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"Snowball" Swaps in Cross-Border Context

"Snowball" Swaps in Cross-Border Context


The aspect of the choice of law governing an agreement in view of mandatory rules of a jurisdiction other than that of the governing law but to which a transaction is somehow connected has become relevant in a number of pending derivatives litigation cases across various European jurisdictions.

Recently, the English Court of Appeal confirmed a first instance judgment concerning two Portuguese companies which entered into an English law governed ISDA Master Agreement with an English jurisdiction clause (Banco Santander Totta SA v Companhia Carris de Ferro de Lisboa SA & ORS [2016] EWCA Civ 1267). The aforesaid decision provides some interesting guidance on the inter-correlation between the selected contractual law on one hand and the mandatory laws of another jurisdiction on the other hand.

The case relates to seven interest rate swaps entered into between Portuguese public sector transport companies (the "TCs") and a Portuguese bank (the "Bank"), where the TCs were the fixed rates payers and the Bank was the floating rate payer. An additional feature of the structure was that upon a move of the interest rates outside upper or lower barriers, the fixed rate payable by the TCs had a spread added to it. As a result of this arrangement combined with the near zero reference rates, the interest rates payable by the TCs increased dramatically from 2009 onwards so that they were in the range of 30% to 92% (the so called "snowball" effect). Following this increase, the TCs ceased to make payments in 2013.

Upon being sued by the Bank, the TCs advanced numerous defences, mainly under Portuguese (mandatory) laws, claiming, inter alia, lack of capacity, the swaps being unlawful games of chance, the obligation of their termination due to an abnormal change of circumstances and a breach of duties by the Bank under the Portuguese Securities Code.

All of the aforesaid arguments were already rejected in first instance as the parties had agreed on English law as the governing law of the transactions and Portuguese law would, only be relevant if "all other elements relevant to the situation at the time of choice" were located in Portugal (article 3(3) of the Rome Convention, in the meantime replaced by the Rome I Regulation) which was, however denied by the first instance. In fact, the court derived the international elements from (i) the right to assign the transaction to a bank outside of Portugal, (ii) the use of standard international documentation, (iii) the practical necessity for the relationship with a bank outside of Portugal (for counter-hedging), and (iv) the international structure of the swaps market.

The narrow interpretation of Article 3(3) of the Rome Convention/Rome I Regulation was reconfirmed by the Court of Appeal, which was emphasizing that the international elements which could be considered in this context were not merely those that might influence a court in its decision as to the applicable law in the absence of a choice of law.

In addition, the choice of the forum also has an influence on the applicability of mandatory laws. In fact, had the action been filed before Portuguese courts, they could have applied certain of the raised defences under Portuguese law by virtue of article 9(2) (overriding mandatory laws of the forum) or article 21 (public policy of the forum) of the Rome I Regulation.

In essence, the case is again a convincing example that the selection of law and forum matters and should be made with precaution.

By Jasna Zwitter-Tehovnik, Partner, DLA Piper Vienna

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