Client Alert

The Application of Mandatory Rules of Italian Law to Interest Rate Swaps Governed by an English Law ISDA Master Agreement: English Law Choice Prevails

26 Jun 2017

Where parties to a contract choose English law to govern that contract, there are few rules that allow a foreign law to intervene. The recent decision of the Court of Appeal in Dexia Crediop SpA v Comune di Prato [2017] EWCA Civ handed down on 15 June 2017 confirms this and demonstrates the courts’ willingness to construe Article 3(3) of the Convention on the Law Applicable to Contractual Obligations 1980 (“Article 3(3)”) more narrowly. It also indicates that an international element may be sufficient to mean that a transaction is not linked to one country for the purposes of Article 3(3) and that the use of an international standard form agreement (such as ISDA Master Agreement) may be sufficient to bring such an international element to a transaction.

The decision in Dexia is likely to be of interest to parties concerned about the potential for mandatory local law to undermine the parties’ agreed choice of law. It is also of significance for other similar disputes involving Italian local authorities and financial institutions where “lack of capacity” arguments are often raised.


Between 2002 and 2006, Dexia Crediop SpA (an Italian bank) (“Dexia”) and Comune di Prato (an Italian local authority) (“Prato”) entered into a number of interest rate swaps to hedge Prato against rising interest rates by allowing Prato to fix the floating rate of interest payable on its bond debt. The swaps were documented under an ISDA Master Agreement and included an express choice of English law and jurisdiction.

Following the financial crisis in 2008 and the fall of interest rates to historical lows, the floor payable by Prato exceeded the floating rates prevailing in the market. In 2010, Prato took steps in Italy to set aside the swaps, and Dexia brought a claim for payment and declaratory relief in the English Commercial Court. Prato’s defence and counterclaim were based primarily on arguments relating to capacity and mandatory provisions of Italian law. In reliance on Article 3(3) Prato argued that the swaps should be held invalid or unenforceable by reason of mandatory rules of Italian law, including mandatory Italian rules requiring Dexia to give Prato written notification of its right to withdraw from each swap during a seven-day “cooling off” period.

Dexia argued that Article 3(3) did not apply to the swap because it was not the case (as asserted by Prato) that, other than the choice of English law and jurisdiction, “all the other elements relevant to the situation” at the time the parties entered into the contract were connected only with Italy. In particular, Dexia relied on the fact that:

  • the ISDA Master Agreement is an internationally recognised industry standard form; and
  • it entered into back-to-back hedging swaps with banks outside Italy in connection with the swaps using the same documentation.

Article 3(3) of Rome Convention

Article 3(3) provides that the choice of English law as the governing law of a contract shall not prejudice the application of the mandatory rules of the law of the one country with respect to which “all the other elements relevant to the situation at the time of the choice are connected with one country only”.

For contracts entered into after 17 December 2009, the Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 (“Rome 1”) also applies. Rome I includes a similar provision to Article 3(3), although it refers to laws that “cannot be derogated from by agreement” rather than “mandatory rules”. Rome I also provides that the “overriding mandatory provisions” of the law of the place of performance (i.e., those provisions of the law that are regarded as crucial by the relevant state to safeguarding its public interest) can be taken into account by a Member State court when determining a contractual dispute even where the parties have chosen a different governing law for their contract.

First and Second Judgement

At first instance, Walker J held that neither the international nature of the ISDA Master Agreement, which did not amount to a connection with any specific country other than Italy, nor the back-to-back swaps, which were not within the contemplation of the parties at the time of the choice of governing law, were elements “relevant to the situation”. Accordingly, Prato was permitted to rely on its defences and counterclaims based on “mandatory rules” of Italian law. Walker J also held that Dexia failed to comply with mandatory rules of Italian law applicable to retail investors (including the seven-day “cooling off” period), resulting in the nullity of the swaps as prescribed by such mandatory rules under Article 30 of a legislative decree (58 of 1998) called Testo Unico della Finanza.

In the second judgement in respect of this dispute, the judge upheld the parties’ restitution claims against each other.

The Appeal

Dexia had a number of grounds for appealing the decision at first and second instance, including that:

  • Article 3(3) had been wrongly engaged; and
  • the seven-day “cooling off” period should not have applied when the initiative for the transaction came from the customer and proposals from the financial institution were not unsolicited such that Prato could not have been surprised at the terms of the swaps.

Prato also argued that the swap was ultra vires under Italian law. However, the Court of Appeal, by reference to a detailed analysis of Italian law on this point, held that the interest rate swaps between the parties were valid and binding and that Prato had full capacity to enter into them under Italian law. Overturning the decision of the High Court, the Court of Appeal also held that Article 3(3) did not apply so as to engage mandatory Italian laws but that, if Article 3(3) had brought Italian law into play, the laws in question did not apply to the transaction. Therefore Prato was bound by the contract.

In particular, the Court of Appeal determined that the fact that the transaction was documented under the ISDA Master Agreement was almost sufficient to make the situation not connected solely with Italy, as “there is at once an international element rather than a domestic element associated with any particular country”, stating “Once an international element comes into the picture, Article 3(3) with its reference to mandatory rules should have no application”. Following Banco Santander Totta SA v Companhia Carris De Ferro De Lisboa SA [2016] EWCA Civ 1267, the Court of Appeal held that it is not necessary to identify connections between that transaction and another country. Aspects that are not connected with the single country in question are sufficient, and these may include elements signaling its international nature. Using a standard contract such as the ISDA Master Agreement introduced an international element beyond the borders of Italy because it is “self–evidently not connected with any particular country and is used precisely because it is not intended to be associated exclusively with any such country”.

The Court of Appeal argued that the fact that international banks tendered for the original mandate that Dexia won was also relevant in demonstrating the international nature of the derivatives market. In addition, the back-to-back contracts were also significant to the decision to give Article 3(3) limited effect. Article 3(3) could not be used in one country on one side of a hedging or swap arrangement to bring about unintended consequences such as a “cooling off” period or withdrawal period. The Court of Appeal further reasoned that as the back-to-back contracts were routine and made with banks outside Italy, they further served to demonstrate the international nature of the swaps market.


This is a very important and widely anticipated ruling that finally settled the long-running dispute between Dexia and Prato. This should constitute authority for resolving similar disputes involving local authorities, state or quasi-state companies and international banks where often arguments of lack of capacity and local mandatory rules are raised to invalidate the derivative transactions documented under an ISDA Master Agreement.



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