The invalidity of derivative contracts in the aftermath of the recent judgement of the Supreme Court: the literal approach adopted by the Florence Tribunal (and a comparison with the approach of the Court of Bologna in a similar case).
With judgement No. 1865/2020 of 24 August 2020, the Florence first instance Court declared a plain vanilla interest rate swap (“IRS”) null and void due to a “genetic flaw” in its subject matter, “irresoluteness” of its causa and lack of hedging function.
The judgment is one of the first to be adopted on the validity of derivative contracts following the known decision of the United Sections of the Court of Cassation No. 8770/2020, and possibly the first to expressly mention and apply the principles set out in said decision, albeit to a derivative between private parties.
This ruling relates to a claim for the termination or, alternatively, for a declaration of nullity of an IRS entered into between the two plaintiff companies and the defendant bank.
The contract in question – a “plain vanilla” derivative (also in the classification made by the court-appointed expert) having effective date of 30 November 2007, maturity date of 30 November 2017 and a notional value of €2,500,000 – had been executed for the purpose of hedging against interest rate risks in connection with the loan executed by the plaintiffs with the defendant bank. The IRS turned out to be unfavourable to the clients, who therefore initiated the action aimed at obtaining full reimbursement of the sums paid to the bank under the contract.
The bank defended itself by arguing that:
-“the derivatives entered into by the plaintiffs were purely hedging (so-called plain vanilla), aimed at shielding the plaintiffs from the interest rate risk”;
– “the fact that interest rates had suddenly fallen after the global economic crisis of the summer of 2008 was entirely coincidental”;
– “precisely by virtue of the mechanism of the hedging derivative, given that the interest on the loan followed the Euribor fluctuations, what the plaintiffs had lost in relation to the swap contracts, they had gained in relation to the lower cost of the loan, and vice versa”;
– “the hedging had in fact achieved the objective for which the derivative had been entered into”;
– “the transaction was adequate and in line with the needs and prospects of the debtor companies, which in any event had the status of qualified investors, also taking into account the companies’ turnover and the size of the financing obtained“.
In granting the plaintiffs’ request, the Court made the following considerations.
First, notwithstanding the fact that there were no public counterparties in the case at hand, the Court stated that the examination of the question of nullity of the derivative must necessarily take into account the principles stated by the recent case law in the known Supreme Court judgment No. 8770/2020 (concerning the different case of derivative contracts executed by a public local entity), due to the general nature of the reconstruction carried out and the principles set out by that decision.
Hence, after recalling some key passages of the judgement of the Supreme Court, the Florence Judge reiterated that “it is essential for the investor to have knowledge of all the elements suitable to allow the identification of the actual value of the derivative at a certain date, and therefore, to have knowledge of the mark to market and of the measure of the risk and of the costs“: in the absence of these elements – the Court stated – “the contract is affected by nullity“.
It is interesting to note at this point that, for the purposes of assessing in practice the respect of the parameters of the Supreme Court in the case at issue, the Court of Florence had no regard to the overall relationship and exchange of information between the parties at the time of negotiation and conclusion of the derivative. Instead, it considered directly (and exclusively) the “contractual document“, from which, according to the Court, the actual value of the derivative under examination should emerge.
In particular, the Court made a comparison between, on the one hand, the clauses of the IRS and the related framework agreement governing the early termination of the contract and its consequences, in particular in terms of calculation and payment of the market value/mark-to-market, and, on the other hand, the complex calculation of the mark-to-market set out in the report of the court-appointed expert (quoted verbatim in the judgment), reaching the conclusion that “the mark to market had not been indicated in the swap contract” and that “this omission results in a genetic flaw in the contract, given that the mark to market relates to its subject matter, as clarified by the Supreme Court“.
As to the requirement of an adequate causa, the Court found that also the other elements identified by the Supreme Court as essential for the purpose of fulfilling the function of financial risk management (i.e., probabilistic scenarios, quantitative and qualitative measurement of the risk and costs, even if implicit), “were not specified” in the contract: the transaction put in place between the parties was therefore characterized by “an underlying irresoluteness, which renders the relevant contract null and void“.
The above assessments led the Court to declare the IRS null and void.
The Florence Court analysed the derivative also from the point of view of its hedging function, holding that, on the basis of the analysis of the court-appointed expert, this function was only partially fulfilled in the case in question and, in any case, the derivative would not have complied with all the requirements of the 1999 and 2001 Consob communications. In particular, there was no “documentary evidence showing that [the IRS] was expressly put in place to reduce the riskiness of the loan agreement“. The Judge concluded that this lack of hedging function determined a lack of merit in the interest pursued by the parties, leading to an additional profile of nullity of the contract, as also stated by the Supreme Court in its Judgment No. 19013/2017.
