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Portuguese swaps case: implications for banks

Slaughter and May lawyers examine a recent ruling that shows how to limit the risk of another law intruding on the parties’ choice of English law

A recent ruling on swaps entered into by Portuguese companies shows how to limit the risk of another law intruding on the parties’ choice of English law

In recent years there has been a string of cases in the English courts regarding the validity of swaps entered into before the crisis by public sector entities in a number of European jurisdictions. The most recent of these will become a key case for banks entering into swaps on market standard Isda [International Swaps and Derivatives Association] documentation.

Following a six week trial in late 2015 – the first in the Financial List – Mr Justice Blair gave judgment in favour of the bank in Banco Santander Totta SA v Companhia de Carris de Ferro de Lisboa SA and others [2016] EWHC 465 (Comm).

The ruling contains guidance on how to limit the risk of another law intruding on the parties' choice of English law, and a reminder that law other than English law may still be relevant to some issues. Before delving into those lessons, it is worth briefly summarising the facts and the case's outcome.

The case

This case concerned the validity of nine interest rate swaps that four Portuguese public sector transport companies had entered into with Banco Santander Totta (the bank), a Portuguese bank in the Banco Santander group, between 2005 and 2007. The transport companies had entered into the swaps as interest rate management instruments, aimed at reducing their borrowing costs.

The transport companies had sought to avoid their obligations under the swaps after interest rates fell to record lows in the wake of the 2008 financial crisis, causing the cost of the swaps to increase significantly. As a result, the bank commenced claims in 2013 seeking declarations as to the swaps' validity. In response, the transport companies raised a number of Portuguese law arguments to deny the validity of the swaps or liability to pay under them. These arguments, in brief, were:

  • the transport companies did not have capacity to enter into the swaps;
  • the swaps contravened certain provisions of the Portuguese Securities Code;
  • the swaps were games of chance or generally against 'public order'; and
  • the events surrounding the global financial crisis amounted to an 'abnormal change of circumstances' under Portuguese law (akin to a frustrating event under English contract law) such that the swaps should be set aside.

The last two points were dependent upon the court finding that article 3(3) of the Rome Convention applied on the facts of the case. This provision (found in similar form in article 3(3) of the Rome I Regulation, which applies to contracts entered into after December 17 2009) governs the circumstances in which mandatory laws of a jurisdiction (in this case, Portugal) apply despite the choice of another law made by parties to a contract (in this case, English law).

At the time of trial, the combined mark-to-market value of the swaps was in excess of €1.3 billion ($1.48 billion), with total unpaid amounts stated to be in excess of €270 million.

The judgment

Mr Justice Blair found for the bank, ruling that all the swaps are valid and that the transport companies' obligations under the swaps are binding and enforceable. On each of the legal arguments, the court found as follows:

  • Each of the transport companies had the capacity to enter into the swaps, and the fact they were owned or controlled by the state did not mean they did not have capacity to enter into transactions of this type.
  • In proposing and entering into the swaps, the bank was not in breach of the applicable provisions of the Portuguese Securities Code.
  • Article 3(3) of the Rome Convention (and therefore mandatory provisions of Portuguese law) did not apply on the facts of the case, because all the elements relevant to the situation were not connected with Portugal only.
  • As the court made this finding, it was not strictly necessary to consider the other Portuguese law defences raised by the transport companies. However, it went on to make the following findings on those arguments:
    • The swaps are not games of chance under Portuguese law, and nor would they be deemed contrary to Portuguese public order.
    • The Portuguese rule on abnormal changes of circumstances is not a 'mandatory rule' for the purposes of article 3(3) of the Rome Convention because it can be waived by the parties after the occurrence of the event that triggered the rule (ex post waiver).
    • However, had the Portuguese law provisions as to abnormal change of circumstances been applicable, the transport companies would have been able to terminate some of the swaps, subject to the court's power to modify the swaps. This is because the court considered that the global financial crisis, and in particular its effect on interest rates (falling to near zero for a prolonged period), amounted to an abnormal change of circumstances.

The defendants have since been granted permission to appeal the aspects of the judgment relating to article 3(3) of the Rome Convention.

Key implications

The international nature of the swaps

In finding that article 3(3) of the Rome Convention did not apply, the judge differed from another recent decision regarding the validity of swaps entered into by an Italian local authority, Dexia Crediop SpA v Comune di Prato [2015] EWHC 1746 (Comm).

In deciding that the elements of the situation were not solely connected with Portugal, the judge applied a broader approach than had been applied in that previous case. In particular, the judge held that an element did not have to be connected to another specific legal jurisdiction in order for that element not to be connected with Portugal. Put another way, the judge found that it is sufficient to prevent the application of article 3(3) if an element of the situation is international in character. The elements of the swaps relied on by the judge to find that they were not solely connected with Portugal, although the transactions were all negotiated and carried out in Portugal by Portuguese entities, were: the international nature of the swaps market, the use of internationally-recognised standard form documentation in the form of an Isda Master Agreement (multicurrency-cross border form), the bank's ability to assign the swaps to entities outside Portugal, and the back-to-back contracts that the bank had in place with Santander in Spain.


