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Deutsche Bank v Busto: The latest chapter in the Italian swaps saga

Deutsche Bank v Busto: The latest chapter in the Italian swaps saga


On 12 October 2021 the English High Court ruled that interest rate swaps executed between Deutsche Bank AG London ("Deutsche Bank") and the Italian municipality Comune di Busto Arsizio ("Busto") in mid-2007 were valid and binding, obliging Busto to maintain its payments to the bank up to the conclusion of the swaps in 2031.

Whilst the English courts have seen a steady stream of similar cases in recent years (flowing from ISDA transaction documentation often providing for English law and jurisdiction in favour of the English courts), this most recent ruling from the Commercial Court (Financial List) in Deutsche Bank v Busto [2021] EWHC 2706 (Comm) is a significant decision amongst the crop.  It follows last year's much-reported Italian Supreme Court Decision No. 8770 of 2020, known as the Cattolica decision, which sets out circumstances in which interest rate swaps would be null and void under Italian law, and upon which Busto sought to rely.

This is the first case in which the English court has considered the application of Cattolica Italian law issues to an English law interest rate swap contract.  In her judgment, Mrs Justice Cockerill establishes important principles surrounding the capacity of Italian public bodies ("IPBs") to execute swap contracts and deftly addresses challenging issues arising from the interpretation and application of the Cattolica decision.

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Before the financial crisis of 2007-2008 reverberated through the global financial markets, scores of local authorities in Italy entered into derivatives contracts with counterparty banks with the aim of managing their financial risk.  In particular, IPBs sought to hedge their exposure to future interest rate rises on floating rate loans by way of interest rate swaps, commonly swapping variable rate obligations for those with a cap and a floor.  The swaps also often served to modify the amortisation profile of the underlying debt, with the IPBs making lower repayments in the early years of the swap, rising to higher payments in later years.  This sought to lessen immediate financial pressures on the IPBs and provide short term liquidity.

Whilst the swaps may have seemed prudent at the time, the subsequent credit crunch and the dramatic fall in EURIBOR (the usual reference rate for the IPBs' variable rate borrowing) shifted the benefit of the swaps firmly in the banks' favour.

Both the Italian and English courts have seen significant traffic of claims brought either by IPBs seeking to have swaps declared invalid or unenforceable, or by banks seeking declarations of validity and enforceability in order to hold IPBs to their bargain.  Some claims were filed only in recent years despite the parties having performed their respective obligations for over a decade.  This perhaps reflects the increased appetite of IPBs to challenge their swaps only once they became overall net payers under the terms of the transactions.  In any event, this slew of derivatives transactions has created a long tail of cases arising from the financial crisis.


In its judgment of 12 May 2020, the Italian Supreme Court set out general principles relating to the validity of interest rate swap agreements entered into by IPBs.  In particular, the court ruled that such contracts would be void in the face of any of the following matters:

  • a) the counterparty bank failing to provide to the Italian party information on the mark-to-market values, probabilistic scenarios and hidden costs of the transaction;

  • b) the swap contract being one of speculation rather than hedging financial risk; and

  • c) the swap involving a form of indebtedness, for example an "upfront" premium payment, and the swap not being approved by the Council (as opposed to the Board) of the IPB.

Unsurprisingly, this ruling represented cause for concern amongst the banks.  Not only could existing swaps executed with IPBs be held to be void, but any future swaps with Italian counterparties could bring with them an associated burden of providing additional information on the costs, risks and suite of potential outcomes of the swap.  It was therefore with some interest that the market awaited this decision signalling how the English court would interpret and apply Cattolica.

