Banco Santander Totta SA v Companhia De Carris De Ferro De Lisboa SA & Ors

It needs to be said at the outset that there are documents that, though not typical of the overall documentation, do the bank no credit. A presentation of November 2005 from Global Treasury (so not emanating from Portugal) aimed at boosting the sale of “exotic products” encourages employees to “Think Big: don’t criticise ourselves. Reward Aggressiveness.” As the Transport Companies point out, the first Lisbon Metro swap (MdL1) is placed at the top of the list of major deals completed in September 2005 internationally, with a profit of US$7,562,500. This kind of attitude is the antithesis of relationship banking.

The position in Portugal was as follows. There were at the material times two Portuguese subsidiaries of Santander, Banco Santander de Négocios Portugal SA (“BSNP”) and BST itself. BSNP had client relationships with the Transport Companies and presumably other public sector companies, but their case is that in practice no distinction was made between the banks in their dealings with them. The Transport Companies place reliance on (among other things) a BST report of 20 June 2007 to show that the bank used its relationship with them to position itself favourably for the sale of structured products like the snowball swaps.

The report of 20 June 2007 was prepared by BST for Santander’s New Products Committee mentioned further below. It covered the Sale of Structured Derivatives for the Public State Sector (“sector público estatal” or “SPE”). Each of the Transport Companies was named, as well as other public sector companies in Portugal the names of which have been redacted.

The report gives what the court regards as a not fully accurate view of the sales process, in particular a reference to stress testing for “extreme scenarios”. In fact, BST only provided stress testing for three of the swaps, two of them being the last of the swaps entered into after the report. Only the last (the STCP swap) was tested for what could be described as extreme scenarios (in accordance with further requirements imposed by Madrid as described below).

Further, as the Transport Companies point out, these products were important from BST’s point of view because (as it was put in the conclusion to an internal memo from August 2007), “The marketing of sophisticated Derivatives is essential for us to be players in the Large Corporates segment in Portugal and is the only way of complying with the budget”. This shows that an important part of the motivation of BST’s investment banking team in selling them to public sector companies was to meet its budget (this may be a reference to a target, and any difference is not material).

Broadly the court accepts that the report of 20 June 2007 shows BST using its relationship with the public sector companies to develop the derivatives business. However, that in itself is not a matter for criticism. An assertion is made by the Transport Companies in closing (BST says it is an un-pleaded point) that BST intentionally took advantage of the relationship, in the sense of unfair advantage. Whether pleaded or not, it is important that the court expresses its view on this.

There is nothing (in the court’s view) in the report to suggest that the bank was intent on taking unfair advantage of its position. The evidence of Ms Cristina Antunes, who was a signatory, and the senior BST witness at trial, is also important in that respect. The court has had to assess her as a witness. It considers that she was, and is, committed and driven, not least by this litigation. She was an exceptionally well prepared witness dealing with events that began over a decade ago.

The court does not consider that she (or her colleagues) set out to persuade Transport Companies to enter into contracts that she thought would be contrary to their interests. The 20 June 2007 report supports the conclusion that the derivatives were seen at the time as advantageous to the bank but also to the clients. The court finds that these swaps were entered into because they suited both parties at the time: the bank got to enter into very profitable transactions, and the Transport Companies got appreciably lower interest rates than they would otherwise have been paying. However, this was at a price in terms of risk, and much of the dispute in this case turns around this equation.

New products such as complex derivatives had to be approved by the New Products Committee of Santander Spain. Above a certain limit, transactions had to be approved by the Credit Risk Committee in Spain. Each transaction also had to be within the approved “REC” for the client. The REC was calculated by a department in Spain called “Canal Transaccional” by an analysis which sought (as it turned out unsuccessfully) to determine “with a confidence level of 97.5%” the maximum potential loss over the lifetime of the derivatives transactions.

Despite the exhortation in the 2005 presentation quoted above to “reward aggressiveness”, there were concerns in Santander Spain over the sale of snowball swaps to public sector companies in Portugal. An email of 30 September 2005 from Santander’s Head of New Products in Madrid described a snowball swap structure as carrying a “great risk for the client”. As he explained, and indeed as is obvious, this is because of the accumulative effect of the structure if interest rates rise above the barrier. He mentions rates rising, because that was presumably seen as the main probability at the time, but his point is equally applicable to rates falling below the barrier.

The risk was to the bank as well as the client. An email of 18 December 2006 from the credit risk department in relation to the first Porto Metro swap (MdP1) noted that “the proposed structure is equivalent to others the bank has been rejecting in Spain for being very speculative and there is a reputational risk that the bank will not want to run”.

However, Santander Spain was not directly involved with the negotiating or transacting of the swaps, which was handled by the officers of BST in Portugal.

Based on a statement in the email of 30 September 2005 that “if there’s no mistake, we are not aware that this product is approved for Portugal”, the Transport Companies’ case is that for some time BST was selling these products without proper approval from Spain. However, it seems that Ms Antunes was relying on a general approval given in 2001 or 2002 for BST to sell derivatives, and it seems unlikely that the products lacked whatever approval was necessary since a further seven snowball swaps were sold to the Transport Companies over the next two years.

The New Products Committee report of 20 June 2007 was the subject of an oral presentation by BST to the Santander Risk Committee (the CDR) in Spain on 24 June 2007, which is also important. The minutes make reference to the characteristics of the products that BST was selling to public sector companies (including the Transport Companies) in Portugal. They are described as having:

“• High degree of complexity, featuring characteristics or components which involve the possibility of leveraging and granting them a speculative nature (and not just interest rate risk coverage)

•

Its purpose is the dynamic management of the counterparties' financial costs, facilitating interest rates lower than market ones as compensation for the speculative options sale

•

Long-time expirations, associated with the Debt being covered.”

Nobody at the meeting gave evidence at trial, but the tone appears from the minutes. The Credit Committee is recorded as expressing its “concern for the reputational risk associated with these operations”. However, it decided that the operation could be continued subject to more rigorous requirements. These were given in a document emanating from Madrid headed (in translation) “CNP – SPE (Footnote: ³) Structured Derivatives Operative” (it is not dated). The document emphasises a number of points: the importance of stress testing so that the client understood the risks, making alternative options available to the client, and making sure the client was not making a “merely speculative transaction”.

Ms Antunes’ evidence was to the effect that these were reinforcements of existing requirements, which may be correct. As to “merely speculative transactions” which the document makes clear were prohibited, her evidence was that what this meant was that the bank had to make sure that the purpose of the clients was not to speculate but to manage financial costs, which she said in these cases it was.

Overall, the court is satisfied that the requirements for selling these products had been reinforced because Santander Madrid had become more aware of the risks of this business. In fact, by the time of the new requirements, all but two of the swaps had already been transacted. The first exception was the second MdP swap with a trade

BST’s case is that it dealt with long-term and experienced finance managers at the Transport Companies. They were well qualified for this task, it says, being professional, sophisticated and highly knowledgeable in the way in which they negotiated the swaps. Overall, the boards included a number of individuals with substantial financial and economic experience. On this basis, it asserts the “financial sophistication” of the Transport Companies which, it says, fully understood the swaps they were entering into, and entered into them with good reason, as a means of managing and, it was hoped, reducing their interest rate liabilities as much as possible in return for taking on what they considered to be an acceptable level of risk.

The Transport Companies say that it is implicit in BST’s internal email correspondence that it gave little or no thought to the Transport Companies’ sophistication: the individuals dealing with the Transport Companies were sales people, and they viewed the Transport Companies as sales targets who had to be persuaded to buy their products. Their case is that they were not financially sophisticated in the context of the complex instruments with which they were being presented, and that the evidence shows some basic misunderstandings on the part of those responsible for the negotiations, such as to pricing and spread.

In support of its case, BST relies on the testimony given by the people heading up the Transport Companies to the Parliamentary Inquiry established to investigate the position of public sector companies in the light of the swaps debacle. The Inquiry is dealt with below.

BST says that it shows that the directors and employees of the companies acted with proper motives to protect the interests of the companies and their shareholders, that the swaps were concluded for a good commercial purpose, namely to reduce the overall interest burden of the Transport Companies; and that none of the companies had any intention of speculating, or gambling, or trading in swaps, nor saw the swaps in such light. No-one who gave evidence to the Parliamentary Inquiry expressed any doubt that the swaps were within the capacity of the Transport Companies.

That evidence, BST says, also highlights the fact that, in deciding to enter into the swaps, the Transport Companies engaged in a proper process, with careful analysis by suitably qualified and experienced in-house experts, inviting competitive proposals from multiple banks (both Portuguese and international); they were aware of the risks that they ran, but regarded them as worth running in return for the rewards available; and they did not feel under any pressure from any bank to conclude a swap, and in the same circumstances (ignoring hindsight) would make the same decision again.

The Transport Companies say that it is easy to understand that the individuals giving evidence before the Inquiry were “on the defensive”. It is unlikely that they would accept that the swaps were high risk, speculative transactions, wholly unsuited to the Transport Companies’ purposes, as this would have opened them up to criticism in a very public forum. For the same reason, it is unlikely that they would accept that they

The court thinks that there is force in the Transport Companies’ contention. It is plain and not surprising that the problems with Portuguese public sector companies and the derivatives products they were sold has become highly politicised. The evidence given to the Inquiry (confirmed by some of the witnesses at trial when they were taken to it), while relevant in some respects - for example it is correct that no-one who gave evidence to the Parliamentary inquiry expressed any doubt that the swaps were within the companies’ capacity - is part of the background, but should not be given undue weight.

The court has of course heard oral evidence from a number of people employed in the Transport Companies’ finance departments at the time. They were not in the court’s view at a particularly high level of financial sophistication, and obviously not on a level with a major international bank when it came to appraising derivatives products like the swaps in this case.

BST remarks on what it calls the “unexplained absences” of potential witnesses from the trial. It says that witnesses have stayed away not least because they would have been exposed to questioning about their wider experience with swaps.

It is correct that there were other people who could have been called, and who may have given further insight into the available financial expertise. However choices were inevitable in these complicated proceedings, and there is no reason to comment adversely on the Transport Companies’ choice of witnesses.

On a similar point, BST points out that the disclosure exercise did not extend to the Transport Companies dealings with other banks. But again this is not a matter of criticism. Disclosure was already a massive exercise, and would have been rendered unmanageable if the entire swaps experience of the Transport Companies had been included.

The court’s conclusion is as follows. Overall, whilst it is important not to underestimate the expertise of the companies, each of which had competent finance departments, the expertise of the Transport Companies in the context of these swaps can be described as “adequate”, rather than “sophisticated” as BST has sought to argue.

There is no need to make any further finding. It is not suggested that their financial sophistication, even if that description is justified, had any regulatory consequences. It is said to matter on the Art. 437 issue, though the court does not consider that it makes a difference there either on the facts.

In any case, to brand the companies as “financially sophisticated” does not assist much in determining the substantive issues. In this context, particular issues are as to the purpose of the swaps, and the Transport Companies’ understanding in entering into them. Both of these are dealt with below.

BST emphasises that the Transport Companies do not plead that they did not understand the risks they were assuming by entering into the swaps, or that they should have been given more information to enable them to do so. It is not, as they themselves say, a mis-selling claim.

The court accepts that this point on the pleadings is accurate.

On the other hand, as the Transport Companies say, by insisting that they are (or were) financially sophisticated, and indeed positively asserting that they fully understood the risks, BST has put the question of their understanding into issue. The Transport Companies are obviously entitled to put their case in that regard. Its relevance depends on the individual defences.

BST’s case is that the Transport Companies had a full understanding of the risks to which the swaps exposed them (albeit that they considered these remote), but also of the benefits the swaps were capable of producing. They understood the way the swaps worked, including the memory effect (the snowball mechanism) which could expose them to accumulating interest rates, and they understood that their liability under the swaps was potentially uncapped.

In response, the Transport Companies do not question that they were sufficiently sophisticated to understand how in mathematical terms the coupon formulae of the swaps worked: as Ms Antunes said, “the memory formula is very straightforward to understand”.

What the Transport Companies were not sufficiently sophisticated to understand, they say, were the possible permutations and combinations of actual outcomes i.e. not how the swaps worked mechanically, but the actual risks of the swaps. They say that the historical data, the forward testing and limited stress testing provided by BST was wholly inadequate to inform them about the real risks of the swaps. Their lack of understanding in that regard was not apparent to them when they entered into the swaps, and, indeed, it probably did not become apparent to them (if at all) until they realised that the swaps had had disastrous consequences which they could not manage.

In deciding this dispute, there are a number of specific matters to discuss.

Selling volatility

The Transport Companies say that the possibility of accumulating interest rates are not the only risks inherent in these swaps. They say that the risks can be illustrated by likening the snowball spread to a series of options. The Transport Companies were, as they put it, selling volatility to the bank in return for low interest rates.

BST does not accept the option analysis, but the court thinks that it is broadly correct. There were not of course true options in the swaps, which appears to be Mr Evans’ objection, but there was similar functionality, and there is some evidence that BST itself recognised this functionality as part of the price (see below).

The main point the Transport Companies derive from this is that the swaps are highly sensitive to volatility (that is, changes in interest rates), which affects the mark to market (MtM) value of the swap. It is therefore, they say, a mistake to solely focus on what is payable by way of spread when considering the risks of the swaps.

This risk was described in the evidence of Mr Harkins, who said that in the case of very small shifts in the forward interest rate curve, the MtM of a snowball swap would behave similarly to that of a vanilla swap. But as the shifts in the forward curve get larger, the MtM decreases rapidly and in a non-linear fashion (in contrast to the linear movements of the MtM of a vanilla swap). Well before the forward curve reaches the swap barriers, the negative MtM of the swap is in the tens of millions.

Likewise, because of their sensitivity to different variables, even though the trend in value is firmly downwards, the MtMs of these swaps can and have increased and decreased sometimes sharply despite the fact that interest rates have been held at a steady, low level.

It is believed that this evidence is not disputed, and the court accepts it.

The overall picture

Turning to the picture as a whole, as BST says, one of the chief challenges for each of the Transport Companies was to manage its mounting debt and funding needs. The evidence suggests that this is typical of large public transport systems.

It is not in dispute that derivatives played an important part in reducing the Transport Companies’ interest rates before the financial crisis struck.

The Lisbon Metro (MdL), the biggest of the companies, entered into numerous swaps, including snowball swaps with other banks.

BST relied on the following:

Mr Pinto of Metro Porto said in his witness statement that, “Many banks proposed snowballs swaps – they were not proprietary to BST – and it appeared to be a commonly used instrument in the financial market”. The Transport Companies cite this as evidence of naivety.

To put it into context, the numbers of snowball swaps sold by banks to the public sector in Portugal was not great. Some fourteen in all were sold by BST.

Mr Evans who has had a long sales career said that he had never sold a snowball swap. The court finds (and it is not seriously in dispute) that these instruments were not in fact common in the swaps market as a whole.

They were presumably uncommon because of the risks involved. But the court does not think that this shows naivety on Mr Pinto’s part. He was talking about proposals not sales.

There is some evidence that the fact that MdL entered into snowball swaps encouraged the other companies to do so.

What is clear is that given their indebtedness and funding needs, each of the finance departments had to have sufficient expertise to cope with considerable tasks of financial management, in relation to commercial bank debt, and other sources of finance. The evidence is that those tasks were rendered possible, or certainly easier, by the perception that ultimately the Portuguese State would stand behind them.

The evidence is that the companies were bombarded with unsolicited offers from international banks including BST to enter into swap transactions. But they themselves sometimes solicited such offers.

There is evidence that BST (and doubtless the other banks) were persistent in their sales pressure. One internal BST email refers to the necessity to keep the “siege very tight” on the finance officer concerned. Again, this does the bank no credit.

On balance however, the finance departments seem to have been able to deal with this high-pressure sales activity, choosing which proposals they regarded as most suitable for their needs. In assessing their overall understanding, as is done below, the fact they were dealing with other banks is relevant—the Transport Companies were not dealing with BST in isolation.

The MtMs as shown in the statements provided by BST to the Transport Companies are contained in agreed form in the Annex. The picture is not complete, because BST did not send statements from the time the swaps were entered into. It began to send them in 2008 (the exception being Carris 1 in respect of which the first statement was sent in 2007), and stopped sending them in 2013 after the Transport Companies ceased making payments.

The experts also agreed the MtMs at the time of inception and all were negative numbers:

It should be noted that, to the limited extent that BST statements are available that far back, the numbers differ, and are positive. This is a reflection of the fact that the calculation of the mark to market value of a swap involves a good measure of judgment.

Also, it is relevant that the first three MdL swaps were entered into to restructure existing swaps with BST, which already had negative MtMs.

The Transport Companies assert that they should have been provided with the MtMs at inception as a means of understanding the risks. They say that had this information been disclosed to them, they would have known that the swaps were not expected to reduce their interest expense over the lifetime of their loans and, therefore, that they were not appropriate for the purpose of reducing their borrowing costs.

However, their case did not appear to be supported by their expert Mr Harkins, who said in that regard that the MtM “doesn’t tell you a lot”, and the court does not accept such an assertion.

Further, the Transport Companies could have asked for MtMs from BST had they wanted them.

In fact, the companies did not show the “fair value” of the swaps in their accounts at this time. So far as the accounting treatment is concerned, the evidence is that MdL did not account for the value of the swaps in their annual accounts until sometime after 2007, from 2009 in the case of STCP, and sometime after 2009 in the case of

The parties have agreed details of the swaps entered into by the Transport Companies, and as might be expected, MdL entered into much the greatest number.

Even allowing for restructurings, there were a considerable number of these swaps, entered into (as noted elsewhere in this judgment) with a wide variety of international banks. Only a small number were snowball swaps. Generally, however, it is not in dispute that MdL was very familiar with swaps as an instrument of financial management.

In support of their case that the Transport Companies did not understand the risk, it was submitted that Mr Evans had calculated that MdL 2 had a 50% chance of making a loss, so that Ms Antunes was wrong to suggest there was a “comfortable risk profile” in respect of this swap.

The court does not accept this. In fact, the agreement between the experts is that MdL 2 had a 46-50% probability of loss and a 50-64% probability of gain when entered into. (This was considerably lower than the other swaps. The experts agree that the swaps overall had a probability of 72% of providing a potential benefit to the Transport Companies over the life of the swaps.)

It is further to be noted that this swap was a restructuring, and the negative value of the original swap has to be taken into consideration. Nothing can be deduced from these facts as regards any lack of understanding on the part of MdL.

Ms Antunes’ evidence is that BST’s proposals did not include any forward or stress testing because they knew from their discussions that MdL was undertaking its own internal analysis.

Twenty one swaps were entered into by MdP between August 2006 and June 2010, though some were restructurings.

The Transport Companies’ case as to Mr Pinto’s naivety, and the inadequacy of the “digicoupon” which he negotiated for the first swap is dealt with elsewhere.

It is said that though the swap was said to give MdP a risk-free gain figure of €5.3m, this was “peanuts” compared to the negative MtM. It is pointed out that on 30 May 2008, this was -€30.8m.

However, by this time, the financial crisis was underway. At inception, the experts agree that the MtM of this swap was negative between €15.3m and €11.6m.

By way of comparison, the experts agree that MdP 2 was negative at inception between €10m and €6m. As explained elsewhere, this swap had no lower barrier, and no loss is alleged in relation to it.

Mr Pinto also said in evidence that the expectation at the time of contracting the first MdP Swap was that “rates below 2% was possible, and it was expectable in scenarios of great retraction … but it was not our expectation that it could go for a long period of time”.

This was fair evidence in the court’s view. He accepted that rates might go below the barrier in extreme circumstances, as is obvious in a swap with a term of 16 years, albeit as he says, no-one expected this to happen in the way and for the period that it did.

The Transport Companies describe the stress testing carried out by Carris itself prior to entering into Carris 1 in November 2006 as “rudimentary”.

The court accepts this, because the application of + 0.25% and - 0.25% shifts in forward rates, which seems to have been what was done, was clearly inadequate. (It is unclear why such low shifts were adopted.)

But the recommendation that went to the Board did not depend on what would happen if rates went outside the barriers. Rather, it depended on the view that “it does not seem credible that it [the 10-year CMS swap rate] can fall below 2.75%” and that “the existing scenarios for EURIBOR 6M do not point towards it being able to surpass 6%”—in other words, that rates would remain within the barriers.

This accorded with the consensus at the time as to rates which was reflected in forward interest rates. However, Ms Cabaço Antunes of Carris effectively accepted in her evidence that it was understood that rates might turn out differently to those predicted, as again is obvious in respect of a swap with a life of 18½ years.

The Transport Companies say that the recording of the call in which the first Carris swap was executed on its behalf by Professor Sousa Bentes does not show any great expertise on his part in snowball swaps, and the court accepts this.

On the other hand, as BST says, he cannot have thought that the risk attached to the spread was literally “null”, and Ms Cabaço Antunes did not. His question about how BST made money from the transaction does not directly go to the risk issue. (The answer he was given was that it came from the options that are implicitly incorporated in the structure and which have value. This point is explained above.)

Carris 2 was structured differently in that the spread becomes payable if the 2-year EURIBOR CMS rate exceeds the 10-year EURIBOR CMS rate—i.e. the 10-year EURIBOR CMS rate is in effect the barrier of the 2-year EURIBOR CMS rate.

Like MdP 2, this structure has not behaved like the other swaps, because without a lower barrier, no spread has become payable and so only the fixed rate element of the pay leg is payable.

The STCP swap had a trade date of 2 November 2007. Société Générale had done a sensitivity analysis in relation to the transaction. It emailed Ms Antunes figures stating that in a “stress scenario you can lose up to 389,368,711 USD. Please confirm us your customer has received all this information”.

In fact, it was not passed on to STCP, the BST response being, “What we can guarantee is that we are aware of the transaction we want to close”.

No explanation was given by BST of what was an odd response, and the Transport Companies emphasised the Société Générale email in their oral closing submissions.

Ms Antunes said in her evidence that, since the swap was uncapped, depending on the stress scenario applied, any value can be achieved, however unlikely. She put it as much less than 1%.

There is logic in this answer, but the failure to pass the information on is nevertheless a matter of concern. The court states its conclusions as follows.

The Transport Companies do not suggest that there was any bad faith on the part of BST—this is cited as an example of the assertion that the Transport Companies did not understand the extent of the risk.

In that regard, it is striking how thorough the process was that led to STCP entering into the swap. The process lasted many months.

At a meeting on 27 February 2007, BST made a presentation to STCP including various stress testing scenarios of the proposed snowball structure, in one of which the upper barrier was breached and remained breached by 40 basis points for the majority of the swap’s term. BST says that this showed interest in excess of 20% being payable by STCP, which is obviously very large.

In all, STCP received 32 proposals from 7 banks. According to BST, by 8 October 2007 it had a choice, from BST alone, of 6 different snowball swaps. Four banks were shortlisted by the company, their proposals including one other snowball swap proposed by another bank (Barclays).

