Merchants Beat Venice: Court of Appeal finds that local authority of Venice did have capacity to enter into Interest Rate Swaps

19 March 2024. Published by Simon Hart, Partner, Head of Banking & Financial Markets Disputes


In a significant judgment in Banca Intesa Sanpaolo and Dexia Credit Local SA v Comune di Venezia [2023] EWCA Civ 1482, the Court of Appeal overturned the findings of the High Court. As discussed in a previous article, at first instance the Commercial Court found that English law governed interest rate swaps entered into by the Municipality of Venice (Venice) were void for lack of capacity. This came as a direct consequence of the 2020 decision of the Italian Supreme Court in Banca Nazionale del Lavoro SpA v Comune di Cattolica (Cattolica). This was a notable judgment as it was the first occasion where an Italian local authority successfully argued that an English law governed swap was void as a consequence of Italian law. It also ran counter to the previous case law in this area. This judgment has now been overturned by the Court of Appeal, which found that the Venice did have capacity to enter into the swaps under the law.

This decision is likely to come as something of a relief to some practitioners. As noted above, the earlier decision of the High Court was at odds with the rest of the case law in this area. Therefore, the Court of Appeal judgment does provide some clarity on proceedings involving swaps and Italian local authorities. Indeed, the judgment was applied and followed in the even more recent case of Banca Nazionale del Lavoro, Commerzbank and Dexia Credit Local v Provincia di Catanzaro.1It remains to be seen whether any other cases involving Italian local authorities and swaps develop the law further here.

The case

The appeal arose from two interest rate swap transactions (the Transactions) conducted in December 2007 between Banca Intesa Sanpaolo SPA and Dexia Credit Local SA (the Banks) and the Municipality of Venice. These Transactions represented a replacement for a swap between Venice and Bear Stearns which had been entered into in 2002 (the Bear Stearns Swap). Venice entered into the Bear Stearns Swap to hedge against its interest rate exposure under a 20-year floating rate bond. Venice was exposed to the risk of paying a fixed rate of 5.45% under the Bear Stearns Swap.

In 2007, Venice proposed a restructure of the Bear Stearns Swap to Bear Stearns. However, the bank was unwilling to agree and intimated that it was prepared to terminate the agreement altogether. As a solution, Venice and Bear Stearns agreed to the transfer of the swap to the Banks. Novation agreements were signed between the Banks and Bear Stearns. Bear Stearns received novation fees to reflect the negative mark to market (MTM) due to it under the swap. It was agreed that the MTM of the Bear Stearns Swap was reflected in the new swaps.

Separately, between 2009 and 2010, a series of cases involving Italian local authorities were heard in the English Commercial Court. The lack of capacity argument was made in Dexia Crediop SpA v Comune di Prato2. In that case, Walker J found that the Comune di Prato did have capacity to enter into swaps because there was no prohibition against speculative swaps and the swaps did not amount to "indebtedness" under Article 119(6) of the Italian Constitution.

Venice failed to dispute whether the transactions were valid until July 2019. Venice then commenced proceeding in Italy for breach of the Banks' advisory duties. Soon after, in August 2019, the Banks sought a declaration from the English courts that the transactions were binding.

Importantly, in May 2020, the Italian Supreme Court found in Cattolica that the Municipality of Cattolica did not have capacity to enter into speculative derivatives and that certain types of swaps could constitute indebtedness for the purposes of Article 119(6). This prepared the ground for Venice's claims against the Banks in this case.

High Court decision: void for lack of capacity

The High Court determined that the transactions were void for lack of capacity. Cockerill J referred to various pieces of Italian statute and distilled the case down to the two key questions that arose before the High Court as a result of Cattolica. These were:

  • Whether the judgment in Cattolica held that Italian local authorities lack capacity to enter into speculative derivative transactions (and whether that judgment was correct as a matter of Italian law); and


  • Whether Cattolica held that swaps were a form of indebtedness (and that Iocal authorities did not have capacity to enter into them other than for the purpose of financing expenditure).

Cockerill J held that Italian law did not provide a comprehensive definition of what makes a derivative speculative. However, she determined that various factors suggested the Transactions were speculative. Firstly, she held that the Transactions had a very significant MTM in favour of the Banks. Cockerill held that this demonstrated the Banks were receiving a far higher value of protection than Venice was receiving in return. On calculations put forward to the court, the probability of a negative outcome for Venice was up to 78%. Cockerill J held that the transactions in the case were "predominantly speculative".

