of the Recast Brussels Regulation (1215/2012), as the English and Italian claims were separate and distinct, and the Banks’ claim could not be heard in Italy due to the exclusive jurisdiction clauses in the Swap documentation. Lastly, the jurisdiction of the English courts was established, whilst the jurisdiction of the Italian courts was being challenged. A stay in such circumstances would rarely be justified on case management grounds. A stay would only delay the English proceedings and would not be conducive to dealing with them expeditiously.

Simon Clarke
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Leaving LIBOR – the ISDA Protocol and Supplement

With LIBOR due to disappear by end-2021, work has been underway to facilitate the transition from LIBOR and other IBORs to alternative risk free rates (RFRs). The derivatives market has been at the forefront of the transition and is some distance further ahead than other financial markets. In particular, ISDA has recently published the 2020 IBOR Fallbacks Protocol and IBOR Fallbacks Supplement, which introduce hardwired fallbacks from IBORs to relevant RFRs for new products and legacy products.

Publication of these documents is a key milestone in the transition journey from IBORs to RFRs, and amounts to the starting gun being fired on what is expected to be a mass market wide repapering and amendment exercise as the market says goodbye to the old world of IBORs and welcomes the new world of RFRs. We expect clients will wish to enter into the IBOR Fallbacks Protocol to amend existing transactions, and to include the IBOR Fallbacks Supplement in new trades. In agreeing to do so, hardwired fallbacks from LIBOR to RFRs will be included in the transactions, which will clearly have a significant impact on those transactions and beyond. Clients are therefore well advised to give careful thought to the issues raised by these documents.

Our briefing (which can be found here) provides a detailed analysis of the two publications, including the issues they raise and how adherence to these documents will affect clients’ existing and future transactions.

Nick May
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Harry Edwards
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Rupert Lewis
Rupert Lewis
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Ceri Morgan
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Commercial Court grants declaratory relief to bank relating to its rights under the 1992 ISDA Master Agreement

The Commercial Court has granted declaratory relief concerning a bank’s rights under an interest rate hedging arrangement governed by the 1992 ISDA Master Agreement: BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2020] EWHC 2436 (Comm).

This is the substantive English trial judgment in the long-running (and cross-jurisdictional) dispute between BNP Paribas S.A. (the Bank) and the Italian public-private partnership, Trattamento Rifiuti Metropolitani S.p.A. (TRM). The dispute relates to a 2008 loan provided by a syndicate of banks (led by the claimant Bank) to TRM, and the associated hedging arrangements, which TRM says the Bank negligently advised it to enter into.

The decision will be welcomed by market participants for providing an abundance of detailed and helpful commentary on key provisions of the ISDA Master Agreement, and more broadly by financial institutions for its analysis of non-reliance clauses, together with guidance for parties seeking declaratory relief. The key takeaways are as follows:

1. Non-reliance clauses in a financial services context

One of the declarations considered by the court tracked the Non-Reliance provisions at Part 5(d)(i) of the Schedule to the ISDA Master Agreement, and asked for a declaration that TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction. A further declaration sought provided that these provisions gave rise to a contractual estoppel, so that TRM was estopped by the ISDA Master Agreement from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule, but the question of contractual estoppel gave rise to more detailed analysis. Following Springwell Navigation Corpn v JP Morgan Chase Bank [2010] EWCA Civ 1221, the court confirmed that there is no distinction between: (a) warranties and undertakings (each of which TRM accepted could give rise to an estoppel); and (b) an acknowledgement or a representation (each of which TRM argued could not). The court referred to Leggatt LJ’s commentary suggesting otherwise in First Tower Trustees and another v CDS (Superstores International) Ltd [2018] EWCA Civ 1396, noting that this was obiter. The court also noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). The court specifically noted that Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also rejected TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA). This can be contrasted again with the decision in First Tower (which, interestingly, was not cited in the judgment on this point), as considered in our blog post: Court of Appeal finds non-reliance clause sought to exclude liability for misrepresentation and was therefore subject to UCTA reasonableness test.