These were the subject of a detailed internal analysis dated 30 October 2007 by the director with responsibility for finance, Mr Paulo Sá. There is no reason to doubt his competence. In the event, the BST proposal was the one adopted.

On balance, the court is satisfied that the Société Générale email does not affect the issues the court has to decide. It cannot reasonably be asserted that STCP was unable

Further:

The court finds that:

The court does not accept the Transport Companies’ case that further information should have been provided to inform them as to the risks. On the totality of the evidence, including its appraisal of the witnesses, it finds that:

It is also relevant how Mr Pinto sought to deal with this risk. He asked BST to introduce a mitigator which would reduce the impact of the risk. In response, BST introduced a “digicoupon”. This is the name given to a mechanism which reduces the spread by 0.5% for each fixing date on which the relevant interest rates come back within the barriers.

The Transport Companies say that the events of the last few years have shown that the digicoupon is useless in circumstances where there are prolonged periods of low or high interest rates which breach the barriers, i.e. in circumstances where the risks of the swap are most damaging.

However, that is to apply hindsight. The instance of the digicoupon tends to show that the risk was appreciated, but on the basis of macro-economic conditions as they were then:

What none of these parties did and could appreciate was that as a result of the financial crisis interest rates would cease to behave in accordance with prevailing conditions. The parties did not and could not appreciate that as a result of the financial crisis, interest rates would behave in an unprecedented manner, and drop to near zero (as economists have traditionally described it, the “zero lower bound”) and stay there. The court’s findings as regards interest rates are set out in detail below.

The experts agree that the fixed rates payable by the Transport Companies are lower than the equivalent ‘vanilla’ swap which could have been obtained at the time the swaps were executed.

This is shown by the following figures:

Overall, the experts agree that the swaps had an approximately 72% chance of providing these potential benefits to the Transport Companies over the life of the swap. This appears from their joint memorandum:

“We agree that, overall, the Swaps can be characterised as having a higher probability (approximately 72%, after adjusting for the mark to market position of prior interest rate derivatives) of providing a potential benefit, over the life of the Swap (through the initial reduction in the interest rate payable and the potential for a continued low interest rate payable for the remainder of the term), than of providing a potential loss. Section 11 shows the probability of a gain and loss and the size of potential gains and losses for each of the Swaps.”

At the same time, this saving was achieved by taking on a high degree of risk as a result of the effect of the leverage/accumulation in the spread formula when interest rates breached the barriers. For reasons set out elsewhere, this risk was understood by the parties.

The following findings are made as to the purpose of the Transport Companies in entering into the swaps:

There is some evidence that the practice of reducing interest rates through the use of swaps by public sector companies had a modicum of official encouragement. This was by the Tribunal de Contas (Court of Auditors) in 2006/2007 in relation to the first MdP swap, and a 2008 report by the Portuguese Inspectorate General of Finance, in which it referred to the Carris swaps as an example of good management. This was reflected in the companies’ accounts.

There is not enough evidence to justify findings by the court of any official “pressure” to enter into these swaps.

What this evidence importantly illustrates, however, is the economic climate at the time. Swaps were seen as useful financial instruments, and the Transport Companies were likely to be interested in such instruments because, as BST puts it, through a combination of insufficient State funding and an inability to raise ticket prices to cover costs, they depended on large and increasing amounts of debt to fund their operations and investments.

The negotiation of the swaps is set out in the agreed chronologies, and the court need not set out the details which do not affect the issues for determination. There are a few points to highlight.

The trade dates for the swaps fall between 6 June 2005 (MdL1) and 2 November 2007 (STCP). As shown above, there were generally a number of banks bidding for the contracts, and typically the negotiation process took some months.

BST typically offered the client a number of prospective structures, with different risk profiles, of which the snowball structure was one. Some of the swaps were restructurings of earlier swaps.

The key facts relating to each swap are set out in agreed form in the Annex. Each swap was transacted pursuant to the terms of an ISDA (Footnote: ⁶) Master Agreement the dates of which are also set out in the Annex.

Each of the nine swaps in issue has broad similarities of structure, but there are a number of differences in the terms. In tabular form, their basic characteristics are as follows:

It is to be noted that:

BST hedged its exposures under the swaps via back-to-back contracts on ISDA terms governed by English law. The back-to-back contracts were entered into between BST and BSNP under an ISDA Master Agreement and Schedule dated 17 June 1998, and were in turn subject to back-to-back contracts between BSNP and Santander Spain under an ISDA Master Agreement and Schedule dated 3 April 1996. These contracts were governed by English law. These facts are agreed between the parties.

Following the merger of BST and BSNP in 2009, a novation agreement was concluded under which all agreements between BSNP and Santander Spain, including the back-to-back swaps, were novated to BST.

BST’s case is that under these back-to-back swaps, it was – and remains – exposed to the same risks as those to which the Transport Companies are exposed under the swaps: “Unlike the TCs, however, BST has complied with its contractual obligations and continues to pay the sums due under the back-to-back swaps. BST is currently, therefore, very substantially out of pocket, and if the TCs were to succeed in their defences or counterclaims would suffer further losses amounting to its uncovered liabilities under the back-to-back swaps. None of this has ever been challenged by the TCs”.

In June 2008, Santander Spain effectively withdrew its approval for the sale of further snowball swaps. By this time, BST had sold a total of fourteen snowball swaps, all to public sector companies.

Ms Antunes’ oral evidence was that one of the reasons for Santander Spain withdrawing approval was because the existing transactions on BST’s balance sheet were “consuming the credit lines with these companies”. BST says that this was the only reason, but the court does not accept that.

Ms Antunes said that there were discussions about the “suitability of the derivatives”, and as the Transport Companies say, given the concerns expressed by Santander Spain about these transactions in the past (see above), it is likely that suitability considerations were a key factor in Santander’s decision to withdraw its approval.

By this time, though interest rates had not yet plunged, the financial crisis was well underway, and suitability was doubtless seen in the very different atmosphere from that prevailing when these swaps were sold.

BST’s case is that though these swaps entailed a large risk, nothing required the Transport Companies to hold on to the swaps as they did, at least in their initial form. It was open to them to adopt, and implement, a dynamic strategy for avoiding or mitigating the losses under the swaps by closing or restructuring them. The importance of such an approach was either already known to them, or made clear to them from the outset.

Essentially, BST seeks to pass responsibility for losses that have accrued on these instruments back to the Transport Companies, on the basis that their predicament “is thus at least in part of their own making”.

The Transport Companies respond that the phrase “dynamic management” is a “fantasy”, because the complexity of the situation was such that BST itself lacked the capacity effectively to manage these swaps, if indeed that could be done within acceptable parameters.

In the court’s view, when these swap transactions were entered into, all of which were long-term, there must have been a reasonable expectation on both sides that the Transport Companies would seek to manage the swaps, as part of the management of their debt:

However, BST was also expected to play a significant part in this process. Ms Antunes accepted that “as a selling point we had told the clients that we would propose, according to our capabilities, restructuring deals”.

Presumably in the light of the relationship that then existed between the public sector entities such as the Transport Companies and the bank, and the complex nature of the swaps, in the summer of 2007 BST received express instructions from Santander Spain to play an active role in that regard.

This appears from the Structured Derivatives Operative that was put in place after the meeting in Madrid following the New Products Committee report by BST of 20 June 2007 as described above.

It states among other things that:

“A dynamic management will be ensured for each closed operation, over its lifetime, in order to make available to the Client, alternative options to the maintenance of the product, namely whenever this last could be less favourable, either because it would worsen the losses, or not allow him to achieve significant capital gains”.

The document emphasises the desire of Santander Spain to see that the client received as much support as possible in connection with structured derivatives that had been entered into and any future transactions. There is no reason to suppose that BST took any different view, but in practice its ability to do so was constrained.

In view of the deteriorating financial position globally, it seems clear that from early 2008 people began to appreciate the depth of the problems. The mark to market values (MtMs) of the swaps, which BST began to send to the Transport Companies in 2008, clearly reflect concerns as to the position.

By way of example, the earliest dates on which the Transport Companies were sent statements showing that the swaps had a negative MtM of more than €5m were:

Almost all of these statements were sent in 2008, the MtMs of the swaps being firmly in negative territory.

The MtMs are highly relevant to the dynamic management/restructuring issue because the cancellation of a swap would involve the company paying the MtM, and its value would be reflected in a restructuring short of cancellation.

The MtMs fluctuated, but the general picture is of one of deterioration during 2009, in some cases very steeply. This deterioration can be seen as particularly pronounced in the case of swaps where statements are available pre-2008.

Also during 2009, the amounts received by the Transport Companies from BST were for the first time less than the amounts payable by BST.

By 2013, when statements ceased to be sent, all the MtMs had declined greatly, and in some cases radically. (The exceptions are Carris 2, where the spread was calculated on a different basis, and MdP 2, which had an upper but no lower barrier: see above.)

Although in these proceedings it has criticised the Transport Companies for not doing more to manage the swaps by way of restructuring, BST was itself subject to criticism for the same reason.

On 19 December 2008, Mr Veiga Anjos, who from 2006 was BST’s Head of Corporate and Investment Banking Division, emailed Ms Antunes saying:

“I remind you that during the purchase of these products we always told the clients that we would follow the structures so as to propose alternatives according to the market evolution. It is natural that the client should feel very disappointed with our inability to suggest alternatives at this point.”

Notwithstanding, BST says that it is common ground between the transaction experts that the Transport Companies could at any time have cancelled the swaps by paying the MtM, subject to any execution costs, and that they could also have sought to restructure or offset the termination costs by entering into a further derivative either with BST or a suitable alternative bank.

However, the question is as to how realistic this was, given the costs involved, and the sensitivity of public sector bodies to agreeing new deals with high interest rates when market rates were so low.

BST relies on settlements reached with other banks:

There is also the question of what BST itself was suggesting:

By mid-2009, interest rates had fallen below the lower barrier of the seven swaps that had one. Over the next few years, there was much communication between BST and the Transport Companies, including various proposals by BST for restructuring. Neither of the parties has gone into the detail. None of the proposals came to anything.

Mr Harkins, who reviewed them, is of the opinion that the Transport Companies did not act unreasonably in not accepting any of the proposals since he says that they simply shifted the risk profiles of the swaps towards greater risks with lower probabilities. Insofar as they involved the full termination of the swaps, this involved crystallising the mark to market value of the swaps, and also, in some instances, significant premia for the removal of the risks.

Mr Evans took the view that it was not his task to review the restructuring proposals and did not have sufficient information to be able to evaluate them. In the context of BST’s submissions, that was not a convincing position to take.

The result is that Mr Harkins’ evidence in this regard was unchallenged, and the court accepts it. It is consistent with the rest of the evidence as to the effect of continuing near-zero interest rates on these long-term swaps.

In particular, it is consistent with views expressed outside the litigation by BST itself.

In an email of 28 October 2011 from Ms Antunes to someone in Santander’s press department in Madrid, she said:

“Performance of Banco Santander

Banco Santander has contracted this type of long-term derivatives during the period 2005-2007. We hold in our portfolio 10 Previous derivatives (with cumulative memory effect). Since then we have been acting with companies proposing restructuration's with the aim of reducing leverage.

With rising volatility and falling interest rates, the cost of restructuring through deleveraging implied increasing running financial costs.

In a risk / cost analysis that companies have carried out, the conclusion has always been that restructuring was not worthwhile: by that time there was no expectation that interest rates could remain low so long. Even in the 1st half of 2011 the consensus was that in 2012 the short-term rates would gradually rise, which meant that it was not worthwhile to assume the high cost of restructuring (very much penalized by higher volatility).

In addition, the sharp rise in volatility increases the difference between MtM and the value of the expected future cash flows, which makes it even more difficult the decision to lock-in the MtM.”

In a presentation to the Portuguese Secretary of State of Treasury and Finance in January 2012, she said:

“Around the end of 2008, after Lehman went bankrupt, the world economic situation is reverted significantly. Just 4 months after the reference rate had risen to 4.25%, the European Central Bank (ECB) initiates the fastest and most extensive cycle of interest rate cuts. In less than 8 months, the European Central Bank cuts 325bps, leaving its reference rate at a historical minimum of 1%. The implicit volatility also set off a sharp rise process, rapidly reaching the historical maximum.

The current crisis, which clearly extends beyond the initial expectations, led to a strong change in the interest rate time structure as well as in the implicit volatilities. The interest rates (both Euros and Dollars) recently reached historical minimums in all maturities.

There have been 2 main constraints to the restructuring of these derivatives:

•

Differential of the derivative’s market value and the expectation of future flows taking into account the market forward interest rates (increase in volatility);

•

Asymmetry between the expectations of interest rate evolution on behalf of the economic agents and the reality of the extension of the crisis scenario (interest rates remaining extremely low).”

In cross-examination, Ms Antunes suggested that these documents reflected “the bank’s ex-post interpretation of why the companies have opted not to restructure”. The court does not accept that. There is no reason to suppose that it does not show what BST thought at the time.

The court:

From about late 2011, the practical responsibility for dealing with the swaps passed to the IGCP (the Agência de Gestão da Tesouraria e da Dívida Pública, the Agency for the Management of the Treasury and Public Debt), the public body which since 2012 has managed and coordinated the funding and debt of public sector bodies in Portugal.

BST says that at a meeting with the Government on 6 March 2013, it was informed for the first time that the State did not intend to make any further payments under the swaps because it considered the derivatives to be speculative and void. No payments have been made since September 2013.

The matters giving rise to these proceedings have been the subject of concern and controversy in Portugal.

The Transport Companies were not isolated among Portuguese public sector companies in their use of swaps.

In 2013, the Portuguese Parliament ordered that an inquiry be held known formally as “The Parliamentary Inquiry Committee on the Signing of Financial Risk Management Agreements (or “swaps”) by Public Sector Companies”:

The Parliamentary Inquiry culminated in the publication of a lengthy final report in early 2014. The court has seen the conclusions, and both sides have provided summaries of the rest of the report.

The court has studied this material carefully, and found it invaluable in obtaining a perspective on the situation. The Inquiry was not, however, concerned with the legal questions which the court has had to address in this judgment. It is sufficient to say

It is in dispute whether these swaps were proper instruments of financial management, as BST says, or are to be treated as speculative as in a bet, as the Transport Companies say.

It is also in dispute whether this issue has any relevance to the specific issues the court has to decide.

The Transport Companies’ case is that they took on the risk of paying the snowball spreads in return for obtaining lower fixed rates of interest payable under the swaps than the fixed rates that would have been payable under plain vanilla swaps. If interest rates stayed within the barriers the bet was a good one, if interest rates went outside of the barriers, the bet was a bad one. The swaps involve speculation in future interest rates with the object of making a profit in order to reduce borrowing costs. The swaps yielded a positive return, as long as the interest rates stayed within the barriers, and that, in turn, was the difference between the fixed interest rates that the Transport Companies paid, and the floating rate that BST paid, but as soon as interest rates moved towards the barriers, in either direction, they were exposed to rising mark to market values and increased volatility, and when the interest rates moved outside the barriers, they were exposed to rising interest rates, whether the reference rates rose or fell.

The Transport Companies say that their case that the swaps are not effective risk management instruments, and are to be characterised as speculative, is relevant to the capacity issue, whether the swaps are ‘games of chance’, and whether having regard to BST’s duties under the Securities Code the instruments ought ever to have been presented to the Transport Companies.

BST’s case is that the swaps cannot be labelled as ‘speculative’ in any relevant sense, whether by reference to English law, Portuguese law or the views of the experts in swaps. The contention that ‘speculative’ in the relevant sense means only “not effective risk management instruments”, and the contention that if the swaps are ‘speculative’ in this sense then that is all the Transport Companies need establish in order to succeed on the capacity, game of chance and Securities Code issues, is neither their pleaded case, nor supported by the evidence.

BST says that none of the Portuguese law tests involves an assessment of whether the swaps were ‘speculative’ in any sense.

The transaction experts were Mr Harkins for the Transport Companies, and Mr Evans for BST. Mr Evans’ experience is primarily in sales, whereas Mr Harkins is an analyst.

BST criticises Mr Harkins, asserting that he had very limited experience in the use of swaps; was unable to deal satisfactorily with relatively simple applications of his own, personal, definition of ‘speculation’; unduly narrowed the matters on which he gave evidence, for reasons he could not sensibly explain; his definition of ‘speculation’ – which was central to his analysis – failed to acknowledge or reflect either the lack of any industry-standard definition, or the range of opinions which might be expressed on the subject; in addition to relying upon a purely personal definition, Mr Harkins’ view on what constituted speculation was both inconsistent and extreme. He proceeded, BST says, with an unbalanced presentation of the swaps, his analysis focusing almost exclusively on the risks run by the Transport Companies, and in particular on the most extreme risks.

The Transport Companies respond that many of BST’s criticisms ignore the detailed analysis in Mr Harkins’ second report. He accepted in his evidence that hedging and speculation are in a spectrum of risk, and so far as he narrowed matters, he was entitled to do so on the basis of BST’s own evidence and other material, and he focussed on risks because that is central to the case. His cross-examination barely touched on the substance of his reports, presumably because BST had no grounds for challenging the substance of his evidence.

The court’s view is as follows:

The Transport Companies approach the issue by asking two questions. The first is whether the swaps are interest rate risk management instruments, and/or instruments for the reduction of borrowing costs.

The parties disagree on the answer to this question, the Transport Companies saying no, BST saying yes.

The Transport Companies say that if the swaps were not properly capable of fulfilling either function, it follows that they are not to be properly characterised as instruments of financial management for the Transport Companies.

The Transport Companies say in summary that:

Many of the specific points raised here are covered elsewhere in the judgment:

An aspect of this dispute is whether the swaps can be characterised as hedges.

BST says that the swaps contained “elements of hedging”. This is on the basis that only the fixed rate was payable so long as interest rates remained within the barriers.

However, in evidence BST’s witness Ms Antunes accepted that these swaps were not hedges. She said that they were financial management, not hedging, tools.

But this issue is of limited significance, because the experts agree that hedging is only one of a number of purposes of swaps.

The experts agree in the joint memorandum that there can be many purposes for an interest rate swap:

“The economic objectives of general users of interest rate derivatives may include (but are not limited to): reducing or mitigating their interest rate risks arising from assets and/or liabilities; achieving Key Performance Indicators, for example net interest cover; improving their earnings and profitability by optimising or managing the risks of either assets or liabilities or both; hedging specific transactions or exposures; improving their cash flows by reducing interest expense, increasing income, or shifting the timing in which income or expense cash flows occur; and/or reducing operational costs related to core and non-core activities.”

Further, as BST says, the fact that a swap is not a hedge does not mean that it is necessarily speculative. This is a point which is developed below.

The Transport Companies argue that the swaps did not reduce or manage their exposure to interest rate risks, and so cannot be interest rate risk management instruments.

However, as BST says:

The Transport Companies argue that the risk taken on was wholly inappropriate compared to the benefits, particularly given their status as public companies, and because the risk was so great, and was present from inception, the swaps increased risk rather than decreasing it, and so were not tools of financial management.

However, the court accepts BST’s case in this respect, finding that:

The second question is whether the swaps are properly characterised as speculative instruments.

This is, as the Transport Companies put it, “effectively a ‘belt and braces’ argument”, which is understood to mean that it is not an essential part of their case.

Given the court’s findings on the first question, the second question does not strictly arise, but the point has been argued and the arguments will be briefly considered.

The question whether a transaction, or a financial instrument, or other financial dealing is “speculative”, is one which often arises. For example, as explained above, Santander Spain told BST in Portugal to make sure that the purpose of these public sector clients was not to speculate but to manage their financial costs. It is a useful term, and one which conveys a particular message. However, at least according to the evidence in this case, there is no standard market definition, though for particular purposes there may be a relevant legal definition.

There were a number of examples of such a legal definition given at trial:

There is a more general discussion of the issue in a well-known international dispute between the Ceylon Petroleum Corporation and various banks. An arbitration between Citibank and the Ceylon Petroleum Corporation concerned CPC’s capacity to enter into instruments which had some structural similarities to those in the present case, though in the oil market.

At ¶5.47 of the arbitration award published on 31 July 2011, a passage on which the Transport Companies rely, the Tribunal distinguishes between hedging and speculation, stating that, “The use of derivative instruments to raise money in order to reduce the effect of already high prices is necessarily speculation, and not risk management”.

However, this approach has not been adopted in the English courts. A major part of the reason is the difficulty of drawing distinctions between the various activities of speculation, hedging, financial management and similar in the absence of an applicable definition, making it difficult to determine—either before or after the transaction is entered into— whether it is within an entity’s capacity or not. So:

Where there is a legal definition of “speculation” or other activities such as hedging to apply, the court’s task is to apply it. But where there is not, as in this case, there are no clear lines to draw. The Transport Companies accept that they have the capacity lawfully to enter into swaps. This can legitimately be for the purpose of interest rate risk management, or hedging, or the reduction of borrowing costs. Their case is that

However, it could be said that all swaps contain an element of speculation in this sense: in the case of vanilla swaps used for hedging against rises in interest rates, if interest rates fall, the counterparty paying the fixed rate will have turned out to make the wrong call. If rates rise, the swap will be an instrument with an inherent value that can be realised if desired. The same could be said of most investments.

There is a debate in the Ceylon Petroleum Corporation dispute as to whether or not the motive of the counterparty is relevant. The arbitral tribunal proceeded on the basis that it is possible to determine the question of speculation objectively. The Court of Appeal, on the other hand, considered that, “Without a formal definition, however, we think that it would be difficult to exclude all subjective elements from a consideration of whether a transaction was speculation or hedging” (ibid at [16]).

If it is relevant in the present case, it is common ground that none of the Transport Companies had any intention to speculate—if anything, the reverse was true. These transactions were seen as legitimate even desirable financial management of the companies’ debt.

BST’s submission is there is no basis in English law or in Portuguese law for treating ‘speculation’ as the opposite of ‘risk management’, and that the exercise of characterising the swaps as ‘speculative’ or ‘non-speculative’ is one in which the court need not engage, not least because none of the Portuguese law tests require this exercise to be performed.

Reference is made to the findings above in relation to the first question. Consistent with what is said in the above authorities, no further findings specific to the second question need be made here.

This is a case where there are basic conflicts of evidence as to what Portuguese law is on a number of important issues. Moreover, as the Transport Companies point out, it is a case where the foreign law is not only in a foreign language (Portuguese), but also involves civil law concepts unfamiliar to English lawyers.

The approach of the English court in determining issues of foreign law is largely agreed, and can be summarised as follows:

There is no dispute as to how these principles apply in the present proceedings. BST asserts that the Transport Companies had capacity to enter the swaps, and therefore BST bears the burden of proof on this Portuguese law issue. The Transport Companies accept that they bear the burden of proof on the defences, that is, the game of chance, abnormal change of circumstances and Securities Code issues.