She turned then to the question of indebtedness. Under Article 42(2)(i) of the Italian Constitution, swaps are speculative if "they are of the type with an upfront loan". Cockerill J was satisfied that the terms of the restructuring of the Bear Stearns Swap equated to an "upfront payment". She regarded this as involving "recourse indebtedness" because it involved the taking of a benefit that was adverse to Venice at the time of the transaction and resulted in enhanced risk for Venice for the subsequent financial years.

In the High Court's view, the transactions did involve recourse to indebtedness. Cockerill J therefore ruled that the Transactions were void due to Venice's lack of capacity.


The Banks appealed on five grounds:

  • the Transactions were not speculative because the pricing reflected the negative MTM of the Bear Stearns Swap;


  • the Transactions did not involve "recourse to indebtedness" because the Transactions did not involve the payment of an "upfront payment" other than "for the purpose of financing investment expenditure";


  • failing grounds one and two, the judge erred in concluding that Italian rules on speculation and indebtedness were characterised correctly as limiting Venice's capacity under English law;


  • failing grounds one to three, the application of Cattolica was wrong because it was not reasonably foreseeable at the time of the Transactions;


  • if the Court of Appeal was still to conclude that the Transactions were void, Venice's claims for restitution were time-barred.


The Appellant Banks were successful on the first two grounds of their Appeal.

English Approach to Decisions of the Italian Court

Sir Julian Flaux referred to the general approach in English courts to proceedings dependent on the evidence of Italian law experts about the unfamiliar civil law system. The agreed approach is that the court will not disagree with findings of fact under Italian law unless those findings are clearly wrong. This is set out by Lewison LJ in FAGE v Chobani3. However, as the facts required a specific answer under Italian law, then the conclusions reached by the original trial judge were more open to amendment by the Court of Appeal in this case.


On the question of whether the Transactions were speculative, the Court of Appeal found Cockerill J made a number of errors on principle. The key issue here was that the Bear Stearns Swap was a valid contract that equated to hedging. This would have bound Venice when the original 20-year floating rate bond was restructured. Cockerill J did not accept this in her judgment. Sir Julian Flaux stated that this initial misanalysis led to Cockerill J's conclusions. Considering the counter-factual, he found that a restructured Bear Stearns Swap would have been hedging, and not speculative. He determined that as the swaps were allocated to the Banks, it would not necessarily follow that the Transactions would automatically become speculative. This led the Court of Appeal to conclude that the Transactions were not in fact speculative, but were rather, hedging.


Sir Julian Flaux then considered whether the novation fees in relation to the Bear Stearns Swap constituted upfront payments, meaning that Venice had recourse to indebtedness. It was seen that an upfront payment could create recourse to indebtedness as Venice receiving funds upfront from the Appellant Banks could equate to borrowing funds. Again, he referred to the source error that Cockerill J had found that the Bear Stearns Swap was not a valid contract that amounted to hedging. Sir Julian Flaux disagreed, finding that it was a valid contract that amounted to hedging. On this analysis, Sir Julian Flaux concluded that if the original Bear Stearns Swap had been restructured rather than novated to the Appellant Banks, rolling over any restructured MTM could not be constituted as an upfront payment.  Sir Julian Flaux applied this to the Appellant Banks, who had paid novation fees to "stand in the shoes" of Bear Stearns. He did not consider that this would make the novation fees an "upfront payment".

Other Grounds

The Court of Appeal found that due to Grounds 1 and 2 being successful, all the other grounds of appeal for both the Appellant Banks and Venice were "academic". These were therefore dealt with briefly. Sir Julian Flaux held that he would have dismissed the Appeal on Ground 3. He also held that permission to appeal on Ground 4 would have been refused. On Ground 5, the Court of Appeal determined that Venice's claim would have been time-barred. The test for discovering the worthwhile claim is to when it would have been discovered with reasonable diligence. The Court of Appeal found that Venice should have discovered this far earlier than they submitted, making the claim time-barred.

1[2023] EWHC 3309 (Comm)

2[2015] EWHC 1746 (Comm)

3[2014] EWCA Civ 5

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