On January 18 the English Supreme Court refused to grant Comune di Prato (“Prato”), an Italian local authority with responsibility for the municipality of Prato in Tuscany, permission to appeal a 2017 decision of the Court of Appeals in favor of Dexia Creditop SpA (“Dexia”), Prato’s swap counterparty. This decision brings to an end a long-standing dispute that was one of many involving swaps entered into by Italian municipalities between 2001 and 2008, when the onset of the financial crisis triggered defaults and brought increased scrutiny to the derivatives market.
The decision of the Court of Appeals, together with the determination by the Supreme Court not to allow further appeal, may provide greater certainty as to the narrow scope of Article 3(3) of the Rome Convention, particularly in respect of derivatives agreements documented under standard documentation that are governed by English law.
Between 2002 and 2006, Prato entered into six swaps with Dexia in connection with its debt restructuring under a 1992 ISDA Master Agreement (Multicurrency – Cross Border) that provided for English governing law and jurisdiction. In December 2010, Prato declared null (with retroactive effect) the resolution by which it had entered into the last swap outstanding between the parties, an interest rate collar, and ceased making payments thereunder. Dexia thereafter sued in the English courts for recovery of damages.
Prato challenged the enforceability of the swap on several grounds, including that it was ultra vires because Prato was prohibited from entering into speculative transactions under Italian law. Prato also argued that Dexia failed to comply with certain Italian regulations that were “mandatory” rules (discussed below) under Italian law pursuant to Article 3(3). Specifically, Prato argued that the swap constituted an “offsite” investment contract between a retail investor and a financial service provider which, pursuant to Article 30 of legislative decree 58 of 1998 (called Testo Unico della Finanza), was invalidated because it did not provide that effectiveness was suspended for seven days after execution during which time Prato had the right to withdraw at no cost.
In 2015 the High Court rejected several of Prato’s arguments, including that the swap was ultra vires because it was speculative. However, the court agreed with Prato that, irrespective of the English governing law elected by the parties under the ISDA Master Agreement, Dexia violated mandatory Italian regulations pursuant to Article 3(3).
Article 3(1) of the Rome Convention allows parties to select the governing law of their contract, but Article 3(3) provides an exception, allowing the application of mandatory local law “[w]here all other elements relevant to the situation [other than the governing law clause] at the time of the choice [of governing law] are located in a country other than the country whose law has been chosen.” The primary purpose of this exception is to ensure that contracting parties are not able to avoid local laws under a domestic contract simply by electing a foreign governing law. The court’s decision suggested that the phrase “elements relevant to the situation” in Article 3(3) had to be connected with a specific country other than Italy. The court agreed with Prato’s position that there were no relevant elements connected with a specific country other than Italy, and that Italy was where both parties were incorporated, where the parties communicated with each other and entered into the swaps, and where the parties had to perform their obligations to each other. The decision of the court raised serious concerns across the global derivatives industry.
However, in June 2017 the Court of Appeals overturned that decision. Relying on a recent precedent known as the Santander case, which also dealt with Article 3(3), the court framed the relevant question as whether, other than English law and jurisdiction, all other elements relevant to the situation were connected with one country (in this case, Italy), and not – as the High Court had done – whether such elements were connected with a specific country other than Italy. In other words, the court evaluated whether there was an international element to the situation and noted that “[o]nce an international element comes into the picture, Article 3(3) with its reference to mandatory rules should have no application.” The court went on to state that it was “bound by the decision of this court in Santander and must therefore decide that the [High Court] judge proceeded on a wrong basis when he concluded that the matters relied on by Dexia were not elements relevant to the situation.” In evaluating those elements, the court concluded that Article 3(3) (and so, the local Italian rules relied upon by Prato) did not apply because, inter alia, the derivatives market was international in nature and the ISDA Master Agreement used by the parties was a standard form of agreement, written in the English language (which was not the first language of either party) and contemplating more than one currency, that was recognized and used globally, and so, was not associated with a single country. In addition, the court found it “highly significant” that Dexia had entered into back-to-back hedging transactions (with non-Italian dealer counterparties), noting that “[i]f the mandatory local laws of a party are to be applied to any individual swap contract, there is a real risk that the back-to-back security will quickly become illusory.”
 Dexia Crediop S.p.A. v. Comune di Prato,  EWCA Civ 428 (the “Appellate Decision”).
 It has been reported that hundreds of Italian municipalities entered into swaps having billions of Euros in aggregate notional amount during this period. Italian municipalities sought significant damages in connection with these swaps, leading to litigation, settlements and various legal reforms, including the €455 million settlement the City of Milan reached with four banks in 2012. For additional information, click here [hyperlink to DIR (15-Oct-11)].
 Dexia Creditop S.p.A. v. Comune di Prato  EWHC 1746 (Comm) (the “High Court Decision”), at paragraph 117. In a traditional interest rate collar, a party simultaneously purchases an interest rate cap (e.g. 5%) and sells an interest rate floor (e.g. 3%), thereby becoming (i) entitled to receive payments from its counterparty if rates exceed the cap and (ii) obligated to make payments to its counterparty if rates decline below the floor. However, it appears that the collar at issue between Prato and Dexia was more complicated. Among other things, it provided for increases over time to the cap and floor, resulting in significant payment obligations by Prato to Dexia. Id. at paragraph 110. The negative mark-to-market of the collar skyrocketed from €1.444 million in October 2007 to €5.205 million at the end of January 2009. Id. at paragraphs 112-14.
 Dexia sought over €6.5 million in damages for amounts that should have been paid under the collar by Prato from December 31, 2010 through December 31, 2013, as well as declaratory relief as to the validity and enforceability of the trade. Id. at paragraph 14.
 This law, in relevant part, provides as follows:
- The effectiveness of contracts for the placement of financial instruments or for management of individual portfolios which are executed off-site or placed at a distance pursuant to Article 32 shall be suspended for a period of seven days starting on the date of the subscription by the investor. Within that period, the investor may give notice of such investor’s withdrawal without charge or compensation to the financial promoter or to the qualified person; such right shall be stated in the forms delivered to the investor. The provisions above also apply to contract proposals made off-site or at a distance pursuant to Article 32.
- Failure to state the right of withdrawal in the forms shall result in the related contracts being null and void, with only the client having the right to enforce this provision.
Testo Unico della Finanza, Article 30.
 High Court Decision, at paragraphs 203-206.
 Id. at paragraphs 208-252.
 In full, this clause provides as follows:
A contract shall be governed by the law chosen by the parties. The choice shall be made expressly or clearly demonstrated 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 to part only of the contract.
Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I), Official Journal of the European Union (L 177/6) (4.7.2008) (the “Rome Convention”).
 Id. at Article 3(3) (emphasis added). In full, this clause provides as follows:
Where all other elements relevant to the situation at the time of the choice are located in a country other than the country whose law has been chosen, the choice of the parties shall not prejudice the application of provisions of the law of that other country which cannot be derogated from by agreement.
 High Court Decision, at paragraph 211.
 Id. at paragraphs 208-13.
 See Banco Santander Totta SA v. Companhia Carris de Ferro de Lisboa SA & Ors,  EWCA Civ 1267. As the court noted, the facts of this case differed in several respects from those in Santander.
 Appellate Decision, at paragraph 137.
 Id. at paragraph 128.
 Id. at paragraph 132.
 Id. at paragraph 135.