Professor Paulo Câmara and Professor José Engrácia Antunes are largely in agreement about the structure of Portuguese law so far as relevant to these proceedings.

The Portuguese legal system is a civil law system. While being traditionally influenced by civil or continental legal systems found in other Western European countries (such as France, Italy and in particular Germany), EU law has now become a major driving force in many respects, especially in the areas of commercial, financial and company law.

Under the Portuguese legal system, the most relevant source of law is the statute

The main statutory laws, listed according to their hierarchical status in a descending order, are: the Portuguese Constitution (“Constituição da República Portuguesa”); ordinary laws, such as Laws (“Lei”) issued by the Parliament and Decree Laws (“Decreto-Lei”) issued by the Government; and regulations, such as regulatory decrees, ministerial orders, or regulations of supervising agencies. As the Portuguese legal order is open to international integration, national statutory laws are subjected to principles of general international law and international agreements (namely, EU treaties).

Jurisprudence (“jurisprudência”), i.e., the set of court decisions, is not a source of law because in Portugal judges are not obliged to respect the precedent established by prior judicial court decisions (“stare decisis”). However, it plays an important role in the interpretation and application of statutory laws as the courts often take into consideration judicial decisions of other courts when deciding in similar matters.

Doctrine (“doutrina”), i.e. the opinion of legal commentators, is also not a source of law in Portugal. However, it plays an important role in the scientific systematisation of legal knowledge and may have significant repercussions on the final result of those responsible for drafting, interpreting and applying legal rules (legislators and courts).

Art. 9 of the Civil Code regulates the interpretation of statutory laws. According to this rule, the result of interpretation should take into account (1) the letter of the law, (2) the spirit of the law, (3) the history behind the law and the specific conditions of the time of its application, and (4) the unity of the legal system.

It is widely accepted in the Portuguese jurisprudence and doctrine that there are three criteria applicable in the case of conflict of legal rules: hierarchy (lex superior derogat legi inferior), posteriority (lex posterior derogat legi priori), and specialty (lex specialis derogat legi generali). (There is disagreement on the scope and content of the criterion of specialty but nothing more need be said here.)

Capacity has to do with the question of what a corporate entity can in law validly do, and if disputed by the company after a contract has been entered into, raises the consequence that the contract may be void, though all concerned have proceeded in good faith on the basis that it is valid, exposing the other contracting party to substantial losses.

This is the Transport Companies’ case in these proceedings. They argue that their capacity is limited by their purposes as public enterprises, that is, the “public missions” which they pursue. They add that it is reasonable to expect a financial institution like BST to satisfy itself as to capacity before entering into a transaction.

They accept that they have the capacity to enter into hedging or risk management derivatives, or “financial management” derivatives, “specifically”, instruments in connection with the “management of [the company’s] borrowing”. However they submit that it is contrary to their public missions to enter into speculative swaps, which increase their exposure to financial risk. They submit that the swaps at issue are all speculative in that they increase financial risk, and therefore fall outside the Transport Companies’ capacity. That includes the two swaps that were not affected in

It is BST’s case that the Transport Companies have the same capacity to enter into derivatives as any private company, with the purpose of pursuit of profits, and that all the transactions were within their capacity. It points out that lack of capacity has not been raised as an issue before in Portugal despite the numerous disputes as to swaps, including those entered into by public enterprises, and their examination in various fora, including the Court of Auditors.

The issues as defined in the pre-trial agreed list of issues help give clarity to the main points of dispute:

Although the list of issues refers to the swaps “in each case”, it was not suggested at trial that there were individual characteristics in the case of particular swaps that led to a different result (see above).

Each of the Transport Companies is a corporate entity, but they fall into two classes, and this is relevant to the parties’ arguments. Carris, STCP and MdP are “sociedade anónima” (Footnote: ¹⁵) (abbreviated to “S.A.”) incorporated under commercial law, and MdL is an “entidade pública empresarial” (abbreviated to “E.P.E.”) constituted by decreelaw.

All the Transport Companies are ‘public enterprises’, that is to say corporate entities wholly or majority-owned by public authorities, and have the following characteristics:

BST’s expert was Professor David Duarte, and the Transport Companies’ expert was Professor José Engrácia Antunes.

Professor Duarte’s evidence is that the different legal form of the four companies gives rise to two different capacity rules, one applying to MdL and the other to Carris, STCP and MdP. Professor Antunes’ evidence is that the fact that all of the entities are public enterprises means that they are subject to a single capacity rule.

To understand the dispute between them, it is necessary to appreciate that (on the Transport Companies’ case) the term “purpose” or “ends” (in Portuguese, “fim” or “fins” (Footnote: ¹⁷)) is a distinct legal concept: it is not to be confused with a legal person’s objects (or “objecto”). The Transport Companies’ case is that the purpose of a legal person is the typical or general goal that a certain type or class of legal persons pursues, whereas its object is the specific activity to which it is devoted as specified e.g. in its Articles of Association.

BST responds that Professor Duarte does not maintain that the concepts of “purpose” and “object” are indistinguishable, but does not accept that under Art. 160 of the Civil Code, the “fim” of a company encompasses only its purpose and not its objects.

Based on their interpretation of the various legal instruments, in summary, the experts’ contentions were as follows.

Professor Duarte’s evidence, and BST’s case based on it, is as follows.

The capacity provisions relevant to the Transport Companies are those that apply to S.A.s and E.P.E.s generally. So far as S.A.s are concerned, this is Art. 6 of the Commercial Companies Code which applies in respect of Carris, STCP and MdP (as S.A.s).

Carris, MdP and STCP, as S.A. public enterprises, have capacity for any act, whether lying inside or outside their corporate objects as defined in their articles of association, provided only that the act is necessary or convenient to their purpose of seeking profit.

The purpose is clear, Professor Duarte argues, from various provisions of the Commercial Companies Code (reference being made to a decision of the Supreme Court of Justice of 27 January 2010, 2380/05.2TBOER.S1), and from Art. 980 of the Civil Code, which defines a contract of incorporation as a contract whereby two or more persons undertake to contribute assets or services with a view to jointly undertaking an economic activity with the purpose of distributing the profits therefrom.

In respect of MdL (as an E.P.E.), the capacity rule is found in Art. 25(2) of DecreeLaw 558/99 (the RSBS). MdL, as an E.P.E. enterprise, has capacity for any act which is necessary or convenient to pursuing its objects, namely the activities defined in its articles of association.

As to the purposes/objects of S.A.s and E.P.E.s, the purpose or mediate end of S.A.s as a class is the pursuit of profits. The purpose or mediate end of E.P.E.s as a class does not limit their capacity and is therefore irrelevant, although BST’s case is that such purpose is also the pursuit of profit. The relevant object of MdL is “the operation, on an exclusive and public services basis, of public passenger transport services...”. For MdL, therefore, capacity is measured by whether the type of contract in question was necessary or convenient to this object.

The test of convenience and/or “appropriacy” (as convenience has sometimes been described) is whether the means are capable of achieving the relevant ends, such that capacity encompasses all legal situations which, in some way, may help in achieving the legal person’s ends.

If the advantage offered by a type of contract is convenient/appropriate to a person’s ends, a particular contract that belongs to that type is within the person’s capacity. This is so, irrespective of whether its specific terms are more or less favourable, for example by being more or less speculative or at a higher or lower price.

Interest rate swaps offer advantages for the financial management of companies and so are necessary or appropriate acts to assist the Transport Companies achieve their ends. The swaps are therefore within the capacity of each of the Transport Companies.

Professor Antunes identifies the governing Portuguese rule on the capacity of legal persons in general i.e. Art. 160 of the Civil Code, commonly known as “principle of specialty of purpose”, which defines a legal person’s capacity by reference to its purposes or ends (“fins”). He then seeks to apply this general Portuguese legal principle to MdL, Carris, STCP and MdP by identifying their common “purpose” as a distinct type of legal person, that is, as “public enterprises”.

The purpose of public enterprises is the pursuit of their public interest missions as identified in Art. 4 of the RSBS (in the case of MdL, Carris and STCP) and Art. 7 of the RLBS (in the case of MdP). As a consequence, the capacity of these enterprises is not to be determined by reference to whether their acts are necessary or convenient for the pursuit of profit, as in the case of other S.A.s.

Professor Antunes says that public administration lawyers (like Professor Duarte) tend to regard such entities as operating exclusively as ordinary commercial companies. Company lawyers tend, by contrast, not to recognise public enterprises as operating as ordinary commercial companies.

Professor Antunes says that Professor Duarte’s analysis fails to explain what the purpose of MdL is as a legal person—and is thus in conflict with one of the most fundamental principles of Portuguese law on capacity, namely Art. 160 of the Civil Code.

The distinctive purpose of the Transport Companies is the pursuit of their public missions as set out in:

The consequence of this is that acts that are not conducive to i.e. necessary or convenient for the pursuit of the public enterprises’ missions or purposes fall outside their capacity. More particularly, they may undertake profit-seeking acts only insofar as those acts prove to be appropriate or instrumental to the achievement of their core public interest goals.

Specifically, the Transport Companies may enter swaps that operate as instruments to protect the enterprises against risk (hedging), but not instruments that involve trading in risk (speculation). Hedging instruments are ones properly designed to eliminate, mitigate or manage exposure to some kind of risk, speculative instruments in this context simply being the obverse of these i.e. non-hedging instruments.

This conclusion, Professor Antunes says, in the absence of Portuguese jurisprudence, or indeed much Portuguese doctrine, is primarily a logical inference. But it is a logical inference that is consistent with the approach of similar civil law systems, in particular with German law, which has greatly influenced Portuguese law.

More importantly, whether swaps have two functions (hedging and speculation) or three (the reduction of financial costs), the swaps in dispute were incapable on an ex ante basis of hedging or reducing the financial costs of the Transport Companies. Accordingly, they fall outside the capacity of the Transport Companies and are void.

It likewise follows that, insofar as the ISDA Master Agreements were entered into only for the purpose of entering the (void) swaps, then they also are void, which was the case in relation to Carris, STCP and MdP. In relation to MdL, the validity or otherwise of the ISDA Master Agreement is an academic issue.

Based on this evidence, the Transport Companies invite the court to find that:

Introduction

The essence of Professor Antunes’ evidence is that the general rule found in Art. 160(1) of the Civil Code to the effect that capacity is to be assessed by reference to a legal person’s purposes, permits, indeed requires in the case of public enterprises, recourse to two particular provisions in order to identify the purposes—these are Art. 4 RSBS (in the case of MdL, Carris and STCP as state-owned enterprises) and Art. 7 RLBS (in the case of MdP as a local enterprise).

The essence of Professor Duarte’s evidence is that the general rule has been displaced in the case of the Transport Companies by special rules applying to the category of legal persons to which they belong. The capacity provisions are contained in Art. 6 of the Commercial Companies Code in respect of Carris, STCP and MdP, these companies being S.A.s, and in Art. 25(2) of the RSBS in respect of MdL this company being an E.P.E.

As the Transport Companies put it in their written closing submissions, Professor Antunes adopts what might be described as a “top-down” approach, identifying the rule on the capacity of legal persons in general in Art. 160 of the Civil Code, and seeking to apply this to the Transport Companies by identifying their common “purpose” as what he regards as a distinct type of legal person, that is, “public enterprises”.

Professor Duarte on the other hand, adopts what might be described as a “bottom-up” approach by reference to provisions which expressly regulate the capacity of entities within their ambit, under which he concludes that Carris, STCP and MdP have the same capacity as other commercial companies, and MdL is subject to the capacity rule in Art. 25(2) of the RSBS.

The court has to choose between these very different opinions. There is no Portuguese jurisprudence, or indeed doctrine, which settles the matter. In particular, BST points out that the capacity issue has not been raised before in relation to swaps. The Transport Companies reply that “snowball” type swaps have not yet come before the Portuguese courts.

Both these points are correct.

However, although the swaps that have come before the courts are not of the snowball type, similar swaps were closed out by public enterprises at considerable expense in 2013. No issue was raised as to capacity.

Further, the particular swaps the subject of this litigation have received attention from the Parliamentary Inquiry, were the subject of testimony by the officers of the Transport Companies and others who gave evidence to the inquiry, were dealt with in reports of the Inspector-General of Finance (IGF) into the swaps, and by the Court of Auditors.

The court considers that it is a matter of legitimate comment that, as BST puts it, if the capacity defence is correct, all of these persons were wrong and simply overlooked an obvious and critical point.

Professor Duarte’s evidence centres on two provisions applicable to S.A.s and E.P.E.s respectively.

As to the former (MdP, STCP and Carris), Art. 6 of the Commercial Companies Code provides that:

“6.1

The capacity of a company comprises the rights and obligations necessary or convenient for the furtherance of its purpose, except those which are prohibited by law or which are inseparable from natural personality.

6.2

Any gratuitous acts, if considered as usual practice, depending on the prevailing circumstances of the time and the conditions of the company itself, shall not be deemed as being contrary to the purpose of the company.

6.3

The provision of secured or personal guarantees for debts shall be deemed as contrary to the purpose of the company, except where the guarantor company has a justified interest, or it is a parent or subsidiary company.

6.4

Contractual clauses and corporate resolutions which establish the given object for the company, or prohibit it from certain acts, do not limit the capacity of the company, but impose on the company officers the duty of not overstepping this object, or of not carrying out these acts.”

As to E.P.E.s (MdL), Art. 25(2) of the RSBS (Decree-Law 558/99) provides that: “Autonomy and legal capacity

The Transport Companies raise three principal objections to Professor Duarte’s approach as explained above. The first two go together, namely that as companies they do not in fact pursue profit, and were described in the hearing as being “technically bankrupt”, and that they do not operate in an ordinary market environment like ordinary commercial companies, remaining operational through

The court agrees with BST:

The third objection goes to the legal principle that governs the capacity of legal persons. The Transport Companies say that principle of specialty of purposes embodied in Art. 160(1) of the Civil Code limits their capacity by reference to their purposes (or “fins”). Art. 6(1) of the Companies Code is in similar linguistic form, albeit that it refers to the capacity of a company in the singular, and thus to its end or purpose (or “fim”). Thus the Companies Code distinguishes a “fim” from a company’s object or “objecto”, which is defined in Art. 11 as the activity which a company is to carry out as specified in its articles of association.

Following on from that, the Transport Companies argue that Professor Duarte’s analysis results in the anomaly that, whereas he is able to identify the source of the “purpose” of Carris, STCP and MdP as commercial companies, namely profit, he is unable to identify the source of the “purpose” of MdL. Although he asserts that all E.P.E enterprises seek profit, and so relies on profit in the case of E.P.E.s as well, he is not (the Transport Companies submit) able to identify the legal provision that specifies this. This means that MdL as an E.P.E enterprise is a legal person without a “purpose” or “fim”, contrary to Art. 160(1) of the Civil Code, with the result that, anomalously for Portuguese law, only its object is relevant for determining its capacity in accordance with Art. 25(2) of the RSBS.

In the court’s view, this is the most substantial objection to Professor Duarte’s theory, and explains why the Transport Companies focused particularly on MdL in their closing submissions.

His response is that there is an overlap of terminology used in Art. 6 and Art. 25(2), in that the word ‘purpose’, which appears as a translation for the Portuguese ‘fim’ but literally means ‘end’, is normally capable of including both the purpose of a given type of legal person (known as the mediate end or fim mediato) and the object of the activity carried on by the particular legal person, known as the immediate end or fim imediato. He says that the same is true of the general rule for capacity of legal persons in Art. 160 of the Civil Code, which provides that the capacity of legal persons encompasses all the rights and obligations necessary or convenient for the furtherance of their purposes (‘fins’).

As the Transport Companies say, there is a degree of artificiality in this analysis. But though the Transport Companies maintain that there is a bright line drawn in the literature, the view offered by Professor Duarte in fact has support.

BST places particular reliance on the work of Professor Pedro Paes Vasconselos, a respected academic, in which the following opinion is expressed:

“The corporate purpose or object has great importance for the determination of the scope of the primary activity of the legal entity. Article 160 of the Civil Code in its text recognises for legal entities the legal capacity corresponding to the rights and obligations necessary or convenient for the pursuit of their purposes, except those that are prohibited by law or which are inseparable from the single personality. The reference to the purposes of the legal entity made in this article should be understood in a broad sense, encompassing the corporate object. (Footnote: ¹⁸)"

Professor Duarte also relies on profit in this context, and in particular on Art. 37 of MdL’s Articles of Association. The Transport Companies say that such reliance is misplaced because that article does not in fact presuppose that MdL will make a profit, but only concerns the application of MdL’s “results”, as it puts it, “if there is a profit”.

However, the court accepts BST’s response. The use of the word "if" does not affect the analysis. Any company's ability to distribute profits is contingent on it making a profit, and it can make no difference if the provisions for distribution begin with, "if there is a profit”, or any similar expression. The court rejects the third objection also.

In the light of all the evidence, the court’s view is that no obstacle has been identified by the Transport Companies to Professor Duarte’s opinion, and that the question is whether the evidence shows that the opinion of Professor Antunes is preferable as a matter of Portuguese law, the onus of proof being on BST in this respect.

Turning to the opinion of Professor Antunes, Art. 160(1) of the Civil Code provides that:

“The capacity of a legal person encompasses all the rights and duties necessary or convenient for the furtherance of its purposes”.

This encompasses all legal persons. The purposes identified by Professor Antunes applicable to public enterprises have to do with their public interest missions, and it is from these missions that he takes his view that what he regards as speculative swaps were outside the capacity of the Transport Companies.

Clearly, such enterprises do have important public interest missions, as of course the court accepts—but the question as it emerged in the evidence is whether these missions define the companies’ capacity to enter into contracts, as opposed to being rules as to how they should conduct their businesses being businesses in the public sector.

The position as regards the wording of Art. 4 of RSBS and Art. 7 of the RLBS from which Professor Antunes derives such purpose is not in fact entirely straightforward. This is because Art. 4 was amended in August 2007 and repealed in October 2013. It provided in un-amended and amended forms as follows:

“The activities of State-owned companies and of the State corporate sector should be guided towards contributing to the economic and financial balance of the public sector as a whole and in achieving adequate levels of satisfaction in meeting the community’s needs.” (Before amendment)

“The activity of the State corporate sector shall be directed towards achieving adequate levels of satisfaction of the needs of the community and shall be undertaken in accordance with stringent parameters regarding quality, economy, efficiency and effectiveness, while also contributing to the economic and financial balance of the entire public sector.” (After amendment)

Prior to its repeal, Art. 7 of the RLBS provided in similar vein that:

“The companies’ management shall be coordinated with the objectives pursued by the respective shareholding public entities, with a view to meeting needs in the general interest, promoting the local and regional development and the efficient operation of concessions, and ensuring the companies’ economic viability and financial balance.”

The submissions on this issue centred on Art. 4, and for these purposes, it is not necessary to distinguish between it and Art. 7.

As can be seen from a comparison of the two versions of Article 4, the 2007 amendment inserted a requirement that the State corporate sector’s activity be undertaken “in accordance within stringent parameters regarding quality, economy, efficiency, and effectiveness”.

If Professor Antunes is correct, then this should form part of the capacity test as well. It was put to him in cross-examination that requirements like these clearly do not fit into a provision which is intended (as he says) to regulate capacity. He accepted this, but did not have a clear answer to the point:

In fact, Article 4 RSBS was repealed in 2013 and replaced with provisions requiring public authorities to issue guidelines and objectives on a triennial basis together with policies under which public enterprises are to develop their activities. This happened well after the last swap was entered into. Nevertheless, though Professor Antunes did not concede this (preferring not to comment), the court regards as convincing Professor Duarte’s evidence that the repeal at least suggests that these rules are to do with management, and not with capacity at all.

But there is a more basic problem with Professor Antunes’ approach. BST says that it is unworkable in practice, because it would be difficult, if not impossible, for either the public enterprise or third parties to determine at the time of concluding a transaction whether it was or was not within a public enterprise’s capacity. This follows from the terms of Art. 4, referring as it does to “contributing to the economic and financial balance of the public sector as a whole and in achieving adequate levels of satisfaction in meeting the community’s needs”.

In short, how could this be established? This problem was accepted by Professor Antunes. In their submissions, the Transport Companies acknowledge that “Professor Antunes … accepted that applying the Art 4 RSBS ‘purpose’ test creates uncertainty for third parties”. They respond that there is also uncertainty in applying the profit criterion.

The court does not accept this response. As BST says, there is a substantial difference between a third party having to determine whether a proposed contract is potentially capable of assisting its counterparty to make a profit (as opposed to for example gratuitously alienating its assets)—which is Professor Duarte’s test—and the third party having to assess whether the contract will allow its counterparty to achieve financial balance for itself and the public sector as a whole, or adequate levels of satisfaction in meeting the community's needs. The court agrees with BST that it is hard to see how Professor Antunes’ test would be workable.

There are further difficulties. Professor Antunes also acknowledged in crossexamination that whether an entity is a “public enterprise” or not, and thus subject to what he considers is the Art. 4 RSBS capacity rule, depends on the requisite level of State ownership. He pointed out that same contingency also determines whether the enterprise is subject to the RSBS, i.e. it is part of the jurisdictional threshold.

But the jurisdictional position can be established at any particular point in time. The difficulty arises if applied as a capacity rule. As BST says, it is not plausible that the purpose of an S.A., and hence its legal capacity, should change according to the proportion of its shares which may, at any one time, be held by the State.

This point is underlined by the fact that Art. 4 of the RSBS applies to the State corporate sector as well as State owned enterprises. A company becomes a member of the State corporate sector if the State acquires a 10% shareholding. As BST says, it would be extraordinary if such companies, by virtue of being subject to Article 4

The conclusion said to follow from the Transport Companies’ analysis is that they may enter swaps that operate as hedges, but not instruments that involve speculation. Hedging instruments are ones properly designed to eliminate, mitigate or manage exposure to some kind of risk, speculative instruments in this context simply being the obverse of these i.e. non-hedging instruments, and the swaps are speculative.

As to the jurisprudence, though there are a number of judicial decisions, and the approach is not always the same, the evidence is that Portuguese law recognises at least one other function of swaps. The Supreme Court in its judgment of 11 February 2015 (309/11.8TVLSB.L1.S1), which is also an important decision in the context of the “game of chance” issue, said that “these contracts entail one of three purposes: reduction of risk variation of the interest rates [i.e. hedges]; possibility of taking advantage of better rates; speculation on their variation”.

The Lisbon Court of Appeal in its judgment of 2 July 2015 (2118-10-2TVLSB.L1.-2) followed the same approach, citing Mr Pedro Boullosa Gonzalez as saying that “three purposes are intended with the conclusion of a swap contract and, in particular, an interest rate swap: risk hedging or reduction, speculation and reducing financing costs”.

The Transport Companies note that Mr Gonzalez is now a lawyer employed by BST. But there is no reason to regard this as relevant, since he was employed in September 2015, and the article was published in April 2013, and in any case his view was adopted by the Court of Appeal.

