LA HIGH COURT OF JUSTICE LONDINESE DICHIARA LA NULLITÀ DEI CONTRATTI DERIVATI STIPULATI DA UN

ENTE LOCALE ITALIANO

Xxxxxxxxxxx Xx Xxxxxxxx

Il 14 ottobre 2022, la High Court of Justice inglese ha dichiarato la nullità dei contratti derivati stipulati da un ente locale italiano con alcune banche nel dicembre 2007 (Case FL-2019-000012, ref. [2022] EWHC 2586 (Comm)). La Corte inglese ha dichiarato la carenza della legittimazione a contrarre del Comune in questione in quanto i contratti stipulati hanno natura prevalentemente speculativa ed hanno generato ulteriore indebitamento per l’ente locale non destinato al finanziamento di investimenti, in violazione dell’art. 119, comma 6, della Costituzione italiana.

La sentenza in parola costituisce una svolta significativa nel panorama giurisprudenziale anglosassone. Nel vasto contenzioso che coinvolge le banche e gli enti locali italiani davanti alle Corti domestiche, diverse banche si sono rivolte alle Corti inglesi sia per risolvere questioni di giurisdizione sia per accertare preventivamente la validità dei contratti swap al fine di evitare le incertezze del contenzioso pendente o potenziale dinanzi ai Tribunali italiani. In contrasto con il consolidato ed univoco orientamento che riconosceva la validità dei contratti derivati, con questa sentenza, per la prima volta, il Giudice inglese ha dichiarato la nullità dei contratti swap disciplinati dalla legge inglese e stipulati da un ente locale italiano, applicando i principi enucleati dalle Sezioni Unite nella nota sentenza n. 8770/2020.

Nel caso di specie, le banche hanno chiesto alla Corte inglese di dichiarare la validità e l’efficacia di alcuni contratti di interest rate swap stipulati il 21 dicembre 2007 con un comune italiano ed in subordine di ottenere un risarcimento nel caso in cui tali contratti fossero stati ritenuti invalidi ed inefficaci. Il Comune, d’altro canto, per diverse motivazioni, ha chiesto alla Corte di riconoscere l’invalidità e l’inefficacia dei contratti in questione (insieme alla restituzione delle somme pagate in virtù dei contratti) e, in subordine, il risarcimento nel caso in cui tali contratti fossero stati dichiarati validi ed efficaci.

Cruciale, dal punto di vista fattuale, è la circostanza per cui nella fattispecie le operazioni swap ristrutturavano, fra l’altro, un precedente derivato posto in essere con una banca statunitense. Tale posizione veniva chiusa anticipatamente a fronte di un pagamento corrisposto dalle banche. Il costo della chiusura del precedente derivato, sopportato dalle banche, veniva successivamente “assorbito” nelle condizioni contrattuali delle operazioni a sfavore del Comune, alterando significativamente gli equilibri contrattuali.

In particolare, l’invalidità dei contratti è stata sostenuta in base a due principali argomentazioni: (i) la Corte inglese ha ritenuto che i contratti fossero speculativi e come tali non potessero essere stipulati dal Comune e

(ii) ha considerato gli stessi come indebitamento per il Comune, indebitamento che non è stato impiegato per finanziare spese di investimento, in ossequio all’articolo 119, comma 6 della Costituzione, ma per finanziare l’estinzione del precedente derivato.

i. Per quanto concerne la natura speculativa dei contratti, in base ad un’analitica ed approfondita analisi della Sentenza delle Sezioni Unite n. 8770/2020 nonché del quadro normativo e giurisprudenziale italiano e del panorama giurisprudenziale inglese, il Giudice conclude che "un tribunale italiano avrebbe chiaramente ritenuto che le Operazioni fossero speculative".

Il Giudice ha ritenuto che il costo di estinzione del precedente derivato avesse avuto un considerevole impatto negativo per il Comune sulle condizioni contrattuali pattuite. Ciò testimonierebbe il carattere speculativo delle operazioni, le quali presentavano alla stipula un considerevole MtM negativo per il Comune (10,5 milioni) proprio a causa del costo di estinzione “assorbito” dalle componenti strutturali del nuovo derivato.

Nei contratti in parola, difatti, il collar presentava un significativo squilibrio a favore delle Banche: il valore del floor corrispondeva a cinque volte il valore del cap; il floor si attestava tra gli 80 e i 100 punti base in più di quanto sarebbe stato altrimenti. Il tasso di interesse minimo che il Comune si impegnava a pagare non era allineato alla curva dei tassi forward all’epoca della stipula, conseguentemente, la probabilità che il Comune perdesse denaro sulle operazioni era più elevata rispetto ai rischi che si sarebbe assunto considerando solo la passività sottostante.

In buona sostanza, come accade in molte operazioni che assorbono il MtM negativo di un precedente derivato, i livelli del collar non erano ancorati solo alle condizioni del debito sottostante, ma erano significativamente influenzati dai costi di chiusura del precedente derivato che venivano assorbiti nei nuovi contratti.

Ciò ha portato il Giudice inglese a ritenere le operazioni prevalentemente speculative.

ii. Le operazioni presentavano un ulteriore profilo di illiceità in quanto creavano ulteriore indebitamento per l’ente locale senza che tale indebitamento fosse destinato a finanziare spese di investimento come richiesto dall’art. 119, comma 6 della Costituzione.

Il Xxxxxxx Xxxxxx non ha ritenuto sufficiente, come sostenuto dalle banche, considerare che il debito sottostante fosse stato emesso per finanziare una spesa di investimento e che il costo della chiusura del precedente derivato fosse parte di una transazione effettuata per ristrutturare tale debito. Al contrario, il Giudice ha considerato tale costo come un pagamento anticipato (upfront), incorporato nelle operazioni, il quale, in base ai principi enucleati dalle Sezioni Unite, costituisce un finanziamento. L'upfront in questione, tuttavia, era finalizzato a coprire i costi di chiusura del precedente derivato e non a finanziare spese di investimento come richiesto dall’art. 119, comma 6 della Costituzione. Per questa ragione, il Giudice ha ritenuto che le operazioni in parola siano state compiute in violazione dell’art. 119, comma 6 della Costituzione.

Il carattere prevalentemente speculativo insieme all’illeceità dell’ulteriore indebitamento sotteso alle operazioni ha portato il Xxxxxxx Xxxxxx a dichiarare la nullità e l’inefficacia dei contratti swap in quanto il Comune non aveva la legittimazione a contrarre, essendo, come noto, vietata agli enti locali italiani la stipula di operazioni speculative e il ricorso all’indebitamento se non per finanziare spese di investimento.

Non hanno, invece, trovato accoglimento presso la Corte inglese, fra le altre, le seguenti contestazioni:

- violazione degli articoli 42 e 192 del TUEL eccepita dal Comune sulla base dei principi riconosciuti dalle Sezioni Unite nella Sentenza n. 8770/2020 per cui le delibere di accensione degli swap devono essere adottate dal Consiglio Comunale in quanto spese che impegnano i bilanci per gli esercizi successivi e devono possedere determinati requisiti. Nel caso di specie il Giudice Xxxxxx salta la questione in base al diritto inglese, per cui la ratifica successiva delle operazioni da parte del Comune è stata ritenuta sufficiente a respingere le contestazioni.

- Violazione di norme imperative di diritto italiano azionabili dinanzi alla Corte inglese in virtù dell’art. 3, paragrafo 3 della Convenzione di Roma (“La scelta di una legge straniera ad opera delle parti, accompagnata o non dalla scelta di un tribunale straniero, qualora nel momento della scelta tutti gli altri dati di fatto si riferiscano a un unico paese, non può recare pregiudizio alle norme alle quali la legge di tale paese non consente di derogare per contratto, qui di seguito denominate ‘disposizioni imperative’”). La contestazione è stata respinta in quanto la disposizione citata non trova applicazione nel caso concreto per via di una serie di elementi "internazionali" che non consentono di riferire l’operazione esclusivamente all’Italia (ad esempio, sono state invitate a partecipare alle gare d'appalto per le operazioni di swap in parola delle banche straniere, le operazioni sono state concluse sulla base di una documentazione internazionale standard, una delle banche stipulanti ha concluso un'operazione back-to-back con una banca estera, le operazioni hanno comportato la chiusura di un precedente swap con una banca statunitense). Di conseguenza, il Xxxxxxx non ha affrontato in modo approfondito le questioni relative alla violazione delle norme imperative italiane, ma si è limitato ad alcune brevi osservazioni.

È interessante notare che, sebbene il Comune abbia diritto alla restituzione delle somme versate alle banche ai sensi delle operazioni dichiarate invalide, il Giudice ha ritenuto applicabile al caso di specie la cd. “change of position defence”, che consentirebbe alle banche di limitare tali pagamenti restitutori opponendo i pagamenti effettuati in virtù delle operazioni di copertura (cd. back-to-back).

In base a questa difesa, in linea di principio non disponibile nel nostro ordinamento, sarebbe iniquo richiedere la restituzione integrale dell’indebito oggettivo in quanto, successivamente alla stipula delle operazioni con il Comune, la posizione delle banche sarebbe cambiata per xxx xxxxx xxxxxxxxxx xx xxxxxxxxx assunte per coprire i rischi derivanti dalle operazioni con il Comune.

Il Giudice ha riconosciuto l’applicabilità di questa difesa al caso di specie al fine di stemperare le conseguenze che altrimenti deriverebbero dalla sentenza delle Sezioni Unite n. 8770/2020 “la quale porterebbe a considerare nulla fin dall'inizio un’operazione che entrambe le parti avevano considerato vincolante per quasi 13 anni".

Vedremo se e come tale eccezione renderà il ricorso alle Corti inglesi più favorevole per le banche in caso di riconoscimento della nullità dei contratti swap stipulati con enti locali italiani.

Neutral Citation Number: [2022] EWHC 2586 (Comm)

IN THE HIGH COURT OF JUSTICE

Case No: FL-2019-000012

BUSINESS AND PROPERTY COURTS (ENGLAND AND WALES) KING'S BENCH DIVISION

COMMERCIAL COURT

Royal Courts of Justice Xxxxxx, Xxxxxx, XX0X 0XX

Date: 14 October 2022

Before :

MR JUSTICE XXXXXX

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Between :

(1) BANCA

(2)

Claimants

- and

COMUNE DI

Defendant

- - - - - - - - - - - - - - - - - - - - -

XXXXXX XXXXXXX KC, XXXX XXXXXX and XXX XXXX (instructed by Pinsent Masons LLP) for the Claimants

XXXXXXX XXX KC, XXXXX XXXX and XXXXXX XXXXX (instructed by Xxxxxxx Xxxxxx LLP) for the Defendant

Hearing dates: 23, 27-30 June, 4-7, 11-14 and 19-21 July 2022

Further written submissions: 9, 15 and 21 September 2022 Draft judgment to parties: 3 October 2022

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Approved Judgment

I direct that no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic.

.............................

THE HONOURABLE MR JUSTICE XXXXXX

This judgment was handed down by the judge remotely by circulation to the parties’ representatives by email and release to The National Archives. The date and time for hand- down is deemed to be Friday 14 October 2022 at 10:00am.

Mr Justice Xxxxxx Approved Judgment

Mr Justice Xxxxxx :

A INTRODUCTION

1. In this case:

i) The Claimants (the Banks which expression, as the context requires, also extends to the Claimants’ predecessors in title) seek declarations that certain interest rate swap ( ) transactions (the Transactions) which they say they entered into with the Defendant ( ) on the terms of the 1992 ISDA Master Agreement are valid and binding, and alternative relief in contract and tort if it is found they are not.

ii) seeks declarations that the Transactions are not valid and binding (and consequential relief in unjust enrichment), and alternatively relief in contract and tort if it is found that they are.

2. Behind that simple symmetry lurks a complex set of questions raising disputes of pure fact, and of Italian and English law, some of them with potentially profound implications for the sanctity of English law contracts. By way of a very short introduction to those issues:

i) contends that, for various reasons, it lacked the substantive power to enter into the Transactions as a matter of Italian law, and that, applying English conflict of law principles, that means that it did not have capacity to enter into the Transactions and that they are not valid.

ii) The Banks deny that the entry into the Transactions contravened any provisions of Italian law, on the basis of arguments as to the effect of Italian law and its application to the facts of this case, and further deny that any such contravention would deprive of capacity to contract as a matter of English conflict of laws principles in any event.

iii) also contends that the Transactions breached various rules of Italian law which have the status of “mandatory rules of law” for the purposes of Article 3(3) of the European Union Convention 80/934/EEC (the Rome Convention) and that as a result the Transactions are void and/or unenforceable.

iv) On this basis, claims restitution of the net amounts paid under the Transactions to date. The Banks contend that they have a defence of change of position to these claims, and that claims are time-barred.

v) If the Transactions are valid and binding, alleges that the Banks owed a non-contractual advisory duty to assess the suitability of the

Transactions, which was breached, and that has suffered loss as a result.

vi) If the Transactions are not valid and binding, the Banks allege that was in breach of various contractual duties or is liable to it in respect of various misrepresentations and/or misstatements, for which they claim damages.

B THE EVIDENCE

3. There was evidence from six witnesses of fact.

4. For the Banks, I heard evidence from:

i) Mr , who at the relevant time was Head of the Debt Management Desk in the Seecond Claimant’s ( ) Public Finance Division in Italy;

ii) Mr who at the relevant time was Head of Local Authorities in the Debt Capital Markets Division in the Investment Banking Team at Banca , which formed part of the ; and

iii) Mr , who at the relevant time worked for Banca

as a relationship manager for the region of Northeastern Italy (which included ).

5. For , I heard evidence from:

i) Mr , who was the Director of Finance Department between 2000 and 2017; and

ii) Ms , who from 1999 to 2017 was the officer in charge of the Loan and Mortgage Office and reported to Mr .

also put into evidence a statement from Mr , who at the relevant time was a senior consultant at Xxxxx Italia SRL (Xxxxx Italia). This evidence was not challenged by the Bank.

6. I am satisfied that the factual witnesses were generally doing the best they could to assist the court, although I felt that Mr xxxxxxxx, when confronted with emails showing that the Transactions had been priced in part to recover the First Claimant’s ( ) contribution to the “Friends ” fund, involved an attempt to distance himself from any involvement in or admitted recollection of an embarrassing subject (see [15] below). All of the factual witnesses faced the great difficulty of being questioned about events which had taken place, in the main, in and before 2007, some 15 years on. The need to reconstruct matters which they could no longer recollect, and to do so in the context of litigation in which the parties held strongly adversarial positions in a dispute with significant implications for both of them, inevitably influenced the reliability of the witness evidence. As is frequently the case, the evidential value of contemporaneous documentation and the inherent probabilities was significantly greater than the witnesses’ oral evidence. That is as true of helpful answers drawn from a compliant witness under skilful cross-examination as it is of answers which support the case of the party who called the witness.

7. I heard expert evidence in three disciplines.

8. First expert evidence on Italian administrative/public law from:

i) Professor a Professor of Administrative Law at the University of Study of Rome “Roma Tre”, called by the Banks; and

ii) Professor , who was formerly a President of Administrative Law at the University of Padua, called by

9. Second, expert evidence on Italian civil law from:

i) Professor , Emeritus Professor of Civil Law at Università Roma, called by the Banks; and

ii) Professor S , a Professor of Banking Law and Financial Markets Law at the Università Cattolica del Sacro Cuore, called by .

10. The Banks submitted that both of Italian law experts were “unsatisfactory”, suggesting that:

i) Professor had a tendency to give “lengthy and discursive answers which failed to engage with the questions”, provided answers which went beyond the questions asked and failed “scrupulously to maintain her independence”, adopting “the role of an advocate for ”;

ii) Professor was reluctant to give direct answers to straightforward questions and tended to add “non-responsive” elaboration, and the court could not be confident that he “fully understood his duty to maintain his independence rather than adopt a partisan approach”.

11. In my view, those criticisms are not made out:

i) As a preliminary matter, they do not make appropriate allowance for the difficulties of experts being cross-examined on highly technical subjects through the intermediation of translation, with the attendant possibility of the intended meaning being lost at both stages of the translation exercise.

ii) I accept that (as with many expert academics addressing their own discipline) there were occasions when Professor gave longer answers than the process of cross-examination in a tightly time-tabled trial can allow for. This was exacerbated by a tendency for the questions put to her to “parse” topics into smaller elements, which Professor did not regard as informative in isolation. However, she responded to the court’s request that she seek to give shorter answers whenever possible. I am satisfied that in answering questions in the way in which she initially did, Professor was not seeking to avoid answering the questions or to be unhelpful – indeed quite the opposite.

iii) Further, there was something of a clash of “the two cultures” when Mr

XX sought to test the evidence of both Italian law experts by reference to its implications for the practicalities of entering into swap transactions or the security of such transactions, considerations which those experts did not regard as relevant to the issues they had been asked to address or within their expertise.

iv) I do not accept that any of the experts (on either side) deliberately sought to withhold what they believed to be relevant materials from the court.

v) The reality is, as I explain below, that the Italian Supreme Court has expressed views which would involve a fundamental restatement of a number of the issues of Italian law debated in this case. Many respectable Italian scholars approve of that development (as is clear from some of the commentaries placed before the

court), and in any event are prepared to treat that reformulation as the best statement of Italian law as it now stands. Professors and

are among their number. Others (including Professors ) do not share that view, believing that the Supreme Court has sought to derive legal doctrines from legislative sources which those instruments cannot support, and has interpreted other court decisions in ways they do not regard as tenable.

vi) That difference in view, and the reasons for it, were always going to give rise to fundamentally different approaches by the experts to the issues of Italian law in this case: Professors and inevitably sought to rely on the (significant volume of) recent court decisions which have tended to favour arguments, and Professors to emphasise the legislative provisions and administrative decrees whose meanings, in their view,

have been distorted or misunderstood by those recent decisions.

vii) That does not make the evidence of any expert partisan. I am fully satisfied that the views expressed by Professors and (like those of Professors ), be they right or wrong, are genuinely held, and fall within the spectrum of legitimate academic opinion on these difficult topics.

12. Both parties added additional Italian law authorities to the trial bundle in the period after the experts’ reports were filed, and in case after expert cross-examination had been completed. I am satisfied that I am entitled to have regard to these decisions, not for any cogency in their reasoning, but as an indication of how in practice the Cattolica case (see [73] below) is currently being applied by Italian courts (the issues of principle having been fully ventilated with the experts).

13. Finally, I heard expert evidence on transactions from:

i) Mr Xxxxxxxx (and formerly Global Head of Derivative Counterparty Risk Management Solutions with ), called by the Banks; and

ii) Ms , an expert advisory service for clients seeking to enter into transactions, called by .

14. As I explain at [219]-[221] below, I was not assisted by the experts’ views on whether or not the Transactions were speculative (and, in fairness to Mr and the Banks, that has been their position throughout, including when seeking to resist permission for this evidence). In relation to the financial evaluation of the Transactions, there was limited dispute between the experts, and I found the evidence of both of them of assistance.

15. On the issue of the reasonableness of the pricing of the Transactions, I accept Mr evidence that the price was within the range of reasonable prices on offer at the

time of trade, given his greater experience of derivative trading in the international swaps market at the relevant time as compared to Ms . I have reached that conclusion even though I accept that the Banks’ margin had been formulated in part to cover the cost of the contribution which had agreed to make to the ‘Amici di or ‘Friends ’ fund. That emerges clearly from Mr emails

of 14 May and 13 December 2007, Mr emails of 18 October and 20 December

2007 and Mr

of Banca

email of 30 October 2007 (Banca

being

Intesa’s predecessor in title as explained at [18] below). I suspect that factor moved profit, in particular, to the upper end of the reasonable range, because it was

not making any such contribution but benefited from the terms intended to recover the contribution which was making. However, it must be kept in mind that the Banks’ offering was chosen after a competitive tender process in which a number of banks participated.

16. The Banks also submitted that Ms evidence was “unimpressive and unsatisfactory” in a number of respects and that her evidence bore “the hallmarks of a partisan witness” (with the result that, from the Banks’ perspective, had been singularly unfortunate or ill-advised in calling three experts, none of whom properly understood or adhered to their duty of independence). Once again, I am satisfied that this particular criticism was not fair. However, I accept that aspects of Ms evidence on the question of whether the Transactions were speculative were difficult to follow or counter-intuitive, which reflected a combination of the inherent unsuitability of that topic for expert evidence, and the fact that certain of the contentions Ms

put xxxxxxx appeared to have been formulated for the first time in the course of cross- examination.

C THE FACTS

17. The parties were able to agree a factual narrative which covered most of the background facts, leaving a relatively limited area of factual dispute. This section of the judgment draws very heavily on that factual narrative, for which the court is very grateful. It then sets out my findings on the limited disputes of fact which arise.

The Parties

18. and are Italian companies carrying on business as banks. is a company within the of companies, which has also includes Banca p d

. is the successor in title of Banca .

19. At all material times, the Banks were authorised and regulated by the Bank of Italy and were ‘authorised intermediaries’ within the terms of Italian Legislative Decree No. 58 of 24 February 1998 and CONSOB Regulation No. 16190 of 29 October 2007 (which entered into force on 2 November 2007).

20. is an Italian municipal authority.

The Governance Structure of

21. The governance of is exercised by:

i) The City Council of (the City Council). The City Council is the democratically elected body of the municipality. I accept Professor

evidence that the City Council’s function was to set policy, but that it was not an executive body.

ii) The executive body (the City Board) comprised of the senior civil servants (the Directors) who were responsible for implementing policy as determined by the City Council. The key Director in this case was the Director of the Finance Department, Mr .

The Bond and the

22. On 25 November 2002, the City Council of passed City Council Resolution no. 194 (Resolution 194) pursuant to which the City Council resolved, amongst other things:

“b. to authorise the issue of one or more bond loans for a total of total of

€156,082,620.00, including placement commissions, for the reasons indicated in the introduction, and the features and terms of which are set out in Annex A to this resolution and form an integral and substantial part thereof, thus also authorising swap transactions where necessary and appropriate to hedge any interest rate fluctuations …

d. to delegate to the Central Finance and Budget Directorate the drafting of all the acts resulting from this resolution and the negotiation and signing of the relevant transactions and contractual documentation.”

23. The bond to be issued became known as the Bond.

24. On 20 December 2002, agreed to an transaction with Bank plc ( ) in connection with the obligations which was to assume under the Bond (the ). The terms of the , as originally entered into, included the following:

i) The notional value was equal to €156,082,000 (i.e., the amount of the

Bond) for the initial Calculation Period, and then reducing in accordance with the table at Appendix 1 of the confirmation.

ii) The maturity date was 23 December 2005, with interest payable in June and December each year.

iii) would receive from the 6-month EURIBOR variable rate plus 17 basis points (0.17%).

iv) would pay the USD-LIBOR-BBA variable rate plus 95 basis points (0.95%), with a cap at 5.55% and a floor at 1.3%.

25. On 23 December 2002, issued the Bond, which comprised 20-year floating rate bond notes, under which the principal amount due was €156,082,000. The notes were due to mature on 23 December 2022, bearing interest from and including 23 December 2002 at EURIBOR plus 0.17% payable semi-annually in arrears on each interest payment date.

Director of

26. An Executive Resolution no. 185 (signed by the Department, Mr ) approved the terms of the

Finance

27. The was subsequently amended. On 17 April 2003, a further fixed

income derivatives confirmation was issued under the which had the same terms as the original

Master Agreement save that it extended the

payable by

termination date until 23 December 2006 and amended the floor rate to between 1% and 1.25% (depending on the period). Executive

Resolution no. 1126, signed by terms of the amendment.

Finance Director (Mr

) approved the

28. On 6 August 2004, the was further amended by a fixed income

to:

derivatives confirmation with an Effective Date of 23 June 2004 which reduced the nominal amount to EUR 148,089,040.78 for the Initial Calculation Period and then in accordance with a Schedule of Notional Amounts attached to the confirmation. This confirmation also extended the termination date of the until 23 December 2022 and amended the variable rate payable by

i) for the period from 23 June 2004 until 23 December 2006, 6-month EURIBOR minus 5 basis points, with a cap of 6% and a floor of between 2.1% and 2.5%;

ii) from 23 December 2006 until 23 December 2022, 6-month EURIBOR with a variable spread falling from 1.50620% to -0.1997%, subject to a cap rate of 7% and a barrier rate of between 3.944% and 5.662% (depending on the period) where, if 6-month EURIBOR fell below the barrier rate, would pay 5.45%.

29. An Executive Resolution no. 2170, signed by Finance Director (Mr ) approved the terms of the amendment.

30. performed all of its obligations under the , including in particular its payment obligations thereunder, up until the date of the restructuring of the Bond.

Proposals to Restructure the Bond

31. In April 2007, held a tender process to invite proposals for restructuring the Bond so as to free up resources in the Municipality’s balance sheet, and for a derivative to be associated with the restructured bond. sent notices to seven banks, including the Banks, inviting them to submit restructuring proposals for the Bond and the . These were signed by Mr and stated:

“This Administration, in order to free up resources in the Municipality’s balance sheet, intends to proceed with the restructuring of the 20-years bond named “ ” issued in December 2002 with Bank for an amount equal to Euro 156.082.000,00. For this reason, the Administration invites this financial institution to formulate within the 19 c.m. a proposal to remodulate the above- mentioned debt, whose outstanding amount is as of today equal to Euro 129.267.112,40, containing the following main characteristics:

• Extension of the maturity from 2022 to 2037;

• Profile of amortization of the “amortizing” capital;

• Recovery of the resources in 2007 and 2008 with respect to the actual situation of circa Euro 7.000.000,00 for each year;

This administration also kindly request the financial institution both to deliver a proposal for an eventual derivative’s transaction relating to the xxxx’x issuance and to communicate its rating.”

It is attached to this communication:

• Amortization plan of the bond “ ”;

• Swap contract in place at the moment.

Moreover, this Administration considers completing its request by establishing a partnership relationship. The membership to the “Club dei Amici di

[Club of the Friends of ] recently established and which for the time being count the accession of three companies leaders in their field, allows the new “Friend” to become a partner of and focus its communication on the image of the city, in this way actively operating to safeguard the city’s cultural, artistic assets and traditions. The status of Friends of determines a partnership relationship with the Municipality of at least three years. To those companies which decide to become members, it is requested a minimum financial contribution equal to Euro 900.000,00 to be made during the entire relationship in exchange for the great visibility offered. The communication plan can be conveniently adapted to the specific needs of the company.”

32. On 19 April 2007:

i) Xxxxx wrote to with an offer to restructure the Bond, comprising an advisory stage (involving assisting in calling and organising the meeting of bondholders) and a subsequent stage, including the cancellation of debts under the . The letter stated that if the “offer proposal” is accepted, the bank would undertake to carry out various activities including:

“Advise on the completion of operations involving derivative financial instruments aimed at optimizing the cost of the bond issue."

ii) wrote to with a debt restructuring proposal presentation which contained a renegotiation proposal for the Bond and a swap restructuring proposal. indicated that it would be prepared to operate with other banking counterparties.

33. On 8 May 2007, sent letters to the Banks asking whether it was feasible for them to offer improved terms with regard to the Bond restructuring and the membership of the “Club of the Friends of ” (effectively a municipal fund to which businesses transacting with were asked to make contributions).

34. On 14 May 2007, the Banks submitted a joint written proposal to headed ‘Debt Restructuring Scenario’ regarding the restructuring of the Bond and the

(the Joint Proposal). The Joint Proposal envisaged two phases:

i) the provision by the Banks of assistance to in relation to the calling and

organising of a meeting of the plan would be presented; and

ii) the entry into by the Banks and

Bond holders, at which a debt restructuring of transactions to replace the

By a cover letter enclosing the Joint Proposal, as a contribution to join the Amici di

offered to pay €930,000 to (Friends of ), conditional on

execution of the bond and derivative restructuring.

35. On 28 May 2007, wrote to the Banks stating:

“Please note that after carefully examining the offers received concerning the restructuring of the ‘ ’ bond and participation in the ‘Friends of

Club’, the Administration has decided to award the aforementioned transactions to your bank. You will be contacted in the coming days to proceed with task.”

36. On 29 May 2007, the Banks gave a presentation to on the consent solicitation process required for the Bond restructuring. The consent solicitation process involved the identification of, and engagement with, the Bond holders for the purposes of approving the restructuring and the drafting of the necessary documentation.

37. On 21 June 2007, the City Board passed Resolution no. 345 which resolved that the Banks be given a joint mandate “in the role of Co-Arranger, Co-Consent Coordinator and Dealers for the performance of organisation and restructuring of the [ Bond] [in] particular concerning the lengthening of the maturity of [notes] to 2037 and the [restructuring] of the [ ].”