Judgment on the key issues in dispute

The central point in issue in Deutsche Bank v Busto was whether Busto had capacity, as a matter of Italian law, to enter into the swaps and, as a consequence, whether the transactions were void.  Busto, placing heavy reliance on the Cattolica decision, contended that:

  • a) Article 119 of the Italian Constitution (which permitted Busto to "resort to indebtedness only for the purpose of financing investment expenditures") imposed limits upon its capacity to execute the swaps;

  • b) Busto's City Council was required to approve the transactions under Article 42(2)(i) of the Consolidated Code of Local Bodies (the "TUEL"), which approval had not been obtained;

  • c) Deutsche Bank was obliged, but had failed, to have provided information to Busto on mark-to-market values, probabilistic scenarios and hidden costs; and

  • d) the swaps were speculative contracts rather than for hedging, which was not permitted.

The court held that, on a plain reading of Article 119 of the Italian Constitution and associated legislative provisions, the transactions did not constitute indebtedness and, as such, fell outside the scope of Article 119.  The judgment observed that Article 119 does not "set out any of the limits on capacity which Busto has pleaded" or prohibit IPBs from executing derivatives contracts even of a "speculative nature".  Accordingly, the straight-forward statutory interpretation was clearly in the bank's favour.  The court noted that "Busto's case therefore requires words to be read into these provisions" in order to succeed.

The court then considered the delineation between speculative swaps and those executed for hedging purposes.  The court acknowledged that, as a matter of Italian law as set down in the Cattolica decision, IPBs may only enter into derivatives contracts to hedge financial risk; not if they are speculative.  The Italian Supreme Court was clear on this point, regardless of the fact that it had not identified any "express prohibition, nor any other basis in law, for this conclusion", or provided guidance as to what may constitute a speculative contract.  It was noted that the matter may be ripe for revisitation in future cases before the Italian courts.  However, the English court did not seek to diverge from the ruling in Cattolica, and proceeded to assess whether the swaps in question were for hedging or speculative purposes.  Busto's argument on this point was ultimately defeated, with the court considering that the swaps were a hedge to balance existing financial risk.

Finally in respect of capacity under Italian law, the English court held that, pursuant to Cattolica, the swaps did require authorisation by the City Council pursuant to Article 42(2)(i) of the TUEL, but only if they involved (i) payment of an "upfront" premium payment from the bank to the IPB, (ii) the extinguishment of existing loans, or (iii) significant modification to existing loans.  In the event, no expert evidence was put before the court on these points.  There was no upfront payment in these particular swaps (although they do feature in swaps that are the subject of other similar disputes brought before the English courts), but Busto sought to argue in closing that the swaps did represent a significant modification to the underlying loans.  Taking a holistic view of the transactions, the court sided with Deutsche Bank and held that the swaps did not significantly alter the reference loans and therefore did not require City Council approval.  In obiter comments, the court considered that, in any event, the transaction documentation had been ratified by the City Council when it approved the city's annual budget every year from 2008.

As to Busto's contention that Deutsche Bank was obliged (and failed) to provide information on mark-to-market values, probabilistic scenarios and hidden costs, there was some debate as to whether the relevant passages in Cattolica went to matters of capacity or rather concerned the elements of a valid contract under Italian civil law.  The court considered that the latter was correct, and sought to address the question of the effect of such Italian law breaches given that the swap contracts were governed by English law.  The court ruled that the validity of the swaps fell to be determined under English law and, accordingly, these requirements of Italian law as determined in the Cattolica decision were inapplicable.

In further obiter comments, the judgment addressed several additional points and arguments made in the alternative which ultimately fell away.  These are not addressed in this article but make for interesting reading.


In light of the key role played by the Cattolica judgment in this case, much turned on the English Court's approach to its interpretation and application of that judgment.  The court considered that it could "diverge from even the highest authority, particularly in the context of a civilian law system" if it was satisfied on the evidence that the relevant ruling did not represent foreign (in this case, Italian) law, although ultimately did not consider it necessary to do so.   This judgment will no doubt be welcomed by the banking sector, although it may not be the final chapter given the attention that it draws to aspects of Cattolica which the Italian courts may look to revisit in due course.


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