The court accepts BST’s submission that “the possibility of taking advantage of better rates” and/or “reducing financing costs” was the purpose of these swaps, so that the distinction between hedges and speculation that Professor Antunes draws is not determinative. See in this regard the discussion above.

The Transport Companies referred to two English decisions, Hazell v Hammersmith and Fulham L.B.C. [1992] 2 AC 1 and Credit Suisse International v Stichting Vestia Groep [2014] EWHC 3103. These decisions however depended on the particular provisions of national law that governed capacity, and do not assist in ascertaining Portuguese law as applicable in this case (Standard Chartered Bank v Ceylon Petroleum Corporation [2012] EWCA Civ 1049 at [28], [2011] EWHC 1785 (Comm) at [368]). The court was told in BST’s oral closing submissions that the actual result of Hazell was reversed by s. 1 of the Localism Act 2011 by which a local authority has power to do anything that individuals generally may do.

Both Art. 6 of the Commercial Companies Code and Art. 25(2) of the RSBS deal with capacity. This is what they say. There is some force, therefore, in BST’s criticism that in his initial report, Professor Antunes made no mention of Art. 25(2), which also presents an obstacle to his opinion that all public enterprises comprise a single type for capacity purposes.

Decisions of the Supreme Court of Justice of 27 November 2007 and 11 February 2010 provide some support to both parties’ contentions as to the underlying profit issue.

As between them:

Professor Antunes is a distinguished commentator, and the court was greatly assisted by his evidence. But though it is not without its difficulties, as the Transport Companies have pointed out, the court prefers the evidence of Professor Duarte. The principal reason is that he provides a workable capacity test based on provisions which actually state that they deal with capacity for the companies within their ambit.

Professor Antunes on the other hand relies on provisions that have no immediately obvious role in this respect. He recognised the problems presented by his reasoning, but did not draw the conclusion that the court considers correct, which is that the provisions he relies on are intended only as principles of good management. They are norms of conduct, not of competence. Further, the court accepts Professor Duarte’s evidence that publicly owned corporate entities are not a distinct class of legal persons subject to separate capacity rules.

From their closing submissions, the court does not understand it to be in contention that on the application of Professor Duarte’s test, the Transport Companies’ case as regards MdP, STCP and Carris (each an S.A.) does not succeed.

The court is in any case satisfied (as BST submits) that each of the swaps was capable, at the time of its execution, of assisting the Transport Company that entered into it to achieve its relevant ends (purpose or object) of pursuing profit (Carris, MdP, STCP). The Transport Companies’ case made as to the speculative nature of the swaps, even if correct, does not affect that conclusion. Accordingly, the court finds that it lay within the legal capacity of these companies to enter into the swaps.

The court need not decide BST’s alternative submission that it is also entitled to succeed on the test contended for by the Transport Companies.

The Transport Companies’ case however is that, even on the hypothesis that Professor Duarte is correct, MdL as an E.P.E. lacked the capacity to enter into the swaps it entered into.

This case is based on a new argument advanced for the first time (certainly in the form advanced) in written closing submissions.

It is asserted that:

Despite the complexity of the argument, the court’s view is that essentially it imports Professor Antunes’ contentions through the vehicle of MdL’s Articles of Association. As such, it suffers from the problems identified above, indeed highlights them, since the contention is that swaps that are cost-reducing are necessary and/or convenient for MdL’s power of borrowing in pursuit of its objects, and therefore within its capacity, provided that this cost reduction is consistent with the aim of “contributing to [MdL’s] economic and social development”.

As noted earlier, as a body that runs the metro system in a great European capital city, Metropolitano de Lisboa has substantial financing requirements. It has entered into many swaps, and doubtless other means of financial management as well. For reasons already given, the court does not consider that a capacity test applicable to such a body that involves great uncertainty represents Portuguese law.

The Transport Companies accept that reliance on Art. 29 is new, but say that the argument has already been raised, albeit briefly, in written opening submissions. It is said that the translation of the article is agreed, and that it would be extremely odd if the court did not take it into account, having been taken to other articles in the document.

BST objects to this course. The argument was not advanced or addressed in any evidence of Portuguese law given to the court, and was not put to Professor Duarte. The court is unable, it is submitted, without evidence from a Portuguese lawyer, to interpret Art. 29. Professor Antunes did not address it, because his evidence was centred on what he maintained were the purposes, not the objects, of the Transport Companies. An expert in Portuguese law may take the view that parts of the article other than those identified by the Transport Companies are relevant. The new argument is constructed outside the expert evidence, and there is no basis in Portuguese law for saying that in order to be within MdL’s capacity, a transaction has to be anything more than convenient to the pursuit of its objects as set out in its objects clause. There is no basis, BST submits, for saying that Art. 29 is relevant to the question of what is convenient to the pursuit of MdL’s objects.

The court accepts BST’s submission in this respect. As set out in the English authorities referred to above, the court is not entitled to construe these provisions itself. This is not a technical objection, because in a field of law as recondite as capacity, the court has to gain its understanding through the Portuguese law experts.

But for the reasons given, it is very unlikely that this argument would have affected the court’s conclusion. The court is satisfied that (as BST submits) each of the MdL swaps was capable, at the time of its execution, of assisting MdL to achieve its relevant ends (purpose or object) of operating a transport system. It does not accept the Transport Companies’ submissions that the swaps lay outside its capacity as being speculative.

BST has a further submission that so far as concerns Carris, MdP and STCP, the swaps are binding on them even if they were outside the capacity of those companies. This is because each of them is a sociedade anónima (‘S.A.’) identified in Directives

This was not subject to detailed analysis in rebuttal by the Transport Companies, but in view of its above findings, the court does not need to decide this submission.

It is for BST to establish capacity, and the court considers that it has done so.

The Transport Companies advance defences that arise under provisions of Portuguese law that apply to “games of chance” and “abnormal change of circumstances”.

The swaps, however, are all subject to an express agreement that English law shall apply. There is no dispute as to the validity of such agreement. It follows that these defences depend upon establishing the application of Portuguese law in these respects despite the choice of English law. The issue depends on the correct application of the European rules contained in the Convention on the Law Applicable to Contractual Obligations 1980 (the Rome Convention).

In summary, the Transport Companies’ case is that applying the test in Art. 3(3) of the Rome Convention, all elements relevant to the situation at the time of the contract are connected with Portugal. That being so, the choice of English law does not prejudice the application of “mandatory rules” of Portuguese law.

This is disputed by BST, which further disputes that the rules as to “abnormal change of circumstances” are “mandatory” in this sense.

The principle of freedom of choice of law in contract, or party autonomy, is recognised in European law. Art. 3(1) of the Rome Convention provides that:

“1.

A contract shall be governed by the law chosen by the parties. The choice must be expressed or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or a part only of the contract.”

The Rome Convention applies to all the swaps because they were all concluded prior to 17 December 2009, when its successor the Rome I Regulation (Footnote: ¹⁹) came into effect.

By way of comparison, Art. 3(1) of the Rome I Regulation is essentially the same as its Convention predecessor:

“1.

A contract shall be governed by the law chosen by the parties. The choice shall be made expressly or clearly demonstrated by the terms of the contract or the circumstances of the case. By their choice the parties can select the law applicable to the whole or to part only of the contract.”

The dispute between the parties centres on the qualification that applies where all elements relevant to the situation (other than the choice of law) are connected with one country only. In such a case, the parties’ choice is not to prejudice the application of rules of the law of that country which cannot be derogated from by contract (called “mandatory rules”). Art. 3(3) of the Rome Convention provides that:

“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`.”

By way of comparison, the principle as contained in Art. 3(3) of the Rome I Regulation is in somewhat different terms (though Recital 15 to the Regulation makes clear that “no substantial change is intended as compared with Article 3(3)” of the Convention):

“3.

Where all other elements relevant to the situation at the time of the choice are located in a country other than the country whose law has been chosen, the choice of the parties shall not prejudice the application of provisions of the law of that other country which cannot be derogated from by agreement.”

The reference to “mandatory rules” is omitted in Art. 3(3) of the Rome I Regulation. Recital 37 (Footnote: ²⁰) indicates that this is to distinguish the concept of “overriding mandatory provisions” (dealt with in Art. 9) from the expression “provisions which cannot be derogated from by agreement” which is the subject matter of Art. 3(3) (Footnote: ²¹).

BST draws attention to the fact that versions of Art. 3(3) in different European languages including the Portuguese language do not contain the words “relevant to”, referring only to “all other elements of the situation”. This “aberration” in the English language version is relied on in the context of the contention that the provision is to be read narrowly.

The court agrees with the Transport Companies that this difference in wording is unlikely to make any difference. As they point out, the Giuliano Lagarde Report to which, pursuant to s. 3 of the Contracts (Applicable Law) Act 1990, regard may be had for the purposes of interpretation, itself uses the words “relevant to the situation” in its commentary on the provision, as do the leading English commentaries. (The 1990 Act is the statute which gives the Rome Convention the force of law in England.)

The principles of interpretation of the Rome Convention are not in dispute, and can be taken from the Transport Companies’ submissions for trial:

The first issue in relation to Art. 3(3) is whether notwithstanding the choice of English law, “all the other elements relevant to the situation at the time of the choice” are connected with Portugal, so that rules of Portuguese law which cannot be derogated from by contract apply to the swaps.

The Transport Companies contend that they are, and that Art. 3(3) is engaged. BST contends that there are a number of elements of the situation not connected with Portugal, and that Art. 3(3) is not engaged.

This is relevant to the “games of chance” defence and the “abnormal change in circumstances” defence.

The second issue is as to whether the provisions of Portuguese law as regards “abnormal change in circumstances” are “mandatory rules” in the sense that they cannot be derogated from by contract (it being conceded by BST that the rules relating to “games of chance” are mandatory).

The dispute does not affect the question of capacity which is outside the scope of the

BST also accepts that the court must apply the relevant provisions in the Portuguese Securities Code regardless of the contractual choice of English law. This was conceded by BST on the basis that the Transport Companies accept that their claims

The court considers that BST’s concession was correctly made, and need not consider whether it was justified on wider grounds, e.g. that regulatory provisions of this kind apply regardless of any choice of law. One of the functions of the Securities Code is to implement in Portuguese law directives that contain certain common conduct of business rules applicable throughout the EU to the provision of financial services.

The Transport Companies argue that:

BST submits that Art. 3(3) of the Rome Convention is not engaged in the present case.

Authority at the European level

In the case of contracts, priority is given to the intention of the parties, to whom Art. 3 of the Rome Convention grants freedom of choice as to the law to be applied (Intercontainer Interfrigo SC (ICF) v Balkenende Oosthuizen BV and MIC Operations BV (Case C-133/08) at ¶¶23-24).

There is no decision at the European level determinative of the questions as to the interpretation of Art. 3(3) that arise in this case. BST cited United Antwerp Maritime Agencies (Unamar) NV v Navigation Maritime Bulgare (Case C-184/12) at ¶49 (Footnote: ²²) for the proposition that as an incursion into the parties’ choice of law, and hence into their agreed rights and obligations, Art. 3(3) needs to be strictly interpreted.

However, the passage in Unamar which BST relies on relates to overriding mandatory provisions under Art. 7 of the Convention, and Art. 3(3) embodies a wider concept (see Recital 37 of the Rome I Regulation referred to above; Dicey, Morris & Collins, ibid, at 32-087).

BST also referred to cases considering derogation from the general rule on jurisdiction contained in the Brussels I Regulation and Brussels Convention. These

Applying this approach, what is the objective of Art. 3(3)? As set out in various commentaries placed before the court, the drafting of Art. 3(3) and its successor in the Rome I Regulation was the subject of discussion and compromise (e.g. Michael McParland, The Rome I Regulation on the Law Applicable to Contractual Obligations (1st ed, 2015), chapter 9).

According to the Max Planck Institute for Foreign Private and Private International Law, “Under art. 3(3) of the Rome Convention, internally mandatory rules cannot be derogated from by a parties’ choice of law if the contract to which they refer has no significant foreign element. The policy behind this approach is to prevent the parties from evading internally mandatory rules in what is for all practical purposes a purely domestic case” (Footnote: ²³).

On the other hand, as Mr Ali Malek QC for the Transport Companies pointed out, it has been said that the application of Art. 3(3) “… does not depend upon any showing of evasiveness or bad faith in choice of law. … Instead it reflects a basic sense that if the situation was entirely connected to one country, some aspects of the law of that country have a claim to be applied. The question is when Art. 3(3) applies, and which aspects of the law are picked up when it does” (Adrian Briggs, Private International Law in English Courts (1st ed, 2014) at ¶7.116).

In the court’s view, this shows that whilst the underlying policy is to prevent the parties from avoiding internally mandatory rules in what is for all practical purposes a purely domestic case, there is no need to show evasiveness or bad faith. It is the state of affairs which matters. There is no suggestion that by adopting ISDA Master Agreements governed by English law either party set out to evade Portuguese law. The question is whether this is a purely domestic case.

One other factor should be mentioned. At least in the context of major financial contracts such as those at issue in this case, legal certainty is an important consideration. Professor Briggs expresses the view that, “The principle of the matter would appear to be that if elements relevant to the situation at the time of the choice of law are substantially located in a country other than the country whose law has been chosen, that may be enough to trigger the application of Article 3(3). But in practice, and particularly in commercial litigation before the English courts, this is only very rarely liable to arise for consideration. The uncertainty of the rule should lead to its narrow interpretation” (ibid at ¶7.117). The court agrees with this statement, and there are in fact only a few English decisions on Art. 3(3).

These decisions are:

Pointing to the back-to-back hedging contracts it entered into, BST places reliance on commentary on linked contracts. Dicey, Morris & Collins (ibid) say at ¶ 32-087 that, “Art. 3(3) does not apply to cases which are apparently connected with one country, but in fact have some connection with other countries, such as string contracts or insurance arrangements”: the Caterpillar case is cited in support. The Transport Companies respond that this is no more than a generalised observation about the circumstances in which such related contracts might be relevant, and says nothing about the degree to which such contracts must be related.

There are three recent decisions of the Portuguese courts which concern swaps entered into under ISDA agreements in which BST is the defendant (the third decision concerns the four swaps with MdL which are the subject of this case).

These were cases concerned with jurisdiction rather that choice of law. Deciding in favour of BST, the Portuguese courts gave effect to the choice of English jurisdiction.

The decisions are:

The cases concerned the application of Council Regulation (EC) No 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Brussels I), and not, as the Transport Companies point out, questions of choice of law under the Rome Convention. Further, the Transport Companies say that the decisions are under appeal and are not res judicata as a matter of Portuguese law. They say that Art. 18 of the Rome Convention by which regard may be had to judicial interpretation from elsewhere in Europe when interpreting the Convention is not concerned with the uniformity of interpretation of rules across different European legal instruments. They submit therefore that these decisions should be disregarded by the court as they are entirely irrelevant to the interpretation and application of Art. 3(3).

However, BST submits that whether Brussels I is engaged involves similar considerations as to whether there is a non-domestic element of the situation under Article 3(3). This is because in the words of the Report on the predecessor Brussels Convention by Paul Jenard, “it alters the rules of jurisdiction in force in each Contracting State only where an international element is involved” (see the decision of the CJEU in Owusu v Jackson(Case C-281/02), at ¶25). This point was considered by the Portuguese courts in relation to the contentions of the claimants that swaps entered into with BST were purely domestic contracts, and therefore, BST submits carries weight in relation to the dispute as to the application of Art. 3(3).

Analysis of the key issues

The Transport Companies cite the writings of Professor Allan Phillip (Mandatory Rules, Public Law and Choice of Law, in North ed., Contract Conflicts (1982), p. 97) for the proposition that where the facts are such that there is no conflicts of law problem at all, the mandatory law provisions of the domestic law of the contract will continue to apply notwithstanding the choice of a foreign law.

They submit that when there are only two systems of laws potentially in play—i.e. the domestic law and the choice of law—and there is no possibility of the laws of a third country being applicable, the effect of Art. 3(3) is that the law chosen by the parties governs their contractual obligations, but it does not displace the mandatory rules of the legal system which, but for the choice, would undoubtedly apply. This is a restriction on the party’s autonomy the purpose of which is to “prevent parties from circumventing the non-derogable rules of a country, in a wholly domestic situation, by

The Transport Companies say that on BST’s analysis, the application of Art. 3(3) is restricted to circumstances in which not only are there no foreign elements relevant to the question of the applicable law, but also there are no random, additional foreign elements to the situation, even though such elements are irrelevant to the question of the applicable law pursuant to the Rome Convention. They submit that this is a curious interpretation in the context of a Convention whose scope is “contractual obligations in any situation involving a choice between the laws of different countries”.

In support, the Transport Companies place particular reliance on the decision in Dexia vComune di Prato, supra. In that case Dexia, an Italian bank, had entered into a series of swap agreements with Comune di Prato, an Italian local authority. The swaps were governed by an ISDA Master Agreement and the confirmations were in English and subject to English law and jurisdiction. In resisting Dexia’s demand for payment, Comune di Prato sought to rely on certain provisions of Italian law as being mandatory.

As in the present case, the bank disputed that Art. 3(3) applied. It contended that there were two "elements relevant to the situation" which were not connected with

In finding against the bank and holding that Art. 3(3) did apply, Walker J rejected both these points, saying at [211] that:

“To my mind, Prato is right to say that both these points are misconceived. As to the master agreement, it is true that it is an international standard form, but it does not follow from this that it is an "element in the situation" which is connected to a country other than Italy. It is of course designed to promote certainty, but that does not give it a connection to a country other than Italy. Nor does the significance and global nature of ISDA. Even if the standard form itself were shown to have a connection with another country, that would not in the present case be an "element relevant to the situation" as it existed at material times. Throughout the relevant period everything relevant to the use of the form happened in Italy. As to Dexia's decision in each case to choose a non-Italian counterparty for its back to back hedging swap, that does not appear to me to be an element relevant to the situation as between Prato and Dexia. Whether or not Dexia entered into a hedging swap is a matter for Dexia alone: to Prato it is immaterial. There was no contemplation that a non-Italian entity would take over obligations of either party. Dexia's choice to use a non-Italian counterparty is something which is completely external to "the situation" at the time that choice of law was agreed.”

The Transport Companies submit that this conclusion applies equally, pointing out that the facts are very similar to the present case, since Portugal was where both parties were incorporated, where the parties communicated with each other, where the swaps were entered into, and where the obligations under the swaps had to be performed (see Dexia at [209]).

BST, on the other hand, submits that elements of a ‘non-domestic’ or ‘international’ character which point outside Portugal should not be ruled out, whether or not such elements point towards a particular country. It further submits that it is not material whether a party is aware that the other party is hedging the swaps, and that the use of the ISDA Master Agreement and the existence of the back-to-back hedges are all elements of the situation which were not connected to Portugal.

As the Transport Companies say, a key difference between the parties on the Rome Convention issue is whether it is sufficient under Art. 3(3) to identify “international” factors, i.e. factors with no connection to a particular legal system, to take the case outside the article. BST says that it is, whereas they say that it is not.

This leads the Transport Companies to put their case in a particular way.

In their trial submissions, it was submitted that the question for the English court in determining whether Art. 3(3) applies in the present case is—“Is there any element linking the contractual dispute between BST and the Transport Companies to the legal system of a country other than Portugal, which the English Court would recognise as a connecting factor under its law of conflicts (other than the choice of law and jurisdiction clauses)?”

The contention that the court should be looking for connecting factors to a particular legal system is central to their case.

However, the court is not concerned to determine the applicable law—there is already a valid choice of law. The question is whether that choice takes effect subject to nonderogable provisions of domestic law. Where there is an express choice of law, there is no need to enquire as to connecting factors which would indicate the applicable law in the absence of an express choice. The court does not therefore accept the approach of the Transport Companies in this regard.

The wording of Art. 3(3) focuses on whether the “situation” is linked to one country only. The Transport Companies objected that BST has failed to define the term “situation”. However, this is addressed in the Caterpillar case in the passage at [18] cited above, where was said that, “It is noteworthy that Article 3(3) refers to elements ‘relevant to the situation’ which is wider than ‘elements relevant to the contract’ ….”. In the Rome I Regulation, the word “situation” rather than “contract” was retained (Footnote: ²⁴).

In that regard, the words of the provision seem to be deliberately general, referring to allelements relevant to the situation. As noted earlier, this wording was the result of negotiation and compromise. In the court’s view, there is no reason to limit it to elements which would point to the applicable law being that of another country.

The swaps were, as BST submits, concluded in an international market for such derivatives. The evidence shows that over the period in question MdL and MdP in particular entered into swaps with a range of international banks from different countries. BST was one of a number of banks competing for the business, and it was able to do so because it is a subsidiary of Santander in Spain, itself part of an international banking group. The Transport Companies submit there is no market in the sense of indicating a connecting factor to the legal system of another country. However, this is inherent in the context of the international capital markets, where the market operates because it is international, and it is why the parties’ choice of law and dispute resolution mechanism is so important.

Documentation is of the essence of such transactions in the capital markets. A Portuguese Framework Agreement had been used for earlier swaps, but by the time of these transactions, the parties had switched to ISDA documentation. The evidence is to the effect that this was a mutual decision, and reflected the position as regards other banks.

Clearly, the fact that documentation is in the English language will not in itself carry any weight, and so far as BST submitted to the contrary, the court does not agree. However, the swaps were also expressed and confirmed in English. Further, it is significant that in relation to each of the swaps, the parties used the “MulticurrencyCross Border” form of the 1992 ISDA Master Agreement rather than the “Local Currency-Single Jurisdiction” form. The use of this form is consistent with the other international elements of the dealings involved.

In the court’s view, there are practical reasons for taking account of the documentation as an element in its own right. The use of this standard international documentation provides an orderly contractual structure, among other things facilitating both hedging and restructuring, which can be important for both or either of the parties. It also promotes legal certainty. If it is left out of account as an element in determining the application of mandatory provisions of domestic law, the prospect arises of different legal rules applying to the swaps and to the back-to-back transactions, which themselves may be, and in this case were, hedged (Footnote: ²⁵). There is no evidence that the Transport Companies were aware of the hedging arrangements, and there was no reason for them to be concerned with them. It is not suggested that there was anything unusual about such arrangements, which in this kind of transaction are (the evidence shows) entirely routine.

These points have been recognised by the courts in Portugal in the three recent decisions cited above. In the decision of the District of Lisbon Central Court of 14 July 2015 (538/14.2TVLSB) (Sociedade de Desenvolvimento do Norte da Madeira v

After the end of the hearing, there has been a further decision of the Supreme Court of 2 February 2016 (542/14.0TVLSB.L1.S1), which is the appeal in the first of the three cases noted above, in which the Supreme Court referred to the CJEU the question of whether a swap entered into on ISDA terms between two nationals of the same Member State has sufficient external or international elements to trigger the application of the Brussels Regulation. (Footnote: ²⁶)

As a result, the Transport Companies say, this issue remains moot in Portuguese law. The court is content to proceed on this basis. (So far as the English jurisdiction is concerned, by reason of Article 2 to the First Protocol of the Rome Convention only the Supreme Court and “other courts from which no appeal is possible” have the power to refer. That does not include this court.)

