SWAPS: “CONFUSION BETWEEN THE OBJECT OR CONTENT OF THE CONTRACT, AND THE INFORMATION THE INTERMEDIARY IS REQUIRED TO PROVIDE, PRIOR TO THE CONCLUSION OF THE SWAP”.
The Court of Turin disapply and redraw the principles set out by the Joint Divisions on the subject of derivatives.
With ruling no. 673/2022, the Court of Turin acknowledges certain concepts known to operators in the field of derivatives and misinterpreted for so long by case law, which have allowed and still allow a sectarian use of actions for damages brought by investors who are simply unhappy with their investments.
In the case in question, the plaintiff company entered into an interest rate swap (IRS) with effective date March 31, 2011, to hedge the interest rate risk on a ten-year loan. The company complained, among other things, of the existence of a contractual risk that originally was in favour of the credit institution, the circumstance that the debt was only partially correlated to the swap and that the most efficient solution would have been a cap option. Such option would have hedged the company against the risk of a rising interest rate against the payment of an initial premium, giving the company the right to collect the difference if positive between the benchmark and a predetermined level of the interest rate (so-called strike). Moreover, the company deduced that it should have been paid the cost of the transaction by the bank as an upfront payment in order to rebalance the contractual payments.
The Turin Judge fully rejected the plaintiff’s requests, brilliantly separating certain concepts regarding derivatives, summarized below.
– Hedging purpose: the Judge reiterates that this purpose is fulfilled when there is a high correlation between the technical and financial characteristics of the hedged item and the swap. Full hedging of the risk for the entire capital or for the entire duration of the underlying transaction is not necessary, according to a clear analysis of the Consob resolutions and the accounting standards on the subject.
– The swap par does not exist: the Court of Turin acknowledges that, once the possibility of accruing positive differentials for contractual parties has been assessed (in concrete terms, at inception), “it is normal that the IRS contract expresses an initial negative value, due to ‘setting of’ parameters and the hedging costs and intermediary’s margin embedded in the contractual structure”. The bank is not obliged to pay the client the initial negative MtM (mark to market, e. the market value of the derivative at a certain date, which is the result of estimates expected from future payments that the parties will exchange) generated by the presence of the implicit costs.
– Mark to market: the Court of Turin clearly affirms (correctly, in the author’s opinion) that the Supreme Court’s rulings on MtM are “poorly controlled“. By ruling no. 8770/2020, the Supreme Court considers that the MtM expresses the “measure of risk” and that therefore it must be the subject of the agreement between the parties. In the absence of an agreement on the contractual risk, the contract would be null and void. The Court of Turin correctly observes that the extent of the risk is not external to the economic conditions of a swap contract (notional amount, rate, spread, any options and so on), but inherent in them since “there is always agreement on” these economic conditions. The Court of Turin correctly pointed out that the failure to communicate the MtM represents a violation of the standards of correctness and transparency pursuant to art. 21 of the Consolidated Finance Act, but it is not a reason of nullity of the contract, as sustained by the Joint Divisions.
– Pricing method: the most recent case law elaboration of the Supreme Court (ruling no. 21830/2021) requires that the client is about the “mathematical formula” on the basis of which the parties calculate the present value of future payments under the contracts. The Turin Judge notes that understanding the mathematical models for calculating the MtM requires advanced knowledge and that Consob regulations do not provide for the communication of the pricing model that is difficult for a non-professional operator to understand. In the case of a plain-vanilla IRS derivative (in other words, a simple derivative that provides for the exchange of one rate against another rate), the results of the calculation are convergent and similar despite the different calculation methods. The court-appointed expert in the case in question, when questioned on this point, stated that the MtM of a plain vanilla IRS can be determined using a method that is commonly and universally used (so-called discounted cash flow) and that the correctness of the calculation can be verified by any institution that has a Bloomberg or Reuters (or other minor) platform, or that in any case, has the necessary historical data for the calculation. The above-mentioned principle set out by the Supreme Court should, therefore, only be applied in the case of non-plain vanilla derivatives that have options or other exotic components, for which it is not possible to use market quotations.
