Court Of Appeal Overturns High Court's High-Profile Italian Swaps Decision

• Published date: 24 January 2024
• Subject Matter: Finance and Banking, Litigation, Mediation & Arbitration, Insolvency/Bankruptcy/Re-structuring, Commodities/Derivatives/Stock Exchanges, Financial Restructuring, Trials & Appeals & Compensation
• Law Firm: Herbert Smith Freehills
• Author: Damien Byrne Hill, Ceri Morgan and Daniel May

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...