In conclusion, the court finds as follows. For the purposes of Art. 3(3) of the Rome Convention, in determining whether, choice of law aside, all the other elements relevant to the situation are connected with one country only, the enquiry is not limited to elements that are local to another country, but includes elements that point directly from a purely domestic to an international situation. In financial transactions, the use of ISDA or other standard documentation used internationally may be relevant, and the fact that the transactions are part of a back-to-back chain involving other countries may also be relevant. Respectfully disagreeing with the conclusion in Dexiav Comune di Prato in these regards, the court considers that this approach is consistent with the authorities set out above, and specifically that the latter point is supported by the Caterpillar case and the commentary in Dicey, Morris & Collins.

It may be noted that there are other limitations on freedom of choice of law, for example in the case of consumer and employment relationships, and that provision is made for overriding mandatory provisions (now in Art. 9 of the Rome I Regulation), and a public policy (ordre public) exception (now in Art. 21 of the Rome I Regulation). Importantly in the present case, for reasons set out above the court’s conclusion on Art. 3(3) does not affect the mandatory application of the relevant provisions of the Portuguese Securities Code, one of the functions of which is to implement EU directives that contain common rules applicable to financial services business.

Applying the above approach, the next question is whether Art. 3(3) applies on the facts.

The Transport Companies’ case is that the answer is obvious: this is not a case like Caterpillar (supra) with an American party, a French party, a loan to build a vessel in Singapore and a contractual provision for payments to a Singaporean builder. It is not a case like Emeraldian (supra) where the guarantor was a Chinese company, the beneficiary of the guarantor was a Liberian company, and the subject of the guarantee was an obligation under a charterparty governed by English law.

The case, they submit, is one of contracts between a Portuguese bank on the one hand, and a publicly-owned Portuguese transport company on the other. The obligations of both parties were to be performed in Portugal, the obligations were entered into in Portugal, the obligations under the contracts were not conditional on or otherwise affected by other contracts, and no other contracts were conditional on or otherwise affected by these contracts. There were no other parties to these contracts, no parties involved in the performance of their respective obligations under these contracts, and so the situation at the time of choice for each contract was a simple one. Accordingly, the Transport Companies submit, by Art. 3(3), provisions of the law of Portugal which cannot be derogated from by agreement apply to the swaps.

The “elements of the situation” relied on by BST to the contrary, and the court’s opinion on each, are as follows:

It has not been suggested by the Transport Companies that the position differs from swap to swap, and the court considers that there is nothing to differentiate them for the purposes of this issue.

Summarising the main points made above, because of the right to assign to a bank outside Portugal, the use of standard international documentation, the practical necessity for the relationship with a bank outside Portugal, the international nature of the swaps market in which the contracts were concluded, and the fact that back-toback contracts were concluded with a bank outside Portugal in circumstances in which such hedging arrangements are routine, the court’s conclusion is that Art. 3(3) of the Rome Convention is not engaged because all the elements relevant to the situation at the time of the choice were not connected with Portugal only. In short, these were not purely domestic contracts. Any other conclusion, the court believes, would undermine legal certainty.

Given this conclusion, the second issue does not arise, but it was fully argued and the court should express its view. The issue is whether Art. 437 of the Portuguese Civil Code is a “mandatory rule” within Art. 3(3) as a provision which cannot be derogated from by contract. The court’s conclusion is set out below in the context of the discussion of Art. 437 where the issue arises.

The Transport Companies’ case is that the swaps are unlawful “games of chance” by virtue of being purely speculative instruments and thus unlawful bets, with the consequence that they are void under Art. 1245 and/or Art. 280 and/or 281 of the Portuguese Civil Code.

The court has held that Art. 3(3) of the Rome Convention is inapplicable, and on this basis it is common ground that the “game of chance” issue does not arise. However, the issue was argued, and the court should express its opinion.

If to the contrary it does arise, it is common ground that the relevant provisions of the Civil Code are mandatory.

BST’s case is that even if Art. 3(3) of the Rome Convention were engaged these provisions would have no application to business transactions contracted between a bank and its counterparties, and the swaps would not, in any event, fall foul of them.

It is not suggested by the Transport Companies that the result differs under any of the three articles of the Civil Code that they rely on. In other words, it is common ground that the arguments are the same on each, and they stand or fall together.

The “game of chance” issue was the issue that received least attention in oral closings. The Transport Companies simply referred to their written closings, adding nothing orally at all.

It is to be inferred that this is because (although they do not accept this) recent decisions of the Portuguese courts point in a clear direction on this issue.

Consequently, the Transport Companies’ written closing submissions focus on drawing a distinction with the position before and after the implementation in Portugal of MiFID the effective date of which was 1 November 2007 (see below).

All the swaps were executed prior to 1 November 2007, and so pre-MiFID, except the STCP swap with a trade date of 2 November 2007.

On this basis, they seek to distinguish in particular a decision of the Supreme Court of Portugal of 11 February 2015.

The relevant provisions of the Civil Code (CC) are as follows.

Art. 1245 CC provides:

“Games and betting are not valid contracts and do not give rise to civil obligations; however, when lawful, games of chance give rise to natural obligations, except where by other motives they shall be deemed void or voidable pursuant to the general law, or, if the creditor has committed fraud in its execution.”

Article 1245 sits within Chapter XV of the CC, entitled “Gaming and betting” (CAPÍTULO XV Jogo e aposta). Article 1245 itself is headed “Nullity of contract” (Nulidade do contrato).

Arts. 280 and 281 CC provide:

“280 Requirements of the contractual object

The Transport Companies’ case is that the swaps, being in substance speculative transactions, or as it was put in closing submissions “purely speculative swaps”, and not effective risk management instruments, are unlawful games of chance and/or contrary to Portuguese ordre public.

The Transport Companies rely on the evidence of Professor de Freitas who states that “when … swap contracts do not play [the function of “managing, hedging or controlling interest rate risk fluctuation”] and are used exclusively to speculate … the provisions of Art. 1245 of the CC in principle will apply”.

Prof. de Freitas considers that where “(i) swaps created [risk], rather than operated as an antidote to risk and (ii) that the margin of risks assumed by the parties was dramatically imbalanced”, they are both contrary to Art. 1245 CC and Art. 280 and, in the present case, additionally Art. 281 of the CC.

Relying on the evidence of Professor Câmara, BST contends that Art. 1245 of the CC (it being common ground that the same arguments apply to the other provisions) does not apply to the swaps because:

The Transport Companies’ second Portuguese law expert, Professor de Freitas, gave evidence on the ‘game of chance’ issue. His background is in procedural law, but (as the Transport Companies say) he is a leading proponent in Portugal of the position that speculative financial instruments are unlawful under Portuguese general law. Though that has been accepted by the Portuguese Supreme Court in one judgment (that of 29 January 2015) it has not been accepted in another (that of 11 February 2015).

The Transport Companies say that Professor Câmara, by contrast, has played no part in this debate in Portugal and is not an expert (on either side of the debate) in this area of law.

However, it is common ground that he is an expert in securities law, and an important aspect of this issue relates to how the Securities Code rules on contemporary financial instruments such as swaps interact with older rules on gaming and betting.

Indeed, the Transport Companies make this point in their closing submissions. Citing the questions posed in the English case of Westdeutsche Bank v Islington LBC [1996] AC 669 to do with swaps and wagers, they say:

“The question for this Court in substance is whether the same is true of Portuguese law, with this difference. Portuguese law has no equivalent of s. 10 of the [UK] Gambling Act 2005 or s. 63 of the [UK] Financial Services Act 1986 [which exclude swaps from the gaming laws]. The answer to the question therefore depends on whether it can be said that the Portuguese Securities Code (in its different iterations) has displaced the Portuguese mandatory law provision regulating “gaming and betting”

(“jogo e aposta”), namely Art 1245 of the Civil Code.”

The “question in substance” goes not least to how European principles have been implemented in the Portuguese Securities Code.

Further, there is the question of the way the Portuguese courts have decided cases since these two decisions of the Supreme Court and whether this amounts to a trend. Whilst paying tribute to Professor de Freitas, who is eminent, and whose evidence was valuable, the court tended to prefer that of Professor Câmara on this quite narrow issue.

Leaving aside decisions of the lower courts where cases went to the Supreme Court, there are seven relevant decisions, the swaps being in some cases pre- and in some cases post MiFID. None involved snowball swaps:

Although (so far as is recalled) this was not mentioned at trial, BST had applied for permission to invoke a special appeal procedure in respect of the Supreme Court judgment of 29 January 2015 asserting that it conflicted with the Supreme Court judgment of 11 February 2015. After the end of the hearing in the present case but before judgment was handed down, BST’s application was rejected by a single judge of the Supreme Court on 12 January 2016. It was held that the requirements for the special appeal process were not satisfied because there were important differences between the factual matters of the two judgments.

BST submits that even where Art. 1245 could apply to swaps, the fact that swaps are regulated by the Securities Code demonstrates that swaps are subject to “special legislation” for the purposes of Art. 1247 CC, and so Art. 1245 does not apply to swaps for that reason. This applies to both pre and post-MiFID swaps.

The Transport Companies submit that:

The court upholds BST’s submissions as supported by Professor Câmara because:

It is correct as the Transport Companies say that there has been a debate in the writings of distinguished commentators such as Professor Ascensão, Professor Cordeiro and Professor Ferreira de Almeida as to whether it is appropriate to treat speculative swaps as a bet as opposed to those with a purpose such as hedging.

However, the effect of the decision of the Supreme Court of 11 February 2015 is to treat speculation in the context of financial dealing as a legitimate activity different from gaming.

The decision is consonant with English law decisions cited above which find it impractical to try to distinguish between speculation and hedging in the financial context in the absence of an applicable definition.

In any event, as BST says, the result of the decision as applied subsequently is that the Transport Companies’ contention based on the proposition that the swaps were purely speculative instruments does not get off the ground.

BST has an alternative submission as follows.

The decision of the Supreme Court of 11 February 2015 expresses different purposes for swaps which are legitimate.

The Court held that interest rate swaps have three purposes: “reduction of the risk of variation of the interest rates; possibility of taking advantage of better rates; speculation on their variation”.

BST submits that the swaps have a legitimate purpose in reducing financing costs. It submits that the swaps in this case fall directly within the second purpose identified. Reducing financing costs is an accepted function of interest rate swaps.

This submission is disputed on the facts by the Transport Companies, their case being that the swaps did not operate to reduce interest rates and were dramatically imbalanced and created risk rather than managed it.

However, Professor de Freitas did accept that if a swap is intended to permit a party to exploit the possibility of obtaining a reduction on the interest rate which it pays on existing borrowings, that is not a purpose which makes the swap invalid.

This dispute is covered in Part C above, and the court agrees with BST for the reasons set out there. Nothing relating to the asserted “dramatic imbalance” so far as this was developed in closing submissions affects this conclusion.

Conclusion

For the above reasons the court accepts BST’s submissions, finding that:

The contention that there has been a fundamental change in circumstances since the swaps were contracted with the result that they cannot in good faith be enforced by the bank was the most extensively argued part of the case.

Portuguese law provides for this kind of situation by an article in the Civil Code that applies where there has been an “abnormal change of circumstances”. The provision follows in the tradition of the rebus sic stantibus doctrine in civil law. It has been relied on by the Transport Companies in defence.

On the above findings, the defence is not open, because Art. 3(3) of the Rome Convention is inapplicable, and on this basis it is common ground that English law applies. (The parties have not raised what the position would be under English law.) But the position under Portuguese law having been fully argued, the court will make findings accordingly. To invoke the defence, the Transport Companies need to show that the relevant provisions are non-derogable so as to prevail notwithstanding the choice of English law.

The defence is raised in relation to seven of the nine swaps: it does not apply to the second Carris and Metro Porto swaps (Carris 2 and MdP 2). This is because one had a different formula for calculating the spread and the other had an upper but not a lower barrier. It is the combination of a spread which is cumulative and the prolonged breach of the lower barrier activating the spread that has resulted in such high rates for the other swaps.

The spread on both these swaps as at 1 October 2015 was zero, so that Carris and Metro Porto are only paying the fixed rate. In effect, therefore, they are in the same position as a party to a vanilla swap. It is accepted by the Transport Companies that this factual distinction puts them outside the ambit of this defence.

Professor da Frada explains the origins of the rebus sic stantibus doctrine in the civil law tradition, saying that the doctrine rests on a theory concerning the parties’ will. He further expresses the opinion that there has been a shift towards an objective theory of contractual justice and good faith. It is common ground that it is an institution of ancient roots in Portugal, though not specifically incorporated in Portugal’s 1847 Civil Code. Influenced by the German “basis of the agreement” doctrine, it was incorporated in its present form in the 1966 Civil Code, the drafting of which was chaired by the leading jurist Professor Adriano Vaz Serra. However, Professor da Frada opines that it encompasses multiple elements and influences, and does not only reflect German legal theory.

Article 437(1) of the Civil Code provides:

“437 Abnormal change in circumstances

The expert evidence on this issue was provided by Professor da Frada (for the Transport Companies) and Professor Câmara (for BST). They agree that the application of Art 437 is dependent on:

It is the Transport Companies’ case that: (a) Art. 437 is a mandatory rule of Portuguese law; (b) the changes to interest rates, and their maintenance at record lows since the second quarter of 2009 amount to and are the consequences of an abnormal

BST submits that Art. 437 CC has no application in the present case even if Art. 3(3) of the Rome Convention is engaged. This is because (a) Art. 437 is not a mandatory rule; (b) even if Art. 437 could apply, there has in any event been no “abnormal change” in the circumstances on which the parties based their decision to enter into the swaps, within the meaning of Art. 437; (c) in any event, any such abnormal change forms “part of the risks covered by the contract”; and (d) fulfilment of the Transport Companies’ obligations under the swaps would not be a “serious breach of the principles of good faith”.

Accordingly, (as summarised by the Transport Companies and not in dispute) the key issues are:

Whether Art. 437 is a “mandatory rule”

The issue is whether Art. 437 of the Portuguese Civil Code is a “mandatory rule” within Art. 3(3) of the Rome Convention as a provision which cannot be derogated from by contract.

As explained above, the reference to “mandatory rules” is omitted in Art. 3(3) of the Rome I Regulation. Recital 37 (Footnote: ³¹) indicates that this is to distinguish the concept of “overriding mandatory provisions” (dealt with in Art. 9) from the expression “provisions which cannot be derogated from by agreement” which is the subject matter of Art. 3(3) (Footnote: ³²). However, Recital 15 to the Regulation makes clear that “no substantial change is intended as compared with Article 3(3)” of the Convention.

Whether or not the rule is “mandatory” in this sense is a matter of domestic law, here the law of Portugal. The approach stated by the CJEU in the Unamar case (supra) at ¶50 in the context of Art. 7 of the Rome Convention also seems to be pertinent as regards Art. 3(3) (“It is … for the national court, in the course of its assessment of whether the national law which it proposes to substitute for that expressly chosen by the parties to the contract is a ‘mandatory rule’, to take account not only of the exact terms of that law, but also of its general structure and of all the circumstances in which that law was adopted in order to determine whether it is mandatory in nature …”).

However, beyond that, there is the question as to what is meant by “rules which cannot be derogated from by contract”. What is the meaning of this phrase? In closing submissions, BST suggested that this is an English law question, incorporating principles of European law and customary international law. The court prefers the Transport Companies’ submission that this is a question to be determined in accordance with the principles of interpretation of the Rome Convention set out above.

Nevertheless, the word “derogate” has to be given a meaning in this context, and neither party has cited an authoritative statement in that respect. In closing submissions, BST submits that ‘derogate’ does not only mean ‘disapply entirely in all circumstances’: parties may derogate from a contractual rule simply by cutting down its scope of application, by agreement (Footnote: ³³). The Transport Companies objected that this was a “novel filter”, resulting in the screening out of some rules which are mandatory in domestic law, thereby defeating the purpose of Art. 3(3).

However, there is no reason why this objection should necessarily be correct. Context is important, as the passage from the Unamar case cited above shows. The term “derogate” has to be read in the light of the rule in question, but subject to that, the court agrees with BST’s submission in this regard, which is that to “derogate from” is not the equivalent of to “oust” completely, as the Transport Companies appeared to submit.

An important further dispute is whether the fact that Art. 437 CC can be waived ex post is decisive. It is common ground that the parties can agree after the abnormal change of circumstances has happened that they will not invoke Art. 437. The dispute is as to whether the article can be waived ex ante, and though the Transport Companies accept that provision can be made for risks ex ante, this is not they say to the extent of excluding Art. 437 entirely.

The core of the dispute between Professor da Frada and Professor Câmara, as explained in more detail in the following paragraphs, is that the former is of the opinion that Art. 437 is a mandatory rule of Portuguese law because it is grounded in good faith, and cannot be excluded altogether. Professor da Frada’s opinion that good faith is a core value of the Portuguese legal system is not in dispute. Professor Câmara, whilst recognising the importance of the principle of good faith in Portuguese law, considers that it plays a limited function within Art. 437, coming into play if to require performance would be a serious breach of the principles of good faith.

The Transport Companies contend that their case that Art. 437 is a mandatory rule is supported by their expert evidence. This is principally in the light of (a) the underlying rationale of the provision (as preventing substantively unfair legal situations, which would otherwise be contrary to good faith) and (b) its modern juridical basis (resting on an objective theory of contractual justice rather than on a theory concerning the parties’ will).

The former is relevant because, were it possible for parties to agree to opt out of Art. 437 in its entirety, they would be agreeing to opt out of a core value of the Portuguese legal system, which self-evidently is not permissible, unless expressly provided for. The latter is relevant because it demonstrates that Art. 437 is not an exception to party autonomy, but the expression of a countervailing legal principle of Portuguese law.

BST contends that Art. 437 is plainly a non-mandatory rule however Art. 3(3) is interpreted. It contends that: (1) It suffices under Art. 3(3) that a rule can be waived by agreement of the parties after circumstances have arisen which allow one or other of the parties to rely upon it (ex post waiver). This is material because, in the present case, it is undisputed that Art. 437 can legitimately be subject to ex post waiver as a matter of Portuguese law. (2) If however Art. 3(3) requires that the parties be able to derogate from the rule before it becomes engaged (ex ante waiver), BST submits that the parties may also derogate from Art. 437 in that way as a matter of Portuguese law.

The jurisprudence (case law)

As is the position in England and elsewhere, swaps transactions have been contentious before the Portuguese courts, and the application of Art. 437 has been considered where contracts have been affected by the fall in interest rates after 2008.

In the present context—i.e. mandatory or non-mandatory under Art. 3(3)— there is however (and unsurprisingly) no decision of the courts which is directly in point.

Professor Câmara and Professor da Frada each cite decisions of the Supreme Court in support of their opposing positions: these are the Supreme Court of Justice decision of 10 October 1984 (process number 71 834)), and the Supreme Court of Justice decision of 18 January 1996 (JSTJ00027759).

The court accepts the evidence of Professor da Frada that the later decision is the more significant.

This is because the Supreme Court refers to the writing of a leading jurist, Professor António Menezes Cordeiro, who speaks of Art. 437 as having a “control function”. Considerable reliance is placed by the Transport Companies on the use of this term.

(Professor da Frada also refers to a decision of the Supreme Court of 27 January 2015 (876/12.9TBBNV-A.L1.S1), which in the context of Art. 437 refers to the “dialectical” conflict between the principles of party autonomy and good faith, however the case does not appear to cast much light on the Transport Companies’ contention that Art. 437 should not be treated as an exception to party autonomy.)

The Transport Companies do not dispute that parties can make specific provision for risks. Their major point comes from decisions in the factual context of swaps.

They (and both experts) refer to three decisions of the Portuguese courts in which the potential application of Art. 437 to swap agreements has been recognised: the Supreme Court judgment of 10 October 2013 (1387/11.5TBBCLG.G1.S1), the Lisbon Court of Appeal judgment of 15 January 2015 (876/12.9TVLSB.L1-6) (Footnote: ³⁴), and the Lisbon Court of Appeal judgment of 28 April 2015 (540/11.6TVLSB.L2-1).

It is important to note that these decisions are fact-sensitive, which is not in dispute. The decision of the Supreme Court of 10 October 2013 was in particular subjected to analysis. It was there stated that “… it would go against the principles of good faith that only the plaintiff bore adverse impacts [of the financial crisis]”. Professor da Frada’s writings among others are referred to in the Supreme Court’s judgment.

The Transport Companies contended in closing that the effect of the decision is that the courts in Portugal have recognised the mandatory nature of Art. 437. They contend that “it is of the essence of an interest rate swap that it makes provision for every possible change in the relevant reference rate”, and, the argument continues, it follows that “… on a formal basis, the parties to a swap will have provided in advance by contract for the risk of changes to interest rates. Thus, if (as BST contends) Art. 437 were subordinate to the principle of party autonomy, there would be no scope for the application of Art. 437 where the relevant change in circumstances is a change in the relevant interest rate. But this is not the case. The Portuguese courts have recognised that Art. 437 applies even to changes to interest rates in swap agreements, thus implicitly accepting the article’s mandatory nature”.

BST says that Professor da Frada did not himself draw this inference in his evidence on the decisions. Though the courts were of course concerned to enquire whether the abnormal circumstances were within the risks covered by the contracts, it was not suggested that the parties were not free to include within the contract whatever risks they saw fit. The submission is not, BST says, grounded in the expert evidence.

The court agrees with BST in this regard. Professor da Frada’s evidence, in which he analyses the three decisions, points out that in the last of them (the Lisbon Court of Appeal judgment of 28 April 2015) the Court says that the risks covered by the contract were exceeded by “a very large measure”. Further, the contention has to be read with the Transport Companies’ case that the long period of near zero interest rates after 2008 did not form part of the risks covered by the contract.

The straightforward point is that none of the decisions show that the Portuguese courts have treated Art. 437 as non-derogable, or were in any way concerned with that issue. These are important decisions in the context of the applicability of Art. 437, but they do not bear on the question whether the provision is “mandatory” under Art. 3(3) of the Rome Convention.

The Transport Companies submit that their case is supported by leading (although they accept not universal) Portuguese doctrine, and in particular, the views of: (1)Professor Vasconcelos, who (it is common ground) is a highly respected authority in the field of private law: in the eighth edition (2015) of his Teoria Geral Do Direito Civil,he says that, “Only when lacking a contractual solution which results from the agreement itself one can resort to article 437 of the PCC. Notwithstanding, article 437 does not cease to be mandatory”. This is a clear statement—on the other hand, inevitably (as BST says) its weight is affected by the fact that Professor Vasconcelos had been retained by the Transport Companies as their Portuguese law expert. (He had to retire from that role due to ill-health.)