38. On 19 July 2007, the Banks and entered into a written agreement with (the Mandate Agreement), which by Article 9 provided for choice of Italian law and the jurisdiction of the Court of . The Mandate Agreement provided, inter alia, as follows:

i) granted the Banks (and ) a joint mandate for the ‘Operation’ in the role of Co-Arrangers, Co-Consent Coordinators and Dealers: Article 1.

]

ii) Recital C defined the ‘Operation’ as “a proposal to restructure [ consisting of the renegotiation of the financial terms and conditions of the [

debt,

Bond], also through an extension of the maturity from 2022 to 2037, and the remodulation of the overlying derivatives operation”.

iii) By Article 1, undertook to negotiate in good faith exclusively with the Banks (and ) as swap counterparties on the terms and conditions for the execution of the restructuring of the derivative position in relation to the

Bond.

iv) No commission would be payable by to the Banks for the services to be provided under the Mandate Agreement: Article 2.

v) The Banks’ mandate was exclusive and would last until 29 February 2009. In the event that the City Council did not approve the ‘Operation’, the mandate would lapse: Article 7.

There is a dispute over whether or not Article 3 of the Mandate Agreement required the Banks to advise on the restructuring of the derivative position.

39. In around July 2007, the Banks instructed and instructed Xxxxxxxx Law Firm (Xxxxxxxx) in relation to the proposed Transactions. In late August and September 2007, and Xxxxxxxx exchanged comments on a draft resolution for the City Council.

40. Banca and both entered into the Mandate Agreement given that they both carried out activities in relation to public finance and it was not clear at the time what the eventual corporate structure of the would be.

41. On 13 September 2007, representatives of the Banks met with to discuss the restructuring of the Bond and the , following adverse press comment on those transactions. asked the Banks to submit a document explaining the restructuring. Accordingly, that evening, (Mr ) emailed (Ms and Mr ) a memorandum named ‘Final CM ’. The memorandum described the objectives that aimed to achieve with the

restructuring of the Bond as follows:

“1. To extend the maturity of the bond by an additional 15 years from 2022 to 2037 (extending the average financial life from the current 8 to 20 years), thereby achieving a more convenient rescheduling of budgetary commitments;

2. To benefit from the extension of the loan at competitive conditions related to the new duration, with a maximum indicative coupon equal to Euribor 6m + 23 bps;

3. To free up resources of about €12 million in capital until the end of 2008.”

42. The 13 September 2007 memorandum also stated in relation to the restructuring of the

“Following the acceptance by the bondholders of the proposed new terms and conditions and therefore the renegotiation of the bond loan, the Municipality will also carry out the restructuring of the derivative entered into in 2004 with

whose underlying item is the international issue in question. The legislation (Article 3 of the Circular of 27 May 2004 explaining Ministerial Decree No. 389 of 2003) provides, inter alia, that “in the event of a change in the underlying liability of a derivative, for example because it has been renegotiated [...], the position in the derivative instrument may be readjusted on the basis of conditions that do not result in a loss for the Body.

Article 3(f) of the same Decree No. 389 further provides that the flows received by institutions through derivative transactions must be equal to those paid in the underlying liability.

Therefore, the Municipality, in unwinding the existing derivative, will refer to the relevant legislation in force, pursuing the objectives of an efficient active debt management and adjusting the existing derivative not only to the new underlying but also to the changed market conditions.”

The Resolutions of the City Council and the Finalisation of the Terms of the Proposed Transactions

43. On 25 September 2007, the City Council issued Resolution no. 129 (Resolution 129). The Recital to Resolution 129 recorded, amongst other things, that:

“Given that the Programmed Forecast Report for the 2007-2008 three-year period, attached to the 2007 Budget approved by Council Resolution No. 19 of

26 February 2007, provides for the active management of debt among the objectives to be achieved in the field of financial policies;

….. Considering that, with [Resolution 194] the City Council authorised the issuance of the [ Bond];

Given the resolution of the Municipal Board of 21 June 2007, No. 345 (mandate for the performance of the restructuring of the [ Bond]) through which the aforesaid Council, in execution of the aforementioned Budget Report, after selection by invitation of primary banking institutions, activated with note protocol No. 160285 of 12 April 2007, jointly gave mandate to [ and the Banks], as Co-Arrangers, Co-Consent Coordinators and Dealers in relation to the restructuring of the [ Bond];

Considered, in particular, that the joint proposal received from the aforementioned credit institutions provides for the possibility of modifying certain terms and conditions of the [ Bond], including the extension of the maturity of the securities, from the current one scheduled for December 2022 up to a maximum maturity of 2037, the change in the interest rate margin, as well as the restructuring of the derivative transaction to cover the interest rate risk associated with the aforesaid issue;

Considering also that the above proposal is subject to the interest in the renegotiation of the terms and conditions of the bond in question by the present holders of the bonds;

Considered that the aforementioned proposal is of interest to the Municipality of in consideration of the current levels of long-term interest rates and the

fact that the City could achieve savings on the service of the debt by means of the aforesaid amendment to the terms and conditions of the debenture loan;

Considering that the Municipality of , as stated by the [Finance Director] is not in a situation of disruption or in structurally loss-making situations as defined by Article 242 of the Legislative Decree No. 267 of 18 August 2000, and that no budget deficits are recorded in the penultimate final balance;

Considering that all the costs foreseen for this operation are included in the budget for the current year; Without prejudice to the fact that, following the restructuring

and renegotiation of the loan, a new financial amortisation plan must be prepared for the restructured debenture loan (Annex 1)… .”

44. Resolution 129 recorded that the total reduced expenditure of minus €3,500,000 included €3,100,000 which was “the partial use of the savings deriving from the restructuring of the [ Bond]). Savings that will also be reflected in the 2008-2009 budgets”. By Resolution 129, the City Council resolved (amongst other things) to:

i) authorise the changes to the terms and conditions of the Bond (Resolution 7);

ii) “also authorise the restructuring of the existing derivative transaction in relation to the [ Bond] in the most appropriate forms, including the replacement of the original counterparty with the banking institutions appointed as Co-arrangers, Co-consent Coordinators and Dealers indicated in the recitals in relation to the [Rialto Bond] referred to in point 7 above), also proceeding to the drafting of the relevant ISDA contract, if applicable” (Resolution 8);

iii) authorise the Finance Department to carry out all the acts resulting from Resolution 129 (resolution 9), including:

“d. the negotiation and execution of the documentation necessary for the restructuring of the derivatives transaction relating to the same debenture loan, in compliance with the provisions of Article 41 of Law no. 448/2001 and the related implementation provisions, including the ISDA documentation (Master Agreement and Schedule) with the new “Swap” counterparties referred to in point 8 above, as well as the definition of the final terms and conditions of these restructuring transactions.”

45. On 17 October 2007, and the Banks entered into a Consent Solicitation Agreement, pursuant to which appointed the Banks ( ) as exclusive Co- Consent Coordinators in connection with the restructuring of the terms and conditions of the Bond. By clause 4, the services of the Co-Consent Coordinators were to be performed for no consideration.

46. On 26 October 2007, Mr emailed (Mr ) asking for an update on the convening of the bondholders’ meeting and noting that the position in relation to the also needed to be clarified and saying;

“I would like to remind you that the City Council asked me to be supported in the choices we make by a third party, which we identified as Xxxxx Italia”.

47. On 2 November 2007, Italian legislation transposing Directive 2004/39/EC (MiFID) came into force in Italy.

48. Banca and entered into an undated Investment Services Agreement (the ISA), which contained, amongst others, clauses providing for the choice of Italian law and the jurisdiction of the Italian courts: Article 15(1)-(2). A version of the ISA was circulated for signing on 14 December 2007.

49. By letters dated 10 December and 14 December 2007, (respectively) informed that they had classified

and Banca

as a retail customer

pursuant to MiFID. On 14 December 2007,

(Ms Xxxxxxxx) emailed

(Mr

and Ms XxXXX, and enclosing

) concerning the obligations on financial intermediaries under an “information brochure” containing various documents,

including a “customer classification letter” and a “client profiling questionnaire”. The Banks sent draft transaction documents to Xxxxxxxx on the 18 December 2007.

50. On 13 December 2007, Mr passed an Executive Resolution resolving to commit €50,000 for activities related to “active debt management” in connection with the Bond restructuring referring to, amongst other things, Xxxxxxxx and Xxxxx Italia.

51. On 14 December 2007, Xxxxx Italia provided with a proposal for technical assistance in relation to the restructuring of the hedging strategy for the Bond. Mr accepted the proposal by an email of 17 December 2007. Also on 14 December 2007, the Banks provided with a letter to send to

requesting assignment of the , and contact details of the relevant person at .

52. On 17 December 2007, Ms emailed the Banks to inform them that would be supported by Xxxxx Italia in relation to the restructuring of the hedging arrangements for the Bond.

Bond.

53. By a letter dated 17 December, formally notified of intention to restructure the swaps position in relation to the

54. On 18 December 2007:

i) Banca ( ) sent an email to Xxxxx Italia (Mr ) attaching the Confirmation and the term-sheet for the Transactions.

ii) Mr spoke to Mr of Xxxxx Italia, and then reported that Mr

had been surprised at the tight timetable for the closing of the derivative, about which he said he had not been notified by .

iii) Ms xxxxx Banca a copy of Resolution 129.

iv) Mr xxxxxxxxx (Mr ) asking it to give consent to request to transfer the to the Banks.

v) Mr Xxx Xxxxx completed a ‘Retail Customer’ questionnaire for Banca Opi, which, amongst other things, identified objectives as “Optimising the financial management of existing transactions, also taking limited risks”, and described

interest rate expectation as being “stability or an increase”.

vi) Mr also completed a “MiFID – Customer Profiling Questionnaire: Debt Management” for which recorded amongst other things, that was familiar with “Plain vanilla derivatives (including products with cap and floor options)”, that its valuations underlying financial choices were usually made “by an internal structure”, that derivative transactions were monitored “with the

support of an external structure”, and that the objectives of its debt management strategy included both “containing the cost of debt within a predefined range, including through its stabilisation at a constant level”, and “Reducing the cost of debt by accepting the possibility of its potential increase”.

55. On 19 December 2007:

i) Executive Resolution no. 3553 signed by Finance Director approving the terms of the restructured Bond was included in the Register of the Resolutions of the Manager.

ii) Banca (Ms ) emailed and its advisors setting out the procedural steps to be taken in order to effect the Transactions.

56. The restructuring of the Bond was concluded on 20 December 2007, following the bondholders’ meeting at 11am CET that day at the offices of Clifford Chance in Rome, which approved the new financial characteristics of the bonds. In particular, the maturity date of the bonds was extended to 2037 and the coupon from December 2007 onwards was to be 6-month EURIBOR plus 0.21%. In order to enable the restructuring to proceed, had purchased outstanding bonds and participated in the vote as bondholder, to ensure that the quorum of 75% was reached.

57. Also on 20 December 2007:

i) Mr passed Executive Resolution no. 3561 which provided:

“Object: Execution of the derivative transaction in relation to the restructuring of the bond of EUR 156.082.000,00 entered into on 20 December 2007 – Implementation of the Municipality’s Council resolution no. 129 of 25 September 2007…

Having considered that on 20 December 2007 the Municipality of

has restructured the 30-years floating rate bond whose original amount was qual (sic) to EUR 156.082.000,00, as resolved by the Council Resolution no. 129 of 25 September 2007;

Having considered that the Municipality’s Council Resolution no. 129 of 25 September 2007, which authorized the Municipality of to proceed with the restructuring of the abovementioned bond, also authorized the Finance and Accounts Interdepartmental Office to restructure the derivative transaction associated with such bond to hedge the interest rate risk;

Having regard to the Municipality’s Board Resolution of 21 June 2007 no. 345, which conferred a joint mandate to Banca

, Banca . and . as Co- arranger, Co-Consent Coordinators and Dealers for the restructuring of the bond as well as the restructuring of the derivative transaction associated with the bond;

Having acknowledged that, in agreement with the swap counterparties (Banca , e ) have been agreed the terms of the derivative transaction whose underlying is the bond mentioned above, as well as the final versions of the relevant Confirmation, the ISDA Documentation (Master Agreement and Schedule) and the Novation Confirmation, which will be used for the assignment to Banca and of the swap contract currently in place between the

Municipality and ;

Having recognised the need to approve the final versions of the aforementioned agreed documents;

Having considered that the abovementioned documentation shall be sent to the Ministry of Economics and Finance pursuant to Article 1, para. 737 of Law no. 296 of 27 December 2007 and relevant Circular dated 31 January 2007, as condition precedent for the effectiveness of the transaction.

DETERMINES

1. to approve, in compliance with the Municipality’s Council resolution no. 129 of 25 September 2007, the terms and conditions of the derivative transaction, as better described in the Confirmation attached hereto;

2. to approve the execution with Banca and of the contractual documentation relating to the transaction (ISDA Master Agreement and relevant Schedule, Novation Confirmation and Confirmation) in the versions attached hereto and which form an integral part of the present resolution.”

ii) (Ms ) emailed a letter headed “Information document on the nature and risks relating to transactions in derivative financial instruments

/swap” (which Mr signed).

iii) (Mr ) emailed to request the assignment of the

to the Banks, and (Mr ) emailed a draft of the novation confirmation the Banks proposed to use.

iv) (by a letter signed by Mr ) wrote to the Italian Ministry of Economy and Finance (MEF) notifying it pursuant to Article 41(2)(ii) of Law no. 488 of 2001 (as amended by Article 1, paragraph 737 of Law No. 296/2006) of the restructuring of the Bond and the Transactions. The letter attached (among other things) the draft Transaction Documents (the Transaction Documents) and stated:

“Following the renegotiation of the above-mentioned international bond effective as of today, it is necessary (including under Article 3, paragraph 3 of Italian Ministerial Decree of Economy and Finance No. 389/2003 and the Ministerial Circular of 27 May 2004 and as specified by Article 1, paragraph 736 of Italian Law No. 296/2001 and the relevant circular of the Ministry of Economy and Finance of 31 January 2007), to restructure the

The Transactions

derivative transaction entered into on 19 December 2005 in respect of the bond itself to adapt the swap to the new financial characteristics of the underlying bond.

The Municipality, following an informal call for tenders in accordance with Articles 19 and 27 of Italian Legislative Decree No. 163/2006, on 28 May 2007 appointed [the Banks] as of Co-Arranger, Co-Consent Coordinator and Dealers in in relation to the restructuring of the “ ” bond issue and the subsequent restructuring of the outstanding derivative transaction for the completion of the renegotiation of the abovementioned bond and for the restructuring of the of the related derivative transaction. Therefore, it is the intention of this City Council to proceed on 20 December 2007, with the restructuring of the above-mentioned swap contract (also following their assignment) and the conclusion of a new swap (the “Transaction”), all with a view to optimising the cost of issuing the international bond under the new terms and conditions resulting from the renegotiation of the latter. It should be noted that this City Council has decided to finalise the interest rate swap transaction, not for speculative purposes, but solely for the purpose of the hedging interest rate risk and for the proper management of its liabilities. It should also be noted that the above transactions are carried out on underlying amounts that are actually due from the Public Entity.”

58. On 21 December 2007, of:

i) an ISDA Master

entered into the Transactions with the Banks in the form

Agreement with accompanying schedules with each of the

Xxxxx, in English (together the Master Agreement); and

ii) a confirmation for each of the Banks recording the terms of the relevant trades, in Italian (together the Confirmation).

), Mr

behalf of

) and Ms

59. The economic terms of the Transactions were agreed on a trade call prior to the execution of the Transactions on 21 December attended by Mr (on behalf of nd A (on behalf of ), Mr (on

of Xxxxx Italia.

60. Xxxxx Italia produced a report for entitled ‘Derivatives: Risk Management and Market Value – Municipality of which bears a date of 21 December 2007 (the Xxxxx Report) and an NPV report. There is a dispute as to when the advice reflected in this report was provided by Xxxxx Italia to and as to whether the report was provided by Xxxxx Italia to prior to the conclusion of the Transactions or not until 2008. My findings in relation to that issue are set out at [89]-[100] below.

61. The basic terms of the Transactions were as follows:

i) The Trade Dates were 21 December 2007, the Effective Dates were 23 June 2007 and the Termination Dates were 23 December 2037.

ii) The initial Notional Amount on the Confirmation was €85,154,842.96,

decreasing in accordance with the amortisation schedule at Annex A to the Opi Confirmation. The initial Notional Amount on the Confirmation was

€40,072,867.28, decreasing in accordance with the amortisation schedule at Annex A to the Confirmation.

iii) agreed to pay the Banks interest on the Notional Amounts (from time to time) as follows:

a) For the period 23 June 2007 to 23 December 2007, at a variable rate equal to 6 month Euribor plus 0.17% per annum.

b) For the period from 23 December 2007 to 23 June 2010:

i) At a Nominal Annual Fixed Rate of 4.67% if 6 month Euribor was less than or equal to the ‘strike floor’ of 4.5%;

ii) At a variable rate equal to 6 month Euribor plus 0.17% per annum if 6 month Euribor was greater than 4.5% and less than or equal to 6.50%; or

iii) At a Nominal Annual Fixed Rate of 6.67% per annum if 6 month Euribor was greater than the ‘strike cap’ of 6.5%;

c) For the period from 23 June 2010 to 23 December 2037:

i) at a Nominal Annual Fixed Rate of 5.465% if 6 month Euribor is less than or equal to the ‘strike floor’ of 5.255%;

ii) at a variable rate equal to 6 month Euribor plus 0.21% per annum if 6 month Euribor is greater than 5.255% and less than or equal to 6.79%; or

iii) at a Nominal Annual Fixed Rate of 7% per annum if 6 month Euribor was greater than the ‘strike cap’ of 6.79%.

d) The Banks agreed to pay interest on the Notional Amounts (from time to time), as follows:

i) at a variable rate equal to 6 month Euribor plus 0.17% per annum for the period 23 June 2007 to 23 December 2007; and

ii) at a variable rate equal to 6 month Euribor plus 0.21% per annum for the period from 23 December 2007 to 23 December 2037.

e) The Payment Dates would be every 23 June and 23 December, commencing on 23 December 2007 and ending on 23 December 2037.

f) The Calculation Periods were 6 month periods, from 23 June 2007 to 23 December 2037.

62. The Novation Agreement between

Novations) provided that:

i) 68% of the Notional Amount of the

€85,154,842.96, be assigned from a fee of €5,484,200.

ii) 32% of the Notional Amount of the

€40,072,867.28, be assigned from

, and the relevant Bank (the

, which was equal to to Banca in consideration for

which was equal to in consideration for a

fee of €2,580,800 paid from to .

63. The effect of the Novations was therefore to reduce the notional amount of the to zero in return for the payment of fees by the Banks to

Xxxxx paid the fees to pursuant to the Novations.

64. Also on 21 December 2007, the Banks entered into back-to-back hedging transactions as follows (together, the Hedging Swaps):

The IRS

i) Banca

ii)

entered into a back-to-back

with Banca

with

;

(a division of

25 June 2003.

1992 ISDA Master Agreement with

is dated

65. Following the execution of the Transactions, Xxxxxxxx provided final versions of the Transaction Documents to for delivery to the MEF.

66. On 17 January 2008, (acting by Mr ) sent a further letter to the MEF enclosing executed versions of the Transaction Documents and noting:

“With respect to this derivative transaction, it should be noted that the underlying debt transaction for an original amount of EUR 156,082,000.00 (ISIN code XS0160255856) was restructured on 20 December 2007 with an extension of the maturity date to 23 December 2037 at a variable rate equal to the six-month Euribor plus 0.21 p.p.a.”

Post-Transaction Events

67. On 24 January 2008, of Xxxxx Italia submitted a draft report to (which has not been disclosed) concerning the restructuring of the Bond and

. The content of the draft report was considered by in emails during February 2008.

68. On 31 October 2008 the President of the VIII Commission of the City Council asked Mr to provide information concerning all of derivatives, and clarification of whether there were any implicit costs:

“due to low incoming cash flow against the risks of the derivative transactions in place, and what costs were incurred to exit the bond issue after endless restructures following the first contract signed in 2002 with , converted on 20 December 2007 into a new derivative, this time with

- Bank with maturity 23 December 2037”.

69. The letter stated that in the writer’s opinion the

did not adhere to hedging purposes, and asked Mr

the Transactions were binding and/or whether could

and swaps with

to verify whether have legal grounds to

cancel the Transactions on the ground that they were speculative.

70. Since the entry into the Transactions, the total sum paid by to pursuant to the Transaction as at 1 June 2022 is €22,156,492. The total sum paid by

to pursuant to the Transaction as at 1 June 2022 is €48,957,048.

71. The City Council passed resolutions approving annual financial statements for each of the years ending 31 December 2007 to 2021 inclusive. Each of

financial statements from 2007 to date has made provision for the performance of obligations under the Transactions and included a statement describing the Transactions (and other derivative transactions to which was a party), including

their anticipated costs and mark-to-market (MTM) values.

72. By a resolution of 21 June 2018, the City Council authorised the Mayor of to bring a civil liability action against the Banks in respect of derivative transactions entered into with

73. On 12 May 2020, the Joint Sections of the Italian Supreme Court of Cassation (the Supreme Court) issued Decision No. 8770/20 between BNL – Banca Nazionale del Lavoro S.p.A and the Municipal Authority of Cattolica (Cattolica). That decision has generated a new wave of Italian swaps litigation in the Commercial Court, and understandably featured prominently in the arguments advanced at the trial. The Supreme Court is the highest civil court in Italy (the highest administrative court being the Council of State).

74. On 10 December 2020, sent letters to and stating that would continue to make the payments envisaged by the Transaction Documents, but that the further payments which it intended to make did not constitute an admission of the validity of the Transaction Documents or prejudice claim in these proceedings that the Transaction Documents were a nullity.

D MY FINDINGS ON THE KEY FACTUAL DISPUTES

75. There were three principal factual areas of dispute. I set out my findings on each of them in this section.

Knowledge and Sophistication so far as Derivative Transactions are Concerned

76. I am satisfied that (and in particular Mr ) had some knowledge and experience of swap transactions before it began its discussions with the Banks in relation to the Transactions, but that it would not be accurate to describe as a “sophisticated” investor. While Mr and Ms were able, in directional terms, to understand the significance of the movement of interest rates in a particular direction on the cap and floor of the Transactions, and when would be “in” and “out” of the money (and thus the basic principles of a collar), they were not able to:

i) arrive at any quantitative assessment of the likelihood of that happening;

ii) assess the MTM of the floor, cap or the Transactions;

iii) reach an informed view of their own of the likelihood of interest rates rising above the cap or falling below the floor during the life of the Transactions; nor

iv) assess the effect of covering the negative MTM of the within the proposed terms on the economics of the Transactions.

77. Such experience as Mr did have was derived from the previous derivative transactions which had undertaken:

i) the , which also had a collar structure and was therefore a structured rather than “vanilla” swap, and the two amendments thereto negotiated in 2003 and 2004; and

ii) three other derivatives contracts: two with (executed in May 2004 and March 2007), and one with (executed in April 2005), for which Mr was once again responsible.

78. I also accept that through those transactions, Mr had acquired some knowledge of the terms of the ISDA Master Agreement.

79. That understanding led to describe its knowledge of financial instruments as “medium” in the MiFID customer profiling questionnaires which it completed for the Banks. That meant it understood “the characteristics of the fundamental instruments/financial products” and “the fundamental risks and threats”. On the basis of its previous swaps experience, I can understand why answered in these terms.

80. However, as a local authority, there were understandably considerable limits to understanding of transactions which had only become open to local authorities

in 2001. Mr D and Ms were civil servants without experience in the financial markets, and in 2007 Finance Department comprised only three personnel. I have seen nothing to suggest that engaged in any particularly sophisticated analysis of the before entering into it or restructuring it. It would appear that the original terms of the which submitted to the MEF for approval were rejected on the basis that they were prohibited (leading to revise the terms to advantage), which suggests that, at that

stage, the level of Mr understanding of the regulatory regime so far as the conclusion by local authorities of derivative transactions was concerned must have been limited.

81. In 2007, both Banks classified as a “retail customer” for MiFID purposes and I have concluded that that was a broadly accurate classification. In particular:

i) There is no evidence of any particularly informed internal assessment of the competing proposals by the Finance Department in 2007. The only document seeking to do so is a spreadsheet prepared by Ms – who, on the Banks’ characterisation, performed an essentially administrative role – and was right to describe that assessment as rudimentary, both in the lack of any consideration of the MTM of the proposals or their relationship with the forward rates curve, and particularly in only considering the period to December 2008

(over which period, the Banks’ proposals brought net payments moving against after that).

ii) While the Note on Derivatives prepared by

early benefits, with the

in June 2008 suggested a

relatively sophisticated understanding of derivatives, I have concluded on the evidence that this was prepared with the benefit of input from Mr , who had joined in 2008 from , and who had the financial market expertise which Mr and Ms lacked. Mr xxxxxxxxxx in cross- examination that he had prepared the document was either a lapse in memory, or a reflection of the fact that he had overall responsibility for the document as Finance Director.

What was Hoping to Achieve through the Transactions

82. The principal issue between the parties under this heading is whether one of the benefits which was hoping to realise through the restructuring of the

was the ability to wind-up the without having to pay the cost of the negative MTM on that transaction at that point.

83. By the time it put out the tender to which the Banks responded, must have concluded that it would need to wind-up the , because

had not been asked to tender, and clearly was not intended to remain in the picture once the restructuring had been completed. In my view, it is improbable that was merely ambivalent as to whether that was achieved by an immediate payment or rolling up that MTM in the restructured transaction. The former would have involved a large and unbudgeted payment, whereas it is clear from Programmed Forecast Report for the three-year period 2007 to 2009 (approved by the City Council on 26 February 2007) that was looking to realise savings through the restructuring: something scarcely consistent with any appetite on its part for paying the cost of winding-up the in 2007.

84. I accept that was also looking to protect itself against a rise in interest rates (and in particular a market shock significantly increasing the cost of its debt) over the extended life of the Bond, as Mr i confirmed (just as it had obtained some protection of this type through the ).

85. While did not expressly state in its invitation-to-tender letters of 12 April 2007 that it wished to avoid having to meet the costs of winding-up the

then and there, it did explain that the purpose of the restructuring was to “free up resources” in its balance sheets so as to recover c.€7m for each of the 2007 and 2008 years. It also provided the banks participating in the tender with a copy of the

and invited a proposal for a derivative transaction in relation to the restructured transaction. I accept the Xxxxx’ argument that, implicit in the invitation- to-tender read as a whole, was that was looking to replace the

without having to pay the winding-up costs.

86. The Banks’ revised Joint Proposal specifically identified as one advantage of the Banks’ proposal the fact that the proposed structure would permit disengagement with the without having to pay the break costs in cash. Instead, they would be “integrated into the flows of the new swap”. I am satisfied that the Banks emphasised this feature because they understood that this would be attractive to .

decision on 28 May 2007 to proceed with the Xxxxx’ revised proposal confirms that the Banks’ understanding was correct.

87. Once produced (and I address the question of when it was provided to in the following section), the Xxxxx Report provides a fair summary of what was looking to achieve from the Transactions when it stated that they had allowed

to:

“a) cancel the negative differentials provided on 24 December 2007 by the previous derivative transaction;

b) set a positive differential for the first half of 2008;

c) have a more favourable overall structure until 23 June 2010; and

d) increase the market risk of the derivative in terms of ‘overall effects on cash flows’ as a result of the extension of the maturity by 15 years and the change in the spread and the floor”.

88. On the receipt of that report, there was no suggestion by that the first three matters were not benefits they were seeking to realise through the Transactions. I am satisfied that, by the time Mr took the final decision to enter into the Transactions, they fairly reflected goals which was looking to achieve through the Transactions.

Xxxxx Italia’s Role and the Xxxxx Report

89. There is no evidence that had used Xxxxx Italia’s services as advisers in relation to debt and derivative transactions before 2007, or after 2008. I am satisfied that a statement to the contrary effect in Ms witness statement, but corrected in her evidence-in-chief, was wrong. Mr could not recall any prior involvement and there is no documentary evidence of it (not even of a resolution of the City Council, the Executive Board or the Finance Director authorising the Finance Department to retain Xxxxx Italia or to meet their fees).

90. However, press reports appeared in September 2007 referring to an investigation by the Regional Public Prosecutor’s Office of the Court of Auditors into derivative transactions entered into by . That led the City Council to authorise Mr

to instruct Xxxxx Italia to advise – something he confirmed in cross- examination, but which is also consistent with the fact that the first documents involving Xxxxx Italia appear in the aftermath of the press reports. Xxxxx Italia then produced a report, in relatively quick time, dated 19 September 2007 and entitled ‘Debt Renegotiation Strategy: ‘ ’ Operation’. That report looked at the decision to enter into the Bond and the , and another transaction known as the Canaletto transaction, and how those transactions had subsequently been handled, and assessed the financial consequences of those transactions under five scenarios and their financial effect to date. It did not address the proposed restructuring of either the

Bond or the .