Although the court considered these arguments in the context of the 1992 ISDA Master Agreement, its findings would also be relevant for a bank relying on the non-reliance language in the 2002 ISDA Master Agreement.

2. Entire Agreement clause in the ISDA Master Agreement

The court rejected TRM’s argument that the standard ISDA entire agreement clause was not effective and that TRM was able to rely on separately negotiated terms of the Financing Agreement as prevailing over the ISDA terms. The court said that the meaning of the entire agreement clause in the ISDA Master Agreement is “clear and unambiguous” on its face, and that TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in the authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (see for example Lomas v Firth Rixson [2010] EWHC 3372).

3. Guidance for applications for negative declaratory relief

The court provided helpful guidance on the correct approach to applications for negative declaratory relief, which are common in these types of cross-border disputes. As set out in more detail below, the court found that the Bank in this case met the threshold requirements for such relief. In particular, the court noted that in such applications, the touchstone will be whether there is any utility in the claimant obtaining the negative declarations sought. It also noted a number of specific limitations on the grant of declaratory relief, including that the court should not entertain purely hypothetical questions and there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (which need not fall within the jurisdiction of the English court).

A more detailed analysis of these issues and further questions of more general application for financial services institutions, is set out below.

Background

In 2008, a syndicate of banks led by the claimant Bank, entered into a loan agreement (the Financing Agreement) with TRM, an Italian public-private partnership, to fund the building of an energy plant. The Financing Agreement was governed by Italian law and contained a jurisdiction clause in favour of the Italian court.

The Financing Agreement included an obligation for TRM to enter into an interest rate swap with the Bank to hedge the interest rate risks associated with the loan. In 2010, pursuant to that obligation, the parties executed a swap pursuant to a 1992 ISDA Master Agreement (the ISDA Master Agreement). The ISDA Master Agreement contained an exclusive jurisdiction clause in favour of the English court.

In correspondence in July 2016, TRM alleged that the Bank negligently advised TRM to enter into the hedging transactions, which (among other things) TRM said were mismatched with its real hedging requirements, generated a significant negative cash flow, and had a negative mark-to-market value.

In September 2016, the Bank issued proceedings in the English Commercial Court against TRM seeking declarations of non-liability in relation to the hedging transaction, in most cases tracking the wording of the ISDA Master Agreement. In April 2017, TRM sued the Bank before the Italian court and then issued an application in the Commercial Court to challenge its jurisdiction.

Jurisdictional challenge

The Commercial Court found that the proceedings for declaratory relief brought before the English court were governed by the jurisdiction clause in the ISDA Master Agreement, finding that this clause was not displaced or restricted by the apparently competing Italian jurisdiction clause in the Financing Agreement (see the first instance decision). This was despite a provision in the Schedule to the Master Agreement that, in the case of conflict between the terms of the ISDA Master Agreement and those of the Financing Agreement, the latter should “prevail as appropriate”. See our blog post for more detail: High Court holds ISDA jurisdiction clause trumps competing jurisdiction clause in separate but related agreement.

The Court of Appeal agreed (see the Court of Appeal decision), finding that there was no conflict between the jurisdiction clauses, which were found to govern different legal relationships and were therefore complementary, rather than conflicting (such that the conflicts provision was not in fact engaged). The Court of Appeal emphasised that factual overlap between potential claims under the ISDA Master Agreement and the related Financing Agreement did not alter the legal reality that claims under the two agreements related to separate legal relationships. See our blog post for more detail: Court of Appeal finds ISDA jurisdiction clause trumps competing clause in related contract.

Decision

The Bank succeeded on the majority of its claim for declaratory relief, with the court (Mrs Justice Cockerill DBE) granting a significant number of the declarations sought. This blog post provides a summary of the court’s analysis below, focusing on the key points for financial institutions seeking negative declaratory relief and the points of interest in relation to the ISDA Master Agreement.

