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Supreme Court of Justice (Portugal)| Swaps & Public Policy | 29-01-2015 | Case #005

Supreme Court of Justice
Date: 29-01-2015
Case Nr. 531/11.7TVLSB.L1.S1


– A swap (interest rate swap) contract must be considered as a mere speculation with no actual and serious connection to an underlying relationship, making it contrary to the fundamental principles of our community, unfit to perform any serious function, and therefore contrary to the public policy.

Summary (considerations not relevant for the tags were removed)
I – (…)
II – (…)
III – The interest rate swap agreement is an agreement by virtue of which the parties, with reference to a certain period in time, agree on the reciprocal payments of money which are cleared on the basis of the application of an interest rate (fixed or variable) to a notional amount previously fixed between them and not exchanged between them.
IV – The swap contract is usually qualified as a future, onerous, consensual, purely obligatory, reciprocal (broad sense) contract and is provided for in paragraph e) of paragraph 1 of article 2 of the CVM (via transposition of Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 and, moreover, No. 5.210 and 5.211 of Regulation (EU) No. 549/2013 of the European Parliament and of the Council of 21 May 2013). It is a contract expressly foreseen in law but not legally regulated.
V – The swap contract, in the sense referred to in III above, is a derivative financial instrument negotiated outside regulated markets, i.e. over the counter. – and is commonly attached to three goals: hedging a financial risk (i.e. interest rate or exchange rate fluctuations, also known as hedging), speculation and arbitrage.
VI – In this context, speculation (also referred to as “trading”) can be defined as a “(…) deliberate and conscious exposure to market uncertainties with the intention of achieving economic benefits (…)”. This is always the case of a derivative as it is contracted in a kind of “financial vacuum”, i.e. without having the involvement of an underlying relationship that is referred to a particular economic variable (…)”.
VII – Given that the facts show that the parties performed under contracts in which the defendant undertook, within the agreed period of time, and on a quarterly basis, to pay to the plaintiff the 3-month Euribor interest rate over the nominal amount designated in the contracts, while the latter was obliged, in return, to pay, at the same frequency and over the same period, a certain interest rate (4.35% in one of the contracts and 4.66% in the other contracts) or the 3-month Euribor interest rate, depending on whether the variation of this rate occurred within the limits established in the agreement or below these, there is no doubt that the adjustments to the interest rate swap contract would be re-classified as “basis rate swap”,”vanilla swap” and “collar swap”.
VIII – (…)
IX – The interest rate swap contract is, like the gambling and wagering, an aleatory contract in that the existence and amount of one or both of the parties’ benefits depends on a future, uncertain fact, out of the control of the parties
X – Art. 1245 of the Civil Code declares invalid those gambling and wagering contracts whose outcome is exclusively based on fortune or mischance (see Art. 1 of Decree-Law no. 422/89 of 2 December).
XI – (…)
XII – It follows from the interpretation of the documents snd other evidences that the parties did not seek to cover any risk associated with one or more financial transactions or a portfolio of assets or liabilities, and that the agreed nominal amount was merely a notional reference, it follows that the risk involved in these swaps was external to them, that is to say, it was exclusively created by them on the basis of a financial vacuum. This fact, in turn, leads to the conclusion that the parties have intended to make pure speculation.
XIII – The tolerance of the law towards speculation is not unrestricted and it is important to distinguish between the speculation that is considered useful as a means to adjust the functioning of the economy and that is ethically acceptable, on one hand, and the speculation that is independent of any other motive and does not have any discernible reason (…)
XIV – It has not been shown that the parties – and in particular, the client petitioner – sought to safeguard a risk. It further remains to prove the existence of a “match” between a hedger (which aims, through a swap, to prevent the risk of an unfavourable scenario) and a speculator (who makes predictions to the opposite direction and is willing to accept such risk by paying a financial compensation), which would make it a contract economically virtuous (or, in other words, serious) and, to that extent, to turn it an acceptable and legitimate speculation.
XV – Given the pure speculative nature of the contracts of the records, which are in clear contrast to the prevailing principles and values ​​in our society (even if interpreted currently), weighing the social and economic disadvantages entailed thereof, it is easy to conclude that the contracts are not in compliance with those fundamental values ​​and to the common welfare. Thus, one should ascertain that the contracts at stake violate the public policy and are therefore null and void according to Art. 280 of the Civil Code.
XVI (…)
XVII (…)