91. City Council Resolution 129 approving the restructuring was passed at the meeting on 25 September 2007. Shortly after that meeting, the City Council instructed Mr

to engage an independent third-party consultant to advise him in relation to the proposed restructuring of the Bond and the , and it is clear that Mr Xxx Xxxxx must have approached Xxxxx Italia to perform that role at some point before 16 October 2007. On that date, Xxxxx Italia provided a proposal for their involvement and an associated costs estimate to (as is apparent from a reference in a later document).

92. It is not clear how much information Xxxxx Italia was provided with for the purpose of preparing their proposal, and whether or not it included the proposed terms of the Transactions. I am satisfied that Xxxxx Italia did no meaningful work with regard to the Transactions during this period over and above what had been done to formulate the proposal in the first place. That is likely to have involved little more than obtaining a broad understanding of what was proposed to determine how much work would be required. Contrary to the Banks’ suggestion, I am satisfied that Xxxxx Italia would not have performed significant work for the purposes of preparing its proposal. In weighing the merit of the contrary suggestion, it is helpful to compare the review performed by a barrister for estimating a fee prior to obtaining an instruction with the work done if the instruction is received.

93. There is no evidence of any activity xx Xxxxx Italia’s part between 16 October 2007, when its proposal was provided to and 14 December 2007, when it provided a further proposal. An internal email of 23 November 2007 referred to “want[ing] the transaction to be scrutinised by Xxxxx Italia, so they need to start updating the new structure and pricing and contact Xxxxx” (i.e., envisaging a role for Xxxxx Italia which had yet to commence). It was only in the second week of December that Mr passed an Executive Resolution approving €50,000 of expenditure for “activities related to active debt management” and referring to the City Council’s instruction that Xxxxx Italia should provide consultancy services and operational support in relation to the restructuring, including “producing analyses and reports”.

94. On Friday 14 December 2007, Xxxxx Italia emailed their new proposal to , referring to prior telephone conversations. The proposed engagement was “to provide your Administration’s management with operational and decision-making support to evaluate the efficiency of the strategy proposed by your financial counterparties, intended to remodulate the coverage in place on the issuance of the ‘ ’ bond loan”. The work proposed included a “focus on the analysis and impact that the swap hedge proposed by the [Banks] will have in terms of market risks and changes in cash flows on the entire debt portfolio”, including by running a sensitivity analysis and performing probability calculations. Xxxxx Italia’s all-in estimate for the scope of work covered by the 14 December proposal was €11,000 ex. VAT. I accept that the proposed work was not subsequently limited to valuing the Transactions on an MTM basis on the Trade Date. If and in so far as Mr Xxxx’x evidence suggested otherwise, I am satisfied that his recollection of such a long-distant assignment is mistaken. The scope of work would not have been narrowed without a reduction in the quoted fee, which did not happen – the amount invoiced and paid in 2008 was €11,000 ex. VAT.

95. Mr accepted Xxxxx Italia’s proposal at 9.27am on 17 December 2007.

Minutes later, Ms xxxx, naming Mr

informed the Banks that Xxxxx Italia would be interacting with as the point of contact. Those events are not consistent with

Xxxxx Italia working on the Transactions prior to that point. I accept that soon after these communications, Xxxxx Italia were instructed, and the structure would have been

presented by the Banks to Xxxxx Italia (as suggested by the email of Mr of

of 17 December 2007). The Banks sent Xxxxx Italia a term sheet at 12.18pm on 18 December 2007, together with the confirmation. Mr and Mr of then spoke, with Mr saying he would inform Mr of

the identities of the Brady Italia personnel working on the project. It is clear from Mr xxxxxxxx email sent after that call that Mr expressed considerable

surprise at the very tight timetable that Xxxxx Italia had been asked to adhere to.

96. On 19 December 2007, (Ms ) emailed (Mr and Ms

), Ms of Xxxxx Italia, and Xxxxxxxx with a summary of the procedural- administrative process for the Transactions which included “[v]erification of swap structure with the Municipality's financial advisor (Xxxxx Italy).” That indicates that this requirement had yet to be fulfilled. The restructuring of the Bond was concluded on Thursday 20 December 2007. On the same day, requested a call with the Banks, and I accept Xxxxx Italia are likely to have participated in that call, given the internal email sent that day by Mr Xxxxxxxxx.

97. The trade call for the Transactions was held on Friday 21 December 2007, following which the Transaction Documents were signed. The trade call (which was short) was attended by both Mr and Ms of Xxxxx Italia. On the trade call, as the transcript shows:

i) Ms xxxxxxxxx, in answer to (Mr ), that the term sheet for the Transactions was clear and that Xxxxx Italia agreed and approved its terms. She also made a reference to the fact that the 5.225% rate featured was slightly more favourable for than the previous 5.26% rate. I accept that she would not have responded to the request for confirmation that Xxxxx Italia had approved the Transactions unless Xxxxx Italia had at least looked at the terms, and not identified any immediate issue with them.

ii) When asked whether approved the Transactions, Mr said that “the last check” was “with Xxxxx” and asked Ms “what does Xxxxx say about this”? Ms replied “yes”, and then gave the indicative MTM valuation. Once again, I accept that Ms Xxxx would not have done this without Xxxxx Italia having performed some level of review of the Transactions, including performing their own MTM review.

iii) The two POLEIS valuations later attached to the Xxxxx Report, and dated 21 December 2007, may well have been available to Ms during this call.

98. A relatively detailed review by Xxxxx Italia of the Transactions is set out in the Xxxxx Report dated 21 December 2007. I am satisfied that neither the Xxxxx Report nor a draft of it were provided to until 2008 and, therefore, after the Transactions had been entered into:

i) There are no communications and nothing by way of metadata which support the provision of a draft at any earlier stage.

ii) The earliest reference to a draft is dated 24 January 2008, which was discussed internally within during February 2008, leading to at least one suggestion from (made by Mr , who had joined s Finance Department

after the Transactions had been entered into) as to a subject which should be addressed within the finalised report.

iii) The Xxxxx Report was finalised by 27 February 2008. There are two Word copies of the Xxxxx Report which the metadata shows were created on 27 February and 29 February 2008 respectively which contain the information which Mr

had suggested be added on 21 February 2008.

iv) I do not believe that Xxxxx Italia would have had time to produce any substantial written document and send it to for its review in the period between 19 and 21 December 2007.

99. I am satisfied that the various versions of the report are all dated 21 December 2007 because that was the date when the Transactions closed. That included the present value illustration in section 6 (showing the savings from the Transactions discounted to their present values as at 21 December 2007) which it is clear was only included at s request following internal emails on 19 and 21 February 2008.

100. I am also satisfied that Xxxxx Italia had not provided with any summary of the detail later included in the Xxxxx Report, which was not the stuff of which wholly undocumented conversations are made. However, I do not accept that Xxxxx Italia did not provide some general indication that could proceed – although possibly not going beyond what was said by Ms in the trade call. That was also consistent with Mr xxxxxxxx in cross-examination (although I am satisfied that his evidence considerably overstated what had been told, when suggesting that the substance or the thrust of the material in the Xxxxx Report was communicated to before the Transactions were entered into). I suspect Mr would have regarded that generalised indication of assent as sufficient to comply with the City Council’s instructions that he obtain advice from a specialist consultant, while recognising the significant timing pressures which everyone was working under. He would also have regarded it as justifying his affirmative answer to question 16 of the Court of Auditor’s questionnaire in January 2010 (did “use consultants in the decision-making and evaluation process leading up to the activation” of the Transactions?).

E INTEREST RATE SWAPS

101. There was no dispute as to the nature or key components of an I . It is an agreement by which two counterparties agree to make periodic interest rate payments to each other on set dates over a defined term, one party typically making payments calculated using a fixed interest rate and the other making payments calculated by reference to a floating rate, usually one of the published reference rates for borrowing for a particular term (e.g. the Euro Interbank Offered Rate or EURIBOR for 6 months or 6m).

102. An which takes the form of a “collar” is a structured product comprising a “cap” and a “floor” which are embedded into the terms of the . Under a collar , the rate payable by the floating rate party is subject to a cap (such that the rate used to calculate the payments it must make can never exceed a specified rate, even if the referenced interest rate rises above that rate). It is also subject to a floor, such that the rate payable can never fall below a specified rate, even if the reference rate does so.

103. IRS transactions are valued by an MTM calculation, which discounts the future cash flows of each party using prevailing market expectations of future interest rates at the valuation date and of the volatility of those interest rates over the term of the . If, on the valuation date, the MTM value of the payments a party is to receive is less than the MTM value of the payments it is to make, the swap is said to have a negative MTM for that party.

104. In v Comune di [2015] EWHC 1746 (Comm), Xxxxxx X explained the nature and purpose of an MTM calculation as follows:

“36. Market participants use a type of calculation known as ‘mark to market”, commonly abbreviated to ‘MTM’ … [The experts] agree that MTM is generally understood in its simplest form to mean the present value of the expected cash-flows, calculated according to a series of generally accepted conventions.

37. How this works can be seen by starting from a theoretical base in relation to the two legs of the simple ... The present value of future cash flows is obtained by discounting them at market rates. If, on inception, each rate is the same as the current market discount rate then the swap is theoretically at par – each leg has a present value of zero because the promised rates equate to what can, in theory at least, be obtained in the market. In this theoretical example the MTM on inception will be zero for both sides, because the present value of what will have to be paid by the fixed leg is neither higher nor lower than the present value of what will have to be paid by the floating leg.

38. However, if the annual discount rate in the market differs from the fixed rate under the swap, then the present value of the fixed rate leg will no longer be zero. [One expert – Mr Xxxxx, as it happens] gives an example where the swap is for a period of a year with a notional sum of €;100. Under a notional loan of €100 the notional repayment by a fixed rate borrower at the end of the year will be €105, comprising the principal of €100 and interest of €5. If the annual discount rate goes up from 5% to 6%, then the party paying the fixed rate will be paying in a year's time interest of €5 while the market would now be willing to promise to pay 6% at the end of a year. That entitlement to pay less than the market rate, when applied to a notional sum of €100, gives the fixed rate leg a positive present value of

€0.95 – because at the rate of 6% that the market would give, it would be necessary only to invest €99.05 in order be entitled in a year's time to a repayment of €105. Making a further theoretical assumption that 1M Euribor is unchanged, the floating leg would continue to have a value of zero. The result will thus be that this simple for a term of a year on a notional sum of €100 will have a positive revised MTM for the fixed rate payer of €0.95, and a negative revised MTM for the floating rate payer of

€0.95.

39. More commonly a transaction will be more complex, involving floors or caps or other components. If so, the MTM of the transaction will be the sum of the MTM of each component.

40. In practice there will be numerous other complexities to take account of. One such will be the spread between bid and offer rates. In relation to any financial product traded between banks, what a bank will be prepared to pay will be less than what it will offer to receive. This difference is the spread charged by the bank for acting as market maker. One way of taking account of it is to calculate MTM on the basis of a mid-market rate halfway between the two.”

105. I have described the MTM of an transaction as a means of valuing a swap. They are frequently used by banks for the purpose of valuing ransactions on their trading books and calculating the level of collateral which needs to be provided in a collateralised transaction (although the Transactions were uncollateralised). The precise calculation of an MTM of the same may vary to some degree between banks (not least because it is sometimes necessary to estimate elements in the MTM calculation and because banks have their own proprietary financial models for the purposes of performing such calculations). However, I accept Mr Xxxxx’x evidence that, when calculating an MTM for internal purposes, banks will generally use “mid-market” inputs. The expression “mid-market” reflects the fact that there will generally be a difference between the highest amount which a potential purchaser of a particular trading position is willing to pay to acquire it and the lowest amount a potential vendor of that same trading position is willing to accept to sell it (the so-called “bid offer spread”). “Mid-market” inputs average the bid and offer rates. As will be apparent from that description, a bank’s MTM will not represent the price at which the bank would trade that position (whether as buyer or seller).

106. The MTM of an on the date it is entered into is often referred to as the “Day 1 Present Value” or “Day 1 PV”. Reflecting the fact that a bank will be looking to make a profit in entering into an (in addition to covering its costs such as those of any hedging transaction it enters into in respect of that ), the “Day 1 PV” of an entered into by a bank “selling” a fixed rate is typically a positive amount in the selling bank’s favour (and hence a negative MTM for the bank’s counterparty). That positive value will generally be higher when the selling bank is transacting with a non-bank counterparty (i.e., outside the inter-bank market), and will reflect factors such as the degree of competitive pressure in the market; the size and complexity of the trade and the ease with which it can be hedged; and counter-party specific factors (such as credit risk).

F THE ANALYTICAL FRAMEWORK

Which Law Applies to Which Issues?

107. The Transactions are governed by English law. That does not mean that every legal issue which arises for determination is exclusively a matter of English law. In particular, it is common ground that issues as to the capacity of (as a legal person) to enter into the Transactions are to be determined by reference to Italian law:

v Stichting Vestia Groep [2014] EWHC 3103 (Comm), [185]. This reflects the fact that, as a legal person, only exists by virtue of, and within the confines imposed by, the municipal legal system which brought it into being. It is also common ground that the actual authority of those who purported to commit to the Transactions is a matter of Italian law.

108. Who is to decide whether a particular issue of Italian law raises a question of capacity, or authority, or some other kind of legal challenge to the validity and efficacy of the Transactions? The Court of Appeal answered that question in Haugesund Kommune v Depfa ACS Bank [2012] QB, 549, confirming that characterisation is to be determined as a matter of English law. Xxxxxx LJ explained:

“38. The objective of conflict of laws rules is to enable a court to decide which system of law is to be applied to resolve a legal question when there is a foreign, ie non-English, element, involved in an issue. In the present case the legal question is: by which system or systems of laws do you decide whether a contract, putatively governed by English law, between a Norwegian legal entity and an Irish one, is valid and binding on the Norwegian legal entity when it is alleged that the Norwegian legal entity did not have the ‘power’ or the ‘capacity’ to enter into the contract because of the terms of a Norwegian statute concerning the ability of kommunes to conclude contracts of loan? I have deliberately used both ‘powers’ and ‘capacity’ in the last sentence. The issue to be resolved is, ultimately, whether the contract is valid or void in the circumstances described.

39. In framing the issue in this way, one is classifying, or characterising, the nature of the legal issue that has to be decided. Traditionally, that is the first stage in identifying the appropriate system of law which is to be applied to deal with the issue when non-English elements are involved, as here. The second stage is to select the rule of conflict of laws which lays down a ‘connecting factor’ to the relevant foreign element for that issue. And the final stage is to identify the system of law which is tied by the connecting factor to that issue.”

109. Xxxxxx LJ gave the following guidance as to how to determine whether or not a particular issue arising under another legal system raised an issue properly categorised as one of capacity for the purposes of English law:

“47. So, I return to the question: in what sense must we interpret the word “capacity” in Dicey’s rule? Counsel have found no authorities in which there is any discussion of the meaning of the word for the purposes of the rule. None of the cases cited in the footnotes to Xxxxx assist on this point. It appears to be a novel issue. How the word ‘capacity’ is interpreted for the purposes of the rule is, as Xxxxxxxx XX has stated in his judgment, ultimately a matter of policy. In my view it is important to remember the purpose of the rule, which is to determine which systems of laws will be used, under English conflicts rules, to decide whether a ‘corporation’ has the ability to exercise the legal right to enter into a binding contract with a third party. If that accurately summarises the rule's purpose, then I think, following the approach of Auld LJ in the Macmillan case [1996]1 WLR 387, 407 that the concept of ‘capacity’ has to be given a broader, ‘internationalist’, meaning and must not be confined to the narrow definition accorded by domestic English law. In my view it should be interpreted as the legal ability of a corporation to exercise specific rights, in particular, the legal ability to enter a valid contract with a third party. So, I agree with the approach of Xxxxxxxxx X; for the purposes of English conflicts of laws, a lack of

substantive power to conclude a contract of a particular type is equivalent to a lack of ‘capacity’, to use English terminology.

48. For similar reasons, it seems to me that the concept of a corporation's ‘constitution’ must be given a broad, ‘internationalist’ interpretation. It is not a question of just trying to find some document, like a royal charter, or the memorandum and articles or some other written description of what the corporation is and can do. For the purposes of this English conflict of laws rule it is necessary to examine all the sources of the powers of the corporation under consideration. This will include any constitutional documents but also relevant statutes and other rules of law of the country where the corporation was created.”

110. The fact that, even in a contract governed by English law, the capacity to enter into that contract is determined (in the case of a legal person) by reference to the law of the place of its incorporation makes it particularly important to distinguish issues of capacity properly so-called from other attacks on the validity and efficacy of an English law contract by reference to the law of some other legal system, including:

i) issues of illegality (English law taking a notably restrictive review as to the circumstances in which foreign law illegality is capable of impugning an English law contract); and

ii) issues of authority (because, as explained at [113] below, the fact that an agent lacks actual authority as a matter of the applicable foreign law to enter into an English law contract is not necessarily fatal to the validity of that contract).

111. In SR Properties x Xxxxxxxxx [2022] UKPC 24, [23]-[24], Xxxx Xxxxxxx distinguished between issues of capacity, illegality and authority in a domestic law context in the following terms:

“23 The concepts of ultra vires and illegality were not clearly distinguished when the ultra vires doctrine was first established in English law and have not always been clearly distinguished since. But the distinction is important. The term ultra vires, in its strict sense in which it has properly been used by the courts below in this action, refers to a situation where a corporation has no legal power (or capacity, as it is often put) to enter into a transaction. That is different from saying that it is against the law for the corporation to enter into a transaction. The two may coincide. There could in principle be a case where, for example, a corporation does not have the power to make a contract and where, even if it did have such power, it would be illegal for the corporation to do so. But lack of power or capacity and illegality are different concepts and the legal consequences of each may differ.

24 A third concept which has not always been clearly distinguished from ultra vires is that of lack of authority of a person or body to act for a corporation. Thus, it may be argued that, for example, a contract entered into or approved by the board of directors of a company is not binding on the company on the ground that it was beyond the powers of the board to make such a contract. This is different from saying that the company itself did not have

the power to make the contract. It is a question of agency, governed by the law of agency.”

112. The test to be applied when identifying issues of capacity adopted by the majority in Haugesund – asking whether there is a legal ability or substantive power to enter into a contract of a particular type, to be judged by reference to any constitutional documents, statutes and rules of the law of the country where the corporation is situated – can make the distinction between issues of capacity and illegality a fine one in those cases in which the limitation on capacity is said to derive from a statute or rule of law rather than a constitutional document. There appears to be limited guidance as to what factors point in favour of one or other categorisation. Without in any way suggesting that the factors identified below are exhaustive or individually determinative, I have been guided by the following considerations:

i) Where the statute in question is of general application, rather than relating to a particular type of legal person, the argument for treating it as part of the corporation’s constitution capable of raising an issue of capacity as a matter of English law analysis (as opposed to imposing a general legal prohibition on activities of a particular kind) will be weak. The more specific the application of the statute to a particular type of legal entity (e.g. a statute applying to a local authority or particular types of public body), the correspondingly stronger the argument that it defines the legal abilities or substantive powers of the corporation.

ii) Where the proscribed activity is of a kind which is inherently wrongful, the statute in question is more likely to be a prohibition. Where, by contrast, it proscribes a particular kind of legal entity entering into a type of contract which other legal and/or natural persons are free to enter into, it is more likely that the statute is defining the legal abilities or substantive powers of the subject corporation.

iii) Where the statute in question is both the legal source of the corporation’s power to undertake a particular act, and the source of qualifications or limitations on that power the contravention of which makes the transaction void (for example where the statute confers a power to borrow on a local authority but only with national government consent, and provides that loan transactions undertaken without such consent are void), the restrictions are more likely to constitute limitations on the legal ability or substantive power of the corporation to enter into a valid contract of that kind, rather than a prohibition. In Xxxxxxxxx, [00], Xxxxxx XX noted that the effect of the statutory provision in issue was:

“both to grant power … to conclude certain types of loan contract and also to restrict their power to conclude certain types of loan … Xxxxxxxxx J was well aware of the distinction between the communes having the power to enter into the swaps contracts but being prohibited from doing so as opposed to the communes not having power to do so at all. In my view he correctly concluded that the effect of [the provision] was the latter and not the former”.

iv) The fact that, under the legal system in question, legal persons have general capacity to enter into contracts is not necessarily determinative of the question of whether other limitations on the freedom of the corporation to enter into valid

contracts of a particular kind raise issues of capacity as a matter of English law categorisation. Taking a legal system which both recognises a general capacity of legal persons, but also a provision of the kind considered in the previous sub- paragraph, that can be rationalised on the basis that a lex specialis overrides a lex generalis.

113. So far as questions of authority are concerned:

i) The question of whether an agent has actual authority to commit its principal to an English law contract is governed by the law applicable to the relationship between the principal and agent.

ii) The apparent authority of that agent to commit the principal to such a contract, and the question of whether the principal has subsequently ratified the contract, are governed by English law.

iii) The consequences of the agent’s lack of authority (actual or apparent) and the consequences of ratification of the English law contract are matters of English law.

(Vestia, [276] and Deutsche Bank AG London v Comune di Busto Arsizio [2021] EWHC 2706 (Comm), [377] and [382] (Busto)).

114. Finally, issues may arise as to the material validity of a contract: for example, whether there has been a coincidence of offer and acceptance, whether the terms are sufficiently certain to give rise to binding obligations and whether the parties intended to create legal relations. In a case such as the present, those are to be determined by English law as the applicable law of the Transactions (Xxxxx, Xxxxxx and Xxxxxxx on the Conflict of Laws (15th), [32-107] and Busto, [263]).

The Date at which the Content of Italian Law is to be Ascertained

115. The issues of whether had capacity to enter into the Transactions, whether those who signed the Transactions on behalf had authority to do so, or whether the Transactions were illegal under Italian law, are all to be determined by reference to the law in force when the Transactions were entered into. That outcome can be reached by a number of legal routes, including on the basis that it forms part of the test of categorisation to be applied under English conflict of laws rules (which in these respects does not refer the relevant issue to Italian law generally but to Italian law at the relevant date).

116. In Xxxxx v National Bank of Greece [1961] AC 255, bonds issued by one Greek bank and an associated guarantee issued by another Greek bank in 1927 were governed by English law. In 1953, a third Greek bank (“the successor bank”) succeeded to the rights and obligations of the guarantor bank, by virtue of Greek legislation to that effect. However, in 1956 the Greek parliament passed further legislation which retrospectively excluded the obligations under the bonds and the guarantee from the scope of that succession. It was argued that this had the effect of discharging the successor bank’s liability under the English law contracts. That argument succeeded before the Court of Appeal ([1960] 1 QB 64, 81-2), Xxxxxx LJ memorably remarking:

“What the plaintiffs have done in the present actions is in the first place to assert and to rely upon Greek law, but to set up Greek law in the form in which it was enacted in February, 1953, and which was to their advantage and to claim to be entitled to ignore the amendments to the Greek law made in July, 1956, which are to their disadvantage. The question raised in the appeals is whether so singular a process of selectiveness can be justified.

It seems to us that those who need recourse to Greek law must take it as they find it. If they assert that Greek law can endow, they must recognise that Greek law can disendow. If they aver that Greek law can create, they must accept that Greek law can change. If they need to have the foundation of Greek law upon which to build a claim, they can hardly say that Greek law as it used to be suits them far better than Greek law as it is”.

117. However, that decision was overturned in the House of Lords, albeit their Lordships reasons for doing so differed in some respects:

i) Viscount Xxxxxxx held that, once the contractual obligation governed by English law had come into existence, no alteration of Greek law would be effective in an English court to discharge that obligation as a matter of conflicts of law analysis (pp.274-275).

ii) Xxxx Xxxx held that the effect of the 1953 legislation was that the successor bank became bound to the English law contract, which obligations were thereafter independent of Greek law (p.279). The English courts could not give effect to a foreign law discharging an English law obligation to pay money in England (p.281), and the question of whether the 1956 law was seeking to discharge English law obligations was to be determined as a matter of substance and not form (pp.282-283).

iii) Xxxx Xxxxxxxxx held that once the successor bank’s English law obligations had come into existence, they could not be discharged by subsequent Greek legislation, and also that “once the validity and consequences of a succession created by foreign law have become established by its rules” it would be “neither just nor convenient … that an English court … should recognise retrospective alterations of that succession which may be propounded by the foreign law” (p.284).

iv) Xxxx Xxxxxx held that the English courts would only recognise the laws of succession in the form they existed at the date of succession (p.285).

v) Xxxx Xxxxxxx held that the English courts should refuse to recognise the 1953 legislation to the extent amended by the1956 legislation because that outcome was “so inconsistent with the essence of the transaction, that there is no comity of nations which requires the English courts to recognise it” (p.290).

118. That approach is relatively easy to apply in the case of legislation (as in Xxxxx), or a government decree of the kind considered in Xxxxx v Provisional Government of Paraguay (1869-72) LR 2 PD 268, but rather more difficult to apply to court decisions as to the meaning and effect of existing legislative instruments, or official guidance as to their meaning. This is an issue which presents difficulties for our own legal system,

in which case law is a source of law, and which adopts the “declaratory” theory as to the effect of judicial decisions on points of law. Those difficulties have led to consideration by the Supreme Court in this jurisdiction as to whether it should have the power to overrule a previous interpretation or holding with prospective effect only. In Re Spectrum Plus Ltd (In Liquidation) [2005] UKHL 41, [40], Xxxx Xxxxxxxx observed:

“Instances where this power has been used in courts elsewhere suggest there could be circumstances in this country where prospective overruling would be necessary to serve the underlying objective of the courts of this country: to administer justice fairly and in accordance with the law. There could be cases where a decision on an issue of law, whether common law or statute law, was unavoidable but the decision would have such gravely unfair and disruptive consequences for past transactions or happenings that this House would be compelled to depart from the normal principles relating to the retrospective and prospective effect of court decisions.”

However, that remains a constitutionally controversial topic, which has yet to venture from the realm of legal theory to practical application.

119. The issue of whether there could ever be a (post-contractual) change in the interpretation or application of legislation in another jurisdiction in force when an English law contract was concluded of so significant a kind that an English court would refuse to give effect to (or recognise) that change on the basis of the principles recognised in Xxxxx, was not raised in this case. An argument xx Xxxxx lines would be fraught with complexity and implications for judicial comity. The Banks did, however, rely on what they said would be the extensive retrospective implications of some of the Italian court decisions relied upon by for antecedent transactions, when inviting the court to determine that those decisions did not correctly reflect Italian law.

The Approach to Ascertaining the Content of Italian law

120. The principles to be applied by the court when seeking to ascertain the content of foreign law were summarised by Xxxxxxxxx J in Busto, [105]-[108]. There was no challenge to that summary in this case, and I shall not repeat it. However, there is one aspect of that summary which merits further elaboration – the approach to be taken when there are decisions of the courts of the relevant jurisdiction interpreting legislative or constitutional provisions, and the English court is asked to accept expert evidence that those decisions are wrong.

121. It has been observed that the purpose of expert evidence on foreign law “is to predict the likely decision of a foreign court, not to press upon the English judge the witness's personal views as to what the foreign law might be” (MCC Proceeds Inc v Bishopsgate Investment Trust plc [1999] CLC 417, 424-425 (Xxxxx LJ – emphasis added). Equally, it is not the role of the English judge to impose their own personal views as to what the foreign law should be. MCC Proceeds was a case in which the relevant foreign legal system was one in which court decisions were a source of law, and it is possible to read Xxxxx LJ’s reference to “predict[ing] the likely decision of a foreign court” with that limitation in mind. However, even when considering a civil law system, the decisions of foreign courts play an important role in ascertaining the content of foreign law. Thus, when the relevant issue is the interpretation of a foreign statute or decree, the English

court does not confine itself to construing the language, but ascertains the effect of the instrument “as shown by its exposition, interpretation and adjudication”(Baron de Xxxx’x Case (1854) 8 QB 208, 266 – emphasis added). Xxxxx XX in A/S Tallinna Laevahauisus v Estonian State Steamship Line (1946) 80 LL L Rep 99, 108, said that when the court is faced with a dispute as to the legal effect of a foreign instrument, “it is still primarily the function of the expert witness to interpret its legal effect, in order to convey to the English court the meaning and effect which a Court of the foreign country would attribute to it, if it applied correctly the law of that country” (emphasis added). Xxxxx X in Yukos Capital Sarl v OJSC Oil Company Rosneft [2014] EWHC 2188 (Comm), [26] noted that it was “not the court’s function to interpret” the provisions of (in that case) Russian legislation, but “to determine how the Russian courts have (or would) interpret them”.

122. The editors of Dicey, Xxxxxx & Xxxxxxx on The Conflict of Laws (15th) observe at [9.20]

“Considerable weight is usually given to the decisions of foreign courts as evidence of foreign law … But the court is not bound to apply a foreign decision if it is satisfied, as a result of all the evidence, that the decision does not accurately represent the foreign law. Where foreign decisions conflict, the court may be asked to decide between them, even though in the foreign country the question still remains to be authoritatively settled.”

