The bumpy evolution in judicial decisions regarding derivative contracts in Italy: appropriate understanding of derivative contracts and reception of the contribution of legal doctrine

AutorAntonio Magni
CargoPhD in Private Law. University of Camerino, School of Law.

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I Introduction: decisions, legal doctrine and derivative contracts

Art. 118, paragraph 3, of the preliminary dispositions of the Italian Civil Procedure Code does not allow juridical authors to be quoted within judicial decisions. Actually, it is permissible to report the opinions of juridical authors, but their names may not be indicated.

Nevertheless, the impact (as well as the missing impact) of legal doctrine (considered as the product of the activities of legal researchers and legal scholars) upon judicial decisions regarding derivative contracts1 appears to be not negligible.

Indeed, the contribution of legal doctrine seems to have been internalized, step by step (in the context of a bumpy evolution), by specific decisions as to the method for the calculation of the value of the so-called "mark to market", as well as concerning the necessity of indicating the criteria used to carry out the appraisal of the "mark to market". In this regard, a national Court has only recently really assimilated the meaning of the contribution made by legal doctrine. The article analyzes the conclusions reached by the national Courts and the related consequences.

Accordingly, an analysis of the choices made by judges within their decisions is worthwhile.

The bumpy evolution in question is an evolution in the appropriate understanding of relevant issues, related to derivative contracts, as well as in the reception of the contribution of legal doctrine.

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II Withdrawal from derivative contracts and the relevance of the so-called "mark to market": contribution of legal doctrine and partial reception in judicial decisions

In the case of withdrawals from derivative contracts2, it is essential to consider - as legal doctrine3has pointed out - the appraisal of the so-called "mark to market", namely, the appraisal of the measure of the so-called "differential"4, and accordingly, the appraisal of the measure of the object of the contract5. The party who desires to exercise the right to withdraw has the obligation to pay the sum of money resulting from the appraisal in question to the other party in the case of a negative "mark to market"6. The value of the "mark to market" cannot be considered as the value of the object7of a derivative contract at the time of the withdrawal, but rather as the value of the object of a derivative contract as foreseen for the date established (by the parties) for the natural expiration of the contract8.

As a consequence, the judge may be requested to decide a controversy regarding the relevant aspects, among which the appraisal of the "mark to market" may deserve particular attention.

In the aforesaid context, the efforts of the legal doctrine seem to be tangible, and allusions to the contribution of an eminent author (even without the indication of his name) are likely to be detected in the judicial decisions. The contribution is twofold: On the one hand, attention has been

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paid to the correspondence between the method for the calculation of the value of the "mark to market" and the method for the calculation of other costs or prices; on the other hand, concerns have been raised about the possible consequences arising from the absence of the indication of the parameters9by means of which the appraisal is performed.

As to the first profile10, legal doctrine has underlined the necessity of referring, when dealing with the method of calculation, to the evaluation techniques and to the so-called "best practice"11; as will be seen, the references in question have subsequently been internalized by a national Court. Indeed, as the legal doctrine has affirmed, the appraisal of the "mark to market" corresponds to the appraisal of the so-called "fair value"12. The "fair value" (and thus also the "mark to market" ) - following the reasoning of the same author13- in compliance with art. 2427 bis, paragraph 1, no. 1,

a), of the Italian Civil Code and with art. 203, paragraph 2, of the Italian Consolidated Law on Finance14, should be appraised15according to the evaluation models and techniques commonly accepted, as well as with regard to the "best practice"16. Similarly, as reported (and evidently, assimilated) by the decision17, "the MTM is that fair value, which art. 2427, bis, paragraph 1, of the Italian Civil Code states must be indicated within the integrative note to the balance sheet and appraised according to the evaluation models and techniques generally accepted. Also art. 203 of the Italian Consolidated Law on Finance refers to the best practice"18.