– Probabilistic scenarios: the “probability” of gain/loss, depending on the occurrence of events that are favorable or adverse to the client, may be the subject of findings and yield simulations, which the intermediary is professionally equipped to elaborate, but no intermediary is able to guarantee that the fluctuation of the parameters will remain within the represented risk range. The fluctuation dynamics of these parameters (in particular, of interest rates) are outside the sphere of the intermediaries’ control, in the absence of a crystal ball. For example, a derivative concluded to hedge the rise in interest rates in March 2011 ignores the fact that in the following winter there will be a sovereign debt crisis in Europe, including that of Italy, and that, in the summer of 2012, the European Central Bank will decide to defend the Euro “whatever it takes“, injecting liquidity on the market with massive purchases of government bonds, which will keep the Euribor close to zero, pushing it until it is in negative territory. Once again, this concerns information that is uncertain and not contractual agreements.
The Consob regulations recommended the communication of the “analysis of yield scenarios” which should be included in the information provided to the client and not in the contractual object. In the specific case, the Judge held that such information had been provided to the client.
Finally, the Court, on the basis of the considerations made by the court-appointed expert, in the case in question, ruled out that an interest rate cap was advisable; moreover, this choice had been presented to the client who had preferred to take out the swap.
In conclusion, the ruling in question has the merit of highlighting some errors which the Supreme Court’s case law has committed in the most recent decisions: in the author’s opinion, the informative elements of the derivative contracts cannot have, and it is not correct that they have, repercussions on the origin of the contract, and therefore cannot generate the annulment of the derivative contract.
However, according to the Turin Judge, the inexact fulfilment of the informative obligations by the intermediary, gives the client the right to refuse the proposed or recommended financial instrument, and to refuse the legal consequences (pursuant to art. 1711 Civil Code, even if referred to the mandate) and therefore to bring an action aimed at ascertaining the contract ineffectiveness and the restitution of the net differentials, in addition to any compensation for damages.
m.divincenzo@macchi-gangemi.com
THE COURT OF CASSATION DEALS WITH THE “RUSSIAN ROULETTE CLAUSE” … AND DOES NOT DECIDE.
In a previous newsletter (on 09.04.2021) we had already written about the so called “Russian roulette” clause, which can be provided for in the company by-laws or in a shareholders’ agreement. It is – as already illustrated – a “deadlock-avoiding” clause, which means that it is aimed at providing in advance a mechanism that overcomes situations where the company’s operations could be blocked (the typical situation is when two shareholders, having the 50% of the stock capital each, are in disagreement, which implies the impossibility to approve the balance sheets or to renovate the corporate bodies).
This mechanism, essentially, provides that a shareholder can invite another shareholder to sell him his own shareholding at a certain fixed price (stated by the proponent), or to purchase the proponent’s shareholding at the same price. Through this mechanism it should be possible to exit the impasse situation, by removing the contrast between the two shareholders (in reality, by completely removing the plurality of shareholders) and thus preserving the company’s activities. For this reason, the clause was deemed as valid by some notarial statements. But it also presents some critical issues
In the previous newsletter we analysed the decision of the Court of Appeal of Rome 3.02.2020 no. 782 which, with broad and articulated argumentations, acknowledged the validity of such a clause.
On the contrary, the appealing companies presented many issues which should lead to the invalidity of the clause, such as:
– lack of an interest worthy of protection according to art. 1322 of the Italian Civil Code;
– the fact that the price is unilaterally and arbitrarily fixed only by one of the parties is in violation of art. 2437-ter of the Italian Civil Code. (or art. 2473 of the Italian Civil Code for ltd companies) and, more in general, violates the principle of fair valuation of the shareholding in every case when a shareholder is bound, due to by-laws provisions or shareholders’ agreements, to sell his shares;
– the violation of the prohibition of the so-called “patto leonino” provided by art. 2265 of the Italian Civil Code,
all issues which, however, were dismissed by the second-degree judges.
This decision was challenged and has been now examined by the Court of Cassation. The Supreme Court, nonetheless, after retiring in the council chamber on 3.02.2022, with the provisional order 29.04.2022 no. 13545, “also considering the absolute novelty and complexity of the objected issues”, deemed necessary to deepen the question, appointing the Court’s Study Office (“Ufficio del Massimario”) to analyse the “legal, jurisdictional and scholar framework, also in the USA and in Canada as far as possible” concerning the clause at stake.
Such order, which is an exception in the ordinary decisions of the Court, is not actually so rare (it has been issued about 90 times in the last four years). What is surprising, on the contrary, is that the Court of Cassation examined the claim in the council chamber only two years after the filing of the challenged decision of the Court of Appeal. Even the second-degree proceedings, indeed, were quite quick in respect of the proceedings’ average duration before the Court of Appeal of Rome.