123. The need for the English court to resolve a conflict between inconsistent court decisions in the relevant jurisdiction requires no further explanation. However, it is worth pausing over the statement that “the court is not bound to apply a foreign decision if it is satisfied, as a result of all the evidence, that the decision does not accurately represent the foreign law”. The principal authority cited for that proposition is Guaranty Trust Corp of New York x Xxxxxx [1918] 2 KB 623 (the other case, Xxxxxxxx x Xxxxxxxx [1960] AC 659, involved the English court not following a US court’s decision as to the effect of Danish law when addressing a different question, and therefore provides no assistance on the issue under discussion).

124. In Xxxxxx, the issue which arose was whether the obligation arising under a bill of exchange was conditional. That very issue, in respect of the same bill and between the same parties, had been resolved to one effect by a New York State first instance judge, but the (English) Court of Appeal concluded that that decision was not correct as a matter of New York law. The decision is, perhaps, rather less bold than the summary in Xxxxx, Xxxxxx & Xxxxxxx might suggest:

i) It was actually a “conflict of decisions” case, there being other New York authority (or decisions from other states on the same wording) to the contrary effect.

ii) The law of New York relating to negotiable instruments was “expressed in a statute which in all material respects is identical with our own Bills of Xxxxxxxx Xxx 0000 and was adopted for the express purposes of assimilating the law of New York to that of England” (p.654).

iii) The decision not followed was one of a puisne judge. It was recognised, certainly by Xxxxxxxx LJ, that had the decision been one of the New York Court of Appeals,

the court would not have felt able to come to a different conclusion as to the position under New York law (pp.638, 644).

125. The more senior the court which gives the relevant court decision, or the greater the number of foreign court decisions to a particular effect, the more difficult it will be for the English court to conclude that, nonetheless, those decisions do not reflect the law of the relevant jurisdiction. Xxxxxxxx LJ’s statement in Xxxxxx was endorsed by Xxxxxxxx LJ in Bankers & Shippers Insurance Company of New York v Liverpool Marine & General Insurance Company Limited (1925) 21 Ll L Rep 86, 91 (observing that it was “almost certain” that an English court would follow a decision of the Supreme Court of New York on the interpretation of the New York Arbitration Act 1920), and by Lords Xxxxxxxxxx and Xxxxxx in the House of Lords in the same case ((1926) 24 Ll L Rep 85, 93-94). More recently, Xxxxx X in Yukos Capital Sarl v OJSC Oil Company Rosneft [2014] EWHC 2188 (Comm), [27(3)] observed that if there is a “clear decision of the highest foreign court on the issue of foreign law, other evidence will carry little weight against it”.

126. That is so even if, as has been alleged in this case, the decisions are unworkable in commercial practice or their reasoning illogical or inconsistent. When it falls to an English court to ascertain the content of foreign law, that means the law with whatever imperfections, policy-orientated determinations and impracticalities it manifests, unless the high threshold for non-recognition is satisfied, or it is possible to formulate some alternative argument by reference to the considerations discussed at [115]-[119] above. The legal system of another country for these purposes is the picture in the attic, not what (to English eyes at least) might seem to be its most idealised expression. The converse is equally true.

127. Finally, in Yukos Capital Sarl v OJSC Oil Company Rosneft [2014] EWHC 2188 (Comm), Xxxxx X considered the position “where the foreign law is going through a period of change” ([30]). He noted that it was for the English court to decide “what conclusion a foreign court would reach on a developing area of the law” but not “to make findings which went beyond the present state of Russian law and to anticipate a rational development of it”. In my view, those observations also apply to any anticipation of a rational restoration of the pre-development status quo.

G THE ARGUMENT THAT LACKED CAPACITY TO ENTER INTO THE TRANSACTIONS: AN INTRODUCTION

The Capacity Arguments Introduced

128. contends that three of the arguments which it raises have the effect that it lacked capacity to enter into the Transactions:

i) The argument that the Transactions were speculative, and as a local authority lacked capacity to enter into speculative derivatives as a matter of Italian

law (the Speculation Argument).

ii) The argument that the Transactions constituted indebtedness other than for investment expenditure, and as a local authority was not permitted to have recourse to indebtedness otherwise that for the purpose of investment (the Indebtedness Argument).

iii) The argument that the Transactions did not receive the requisite approval from the City Council, and consequently lacked capacity to enter into the Transactions (the Article 42 TUEL Argument).

The Key Legislative and Administrative Instruments

129. In order to understand the discussion which follows, it is helpful at this stage to set out the key legislative and administrative documents which feature in that part of the case directed to capacity by way of a chronological overview.

130. In terms of both chronology and hierarchy, it is possible to begin with Article 119 of the Italian Constitution, originally adopted in 1947, which provides:

"(1) Municipalities, Provinces, Metropolitan Cities and Regions shall have financial autonomy in terms of revenue and expenditure [in observance of the equilibrium of the relative budgets, and shall contribute to ensuring the observance of the economic and financial constraints deriving from the legal system of the European Union].

(2) Municipalities, Provinces, Metropolitan Cities and Regions shall have independent financial resources. They set and apply taxes and revenues of their own, in compliance with the Constitution and according to the principles of coordination of State finances and of the tax system. They have co-participation in the tax revenues related to their respective territories. …

(4) Revenues deriving from the above mentioned sources shall enable Municipalities, Provinces, Metropolitan Cities and Regions to fully finance the public functions assigned to them.

…

(6) …Municipalities, Provinces, Metropolitan Cities and Regions have their own assets, allocated to them pursuant to general principles laid down in the State law. They may have recourse to indebtedness only for the purpose of financing investment expenditures [with the simultaneous definition of amortization plans and provided that the budget balance is complied with reference to all entities of each region]. Any State guarantee on loans taken out by them is excluded.”

131. The italicised provision features prominently in this litigation. The words in square brackets were added by Article 4 paragraph 1 of Constitutional Law No 1/2012.

132. So far as local authorities were concerned, Article 2 of Regulation 420/1996 provides:

“1. In order to hedge against exchange rate risk, all bonds in foreign currency must be accompanied, at the time of issuance, by a corresponding swap transaction. The swap transaction shall convert, for the issuer, the bond in foreign currency into a bond in lire, without introducing risk elements”.

133. When these regulations were introduced, local authorities could not enter into transactions (as opposed to foreign exchange swaps), but private corporations could, and, in that context, it was relevant for certain regulatory purposes to determine whether

or not an IRS was a hedging transaction. In response to a query on this subject from one such corporation, on 26 February 1999, the Italian financial regulator (CONSOB) issued determination no. DI/99013791 (the “CONSOB Determination”). It provided that a transaction qualified as ‘hedging’ if the following conditions were met:

i) The transaction is explicitly carried out to reduce the risks connected with an underlying debt instrument.

ii) There is a ‘high correlation’ between the characteristics of the underlying debt and those of the derivative transaction.

iii) There are procedures and internal controls within the intermediary which are sufficient to make sure that the above conditions are satisfied (the significance of this third element being a matter of dispute).

134. A significant reform was made to the governance of Italian local authorities by the Local Authorities Consolidations Act (Consolidated Code of Local Bodies) or TUEL implemented by Italian Legislative Decree No 267 dated 18 August 2000. In particular, TUEL contained provisions which defined the respective responsibilities of a local authority’s city council, executive board and executives. Article 42(1) of TUEL provided:

“Attributions of City and Province Councils

1. City and Province Councils are the political-administrative guidance and control bodies.

2. City and Province Councils shall be responsible only in respect of the following fundamental acts:

i) expenditure which commit the budgets for subsequent financial years, with the exception of expenditure relating to the rental of buildings and the supply of goods and services on a continuing basis.”

135. In December 2001, Finance Law No 448/2001 (the 2002 Finance Law) was enacted which gave local authorities the power to borrow and expressly permitted them to enter into derivative transactions for certain purposes including, for the first time, transactions. Article 41 of the 2002 Finance Law provides:

"(1) In order to contain the cost of debt and to monitor public finance developments, the MEF coordinates access to the capital markets of the provinces, municipalities, unions of municipalities, metropolitan cities, mountain communities and island communities … as well as consortia of local authorities and regions. To this end, these entities regularly send data on their financial situation to the Ministry. The content and data coordination and transmission methods are established by decree of the MEF to be issued jointly with the Ministry of the Interior, after consultation with the Unified Conference referred to in article 8 of Legislative Decree no. 281 of 28 August 1997, within thirty days from the date of entry into force of this law. The same decree approves the rules on debt amortisation and on the use of derivatives by the above entities.

(2) The bodies referred to in paragraph 1 may issue bonds with the reimbursement of capital in a lump sum on expiry, subject to the creation – at the moment of issuance – of a fund for amortizing debt, or subject to the conclusion of swap contracts for the amortization of the debt. Without prejudice to the provision of the relevant contractual arrangements, the entities may provide for the conversion of mortgages taken out after 31 December 1996, also through the placement of new bond issues or through the re-negotiation, also with other institutions, of mortgages, under refinancing conditions that allow a reduction of the financial value of total liabilities to be paid by the bodies themselves net of fees and of the possible downgrading of the substitute tax proceeds mentioned in article 2 of Legislative Decree no 239 of 1 April 1996, and subsequent amendments."

136. Pursuant to that power, Decree 389 was issued by the MEF on 1 December 2003 (Decree 389), Article 3.2 of which provided:

"In addition to the transactions referred to in paragraph 1 of this article and article 2 of this decree, the following derivative transactions are also allowed:

a) interest rate swap between two parties taking the commitment to regularly exchange interest flows connected to major financial market parameters according to the procedures, timing and conditions stated in the contract;

b) purchase of a forward rate agreement in which two parties agree on the interest rate that the buyer agrees to pay on a capital at a future date;

c) purchase of an interest rate cap in which the buyer is protected from increases in the interest rate payable above the set level;

d) purchase of an interest rate collar in which the buyer is guaranteed an interest rate to be paid, fluctuating within a pre-determined minimum and maximum;

e) other derivative products containing combinations of the above that enable the transition from a fixed rate to floating rate and vice versa when a predefined threshold has been reached or after an established period of time;

f) other derivative products aimed at restructuring debt, only if they do not have a maturity subsequent to that of the underlying liabilities. These transactions are allowed when the flows received by the interested bodies are equal to those paid in the underlying liabilities and do not involve, at the time of their conclusion, an increasing profile of the present values of single payment flows, with the exception of a discount or premium to be paid at the conclusion of the transactions, not exceeding 1% of the notional of the underlying liability."

137. On 24 December 2003, Finance Law 350/2003 (the 2004 Finance Law) was enacted. Article 3 addressed the concepts of indebtedness and investment in Article 119.

138. Article 3.17 provided:

"For entities, referred to in paragraph 16 above, pursuant to article 119(6) of the Constitution, the following constitute indebtedness: the assumption of mortgages/loans, the issue of bonds, securitizations of future flows of income not linked to a pre-existent financial activity and securitization with initial charge less than 85 percent of the market price of the object of securitization rated by an independent and specialized body. In addition, constitute indebtedness also securitizations accompanied by guarantees provided by public administrations, and securitizations and the assignment of receivables due from other public administrations. Operations that do not involve additional resources, but permit to overcome, within the maximum limit established by current State legislation, a temporary shortage of liquidity and to incur expenses that already have a suitable budget cover, do not constitute indebtedness, pursuant to the aforementioned article 119".

139. Article 3.18 provided:

“For the purposes of article 119(6) of the Constitution, the following are investments:

a) the acquisition, construction, renovation and extraordinary maintenance of property, consisting of both residential and non-residential buildings;

b) the construction, demolition, renovation, restoration and extraordinary maintenance of works and facilities;

c) the purchase of machinery, technical and scientific equipment, means of transport and other mobile equipment for long-term use;

d) charges for non-material assets for long-term use;

e) acquisition of land, expropriation and easements;

f) share holdings and capital contributions, within the extent of the possibility to participate granted to the single borrowing institutions by their respective rules;

g) capital transfers specifically earmarked for the implementation of the investment by another agency or organization within the public administration;

h) capital transfers in favour of subjects with public works licenses, or owners or operators of facilities, networks or equipment functional to the delivery of public services, or entities that provide public services, whose1icenses or service contracts provide for the retrocession of investments to the purchasing institutions as they mature, or in advance. The financial intervention in favor of the licensee referred to in paragraph 2, article 19, Law no. 109 of 11 February 1994 is comprised therein;

i) the interventions contained in the general implementation and execution programs related to urban planning declared a primary regional interest with a public purpose to recover and to promote the area.”

140. An explanatory circular was issued by the MEF on 27 May 2004 (the 2004 MEF Circular) to clarify the interpretation of Decree 389. This provided:

“Implicit in the purchase of the collar is the purchase of a cap and the simultaneous sale of a floor, which is permitted solely for the purpose of financing the protection against rising interest rates provided by the purchase of the cap.”

141. Article 1 of Law 296/2006 of 27 December 2006 provided:

“… The rules of this paragraph are core principles for the coordination of public finance mentioned in articles 117, third paragraph and 119, second paragraph, of the Constitution. Debt management transactions that use derivatives, performed by regions and entities referred to in the consolidated act referred to in Legislative Decree no 267of 18 August 2000, must be aimed at the reduction of the final cost of debt and at reducing exposure to market risks. Entities may enter into such transactions only on corresponding due liabilities, having regard to the hedging of the undertaken credit risks”.

142. The MEF issued a further circular on 22 June 2007 (the 2007 MEF Circular) which provided:

“1) … Following the legislative amendments that occurred on derivative instruments and on the definition of indebtedness, and also in light of the evolution of local authorities' resorting to the derivatives market, there is the need to clarify some interpretative aspects regarding the use of delegations of payment disciplined by Article 206 of the Local Authorities' Consolidated Act (TUEL) – Legislative Decree of 18 August 2000, no. 267.

It seems appropriate to remind that the explanatory Circular of the MEF Decree 389/2003 already included a general consideration such that no derivative is classifiable as a liability.

Therefore, derivatives are identified, according to the rules mentioned above, as "debt management instruments and not as indebtedness".

2) Article 3, paragraph 17, Law of 24 December 2003, n.350, amended by Article 1, paragraph 739, Law of 27 December 2006, no. 296 – Definition of indebtedness

“Article 119, sixth paragraph, of the Constitution indicates that "Municipalities, Provinces, metropolitan cities and Regions […]. May have recourse to indebtedness only to fund investment expenses. […]". In the implementation of this constitutional principle, the 2004 Financial Law (Law 350/2003) gave a precise and detailed definition of the concept of indebtedness, indicating the types of transactions to be considered as such in reference to the abovementioned constitutional law….

In conclusion, the definition of swap as mere instrument of debt "management" is further confirmed by the fact that derivative instruments are not mentioned in any of the abovementioned provisions of law;

therefore, in light of the above, derivative instruments do not qualify as indebtedness transactions."

143. With effect from 1 January 2007, Article 41 of the 2002 Finance Law was amended to add a new sub-paragraph 2 bis:

“From 1 January 2007 within the public finance coordination framework, mentioned in article 119 of the Constitution, the contracts with which the regions and entities, referred to in the consolidated act referred to in Legislative Decree no. 267 of 18 August 2000, set up debt sinking transactions with single payment at maturity, and derivative transactions, must be transmitted, by the contracting authorities, to the Ministry of Economy and Finance – Treasury Department. This transmission, which must occur before the signing of the contracts themselves, is a constitutive element of the effectiveness of the same. The provisions of the decree referred to in paragraph 1 of this article, relating to monitoring, remain valid.”

144. It is at this point that the Transactions were entered into.

145. Law No 244 of 24 December 2007 introduced further provisions intended to regulate the entry by Italian local authorities into derivative transactions. Paragraph 381 provided that “financial instrument contracts – including derivatives – signed by Regions and local entities should heed the principle of maximum transparency”, and paragraph 383 required the local authority to “certify unequivocally that it is fully aware of their risks and characteristics, making clear, in a specific note attached to the balance sheet, the financial commitments and undertakings arising from such activities”. It also required such transactions to follow a form approved by the MEF (paragraph 382).

146. Article 62 of Law Decree no. 112 of 25 June 2008 (the 2008 Decree) made a number of significant amendments in relation to the entry into transactions by local authorities:

i) Article 62(6) (as later amended) stated that the local authorities "are prohibited from entering into … contracts relating to derivative financial instruments” until new regulations to be made by the MEF came into force, and in any case for a minimum period. However, “there still remains the possibility of restructuring the derivative contract following change in the liability to which the same derivative contract refers, in order to maintain the correspondence between the renegotiated liability and the related hedging transaction”.

ii) Article 62(9) amended Article 3.17 of the 2004 Finance Law with effect from 1 January 2009 so as to provide that indebtedness included “on the basis of the criteria defined at European level by the Statistical Officer of the European Communities (EUROSTAT), any premium received at the entry into derivative transactions”. By way of further explanation, a premium – sometimes referred to as an “upfront” – is a payment made by the bank at the time of transacting (I address the issue of whether such a payment had to be made to the bank’s counterparty at [261] below). A bank who paid an upfront would transact on more advantageous terms (for the bank) than one who did not, those improved terms being provided as the quid pro quo for the payment.

147. On 27 December 2013, Article 1, paragraph 572 of Law 147/2013 (the 2013 Finance Law) amended Article 62 of decree-law no. 112 of 25 June 2008 (as subsequently amended) to the following effect:

"3. Without prejudice to the provisions of the following paragraphs, the institutions referred to in paragraph 2 are prohibited from:

a) entering into contracts relating to derivative financial instruments provided for by article 1, paragraph 3, of the Consolidated Financial Law, as per Legislative Decree no. 58 of 24 February 1998;

b) renegotiating derivative contracts already in place at the date of entry into force of this provision;

c) entering into financing contracts that include derivative components.”

148. It will be apparent from this summary that:

i) After an initial liberalisation of the ability of local authorities to enter into derivative transactions, there has been a progressive tightening of the position, culminating in the general prohibition (with limited exceptions) effected by the 2013 Finance Law.

ii) Many of the provisions – particularly those which appear in primary legislation – appear in broadly drafted language, which has been “fleshed out” over time.

The Italian Swaps Crisis

149. There are helpful explanations of the background to the Italian swaps litigation in articles by Xxxxx Xxxxxx and Xxxxxx Xxxxxxx, “Italian Case Law on Derivative Contracts: An Interdisciplinary Analysis” (2020) III(II) Revista di Diritto Bancario 195 (which was an exhibit to one of Professor Xxxxxxx’x reports) and Xxxxxx Xxxxx, “The ‘Derivative’ Contracts of Public Bodies: Between Negotiating Authority Autonomy and the Principle of Legality” Crisi d’impresa e Insolvenza 2020, 1 (the Xxxxx Article), which placed before the court and which was written shortly after the Cattolica judgment. The Banks submitted that no reliance should be placed on the Xxxxx Article because it was not referred to in the experts’ reports or put to any expert in cross- examination, Xxxxx was Xxxxxxxxx’x in-house counsel and the journal in which the articles was published is not an authoritative academic journal. I have placed no reliance on the Xxxxx Article for the purposes of identifying the content of Italian law. However, the summary it provides of the background to Cattolica is not substantially in dispute and is amply supported by the various cases and articles which were exhibited by the experts.

150. In summary, the fall in floating market interest rates beginning at the end of 2000 was the occasion for a number of Italian local authorities to take advantage of their new ability to enter into transactions, by which they sought to take the benefit of those lower floating rates. When interest rates began to rise in 2005, many of those contracts were “restructured” on revised terms. When restructuring those transactions – frequently in connection with an extension of the period for repayment of the underlying debts – it was often necessary to address what was, from the local authority’s

perspective, the negative MTM under the existing swap. This was often done not by the local authority making a payment to the bank sufficient to close out the existing transaction, but by adjusting the terms of the restructured swap in such a way as to make the bank whole in respect of the negative MTM under the original swap. However, the 2008 financial crisis led to a dramatic reduction in (and even negative) interest rates. The result was that many local authorities found themselves paying higher fixed rate interest on their borrowings but receiving very much lower floating rate payments under their swap.

151. A report of the Bank of Italy published on 28 February 2020 refers to 98 local authorities being party to outstanding derivative contracts with negative MTMs of over

€1 billion. Xxxxxx and Xxxxxxx suggest that, as at 31 March 2020, data compiled by the MEF records 1,676 derivative contracts having been entered into by local authorities with a notional value of over €50 billion.

152. The increasingly disadvantageous terms of the swap transactions entered into by Italian local authorities as against prevailing market rates, and the corresponding strain imposed on local authority finances, resulted in a significant volume of litigation. Many of those disputes were raised before the Italian civil or administrative courts. Where, however, the local authorities had entered into transactions on the terms of the ISDA Master Agreement, the transactions in question were subject to English law and English jurisdiction. As a result, disputes relating to transactions entered into by Italian local authorities began appearing in the Commercial Court.

Italian Swaps Litigation in the English Courts

153. Disputes involving Italian local authorities who had entered into English law swaps transactions first began to appear in the Commercial Court in 2009 and 2010. The initial disputes were jurisdictional in nature (Depfa Bank plc v Provincia di Pisa [2010] EWHC 1148 (Comm), [2012] EWHC 687 (Comm); UBS Ltd and Another x Xxxxxxx Xxxxxxxx [0000] EWHC 699 (Comm) and later Dexia Crediop S.P.A. v Provincia Di Brescia [2016] EWHC 3261 (Comm) and Deutsche Bank AG v Comune di Savona [2017] EWHC 1013 (Comm); [2018] EWCA Civ 1740), or applications by the banks for declarations as to the validity of the swap transaction in response to actual or threatened litigation in Italy (Xxxxxxx Xxxxx v Comune Di Verona [2012] EWHC 1407 (Comm), in which the local authority did not appear, and Dexia Crediop SPA v Provincia Di Crotone [2013] EWHC 3363 (Comm) in which it did, and summary judgment was refused).

154. In this early phase of the Italian swaps litigation in the English courts, the courts had cause to engage with the merits of the complaints raised by Italian local authorities in two cases.

155. The first was a dispute between two banks, arising from litigation in which it was a bank which contended that the swaps were void: HSH Nordbank AG v Intesa Sapaolo SPA [2014] EWHC 142 (Comm). The defendant bank had entered into an interest rate swap with the Comune di Benevento in 2005. There was an agreement to restructure the 2005 swap, leading to a new swap – the 2006 swap – between the defendant and the comune. That swap was itself novated to the claimant pursuant to a three-way agreement between the two banks and the comune, under which the claimant made a substantial payment to the defendant. The claimant entered into a fresh swap with the

comune (the 2007 swap). Following certain investigations, reports and decisions in Italy, the claimant sued the comune for a declaration that the 2007 swap was void, Those proceedings settled. The claimant then sued the defendant for a declaration that the 2006 swap had been avoided, with the result that the novation agreement was not binding. The arguments raised considered some of the legislative provisions at issue in this case, the 2002 Finance Law, Decree 389 and the 2004 MEF Circular. On the basis of the expert evidence before him, Xxxxxx X rejected the contention that the 2006 swap was void.

156. The second arose from an application made by a local authority, who had not previously engaged in the proceedings, to set aside a declaratory judgment obtained by two banks as to the validity of the swaps transaction the local authority had purported to enter into: Xxxxxx xxxxxxxx s.p.a. v Regione Piemonte; Dexia Crediop S.p.A. x Xxxxxxx Xxxxxxxx [0000] EWHC 1994 (Comm). For the purposes of seeking to persuade the court that it was appropriate to exercise its discretion to set the summary judgment aside, the region contended that it had strong arguments that the swaps in issue were not binding as a matter of Italian law. That argument failed before Xxxx X. The possible defences to the claim were advanced “in a most unsatisfactory way” in “inchoate and tentative” terms. For that reason, the Judge dealt with them relatively succinctly. However, those issues were given rather greater consideration in an oral hearing of the local authority’s application for permission to appeal which was dealt with at a rolled-up hearing (Regione Piemonte v Dexia Crediop Spa [2014] EWCA Civ 1298).

157. The proposed capacity defence turned, once again, on Article 41 of the 2002 Finance Law, Decree 389 and the 2004 MEF Circular, which Xxxxxxxxxxx Xxxxxx LJ considered in detail. He did so without the benefit of factual findings based on the evidence of expert witnesses, given the procedural context in which the issue had arisen, and as he noted, he had looked at the provisions relied upon “through English eyes” ([83]). Xxxxxxxxxxx Xxxxxx XX held as follows:

i) The purpose of Article 41 of the 2002 Finance Law was “to indicate the purpose for which the Ministry acts” but “the Article, itself, does not specify or limit the type of derivatives which may be approved, nor indicate that they must successfully contain the debt if they are to be valid” ([72]).

ii) While it was not clear what the phrase “containment of the costs of the debt" in Article 41 covered, it was not possible to read "containment" as meaning that, at the date of the swap contract, its predicted effect on the expiry of the bond to which it related was that the cost of the debt to Piedmont would be no more than the coupon on the bond (i.e. that there was no negative mark-to-market).

158. So far as Decree 389 was concerned, Xxxxxxxxxxx Xxxxxx XX observed that there was nothing in Decree 389 which, in the case of an interest rate swap with a collar, required that “the present value of the anticipated payments and receipts by each party over the life of the derivative is such that neither party is a net gainer” and nothing “in Decree 389 which requires the cap and floor costs or values to be evenly balanced” ([75]). Nor did the terms of the 2004 MEF Circular (which was “not a legislative instrument but sets out guidelines”), Xxxxxxxxxxx Xxxxxx LJ noting at [75]:

“The valuation of a floor or a cap is no exact science; and depends on a number of assumptions and/or complex mathematical formulae or models, of which there

are several, predicting what may be a long term future. If the validity of a derivative with a floor and a cap depends on an alignment of cap and floor values current at the date of the agreement – a question affording wide scope for argument - the result would appear unworkable.”

159. While recognising that there appeared to be an arguable case of breach of Annex 3 of Regulation 11522 (given a decision of a Milan court to that effect) ([76]), he held that was not sufficient to justify setting aside the judgment. Given the circumstances in which the judgment had been entered, and the delay in applying to set it aside, “it would require a defence of some considerable cogency, based on pretty convincing evidence” to justify setting the default judgment aside, and the judge was entitled to take the view that this had not been made out.

160. The first trial of these issues came before Xxxxxx J in Dexia Crediop S.p.A. v Comune di Prato [2015] EWHC 1746 (Comm). In addition to the arguments relating to the 2002 Finance Law, Decree 389 and the 2004 MEF Circular, the defendant in that case also raised an argument by reference to Article 119 of the Italian Constitution and Law 350/2003. On the basis of the expert evidence before him, Xxxxxx X held as follows:

i) Article 119 was a provision “of a high order of generality” ([144]), and the concept of “indebtedness” was exhaustively defined by the list in Article 3 of Law 350/2003 ([144]). That list did not include derivatives and did not extend to the transactions in issue.

ii) The change in the scope of Article 3 which took effect from 1 January 2009 was not merely clarificatory of the position before that date ([156]).

iii) Article 41(2) of the 2002 Finance Law imposed a financial advantage requirement which applied to derivatives where there was a debt refinancing transaction which involved new debt. For this purpose, it was necessary to consider the effective cost of the refinanced debt taking into account the effect of any derivative which formed an integral part of a debt refinancing transaction. The requirement did not involve examination of a derivative transaction in isolation: the overall benefit of the whole debt refinancing transaction is what mattered for the purposes of Article

41.2. Although he said he did not need to decide the point, the Judge also said that he favoured ase that there was a fourth qualification to the application of Article 41(2) to derivatives, namely that the requirement does not involve taking account of either the initial MTM or the so-called “implicit costs” of the derivative, since they are not actual costs.

iv) Article 3 of Decree 389, as interpreted with the benefit of the 2004 MEF Circular, was not contravened because it imposed no requirement that, when a local authority purchased a collar, the MTM of the floor at inception had to be equal to the MTM of the cap at inception ([190]) and there was no contravention of Article 3.2(f) because an analysis of cashflows did not show “an increasing profile of the present values of single payment flows.”

v) The statement in the 2004 MEF Circular that:

“In the event of a variation in the underlying debt of a derivative instrument, for example because the debt has been renegotiated or converted, or because

it has reached an amount inferior to what was initially foreseen, the position in the derivative instrument can be readapted on the basis of conditions that do not determine a loss for the agency”;

went “well beyond what is said in article 3.3” ([199]) and had not been the subject of Italian law evidence ([200]).

vi) There was no general prohibition on local authorities entering into speculative transactions under Italian law ([203]).