Preliminary issue: correct approach to applications for negative declaratory relief

Before turning to the substantive issues in dispute, the court considered a preliminary point on the correct approach to applications for negative declaratory relief.

The court noted that its power to grant such relief lay in section 19 of the Senior Courts Act 1981, which appears to be unfettered, but said that the grant of a declaration remains a discretionary remedy (see Zamir & Woolf, The Declaratory Judgment, Fourth Edition at 4-01). While the court acknowledged the authorities indicating that a court should be cautious when asked to grant negative declaratory relief, it was not persuaded by TRM that there should be a reluctance in cases involving foreign proceedings. The court confirmed the following general principles to be applied when considering negative declarations:

  1. The touchstone is whether there is any utility in the claimant obtaining the negative declarations sought.
  2. Negative declarations should be scrutinised by the court and rejected where they would serve no useful purpose.
  3. The prime purpose is to do justice in the particular case, which includes justice to both the claimant and defendant.
  4. The court must consider whether the grant of declaratory relief is the most effective way of resolving the issues raised and consider the alternatives (as per Rolls Royce v Unite the Union [2010] 1 WLR 318).
  5. Limitations on the court include: (i) it should not entertain purely hypothetical questions (see Regina (Al Rawi) v Sec State Foreign & Commonwealth Affairs [2008] QB 289); (ii) there must be a real and present dispute between the parties as to the existence or extent of a legal right between them (see Rolls Royce); and (iii) if the issue in dispute is not based on concrete facts the issue can still be treated as hypothetical. This can be characterised as “the missing element which makes a case hypothetical”.
  6. Factors such as absence of positive evidence of utility and absence of concrete facts to ground the declarations may not be determinative. However, where there is such a lack (in whole or in part) the court should be particularly alert to the dangers of producing something which is not useful and may create confusion.

The court confirmed that it would apply these general principles when considering each of the declarations sought.

Application of general principles for negative declaratory relief

TRM made the overarching submission that the general principles applicable to negative declaratory relief (as outlined above), precluded such relief from being granted in this case. The court found that the application met the threshold requirements for declaratory relief, considering the following two key principles, in particular:

No hypothetical questions / real and present dispute between the parties

TRM argued that the “dispute” on which the Bank relied to bring the claim for negative declarations did not arise in the English court, pointing out that no claims had been brought or intimated by TRM in this jurisdiction, and that the Bank was not able to identify what claims TRM might bring before the English court. Accordingly, it said the “dispute” was purely hypothetical.

The court was not persuaded that it would be appropriate to shut the Bank out from the possibility of declarations based on this ground. In particular, it noted the Bank’s intention to use the declarations sought by way of defence to the Italian claim. Although TRM had brought no claim under the ISDA Master Agreement in the Italian proceedings, the court considered that there was plainly scope for overlap. Moreover, the Bank had specifically pleaded the contractual rights under the ISDA Master Agreement as defences to the Italian claim.

In the court’s view, this was a case that was comfortably on the right side of the hypothetical/actual divide, noting as follows:

“The bottom line is that regardless of where the parts of the debate take place, there is a dispute between the parties as to whether the picture as to TRM’s rights is one which is framed within the [ISDA Master Agreement], or whether, despite the existence of the [ISDA Master Agreement], those rights are different. That is a dispute as to the existence of the rights which the Bank asserts, which is an actual existing dispute. That dispute is not divorced from the facts or based on hypothetical facts. It is plainly not one which has ceased to be of practical significance.”

Utility in obtaining the declarations sought

The court found that at least some of the declarations met the utility threshold requirement. In particular, the court noted that a judgment in England as to the meaning and legal effect as a matter of English law of specific clauses within the ISDA Master Agreement would be enforceable against TRM in Italy under the Brussels Regulation. Given that the ISDA Master Agreement was governed by English law, to the extent the Italian court had to grapple with what the agreement meant, the English court was best placed to decide and the Italian court was likely to be assisted by that determination.