The defendant bank was therefore ordered to repay the entire amount requested by the plaintiffs, as it had been unduly received.
The first instance decision discussed above clearly follows in the footsteps of the Supreme Court judgement No. 8770/2020, whose principles it appears to apply in a literal, and almost religious, fashion. It remains to be seen whether other merits courts (be it of first instance or appeal) will take a similar stance, or, as one hopes, there will be a case-by-case modulation, “through a concrete approach“, according to the methodological indication proposed by the Supreme Court itself.
In this respect, a brief mention should be made of a recent decision of the Court of Bologna of 15 December 2020 regarding the validity of a derivative contract (namely, an interest rate collar) between a bank and a private client. The Bologna Judge took the opposite approach to that of the Court of Florence: the Supreme Court judgment is never mentioned, not even incidentally; the typical causa of the derivative contract is not identified in the rational and measurable risk (as put forward by a case law considered “superseded and outdated” by the Bologna Judge), but in the “exchange of the differential of the values of the underlying notional calculated on the bases of the interest rates“; consequently neither the mark-to-market nor the pricing model are essential elements of the derivative; instead, such essential elements consist of “the notional amount, the benchmark for the floating interest rate, the fixed rate, the interest payment dates, the duration of the contract and its expiration“, all of which were indicated in the contract at issue. The plaintiff’s claims were therefore rejected in their entirety, and the plaintiff was ordered to reimburse the defendant’s legal costs.
According to the Court of Justice of the European Union, are national sports federations entities governed by public law?
On February 3, 2021, the Court of Justice of the European Union published a long-awaited decision (Joined Cases C-155/19 and C156/19), in which it replied to questions posed by the Council of State regarding the status of body governed by public law of the national sports federations, and in particular of the FIGC – Federazione Italiana Giuoco Calcio (Italian Football Federation), with all the consequences regarding compliance with the Code of Public Contracts.
It was thought that the real question to which the Court of Justice would give a clear and definitive answer would be whether sports federations should be regarded as bodies governed by public law and consequently be obliged to hold public tenders for the purchase of goods and services as happens with other contracts.
Instead, as it had previously done with the issue regarding the inclusion of Federations in the ISTAT list (judgment of 11 September 2019 EU-C-2019-705), the Court of Justice deemed that it should be the national court that verifies whether or not there is active control exercised by CONI over the FIGC such to affect the management of a national sports federation like the FIGC, in particular regarding the award of public contracts.
However, though emphasizing that it is up to the national court to verify the existence of a dependency accompanied by a possibility of such influence, the Court has provided certain clarifications and criteria.
In particular, according to the Court, in order to assess the existence of an active control by CONI over the management of the FIGC, it will be necessary to analyze the different powers CONI is vested vis-a-vis the FIGC itself, and the assessment shall have to be an overall one and not specific for each individual CONI intervention.
According to the Court, only after assessing the nature and extent of the active control and its incisiveness can the national court answer the abovementioned question.
Furthermore, the Court noted that: ‘in the event that it is concluded that CONI controls the management of national sports federations, the fact that the latter, by virtue of their majority participation in the main CONI bodies, can exercise an influence on CONI’s activities is only relevant if it can be demonstrated that each of the national sports federations, taken independently, is capable of exerting a significant influence on the management control exercised by CONI vis-à-vis the federation itself, so that this control is neutralized and such federation thus regains control over its own management.‘
From the examination of the decision and the criteria included therein, it seems too easy to conclude that Federations are not bodies under public law. The active control to which the decision refers is so all-pervading that it is difficult to find it in practice. However, in the author’s opinion, the perspective could be reversed if one of the profiles related to the so-called active control is more carefully evaluated: that is, the Federation’s autonomy of management, i.e., the nature of the membership fees paid by the members. If one had to contemplate the idea of the public nature of membership fees (as indeed the Luxembourg Court itself does in the previous decision regarding the inclusion of Federations in the ISTAT list (see our Newsletter of 21 January 2021), “the degree of decision-making autonomy” and “at which decision-making level and within which limits, the public intervention, implemented with the allocation of public contributions, conditions the program and the activity of the federations themselves” (cf. Court of Auditors United Sections in plenary meetings nos. 9 and 10 of 30 April 2020) will also have to be assessed.