161. There was an appeal against Xxxxxx J: Dexia Crediop SpA v Comune di Prato [2017] EWCA Civ 428. The only capacity challenges maintained were those advanced under Article 119 of the Italian Constitution read with Article 3 of Law 250/2003, and a challenge to one swap under Article 41.2 of the 2002 Finance Law. The Judge’s conclusions were upheld. So far as the conclusion on Article 119 is concerned, the Court held that the judge had been entitled to conclude that a decision of the Court of Appeal of Bologna in Municipality of C (clearly the Court of Appeal of Bologna in the Cattolica case), on which the comune had placed significant reliance, did not correctly state Italian law, holding at [63]:

“The Court of Appeal of Bologna is, of course, not the highest Italian court with jurisdiction in administrative law matters. The task for the judge was to predict how the highest court would determine the matter if it came before it. In our judgment, the judge was plainly entitled to prefer the evidence of Professor Xxxxxxxxxx and conclude that the highest court would not follow the reasoning in Municipality of C. Neither expert supported its essential reasoning, which is indeed extremely vague, difficult to follow and devoid of any analysis of paragraph 17 or the 2009 amendment. Moreover, the 2009 amendment, to include premiums on derivatives, is striking. If swap transactions were a form of indebtedness already covered by paragraph 17, it is impossible to see why the amendment was a rational one to make.”

As noted below, in 2020 the highest court on civil matters, the Supreme Court, upheld the decision of the Court of Appeal of Bologna.

162. So far as Article 41.2 is concerned, the Court of Appeal held:

i) The judge was entitled to accept Professor Xxxxxxxxxx’x evidence as to the legislative purpose of Article 41.2 ([97]) and as to the requirement of “new debt” for Article 41.2 to apply ([99]), supported as this latter conclusion was by the Court of Appeal of Milan in the Arosio case.

ii) Even if Article 41.2 had applied to the swap in question, the judge was right in his (obiter) conclusion that a negative initial MTM was not to be taken into account when calculating financial advantage ([117]).

163. Legal developments in Italy have since given rise to a further round of Commercial Court decisions. These have involved jurisdiction challenges (BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2018] EWHC 1670 (Comm), [2019] EWCA Civ 768), an application for negative declaratory relief by a bank (BNP Paribas SA v Trattamento Rifiuti Metropolitani SPA [2020] EWHC 2436 (Comm)) and an

application to lift an automatic stay of proceedings commenced by two banks for declaratory relief (Bank of America Europe DAC v Citta Metropolitana di Milano [2022] EWHC 1544 (Comm)).

164. Most significantly, on 12 October 2021, Xxxxxxxxx J handed down judgment in Busto. Xxxxxxxxx J had to consider many (but not all) of the issues raised in this case, including the meaning and effect of the Cattolica decision. Xxxxxxxxx J rejected the comune’s challenges to the validity and efficacy of the swaps transactions in issue in that case, and the Banks understandably placed considerable reliance on her decision.

165. The position so far as the status of the Busto judgment in this litigation is concerned is as follows:

i) To the extent that the judgment determines issues of English law (and I include within that description issues as to the characterisation for English conflicts of law purposes of certain issues raised by reference to Italian law), the decision is not strictly binding on me. However, as Xxxx Xxxxxxxxx observed in Xxxxxxx x Xxxxx (No 2) [2016] UKSC 44, [9]:

"So far as the High Court is concerned, puisne judges are not technically bound by decisions of their peers, but they should generally follow a decision of a court of coordinate jurisdiction unless there is a powerful reason for not doing so."

ii) To the extent that the judgment makes findings of fact on Italian law, the effect of s.4(2) of the Civil Xxxxxxxx Xxx 0000 is that the judgment could have been rendered admissible in evidence for the purpose of proving the content of that law, in which case “the law of that country, territory or part with respect to that matter shall be taken to be in accordance with that finding or decision unless the contrary is proved”. However, it is necessary for a party seeking to rely on s.4(2) to serve a notice of an intention to rely on the other judgment for this purpose. No such notice has been served, with the result that the findings as to the content of Italian law in Busto have no evidential status.

iii) However, Mr Xxxxxxx XX adopted the reasoning which had led Xxxxxxxxx J to reach her conclusions as part of his case.

166. Busto is the only decision before this one which has had to engage with the Cattolica decision, which indisputably constitutes a highly significant development in the response of the Italian courts to the status of swaps contracts entered into by Italian local authorities. That has to be born in mind when considering findings of Italian law made by English courts in the Before Cattolica Era.

H THE CATTOLICA DECISION

The Legal Context

167. Understandably the decision of the Italian Supreme Court in Cattolica loomed large in the parties’ submissions on the issues of capacity, and a detailed analysis of that case is required to determine arguments that it lacked capacity to enter into the

Transactions. Before doing so, it is helpful to consider the legal background to the decision.

168. The financial pressures which transactions imposed on those whose who had entered into them (including local authorities) led to a renewed legal focus on the nature of such contracts, and attempts to explore the legal options which might be available to challenge this type of transaction. This involved the exploration of issues of both private (or civil) and public (or administrative law), albeit those separate lines of analysis became intertwined. For that reason, it is helpful briefly to summarise some of the legal theories in circulation when the Cattolica decision came to be determined.

169. First, there was the argument that transactions were in the nature of gaming transactions and therefore unenforceable by virtue of Article 1933 of the Italian Civil Code (ICC) (which makes all gaming debts unenforceable). That was a challenging analysis in many respects, not least given the fact that Article 23.5 of Legislative Decree No 58 of 24 February 1998 had exempted derivative contracts in the context of investment services from the Article 1933 prohibition. However, by way of a development of that argument, the policy reasons for enforcing transactions came under close scrutiny, as part of an attempt to confine the enforceability of these type of transactions to contracts which were perceived to serve that policy.

170. Second, there was the possibility of those who had entered into transactions invoking investor protection legislation, having regard to the advice or information provided (or not provided) to them by the counterparty banks at the point of transacting. However, the remedies available for complaints about the information or advice provided pre-contractually would not lead to the nullity of the , but at best provide the basis for claims for compensation which were perceived as less satisfactory. Further, in many cases, there was a risk that compensatory claims were time-barred. Finally, so far as local authorities were concerned, they had generally confirmed as part of the pre-contractual process that they were competent and experienced in investor transactions of this type.

171. However, those two themes – whether the nature of an was such as to merit enforceability at law, and complaints about the level of advice and information provided by banks before entering into the – have remained central to Italian legal analyses of the swaps crisis. So far as the first is concerned, that concern has been addressed by focussing on Articles 1322, 1325 and 1346 of the ICC:

i) Article 1322 provides that “(1) the parties can freely determine the content of the contract within the limits imposed by the law; (2) the parties can also enter into contracts of a type that do not have a specific regulation, provided that they are directed to the realisation of interests worthy of protection according to the legal system” (the requirement that the contract be directed to the realisation of interests worthy of protection being referred to as a requirement that the contract have a lawful cause or causa).

ii) Article 1325 provides that two essential elements of a contract are “the function” or causa and the “object” or oggetto.

iii) Article 1346 provides that “the object of a contract must be possible, lawful, determined or determinable”.

172. The general requirement as a matter of Italian contract law for a contract to have a worthy causa or oggetto before it would be enforced was used to support a legal analysis whereby only swaps which were “rational bets” because the risks being run were known at the time of contracting were enforceable. That theory also accommodated complaints about informational asymmetry at the point of contracting as between the bank and its client, by requiring the risks being run to be identified in the contract itself (thereby, in effect, introducing not simply a requirement that information of a particular kind be made available to the counterparty at the point of contracting but also a requirement as to the form of transactions as well). Anolli and Xxxxxxx refer to this development as:

“the reconstruction according to which derivative contracts are a ‘rational risk’, causally valid only if, at the time of entering into it, the contract identifies the risk borne by the parties by means of certain indicators: the current market value (mark to market); the possible future scenarios of performance of the contract, with an estimate of the related probabilities; the costs, normally implicit, incurred by the client, from the contract. By refusing to protect ‘a transaction characterised by risks unknown to one of the contracting parties and outside the scope of the agreement’, the approach has in fact ‘the characteristic of automatically entailing the complete nullity of most, if not all, of the derivatives in circulation which have been concluded without an agreement on the quantative and qualitative extent of the risks”.

173. It would appear that the view that only transactions which involved a ‘rational bet’ in this sense were enforceable gained support in Italian courts from 2013 onwards, including in decisions of the Court of Appeal of Milan of 18 September 2013, the Court of Appeal of Bologna of 11 March 2014 and a further decision of the Court of Appeal of Milan of 11 November 2015.

174. In the public law context, when dealing with transactions entered into by local authorities, similar concerns (as to the worthiness of the social purpose of the transaction and the knowledge available to the local authority at the point of contracting) were also explored, both by reference to the concepts of causa and oggetto but also by reference to the restrictions or controls on the ability of local authorities to enter into particular kinds of transactions, and in particular the restrictions on borrowing and in relation to the entry into derivative transactions imposed by the legislation and associated instruments outlined at [129] to [147] above.

175. In particular, local authorities argued that the entry into transactions, either generally or with particular features, involved borrowing other than for investment purposes for the purposes of Article 119 of the Italian Constitution and/or were transactions which could only be approved by the city council of a local authority, and not by its executive board, under Article 42 of TUEL. By the time of the Cattolica decision, it would appear that inconsistent decisions had been reached on these issues by the regional Court of Auditors (which are administrative tribunals appointed to control public expenditure and which are the competent courts to determine the liability of public officials).

The Cattolica Litigation

176. Those arguments were also raised in the civil courts, including in proceedings which had been commenced by the Municipality of Cattolica before the Court of Bologna (No. 5244/2009) seeking a decision that the three swap transactions which it had entered into were null and void, and consequential relief. Two of those transactions had involved an upfront payment being made to the Municipality.

177. The Municipality failed before the Court of Bologna, who found that the swap contracts could not be considered a form of indebtedness, whether for the purposes of Article 119 of the Italian Constitution or the provisions of law (discussed at Section L below) in relation to the respective decision-making responsibilities of the city council or the executive board.

178. However, the Municipality succeeded before the Court of Appeal of Bologna, which handed down judgment on 11 March 2014. In summary, the Bologna Court of Appeal found as follows:

i) The swap transactions required the approval of the city council under Article 42 of TUEL, and in the absence of such approval were void.

ii) There had been a breach of Article 119(6) of the Italian Constitution because the swap transactions represented indebtedness (actual or potential) and the Municipality had not undertaken this indebtedness for the purpose of financing investment expenditure.

iii) This was so for both the two transactions which included an upfront element and the third which did not, it not being significant so far as the former was concerned that the 2008 Decree which had stipulated that swap transactions involving an upfront payment were a form of indebtedness for the purpose of Article 119(6) of the Italian Constitution had only been passed and come into effect after the swaps had been entered into.

iv) Moving from the law regulating the actions of public authorities to the law of contract generally, the swaps did not comply with Article 1346 of the ICC because the swap contracts did not contain a specific reference to the underlying loans nor an MTM valuation and therefore lacked the essential element of a worthy causa (adopting the “rational bet” analysis).

179. The bank sought to appeal that decision to the Supreme Court. On 23 October 2018, the First Division of the Supreme Court made an interlocutory order (the Interlocutory Order) referring the bank’s appeal to the First President (the President of the First Civil Division of the Supreme Court) to ask him to consider assigning the appeal to the Joint Divisions of the Supreme Court. That power falls to be exercised when an appeal involves issues of law of the greatest importance, or where single panels of the Supreme Court have given conflicting rulings on the same issue of law (which was not the case here). When the Supreme Court sits in Joint Divisions, it does so in a panel of nine judges, rather than the usual five, and the bench includes the First President.

180. In considering the weight to be attached to the decision of the Supreme Court in Cattolica, the reasons given in the Interlocutory Order for taking this course, and the issues which the Interlocutory Order identified as arising, are of significance.

181. The Interlocutory Order noted that the Bologna Court of Appeal had held that:

i) All three swaps constituted indebtedness because of their uncertain nature and violated Article 119(6) of the Italian Constitution because they had not been undertaken “to finance investment expenses”.

ii) The decision to enter into the swaps could only be taken by the city council, by reason of Article 42 of TUEL.

iii) The upfront payments had not been specifically allocated to investment expenditure at the point of contracting, as required.

iv) The swaps lacked essential elements of an enforceable contract in the form of a worthy causa and/or an oggetto in failing to identify the underlying loan contracts in connection with which it was said that the swaps had been taken out.

v) The swaps lacked essential elements of an enforceable contract in the form of a worthy causa and/or an oggetto in failing to state the current MTM at the time of contracting.

182. The Interlocutory Order noted that all these conclusions were challenged by the bank on appeal, and that the first three were connected. Having briefly set out the relevant legislative and administrative decrees, the Interlocutory Order noted that there had been inconsistent decisions of the Courts of Auditors on the issue of whether entering into an which included an upfront payment constituted the assumption of indebtedness, and between the decisions of various Courts of Auditors on the one hand, and observations in a decision of the Council of State on another, on the issue of whether an transaction (at least in some circumstances) required the approval of the city council under Article 42 of TUEL. It suggested that the issues raised:

“may be of particular importance, in the framework of Article 374 of the Code of Civil Procedure, paragraph 2: in addition to being of great importance, on a practical level, for the concrete effects that the solutions to be adopted may have in the framework of the litigations between financial intermediaries and local authorities on derivatives (litigations often involving large monetary flows), they relate to issues on which the Court of Auditors, in its various administrative and jurisdictional forms, and the Council of State have provided conflicting responses. The importance of the issues to be dealt with derive, therefore, from the framework of serious uncertainty that is handed over by the various bodies that have dealt with them during the administration of control, judicial verification of accounting liability and judicial examination of the legitimacy of the exercise of the local authority's self-redress power.

The Panel, although obviously aware that in the dispute brought to its examination there are legal positions, not involved in the assessments made by the Court of Auditors and the Council of State, believes that the need to avoid, for the future, that the rulings made by the first section of the Supreme Court mark fluctuations on an issue, which is of fundamental importance for the interests of local authorities and banking and financial intermediaries, considering that this issue is already marked by the aforementioned disagreements. It is therefore considered

appropriate to refer the case to the First Chairman, for the eventual assignment to the Joint Sections.”

183. There can be no doubt, therefore, that the Interlocutory Order envisaged that the first three issues, in particular, raised questions of fundamental legal and practical importance, on which a decision of the Joint Divisions of the Supreme Court would provide important guidance in the face of currently conflicting judicial decisions. I was referred by Mr Xxx KC to Xxxxxxx Xxxxxxxxxxx, Xxxx Xxxxxxxx Xxxxxxx and Xxxxxxxxx Xxxxxx, The Italian Legal System: An Introduction (2nd) (2015) which noted at [7.22]:

“According to the traditional doctrine, judicial decisions are not a source of law. One way to put the proposition is to state that judicial decisions are not binding precedents in subsequent cases; another is to say that decisions of courts affect only the parties and have no effects erga omnes. However the matter is put, it is obvious that the traditional Italian view of precedent is an organic part of the traditional view of the legal process, with its emphasis on legislative supremacy and a sharp separation of powers. The judicial function is limited to the interpretation and application of the law. If a decision of a court is a precedent or is otherwise effective beyond the limits of the case, it is engaging in a function reserved to the legislator.

This theory of the limits of the judicial process, like other aspects of the folklore of judicial interpretation, is in conflict with the facts in Italy ....

There are other factors...that call the validity of the folklore into question. The Supreme Court of Cassation is the highest court of judicial, as distinguished from administrative and constitutional, jurisdiction. It is at the apex of that part of the Italian judiciary most like common law courts in function. Article 65 of the 1941 Law on the Judiciary places the obligation of assuring the “uniform interpretation of statutes” and the “unity of national law” on the Supreme Court of Cassation. At an earlier time there were five such courts, all on the same level of authority, and considerable disparity existed among their interpretations. A principal argument for a single such court was the desire for an authoritative final voice on the interpretation of the law, and the statute expressly confers that function on the Supreme Court of Cassation. Even though the decisions of that court are not “binding” in theory, few judges would knowingly adopt a different interpretation. They may not be bound, but the pressure to conform is irresistible.”

184. I accept that description of the practical status of court decisions in the Italian legal system, which is supported by the evidence of Professor Xxxxxxxxxxxx on this topic (which I accept) and consistent with the practical status of jurisprudence in other civilian systems. In particular, I accept the particular normative force which in practice attaches to decisions of the Supreme Court as “the highest court of judicial … jurisdiction”. An even greater normative force attaches to decisions of that court when sitting in Joint Divisions: if a subsequent Supreme Court does not agree with the view expressed by the Joint Divisions on a point of law, it is not free to depart from it, but must refer the point back to the Joint Divisions.

The Supreme Court Decision

185. I can adopt Xxxxxxxxx J’s summary of the structure of the Supreme Court’s judgment set out in Busto,([137]):

“The substantive part of the Supreme Court Judgment (under the heading Reasons for the Decision) consists of 10 sections. These provide in summary as follows:

i) Section 1 sets out the five grounds of appeal against the Court of Appeal judgment relied upon by the bank;

ii) Section 2 sets out the ground of the Municipality's conditional cross-appeal. That has no relevance to the issues in this action;

iii) Section 3 refers to the Interlocutory Order and the issues raised by it;

iv) Section 4 contains an analysis of the ‘topic of derivatives’, with a particular focus on the interest rate swap ( ). The section of the judgment also describes certain market concepts, most significantly mark to market;

v) Section 5 of the judgment considers the function/purpose of a swap;

vi) Section 6 of the judgment addresses ‘the validity of the contractual instrument that contains’ the swap;

vii) Section 7 of the judgment begins:

‘After these necessary preliminary clarifications, we can proceed with examining the issue (which is the basis of the questions posed by the division that referred the matter to these Joint Divisions) relating to the execution of derivatives, swaps and by public entities in general and local entities in particular’

Section 7 of the judgment then goes on to address the constitutional and statutory framework that governs the entry into derivative contracts by Italian local authorities, explaining how that statutory framework has changed over time;

viii) Section 8 of the judgment begins by stating:

•

‘The Court notes that the aforementioned changes in the law, while turbulent and not always linear, make it possible to conclude that, even during the period that Article 41 of the 2002 Budget Law was in effect and, thus, until 2008 (the year the legislature imposed more stringent limits on entities' ability to enter into derivatives) the contractual power of local entities had clear limitations’;

ix) What is being addressed at Section 9 of the Supreme Court's judgment is highly controversial between the parties and is a specific topic of expert evidence. It begins as follows (at paragraph 9):

‘However, that does not fully solve the problem brought to the attention of these Joint Divisions, since we must – within the ambit of the path theoretically admissible – determine whether other limits exist on the lawfulness of those contractual types for the Public Administration’.

[I would note that Xxxxxxxxx J went onto hold that Section 9 was concerned with the general requirements of the Italian law of contract so far as derivative transactions are concerned, and in particular with the essential elements of an Italian law contract of oggetto and causa and there has been no challenge to that conclusion in these proceedings].

x) Section 10 of the judgment addresses the two remaining grounds of appeal. This section of the judgment is introduced by the court stating (at paragraph 10):

‘However, that does not fully solve the problem brought to the attention of these Joint Divisions, because of the remaining grounds (1 and 2) of the appeal, which involve the problem of the indebtedness of public entities and the authority to decide in relation to the same’".

186. The issues which arise as to the effect of the Cattolica judgment before me are as follows:

i) Does Section 8 of Cattolica hold that Italian local authorities lack capacity to enter into speculative derivative transactions, and, if so, was that decision correct as a matter of Italian law?

ii) Did Sections 8 and/or 10 of Cattolica hold that swaps were a form of indebtedness (whether for the purposes of Article 119 of the Italian Constitution or otherwise) and that local authorities did not have capacity to enter into them other than for the purpose of financing expenditure?

iii) Did Section 10 of Cattolica hold that all swap agreements, or only certain kinds of swap agreement, required approval by the City Council (and, if the latter, which kinds)? It is accepted that Section 10 of Cattolica held that at least certain kinds of swap required approval at City Council level.

iv) In the extent to which Cattolica held that swap agreements required approval by the City Council, was that decision correct as a matter of Italian law?

I THE SPECULATION ARGUMENT

What did Cattolica Decide?

187. This is a particularly difficult question. The Bologna Court of Appeal had not reached any conclusion expressly based on the speculative nature of the swaps in Cattolica, but rested its decision on its determination that the swap transactions in issue were a form of actual or potential indebtedness which had not been entered into for investment purposes. The Bologna Court of Appeal referred to the issue of speculation only in the context of the ground of appeal concerning the failure to refer in the swap contracts to the underlying loan transactions, that being necessary because “derivatives could only

be used for hedging purposes and not … merely speculative”. Further, the Interlocutory Order had not expressly raised the issue of whether local authorities could enter into speculative derivative contracts, albeit it had, in the context of the indebtedness issue, suggested that “it would be appropriate to analyse whether, during the relevant period, the conclusion of derivative contracts by local authorities was permitted”.

188. Mr Xxx XX submitted that the effect of the Supreme Court’s finding in Section 8 of Cattolica was that all derivatives were a form of indebtedness for Article 119(6) purposes, and that speculative derivatives fell foul of Article 119(6) because they were not (ex hypothesi) entered into for the purposes of funding investment expenditure. In support of that conclusion, Mr Xxx XX points to the Supreme Court’s reliance on the Constitutional Court Decision No 52/2010. If that argument is correct, then the Speculation Argument essentially folds into the Indebtedness Argument, and the specific issues arising on that interpretation of Section 8 of Cattolica which are addressed in that context at [248]-[254] below. That argument is undoubtedly tenable, but in the final analysis, I am not persuaded that it is correct.

189. The Constitutional Court Decision No 52/2010 involved a challenge brought by two Italian regional authorities to the restrictions on the power of local authorities to enter into transactions introduced on a temporary basis by the 2008 Decree (see [146]):

i) One of the regions, Calabria, appears to have argued that Article 119(6) gave local authorities the constitutional right to borrow for investment purposes, and that the temporary prohibition on entering into transactions would unlawfully restrict that right. It is not clear to me whether that argument was advanced on the basis that an was itself a permitted form of indebtedness, or a necessary adjunct to permitted forms of indebtedness (e.g., to the taking out of long term loans at floating rates of interest).

ii) In response, the President of the Council of Ministers argued that the temporary prohibition was necessary to address an economic and financial crisis "largely caused also by the indiscriminate use of derivative financial instruments that have led to significant debt for public bodies" and that “the complaint of breach of Article 119 of the Constitution is also unfounded, ‘it being clear that the provision criticised does not prohibit the use of debt for investment expenses, whatever the financial instrument used’".

iii) The Constitutional Court noted of derivative transactions that “on a functional level, as is well known, the transactions in question, in addition to having a hedging purpose, can also perform a speculative function, affecting the same causal structure of the contract, with consequent risks of insolvency linked to various factors connected above all to the overall performance of the market”. It held that the temporary ban was necessary “to prevent, through the conclusion of highly random contracts, the finances of the institutions themselves from being subject to debt exposures that are very onerous”.

iv) The Constitutional Court held that the 2008 Decree was not inconsistent with Article 119(6), the Court noting that “the last paragraph of Article 119 of the Constitution places a financial equilibrium constraint that is substantiated in allowing local authorities to resort to debt only to finance investment expenses”, and that it was open to the state by legislation to define what constitutes

indebtedness and investment, including by determining on a temporary basis that transactions “cannot be classified as investment activity” and “to prohibit, among other things on an interim basis, the use of these types of transaction that

are objectively dangerous for the equilibrium of regional and local finance”.

v) It is that finding which Mr Xxx XX invites me to interpret as the court determining that all transactions are a form of indebtedness for Article 119(6) purposes, with the state using the legislative power permitted to it by Article 119 to provide through the 2008 Decree that such transactions could not (for an temporary period at least) constitute debt incurred for investment purposes.

vi) However, it is unclear to me whether the Constitutional Court was intending to go that far, or simply answering Calabria’s argument that the 2008 Decree unlawfully limited its Article 119(6) right to incur debt for investment purposes through the conclusion of transactions with the repost “it is for the state through legislation to define what constitutes an investment, and they said that these transactions do not serve that purpose”.

vii) In any event, as the state had the legislative power to define both what constituted indebtedness and what constituted investment for Article 119(6) purposes, the 2008 Decree is essentially self-defining – the prohibition or limitation it imposes will by definition establish the scope of Article 119(6) with effect from the date the 2008 Decree came into force. That makes it unlikely that the Constitutional Court was intending to determine on an a priori basis that independently and in advance of the 2008 Decree, all transactions constituted a form of indebtedness for Article 119(6) purposes.

190. The second difficulty I have with Mr Xxx KC’s interpretation is that Section 10 of Cattolica is flatly inconsistent with the premise of that interpretation, namely that all transactions constitute recourse to indebtedness for Article 119(6) purposes. I

consider this further at [236]-[254] below, but for present purposes simply note that:

i) [10.1.3] held specifically in relation to transactions involving an upfront that they constituted recourse to indebtedness:

“Amounts received as an upfront constitute indebtedness for purposes of public accounting law and Article 119 of the Italian Constitution”.

That conclusion in relation to a specific type of transaction would be superfluous if the Supreme Court, in Section 8, had already held that all transactions constituted recourse to indebtedness.

ii) More significantly, [10.1.4] expressly rejects the argument that all other transactions also constitute recourse to indebtedness, suggesting that answering this question requires a consideration of each swap transaction “as a whole”.

191. So, if Section 8 did not decide that all transactions constituted recourse to indebtedness for Article 119(6) purposes, what did it decide?

192. In Section 7, the Supreme Court had reviewed the various legislative provisions regulating the power of local authorities to enter into transactions, noting that “the

contractual power of local entities [sc. to enter into transactions] had clear

limitations” in the period after Article 41 of the 2002 Financial Law first gave local authorities the power to enter into transactions.

193. In Section 8, the Supreme Court then identified, as one of those limitations on the contracting power of local authorities, the fact that the had to be “financially cost effective, since entering into speculative derivatives was prohibited”. That prohibition was said to be attributable in the first instance to Article 119(4) and (6) of the Italian Constitution. By way of a reminder:

i) Article 119(4) provided that “revenues deriving from the above mentioned sources shall enable Municipalities, Provinces, Metropolitan Cities and Regions to fully finance the public functions assigned to them”, a provision which the Supreme Court held imposed the “constraint of financial balance”.

ii) As will already be clear, Article 119(6) provided that local authorities “may have recourse to indebtedness only for the purpose of financing investment expenditures”.

194. As I have mentioned, the Supreme Court relied on the Italian Constitutional Court Decision No 52/2010 in attributing a prohibition on local authorities entering into speculative derivatives to Articles 119(4) and (6). It is difficult to find direct support in the Constitutional Court Decision no 52/2010 for that conclusion. However, the Constitutional Court judgment does provide support for the conclusion that Article 119 imposes a “financial equilibrium constraint” on local authorities, and highlights the extent to which I ransactions may prove to be incompatible with that restraint. While the reliance placed by the Supreme Court on the Constitutional Court decision might be said to read much into the latter judgment, I do not feel able to say it is not a tenable interpretation of a judgment which is clearly susceptible to more than one reading.

195. In any event, the Supreme Court supplemented its reliance on the Constitutional Court Decision No 52/2010 with its own reasoning:

i) The Supreme Court held that the “aleatory” nature of derivative contracts (as the difference between the amounts to be paid and received by a local authority under an is uncertain, and exposed to market risk) was not compatible with “the fixed nature of expenditure commitments” (and presumably, therefore, prima facie inconsistent with the need to balance income and expenditure as envisaged by Article 119(4)).

ii) The Supreme Court’s reference to Article 119(6) in this context is less clear. The Supreme Court had yet to address the issue of whether entering into an constitutes the assumption of indebtedness, and in due course it concluded that not all transactions constituted indebtedness ([10.1.4]). However, the Supreme Court may have had in mind that the matching of borrowing to (investment) expenditure in Article 119(6) was a further example of the “constraint of financial balance”.

iii) That would prima facie lead to the conclusion that local authorities could not enter into any derivative transactions, because they are all aleatory. However, that

conclusion cannot be reconciled with the specific legislative provisions the Supreme Court had reviewed at [7.1.1], [7.1.3], [7.1.5] and [7.1.6] which permitted local authorities to enter into derivative transactions in certain circumstances. The Supreme Court reconciled those provisions by treating them as specific permissions operating as exceptions from a general prohibition on local authorities entering into derivative transactions ([8.2]: “we must conclude that the law provisions examined above … only allowed what, normally, would be prohibited, with the result that those provisions were, above all, exceptional and had to be narrowly interpreted”).

196. While the reasoning in the decision may not appear entirely satisfactory, the court’s conclusion at [8.3] based on the “legal and axiological framework” it had set out is clear enough:

i) A public authority had contractual capacity to conclude derivative contracts until the 2013 Finance Law came into effect ([147]).

ii) However, only in the case of a hedging (and not a speculative) derivative “could be a local authority be said to have capacity to enter into them”.