Contractual construction of the ISDA entire agreement clause

Before considering the individual negative declarations sought by the Bank, the court ruled on a question of contractual interpretation of the standard entire agreement clause found in the ISDA Master Agreement.

TRM argued that the Entire Agreement clause was not effective and that it was able to rely on separately negotiated terms of the Financing Agreement prevailing over ISDA Master Agreement (relying on the comments of Lord Millett in The Starsin [2004] 1 AC 715).

The court rejected TRM’s approach, making the following observations, in particular:

  • On its face, the meaning of the ISDA entire agreement clause is “clear and unambiguous”. This was reflected by the decision in Deutsche Bank v Commune di Savona [2018] EWCA Civ 1740 (see our blog post), which said that the ISDA Master Agreement is a “self-contained” agreement, exclusive of prior dealings.
  • The court was not persuaded that TRM’s approach successfully undermined this simple reading of the clause, in particular because it did not identify the specific provisions in the ISDA Master Agreement which were allegedly offensive and which provisions of the Financing Agreement overrode them.
  • While TRM was a party to both the ISDA Master Agreement and to the Financing Agreement, the Bank was a party to the latter as Mandated Lead Arranger (and other roles), not in its capacity as the “Hedging Bank” (even though the Bank was separately defined in the Financing Agreement as fulfilling this role). The court said it would be something of an oddity if the terms of a separate agreement in which the Bank participated with a different hat on, could impact the ISDA Master Agreement.
  • The hedging transaction was entered into “in connection with” the Financing Agreement, highlighting the fact that there were two distinct, albeit connected, agreements.
  • TRM’s approach would sit uneasily with, while the Bank’s argument was harmonious with, the dicta in various authorities as to the importance of certainty and clarity in interpreting the ISDA Master Agreement (most famously in Lomas v Firth Rixson).

Analysis of the individual negative declarations sought

The court then turned to consider the individual negative declarations, granting the majority of them, particularly where those declarations simply tracked the wording of the ISDA Master Agreement, Schedule or Confirmation.

Of the declarations considered by the court, there is one category which has particular significance for financial services contracts. This is the court’s analysis of the effect of the ISDA versions of “no representation” clauses and “non-reliance on representation” clauses, and the application of contractual estoppel to those clauses.

No representation / non-reliance on representation / contractual estoppel

The Bank sought a number of declarations which simply tracked the ISDA documentation:

  • That TRM had “made its own independent decision” to enter into the hedging transaction and was not relying on communications from the Bank as investment advice or as a recommendation to enter into the hedging transaction (the Non-Reliance provisions at Part 5(d)(i) of the Schedule).
  • That TRM was capable of evaluating and understanding the terms, risks etc. of the hedging transaction (Evaluations and Understanding at Part 5(d)(ii) of the Schedule).
  • That TRM was acting as principal and not as agent or in any other capacity, fiduciary or otherwise (Acting as Principal at Part 5(d)(iv) of the Schedule).
  • That TRM had specific competence and expertise to enter into the hedging transaction and in connection with financial instruments (Competence and Expertise at Part 5(e)(i) of the Schedule).
  • That TRM entered into the hedging transaction for hedging purposes and not for speculative purposes (Hedging Purposes at Part 5(e)(ii) of the Schedule).
  • That TRM had full capacity to undertake the obligations under the hedging transaction, the execution of which fell within its institutional functions (Capacity at Part 5(e)(iii) of the Schedule).

In addition, the Bank sought a further declaration that these clauses gave rise to a contractual estoppel, which prevented TRM from contending, for example, that it had relied on any representations given by the Bank as investment advice or a recommendation to enter into the hedging transaction).

The Bank argued that applying accepted principles of contractual interpretation, it was clear that TRM agreed that the Bank did not make any actionable representations to TRM, and that TRM did not rely on any representations in connection with the hedging transaction.

