Determining which national laws apply to agreement

The Court of Appeal so held in dismissing the appeal of the defendants, Companhia Carris de Ferro de Lisboa SA and others, against the decision of Mr Justice Blair, sitting as a judge of the Financial List ([2016] 4 WLR 49) by which he declared that the obligations of the claimants, Banco Santander Totta SA under various interest rate swap agreements, made under International Swaps and Derivatives Association master agreements and subject to English law and jurisdiction, were legal, valid and binding.

The Rome Convention on the Law applicable to Contractual Obligations (1980) (80/934/EEC) provided:

Article 1(1) “The rules of this Convention shall apply to contractual obligations in any situation involving a choice between the laws of different countries.”

Article 3(3) “The fact that the parties have chosen a foreign law, whether or not accompanied by the choice of a foreign tribunal, shall not, where all the other elements relevant to the situation at the time of the choice are connected with one country only, prejudice the application of rules of the law of that country which cannot be derogated from by contract, hereinafter called ‘mandatory rules’.”

Mr Ali Malek, QC, Mr Richard Brent and Ms Kate Holderness for the defendants; Mr Laurence Rabinowitz, QC, Mr John Odgers, QC and Mr Simon Colton for the claimant.

THE MASTER OF THE ROLLS said that the claimant was a member of the Banco Santander group. Between June 2005 and November 2007 it entered into interest rate swaps with the defendants which ran the metro, bus and tram services in Lisbon and Porto, Portugal.

The swaps were long-term interest rate swaps, under which the claimant was (with one exception) the floating rate payer and the defendants were the fixed rate payers. An unusual feature of the swaps was that once the reference interest rates (Euribor and sometimes Libor) moved outside upper or lower “barriers”, the fixed rate payable by the defendants had a “spread” added to it which was cumulative at each payment date and was subject to leverage: hence the swaps being described as “snowball” swaps.

The swaps initially provided positive cash flows for the defendants. The consequence, however, of sustained near zero interest rates since 2009 and the “snowball” structure of the swaps was that the interest rates payable under the swaps increased very substantially. The defendants ceased to make payments under the swaps in 2013.

The claimant commenced the proceedings for declarations that the defendants’ obligations under the swaps constituted legal, valid and binding obligations, enforceable in accordance with their respective terms, together with an order for payment of the sums due or equivalent damages.

The defendants advanced the following defences:

First, under Portuguese law, the defendants lacked capacity to enter the swaps which were therefore void.

Second, the effect of article 3(3) of the Rome Convention was that, even though the agreements specified that they were governed by English law, certain mandatory rules of Portuguese law applied under which (i) the swaps were void for being unlawful “games of chance” or speculations, and (ii) they were liable to be terminated due to abnormal change of circumstances since the swaps had been entered into.

Third, the claimant was in breach of its duties under the Portuguese Securities Code, entitling the defendants to damages which extinguished their liabilities under the swaps.

The Rome Convention had been replaced by Regulation (EC) No 593/2008 on the law applicable to contractual obligations (the Rome 1 Regulation), which came into effect on December 17, 2009. The Rome Convention applied to the swaps because they had all been concluded before that date.

There was continuity in some respects between the Rome Convention and the Rome 1 Regulation, including, in particular, articles 1(1) and 3(3) of the Rome Convention and Rome 1 Regulation respectively. Recital (15) of the Rome 1 Regulation stated expressly that (even though the wording of article 3(3) of the Rome 1 Regulation was different) no substantial change was intended compared with article 3(3) of the Rome Convention.

In his Lordship’s judgment, if it had been intended that “elements relevant to the situation” in article 3(3) of the Rome Convention should be confined to factors of a kind which connected the contract to a particular country for the purpose of identifying the proper law in the absence of an express choice, the drafter could have used the familiar and simple conflict of laws language of “close connection”, which was found in article 4.

The marked difference between the language of article 3(3) and of article 4(1) was striking and supported an interpretation of article 3(3) in accordance with the natural and ordinary meaning of its words. That striking difference was also apparent from other language versions of the Convention, such as the French, Italian and Spanish versions. His Lordship accepted the submission, that the only question under article 3(3) was whether the situation was purely domestic.

The judge had to carry out an evaluative exercise when identifying “elements relevant to the situation” for the purposes of article 3(3) and then assessing whether they were all connected with one country only.

The court should only interfere with that evaluation if there was an error of principle or it was plainly wrong and should be particularly cautious of reaching such a conclusion in a case like the present, where the appeal was from an expert and specialist court, the Financial List.

The defendants acknowledged that the judge had fairly summarised their case and addressed the various points raised as to relevance of the factors relied upon by the claimant and whether such factors were connected only with Portugal.

His Lordship could not see any error of principle by the judge and it was simply impossible to say that he had been plainly wrong.

Lord Justice Longmore delivered a concurring judgment and Sir Martin Moore-Bick agreed.

Solicitors: Lipman Karas LLP; Slaughter and May.