It is to be noted that it is only in [8.3] of the Supreme Court decision in Cattolica that (two) express references to capacity are to be found.

197. The Banks argue that, properly interpreted, these paragraphs of Cattolica did not involve a finding that, as a matter of Italian law before an Italian court, a local authority lacked the substantive power or legal ability to enter into a valid speculative derivative transaction, but only that a local authority was prohibited from entering into such transactions. It should be noted that, in a case concerned with transactions governed by Italian law, the distinction between those categorisations was likely to be of far lesser moment than it might prove to be in the present context. While what ultimately matters in this regard is how English law categorises the position (which I discuss below), I am satisfied that the effect of the Supreme Court’s decision was that, as a matter of Italian law, local authorities lacked the substantive power to enter into speculative derivative contracts rather than that they were acting illegally in doing so:

i) The Supreme Court’s summary of the statutory framework referred to various enactments making it “possible” for local authorities to enter into particular derivative transactions (e.g. [7.1.1]), or giving them “authority” to do so ([7.1.3]), or which “precluded” local authorities from entering into such transactions ([7.3]).

ii) The various statutory restrictions were described in [8] as “limits of entities’ ability to enter into derivatives” and the Supreme Court introduced the discussion of speculative derivatives which followed as showing that “the contractual power of local entities had clear limitations”.

iii) While the language of “prohibition” can be found in [8.1] and [8.2] in relation to speculative derivatives, that was linked to Articles 119(4) and (6) of the Constitution. As I explain at [270]-[271] below, I am satisfied that Article 119(6) is a limit on the substantive power of a local authority, and while the Supreme Court may not have been directly applying Article 119(6) at this stage of its

judgment, the significant reliance placed on Article 119(6) suggests that the Supreme Court was dealing with a limitation on local authorities’ powers of the same kind.

iv) When addressing the civil law restrictions relating to oggetto and causa in Section 9, the Supreme Court referred back to its Section 8 distinction between speculative and hedging derivatives in language which distinguished between the ability of local authorities to enter into hedging derivatives, and their ability to “usefully and effectively do so”:

“In regard to derivative contracts entered into by Italian Municipalities based on the laws in effect until 2014 … and the distinction between hedging and speculative derivatives based on the criterion of the different degree of risk of each of them, although local authorities could enter into the former with qualified financial intermediaries, local entities could usefully and effectively do so only if the contractual object … could be precisely measured/determined”.

That passage appears to be drawing a distinction between the power to contract at all (in relation to the speculative/hedging distinction, with local authorities having power to enter into derivatives of the latter kind but not the former), and the enforceability of the transaction where there was such a power (having regard to the requirement for a legitimate oggetto).

198. The Banks also argued that, if the Supreme Court did hold that local authorities had no substantive power to enter into speculative derivative contracts, its decision was wrong as a matter of Italian law, relying in this regard on Professor Xxxxxxx’x evidence. The effect of that evidence was as follows:

i) As a matter of Italian law (Article 11 of the ICC and Article 1(1 bis) of the Law of Administrative Procedure), a local authority has the same capacity to contract as other legal and natural persons, save to the extent that its capacity is expressly restricted by law.

ii) There is no legislation which removes the contractual power of Italian local authorities to enter into speculative derivative contracts.

iii) The Supreme Court was in error in purporting to derive a limitation on the contracting power of local authorities so far as speculative derivatives are concerned from the Constitutional Court Decision No 52/2010.

iv) Article 119(6) of the Italian Constitution does not limit the capacity of a local authority, but renders any transaction which does not comply with that provision void.

v) The provisions of the 2008 Decree and the 2013 Finance Law did not themselves limit the contractual capacity of local authorities, because they allowed the local authority (but not its counterparty) to enforce such a transaction.

199. Those objections fall into two categories – an objection that there was no restriction on the ability of local authorities to enter into speculative derivatives as a matter of Italian

law; and an objection that such restrictions as there were in relation to a local authority’s power to enter into contracts of a particular kind were in the nature of prohibitions rather than restrictions on the local authority’s power to contract.

200. As to the former,

i) I have noted that the Supreme Court’s decision involved reading much into Constitutional Court judgment No 52/2010. However, for the reasons I have set out at [194] above, I accept that there are aspects of that decision which can be read as providing support for the Supreme Court’s analysis, and I am not persuaded that the Supreme Court’s interpretation is untenable, nor does its analysis rest entirely on its reading of Decision No 52/2010 in any event.

ii) While I accept Professor Xxxxxxx’x evidence that, as a matter of Italian law, a limitation on the substantive power of a local authority to enter into a contract of a particular type must be found in legislation, the Supreme Court purported to found that limitation in its interpretation of Articles 119(4) and (6), and the limitations of the “enabling” legislation it summarised in Section 7 of the judgment.

iii) The Supreme Court’s interpretation does not appear to have involved the direct application of those provisions, or a process of textual interpretation in a conventional sense, but reliance on those provisions to identify a principle which the Supreme Court then applied. It was, undoubtedly, the Supreme Court itself, rather than the language of the legislative enactments, which did the “heavy lifting” in formulating this restriction. Indeed, Italian academics have noted that the contribution of case law on the issue of local authority swap transactions “is to be appreciated on an objective level, as a particularly ‘creative’ and decisive intervention in the development of the matter” (XX Xxxxxxxx cited in Xxxxx Xxxxxx and Xxxxxx Xxxxxxx, “Italian Case Law on Derivative Contracts: An Interdisciplinary Analysis”(2020) III(II) Revista di Diritto Bancario 195). The Xxxxx Article, 37 described the Supreme Court as “drawing from the system, in an interpretative way, the guiding principle that directs the administrative action” (which reflects the fact that, as Mr Xxxxxxx XX submitted, there was no conventional process of ascertaining and directly applying the text of the relevant enactments).

iv) However, applying the deference to which a decision of the Joint Divisions of the most senior civil court in Italy is entitled (see [125] above), I do not feel able to conclude that the decision was not open to the Supreme Court as a matter of Italian law or that it does not represent Italian law as matters stand.

v) Further, there have been four subsequent decisions of the Italian Supreme Court which have applied Cattolica (Decisions Nos 2157/2021, 21830/2021, 24014/2021 and 8603/2022). While these decisions were all concerned with that part of the Cattolica decision concerned with Articles 1322, 1325 and 1346 of the ICC (and hence oggetto and causa), those were, if anything, even more controversial elements of the Cattolica decision, and there are some similarities between aspects of the reasoning in Section 9 of Cattolica and that in Section 8. There is nothing to suggest that the Italian Courts are experiencing any “buyer’s

remorse” at the very significant changes in Italian law effected by Cattolica so far as transactions are concerned.

201. So far as the second issue is concerned, what ultimately matters is the proper characterisation of the provision as a matter of English conflicts of law analysis (see

[273] below). The fact that Italian law does not recognise a doctrine of nec ultra vires or that there are circumstances in which a transaction may nonetheless be enforceable notwithstanding the restriction on a local authority entering into a transaction of a particular type are not in themselves determinative in that analysis. However:

i) The heart of the Banks’ submissions on this issue (to quote from paragraph 168 of their opening) is that there is a “fundamental distinction between a prohibition which renders an act unlawful such that the law provides for a specific consequence (e.g. providing that the resulting act shall be void) ... and a restriction placed on the power of an entity to do an act”, with Article 119(6) being a provision of the former kind.

ii) However, and with respect, that distinction of such central importance to English lawyers proved rather more elusive in the Italian legal materials.

iii) Thus, when identifying exceptions to the general capacity of public bodies to undertake private law acts such as entering into contracts, Professor Xxxxxxx, Professor Xxxxxxx and the underlying materials generally defined the exception to general capacity as something which would arise from a “prohibition”. Thus, Professor Xxxxxxx in her first report stated that “public bodies have a general capacity to acquire legal rights and obligations, unless there is an express prohibition by law” ([14.2]) and referred to “the general capacity of public authorities to enter any kind of contract – unless there is an explicit prohibition set by law” ([14.4]). Professor Xxxxxxx in his report also referred to the general capacity of public authorities unless “there is an explicit prohibition set by law” ([5.75]).

iv) I was referred to Supreme Court Decision No 11656 of 12 May 2008 which stated “both public legal entities and private legal entities have the same capacity, so that the public administration can enter private law contracts if there is not a specific prohibition” (emphasis added). Further, Council of State Decision No 1156/2010 referred to the capacity of a public administration to enter into contracts only existing when “exercised in accordance with the procedures defined by the legislature and, in the species, by the express will of the legislature” ([6.7.1] and to “lack of capacity of the public [authority]” depending on “the violation of rules dictated in the public interest concerning, ultimately, the economic public order”. While that statement was made in the context of a failure to comply with public tender rules it is equally (or even more) apposite as a means of referring to a failure to comply with Article 119(6) of the Constitution.

v) While the 2013 Finance Law permitted public authorities to enforce prohibited swaps, the effect of contravention of Article 119(6) of the Constitution prior to that date was the transactions were void and unenforceable for both parties.

When is a Derivative Speculative?

202. It is common ground that while the Italian legal or regulatory regime treats the question of whether a derivative is a hedge or a speculative transaction as significant for certain purposes, Italian law does not provide a definition of what constitutes a speculative derivative. Indeed, the lack of any clear definition was one reason why the Banks submitted that there could be no limit on a local authority’s ability to enter into speculative derivative transactions.

203. The evidence as to what made a derivative transaction a hedge, or speculative, comprised:

i) evidence of Italian law (both from the experts and from Italian case law);

ii) reference (on part) to English case law addressing this topic under other legal systems; and

iii) evidence from the two market practitioners as to their understanding.

204. As the issue which arises for determination concerns a restriction on the ability, as a matter of Italian law, of Italian local authorities to enter into a transaction of a particular type, I found the evidence in the first category of the greatest assistance.

The Italian Law Evidence

205. It was Professor Xxxxxxx’x evidence that, by the time of the Transactions, the concept of “hedging” had “de facto achieved a specific and technical and legal meaning under Italian law”, namely a derivative which satisfied the test set out in the CONSOB Determination (see [133]), and that it could be inferred that a derivative transaction which did not satisfy those requirements was speculative.

206. The CONSOB Determination advised that a derivative would be considered a hedging transaction (and implicitly not a speculative transaction) if three conditions were satisfied:

i) the transaction is explicitly carried out to reduce the risks connected with the underlying instrument;

ii) there is a “high correlation” between the technical and financial characteristics of the underlying instrument (i.e., maturity, interest rate, etc.) and those of the derivative transaction; and

iii) there are procedures and internal controls within the intermediary which are sufficient to make sure that the above conditions are satisfied.

207. In Professor Xxxxxxx’x view, that third element (which essentially concerned the records kept in relation to the conclusion of the transaction rather than anything intrinsic to the transaction itself) was not relevant in this regard. I agree with that assessment, although no doubt the absence of such records might make it difficult for a contracting party to persuade an interested observer that the transaction in question was a hedge.

208. I accept that the CONSOB Determination is of assistance when determining whether or not a derivative is a hedge. It has been relied upon in a number of Italian court decisions (including the Supreme Court in Decision No. 19013/2017 and the Court of Appeal of

Milan in Decision No 921/2021), and in determinations by the Italian Arbiter for Financial Disputes (in Decision No 5017 of 25 January 2022).

209. However, it is clearly not exhaustive. It was issued in 1999 to deal with a specific query raised by a private company in the context of various articles of CONSOB Regulation No 11522/98:

i) Article 28.3 (the obligation of authorised intermediaries to inform investors as soon as derivative instruments entered into “for purposes other than hedging” have generated a particular level of actual or potential loss).

ii) Article 37.1(d) (a management contract had to indicate whether derivative financial instruments could be used for purposes other than hedging the risks associated with the positions held under management).

iii) Article 43.5 (permitting authorised intermediaries to carry out derivative financial instruments only when certain conditions were met, including, in the case of options, derivatives and short sales, that they were traded on regulated markets “unless the contracts are concluded for the purpose of hedging the risks associated with positions held under management”).

The CONSOB Determination was not, therefore, formulated with the specific considerations regulating local authority finance in mind, but by reference to the services being provided by financial intermediaries or asset managers. Nor did it engage with more nuanced questions such as the status of a swap which (in part at least) is entered into for hedging purposes, but the parameters of which are structured for the purpose of eliminating an exposure such as a negative MTM on an existing transaction which the contracting party wishes to close out. Finally, there are many Italian court decisions which have addressed the issue of whether a derivative was hedging or speculative in nature without referring to the CONSOB Determination or applying the three-stage test (for example those referred to in Professor Xxxxxxxxx’x third report, [12]).

210. I also accept Professor Xxxxxxx’x evidence that the issue of whether an transaction is in the nature of a hedge or speculative must be judged ex ante rather than in hindsight. While good fences may make good neighbours, it is not the case that bad xxxxxx make void contracts. That conclusion is supported by three decisions to which Professor Xxxxxxx referred, of the Court of Appeal of Milan in Decision No 921/2021 and the Supreme Court in Decisions No 18724/2018 and No 24014/2021.

211. Professor Xxxxxxxxx sought to draw her test for the distinction between a speculative derivative and a hedge from the Cattolica decision. It was her evidence that “a hedging derivative causes a reduction of the underlying risk borne by a protection whereas a speculative derivative gives rise to a new risk or causes an increase of the underlying one”. However:

i) Any hedge will necessarily involve a risk that the actual rate may move in such a way that the protection buyer will be worse off than if they had not brought the protection, as well as being better off. A vanilla in which the protection buyer who has a variable interest rate exposure purchases an to hedge that exposure by agreeing to pay a fixed rate to a bank in return for receiving interest at the

variable rate runs the risk that the fixed rate paid will exceed the variable rate received.

ii) It was no doubt for that reason that the Supreme Court in Cattolica was at pains to point out that both hedging and speculative derivatives involved the assumption of risk by a local authority, albeit (in the Supreme Court’s determination) different degrees of risk: [8.2], [8.3] and [9.8].

212. In my assessment, Professor Xxxxxxxxx was on surer ground in relying on judicial determinations on this issue in other cases, an analysis which was supplemented by additional authorities placed before the court to similar effect:

i) A number of these decisions found (not surprisingly) that a derivative contract entered into when there was no underlying risk to hedge was speculative (see Court of Turin, 21 October 2021 Decision No 4685, Court of Florence, 5 June 2012 and Court of Lucera, 26 April 2021).

ii) A significant discrepancy between the notional amount, maturity date, exchanged interest rate or cash flows of the derivative and the underlying risk has also been relied upon to support the conclusion that a derivative was speculative: e.g. the Court of Cassation Decision No. 19013/2017, the Court of Rome, 8 January 2016, Decision No. 212, the Court of Novara, 24 July 2012, Decision No. 569, and the Court of Turin, 21 October 2021, Decision No. 4685. Those cases reflect the second stage of the test propounded in the CONSOB Determination of the need for a “high correlation” between the technical and financial characteristics of the underlying instrument and those of the derivative transaction.

iii) A decision of the Court of Auditors of the Lazio Region of 12 April 2022 (No 42), which was added to the trial bundle after the expert witnesses had given evidence, held a swap to be speculative where the local authority, whose own borrowings were on a fixed rate basis for 86.5% of its underlying debt, agreed to receive a fixed rate from the bank in return for paying the bank interest in two tranches calculated by reference to two structured variable rates. The Court of Auditors held that this could not be a hedge because there was “no risk to be hedged” (because the vast majority of the authority’s borrowing was at a fixed rate), but was “a mere financial speculation, at high risk of loses” (the authority hoping that market movements would be such that the interest payable to the bank would be less than the fixed rate being received). also relied on another decision added to the trial bundle after the expert evidence (a decision of the Court of No 696/2022) to similar effect so far as the 2005 swap in that case is concerned.

iv) A decision of the Court of Appeal of Milan in Decision No 2393/2020 involved a “collar” swap in which the MTM of the cap at the date of the swap was much lower than the MTM of the floor. The Court of Appeal held that this was a speculative derivative. In reaching that conclusion, the Court of Appeal relied on Article 3, paragraph 2(d) of Ministerial Decree 389/2003 (see [136]) and the 2004 MEF Circular ([140]), stating that it permitted a local authority to purchase a collar, not to sell one, and it was held that if the MTM of the floor in favour of the bank was significantly greater than the MTM of the cap, it was the local

authority which was purporting to “sell” a protection which was an inherently speculative transaction. The Court of Appeal concluded:

“An invalidity that - due to its speculative characteristics - must therefore affect the entire contract, and not only the part that concerned the imbalance between the MTM of the cap option and the MTM of the floor option, as also argued in the alternative by the appellant and, in the opinion of this Court, without foundation.”

v) A (pre-Cattolica) decision of the Court of Orvieto of 12 April 2012, applying a “prima facie likelihood of success” (fumus boni iuris) test in the context of an application for an injunction, found the derivative contract in that case prima facie speculative because the terms of the contract had been structured to absorb the negative MTM on prior swap transactions. The Court observed:

“The reason that drives the said authority to renegotiate the derivative contract is to stop excessive and out-of-control losses arising out of the accrual of negative differentials. As a consequence, the derivative contract as renegotiated appears to be less and less connected to its original reason (the hedging of a material risk), getting dangerously close to purposes that can properly defined as speculative … Local authorities are only allowed to underwrite derivative investments with hedging purposes (Article 3 of Ministerial Decree No 389/2003 and Article 41 of law No 448/2001)”.

vi) The Court of Turin of 21 October 2021 in Decision No 4685/2021 was a non- local authority case in which the intermediary had suggested to its client that a proposed swap transaction was a hedge. The “hedge” in question replaced a previous swap transaction with a negative MTM, which was rolled into the new structure. In considering whether the new swap was a hedge, the Court considered and applied the CONSOB Determination. With specified reference to the negative MTM rolled over from the previous swap, the Court noted

“Renegotiation can procrastinate the matured loss over time, dilute it (if e.g. the duration of the contract is extended compared to the original swap) and, to the limit, makes the exposure in client derivatives assume a highly speculative connotation, regardless of the coverage function of the first contract, to the extent the contract is renegotiated, to resorb the accrued loss, contains features (notional, duration and parameters) without ‘high correlation’ to existing exposure”.

vii) By contrast, the Supreme Court in Decision No 21830/2021 held that a vanilla swap transaction (the purchaser paying a fixed interest rate in an amount aligned with its underlying borrowing in return for receiving a floating rate on the same amount) was a hedge, and not a speculative transaction. In addition to the close alignment of the with the terms of the underlying borrowing (cf, the second element of the CONSOB Determination), the court noted the “alignment between the financial parameters included in the derivative contract and the forecasts of the trend of interest rates for future years covered by the (so- called forward rate curve)”. I would note that if the terms of the derivative have been structured not simply to reflect current expectations of the potential for future interest rate movements, but “off market” in an effort to cover the cost

involved in covering a negative MTM on a transaction which is to be closed out, that “alignment” will necessarily be absent.

213. On this last topic, it is to be noted that one of the swaps in issue in Cattolica had been structured so as to absorb a negative MTM under a preceding swap transaction, the First Division noting in the Interlocutory Order that upfront payments were “obviously useful for management of current expenses or for settlement of previous debt exposures (as happened in the case of second transaction in question, where the disbursement was almost entirely used to cover the losses previously incurred)”.

The English Authorities

214. Next, Mr Xxx XX relied on various English authorities which have considered, in the context of foreign law restrictions on the ability of legal persons to enter into particular types of transactions, whether particular derivatives were speculative. In Busto, Xxxxxxxxx J observed of an attempt to rely on English decisions applying English law in this context at [289(ii)] that:

“the case on the dividing line between hedging and speculation is in this case one of Italian Law. It is impermissible for me to impose English Law concepts of hedging as it would be to impose an English Law understanding of the capacity/validity divide”.

215. I share Xxxxxxxxx J’s view as to the limits on the utility of referring to decisions reached when applying the law of other jurisdictions to the issues which arise under Italian law. For that reason, I have placed only limited weight on the English decisions on which Mr Xxx XX relied. However, it is of interest to note that many of the factors highlighted in the Italian case law are echoed in the English cases, and that in each of those cases, the courts recognised and applied a limit on the contracting power of a corporation to enter into speculative derivatives without the benefit of a statutory or judicial definition of what made a derivative speculative.

216. In Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm), the issue arose in relation to the capacity of a housing association incorporated under Dutch law. At [217], Xxxxxx Xxxxx J found that hedging encompasses:

“Instruments that reduce, as well as instruments that eliminate, exposure to risks from borrowing liabilities. The defining characteristic of hedging is that it eliminates or reduces an exposure to some market risk or risks: see the definition of ‘hedging’ published by ISDA, ‘A trading strategy which is designed to reduce or mitigate risk. As I understand what constitutes ‘hedging’, Xxxxxx would properly be said to have ‘hedged’ a risk of loss if they entered into a transaction that reduced or limited it, either in the sense of limiting the amount of the overall loss that Vestia potentially face from market movement (or in other circumstances) or in that the hedge would protect them from loss only in particular circumstances.”

In respect of certain transactions, the Judge concluded that they were speculative as a whole even though they included elements which would operate as a hedge in certain circumstances.

217. In UBS AG v Kommunale Wasserwerke Leipzig GmbH [2014] EWHC 3615 (Comm), [159], Males J held that a swap which materially increased a risk to which the purchaser was already exposed was speculative.

218. Finally, Mr Xxx XX referred to the consideration of the distinction between hedging and speculation by an arbitral tribunal comprising Xxxx Xxxxxxx, Mr Xxxxxxx Xxxxx SC and Mr XX Xxxxxx QC when considering the contracting powers of a corporation incorporated under Sri Lankan law. The tribunal’s analysis is set out and discussed by a judgment of the Court of Appeal in Standard Chartered Bank v Ceylon Petroleum Corp [2012] EWCA Civ 1094, [9]-[12]. The tribunal held that:

i) hedging involved reducing existing exposures to a particular risk, whereas speculation involved the assumption of a new risk for the purpose of financial gain independently of any other risk;

ii) hedging involved protection against future adverse price movements, and the use of derivative instruments to raise money to offset the effect of existing high prices was necessarily speculative; and

iii) the derivatives in question gave the purchaser a small return unless the market collapsed, in which case it would suffer catastrophic losses, and were therefore speculative because they involved the purchaser “acting as insurer, not as insured”.

The Evidence of Market Participants

219. btained permission to call expert evidence on the issue of “how would market participants in 2007 have determined whether a derivative contract was speculative?” However, the answer to that question would necessarily depend on the context in which it was asked. If the question had been “how would markets participants in 2007 have determined whether a derivative contract was speculative for the purposes of determining whether an Italian law restriction on the contracting power of local authorities was engaged?”, the answer would almost certainly have been “I would have asked an Italian lawyer”.

220. In any event, I was not persuaded on the evidence that this was a question which market participants would have asked themselves in 2007 in any context. It was the evidence of Mr Xxxxx, who had over 20 years’ experience of trading, structuring, risk-managing and advising on derivatives, that he had never had cause to answer that question in any context. Ms Xxxxx also accepted in cross-examination that the answer to that question was context-dependent (including by reference to the legal and regulatory framework). Neither expert pointed to any market standards, definitions or publications which had informed their evidence. In the final analysis, I was not persuaded that either expert was doing (or was able to do) anything more than offering their own subjective view, and a view which reflected their de novo analysis having been asked to consider the issue in the context of this litigation, rather than one which drew on practical experience of addressing the same issue in their professional lives.

221. In these circumstances, while I was assisted by the market participants’ evidence in relation to pricing, valuation and their probabilistic evaluations of elements of the Transactions, I have not (with respect) been assisted by their evidence as to what and

what does not constitute speculation for the purposes of the Italian law question I have to decide.

Conclusion

222. I will not attempt to formulate a definitive test of what makes a derivative speculative as a matter of Italian law, when the Supreme Court in Cattolica did not itself do so, and when it remains possible to apply a restriction by reference to that criterion without doing so ([215]). The Italian case law identifies a number of indicia or features which, either individually or in combination, may have the effect that a derivative is a hedging transaction, or a speculative transaction (many of which, as Mr Xxx XX submitted, are reflected in English case law on the same topic).

223. In Xxxxxxxxxx v Ohio 378 U.S. 184, 197 (1964), Justice Xxxxxx Xxxxxxx famously observed of the topic of obscenity, “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it”. The time has come to see if speculation is to be seen in the Transactions.

Were the Transactions Speculative?

224. Over the course of the trial, there was a considerable amount of skirmishing around the fringes of this issue – debates as to whether it was being said that any transaction involving an element of risk or uncertainty as to the payments which would be made on either side was speculative (for example insurance contracts or floating interest rate loans). However, commendably, in closing Mr Xxx XX cut right to the heart of the matter so far as this particular case was concerned – the fact that the terms of the swap had been structured so as to cover amounts which the Banks had to pay to

to close out the .

225. In my determination, the essential facts relating to decision to enter into the Transactions were as follows:

i) wanted to restructure the Bond (in particular by lengthening the repayment date by 15 years) in order to realise savings and “free-up” its budget, and also to obtain protection through an against the risk of a significant increase in interest rates over the extended duration of the Bond.

ii) The reflected the original tenor of the Bond, and by the end of 2007, the had a significant negative MTM so far as was concerned of €7.5m. s was also entitled to additional fees

and costs as the price of unwinding the .

iii) Any restructuring of protection to reflect its desire to extend the repayment date of the Bond required to address the

and the negative MTM on it. That could have been done (i) by making a payment to to unwind the and entering into a new and independent transaction with or someone else; (ii) re-negotiating the duration of the on a basis which rolled over the negative MTM or embedded it in an adjustment of the terms of the new swap; or (iii) entering into an with another bank or banks who would themselves make the

payment necessary to close out the

doing so through the terms of the new swap.

, and recover the cost of

iv) As I have explained at [82]-[88] above, I am satisfied that by the time it issued the tender letters, had decided to replace the , and that it wished to do so without having to meet the wind-up cost in 2007. A proposal which rolled that wind-up cost into the terms of the new derivative was attractive to As a result, chose the third option, with the Banks paying

a total of c €8m to effect the unwinding of the .

v) The result was that the Transactions were entered into in part for the purpose of providing protection against a significant increase in interest rates during the extended period of the Bond. The many statements made by to that effect – for example in Resolution 129, Executive Resolution 3561 and in the representations made at Part 5 paragraph 3(ii)(B) of the Schedules to the

Master Agreement and otherwise – were, to that extent, correct.

vi) However, that is not the whole story. In doing so, also wanted to provide for its exposure in respect of the negative MTM under the , and to do so through the floor and cap in the Transactions. was also attracted by the fact that the terms offered by the Banks would provide a short-term net cashflow benefit (in the first half of 2008).

226. The impact on the terms of the Transactions of structuring the collar to cover the costs of winding up the was considerable:

i) This was the principal reason why the Transactions had a very significant MTM in the Banks’ favour from the outset (a combined positive Day 1 MTM of c

€10.5m in the Banks’ favour).

ii) This was the principal reason why the value to the Banks of the interest rate floor (estimated by the experts at between €12.4m and €12.974m) was more than five times the value to of the cap (estimated by the experts at between €1.7m and €2.4m).

iii) This was the principal reason why, on the basis of a Day 1 statistical probabilistic calculation, the probability of losing money on the Transactions was high:

a) On Ms Xxxxx’x calculations, the probability of a negative pay-off for under the Transactions was between 77.1 and 78.7% (depending on

whether or not the calculation is performed on an “absolute” basis or on a basis which discounts future cashflows to present value), whereas if the amount paid to wind up the is removed from the calculation, the figure is 59.3%.

b) Mr Xxxxx did not put forward his own calculation of the probability of a negative pay-off for under the Transactions or challenge Ms Xxxxx’x calculation of 78.7%, saying that in his experience banks did not produce such calculations and he did not consider that they had utility for customers. He did perform a calculation removing the amount paid to wind down the B from Ms Xxxxx’x calculation and arrived at a

figure of 57.3%. The Banks’ closing submissions did not challenge Ms Xxxxx’x figure, but noted that “stripping out” the wind up cost reduced that figure to 57.3% on Mr Xxxxx’x figures.

iv) On Mr Xxxxx’x evidence, it led to the floor being between 80 and 100 basis points higher than it would otherwise have been.

v) On Ms Xxxxx’x calculations, it meant that the Transactions involved a modelled “realistic worse case” outcome for of the order of €70.6m (modelling to a 95% confidence level). Mr Xxxxx gave evidence that the MTM distribution analysis which Ms Xxxxx had performed would be of limited use to customers, and that xxxxx did not provide MTM distribution analyses to customers. He did accept, however, that the effect of including the large negative MTM from the was to lower the probability of the Transactions being positive

in the future.