The court swiftly agreed to grant the declarations tracking the parts of the Schedule listed above, but the question of contractual estoppel gave rise to more detailed analysis.

Existence of a contractual estoppel

The court noted that Springwell broadly supported the finding of contractual estoppels arising from such clauses, citing the following comments from Aikens LJ in that case:

“…there is no legal principle that states that parties cannot agree to assume that a certain state of affairs is the case at the time the contract is concluded or has been so in the past, even if that is not the case, so that the contract is made upon the basis that the present or past facts are as stated and agreed by the parties.”

TRM argued that there was a distinction between warranties and undertakings on the one hand (which it accepted could give rise to a contractual estoppel), and an acknowledgement or a representation on the other. In relation to the latter, it said that there was no “agreement”, and therefore an acknowledgement/representation could not create a contractual estoppel. TRM pointed to the judgment of Leggatt LJ in First Tower, in which he questioned whether a clause which simply said that a party “acknowledges” that it has not entered into the contract in reliance on any representation could give rise to a contractual estoppel.

However, the court noted that Springwell itself disagreed with this proposition, with the Court of Appeal finding in that case that Springwell was bound contractually to its statement, or acknowledgement, that no representation or warranty had been made by Chase Manhattan. The court emphasised that Leggatt LJ’s commentary in First Tower was obiter, and did not think he was intending to overrule or qualify Springwell. The court noted that the factual situation in First Tower was very different (since the case concerned the effect of an exclusion clause in a commercial lease and its effect vis à vis pre-contractual enquiries which misrepresented the position as regards asbestos on site). Leggatt LJ was not purporting to consider the effect of representations typically made in a financial services context.

The court also considered obiter comments in Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm), a case concerning the ISDA Master agreement, which TRM suggested drew a distinction generally between warranties and mere representations. Again the court was not persuaded that this authority took matters any further forward, as it was bound by Springwell.

Even if not bound by Springwell, the court considered that the question was whether it could “objectively conclude that by the relevant contractual materials the parties did intend to agree” to the contractual estoppel. It said the question was not dependent on the precise wording (representation vs warranty), but was a question of substance (per Hamblen J in Cassa Di Risparmio Della Repubblica Di San Marino Spa v Barclays Bank Ltd [2011] EWHC 484 (Comm)). This would require the court to discern the intention of the parties, taking into consideration the relevant factual background, including the nature and status of the ISDA Master Agreement. On that basis, even if it had not been bound by Springwell, the court said it would have reached the same conclusion, namely that a contractual estoppel existed.

Effect of the Misrepresentation Act 1967

The court also considered TRM’s argument that the Non-Reliance provisions sought to exclude liability for misrepresentation under the Misrepresentation Act 1967, and so were subject to the requirement of reasonableness under section 11(5) of the Unfair Contract Terms Act 1977 (UCTA).

The court was “entirely unpersuaded” of the merits of this argument. In particular, the court specifically endorsed the decision in Barclays Bank plc v Svizera Holdings BV [2014] EWHC 1020 (Comm), which held that a clause in a mandate letter gave rise to a contractual estoppel against reliance on alleged representations. In that case, the court referred to the consistent judicial recognition of the effectiveness of such clauses giving rise to a contractual estoppel, and said the suggestion that the clause should be struck down as unreasonable under UCTA was “hopeless”. In the present case, the court commented that this conclusion might very well apply here.

The court was critical of TRM’s approach to the argument on the Misrepresentation Act, in particular because it had failed to put its argument formally in issue in the proceedings, cautioning as follows:

“It cannot be acceptable for a party to (as TRM did here) stay absolutely quiet on the subject until the door of the court, and then play their joker in the form of the [Misrepresentation Act], asserting that the burden of proving reasonableness has not been discharged by its opponent.”