Regarding this point, it should be noted that for a Federation, the classification as a body under public law, is not only relevant for compliance purposes with the Code of Public Contracts, but also to determine the so-called “damage deriving from competition or from failure to compete” which was elaborated by case-law of the Court of Auditors as a specimen of the broadest genus of fiscal damage. To this effect it is worth recalling that – in the context of fiscal liability, as a subtype of an accounting offence linked to the infringement of rules of public evidence that required prior execution of a competitive procedure in order to choose the best offer for the acquisition of goods, services or works – the concept of damage to competition was used for the first time by certain regional chambers of the Court of Auditors (ref. Court of Auditors, Sez. Lombardy, 27 July 2006, n. 477). The damage to competition, to use a recent definition: “was understood as a financial damage linked to the failed performance of a healthy competitive encounter between all parties potentially interested in the contracts being awarded“(ref.CourtofAuditors, United Chambers Campania,5September 2017,no.321).
Officials and managers of national sports Federations could be held responsible before the Court of Auditors for this type of damage: for causing financial damage to the Treasury.
Having said that, we will have to wait for the national court’s decision to find an answer to the question asked. And, in fact, now that the Court of Luxembourg has indicated the criteria, the ‘ball’ (this is truly the case) is back in the court of the Council of State.
The Court of Cassation returns to the issue of the burden of proof in relation to liability actions against company directors (Court of Cassation, decision no. 25056 of 9 November 2020).
On directors’ liability, the judges of the Supreme Court clarify how the burden of proof falling on the directors themselves operates. The decision provides further confirmation of the need for directors to take particular care in the performance of their functions, not only by complying with the duties incumbent on them, but also by preparing material demonstrating compliance with their obligations.
The case concerned the conduct of a director of a company which had continued to supply goods to a pharmacy, despite the latter’s considerable delays in payment. The director had obtained a personal guarantee from the wife of the pharmacy’s owner for the pharmacy’s total debt. The pharmacy then went bankrupt, the guarantor was found to be unable to pay, and the supplying company brought a liability action against its director.
The Court of Appeal of Messina (in its decision of April 30th, 2015) had excluded the director from being convicted. The judges had noted that (on the basis of the previous decision of the
Supreme Court no. 1045 of January 17th, 2007) – in the absence of a breach of the law or of the articles of association – in order to have the director’s liability established, the plaintiff would have had to prove not only the act performed by the latter (which is not unlawful per se) but also those elements of context from which it is possible to deduce that said act implies a breach of the duties of loyalty and diligence and, furthermore, that he should have indicated the alternative conduct that he should have correctly performed. This was not done in the present case. In particular, the Court of Appeal had held that it could not be argued that the administrator had been insufficiently diligent in the absence of evidence that the administrator himself was aware of the pharmacy’s financial difficulties and that the guarantor’s assets were insufficient.
The Court of Cassation upheld the decision of the lower courts. The judges of legitimacy deem, in fact, that it is certainly correct to maintain that the plaintiff fulfils its burden of proof by demonstrating those behaviours which, in the particular contingency, denote the failure by the administrator to comply with his duty of loyalty or diligence and, however, once such evidence has been acquired at trial, it is up to the administrator summoned in Court to allege and prove the further facts – consisting of precautions, information, checks which are capable of excluding (or mitigating) his culpable liability (see, in this regard, Court of Cassation, 22 June 2017, no. 15470) .
The Court of Appeal, in contrast, had first implicitly recognised the director’s negligent conduct by highlighting the request for a guarantee as a cause for excluding liability; subsequently, however, it had passed on to the plaintiff company the consequences of the guarantor’s inability to pay, whereas it was the director who had to prove that the damage was not attributable to him.
In the light of the Court of Cassation’s clarifications, the cautions that directors are required to take in the exercise of their activity, preparing as much evidence as possible to show that the decisions taken are not reckless and superficial, especially where they present a greater risk to the company, become even more relevant.
ABI schemes on ‘omnibus’ sureties, anti-competitive clauses and leasing contracts.
With a judgment of July 22nd, 2020, the Court of Appeal of Milan established that Bank of Italy provision no. 55 of 2005 (which had ascertained that certain articles of the surety bond contractual scheme prepared by ABI constitute an agreement restricting competition pursuant to art. 2, paragraph 2, letter a), of Law no. 287 of October 10, 1990) does not apply to sureties issued to guarantee leasing contracts.
