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.