Professor Câmara suggested in cross-examination that the word “supletiva” in this passage means “non-mandatory”. However, as the Transport Companies put it, the material before the court shows that the word “supletiva” is polysemic, and its meaning depends on context. It has been variously translated (in agreed translations)

The court agrees with the Transport Companies that the word does not have the single sense of “non-mandatory”, as indeed is plain from the passage quoted from Professor Cordeiro’s book, and that the use of the word is not determinative in the context of Art. 3(3) of the Rome Convention.

Professor Câmara also said in evidence that in subsequent writings, Professor Cordeiro had qualified this expression of his views. BST relies on this to submit that Professor Cordeiro now “consigns Art. 437 to a derogable regime that applies only when the parties have not agreed an alternative regime”.

The court agrees with the Transport Companies supported by the evidence of Professor da Frada that, when read in full, the passages in the later writings relied upon do not materially alter the meaning of Professor Cordeiro’s views on Art. 437 as expressed in the passage above.

As regards commentary in general, BST submits that the commentary supports the evidence of Professor Câmara that Art. 437 is non-mandatory and may be derogated from by agreement. (Footnote: ³⁵) It relies on the writings of Professor Luis Carvalho Fernandes and other commentators, but the most clear is that of Professor Mário Júlio de Almeida Costa who says in his Direito das Obrigações (2006): “The risks inherent to the type of contract in question must be treated, as it seems obvious, in the same way as the risks specifically covered by the parties in the concluded contractual agreement. It is possible for the contracting parties to waive or limit the application of art 437, [by/thus] assuming greater risks”.

As Professor Câmara says, this commentator seems to express the opinion that Art. 437 can be waived, which is inconsistent with its mandatory nature. There is no force in the Transport Companies’ objection that Professor de Almeida Costa is a former director of Banco Totta & Açores (now BST). The book was published long before the dispute as to the swaps arose, and there is no reason to regard it as other than an independent expression of views.

In the opinion of Professor da Frada, the mandatory nature of Art. 437 is a result of (a) the underlying rationale of the provision (as preventing substantively unfair situations, which would otherwise be contrary to good faith) and (b) its modern juridical basis (resting on an objective theory of contractual justice rather than on a theory concerning the parties’ presumed will). If it were it possible for parties to agree to opt out of Art. 437 in its entirety, they would be agreeing to opt out of a core value of the Portuguese legal system.

He accepted that the parties can make specific provision for risks—and that can be done not only ex ante but also ex post. An agreement following the occurrence of a particular risk not to rely on Art. 437 is no more, he says, than a provision concerning

In his evidence, Professor Câmara accepted the importance of good faith in Portuguese law. However, he points to the importance of other considerations, in particular the importance attributed to party autonomy, and emphasises that the good faith principle appears in different statutory contexts, and that it plays a limited function within Art. 437. He identifies six “indicators” which in his opinion show that Art. 437 is non-mandatory. These (and the court’s view on each) are as follows:

In the light of this discussion, the court expresses its conclusion as to whether Art. 437 is a rule which cannot be derogated from by contract, in other words a “mandatory rule” within the meaning of Art. 3(3) of the Rome Convention.

In closing, BST submitted that it suffices under Art. 3(3) that a rule can be waived by agreement of the parties after circumstances have arisen which allow one or other of the parties to rely upon it (ex post waiver). This is material because, it says, in the present case, it is undisputed that Art. 437 can legitimately be subject to ex post waiver as a matter of Portuguese law, and it follows that it is non-mandatory.

The Transport Companies suggested in closing that this was a new point, not referred to at the opening of the trial.

The court does not accept this. The reference to “waiver” may be new, but it has been BST’s case from the beginning of the trial that Art. 437 needs to be invoked by a party before it applies, and that if the parties are free not to raise it, the parties can

The Transport Companies submit that an ex post agreement not to rely on Art. 437 following the occurrence of a particular risk is an agreement concerning the occurrence of what is by then a specific and known risk, rather than an agreement to exclude Art. 437 altogether.

However, such an agreement does have the effect of excluding Art 437 from the time of the agreement, and the rule is therefore derogable at least to that extent.

The court further accepts the submission of BST that to “derogate” from a rule does not mean that the rule must be capable of being “ousted” altogether.

It is sufficient to take a rule out of Art. 3(3) of the Rome Convention, in the court’s judgment, if the rule can be disapplied by agreement between the parties whether ex ante or ex post. To take the present case, this distinguishes Art. 437 of the Civil Code, which deals with change of circumstances, from Art. 1245, which invalidates gaming and betting contracts. BST accepts that this is mandatory. Plainly, parties cannot contract out of rules applicable to gaming and betting contracts in any circumstances.

This conclusion seems consonant with commercial sense. All modern legal systems have to provide for the situation in which following the parties’ agreement, there has been a fundamental change of circumstances. Depending on the precise provision, outcomes may be different, but at least in the context of financial contracts like swaps, there seems no reason why the issue should not be referred to the law chosen by the parties.

For these reasons, BST succeeds on this issue.

If this conclusion is wrong, and the ability to contract out of the provision after circumstances have arisen which allow one or other of the parties to rely upon itdoes not suffice to take it outside Art. 3(3) of the Rome Convention, what is the position then?

The issue is a narrow one. The Transport Companies’ submission in substance is that Art. 437 is to be treated as mandatory within the meaning of Art. 3(3) of the Rome Convention because before it becomes engaged, the parties are not able to contract out of the rule entirely.

As a matter of background, the experts agree that “abnormal change” is often referred to in Portuguese doctrine and jurisprudence as change which is “unpredictable”. The Transport Companies say that, as a matter of logic, if a change cannot be foreseen or predicted, the parties cannot make provision for it in the contract. This is relevant, because it is a condition for the operation of Art. 437 that “the abnormal changes do not form part of the risks covered by the contract”.

The principal difference between the experts in this regard is identified in their joint memorandum.

Professor Câmara accepted that he had not come across a contractual provision that specifically excluded Art. 437.

Professor Câmara also expressed the view that the parties can disapply Art. 437 by choosing a governing law that does not include an equivalent rule. This accords with the court’s view of the commercial sense of the situation. But it was not greatly explored in the Portuguese law evidence or submissions. Professor da Frada must clearly be taken to be of the opposite view.

The court does not accept BST’s submission that there is a “heavy preponderance” of commentary directly suggesting that Art. 437 is non-mandatory.

In particular, Professor Câmara himself accepted that the importance of the role of good faith in Art. 437 is not a matter on which there is consensus.

The court finds that there is no consensus as to whether the role of good faith is a limited one within the terms of Art. 437, as he maintains, or whether it has a residual role which cannot in any circumstances be wholly contracted out of, as Professor da Frada maintains:

Ultimately, the court has to choose between two expert opinions. Although at one point BST asserted Professor da Frada’s “serious loss of objectivity”, rightly neither side made any serious attack on the quality of the other party’s experts.

The Transport Companies point out that Professor Câmara has spent most of his professional career as a regulatory lawyer first with the Portuguese Securities Commission and thereafter in private practice in this specialist area of law. He is an expert in financial regulatory law, but he does not have the same expertise in private law, and in particular in the rebus sic stantibus doctrine of Art. 437 of the Civil Code. By contrast, Professor da Frada is pre-eminent in Portugal in this area of private law.

Though Professor Câmara is interested in the relationship between financial law and civil law, the court considers that there is force in this point. The particular appraisal

Good witness though Professor Câmara was, Professor da Frada was better qualified in that respect. His views are cited by the Supreme Court in its decision of 10 October 2013 referred to above (and below) which involved a swap. The writings of Professor de Almeida Costa provide a counterweight, but as Professor Cordeiro put it, “We have accepted the derogable nature on principle of the doctrine of change of circumstances; however, even here, the nihil obstat of good faith always prevails”.

On balance, the court accepts Professor da Frada’s evidence that as a matter of Portuguese law the application of Art. 437 of the Civil Code can never be totally excluded on an ex ante basis.

If, contrary to the court’s opinion expressed above, this has the result that Art. 437 is a provision which cannot be derogated from by contract within the meaning of Art. 3(3) of the Rome Convention, the Transport Companies would succeed on this issue.

The Portuguese case law

The finding on the first issue means that the substantive issues as to the meaning and application of Art. 437 do not arise. However, since they were argued in full at trial, the court will express its conclusion. Each is important, and each is in dispute.

The decisions

It is convenient first to consider the evidence as to the Portuguese cases that deal with interest rate swaps and the application of Art. 437. This is potentially relevant to each of the substantive issues.

There is some difference between the experts as to what is meant by “abnormal change”. Professor Da Frada says that there is no requirement that the change has to be “extraordinary”: it is enough that the change is “objectively out of the usual and atypical”.

In the light of the view taken by the court on the facts, it is unnecessary to resolve this. The court is content to proceed on the basis that Professor Câmara is correct to say that only an unpredictable and extraordinary change that gravely affects the performance of at least one of the parties may justify the application of Art. 437. The formulation that sometimes appears in the Transport Companies’ submissions as to “great” change of circumstances is consistent with this.

The experts disagree as to the effect of the jurisprudence regarding the application of Art. 437 to swaps. In their statements in the joint memorandum, Professor da Frada considers that the Portuguese courts have consistently acknowledged the relevance of the financial crisis as regards swaps, deeming Art. 437 as applicable to such agreements. Professor Câmara considers that Portuguese court decisions have so far come to disparate conclusions.

Three of these decisions have been referred to above: the Supreme Court judgment of 10 October 2013 (1387/11.5TBBCLG.G1.S1), the Lisbon Court of Appeal judgment

The discussion between the experts mainly concerned what can be derived from these decisions so far as the present case is concerned.

It is important to note that:

The most significant decision discussed by the experts is the Supreme Court decision of 10 October 2013. Professor da Frada’s earlier writings were cited by the Court, which said:

“As Carneiro da Frada warns, with regard to whether the current financial crisis represents a major change of circumstances, “the unexpected and profound manner with which the current crisis erupted, to the surprise of many or almost all, even experts, it seems to point in that direction. Among the factors to be considered the following must be considered, the scope of its reach, the fact that it could not be anticipated and the fact of it being rooted in multiple interdependent causes that are beyond the control and influence of individual economic stakeholders (however important they might be) so that they can protect themselves, as a global crisis, beyond the boundaries of countries and various economic areas of the planet) (see page 682 of the cited work).”

In the result, the Supreme Court upheld the decisions of the lower courts applying Art. 437 to swaps in the context of the financial crisis, regarding it as being an abnormal change of the circumstances upon which a five-year interest rate swap had been contracted.

As BST points out, the court treated the counterparty as unsophisticated in that case, and this played a part in the decision.

It was criticised by Professor Câmara along with the Lisbon Court of Appeal decision of 8 May 2014 on the basis that the Courts had not made a proper assessment of the risks covered by the contract. However that criticism was not convincing, and the court rejects it.

But as he says, that decision can be contrasted with other decisions (including several first instance decisions).

In the three Lisbon Court of Appeal decisions of 2015, being the most recent upon which the experts commented, the outcomes varied.

In the decision of 15 January 2015, the Court considered that the lowering of interest rates was not sufficiently serious to invoke Art. 437. The court said that “…the downward variation that was seen in the rate that was no more than 4%, leads us to conclude that the change that was neither subjectively nor objectively involves the seriousness, unpredictability and especially onerousness that justifies recourse to the special/exceptional termination of the agreement due to abnormal change of circumstances”.

In the decision of 28 April 2015, on the other hand, the Court treated the economic crisis as a change in the circumstances on which a 5-year swap had been contracted.

BST seeks to distinguish this decision on the facts, commenting that the swap was considered to have been “grievously mis-sold” as protection against an increase in EURIBOR.

But in rejecting the bank’s contention that the fall in 3M EURIBOR rates was envisaged by the contract was normal and an inherent risk of the contract, the Court identified the prolonged nature of the situation, saying:

“… in the face of the (lack of) information provided by the bank to R, the contingency factor of the contract envisaged the occasional case of a fall in the 3-month EURIBOR rate below 4.05% as result of normal market oscillations, in which case R. would have to pay 4.72%. But in no way did it envisage a situation of prolonged and significant reduction of this rate as a result of a persistent international crisis as occurred in 2008/2009. This was an abnormal alteration of circumstances seriously affecting the obligations undertaken by R. according to the principles of good faith. All the more so because the lack of information already mentioned makes the abnormality of this alteration in circumstances more apparent. Thus there are legal grounds for the termination of the contract under the terms of art. 437.1 of the CC, therefore this part of the ruling appealed against is to be confirmed”.

The last of the three Lisbon Court of Appeal decisions, that of 2 July 2015, also concerned a plain vanilla swap (page 8). Having cited extensively from academic commentary, the Court held that the “sharp fall” in interest rates was within the risks covered by the contract:

The decision of the Lisbon Court of Appeal of 15 January 2015 was upheld by the majority of the Supreme Court on 26 January 2016. It was stated (in the translation agreed by the parties):

“As for irresistibility, we would have to take a trip from the Letter of Washington, by the commemorated Bill Clinton or from the policy of totally loose capitals unleashed in 1997, to the first Margaret Thatcher government introducing total market deregulation principles in order to explain why the regulators have failed and the lethargy of supervising authorities (?) of banking entities in order to offer an exact and full explanation on the unpredictability of the crisis. It would be inappropriate for a judicial decision to go through an assessment of all the reasons, but a brief look (even if superficial) to the works referred to in note 8 (Footnote: ³⁷) may provide capable and valid elements to lodge the idea that crises are inherent to capitalist systems and that only extreme situations such war or a disaster induced by natural uncontrollable factors (human or Act of God) may grant the character of externality to crises of the system.”

The court considers that overall these decisions result in a restrictive view of the effect of the financial crisis on interest rate swaps.

As BST says, movements in interest rates are not in and of themselves abnormal changes of circumstances.

Equally, however, it has been held that, if prolonged and significant as a result of the crisis, movements in interest rates can be abnormal changes of circumstances.

BST also says, and this is consistent with the terms of the decision of 28 April 2015, that interest rate changes can only be abnormal changes of the circumstances under which parties enter into a contract if the basis of the contract was that the rates would not behave as they have done.

However, BST’s further submission that, in the present case, this would mean the Transport Companies proving that the swaps were entered into on the basis that the relevant reference rates could never fall (and stay) below the relevant barriers, is an unjustified gloss which the court does not accept.

Insofar as either side submitted that there was a “trend” in the cases either in favour of enforcing or not enforcing interest rate swaps post-crisis, the court does not consider that the evidence justifies such a finding.

On the evidence it has received, the court finds that these decisions are fact-sensitive.

BST says that the Supreme Court decision of 26 January 2016 supports its submission that there is no basis to regard the interest rates movements following the 2008 financial crisis as an abnormal change of a relevant circumstance for the purposes of the swaps in these proceedings.

The Transport Companies contest this.

The court’s view is that:

The circumstances on the basis of which the parties entered the swaps

The first substantive issue is as to the circumstances on the basis of which the parties based their decision to enter into the swaps—see the language of the article set out above. This is a factual matter.

The seven swaps relevant to this part of the case were entered into between 6 June 2005 and 2 November 2007.

The Transport Companies’ case is that the basis on which the parties contracted in broad terms was that existing macro-economic conditions would continue i.e. there would be no prolonged major shock to the economic system, such as has occurred as a result of the Global Financial Crisis (“GFC”), affecting interest rate levels.

Their case is that the parties did not anticipate the effect of the GFC, which was to reduce interest rates to zero or near zero levels for a prolonged period of time in, they submit, a completely unprecedented manner.

In closing submissions, BST reiterated a submission made in oral openings, to the effect that the Transport Companies should be held to their pleaded case in this regard.

BST submitted that this limited the Transport Companies’ case as to relevant circumstances to (i) an historical analysis of interest rates, including the fact that 6month EURIBOR rate had dropped below 2% on only one occasion prior to the crisis, (ii) that market consensus was that reference interest rates would continue to rise in 2007, and (iii) that as at the time of concluding the relevant swap, forward rates for 6month EURIBOR rate until October 2017 were between 3.5% and 4.25%.

As at the time the swaps were concluded, BST pointed out, these points were factually correct.

On that basis, BST submitted that the pleaded circumstances on the basis of which the parties based their decision to enter into the swaps were historical facts which never underwent any change. It is said that there is no plea that only normal economic activity was anticipated by either party to be encountered throughout the swaps’ respective terms, and though there is a plea that the Transport Companies considered that it was highly unlikely that rates would evolve in a manner as would expose them to substantial losses, this was again not a circumstance which underwent any change.

The court agrees with BST that a case based on market consensus that reference interest rates would continue to rise, or that rates would not change so as to expose the Transport Companies to substantial losses, would be unsustainable. It could not be credibly argued that the parties based their decision to enter into the swaps on such a consensus, which in any event could be no more than an opinion or forecast. As BST says, this was factually the consensus at the time.

However, that is not the Transport Companies’ case. They rely on these matters as evidence that the parties contracted on the basis that past macro-economic conditions would continue in the future.

The court accepts their submission that taking the pleadings as a whole, their case as to the continuance of macro-economic conditions is sufficiently pleaded in substance. The precise words “macro-economic” are not used in the pleadings, but there is reference to the “economic climate” and “normal economic activity”, and reliance is placed on the abnormal position as regards interest rates since the second quarter of 2009 following the financial crisis.

Further, their case is addressed by the experts in their reports, was the subject of evidence and submission at trial, and was met by a detailed rebuttal in BST’s written closing submissions. It is not in the court’s view credible to say that the Transport Companies could not run it.

The Transport Companies submit that the contemporary material shows that the events of the GFC and its impact on interest rates did not form part of the expectations and therefore part of the basis on which the parties contracted the swaps.

The court accepts this. The fact that the parties never expected a long period of near zero interest rates was confirmed in the oral evidence at trial as the evidence of Ms Antunes for BST shows:

“Q. … Would I be correct in saying that even on a worst case scenario the bank never expected, when it entered into the swap, that the lower barriers of the first MdL swap would be breached for such a sustained period of time.

A.

That’s correct.”

The Transport Companies’ witnesses expressed similar views. As Mr Pinto of MdP put it, the expectation at the time of contracting the first MdP Swap was that “rates below 2% was possible, and it was expectable in scenarios of great retraction … but it was not our expectation that it could go for a long period of time”.

As the Transport Companies say, this is not surprising. The contemporary material including by way of technical analysis shows expectations as to interest rates on the part of the parties which were conventional at the time. This includes the last trade date, which was 2 November 2007 (the STCP swap).

It is correct to state, as BST points out, that even under “normal” conditions, these expectations might turn out to be completely wrong. But the parties could not foresee the drastic changes to macro-economic conditions caused by the Global Financial Crisis, or the effect that this would have on interest rates as described below.

As a matter of fact, the court finds that the circumstances on the basis of which the parties based their decision to enter into these swaps, being “snowball” swaps in respect of which once interest rates fell below the lower barrier the amount payable rose on a leveraged and cumulative basis, was that existing macro-economic conditions would continue to the extent that neither party envisaged that interest rates would fall to near zero for a prolonged period—which as explained below, is unprecedented. This possibility was not foreseen even as very unlikely. The court accepts the Transport Companies’ case in relation to this issue.

Whether there has been an abnormal change in circumstances

It is of the essence of this provision that circumstances have changed abnormally. This hinges on the effect of the Global Financial Crisis (GFC) and its aftermath on interest rates in the context of these particular swaps.

The law in this respect is set out above.

The Transport Companies’ case is that:

BST’s case is that:

At one point, the Transport Companies also appeared to contend that the relevant reference rates themselves, that is EURIBOR and USD LIBOR, were a “very different phenomenon” in the post-financial crisis world. This point does not appear to have been pursued, and it would have been rejected by the court if it had been. Such changes as there have been in these benchmarks are legally irrelevant. The rates continue to be similarly constructed, seek to reflect the wholesale cost of financing for banks, and to move closely with the rates set by central banks. The nature of EURIBOR and USD LIBOR has not changed since the financial crisis.

The expert evidence on this subject was given by economists, Professor Charles Wyplosz for BST, and Professor Giancarlo Corsetti for the Transport Companies. Both are respected international commentators on the financial scene. On the face of their reports, there was a considerable difference of opinion between them, but much of this evaporated in the course of the evidence.

For convenience, Professors Corsetti and Wyplosz break down the analysis of the GFC thus far under three phases: from August 2007 to September 2008, from September 2008 onwards, and the sovereign debt crisis.

In summary, for present purposes, the crisis can be taken to have begun on 9 August 2007, when BNP Paribas terminated withdrawals from three hedge funds on the basis of “a complete evaporation of liquidity” (Footnote: ³⁸). Reflecting this, the first phase of the crisis is generally known as the “credit crunch”.

At that time interest rates did not diverge radically from a “conventional” pattern. EURIBOR had been raised in August 2008, and was around 5% by Autumn 2008. The Fed Funds Target rate was at 2% in September 2008, rates having been progressively lowered—in June 2008, a decision was taken not to lower them further as “financial market conditions generally appear to have improved modestly”.

In fact, financial market conditions did not improve, and the next phase of the crisis began with a cluster of well-known events in September 2008. In particular, on 15 September 2008, Lehman Brothers filed for bankruptcy, and on 16 September 2008, AIG (Footnote: ³⁹) required emergency assistance to prevent it also failing.

Interest rates swiftly and sharply reduced, EURIBOR falling from 5% to around 0.5% in six months. The Fed Funds Target rate which had been at 2% fell to within a range of 0-0.25% by the end of 2008, closely tracked by LIBOR.

The next phase of the crisis concerned sovereign debt, and arose (so far as relevant) in the euro area. There is disagreement between the experts as to the time of commencement of this phase: Professor Corsetti places it in 2011, and Professor Wyplosz places it in 2010, but the difference is immaterial.

By 2011 there was a crisis, and EURIBOR rose to just over 1% for a time in 2011— the experts agree that this was in response to a “policy mistake” by the ECB. The rates fell back to near zero in 2012. The significant point is that the experts agree that since February 2009, 3 month EURIBOR rates have been at a low level which was unprecedented since EURIBOR was established in December 1998 (on the introduction of the euro on 1 January 1999).

US dollar interest rates have remained at near zero from the end of 2008. After the hearing ended, the fact that the Federal Reserve decided on 16 December 2015 to

Economists refer to the situation in which policy interest rates set by a central bank are at or near zero as the “zero lower bound” (ZLB), or the zero lower bound problem. The theory is (or was) that interest rates cannot readily be set at lower than zero, since there is no incentive to place money at a negative rate, thereby placing a constraint on monetary policy. Negative interest rates slightly below zero have in fact been introduced by the ECB and some other central banks on bank reserves, the evidence being that this is a direct response to the conditions created by the crisis.