227. In my view, Mr Xxx XX was right to submit that, in addressing the cost of winding up the through the terms of the Transactions, was obtaining the possibility that interest rate movements during the life of the Transactions would be such that would not have to pay a sum equivalent to the wind-up cost, but in return, was running the risk that interest rate movements during the life of the Transactions would be such as to lead to it paying a great deal more.

228. The decision to address the cost of winding-up the within the terms of the Transactions had other consequences:

i) It meant that the terms of the Transactions were in material and financially significant respects (the level of floor and cap) not determined by the terms of the Bond (although I accept that important terms were so determined – the Notional Amounts, the amortisation rate, the maturity date and the interest rate

received by from the Banks).

ii) It meant that the minimum interest rate which was committing to pay was not aligned with the forward rate curve at the time of contracting.

iii) It involved the assumption by of a new and significant risk (viz of having to pay interest to the Banks at the floor level while receiving interest payments at a much lower rate) which did not arise under the Bond. While the character of the Transactions must be determined ex ante, some indication of the degree of risk run can be seen in the fact that by the end of the most recent payment period (24 June 2022), had made total payments to the Banks of €70,995,695.95 (in part because EURIBOR 6m became negative in November 2015).

229. Standing back, therefore, and considering the matters discussed in [226] to [228] above:

i) The Transactions were explicitly carried out in the terms adopted both to reduce the risks connected with the Bond and to cover the winding-up costs of the

(CONSOB Determination (a)).

ii) While many of the terms of the Transactions matched the financial characteristics of the Rialto Bond, important and financially highly significant terms were

arrived at for other reasons (CONSOB Determination (b); the Court of Cassation Decision No 19013/2017, the Court of Rome 8 January 2016, Decision No. 212, the Court of Novara, 24 July 2012, Decision No. 569, and, the Court of Turin, 21 October 2021, Decision No. 4685).

iii) There was a very significant difference between the MTM of the cap and the floor, such that was providing the Banks with a protection of a significantly greater value than the protection it was obtaining from the Banks (the Court of Appeal of Milan in Decision No 2393/2020 and cf Standard Chartered Bank v Ceylon Petroleum Corp [2012] EWCA Civ 1049, [9]-[12]).

iv) The fact that the desire to cover the winding-up costs of the was a highly significant factor in setting the terms of the Transactions itself pointed to the speculative character of the Transactions (Decision of the Court of Orvieto of 12 April 2012 and of the Court of Turin of 21 October 2021 in Decision No 4685/2021). It meant that the Transactions were, to a significant extent, serving the purpose of seeking to address a past adverse event (cf Standard Chartered Bank v Ceylon Petroleum Corp, [9]-[12]).

v) The significant non-alignment between the terms of the Transactions and the prevailing forward rate curve was also suggestive of speculation (Supreme Court Decision No 21830/2021).

vi) The fact that ook on a significant new risk to which it was not exposed under the Bond was also suggestive of speculation (Professor Xxxxxxxxx’x evidence and cf. Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103 (Comm), [217], UBS AG v Kommunale Wasserwerke Leipzig GmbH [2014] EWHC 3615 (Comm), [159] and Standard Chartered Bank v Ceylon Petroleum Corp [2012] EWCA Civ 10494, [9]-[12])).

230. As submitted in its closing, the structuring of the Transactions to cover the costs of winding-up the with its substantial negative MTM was:

“akin to borrowing money but instead of repaying it on predictable terms, entering into a bet with a range of possible outcomes. might never have had to repay the money at all, if rates had suddenly risen to well above the cap and stayed there such that it was in the money throughout the life of the swap. Conversely, might – as has in the event occurred – have had to pay it back many times over, because its impact on the floor level as resulted in

paying much more than would otherwise be the case. The only rational basis for proceeding in such a way is the possibility that the bet could have worked out better for than if it had simply paid the break cost itself …

Borrowing money on terms that one might never have to repay it, might have to repay a much greater sum, or might have to pay anything in between for it depending on where interest rates sit, is speculation”.

231. Having regard to the cumulative effect of these factors, and regardless of whatever uncertainties might arise at the fringes of this debate, I am satisfied that an Italian court would clearly find that the Transactions were speculative for the purpose of the legal restriction under Italian law formulated in Cattolica. The most that can be said is that

the Transactions served mixed motives (as I accept). However, the Court of Appeal of Milan in Decision No 2393/2020 noted that:

232. In any event the significance of the speculative elements of the Transactions (as outlined at [226]-[228] above) were such that the Transactions can fairly be characterised as predominantly speculative.

J THE INDEBTEDNESS ARGUMENT

Introduction

233. As I have noted at [188] above, it was Mr Xxx KC’s primary contention that the Supreme Court in Cattolica had decided that all transactions involved recourse to indebtedness for the purposes of Article 119(6), and that local authorities could not enter into speculative derivative transactions because they involved indebtedness otherwise than for the purpose of financing expenditure. If he is wrong in that conclusion (which is my determination, and which appears also to have been the view of Xxxxxxxxx J in Busto, [195] and [280]), then Mr Xxx KC advances the alternative argument that the Transactions breached Article 119(6) because they involved recourse to indebtedness otherwise than for the purpose of financing expenditure.

234. There is a further complexity that Xxxxxxxxx dealt with the Indebtedness Argument and the Article 42 TUEL Argument together in Section 10, and appears to have adopted a common analysis of what constituted indebtedness for Article 119(6) purposes, and what amounted to “expenditure which commits the budgets for subsequent financial years” for the purposes of Article 42(2)(i) of TUEL.

Can an Transaction Ever Constitute Indebtedness? – the Position Leaving Cattolica

Aside

235. The Banks argue that, at the relevant time, no transaction could constitute indebtedness. That argument has three principal elements:

i) First, that transactions do not feature in the list in Article 3(17) of the 2004 Finance Law, which is said to contain an exhaustive definition of what constitutes “indebtedness” for the purposes of Article 119(6).

ii) Second, that the contrary argument would be inconsistent with the guidance given in the 2007 MEF Circular.

iii) Third, it is said that the argument is inconsistent with the decision of the Council of State, Italy’s highest court in administrative law matters, in Decision No. 3174/2017.

236. As to the first argument, Professors Xxxxxxx and Xxxxxxxxxxxx held different views on the issue of whether Article 3(17) of the 2004 Finance Law (and any successor

legislation) contained an exhaustive and exclusive identification of what constituted “indebtedness” for Article 119 purposes. In my view, the arguments in favour of the “exclusivity thesis” are formidable:

i) The terms of Article 3(17) of the 2004 Finance Law (“pursuant to Article 119(6) of the Constitution the following constitute indebtedness”; “in addition constitutes indebtedness”; certain operations "do not constitute indebtedness, pursuant to the to the aforementioned Article 119”) are far more redolent of a provision whose purpose is definitional rather than illustrative.

ii) Article 3(18) – identifying what constitutes “investment” for Article 119 purposes

– would appear to be exhaustive (and one can see every reason why it should be).

iii) That conclusion is reinforced by the fact that, as originally enacted, Article 3(17) provided that “changes to the aforementioned types of debt are set by decree of the Minister of Economy and Finance, after consulting ISTAT, on the basis of criteria defined at the European level”. Those words were held to be constitutionally illegitimate by the Constitutional Court in Decision No 425 of 29 December 2004 (for reasons which I will turn to shortly). However, the suggestion that Article 3(17) identified “types of debt” to be changed in a particular way and on a particular basis strongly supports the argument that its terms were intended to be exhaustive.

iv) That conclusion is also supported by the Constitutional Court Decision No 426/2004, which addressed a series of constitutional challenges to this part of the 2004 Finance Law. The Court defined the issue before it as follows:

“The question that arises is whether and to what extent the law of the State can lay down specific rules concretising and implementing the constraint laid down in Article 119(6) of the Constitution, in particular by defining what is meant, for these purposes, by 'indebtedness' and 'investment expenditure'. These are not notions whose content can be determined a priori, in an absolutely unequivocal manner, on the basis of the constitutional provision alone, of which this Court is able to offer an exhaustive and binding interpretation for all, once and for all. These are notions that are based on principles of economic science, but which cannot fail to give room for rules of concretisation marked by some political discretion … The very definitions which the State legislature has provided

… derive from economic and financial policy charges.” (emphasis added).

v) The challenge brought to Article 3(17) (together with Article 3(20)) was that “they grant the Minister of Economy and Finance the power, essentially regulatory, to modify by decree the types of operations constituting debt and investment”. That challenge was upheld on the following basis:

“These provisions (one of which, paragraph 20, partly repeats the provisions of paragraph 17 as regards the types of debt, and extends the same mechanism to the types of investments) grant the Minister a power whose exercise may entail a further restriction of the power of autonomous

entities to resort to debt to finance their expenditure, and essentially translate into a delegation of the provisions contained in the aforementioned paragraphs, which define the notions of debt and investment for the purposes of applying the constraint set out in Article 119(6) of the Constitution to regions and local authorities. 119, sixth paragraph of the Constitution. However, such a provision would presuppose compliance with the principle of substantive legality, under which the exercise of political-administrative power affecting regional autonomy (as well as local autonomy) can be admitted only on the basis of legislative provisions that predetermine in a general way the content of the executive's rulings, delimiting its discretion”.

vi) The conclusion that a statutory provision empowering the MEF to add “types of debt” to Article 3(17) was unconstitutional, because this would curtail the autonomy of regions and local authorities without the legislative sanction which Article 3(17) had itself provided weighs strongly against the suggestion that Article 3(17) is not exhaustive, and that it is open to someone other than the legislature (e.g. the courts by way of a process of interpretation of Article 119 of the Constitution or reasoning by analogy) to include new types of transaction within the Article 119 restriction.

vii) Contravention of Article 119(6) exposes public officials to the imposition of very significant penalties. Article 3(15) of Law No. 289/2002 provides:

“Whenever the territorial entities take on debt to finance expenses other than investment, in violation of Article 119 of the Constitution, the relative acts and contracts are null and void. The regional jurisdiction sections of the Court of Auditors may impose on administrators who have adopted the respective resolutions sentencing to a financial penalty equivalent to a minimum of five and a maximum of twenty times, the reserve indemnity earned upon committing the breach.”

That consideration supports an interpretation which limits the concepts of indebtedness and investment for this purpose to transactions specifically enumerated in legislation.

viii) Finally, the subsequent legislative history of Article 3(17) – in which new types of transaction were brought within the Article 119 concept of indebtedness by express enactment – also suggests that the list (as it existed from time-to-time) is exhaustive rather than illustrative. By 2021, the original list had been amended extensively by Article 1(740) of Law 296/2006, Article 62(9) of Legislative Decree No 112/2008 as amended in turn by Article 3 of Law 203/2008 and Article 1(289) of Law 170/2020. It is to be noted that certain of those changes were expressly prospective in effect – for example “financial leasing transactions entered into on or after 1 January 2015” and a provision relating to the provision of guarantees “as of 2015”.

237. Professor Xxxxxxxxxxxx suggested that the following words in Article 3(17) of Law 350:

“Operations that do not involve additional resources, but permit to overcome, within the maximum limit established by current State legislation, a temporary

shortage of liquidity and to incur expenses that already have a suitable budget cover, do not constitute indebtedness, pursuant to the aforementioned article 119;"

(which I will refer to as “the negative proviso”) carry with them the implication that “all operations” which do not share those characteristics constitute indebtedness, even if they do not fall within the preceding list of debt types.

238. Once again, I found this argument unpersuasive, and found Professor Xxxxxxx’x contrary view more compelling:

i) Simply looking at Article 3(17) itself, it seems to me more likely that the effect of the negative proviso is to remove transactions within the preceding list of debt types from the scope of Article 119.

ii) On the alternative hypothesis, the word “operations” would be important but extremely vague, potentially bringing a very wide category of transactions into the scope of Article 119 simply because they do not share the characteristics referred to in the negative proviso. By contrast, if the negative proviso is intended to remove transactions of the preceding debt types from the concept of indebtedness for Article 119 purposes, the meaning of “operations” is clear (namely operations within the preceding list).

iii) If the negative proviso is intended to provide an additional, free-standing, test for transactions falling within the concept of “indebtedness” in Article 119(6), it would seem to follow that transactions appearing in the list of debt types would still constitute indebtedness even if they did not involve additional resources and involved expenses that already had a suitable budget cover.

iv) The argument would give Article 3(17) (defining “indebtedness” for the purposes of Article 119(6) which requires “resort to indebtedness only for the purpose of financing investment expenditure”) a very different structure to Article 3(18) (defining “investment” for exactly the same purpose), in that the former would include unlisted transactions which did not share the characteristics of the negative proviso, whereas the latter is simply a list of qualifying transaction types.

v) The argument appears to be inconsistent with the judgment of the Constitutional Court in Decision No 425, to the extent that it involves the court adding to the list of transactions constituting indebtedness through the application of the negative proviso.

239. So far as the 2007 MEF Circular is concerned, this stated:

i) “It seems appropriate to remind that the [2004 MEF Circular] of [Decree 389] already included a general consideration that no derivative is classifiable as a liability [emphasis in original].

Therefore, derivatives are identified, according to the rules mentioned above, as

`debt management instruments and not as indebtedness’.”

The reference to the 2004 MEF Circular was to Article 3 thereof which identified permissible types of derivative transactions. A consistent theme of that Article was the need for a sufficient relationship between a derivative and an underlying transaction or liability. In that context, the 2004 MEF Circular stated:

“In addition, derivative transactions referring to other pre-existing derivative transactions are not allowed, on the basis that no derivative is a liability”.

ii) The 2007 MEF Circular went on to state that the 2004 Finance Law had given “a precise and detailed definition of the concept of indebtedness, indicating the types of transactions to be considered as such in reference to the above constitutional law”. It then traced subsequent legislative changes to that definition, before summarising the position which had been reached in the following terms:

“Therefore, in light of the recent legislative changes introduced on the matter, the following have to be considered indebtedness transactions: mortgages and credit openings, bond issuances, securitizations of future income flows, securitizations with initial payment below 85 percent of market price, securitizations guaranteed by other public administrations, securitizations of receivables towards other public administrations, transactions entailing transfer and securitizations of receivables towards suppliers of goods and services.

In conclusion, the definition of swap as mere instrument of debt “management” is further confirmed by the fact that derivative instruments are not mentioned in any of the abovementioned provisions of law; therefore, in light of the above, derivative instruments do not qualify as indebtedness transactions.”

240. The 2007 MEF Circular, therefore, is strongly consistent with the view that Article 3(17) as amended exhaustively defined which transaction types constituted indebtedness for Article 119 purposes, and that, as a transaction type at least, “indebtedness” does not embrace all swaps (a conclusion similar to that reached independently by Xxxxxxxxx J in Busto, [328]). However, neither the 2004 or 2007 MEF Circulars have the force of law, although they express the MEF’s official view and are used by judges as an aid to interpretation.

241. So far as the Banks’ reliance on Council of State Decision No. 3174/2017, is concerned, that decision considered the application of Article 42(2)(i) of TUEL in the context of transactions. However, as I have mentioned, the Supreme Court in Cattolica treated that issue compendiously with the issue of whether the swap transactions in that case constituted indebtedness for Article 119 purposes. In Decision No 3174/2017, a municipality had amended various existing swap agreements for the purpose of restructuring its debt under multi-year instruments. It had later purported to invalidate the amended swaps, inter alia on the basis that they had not been approved by the City Council as required by Article 42(2)(i). That argument succeeded at first instance, but the swap counterparty appealed to the Council of State. The arguments in question

appear to have been as follows:

i) On the bank’s part that “the purpose of the swaps that were executed was to obtain costs savings based on lower interest paid” on the underlying debt (paragraph 1).

ii) On the municipality’s part, that what constituted expenditure depended “on the notion of ‘expenditures’, regardless of the legal instrument used” and “solely relates to the financial effect of that instrument” (paragraph 9). The municipality also argued that the swaps in question “had a speculative purpose due to the absence of a cap on the interest rates exchanged” (ibid).

242. Neither party, therefore, appeared to be arguing that swaps, as a type of transaction, either a priori did or did not constitute expenditure within Article 42.2(i), the swap counterparty saying that what mattered was the purpose of the transaction and the municipality saying that what mattered was its effect. While there are certainly passages in the Council of State’s judgment which would suggest that any swap which it was lawful for the municipality to enter into will automatically fall outside Article 42.2(i) (paragraph 13), the court’s reasoning was that the function of these swaps “is … to reduce the financial costs associated with the debt already entered into and thus reduce the risk connected with it” and “the swaps can thus have the purpose of restructuring the debt … in order to obtain costs savings”, such that “the reasons that led to entering into those contracts are actually antithetical to the rationale for giving the City Council authority over multi-year expenditures under letter i) of Article 42 paragraph 2”. Elsewhere the Council of State said that the relevant provisions of TUEL were not relevant “to this case”.

243. Further, I accept Mr Xxx KC’s submission that there had been at least six prior judgments at Court of Auditors level holding that the decision to enter into certain swaps did fall within Article 42(2)(i). Had the Council of State been intending to depart from the view of the law acted on in those decisions, it seems improbable that it would have addressed the issue so briefly and in such general terms.

244. It follows that I agree with Xxxxxxxxx J’s view in Busto, [323] that the Council of State did not decide that, as a type of contract, swaps were not capable of falling within Article 42(2)(i), merely that the specific swaps it was considering did not do so.

245. For its part, rgued that the Constitutional Court Decision No 52/2010 found that derivative transactions did (or could) constitute indebtedness for the purposes of Article 119(6), which presupposes that Article 3(17) of Law 350 does not contain an exhaustive definition. However, for the reasons I have set out at [189] above, I am not persuaded that the Constitutional Court was addressing, still less determining, this important issue.

246. Finally, it is necessary specifically to consider the status of “upfront” payments under swaps:

i) These were brought within Article 3(17) by an amendment made on 25 June 2008 (by Article 62(9) of Law Decree No. 112 of 25 June 2008):

“In Article 3, paragraph 17, second sentence, of Law no. 350 of December 24, 2003, after the words: ‘assignment of receivables due from other public entities’ the following inserted: ‘and, based on criteria defined in the

Statistical Office of the European Communities (EUROSTAT), any premiums received at the conclusion of derivative transactions’.”

ii) That amendment stated that the contents of the law Decree were “in force as of 1 January 2009” and, on its face, appears only to have prospective effect. It is not, therefore, applicable on its own terms to the Transactions.

247. Standing back, approaching the issue as a matter of principle, and putting the Cattolica decision on one side, I see a great deal of force in Professor Xxxxxxx’x view that Article 3(17) provides an exhaustive definition of what (from time to time) constituted recourse to indebtedness for Article 119(6) purposes. But, of course, Cattolica cannot be put aside and I will now turn to it.

What did Cattolica Decide on the Indebtedness Argument?

248. There was no dispute that the Supreme Court in Cattolica held that at least some derivative transactions constituted indebtedness (for both Article 119 and Article 42 TUEL purposes) and also (implicitly) held that Article 3(17) of Law No 350 did not exhaustively identify which transactions constituted indebtedness for Article 119(6) purposes at any particular point in time. argues that Xxxxxxxxx decided that all derivative transactions constituted indebtedness.

249. The Cattolica judgment undoubtedly offers paragraphs which, taken in isolation, offer support for both views – so much so, that one might almost imagine that the judgment reflects an attempt to accommodate two divergent views on the subject, with the competing views set out in alternating paragraphs:

i) There is a clear finding that derivative contracts which involve upfront payments constitute recourse to indebtedness (and by implication expenditure for Article 42(2)(i) purposes) ([10.1.3]). That much is not in doubt.

ii) The immediately following paragraph ([10.1.4]) appears to reject the suggestion that swaps which do not involve an upfront necessarily amount to indebtedness:

“If the money obtained with the upfront must be considered indebtedness, the same cannot be said of the concluded by public entities which, eventually, may presuppose an indebtedness. A swap transaction must be examined as a whole, because its effects may essentially amount to indebtedness, as was demonstrated by the local entities that were able to use as loans, and, through them, actually modify and manage the level of

the indebtedness (without saying that those s usually arouse of, by law, preceding indebtedness).”

iii) Paragraph 10.2 provides:

“In regard to the municipal body that is required to authorise the use of prevailing legal scholars and case law have, rightfully, held that the

City Council has this authority.”

Read in isolation, this would suggest that the Supreme Court is expressing its approval of the view expressed by legal scholars and case law that the City

Council must authorise the use of (sc. all) transactions. However, if so, that

would suggest that this would be the case even in cases when “examined as a whole” (as [10.1.4] requires), the transaction did not “essentially amount to indebtedness”. Further, if the reference to “case law” was intended to embrace the Council of State Decision No 3174/2017, it would not be accurate to suggest that this had held that the City Council had to approve all transactions (see [241]-

[243] above).

iv) By contrast, [10.3] appears to contemplate that the court is considering only two specific issues – whether a swap in the context of debt restructuring and a swap including an upfront clause – constituted indebtedness, rather than any more general enquiry.

v) [10.4] and [10.5] undoubtedly offer support for interpretation:

a) [10.4] offers a rationale for a requirement of City Council approval (the need to ensure the involvement of minority members) and contemplates that the mere fact that the swap is intended to be debt-reducing is not sufficient to take it outside the City Council’s sphere of responsibilities (because although the swaps may have been “concluded … with the purpose of renegotiating loans on more favourable terms” they may “entail expenses

… [which] impact financial years after the year the contract was entered”).

b) [10.4.1] suggests the City Council needs to approve transactions which “may” impact future financial years.

c) [10.4.2] and [10.5] note that only hedging swaps are permissible, pre- supposing the existence and perhaps the amendment or termination of an underlying debt transaction which will itself have required City Council approval. Those matters provide support for the view that the City Council must approve the swap as well.

vi) By contrast, the immediately following paragraph, [10.6], which appears to have been intended to draw a conclusion from those preceding it (“we must therefore rule”) clearly does not hold that all swaps require City Council approval, but only those where certain conditions are met:

“If the concluded by the Municipality affects the total amount of the entity’s indebtedness, the financial transaction must, upon penalty of voidness, be authorised by the City Council”.

vii) [10.7] is expressed as a conclusion following from the preceding paragraphs (“as a result”). It provides:

“The appealed judgment cannot be challenged that the swap contract and, particularly, (but not only) the contract that included an upfront clause constituted, because of its aleatory nature, a form of current or potential indebtedness for the public entity”.

The reference to the conclusion of the Court of Appeal of Bologna, and the language which clearly repeats the summary of the conclusion of the Court of

Appeal which the Supreme Court had previously set out at [2.1(a)], does suggest that the Supreme Court was endorsing the conclusion reached by the Bologna Court of Appeal. It is less clear whether that is a conclusion which is concerned with the specific swaps in issue, or a more general conclusion (although, notably, both paragraphs refer to “the swap contract”).

250. That leaves what both parties recognise is an important paragraph: [10.8]. Before turning to it, it is important to remember that the Council of State, Italy’s highest administrative court, had held that at least some swap transactions did not fall within Article 42(2)(i) ([241]-[244]). In referring the appeal to the Joint Divisions of the Supreme Court, in paragraph 12 of its Interlocutory Order, the First Civil Division had expressly referred to that decision of the Council State. If the Supreme Court had wanted to arrive at the opposite conclusion, this was a conclusion which ought to have arrived with a bang, rather than a whimper. Further, [10.8] is the final substantive paragraph of the judgment, and one which clearly seeks to formulate a set of legal propositions so far as the first and second grounds of appeal are concerned (“the rule of law that”). It followed paragraphs which, as has been seen, offered conflicting indications on the application of Article 42(2)(i) to derivative transactions. If there were voices within the Supreme Court who wanted the Court to adopt a rule that all swap agreements required City Council approval under Article 42.2(i), this was the paragraph, above all others, in which that conclusion had to be manifest.

251. But it was not. Instead [10.8] provides:

“In conclusion, those additional grounds must also be dismissed, according to the rule of law that:

Authorisation for Italian Municipalities to conclude a swap contract, especially if they are of the type with an upfront loan, but also in all cases where its negotiation entails extinction of the previous underlying loan agreements or even if they remain outstanding, but with significant modifications, must be given, upon penalty of voidness, by the City Council pursuant to Article 42, paragraph 2, letter

i) of the T.U.E.L. under Italian Legislative Decree No. 267 of 2000 where it provides that “The city council’s authority extends solely to the following fundamental actions: (...) ~ expenditures that affect budgets for subsequent financial years (...)”], as this is not comparable to mere act of management of the local entity’s indebtedness aimed at reducing the financial costs inherent to it, which can be adopted by the city board pursuant to its reserved managerial authority under Article 48, paragraph 2 of the T.U.E.L.”

252. In short, Cattolica holds that Article 42(2)(i) (and by implication Article 119(6)) applies to the following swaps:

i) Swaps “if they are of the type with an upfront loan”.

This picks up the statements that a swap with an upfront provision constitutes indebtedness in [10.1.2] and [10.1.3].

ii) If the negotiation of the swap “entails extinction of the previous underlying loan agreements”.

This picks up the reference to the termination of indebtedness in [10.5].

iii) If the negotiation of the swap entails significant modifications of the underlying loan agreements, even if they remain outstanding.

This picks up the reference to amending the underlying contract including “by extending the length of the debt exposure” in [10.5].

It follows that I have arrived at the same conclusion as that reached by Xxxxxxxxx J in Busto, [325]. Xxxxxxxxx J regarded that outcome as being one which “apparently sounds good sense” ([327]). describes the Banks’ fallback case in reliance upon it as having been “adopted opportunistically rather than on a principled basis”. Even if that latter characterisation is correct, it is clear that the status of transactions entered into by local authorities raises a number of conflicting interests, policy considerations and legal principles. If the decision in Cattolica as Xxxxxxxxx J and I have interpreted it is an act of judicial pragmatism rather than a principled determination, that does not affect its status as a statement of Italian law.

253. So far as subsequent cases and academic commentary are concerned:

i) The Court of Appeal of in Decision No 696/2022 referred to Cattolica as having decided that City Council approval was required for swaps which involved an upfront payment or entailed the extinguishing or significant modification of the underlying loan, as did the Court of Appeal of Rome in Decision No 6894/2021 (in which they engaged in analysis which would have been wholly unnecessary if s interpretation of this aspect of Cattolica was correct) and the Court of Auditors of the Lazio Region in Decision No 42/2022 also quoted only [10.8] of the judgment when summarising the Supreme Court’s decision on this issue.

ii) The Xxxxx Article described the Supreme Court as having held that City Council approval was required in “at least two cases”, being the two instances referred to in [10.8]. The Banks have informed the court that Xxxxxx Xxxxx was Xxxxxxxxx’x in-house counsel, which makes the absence of any statement that City Council approval is always required for swaps noteworthy.

iii) By contrast, the Court of Appeal of L’Aquila in Decision No 567/2021 referred to Article 42(2)(i) being engaged “on the execution of a swap on the part of a local authority”.

254. These materials do not persuade me that the interpretation which Xxxxxxxxx J and I have adopted of Cattolica is wrong, and, on balance, they support it.

Does Cattolica Correctly State Italian Law in this Respect?

255. The Banks argued that Cattolica was wrong to decide that any transactions could constitute recourse to indebtedness, until Decree 2008 came into effect, and then only so far as derivatives involving upfront payments are concerned.

256. My concerns at the manner in which the Supreme Court, through what it described as a process of interpretation:

i) effectively did what the Constitutional Court had held could only be done by legislation, and added new categories of indebtedness to the scope of Article 119(6); and

ii) held that derivative transactions which involved upfront payments constituted recourse to indebtedness even before Decree 2008 had made an explicit legislative change to this effect, which was specified to take effect in 2009;

will already be apparent.

257. However, for similar reasons to those given when addressing the Speculation Argument above, I do not feel able to say that this does not represent Italian law. On this occasion, the Supreme Court had sat in Joint Divisions squarely to consider this argument, which had already found favour with the Court of Appeal of Bologna. The decision has since been followed by the Court of Appeal of Rome in Decision No 6693/2021 of 20 October 2021 which observed of Cattolica:

“BNL … argued that at the time the contract at issue was entered into (2005) the swaps with upfront were fully legitimate and did not fall within the notion of indebtedness, and this latter conclusion had also been expressly indicated by the Ministry of the Economy in the cited circular no 63013 of 22.06.2007. However, it should be noted that the Unified Sections of the Supreme Court, which enunciated the aforesaid maxim in relation to cases in which the contracts in question were stipulated in 2003 and 2004 affirmed the interpretative nature of the new rules (Article 62, paragraph 9 of Law Decree No 111/2008 which amended Article 3, paragraph 17 of Law No 350/2003) which for the first time defined the ‘upfront’ as ‘debt’ so that it did not set limits for the future on the use of derivatives by public administration but it did “interpret” the pre-existing negotiating and regulatory reality”.

Did the Transactions Fall Within the Categories of Indebtedness Identified in Cattolica?

