Challenging governing law clauses: re-match in the Court of Appeal

Article 3(3) of the Rome I Regulation is an exception to the general rule that a choice of governing law clause in a contract will be upheld. It provides that where all other elements relevant to the situation at the time of the choice of law are connected with one country only, the mandatory laws of that country shall apply despite the choice of law of a different country.

Prior conflicting High Court authority on the scope of Article 3(3) has now firmly been resolved in favour of a restrictive interpretation. This has been confirmed by the recent Court of Appeal decision in Dexia Crediop SPA v Comune di Prato [2017] EWCA Civ 428 (Dexia). It follows the reasoning of the Court of Appeal in Banco Santander Totta SA v Companha de Carris de Ferro de Lisboa SA [2016] EWCA 1267 (Santander).

In the last issue of Banking and finance disputes review, we saw how the competing High Court authority concerning the interpretation of Article 3(3) in Dexia and Santander had appeared to be resolved in favour of a narrow interpretation of the provision. This followed from the Court of Appeal decision in Santander, where it was held that the relevant elements to take into account when assessing whether all the elements are connected with a particular country include elements which have an “international character”. Those elements do not have to point to or relate to another specific country. Accordingly, the use of the internationally accepted ISDA documents and entry into back-toback swaps with a non-Portuguese counterparty were enough to mean that all the other elements of the situation did not just point to Portugal. That meant that Portuguese mandatory rules could not be relied on to escape the swaps and the effect of the English governing law clause was upheld.

Santander was in contrast to the reasoning of the High Court in Dexia which found that mandatory rules of Italian law did apply, in spite of an English governing law clause, because all relevant elements did point to Italy. The contrast with Santander was particularly acute as both cases involved use of the ISDA documentation and back-to-back hedging arrangements with crossborder parties “(see Challenging governing law clauses: New ideas in European public body litigation in February 2017 Banking and finance disputes review).

At the time of the last article there was an ongoing appeal to the Court of Appeal in the Dexia litigation. That judgment has now been handed down.

The Court of Appeal overturned the decision of the High Court in Dexia. The Court said that it was bound to follow the prior decision of the Court of Appeal in Santander. This closes the door on an attempt to widen article 3(3). If there is an element of the situation that is international in nature but not connected to a particular country, that will be enough to prevent a party from relying on Article 3(3). The trial judge was therefore wrong in Dexia to discount

• Dexia’s decision to enter into a back-to-back hedging swap with a non-Italian counterparty
• The use of the international standard ISDA Master Agreement

as elements “relevant to the situation” for the purpose of Article 3(3).

The Court of Appeal then had to assess whether all elements relevant to the situation at the time of the contract were in fact located in a country other than England (the country of the governing law clause). The Court of Appeal concluded that the relevant factors did not point exclusively to Italy, because

• The standard form of the ISDA Master Agreement immediately created an international element outside of any particular country. By itself, this would have been enough to preclude all the elements being related to one particular country outside of England (in this case Italy).
• The fact that back-to-back hedging was routine in these transactions and often with counterparties outside of the country of the main counterparty was a further relevant factor “showing just how international the swaps market actually is”. Further, there would be real uncertainty if different laws governed the original swap contract and the back to back hedging arrangements – it was exactly this kind of consideration that meant a restrictive interpretation of Article 3(3) that promoted certainty was to be preferred.
• An additional factor also pointing away from Italy was that non- Italian banks tendered for the original advisory contract that was ultimately awarded to Dexia.

In short, the Court of Appeal concluded that once an international element comes into the picture, Article 3(3) should have no application. In this case, there were multiple relevant international elements, each of which would have been sufficient on its own. In fact, there were fewer international elements in Dexia than in the previous Court of Appeal decision in Santander, so that Dexia may be seen as even stronger decision in limiting the scope of Article 3(3).

This decision resolves a series of conflicting judicial decisions. It is a robust, commercial decision that will be welcomed by financial institutions and participants in the international derivatives markets. For back-to-back arrangements to be relevant, it was not even necessary to show that the parties foresaw that the bank might hedge the swaps with non-Italian counterparties – it was sufficient simply for crossborder hedging to be a routine part of the market.

Of course, greater certainty in the application of one Article in the Rome Regulation is overshadowed by the greater unknown of Brexit and its implications for choice of law. At present, the aim of the Government (as set out in their future partnership paper on Providing a cross-border civil judicial cooperation framework) is to incorporate the Rome I Regulation into domestic law. This option would minimise any disruption. In any case, Dexia provides a positive short-term distraction from the Brexit negotiations.