BST points to the fact that it is common ground between the experts that “real interest rates have not been unusually low”. But this is the result of the relationship between “real” interest rates and inflation, and inflation has also been near zero. The court agrees with the Transport Companies that it is not relevant to the issues for decision, which concern the effect of low nominal interest rates on the contracts in question.

BST’s case is that banking crises tend to be more prolonged than pure stock market crashes, and typically endure for four to six years. The usual response of central banks is to adapt their monetary policy and bring interest rates low and to hold them for as long as is necessary, as is common ground. It submits that low nominal interest rates, constrained by the ZLB, for periods in excess of four to six years, were a predictable outcome of a banking crisis, and are consistent with the “existing macroeconomic conditions” when the swaps were entered into. It relies on the following main points.

BST says that when talking about monetary policies, interest rates, or the economy more generally, there are times which may be described as ‘normal’, but that times of crises or unusual policies or rates are not ‘abnormal’. Professor Wyplosz described the GFC as a classic financial crisis. He added that there is no concept of “abnormality” in economics.

However, as the Transport Companies submit, the fact that in the abstract crises occur, and are in that sense normal, does not inform one about this crisis. It is correct that there have been a number of crises in recent times—BST cites the 1970s energy crisis, the early 1980s recession, the 1987 stock market crash (‘Black Monday’), the Swedish banking crisis and other Scandinavian crises of the 1980s and 1990s, the Asian crisis of the late 1990s, affecting Thailand, South Korea and others, the 1998 Russian crisis and rescue of LTCM; and the bursting of the dot.com bubble in the early 2000s. Others might be added.

But the court accepts the evidence of Professor Corsetti that these bear no comparison with the Global Financial Crisis that came to a head in September 2008 as described above. Nor is there any real comparison with the position in Japan so far as this analogy was pursued.

By the end of the evidence, this was not really in dispute. The only true comparator of the GFC is the stock market crash of 1929 and the ensuing Great Depression, and

Professor Wyplosz did not demur from this description, accepting Mr Bernanke’s status as an economic historian. It is consistent with his own writing prior to the trial. In an October 2011 note, he referred to the financial crisis being of “historical proportions, fully remindful of the 1929 crisis”.

Whether or not there is a concept of “abnormality” in economics appears a largely semantic objection, and arises because “abnormal circumstances” is the term used in the applicable provision of the Portuguese Civil Code. In fact, the evidence is that references to normality are frequent in the literature, including by Professor Wyplosz himself, and other distinguished economists. There is in any case no difficulty in applying the term to a factual situation like this.

The crucial issue is how the effect of the crisis on interest rates is to be regarded, because as magnified by leverage and accumulated by the “snowball” structure, this is what has produced the very high interest rates in the case of these particular swaps. In this regard, BST makes a number of points.

As BST says, Professor Corsetti did not maintain his initial position that rates could be defined as unusually low if held at near zero for a period in excess of six quarters. This however was only put forward as an attempt at an objective test, and does not affect the thrust of his evidence.

The court does not accept BST’s suggestion that the effect of the raising of EURIBOR in 2011 means that there would in any event be no possibility for the Transport Companies to establish six consecutive quarters of reference rates at the ZLB—the experts agreed that the temporary rise to just over 1% was in response to what they called a “policy mistake” by the ECB, and one which was soon reversed. The court finds that the temporary rise in 2011 in the context of the sovereign debt phase of the crisis does not affect the overall picture.

Professor Wyplosz’s evidence, which in this respect is common ground, is that the response of central banks to banking crises is to adapt their monetary policies typically involving (i) quickly and sharply cutting the policy interest rate, (ii) promptly injecting a large amount of liquidity into the interbank market and (iii) providing emergency support to ailing commercial banks.

The question to be answered however is as to the response in relation to the GFC. All these things were done, but it is common ground that the scale of the crisis as it erupted in September 2008 required a response that went well beyond this.

There were two main elements that were explored in the evidence, the first being quantitative easing. This is the process by which certain central banks have created money to buy financial assets on a large scale in response to crisis conditions. In a commentary in September 2013, Professor Wyplosz described the Federal Reserve’s quantitative easing programme as “having no historical precedent”. This applies equally to the quantitative easing programmes adopted by the ECB and the Bank of England.

As regards interest rates, which are the second element, the factual position is described above. BST is correct to point out that there have been other instances where low interest rates have prevailed for extended periods. The evidence identified US interest rates during the Great Depression and the Second World War (there was disagreement between the experts as to the appropriate rate which the court need not resolve), and contemporary interest rates in Japan.

However, the court accepts Professor Corsetti’s evidence that the situation resulting from the Global Financial Crisis is very different even from these. In fact, among the vast amount of material before the court on this issue (Footnote: ⁴⁰), the point emerges sufficiently from a paper⁴⁴ prepared by Professor Wyplosz for the European Parliament in February 2013. He refers to “the down phase of the cycle” as being “extraordinarily long”, saying that “interest rates may eventually revert to normal levels”, but because of “the depth of the crisis” especially in the euro area “this might take quite some time”.

He pointed out in the paper that the ECB’s policy rate had been almost at the zero lower bound for about four years, and predicted that “we may experience a few more years of near-zero rate”. In fact, at the time of this judgment, they are still at this level. 604.As a result, Professor Wyplosz said, “we seem to live in a different world”.

Of the three central banks whose policy interest rates featured most in the evidence, the Bank of England has the longest experience. Since March 2009, the Bank of England base rate has been 0.5%. Statistics produced by Professor Corsetti go back to 1824, and show that prior to March 2009, the base rate had never fallen below 2%. Professor Wyplosz points out that the effect of going off the gold standard in 1931 was to devalue the currency obviating, he says, the need to further lower interest rates—but this does not detract from the fact that current interest rates are unprecedented.

The issue then arises between the parties as to the extent to which this state of affairs was predictable.

It is agreed that it was not in fact predicted, and that even figures who expressed concerns prior to the crisis did not predict its precise modalities. Though concerns as

It is common ground that this turned out to be wrong.

Nevertheless, BST argues that the current interest rate environment was predictable in the sense that the period of time for which nominal rates would have to be held at or near the zero lower bound was a ‘known unknown’ when the swaps were concluded, because with low inflation rates in the years preceding the crisis, and a desire to bring real rates low, central banks would be more likely to bring nominal rates down to their ZLB. Whilst there was uncertainty in this respect, commentators (Footnote: ⁴¹) appreciated that at the ZLB non-standard monetary policies might have to be adopted.

However, it is clear on the evidence that what happened as a result of the crisis went far beyond this.

In an analysis by the President of the Federal Reserve Bank of San Francisco, the ZLB was described as going from a theoretical problem, to a very real problem (Footnote: ⁴²). The Transport Companies rely on this analysis, and in particular as to what forecasts showed. In that regard “a wide range of macroeconomic forecasting models constructed based on postwar U.S. data predict that the probability of multiple years stuck at the ZLB, is extremely remote—essentially nonexistent”.

But this is what has happened, and as this passage highlights, it is not just the fact of, but also the longevity of, interest rates “stuck at the ZLB” that has had such a dramatic effect on the “snowball” swaps in this case.

An explanation for this failure to foresee or predict what happened is to be found in academic commentary (Footnote: ⁴³) cited by the Transport Companies:

“The global financial crisis of 2008 was fundamentally a credit crisis on a massive, international scale”. Nothing remotely like it had been seen since the 1930s”.

“… we did not think something like this could happen. This mistaken belief had two flawed ingredients. First, we saw the chances of a financial crisis as almost impossibly remote – we thought these events happened to others, like emerging markets, but not to us. Second, even if we did admit some tiny risk of crises, we thought they would not be too painful: We could cope and clean up satisfactorily using the policy tools and skills at hand. All seemed well, and faith rested on the Great Moderation (Footnote: ⁴⁴), inflation targeting, financial development, efficient markets, and a slew of institutional reforms.”

Drawing the material together, the court broadly accepts Professor Corsetti’s evidence to the limited extent that there is still any difference with that of Professor Wyplosz.

Professor Wyplosz accepted that the combination of zero interest rates and massive increases in the balance sheets of central banks caused by quantitative easing was unprecedented, and the court finds that each of these factors was unprecedented.

The court rejects BST’s submission that in light of the macro-economic conditions existing in 2005, including the known uncertainties, what happened in 2008 and following was “not outside the landscape of normal economic activity”. As Professor Wyplosz put it in his writing, “we seem to live in a different world”.

That being so, the court accepts the Transport Companies’ submission that, in the case of these swaps, in which the effect of interest rates behaving in an unprecedented manner has been magnified by the snowball structure, there has been a profound change in the macro-economic circumstances on which the parties based their decision to enter the swaps. Applying the test in Art. 437 of the Civil Code, the court accepts their submission that the global financial crisis constitutes an “abnormal change of circumstances” occurring since the parties entered into the swaps in the period 2005-2007; and that the fact that since 2009 policy and swap reference rates have been at unusually low levels for an abnormal length of time, by itself amounts to an abnormal change of circumstances.

That finding is consistent with those Portuguese cases which uphold swaps notwithstanding the crisis, because none of them involved snowball swaps.

Whether, if there has been an abnormal change, that change forms part of the risks covered by the contract

The next issue is whether, if there has been an abnormal change, that change forms part of the risks covered by the contract.

In closing, BST summarised its case on this issue as follows. There are two reasons why, in this case, any abnormal changes in interest rates are part of the risks covered by the swaps. (1) The risks were known to and willingly taken by the Transport Companies; and (2) it was the very purpose of the swaps to respond to movements in interest rates, including those that have been encountered.

In closing, the Transport Companies summarised their case on this issue as follows. The essence of a great change of circumstances is that neither contracting party saw it coming, however sophisticated. That is, in substance, what the Transport Companies say about the Global Financial Crisis. Neither the Transport Companies, nor BST, expected interest rates to stay so low for so long with the impact that had on the rates payable under the swaps, so it follows from this that BST cannot have anticipated

It is obvious that, and the court accepts that, even under normal conditions, it was foreseeable that interest rates might cross the upper and/or lower barriers for substantial periods of time resulting in elevated interest levels. As BST says, this risk was the quid pro quo for the payment stream that the bank paid to the Transport Companies in the early years of the swaps based on the low fixed rate. The risk of elevated interest payments was built into these swaps, and the Transport Companies freely entered into them.

However, normal conditions did not prevail. For reasons set out above, the risks that transpired in the Global Financial Crisis of near zero interest rates for a prolonged period (which continues at the time of this judgment) were not known to, and could not have been foreseen, by either party. It is correct that a purpose of the swaps was to respond to movements in interest rates, but not those that have been encountered.

BST points to the passage already referred to in the Transport Companies’ written closings, in which it is said that it is of the essence of an interest rate swap that it makes provision for every possible change in the relevant reference rate. This, it is submitted, resolves this issue in BST’s favour. The court does not accept that, and read with the rest of the Transport Companies’ case, the passage in question lies within the macroeconomic framework that obtained at the time.

As to the law, reference is made to the discussion above. The test applied by the Portuguese Supreme Court in the decision of 10 October 2013 is whether the risk is “… the tolerable risk; that is to say, the reasonable risk and somehow foreseeable in light of the economic and financial climate at the time the contract was concluded, at the time in which the plaintiff and also the defendant could assess, on an informed basis, if the bank’s proposal would meet or not their interests”. As explained above, the cases have differed in result depending on the facts.

The Transport Companies rely on a comparison between the facts of the present case, and those of the cases considered by the Portuguese courts as set out above. Though it is common ground that the effect of the circumstances on the particular contract is to be taken into account under Art. 437, BST submits that it is not something to be taken into account at the stage of trying to understand what risks have been allocated in the contract. However, as noted earlier, in the course of their decisions, the Portuguese courts discuss the questions that arise under Art. 437 together, as one would expect. The facts are relevant at this stage too.

The terms of the swaps in the five most significant cases are not in dispute:

Thus the rates payable by the counterparty in these cases (broadly) ranged from 4.55% to 4.72% over a term of five years. The disparity with floating rates is not comparable to the present case.

This is the context of the decision of the Lisbon Court of Appeal of 2 July 2015 cited above that the “sharp fall” in interest rates was within the risks covered by the contract, and so far as it covers this issue (which the Transport Companies dispute) the Supreme Court decision of 26 January 2016.

It is the context in which commentators such as Professor Maria Clara Calheiros in O Contrato do swap no contexto da actual crise financeira global (2013) cited by BST have written that “it is hard to understand that the sharp drop of the interest rates did not constitute a risk of the contract itself, since it is precisely the possibility that this sharp rise or fall may occur that leads the parties to conclude the swap contract”.

The Transport Companies are liable to pay interest rates which are far higher than those in the decided cases, as the following table as at 1 October 2015 taken from their submissions (and not disputed), together with the rates payable by BST by comparison, shows:

So long as interest reference rates remain outside the barriers—and there is no sign of them moving inside the barriers at the time of this judgment—these rates will continue to rise as a consequence of the “snowball” and leverage factors. Further, the swaps have much longer terms than the five year terms typical of the decided cases.

As at 16 March 2015, Mr Harkins expected the interest rate on MdL 3 to rise to 50.61% and the interest rate on MdP 1 to rise to 164.326%. His calculations have not been challenged.

The court agrees with the Transport Companies that the risk of this occurring is not a risk covered by the swaps.

The ‘Risk Evaluation’ representation in the Master Agreements (by which the company represented that it was aware “that OTC derivative transactions, like other financial transactions, involve a variety of significant risks… Highly leveraged transactions may experience substantial gains or losses in value as a result of relatively small changes in the value or level of an underlying or related market factors”) does not apply to circumstances such as this.

Whether requiring the Transport Companies to continue to perform their obligations under the swaps would be a serious breach of the principles of good faith

Professor da Frada and Professor Câmara are broadly in agreement that this requirement applies if performance has become excessively hard and its maintenance would lead to a result contrary to both law and justice. As both parties’ closing submissions implicitly recognised, the conclusion on this issue goes with the earlier conclusions.

In the language used in the cases, the court agrees with the Transport Companies that the consequence of the GFC and its effect on interest rates has resulted in a financial imbalance between the parties to the swaps, adversely affecting the equilibrium of the contracts. Requiring the Transport Companies to continue to perform their obligations under the swaps would require them, and them alone, to bear the burden of the adverse effects of the GFC, which, applying Art. 437 of the Civil Code, as the Portuguese Supreme Court put it in its judgment of 10 October 2013, would be “contrary to what good faith dictates”.

For the avoidance of doubt, this has nothing to do with the parties’ good faith when the contracts were entered into. These were always very risky contracts, but having seen the bank officers testify, the court is satisfied that they never foresaw that the bank would become entitled or the Transport Companies liable to payment at these massive rates.

As Mr José Manuel Alves Elias da Costa, Head of BSNP between 2002 and 2008, and who was involved with maintaining the client relationship with Transport Companies at a senior level, told the Parliamentary enquiry, “At the time this structure was contracted the possibility of the 2% barrier being breached was practically nil”.

In the light of what has happened, the court finds that as a matter of Portuguese law, requiring the Transport Companies to continue to perform their obligations under the swaps would be a serious breach of the principles of good faith within the meaning of Art. 437.

It follows that if Portuguese law had applied to the swaps, the court would have upheld the Transport Companies’ case that the requirements of Art. 437 of the Civil

Had the court found in favour of the Transport Companies on this issue, the question would have arisen whether they are entitled to termination of the swaps and, if so, from what date(s), or whether modification should apply. The possibility of modification arises from the terms of Art. 437(2) which is set out above.

In the event, both parties told the court in closing that if it found in favour of the Transport Companies, the question of remedy should be dealt with at a subsequent hearing.

The court will therefore limit itself to the following comments on the issue of remedy. It is common ground that where Art. 437 applies, priority is given to contractual modification over termination. A solution which is fair to both sides could be fashioned, in the court’s view. It is also common ground that it would be open to the English court to modify the swaps if Art. 437 were engaged—though not entirely free from doubt, this seems a sensible approach (Footnote: ⁴⁵), and the court does not demur from the position adopted by the parties.

This issue concerns breaches asserted by the Transport Companies on the part of BST of certain provisions of the Securities Code, being provisions which apply to derivatives such as swaps. It is not in dispute that these provisions are mandatory— see above.

The Securities Code is a central component of securities law in Portugal, the current code being that adopted in 1999, which has since been amended on various occasions.

The Code followed the implementation in Portuguese law of the then applicable European legislation, namely the Investment Services Directive (Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field). The ISD established the conditions under which authorised investment firms and banks could provide specified services in other EU member states, and relevantly for present purposes, included harmonised conduct of business rules.

Substantial changes in the code were required by the Markets in Financial Instruments Directive (Directive 2004/39/EC) which is invariably referred to as MiFID, which replaced the Investment Services Directive as of the effective date, 1 November 2007.

It is not in dispute that whereas the ISD was an instrument of “minimum harmonisation” which could be implemented in national law with higher standards, MiFID is an instrument of “maximum harmonisation”, intended to apply a “level playing field” through the European Union in the areas it covers.

The relevant part of the text of Arts. 304 and 309 Securities Code (as set out in the 2006 version) on which the Transport Companies’ claim is based is as follows:

“304 Principles

The Transport Companies’ claim for breach of these articles was articulated as a composite claim—in other words, it tends to read the articles together. In its analysis, BST tends to read the articles separately. However, the same issues arise, and the court will follows the Transport Companies’ structure in this respect. The issues are:

It is the Transport Companies’ case that BST acted in breach of its duties as a financial intermediary under Arts. 304 and 309 of the Securities Code. In putting forward the swaps to them, which were both incapable of performing the interest rate risk management function that was their purported purpose and which were significantly imbalanced in favour of BST, BST acted in breach of its duties as a financial intermediary to act: (a) so as to protect its client’s legitimate interests and/or observe the rules of good faith in accordance with high standards of loyalty (as required by Arts. 304(1) and 304(2) of the Code); and/or (b) so as to minimise the risk of conflicts of interest and to give preference to its client’s interests over its own (as required by Arts. 309(1) and 309(3) of the Code).

The Transport Companies submit that on a proper understanding of these provisions, BST is wrong to contend that insofar as Art. 304 applies at all, it is satisfied by BST’s compliance with Art. 312 (Duties of Information). As a financial intermediary, it was under a pre-contractual duty of good faith and loyalty to them in relation to the swaps and was therefore under the statutory duties imposed by Arts. 304(1), 304(2) and 309 of the Securities Code.

The Transport Companies’ case is that the circumstances of the swaps and their presentation to the Transport Companies were exceptional and that, in these exceptional circumstances, BST acted in breach of its pre-contractual duties of good faith and loyalty as imposed by Art. 304 and in breach of its duty under Art. 309 to manage its conflicts of interest when it proposed these instruments to the Transport Companies. BST knew – or ought to have known – better and, just as an intermediary is obliged to refuse to execute an order under Art. 326 of the Code when it is contrary to the intentions of the entity placing the order, so BST was obliged not to have proposed these instruments to the Transport Companies, when they were so contrary to their objectives. In doing so, BST acted contrary to its pre-contractual duties of good faith and loyalty imposed by Portuguese law under (and so in breach of) Arts. 304(1), 304(2) and 309 of the Securities Code.

In summary, these “exceptional circumstances” were that (1) BST did not act as a “pure” principal-to-principal counterparty in its dealings with the Transport Companies presenting itself as their “partner”, (2) BST presented the swaps as instruments of “financial risk management” when they were not, but were speculative and risky, (3) BST knew the extent (if not the full extent) of the risks that the Transport Companies would run by entering the swaps, (4) BST knew that the Transport Companies provided services of public importance, that the fares they could charge were restricted by the State, and that if they sustained the losses that BST calculated they might suffer, they would have to look to the State, (5) BST knew – or ought to have known – that the Transport Companies had no experience of leveraged, snowball swaps; by comparison with the ordinary consumer, the Transport Companies may have been sophisticated; by comparison with BST – which is the right comparator – they were not, (6) BST knew – or ought to have known – that the Transport Companies, whilst they might have understood mathematically how the formulae in the swaps worked, did not appreciate the risks that they were running, (7)

As a result, the Transport Companies assert that they have suffered loss and damage in respect of eight of the nine swaps, which they claim from BST. (No damage is alleged in relation to the MdP 2 swap, which MdP claims to be entitled to rescind by way of a remedy under Art. 562 Civil Code.)

BST’s case is that when transacting swaps on own account, as in the present transactions, it did not have a duty not to propose or contract swaps based on an evaluation of their suitability for the client. When entering into a transaction with a client on own account, the general duties in Art. 304 are satisfied by compliance with the information duties in Art. 312. If a bank transacts a swap with a client (at least in the absence of deceiving the client) the bank is not thereby put in breach of its conflict of interest duties or to prefer their clients’ interests with regard to their own. It was for the Transport Companies themselves, not BST, to reach a decision whether or not to contract the swaps.

The Transport Companies were sophisticated financial operators with highly experienced finance departments and a wealth of financial expertise within their respective boards, having entered into numerous swaps prior to the swaps. As a result, they well understood the terms of the swaps and the operation and risks of the snowball mechanism, in particular that spreads would accumulate upon a breach of the relevant barriers and that liability was potentially uncapped. They understood that the swaps offered a greater reward in return for these risks, and reached the view that, on balance, entering into them would further their legitimate interests, namely to protect against rising rates and reduce their cost of funds, within the relevant barriers.

When a firm contracts with a client as a counterparty, no duty to prefer the client’s interests arises and where a client freely enters into a contract with a firm, and knows the firm is dealing as its counterparty, this does not put the firm into a position of conflict of interest under Art. 309. The situation is one under which the firm is required to be transparent about the transaction, but the client is free to make up its own mind and is bound by the consequences of an investment which is freely made with the firm.

As to Art. 304, in the context of dealing on own account, the only concrete inference of the duty of good faith and loyalty is the disclosure duty; and the requirement of putting other people’s interests above one’s own cannot apply to own-account dealing.

In any event, BST asserts that all of the Securities Code claims are time-barred, and that even if BST were liable, the claims made by the Transport Companies would fall to be reduced under Art. 570 Civil Code by virtue of (1) their failure to have proper regard to protecting their own interests when entering into the swaps (c.f. English contributory fault defence), (2) savings achieved by MdP and MdL in entering into further instruments with third parties to hedge and reduce their liability under the swaps, and (3) the Transport Companies’ failure further to mitigate or avoid the losses suffered by them. The validity of each of these additional assertions is also denied by the Transport Companies.

The parties were in dispute at the end of the trial as to the scope of the Transport Companies’ pleaded case. The essence of the dispute goes to whether the Transport Companies are entitled to rely on any assertion that they did not appreciate the risks they were running on entering into the swaps, and BST’s awareness of this said to have arisen from BST’s failure to provide them with relevant information. This argument arose over the seven factors in the section on “exceptional circumstances” in the Transport Companies’ written closing submissions—these are summarised above.