In the case submitted to the Court of Appeal, the appellant had objected to the invalidity of the surety bond’s clause that derogated from the application of art. 1957 of the Italian Civil Code, which the Bank of Italy considered to be one of the clauses in the ABI scheme that harmed competition.
The Court of Appeal, however, pointed out that the Bank of Italy’s provision specifically concerned the banking sector and the repercussions of the ABI scheme on the relevant credit market, not the guarantees relating to a series of leasing contracts regarding motor vehicles.
Moreover, the Court of Appeal observed that, unlike what happens in omnibus sureties or for future obligations pursuant to art. 1938 of the Italian Civil Code, to which the Bank of Italy’s provision refers, the sureties in question concerned a precisely identified credit, coinciding with the amount that the user must pay in instalments.
The Court’s decision, therefore, did not examine the different question of the consequences of the Bank of Italy’s provision on the validity of sureties used to guarantee banking transactions (so-called omnibus sureties), considering that the latter were outside the cases covered by the provision itself.
In this regard, jurisprudence has adopted different approaches.
According to a first approach, the sureties containing the clauses in question would be entirely null and void. According to another case law, however, the nullity would concern only the individual clauses. According to a third approach, the guarantees would not be null and void, either in full or limited to the individual clauses, because the nullity would only regard the restrictive agreement between the banks, not the contracts that the banks have signed with clients in execution of the agreement. In this case, the guarantor who considers himself damaged by the restrictive agreement would have to bring an action for damages. Another question debated by case law concerns whether or not the guarantor is obliged to demonstrate the uniform application of the clauses in question even after the Bank of Italy’s measure.
An eccentric and original position with respect to this debate is the one expressed by the Court of Verona in its recent judgement of October 6, 2020, according to which it may be questioned whether the regulations of Law no. 287/1990 apply to omnibus sureties having a wording that conforms to that provided by the ABI. In particular, with detailed reasoning, the Court observes that competition must be protected with respect to the bank client, not with respect to the guarantor, who is third party with regard to the banking relationship and does not operate in a competitive market.
In conclusion, the judgment of the Court of Appeal of Milan offers the opportunity to think about the broader theme of the repercussions of the Bank of Italy’s provision on omnibus sureties, in relation to which jurisprudence has not, to date, reached a univocal solution. In particular, a clarifying intervention by the Court of Cassation is desirable, given that the relevant pronouncements made so far have been invoked by the trial courts in some cases in favor of the thesis of nullity, in others in favor of the thesis of compensation for damages.
New tax incentives for M&A transactions.
The New Budget Law introduces new tax incentives on corporate aggregations, and this may have a significant impact on M&A transactions in Italy.
To enhance M&A transactions in Italy, Art. 1, paragraphs from 233 to 242 of Law no. 178 of 30 December 2020 (hereinafter “2021 Budget Law”) provides the possibility to convert deferred tax assets (“DTAs”) even if not accounted in the financial statements into a tax credit in the event of mergers, demergers or contributions of going concern that are approved between 1 January 2021 and 31 December 2021, to the extent that the convertible DTAs refer to:
a) tax losses carried forward up to the tax period prior to the ongoing year as of the date of legal effect of the transaction and not yet used to offset the taxable income;
b) allowance of corporate equity (“ACE”) benefit accrued up to the tax period prior to the ongoing year as of the date of legal effect of the transaction and not yet used to offset the taxable income or as a tax credit.
The tax credit can be offset with other taxes payable, transferred or asked for refund.
In order to take benefit of this regime, the following conditions shall be satisfied:
– the companies participating to the M&A transaction shall have been operating for at least two years;
– on the date of the transaction and in the two preceding years, the companies involved in the M&A transaction shall not have been part of the same corporate group, have been linked by any shareholding relationship higher than 20% and have been controlled, even by means of indirect control, by the same person.
In case of M&A transactions carried out through mergers and demergers, it is allowed to convert the DTAs accrued by both parties participating in the transaction, if they refer to tax losses and ACE benefit that can be carried-forward pursuant to the vitality and benefit tests set forth by Art. 172, paragraph 7 of the Income Tax Code for mergers and Art. 173, paragraph 10 of the Income Tax Code for demergers. In case of contributions of going concern, differently, it is possible to convert only the component accrued by the transferee within the limits provided for by Art. 172, paragraph 7 of the Income Tax Code.
The effectiveness of the conversion of the DTAs into a tax credit is subject to the payment of a fee amounting to 25% of the converted DTAs. The fee is deductible for corporate income tax (IRES) and regional tax (IRAP) purposes.
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