258. pleaded case as to why the Transactions constitute indebtedness is set out at Defence ¶11A:

i) The “significant negative mark-to-market value of the Transactions” and “the fact that there was a 72% likelihood that [the Transactions] would result in a net loss to ”, meaning “it was very likely (and has proved to be the case) that would have to pay millions of euros to the Banks over the following years”

which “was a commitment of a material proportion of future resources” (“the First Argument”).

ii) “The Transactions formed part of a major restructuring of borrowings and associated derivatives whereby the maturity of the debt and termination date of the derivatives were both deferred for a period of 15 years until December 2037 and their respective terms varied” (“the Second Argument”).

259. Further, paragraph 41G(a) of s Reply to Defence to Counterclaim pleads that the sums applied to close out the were “upfronts … for the purposes of the Italian laws on which relies”. That was supplemented in opening where what is now s principal case that the Transactions involved an “upfront”

in the form of the payment made to unwind the

Third Argument”). I accept that the Third Argument is open to

is clearly set out (“the

260. The Third Argument relies on the fact that the €8,065,000 paid by the Banks to under the Novations to wind-up the was then “priced in” to

the terms of the Transactions. argues that this is as much an “upfront” as if the

payment had been made by the Banks to which had itself paid to

unwind the . In response, the Banks argue:

“The question is therefore whether the Banks’ payments to under

the Novations amounted to an ‘upfront payment’ to . The Banks submit

that, plainly, they did not. These payments were not any form of compensation provided by the Banks to . They were instead the price which the Banks, as transferees, needed to pay to buy out the existing rights of the transferor,

, under the Novations. That was a necessary part of enabling the to be unwound …”

261. I am satisfied that the amount paid by the Banks to and then “embedded” into the terms of the Transactions constituted an “upfront” for the purposes of the Cattolica principles:

i) The rationale for treating a swap with an upfront payment by the bank to the local authority as expenditure or indebtedness is because it involves taking a benefit at one point in time (and in one financial year) in return for structuring the transaction in a manner which, in Day 1 PV terms at the date of transacting, is adverse to the local authority, with the attendant enhanced risk of payments by the local authority in subsequent financial years. It may be that there will never in fact be a negative cash outflow by the local authority (because the market moves in a manner which ultimately reverses that adverse Day 1 PV from the local authority’s perspective). However, Cattolica decides that, as a matter of Italian law, that risk is sufficient to engage Articles 119(6) and 42(2)(ii).

ii) That rationale is equally applicable in the present scenario. There was “jam today” (in that the funds were made available to meet the price of exiting a transaction which wished to exit) in return for accepting a greater risk of bare bread tomorrow. The fact that the “upfront” here was not paid to neutralise an imbalance in the MTM of the respective obligations, but the respective obligations are structured in an unbalanced way to cover the cost of the “upfront” does not negate the issues of inter-budgetary equity which Article 42(2)(i) recognises nor the limits of Article 119(6) as established in Cattolica.

iii) I accept Mr Xxx KC’s argument that the fact that the payment in question moves from the Banks to rather than through does not change the analysis. Professor Xxxxxxx accepted in cross-examination that if A (sc ) had asked C (sc the Banks) to make the payment to B (sc B ), it would still be treated as an upfront payment by C to A (Day 6/107). That is essentially what happened.

iv) While in no way determinative, it is noteworthy that the Banks referred to the payment being made to to unwind the as an upfront. A particularly telling internal communication, in the context of the case

as a whole, was a note prepared by Xxxxxx in 2009 when explaining the high negative MTM of the Transactions from s perspective by “the need to absorb the Upfront paid to the municipality for the early termination of the derivative with ”.

262. So far as the Second Argument is concerned, the Banks argue that:

“The second and third situations described by Xxxxxxxxx involve, respectively, the extinguishing and modification of pre-existing loans. But the Transactions did not extinguish or modify (and were not themselves) ‘loans’; they were debt management instruments, entered into by to hedge its interest exposure on debt (i.e., the restructured Bond) …

It is correct that the Transactions formed part of a major restructuring of borrowings under the Bond and that the restructuring of the Bond was a significant modification of s debt affecting its budget for future financial years. However, it does not follow that the Transactions also modified

debt. The Transactions had no effect on the principal amount owing under the Bond, which remained the same following the restructuring (albeit with an extended maturity date). s argument would mean that any swap which hedged an underlying loan, where that loan was simultaneously restructured in a way that significantly modified a borrower’s debt, would itself require City Council approval. That cannot be spelled out of TUEL Article 42 or from the treatment of that provision in Cattolica.”

263. This argument assumes that a swap which “entails extinction of the previous underlying loan agreement” or “significant modifications” to the underlying loan agreement will only apply where the swap itself extinguishes an existing loan or modifies that loan, rather than being entered into as part of a restructuring which involves such changes.

264. In the course of oral closing argument, I (rashly) expressed the view that it was difficult to identify a case in which the swap itself will extinguish or modify an underlying loan. Mr Xxxxxxx KC’s team disagreed with that view, and provided a note addressing this topic. The note did not explain how a swap could extinguish an existing loan but it did offer a scenario in which a swap would have the economic (although not the legal) effect of extending the term of a loan or altering its amortisation rate, while leaving its terms in place:

“The example is a cashflow swap in which the bank and the local authority swap cashflows by reference to different underlying obligations. This could include the cashflows which would be due on an actual underlying loan and the cashflows which would be due on a different hypothetical loan.”

The examples given involved, in effect, cases in which the bank would make payments equivalent to the amounts due under the existing loan on the dates they were due, in return for the local authority making the payments to the bank which would have fallen due had the loan been for a longer period or had a different amortisation profile.

265. I accept that there is scope for argument as to whether, when referring to swaps whose “negotiation entails extinction of the previous underlying loan agreements or even if they remain outstanding, but with significant modifications”, the Supreme Court was

intending only to refer to swaps entered into to change the economic effect of an outstanding loan without changing its terms. That interpretation would embrace “cash flow” swaps (under which different principal amounts were swapped, sometimes over different periods) which were clearly a widely used form of derivative transactions in which Italian local authorities were involved, albeit the Cattolica decision was not concerned with a swap of that type, but only with transactions.

266. Elsewhere in the judgment, the Supreme Court had noted the legal nexus required between a permissible and an underlying debt transaction because local authorities could only enter swaps for hedging purposes ([10.4.2]). It is certainly arguable that it is for that reason that the Supreme Court concluded that it was appropriate to link the circumstances in which City Council approval for an was required with associated changes to the underlying debt transaction in [10.5], [10.6] and [10.8], which provides support for the argument that the word “entails” in [10.5] and [10.8] is not limited to those cases where it is the terms of the transaction itself which economically effect the termination or modification of the underlying debt transaction, but embraces those cases in which the is a component of a restructuring package undertaken to terminate or modify the underlying debt exposure. It does not appear that Xxxxxxxxx J in Busto interpreted this part of Cattolica as applying to swaps which adjusted the economic effects of loan transactions. As I understand the facts in Busto, there was no change to the terms of the underlying indebtedness effected as part of the transaction of which the swaps formed part, but the economic effect of the Cash Flow Swap was to “smooth” the payment profile on Busto’s part within the existing debt term. On the Banks’ analysis, it would appear that that would have constituted a significant modification of the economic effects of the loan, but that was not Xxxxxxxxx J’s conclusion (see Busto, [341]-[342]).

267. However, it is not necessary for me to reach a final view on the Second Argument (nor indeed on the First Argument), and I will refrain from doing so. The effect of my conclusion on the Third Argument is sufficient to establish that the Transactions involved recourse to indebtedness for the purposes of Article 119(6) of the Constitution.

268. As to the second element of Article 119(6) (“for the purpose of financing investment expenditure”):

i) It follows from my conclusion that the Transactions, as a whole, were speculative that they were not undertaken for the purpose of financing investment expenditure.

ii) In any event, focussing on the upfront payment which (per Cattolica) was the loan element which rendered the Transactions a recourse to indebtedness, that was not entered into for the purpose of financing investment expenditure, but in order to meet the winding-up costs of the . I do not think it is sufficient, as the Banks contend, to argue that the Bond was issued to finance expenditure, and that the upfront was paid as part of a transaction undertaken to restructure that debt (the “ancestor” indebtedness argument).

iii) That will be the case in many of the transactions entered into by Italian local authorities, which often involved the restructuring of underlying loans and their associated transactions, with the upfront for the new transaction covering

the negative MTM on the original swap. It will be recalled that this was the background to the second swap transaction in Cattolica itself (see [213]).

iv) The upfront paid to the benefit of n this case did not in any way reduce or replace the outstanding amount under the Bond, but created “new debt”.

269. The conclusions at [267] and [268] necessarily entail that the Transactions contravened Article 119(6) of the Constitution.

K WHAT ARE THE CONSEQUENCES AS A MATTER OF ENGLISH LAW OF THE FINDING THAT THE TRANSACTIONS WERE SPECULATIVE AND/OR CONTRAVENED ARTICLE 119(6) OF THE CONSTITUTION?

270. I have set out above at [197]-[201] my reasons for concluding that, on the basis of the Cattolica decision the restriction on local authorities entering into speculative derivatives which Cattolica derived from Articles 119(4) and (6) of the Constitution had the effect that local authorities had no substantive power or legal ability to enter into such transactions rather than a measure prohibiting a local authority from entering into a contract which it had power to enter into. It seems to me unrealistic to contend that Cattolica regarded Article 119(6) in its direct application as having any different effect, and in any event the language of Article 119(6) (local authorities “may have recourse to indebtedness only for the purpose of financing investment expenditures”) is itself suggestive of a limitation on the power of local authorities.

271. In any event, applying the criteria I identified at [112] above, I am satisfied that the restrictions on local authorities in relation to the entry into transactions arising under or derived from Article 119 are, as a matter of English law classification, provisions which mean that a local authority lacks the legal ability or substantive power to enter into a valid contract with a counterparty of the infringing kind, rather than a prohibition against exercising a legal ability or substantive power which it did have:

i) Article 119 is specifically directed to local authorities, rather than a provision of general application, and is directed to the entry by local authorities into transactions of a specific type.

ii) The restriction imposed does not relate to an activity which is inherently wrongful, but on the contrary an activity which is lawful for other legal and for natural persons.

iii) Article 119(6) specifically confers the power to have recourse to indebtedness on local authorities, but does so in terms which restricts that power to indebtedness for a particular purpose (like s.50 of the Norwegian Local Xxxxxxxxxx Xxx 0000 considered in Haugesund). Like s.50, the effect of Article 119 is “both to grant power … to conclude certain types of loan contract and also to restrict their power to conclude certain types of loan”.

272. As I noted at [198] above, it is Professor Xxxxxxx’x evidence that Articles 119(4) and (6), and any restriction Cattolica derived from them, did not restrict the capacity of local authorities to contract as a matter of Italian law, relying on the following matters:

i) Local authorities have general contractual capacity under Italian law.

ii) Article 3(15) of Law No. 289/2002 provides that where a local authority takes on debt for a purpose other than investment in violation of Article 119, the relevant acts and contracts are “null and void” and an administrative penalty can be imposed on the relevant administrators. It is said that this is more consistent with Article 119 imposing a prohibition than a restriction on a local authority’s capacity.

iii) It is pointed out that the local authority (but not its counterparty) is able to enforce contracts which infringe the 2008 Decree and the 2013 Finance Law.

273. did not take issue with any of those statements of the position under Italian law (although it submitted that the reference to Article 3(15) did not take the Banks very far, because if Article 119 limited the substantive powers of the local authorities, the expected consequence would be that the purported transaction would be “null and void”). However, it points to the fact that, on the authority of Haugesund, [60], once the English court has classified the restriction on the legal person arising under the foreign legislation as amounting to a restriction on capacity, the consequences for that decision on an English law contract are a matter for English law. In this regard, the fact that the foreign legal system does not recognise a doctrine of nec ultra vires as English law does, but rather confers general contractual capacity on legal persons subject to such specific restrictions as the law imposes, or that it permits enforcement of the terms of contracts of the proscribed kind in certain circumstances, does not change the position. That was also the position in Haugesund ([55]).

274. Applying English law, and on the basis of Haugesund, the inevitable consequence of my conclusion that, on the basis of the Speculation and/or Indebtedness Arguments, lacked the substantive power or legal ability to enter into the Transactions, is

that they are void. In this regard, this case might be said to present a more compelling case for such a conclusion that Haugesund, in which the swap transactions would, as a matter of Norwegian law, have been enforceable against the local authority under provisions protecting those dealing with such entities in good faith ([55]). The outcome which particularly troubled Xxxxxxxx LJ in that case – that “the swaps contracts would be bound to be treated as void in the English courts, under a contract governed by English law, even though English domestic law would treat them as valid and enforceable, and even though Norwegian private law would also treat them as valid and enforceable” ([136]-[137] and [144]) – does not arise. So far as the Banks are concerned, at least, the conflict of laws aspects of this issue present what US lawyers would refer to as a “false conflict”.

275. I have reached this conclusion with some diffidence. That is not because of any reluctance to find that a financial transaction which a local authority was fully content to enter into in what it saw as its own best interests is of no effect because it exceeded the substantive powers of the local authority. The particular legal and political risks of entering into derivative contracts with local authorities would have been well known to all when the Transactions were negotiated and entered into, not least because of the wave of English local authority swaps litigation which had unfolded some 20 years before. In any event, those risks in a specifically Italian context were highlighted shortly before the Transactions were finalised (see [41] and [90]).

276. However, it is a striking feature of this case that it is a decision of the Supreme Court in 2020, some 13 years after the Transactions were entered into, which has completely

altered the legal landscape and compelled me to conclude that, in English law terms, lacked the capacity to enter into the Transactions. At least on the material before

me (and I accept that it is possible that the road to Cattolica may have been a good deal longer and more winding than the sudden sharp turn it appeared to be in this case), the Supreme Court decision in Cattolica involved a very significant discontinuity with Italian law as it was understood and applied at the time the Transactions were finalised. Xxxxx described the decision as involving a “fundamental moment of rethinking”. It is noteworthy that:

i) on own case, the principle of law it relied upon in support of the Speculation and Indebtedness Arguments emerged “first and foremost from Cattolica”, and is “an important principle which emerges from recent Italian jurisprudence”; and

ii) in relation to the issue of indebtedness, and in particular the status of “upfronts”, the Supreme Court by a process of what it described as interpretation concluded that legislation introduced by Decree 2008 and which took effect in January 2009 was simply stating the law as it had existed from 2001.

277. There may be room for a legitimate debate as to whether, when the issue arises before an English court, the security of obligations governed by English law should be capable of being subject to a continuing jurisprudential jeopardy of this kind arising from the courts of the domicile of one of the contracting parties (see [116]-[119] above).

L THE ARTICLE 42(2)(I) TUEL ISSUE

Introduction

278. This issue turns, in the first instance, on the interpretation of TUEL. Article 42 of TUEL provides:

“Attributions of City and Province Councils

1. City and Province Councils are the political-administrative guidance and control bodies.

2. City and Province Councils shall be responsible only in respect of the following fundamental acts:

279. The issue in this case is whether the decision to enters into the Transactions falls within Article 42(2)(i), so as to require approval by the City Council (and, if so, whether such approval was given).

280. So far as matters which do not require the approval of the City Council under Article 42 of TUEL are concerned:

i) Article 48 deals with the “Competences of the City Board”. Article 48(2) provides:

“2. The city board performs all acts pursuant to Article 107, paragraphs 1 and 2, in the functions of government bodies, which are not reserved by law to the city council and that do not fall within the powers, provided for by law or by the statute, of the mayor or of the president of the province or of the decentralization bodies; it collaborates with the mayor and the president of the province in the implementation of the general guidelines of the city council; it reports annually to the city council on its activities' and it carries out proposal and impulse activities towards the same (the city council).”

ii) Art. 107, headed “Functions and responsibilities of the city servants”, provides: “1. Civil servants are responsible for managing offices and departments

according to the criteria and rules laid down by the statutes and

regulations. They comply to the principle by which the powers of guidance and political administrative control are the responsibility of government bodies, while the administrative, financial and technical activity is attributed to municipal servants through autonomous powers of expenditure, organization of human resources, control and instrumental power.

2. Civil servants are responsible for all tasks, including the adoption of administrative acts and measures that commit the administration externally, which are not expressly included by law or by the municipal statute among the functions of political-administrative direction and control of the governing bodies of the entity or not included among the functions of the secretary or general manager, as per articles 97 and 108 respectively. Art. 147(4).”

281. Finally, Article 192 provides:

“Determinations to stipulate and related procedures

1. The stipulation of the contracts must be preceded by a specific determination by [the person/civil servant] in charge of the expenditure procedure indicating:

a) the purpose that the contract intends to pursue;

b) the object of the contract, its form and the clauses considered essential;

c) the methods for choosing the contractor admitted by the provisions in force regarding public administration contracts and the underlying reasons.

2. In any case, the procedures established by the implemented European Union legislation or in any case in force in the Italian legal system apply.”

282. The words in square brackets in Article 192(1) reflect the competing translations used by Professors Xxxxxxxxxxxx and Xxxxxxx respectively, a dispute which unfortunately

was only crystallised in a footnote in closing argument which offered a third

translation more clearly capable of embracing a body as well as a single natural person.

Does Article 42(2)(i) Apply to Transactions At All?

283. The argument on this issue proceeded on the basis that, to fall within Article 42(2)(i) of TUEL, the Transactions had to constitute a form of actual or potential indebtedness. At first sight, the use of the concept of indebtedness as the touchstone of this argument is curious, because, unlike Article 119(6) of the Italian Constitution, Article 42(2)(i) uses the language of “expenditure”, not that of indebtedness. Further, Article 202 of TUEL expressly addresses “the recourse to indebtedness” by local authorities in a different context, which (from an English lawyer’s perspective at least) might suggest that the fact that the term “indebtedness” was not used in Article 42(2) is significant.

284. However, for their own forensic reasons, both sides proceeded on the basis that the issue to be decided for Article 42(2)(i) purposes is whether the Transactions constituted “indebtedness”, and hence raised the same question as that arising under the Indebtedness Argument:

i) From perspective, Cattolica approaches the issue of whether Article 42(2)(i) is engaged by reference to the concept of indebtedness, and repeatedly stresses the close link between that issue, and the issue of whether there has been a breach of Article 119: see for example the introduction to [4] (“the first three grounds for the main appeal … were connected”); [4.1] (“two issues that were closely connected”); [3] of the Reasons section (“two closely related questions”); and section 10 passim.

ii) From the Banks’ perspective, accepting this equivalence allowed it to run its argument that Article 3(17) of the 2004 Finance Law contained an exhaustive definition of indebtedness which did not include transactions.

However, I do not think that actually conceded that, if its argument as to the non-exhaustiveness of Article 3(17) of the 2004 Finance Law was rejected, it followed that Article 3(17) of the 2004 Finance Law determined not only what constituted indebtedness for the purposes of Article 119, but also what did and did not constitute expenditure for Article 42(2)(i) purposes.

285. For my part, I am not satisfied that the definition of “indebtedness” for Article 119(6) purposes necessarily answers the question of whether or not a transaction constitutes expenditure for the purpose of Article 42(2)(i) of TUEL:

i) Article 3(17) does not purport to specify indebtedness for the purposes of Article 42(2)(i) of TUEL, but only for the purpose of the limitation in Article 119(6) of the Italian Constitution. Thus paragraph 17 provides:

“For entities, referred to in paragraph 16 above, pursuant to article 119(6) of the Constitution the following constitutes indebtedness”.

ii) The purposes of the two provisions are not the same. Article 119 of the Constitution is concerned with limiting the purposes for which a particular liability can be incurred, and creates an absolute prohibition against incurring

liabilities of the relevant kind save for a particular purpose. Article 42(2)(i) is concerned with the duration of the commitment rather than the purpose for which it is incurred, and addresses the issue of who is entitled to take the decision to incur the commitment rather than prohibiting such transactions altogether.

iii) The decision of the Council of State, Italy’s highest court in administrative law matters, in Decision No 3174/2017, when considering whether swap transactions which had been entered into without complying with Article 42(2)(i) of TUEL were enforceable, does not refer to Article 119 of the Italian Constitution nor Article 3(17) of Law 350/2003.

286. As I have mentioned, the Banks relied on Decision No 3174/2017 to support the proposition that no derivative contracts fall within Article 42(2)(i) of TUEL, but I do not accept that argument for the reasons set out at [241]-[244] above. I have concluded that the Supreme Court in Cattolica held that only some swap transactions fall within Article 42(2)(i) of TUEL ([248]-[254]) and that I should accept Cattolica as establishing the content of Italian law on this issue ([255]-[257]). I have much less reluctance in doing so on the Article 42(2)(i) issue, than in the context of the Indebtedness Argument, for the reasons identified in [285] above. Further, Cattolica has been followed in this regard by subsequent decisions: the Court of Appeal of

in Decision No 696/2022, the Court of Appeal of L’Aquila in Decision No 576/2021; the Court of Appeal of Rome in Decision No 6894/2021 and the Court of Auditors of the Lazio Region in Decision No 42/2022.

287. While it probably does not matter, I was not persuaded that Article 42(2)(i) has a wider import as a matter of Italian law so far as derivative transactions are concerned than the specific instances identified in Cattolica. Professor Xxxxxxxxxxxx contended that this followed because Article 42(2)(i) reflected a general principle of “budgetary equilibrium”, and should be interpreted so as to give effect to that principle. He elaborated on that principle as follows:

“Revenues and costs associated with indebtedness must be certain, in the sense that they must be rationally predictable and cannot expose the public budget to an erratic performance that does not make it possible to guarantee continuity in planning and the achievement of its aims.”

In closing submissions, Mr Xxx XX submitted that a purpose of Article 42(2)(i) was to bring the regime for approving individual “off-balance sheet” expenses into line with those subject to approval within the multi-year budget (something which was common ground between Professors Xxxxxxx and Xxxxxxxxxxxx).

288. However, these are very generalised principles, which a legislative regime applicable to local authorities could chose to pursue with varying degrees of zeal or specificity. Reverting to Article 42(2)(i), the entry of a long-term contract relating to the supply of goods and services would be capable of having a material impact on the budget for future years, with the risk of market movements making such payments unprofitable from the local authority’s perspective or involving a commitment to acquire goods and services which are no longer required. Yet Article 42(2)(i) does not require such a decision to be taken by the City Council, any principle of “budgetary equilibrium” notwithstanding. In the final analysis, the issue is what the relevant legislation, as interpreted by the Italian courts, requires as a matter of Italian law, not what the purest

application of a principle of “budgetary equilibrium” might require. That is also true of the reliance places on “the constitutional rationale” of Article 42(2)(i).

Did the Transactions Require City Council Approval Under Article 42(2)(i) of TUEL?

289. I have set out my reasons at [260] to [261] above for concluding, on the basis of the Cattolica decision, that the Transactions fell within one of the categories of derivative which the Supreme Court held constituted indebtedness or expenditure for the purposes of both Article 119(6) of the Constitution and Article 42(2)(i) of TUEL (the Supreme Court having addressed these issues compendiously).

Was the Requisite Approval Given?

Introduction

290. It was agreed by the parties that a resolution under Article 42(2) had to be in writing. There is no express requirement in Article 42(2) to this effect, but both Professors Xxxxxxxxxxxx and Xxxxxxx were content to deduce such a requirement from Article 124 of TUEL, which requires all Municipal Authority resolutions to be published on the council noticeboard for a set period. The issue of whether a resolution which was not set out in written form could ever be valid, or whether it was simply not valid until publication, was not explored in the evidence.

291. goes further and argues that:

i) the (ex hypothesi written) resolution by the City Council must comply with Article 192 of TUEL (which I understand to mean both that the decision must have addressed the matters in Article 192 and that those matters must be addressed in the written document, imposing a requirement both as to the nature of the City Council’s decision-making and the form in which it is expressed); and

ii) the effect of Cattolica is that (whether or not is right in contending that the Article 192 requirements apply to a decision of the City Council) the matters which Article 192 require to be included in the resolution include “the MtM, the price of the proposed transaction, the consequent adjustments to the budget, the hidden costs, the presence of any upfront clause and the probabilistic scenarios” (which appears to be the qualitative distribution of the probabilities of which the MTM is the weighted average) – information referred to as “the Required Information”.

Does Article 192 Apply to the City Council?

292. At first sight, the suggestion that Article 192 sets out requirements for the decision of the City Council in respect of a “fundamental matter” within Article 42(2) – to the extent that the decision will culminate in the entry into a contract – seems improbable:

i) At least in the translations before me, Article 192(1) is addressed to “the person/civil servant/[responsible party] in charge of the expenditure procedure”, not the City Council. When I asked Mr Xxx XX in the course of oral closings how I was to resolve the dispute as to the interpretation of the provision at that stage, he expressed confidence that the issue could be agreed, but went onto confirm

that accepted that the language of Article 192 indicated that its contents

were addressed to those with technical rather than political responsibilities.

ii) Articles 42 and 192 appear in very different sections of TUEL: Article 42 in Part I (“Institutional Ordinance”) Title III (“Organs”) Chapter I (“The governing bodies of the municipality and the province”) and Article 192 in Part II (“Financial And Accounting Order”) Title III (“Management of the Budget”) Chapter 4 (“Principles of management and management control”).

iii) The technical content of Article 192 – identifying the key clauses and the tender process – are matters of obvious relevance to the executive branch of the municipality, but outside the ordinary experience and competence of the elected members of the City Council.

iv) That analysis, which was put forward by Professor Xxxxxxx, is supported by Article 107 of TUEL which provides:

“Functions and responsibilities of the city servants

1. Civil servants are responsible for managing offices and departments according to the criteria and rules laid down by the statutes and regulations. They comply to the principle by which the powers of guidance and political-administrative control are the responsibility of government bodies, while the administrative, financial and technical activity is attributed to municipal servants through autonomous powers of expenditure, organization of human resources, control and instrumental power.

The activities contemplated by Article 192 naturally fall within the matters for which civil servants are responsible within the dichotomy which the second sentence of Article 107(1) creates.

v) It is also supported by the following passage from the decision of the Administrative Regional Tribunal of Calabria Decision No 153 of 13 February 2004:

“In local authorities, according to art. 32 and 56 of the law n. 142 of 1990, the resolution to negotiate was the responsibility of the Council; today, however, ‘the determination to contract’, while maintaining the same contents (it must, in fact, always specify the purpose that the contract intends to pursue, the object of the contract, its form and clauses deemed essential, as well as the methods for choosing the contractor admitted by the provisions in force on public administration contracts and the reasons

of this choice), is a management act, which is the responsibility of the person in charge of the expenditure procedure (art. 192 TUEL), which follows the resolution of council, expression of the power of direction and political-administrative control (art. 107, paragraph 1, TUEL). On the other hand, it is the managers who must implement the objectives and programs defined with the guidelines adopted by the council and it is they, in particular, who assume the responsibilities of the procurement procedures (Article 107, paragraph 2, letter b).”

vi) Finally, it receives significant support from the Council of State Decision No 4192 of 20 August 2013.

a) That decision emphasised the constitutional significance of the different roles of the City Council, the City Board and the directors in what was referred to as a “distribution of responsibilities between political and bureaucratic bodies as outlined by [TUEL]”. That division of responsibilities was adopted “to convert the Municipal City Council from a body with general and residual jurisdiction … into a body with specifically identified and exclusive powers”, in order “to make the Municipal Council’s institutional life lighter, as this was notably weighed down by all the myriad of tasks [that] burden the Council”.

b) The argument that the terms of the Article 192 (and the technical requirement it imposes) applies to the City Council cuts across that “distribution of responsibilities.” The Council of State observed that “the Municipal City Board is a governing body of the local authority and therefore performs a function of political implementation of the fundamental choices made by the Municipal City Council, while the directors are responsible for technical, financial and accounting management and for taking all the administrative measures or acts of private law necessary to achieve the objectives established by the governing bodies”.

293. Leaving the Cattolica decision to one side for the moment, Professor Xxxxxxxxxxxx’x contrary view is as follows:

“As far as the procedural sequence is concerned, there is first a resolution issued by the Municipal Council, in the cases described in Article 42 of TUEL (or by the Council Board in all the cases described just above), which is followed by the decision to enter into a contract pursuant to Article 192 of TUEL, which is the duty of the individual responsible for the cost procedure (which, in cases where the Municipal Council or Council Board has the power, is limited to referring to, if not actually copying, the resolution passed by the above-mentioned collegial bodies), and finally the entering into of the contract by the sector manager (who may also be the same person who is responsible for the procedure).”

(emphasis added).

294. With respect, that essentially conclusory analysis strikes me as improbable. Article 192 imposes important duties on a senior civil servant in respect of the entry into contracts, but on Professor Xxxxxxxxxxxx’x analysis, in an Article 42(2) case, the senior civil

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LA HIGH COURT OF JUSTICE LONDINESE DICHIARA LA NULLITÀ DEI CONTRATTI DERIVATI STIPULATI DA UN

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