The factor which BST in particular objects to asserts that:

“Sixth, BST knew – or ought to have known – that the Transport Companies, whilst they might have understood mathematically how the formulae in the Swaps worked, did not appreciate the risks that they were running. BST knew or ought to have known that from the fact that it did not inform the Transport Companies of the RECs or the initial MtMs and that the Transport Companies did not have the internal capability to calculate either. It knew or ought to have known that from the fact that BST (other than in relation to 3 Swaps) did not provide the Transport Companies with any stress testing …. It knew or ought to have known that from such matters as the fact that it (BST) itself informed e.g. Carris in relation to the First Carris Swap that the risk of the barriers being exceeded was “predicted to be of null value” … and the fact that Pedro Pinto for MdP considered in relation to the First MdP Swap that the digi-coupon was an effective risk mitigator, whereas clearly it was not …”.

In short, BST says that the Transport Companies have gone beyond their pleaded case which does not assert any such lack of understanding or lack of information. As it put it in its written closing submissions, this is not a case where any complaint is made about the information provided by the bank being either inaccurate or inadequate in order to enable the Transport Companies to understand both the transactions and the nature of the risks involved.

The Transport Companies respond that it is BST that has put their supposed financial sophistication on the agenda, and that they are entitled to meet this allegation, and rely on the case to the contrary.

In considering these submissions, the starting point is the Transport Companies pleaded case as to breach. This is that:

“49.

BST acted in breach of the said duties in that:

Paraphrasing paragraph 49, the pleaded case is that in the event that the relevant reference rates did not perform in accordance with market expectations, BST stood to profit significantly whereas the Transport Companies were completely exposed, and so in the circumstances (1) BST gave preference to its own interest, (2) failed to protect the Transport Companies’ interests, and (3) failed to act in good faith and/or in accordance with high standards of loyalty. Sub-paragraph (1) is directed at Art. 309(3), and the remaining sub-paragraphs at Art. 304.

In its Reply to BST’s Defence to Counterclaim, it is further pleaded that BST was in breach, “by proposing the Swaps to Carris, which were not in Carris’s interests …”. It is therefore the Transport Companies’ case that BST was in breach in proposing the swaps to the Transport Companies.

All these extracts are from the Carris pleadings, those of the other companies being the same.

BST maintains that this pleading excludes any case of breach of the Securities Code based on a failure on its part to explain the swaps, or a failure on the part of the Transport Companies to understand them based on a failure to provide information. This was plainly put in BST’s written opening submissions at the start of the trial:

“It must be stressed that (as the TCs themselves put it) “there is no allegation of mis-selling in the present case”. Their complaint is not that any of the Swaps, or their respective characteristics, were misrepresented to them, or imperfectly understood by them. They likewise raise no allegation that BST owed or breached any advisory duty. Nor do the TCs allege that BST failed to provide them with relevant information about the Swaps. Similarly, they do not contend that their experience or expertise in relation to financial transactions was insufficient for the Swaps to be appropriate for them. In short, all the normal elements of a financial mis-selling claim are absent …”. 671. In response, the Transport Companies maintain that the duty of good faith under Art. 304, and the duties under Art. 309, are adapted in any given situation, and that the factual background is important therefore when assessing whether, as the Transport Companies allege, BST acted contrary to these duties. The factual background is obviously a matter of evidence, and that evidence will develop in the course of the trial. They submit that there is no pleading objection to their case as put in closing submissions when one takes into account an understanding of how the factual background has emerged in the evidence, and the findings of fact sought by BST itself.

The court agrees with the Transport Companies that BST has sought to emphasise (to quote from its closing submissions) that the Transport Companies “were sophisticated financial operators”. The relevant submissions are set out above. The Transport Companies are right to say that they are entitled to challenge this assertion, and ask the court to make factual findings (which the court has done above), and rely on those findings.

Nevertheless, it is a feature of the conduct of business rules in MiFID and its ISD predecessor that they are stated at a high level of generality. Where a claim is brought based on breach of the rules, here breach of its implementation in national law by way of the Securities Code, it is important that the claimant clearly pleads the nature of the breach alleged. Unless the case is clearly spelled out, there is a danger that the claim becomes a moving target.

The court agrees with BST that in essence the Transport Companies’ pleaded case is that "the reason that you have acted in breach of these obligations is because you entered into a transaction that led to us having potentially unlimited liability in circumstances where you were going to make a profit". It is similarly summarised in paragraph 471 of the Transport Companies’ written opening submissions.

There is no pleaded case based on a failure on their part to understand the swaps, or that BST “knew or ought to have known this” based on a failure to provide information which should have been provided. The evidence, perhaps disclosure (though this already was very extensive), arguments, etc., may have been different if there had been. The court accepts BST’s submission that it would not be right to allow such a case to be advanced now.

In any event, the court does not accept the factual premises of the Transport Companies’ closing submissions. This is dealt with further below.

The expert evidence was given by Professor da Frada for the Transport Companies, and Professor Câmara for BST. The court refers to what it said above as to these two good witnesses. Here, in a sense, the table is turned, because the subject matter of the Securities Code issue is in the specialist area of financial regulatory law, and specifically the effect of provisions deriving from the Investment Services Directive/MiFID. Professor Câmara has spent most of his professional career in this field with the Portuguese Securities Commission and thereafter in private practice.

By contrast, Professor da Frada is pre-eminent in Portugal in the field of private law, and financial regulation is not within his particular area of expertise. His evidence that there was nothing in the Securities Code on the subject of “own account” dealing was incorrect, since a chapter of Title VI is concerned with ‘Dealing on own account’. The court does not accept the Transport Companies’ assertion that Professor Câmara’s evidence was not directed to the particular facts of the situation the court has to consider. On this issue, save where otherwise stated, the court prefers his evidence.

It is common ground that the regulatory classification of the Transport Companies does not affect the scope of the duties owed by BST.

It is also common ground that, when BST entered the swaps, it did so as principal on its own account. In other words, in their contractual dealing, BST and the Transport Companies contracted on a principal to principal basis. The bank acted on its own account, and not as agent, or adviser. The evidence is that this is how the OTC swaps market operates.

It is also common ground that, when it did so, BST was acting as a “financial intermediary” within the meaning of the ISD and the Securities Code. Art. 304 applies to a diverse range of activities of financial intermediaries, including executing transactions for clients, advice and portfolio management, corporate finance, and, the relevant category here, “dealing for own account”, as when a bank executes a swap with a counterparty. In the latter case, the relevant activity is defined in the Annex to the ISD as “Dealing in any of the instruments listed in Section B [which includes interest rate swaps] for own account”. (The term used in the equivalent Annex to MiFID is “dealing on own account”.)

As the Transport Companies say, Professor Câmara draws a distinction between an “investment service”, which is said to amount to a fiduciary service, and an “investment activity”, which does not. They say that this distinction is Professor Câmara’s personal gloss on the Securities Code, and has no support in the code itself, and results in difficulties and contradictions, arising from the terms of the Investment Services Directive, and its implementation in the Securities Code.

It is also said to result in an inconsistent approach to the requirement of good faith. The Transport Companies’ case is that Professor da Frada’s interpretation of Art. 304(2) of the Securities Code ensures the general application of Art. 227 of the Civil Code (which requires the observance of good faith in pre-contractual relations).

They contend that if Professor Câmara were to accept (as Professor da Frada accepts and the Transport Companies contend), that Arts. 304(1), 304(2) and 309 apply in full to financial intermediaries at all times, albeit with varying “intensities”, depending on the relationship between the intermediary and the client and the particular fact situation, none of these difficulties and contradictions would arise.

They contend that the material in support of the non-application (as opposed to the level or “intensity” of application) of these duties is unconvincing. They submit that:

The Transport Companies’ case (based on Professor da Frada’s evidence as to the particular standards which are applied in Portuguese law) is that BST as a financial intermediary was under a pre-contractual duty of good faith and loyalty to the Transport Companies in relation to the swaps, and was therefore under the statutory duties imposed by Arts. 304(1), 304(2) and 309 of the Securities Code.

As regards Art. 304, the Transport Companies argue that BST is wrong in its contentions based on the fact that they did not give BST a mandate to decide on their behalf whether or not to enter the swaps. It does not follow, they say, that “there is no scope for any contention that BST owed … an ‘evaluative duty or duty not to propose or contract swaps’. It is precisely such a duty – or as the Transport Companies would say, remedy – that the pre-MiFID Securities Code does contemplate”.

BST’s case (based on Professor Câmara’s evidence) is as follows. The range of financial activities which is subject to regulation in Portugal, it submits, as in the rest of the EU, is heterogeneous, but distinguishes between (1) services which a firm renders on the client’s behalf; and (2) others that are not rendered on the client’s behalf. This was the case at all relevant times for these proceedings, whether pre or post MiFID.

MiFID, and the post-MiFID Securities Code, it submits, reflect a progressive articulation of categories of investment activities which are performed by a financial intermediary on its own account, on the one hand, and investment services which it provides on its client’s behalf, on the other hand. Under this regime, in the case of investment activities, the firm does not act on behalf of the client—it acts in the financial firm’s own interest and behalf. Therefore, agency duties, such as the duty to put the client’s interests before the firm’s interests (as Art. 309(2) contemplates), do not arise when acting on own account (such as when executing an OTC swap trade as counterparty or principal), as the deal is contracted on a principal to principal basis.

The court’s findings on the opposing contentions are as follows:

Nor does there seem much basis for the duties contended for:

The Transport Companies argue that BST should itself have assessed whether the swaps were appropriate and warned the Transport Companies accordingly. But on that basis, the evaluative duty they contend for becomes indistinguishable from a duty to advise, which they themselves make clear they do not assert.

Broadly, the court would accept the distinction drawn by Professor Câmara between “activities” and “services”. But the key point is a functional one—when a bank is

The court is satisfied that this is equally the position under Portuguese law, and does not accept Professor da Frada’s evidence so far as it was to the contrary.

It finds support in the decision of the Lisbon Court of Appeal of 13 May 2013, which also involved an interest rate swap. As the court put it, “we do not see how it can be claimed that there is a conflict of interests which the Defendant Bank did not know how (or did not want) to avoid or reduce, to give priority to the client’s interests”. This goes further than a finding on the particular facts, as the Transport Companies suggest.

The Transport Companies cite the judgment of the Supreme Court of 10 January 2013 (89/10.4TVPRT.P1.S1) recording the Plaintiff as stating that Art. 304(2) provides a “diligentissimus pater familias” standard. But Professor Câmara did not agree that this applied in an own account case, and the court accepts his evidence.

The court further accepts that in this situation there is no duty to advise as to the suitability of the swaps for the client:

There is no support for their contention that Art. 304 has the effect that if the swaps were “manifestly disproportionately” in BST’s favour, they ought never to have been proposed to the Transport Companies, and the court rejects the contention. It finds that the bank had the duties of transparency required by Art. 312, but that as a matter of Portuguese law, it was for the Transport Companies themselves, not BST, to reach a decision as to whether or not they contracted the swaps.

On the pleaded case, no question of breach arises. The court has upheld BST’s submission that the alleged duties under the Securities Code do not exist. It follows that there was no breach of duty in proposing these swaps.

That finding sits with the evidence as a whole. BST was told that MdL was speaking to a number of competing banks in order to find the structure that was most favourable to it. As BST says, the circumstances in which the swaps were concluded included competition between various banks for the Transport Companies’ business. They entered into the swaps that they considered were best—it is a reasonable inference that if BST had not proposed the swaps, other banks would have done so. Contrary to the Transport Companies’ submissions, for reasons given earlier, the swaps were capable of performing their purpose.

In closing, the Transport Companies emphasised what they contend were the exceptional circumstances of the swaps and their presentation. They say that in these exceptional circumstances, the court should find that BST acted in breach of its precontractual duties of good faith and loyalty as imposed by Art. 304 and in breach of its duty under Art. 309 to manage its conflicts of interest when it proposed these instruments to the Transport Companies. They say, “In short, BST knew – or ought to have known – better …”.

For reasons set out above, it is not open to the Transport Companies to advance a case under the Securities Code based on the exceptional circumstances here set out, centrally, the asserted failure on their part to understand the swaps where BST knew or ought to have known that they could not do so.

The “exceptional circumstances” relied on by the Transport Companies are summarised above. The factual points made are picked up elsewhere in this judgment where necessary. There are two to mention specifically here.

The Transport Companies contend that BST did not act as a “pure” principal-toprincipal counterparty in its dealings with the Transport Companies presenting itself as their “partner”. This is based on the report of the New Products Committee of 20 June 2007 referred to above. However, this does not provide any foundation for a submission that the parties were not acting on a principal-to-principal basis.

As explained above, the Transport Companies sought to contend that BST knew the extent (if not the full extent) of the risks that the Transport Companies would run by entering the swaps, and knew – or ought to have known – that the Transport Companies, whilst they might have understood mathematically how the formulae in the swaps worked, did not appreciate the risks that they were running.

Reliance is placed on a number of points. It is said that BST knew or ought to have known that from the fact that it did not inform the Transport Companies of the RECs or the initial MtMs and that the Transport Companies did not have the internal capability to calculate either. The court does not accept this. BST was not under a duty to provide this information, and it did not anticipate the risks that followed from the financial crisis.

The court has dealt with the “predictions of null value” and the fact that Mr Pinto considered in relation to the first MdP swap that the digi-coupon was an effective risk mitigator, and need add nothing here.

Reliance is also placed on the fact that BST (other than in relation to three swaps) did not provide the Transport Companies with any stress testing. The facts are set out above.

However, for reasons set out above, the court finds that there cannot have been any real doubt on the part of the Transport Companies about the scale of the risks that these swaps entailed. The position as to stress testing does not in the court’s view affect that conclusion. This formulation of the Securities Code claim put in closing submissions would not therefore have succeeded on the facts even if it had been pleaded.

In the circumstances, BST’s assertion that the claims are time barred, as having been begun outside the three year period in respect of tortious claims under Art. 498(1) of the Civil Code, or the two year period under Art. 324 of the Securities Code, does not arise.

However, since BST placed some emphasis on limitation in its closing submissions, the court expresses its conclusions as follows.

BST argues that the Transport Companies would have known the factual prerequisites for a claim for compensation as at any and all of the following dates—the date of the conclusion of the swaps themselves; the date on which the Transport Companies were first informed that the swaps had any negative mark to market value; the date the Transport Companies were first informed that the swaps had very substantial negative MtMs; the date on which the Transport Companies first found themselves paying more out under the swaps than they were receiving. All were outside the limitation period calculated from the dates the claims were made in these proceedings, which as stated above were commenced in May 2013.

Had the issue arisen, the court would have found for the Transport Companies. BST’s submission that time started running at the date of the conclusion of the swaps is not realistic.

As it was put by the Transport Companies, if that is right, it begs the question why they entered into the swaps in the first place, unless they had some kind of urge to damage themselves.

The problem with the alternatives proposed by BST is that the circumstances obtaining in the financial crisis were so unusual that bright line dates do not hold good.

The court would have upheld the Transport Companies on this point, preferring in this regard (so far as it is a matter of Portuguese law) the evidence of Professor da Frada, holding that they did not know the permanent nature of the damage that they had suffered until it became clear that the GFC was no ordinary recession. This was not

Given its above conclusions, the court need not make a finding on certain other issues between the parties, being BST’s assertions that damages should be reduced on the basis that the Transport Companies caused and/or contributed to their losses, and the Transport Companies’ assertion that MdP is entitled to rescission in respect of MdP2—it suffered no loss in this case, since there was no lower barrier (BST says that the English court cannot give this remedy as being a form of compensation for tort which is not available in English law).

If this is still pursued, the court need not make a finding either as to whether BST is entitled to rely on the representations in the ISDA Master Agreement so as to exclude or limit its duties under the Securities Code in respect of the sale of the STCP swap. From 1 November 2007 (when MiFID came into effect) STCP was classified as a “qualified investor”. The trade date of 2 November 2007 is on the face of it the relevant date (though the Transport Companies rely on the fact that the proposal was made on 24 October 2007 followed prior to 1 November by some other pre-trade steps).

The remedies each party seeks are set out at the beginning of this judgment.

The subject was addressed briefly by the parties in written closings, but neither party dealt with remedies in oral closings, and these were effectively left over to be determined in the light of the court’s findings.

The remedies sought by BST in the event of it succeeding on the above issues, as it has, are not understood to give rise to particular issues, though questions such as interest remain to be decided, and there will need to be a careful formulation of the court’s order.

BST raised issues as to the Transport Companies’ claims for restitution and damages and other relief had their claims succeeded, and it is sufficient to note these:

An outline of the facts is contained in the introduction. The court’s detailed findings of fact are set out above. There are some particularly significant factual findings which are summarised here.

These swaps were very risky. This is because, although the transaction experts agree that at inception the swaps overall had a probability of 72% of providing a potential benefit to the Transport Companies over their life, these were long-term swaps, and there was obviously a risk that interest rates would breach the upper or lower barrier, and might do so for substantial periods of time. The effect would be magnified by the leverage and accumulation contained in the “snowball” structure of the swaps.

Because of the risk, there were concerns in Santander Spain over the sale of “snowball” swaps to public sector companies in Portugal. However, Santander Spain was not directly involved with the negotiating or transacting of these swaps, which was handled by the officers of the bank in Portugal.

An important question is why the parties entered into such risky swaps.

The court has made several criticisms of the bank by reference to disclosed contemporary documents. However, the officers concerned did not set out to persuade the Transport Companies to enter into contracts that they thought would be contrary to the companies’ interests. In fact, the bank offered the companies alternative structures in a process in which it was in effect competing for business against various international banks. The Transport Companies do not allege and have never alleged that the bank misrepresented the position, or gave them negligent advice.

From the Transport Companies’ perspective, they had extensive debt to manage. Their purpose in entering into the swaps was to reduce the amount of interest they were paying on the underlying transactions. These savings were in the early years largely achieved.

There was clearly a price to pay for the payment stream coming from the bank, and the risk was in effect the price. However, the companies’ officers had no intention of speculating. The transactions were seen at the time as sound management of the companies’ debt, this being a time when a very different attitude prevailed as regards such instruments than was the case after the financial crisis.

The swaps were seen as advantageous to the bank but also to the clients. They were entered into because they suited both parties: the bank got to enter into profitable transactions, and the Transport Companies got appreciably lower interest rates than they would otherwise have been paying.

A further question is whether the Transport Companies understood the risk when they entered into the swaps.

Whilst the expertise of the Transport Companies should not be underestimated (each company having a competent finance department), their expertise in the context of these swaps can be described as “adequate”, rather than “sophisticated” as the bank has sought to argue.

It is doubtful that the Transport Companies, or for that matter the bank, fully appreciated the sensitivity of the mark to market value of the swaps to interest rate volatility. But it is not suggested that they were unaware that MtMs would have to be settled on any restructuring, and would reflect a trend in interest rates towards the barriers.

Overall, there cannot have been any real doubt on the part of those responsible within the Transport Companies for entering into the swaps about the scale of the risks that the swaps entailed. This did not require any great degree of financial sophistication.

The risk can now be seen in the light of subsequent events, but it is wrong to apply hindsight—at the time the risk was seen as acceptable.

However, what the parties did not, and could not, foresee was that as a result of the financial crisis, the reference interest rates would fall to near-zero for a sustained period that is still continuing. The economists’ evidence shows that this is unprecedented.

These swaps were uniquely affected, because the effect of sustained near zero rates was magnified by the “snowball” structure. This also has had the result that the “mitigating features” have not taken effect.

Though this is not directly relevant to liability, when the swaps were entered into, all of which were long-term, there must have been a reasonable expectation on both sides that the Transport Companies would seek to manage the swaps, as part of the management of their debt, potentially including restructuring.

As the financial crisis set in, the bank tried to come up with restructuring solutions. But attempts to manage the swaps were ultimately unsuccessful because for a long time it was unclear whether it was in the Transport Companies’ interests to terminate or restructure the swaps, or to wait. They did not act unreasonably in not terminating or restructuring the swaps within this time period.

The court’s task is to apply the law to the facts. The parties have identified the issues on which a ruling is required. In summary, the following are the court’s principal findings with reference to the paragraphs above where the reasons are set out.

Many of the issues are issues of Portuguese law. The court expresses its appreciation for the jurists who gave expert evidence, and who expounded the wealth and depth of Portuguese jurisprudence and doctrine on the issues that arise for decision.

A Portuguese Framework Agreement had been used for earlier swaps, but by the time of these transactions, the parties had switched to ISDA documentation. The evidence is to the effect that this was a mutual decision, and reflected the position as regards other banks. The swaps were entered into under the ISDA Master Agreements and were subject to English law and jurisdiction.

The choice of law does not affect two of the issues which it is agreed are governed by Portuguese law. In this regard, the court has found that:

The outcome on the other two issues is dependent on the correct application of the rules as to applicable law.

The principle of freedom of choice of law in contract (or party autonomy) is recognised in European law.

This is subject to Art. 3(3) of the Rome Convention (now Art. 3(3) of the Rome I Regulation) which provides that where all the other elements relevant to the situation at the time of the choice are connected with one country only, the choice of law does not prejudice the application of rules of the law of that country which cannot be derogated from by contract (described as “mandatory rules”).

A central dispute between the parties is whether Art. 3(3) applies in the circumstances of this case.

In the court’s view, the legal test is as follows. For the purposes of Art. 3(3) of the Rome Convention (now Article 3(3) of the Rome I Regulation), in determining whether, choice of law aside, “all elements relevant to the situation are connected with one country only”, the enquiry is not limited to elements that are local to another country, but includes elements that point directly from a purely domestic to an international situation. In financial transactions, the use of ISDA or other standard documentation used internationally may be relevant, and the fact that the transactions are part of a back-to-back chain involving other countries may also be relevant.

Applied to the facts of this case, because of the right to assign to a bank outside Portugal, the use of standard international documentation, the practical necessity for the relationship with a bank outside Portugal, the international nature of the swaps market in which the contracts were concluded, and the fact that back-to-back contracts were concluded with a bank outside Portugal in circumstances in which such hedging arrangements are routine, the court’s conclusion is that Art. 3(3) of the Rome Convention is not engaged because all the elements relevant to the situation at the time of the choice were not connected with Portugal only. These were not purely domestic contracts. Any other conclusion would undermine legal certainty.

The other two Portuguese law defences do not arise for decision on this basis, but were fully argued. The court’s findings are as follows.

The swaps are not “games of chance”, or bets, so as to be void under the provisions of the Portuguese Civil Code (the reasoning is set out in ¶¶ 413-453 above).

In respect of the provisions of the Portuguese Civil Code as to “abnormal change of circumstances”:

The court has made findings in favour of the bank and findings in favour of the Transport Companies. For the reasons set out above, the overall decision is in favour of the bank.

The court has decided the legal issues. This clarification may now enable the parties to move forward to resolve the difficult circumstances that have arisen between them.

This judgment will be followed by consequential submissions by the parties as to the form of the court’s order.

The court expresses its appreciation to the parties for their assistance.