It is also interesting that the order at hand paid attention to the law and praxis of foreign systems. This attitude, too, is becoming increasingly common among jurisprudence, which is sensitive to a regulatory environment with an international scope that is increasingly permeable to institutions from other countries (and this not only in the areas of corporate, financial or business contract law, but also in civil liability – think of so-called punitive damages – or family law – think of the proposals put forward on prenuptial agreements).
And yet, in the light of the evident perplexities shown by the Supreme Court and pending the in-depth investigations requested by it, it is worth suggesting a very cautious approach where one intends to introduce such a clause within a company’s by-laws or to agree on it in a shareholders’ agreement.
It remains to be hoped that the fast-moving pace that has marked the proceedings under consideration so far, will also characterize the in-depth work of the Court’s Study Office (“Ufficio del Massimario”), and that the Supreme Court will soon clarify its position in this regard, providing a stable benchmark in all situations in which such a clause could find application.
NOTIFICATION AND LOSS OF THE ORIGINAL RETURN RECEIPT: IS A DUCPLICATE VALID EVEN IF NOT SIGNED BY THE RECIPIENT?
In the case of notification of a judicial act by means of the standard postal service, is it possible to prove that the judicial act has been properly notified even if the return receipt is lost or misplaced? In such cases, is a duplicate sufficient, even if it’s not signed by the recipient?
The sixth section of the Civil Court of Cassation published ordinance n. 13798 on 2 May 2022, which confirms that a duplicate of the return receipt is sufficient to prove that the notification has been properly served, even if the receipt does not contain the signature of the person who received the item.
In this case, a citizen challenged a fine for traffic violations. The citizen notified the challenge both to the Justice of the Peace and to the Prefect, both of whom rejected the challenge. The matter was then appealed to the Tribunal, which again rejected the appeal on the grounds that the appellant had not been able to prove that the challenge had been duly and timeously notified to the Prefect and the Justice of Peace since a duplicate of the return receipt does not constitute proof of the regular notification, since it does not contain the signature of the recipient.
The citizen subsequently appealed the decision of the Supreme Court, citing the violation or wrongful application of art. 8 of the Republic’s President Decree n. 655/82.
For clarity, the precise wording of the above-mentioned provision is provided below:
“1. The Postal Officer who delivers an item with return receipt, requires the recipient to sign the return receipt; should the latter refuse to sign, the Officer shall take note of the refusal on the receipt and such annotation is sufficient to prove the regular receipt of the item. 2. The return receipt must then be returned to the sender. 3. In case of loss of the return receipt, the sender has no right to any restoration, however they have the right to obtain for free a duplicate of the same return receipt.”
Returning to the case at hand, the Supreme Court upheld the appeal in light of the case law on the topic and proposed the correct application of the above-mentioned art. 8.
The decision of the Supreme Court was based on the following: first and foremost, the Judges referred to a longstanding precedent according to which the duplicate of the return receipt must be deemed as fully valid even if missing the recipient’s signature. Nevertheless, it is necessary that the duplicate “…contains all the information contained in the original return receipt, even the name of the person receiving the mail…” (reflecting decision n. 3920 of 25/10/1956 of the First Section of the Court of Cassation).
Provided that the duplicate reproduces precisely the information contained in the original receipt, the former has the validity of full evidence, pursuant to art. 2700 of the Italian Civil Code, “…with regards to the declarations and facts occurred in the presence of the Posalt Officer and confirmed by the latter…” (reflecting decision n. 22348 of 15/10/2020 of the Fifth Section of the Court of Cassation). In fact, anyone who wishes to claim that the notification has not been properly served has to raise the exception of forgery of the document.
According to the Court, it is not necessary for the duplicate of the return receipt to contain the recipient’s signature, given that the delivery registry held by the post office is the source of the duplicates and it is valid to prove the receipt of items (Civil Court of Cassation, Tax section, decision n. 14574 of 06/06/2018, available in Giust. Civ. Mass. 2018).
Thus, the duplicate of the receipt is nothing less than a precise copy of the registry’s content, which of course includes the name of the person in whose hands the item was delivered.
The Supreme Court concluded that in case of loss or destruction of the return receipt, pursuant to art. 8 of the D.P.R. n. 655/82, the duplicate of the receipt released by the post office is sufficient to prove the regular receipt of the item, even in the absence of the recipient’s signature.