"Banks may take some comfort from the judge’s recognition that banks entering into swaps are acting as counterparty to their customers"


In reaching this conclusion, the judge emphasised the importance of legal certainty: "At least in the context of major financial contracts such as those at issue in this case, legal certainty is an important consideration". If the court had reached a different view, banks outside England entering into swaps with domestic counterparties under an Isda Master Agreement governed by English law would need to consider the implications of mandatory rules of domestic law, even when the transaction was not solely connected to that jurisdiction. This could add a significant layer of risk to banks which would expect swaps on identical terms to be treated identically by the English courts.

Take, for example, a French bank that entered into a swap with a French customer and then a back-to-back swap with a German bank, both under Isda Master Agreements governed by English law and subject to the jurisdiction of the English courts. If all the elements of the first swap were found to be connected to France, then the customer might be able to have the swap deemed invalid due to a mandatory rule of French law which has no equivalent in English law. In practice, the customer is only likely to do so when the swap is out of the money for the customer and the French bank is the net recipient of payments under the swap with the customer. However, the French bank would still need to perform the back-to-back swap with the German bank on the same terms because it was subject to English law only (not being solely connected with France or Germany). If the instrument had been out of the money for the customer, this back-to-back swap would be out of the money for the French bank, which would be left bearing the cost of either terminating the back-to-back swap or continuing to service the payment flows under it.

To limit this risk and avoid arguments that their swaps are connected solely with one jurisdiction other than England, banks may prefer that all their swaps entered into with customers in one jurisdiction are entered into by a bank entity based in another jurisdiction. If that is not possible (for regulatory or other reasons), banks will want to ensure that their swaps contain as many as possible of the features that the judge relied on in this case to find that the swaps were not solely connected with Portugal. That includes: international standard form documentation (the multicurrency-cross border form of the 1992 Isda Master Agreement), the right of the bank to assign the swaps to an entity in a different jurisdiction, and back-to-back swaps with an entity in a different jurisdiction.

The extent to which it is possible to reflect these factors in any given transaction will, of course, depend on the context of that transaction. For example, while many counterparties will not need to be persuaded to use an Isda Master Agreement, that documentation does not permit free assignability of transactions entered into under it. Counterparties may not be willing to alter this default position, given the potential effect of a transfer on credit and counterparty risk, and other factors such as tax and regulatory treatment. Equally, for reasons of efficiency, banks may not hedge transactions on a strict back-to-back basis and this could make it harder to demonstrate that the bank did not intend to accept a degree of mismatch.

Areas where domestic law is relevant

The case also serves as a reminder of some of the issues to which the domestic law of a country other than England will be relevant, even where the parties choose English law and article 3(3) of the Rome Convention does not apply.

The capacity of the bank's customer to enter into the swap is one such issue. Capacity is governed by the law of the jurisdiction in which that customer is incorporated. Further, the burden is on the party seeking to enforce the swap, usually the bank, to show that the other party had capacity to enter into it. Indeed, in the past this has proved a difficult hurdle to surmount – see for example Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm). Accordingly, legal advice on this issue should be sought from the relevant jurisdiction before a swap is concluded. Particular care should be taken if, as was argued in relation to Portuguese law in this case, the question of capacity depends upon the purpose for which the customer is entering into the swap.

It is also worth noting, on the subject of capacity, that the judge decided he did not need to deal with the bank's submissions on the Company Law Directives (68/151/EEC and 2009/101/EC). The bank argued that by virtue of those directives, some of the companies would have been bound even if the swaps fell outside their capacity under Portuguese law. While this point was not tested in this case, it may yet prove to be an important argument in future disputes of this kind.

A further issue which may be governed by a law other than English law is the regulatory framework to which the bank is subject in entering into the swap. In this case, it was accepted that the Portuguese Securities Code applied to the instruments despite the parties' selection of English law in the Isda Master Agreements. The position may be more complex if a bank authorised and regulated in one (home) jurisdiction enters into a swap with a customer in another (host) jurisdiction. In those circumstances, regulatory provisions from the bank's home and host state may apply, and need to be reconciled.

However, banks may take some comfort from the judge's recognition, albeit in the context of determining Portuguese law as a matter of fact in this particular case, that banks entering into swaps are acting as counterparty to their customers. The bank's duties to the transport companies in those circumstances were found to be commensurate with that relationship. In particular, there was 'no room for applying a rule relating to conflicts of interest in this situation'.

These two key lessons from the judgment are important for banks to bear in mind at the outset of a transaction, to minimise the risk that the swap will be found void or unenforceable.

By Slaughter and May partner Jonathan Clark and associates Camilla Sanger and Leo Kitchen in London. Slaughter and May acts for Banco Santander Totta

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