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Local Authority Pays € 36 Million Price of Doing Nothing

Town CouncilIn a ruling which vividly underlines that even public authorities are not entitled to sit on their hands when faced by court proceedings, an Italian local authority has been ordered to pay more than € 36 million to two banks with whom it entered into complex derivatives transactions that it later considered to have been ill-advised.

The authority had put in no formal defence to the bank’s claims, which were brought before the Commercial Court under an English jurisdiction clause in the contracts, and had, by its inactivity, forfeited the right to put forward a number of defences which the Court ruled had no realistic prospect of success in any event.

The authority had entered into three derivatives contracts with the banks in order to manage interest rate risks in respect of a bond that it had issued and to create an amortisation fund to repay the bond on maturity. However, the authority ceased to meet its obligations under the contracts on receiving a report that the banks had ‘generated very substantial secret profits’ from the transactions.

The banks launched proceedings in England and obtained a judicial declaration that the derivatives contracts were legal and valid and placed binding obligations upon the authority. Despite not having put in any formal defence to the claims, the local authority sought to set aside that decision.

The authority’s lawyers argued, amongst other things, that the banks had acted in breach of fiduciary duties and had misrepresented the nature of the transactions. It was also submitted that, as a matter of Italian law, the authority had lacked the legal capacity to enter into the contracts. Whilst not alleging fraud against the banks, the authority also argued that the transactions involved very substantial negative costs and that it would not have entered into them if properly advised.

However, the Court ruled that none of those defences stood any real prospect of success and entered judgment for the banks for sums in excess of € 36 million, plus interest. Given the authority’s lack of formal response to the claims, the Court noted that any party which deliberately ignores proceedings which are properly constituted and served does so at its peril, particularly where the parties have agreed that English law and jurisdiction should govern their relationship.