As far as the second aspect is concerned19, the same doctrine20has noted that allowing one of the parties to carry out the appraisal of the "mark to

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market" (through a specific clause or a subsequent agreement21), without enabling the other to verify the criteria and the methodologies deployed to this end22, would result in a violation of the rule contained in art. 1346 of the Italian Civil Code23. According to this article, the object of the contract must be "possible, lawful, determined or determinable"24. Otherwise, the contract is not valid in compliance with art. 1418, paragraph 2, of the Italian Civil Code25. What is indeterminable, in the case of derivatives, is not stricto sensu the object (in the context of derivatives, that is represented by the so-called "differential"), but the criteria and the methodologies (if not indicated, and therefore, if not verifiable) deployed to perform the appraisal of the "mark to market". The latter26is defined as the appraisal of the measure of the "differential", and therefore, as the appraisal of the measure of the object of a derivative contract27. As a result, the appraisal of the "mark to market" is strictly and intrinsically connected to the object of the contract. In this regard, the same Court28has acknowledged the relevance of the "mark to market", but it appears to have only partially grasped the meaning of the abovementioned remarks29. Indeed, as stated in the decision30, even if a separate agreement - through which the parties agree to carry out the appraisal31- is considered to be admissible, there nevertheless is no suggestion that a specific clause should be inserted allowing one of them to carry out the appraisal, nor is there a recommendation that the criteria and the methodologies deployed to this end should be indicated. In fact, in the view of the Court, "the mark to market might only be the object of an agreement (ancillary to a derivative) with which the parties expressly agree to perform the abovementioned appraisal"32.

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III The missing reception of the contribution of legal doctrine

An important decision (of a national Court of Appeal)33has warned of the possible invalidity (the "nullity")34of a derivative contract, due - as has been affirmed - to the indeterminableness of the amount of the commission to be paid to the "mandatary"35. In the opinion of the Court of Appeal36, the amount of the commission shall be clearly established by the parties and shall not constitute a hidden cost in compliance with art. 1709 of the Italian Civil Code37. Otherwise, the contract would not be valid. As a result, the invalidity (the "nullity") of the contract would be caused by the indeterminableness of the commission38. Indeed, the Court of Appeal upheld

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that the commission is linked to the context of the "mark to market"39. As such, the amount of the commission is likely to be indeterminable40;

therefore, this indeterminableness might lead to the invalidity (the "nullity")41. As just noted, according to the decision reported42, the legal nature of the derivative contract is that of a contract of "mandate"43on the basis of art. 21 of the Italian Consolidated Law on Finance44. The article in question states that the bank, when proposing the investment strategies, must comply with the standards of diligence, correctness and transparency, which are specifically requested for that kind of client. As a matter of fact, in this phase, it is very possible to detect a sort of contract of mandate, given that the bank must act in the client’s best interest (in compliance with the abovementioned art. 21) by suggesting the type of investment that best suits his profile.

However, when the client becomes a party to a derivative (and for this reason, an investor), the bank is not in a position to pursue the client’s interest, since both parties have different45and/or opposed46interests. Indeed, suffice it to mention the so-called "hedging cost", which is included within the so-called "confirmation"47of a derivative, in cases in which

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derivatives are used to hedge pre-existing risks48and in cases in which derivatives are used to speculate49. The cost in question is contemplated by the bank in order to manage the market risk (and is considered50to be paid by the client). In so doing, the client (hypothetically, the "mandator", if an alleged existence of the contract of mandate is admitted) would pursue the interest of the bank (hypothetically, the mandatary). This fact would stand in stark contrast to the client’s interest, and accordingly, to the "causa"51of

the contract of mandate. Indeed, the client’s interest is not related to holding the bank free from risk, but to the achievement of a positive outcome52.

Actually, the "causa" in the contract of mandate, as far as Italian law is concerned, consists of pursuing the interest of the mandator53, even in the case of the contract of mandate called "in rem propriam"; the contract of...

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