The court was also critical of the fact that TRM failed to identify clearly which clauses were said to be exclusion clauses, and the absence of any factual evidence to suggest that the provision should be struck down as unreasonable.

In fact, the court pointed to a number of factors suggesting that the clause was in any event reasonable, including that: this was not a case of a consumer transaction or where there was an inequality of bargaining power; the terms were contained within an ISDA Master Agreement which contains effectively market standard terms; and the bespoke Schedule was agreed between two commercial parties.

The court was therefore prepared to grant the declarations sought relating to representations and contractual estoppel.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

Court of Appeal upholds High Court decision to grant summary judgment in FX de-pegging case

The Court of Appeal has upheld the High Court’s decision to grant summary judgment in favour of a bank defending a claim brought by a foreign exchange (FX) broker seeking to recover losses incurred on FX spot transactions during the 2015 “Swiss Flash Crash”: CFH Clearing Ltd v MLI [2020] EWCA Civ 1064.

In doing so, the Court of Appeal has confirmed that the bank’s terms and conditions of business (TOB) did not import into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions, or otherwise cancel them.

This decision will be of broader interest to financial institutions in that it provides reassurance that English courts are prepared to determine decisively, at the summary judgment stage, that the express terms of market standard master agreements will be enforceable and will not readily incorporate vague concepts of market practices into such contracts. This will be the case even if the claimant can point to its loss arising from unusual or important market events – a sophisticated claimant investor will be held to the consequences of an agreement in which they have failed to provide for market disruption.

Background

This case concerned FX transactions which the claimant broker entered into with the defendant bank on 15 January 2015, in which the claimant bought Swiss francs and sold euros, and were documented by a 2002 ISDA Master Agreement (the ISDA Agreement) together with an electronic confirmation. The FX transactions took place on the same day (and shortly before) the Swiss National Bank ‘de-pegged’ the Swiss franc from the euro, by removing the currency floor with respect to the value of the Swiss franc against the euro. This led to severe fluctuations in the foreign exchange market in those currencies. The extreme rates triggered automatic liquidation of certain client positions of the claimant at prices below the official low set by the e-trading platform for Swiss franc interbank trades, known as the Electronic Broking Service (EBS). Later that day, other banks amended the pricing of trades which they had executed with the claimant to prices at or above the official EBS low. The bank agreed to improve the pricing of its trades, but to a level below the EBS low.

The claimant’s case was that since the FX transactions were entered into at a time of severe market disruption, the bank was obliged to make a retrospective adjustment to the price of those transactions (e.g. to adjust the price to a rate to the EBS low, in accordance with alleged market practice), or to cancel them, in accordance with its express or implied contractual obligations and/or pursuant to a duty of care in tort.

The bank applied for strike out and/or summary judgment.

High Court decision

The High Court granted summary judgment in respect of all claims, holding there was no real prospect of the claim succeeding and that there was no other compelling reason for the claim to proceed to a trial. 

The High Court’s reasoning is summarised in our previous blog post here.

The claimant appealed.

Court of Appeal decision

The claimant contended that the effect of the bank’s TOB imported into the FX transactions a contractual obligation to comply with “market practice”, so as to require the bank to re-price the transactions at the EBS low, or otherwise cancel them. This was on the basis that the bank’s TOB provided that:

“All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together the “applicable rules”). In the event of any conflict between these Terms and any applicable rules, the applicable rules shall prevail…”

The Court of Appeal dismissed the appeal, finding that there was no arguable basis for holding that such an agreement had been made by the parties. The words “subject to” did not incorporate “market practice” into the contract; rather it meant that neither party was required to act contrary to such market practice (in which case it would be relieved of its contractual obligations).

