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Derivatives, options and insolvency rules

Article 76 of Royal Decree 267 of March 16 1942, as subsequently amended and supplemented (the Bankruptcy Law), provides that stock exchange contracts expiring after the declaration of bankruptcy of one of the contracting parties are terminated on the date of declaration of bankruptcy.

The difference between the contract price and the value of the assets or securities, calculated on the date of declaration of bankruptcy, shall be paid to the bankruptcy procedure if the amount is owed to the bankrupt party – and shall be admitted as a claim against the bankruptcy procedure if the credit is owed by the bankrupt to the non-defaulting party.

The purpose of Article 76 of the Bankruptcy Law is to avoid bankrupt assets undergoing the risks deriving from fluctuations of the value of stock exchange transactions. According to the majority of scholars, Article 76 of the Bankruptcy Law is also applicable to derivative transactions. Such applicability has been expressly contemplated by Article 203 of the Italian Financial Act.

In the case of interest rate options (such as an interest rate cap or an interest rate floor) the applicability of Article 76 of the Bankruptcy Law may vary depending on which contracting party (purchaser or seller of the option) is the defaulting party, since rights and obligations of the relevant parties are different.

Should the purchaser of the option be the bankrupt party, the receiver appointed under the relevant bankruptcy procedure may continue or terminate the transaction, since in this event the bankrupt purchaser has already fulfilled its contractual obligations (with the payment of the premium) and is not subject to the fluctuations of the financial markets.

On the contrary, should the seller of the option (who has already collected the relevant premium and whose obligations depend on the fluctuations of interest rates) be the bankrupt party, the relevant transaction is terminated since the bankruptcy procedure shall not be subject to the risks deriving from fluctuations of interest rates.

In this event, the counterparty (the purchaser of the option) has a claim against the bankruptcy procedure for an amount equal to a premium which may have been paid under an option entered into on the date of the bankruptcy and having similar terms and conditions.

As to the claw-back provisions, Article 67, paragraph one of the Bankruptcy Law provides, among other things, that abnormal transactions (where the obligations of the bankrupt exceed more than one-fourth the consideration received by it) entered into within one year prior to the declaration of bankruptcy are declared null and void, unless the other party can prove that it was not aware of the insolvency of the bankrupt.

According to scholars the above mentioned provision is not applicable to derivative transactions, since the obligations arising from such transactions may vary depending on the fluctuation of financial markets whose risks the parties agree to accept.

Paragraph two of Article 67 of the Bankruptcy Law – pursuant to which transactions and payments made six months prior to the declaration of bankruptcy are null and void if the receiver proves that the counterparty was aware of the insolvency – is, on the contrary, applicable to derivative transactions entered into and terminated within six months prior to the bankruptcy.

Claw-back provisions are not applicable in derivative transactions entered into within six months prior to the bankruptcy but not terminated at such date, since these transactions are subject to the provisions of Article 76 of the Bankruptcy Law and are immediately terminated on the date of bankruptcy.

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