The solution provided by the Supreme Court is in fact more closely correlated with the wording of the third section of the above-cited provision: in the absence of the original return receipt, the Postal Officer has the power to record on the duplicate the facts of the delivery, including the recipient’s refusal to sign the receipt (section 1) and the actual delivery of the mail (section 3); without any requirement for the recipient’s signature.
In conclusion, the duplicate of the return receipt is sufficient to prove the regular notification of a judicial act, even if it is missing the recipient’s signature.
e.storari@macchi-gangemi.com
g.briggi@macchi-gangemi.com
MERGER OF SPECIAL PURPOSE ACQUISITION COMPANIES AND SPECIAL PURPOSE VEHICLES IN MLBO TRANSACTIONS: RECENT CLARIFICATIONS OF THE ITALIAN REVENUE OFFICE REGARDING CARRYING FORWARD OF TAX LOSSES.
Through its answers to rulings no. 234 and 235 of April 28th, 2022, the Italian Revenue Office provided clarifications regarding the carrying forward of tax losses in the event of a merger of SPACs and SPVs in MLBO transactions. The Italian Revenue Office highlights that the right to carry forward tax losses is contingent upon the permanence of conditions of economic viability of the loss-making companies, in order to verify that the company carrying forward tax losses (and other relevant items) has not been depleted prior to the merger transaction.
The regulations governing tax losses in merger operations, set forth by Art. 172, paragraph 7 of the Income Tax Code, limit the possibility of carrying forward the tax losses in order to prohibit companies lacking productive capacity from implementing operations aimed to offsetting the tax losses of one company against the taxable profits of the other. The same regulations also provides that such limitation regarding carrying forward of tax losses (as well as the non-deductible interest expense pursuant to Art. 96 of the Income Tax Code and “notional ACE deduction” surpluses) in the event that the conditions of financial soundness and economic viability envisaged by the same regulations do not exist.
In fact, the legislator has provided that the tax losses of the companies taking part in the transaction, including the acquiring company, can be deducted from the income of the company resulting from the merger or the acquiring company for the part of their amount that does not exceed that of the net equity (reduced by the amount of any recapitalizations carried out in the previous twenty-four months) of the company carrying forward the losses, as shown in the latest financial statements or, if lower, in the balance sheet prepared pursuant to Art. 2501-quater of the Italian Civil Code (the “Mandatory Timeframe”).
In this scenario, according to recent clarifications by the Italian Revenue Office, it is required to verify that the company carrying forward the tax losses (and the other relevant items) has not been depleted – in addition to the Mandatory Timeframe – also in the period preceding the merger operation.
As a consequence, from an anti-avoidance perspective, the result is that the minimum requirements of economic viability must exist not only in the Mandatory Timeframe, but must also continue to exist until the merger is actually implemented, that is, until the date of its legal effectiveness.
According to the recent view of the Italian Revenue Office, indeed, the applicable regulations would be deprived of their anti-avoidance purpose if they allow the carrying forward of tax losses to a company that has been completely weakened in the period of time between the end of the financial year preceding the merger resolution (as emerges from the regulations) and the date on which the transaction itself became legally effective.
This being generally stated, the Italian Revenue Office concluded that:
a) in case of mergers involving Special Purpose Acquisition Companies (“SPACs”), the provisions of Art. 172, paragraph 7 of the Income Tax Code are considered inapplicable, since this type of special purpose vehicle company are considered “allowable” due to their specific role in the transaction, irrespective of the fact that they have not generated revenues or are in a loss position;
b) the provisions of Art. 172, paragraph 7 of the Income Tax Code are also considered inapplicable in the case of mergers of Special Purpose Vehicles (“SPVs”) in merger leverage buy-out (“MLBO”) transactions, given that these SPVs are considered “allowed” insofar as they carry out the activities that are instrumental to the implementation of the MLBO as a whole.
In these cases, therefore, in order to carry forward tax losses (as well as non-deductible interest expenses pursuant to Art. 96 of the Income Tax Code and “notional ACE deduction” surpluses) at the time of the merger, it is not necessary to comply with the so-called “economic test” and the “net equity limit” provided for by Art. 172, paragraph 7 of the Income Tax Code.
In any event, the Italian Revenue Office finally observe that, pursuant to Art. 10-bis of Law no. 212/2000, this is without prejudice to any power to control exercised by the Italian tax authorities in order to verify whether the transaction under review form part of a broader abusive plan and, therefore, challenged.
a.salvatore@macchi-gangemi.com
f.dicesare@macchi-gangemi.com
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