The starting point for the contractual analysis was that the parties had agreed that their FX transactions would be governed by a standard ISDA Master Agreement, had negotiated the specific terms of the Schedule and had incorporated the 1998 FX Definitions, which would have permitted them to provide for market disruption. The transactions were therefore governed by a detailed contract which on industry standard terms reflected market practice and was tailored by the parties for their specific business relationship. The Court of Appeal also referred to the well-known observation of Briggs J in Lomas & Ors v JFB Firth Rixson Inc & Ors [2010] EWHC 3372 that the ISDA Master Agreement is probably the most important standard market agreement used in the financial world and that it was obvious that it should be interpreted in a manner that met the objectives of clarity, certainty, and predictability, so that the very large number of parties using it should know where they stand. The suggestion that the parties had agreed to incorporate “market practice” generally, even though not reflected in the ISDA Agreement and, indeed, overriding its provisions, therefore must be treated with considerable caution.

In the Court of Appeal’s view, it was also difficult to see how a “market practice” overriding the ISDA Agreement’s standard terms could be derived from the International Code of Conduct and Practice for the Financial Markets (the Code). Indeed, the Code itself recognised that Master Agreements should be entered into to reflect market practices and to provide for exceptional circumstances. The claimant in its arguments had focused on only one provision of the Code whilst ignoring the more fundamental recognition in the Code that legal certainty, including as to market practices and exceptional circumstances, should be ensured by adopting a Master Agreement.

Furthermore, the Court of Appeal considered that the alleged “market practice” was far too vague and uncertain to be incorporated as a contract term. It was not clear precisely what obligation was said to have arisen with regard to re-pricing (there being no reference in the Code to the “authenticated market price” or the “official low”), and when a party must re-price and when it must cancel. In the Court of Appeal’s opinion, the inclusion of those two very different routes would give rise, at best, to an unenforceable agreement to agree. The fact that the other liquidity providers “readily” complied with the alleged practice was deemed by the Court of Appeal to be rationalisation after the event, in circumstances where the terms of the relevant contracts with those counterparties were unknown to the court.

Finally, the Court of Appeal also firmly rejected the suggestion that the unusual and important nature of the market events was itself a compelling reason that the matter should be allowed to proceed to trial. The Court of Appeal remarked that there was no reason why the claimant should not be held to its bargain on the basis that it: (a) was a sophisticated commercial party who had entered into automatic transactions at the next available price without specifying a limit; and (b) had negotiated and agreed with the bank the ISDA Agreement, an agreement in which it could have but did not provide for market disruption.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7466 2529

ISDA pre-cessation fallback consensus: will this reduce legacy LIBOR risk in the derivatives market?

The International Swaps and Derivatives Association (ISDA) has announced the preliminary results of its re-consultation on the implementation of pre-cessation fallbacks for derivatives referenced to LIBOR (see press release). It follows an earlier consultation on pre-cessation fallbacks last year, which failed to achieve market consensus on whether or not (and if so, how) to include a pre-cessation trigger (see the consultation and the results), causing a delay to the development of a way forward in the critical derivatives market. See our previous blog post on ISDA’s decision to carry out a second consultation.

While these are only preliminary results, ISDA expects to proceed on the basis of the views of the significant majority of respondents who are in favour of including both pre-cessation and permanent cessation fallbacks as standard language in the amended 2006 ISDA Definitions for LIBOR and in a single protocol for including the updated definitions in legacy trades.

It is noteworthy that ISDA has published the fact that consensus has been reached at the earliest opportunity (without the usual practice of including a preliminary report), recognising the significance of the outcome of this consultation for the market.

The outcome is significant because it will allow ISDA to press ahead with finalising the way forward in the critical derivatives market and give impetus to other markets to progress their own solutions.  Moreover, this should avoid different derivative contracts switching away from LIBOR at different times (which would have created mismatches between different parts of a portfolio). However, some market participants will be concerned at the loss of flexibility in how to address LIBOR cessation across their derivative positions, which may have the undesirable effect of putting them off adhering to the protocol at all.

Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Harry Edwards
Harry Edwards
Partner
+61 448 072 588
Nick May
Nick May
Partner
+44 20 7466 2617
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948