Swaps and Non-Divisible Contractual Scheme (Ensemble Contractuel Indivisible)
On 08 September 2021, the French Supreme Court dealing with private matters (Cour de cassation) ruled a remarked decision relayed by economic specialized press (see Sophie Rolland, Les Echos dated 18 November 2021 « Swaps de taux : un arrêt de la Cour de cassation sème le trouble chez les professionnels du financement »).
This decision (Cour de cassation, civ., 1, 08 September 2021, 20-14.201), albeit non-published (inédit) on the Bulletin de la Cour de cassation, is important as to its impact on the financial field and by the use of the concept of non-divisible contractual scheme (ensemble contractuel indivisible).
The contractual scheme put in place is quite widely spread: a loan hedged by a rate interest swap entered into between a bank and a real estate civil company (SCI – Société Civile Immobilière). In this contractual scheme, the SCI, which corporate purpose is to acquire real estate, entered into a loan agreement with a floating interest rate (namely Euribor 1M plus 1% per year), such loan being hedged by the same bank, this later paying Euribor 1M and receiving a fixed rate of interest of 3.73%. It has to be stressed that the position of the SCI was not fully hedged as a delta of 1% per year remained to be paid by the SCI under the loan. From a strictly legal standpoint two separate agreements were entered into by the same parties: the loan and the swap, resulting in the bank receiving 3.73% plus 1% per year.
This case arose due to the contractual reimbursement before maturity of the loan by the SCI after the real estate being sold by the SCI. In terms of sequences, from a chronological standpoint, the SCI sold the real estate, contractually reimbursed the loan which triggered the unwind of the swap. The question raised to the Court was the existence of an unwind cost under the swap in addition to the cost associated with the reimbursement of the loan before maturity.
The Court of appeal of Paris, with a decision dated 27 November 2019, ruled that no amount shall be paid as to the unwind of the swap and ruled that the amount of 175,000€ (paid by the SCI in respect of the unwind costs plus legal interest as of 10 July 2014 – under penalty payment (astreinte)) shall be reimbursed to the SCI. In this context, the bank seized the French Cour de cassation, with the view of cancelling this reimbursement and receiving what it considers the contractual unwind costs.
The French Cour de cassation ruled that the Court of appeal of Paris rightly deducted, by the contractual terms and the behavior of the bank a manifest willingness, as to the borrower, to enter into an indivisible contractual scheme composed of the loan and the swap, with the cancellation of the first (the loan) resulting in the caducity of the second (the swap), the bank being obliged to pay back the unwind costs associated with the swap.
This concept of contractual scheme (initially groupe de contrats) is commonly used by French case law and was named and revealed in France by French doctrine (firstly Bernard Teyssié, Les groupes de contrats, LGDJ 1975 cited in Droit des obligations P. Malaurie, L. Aynès, P. Stoffel-Munck LGDJ 11 ed. N°494 and A. Bénabent, Droit des obligations LGDJ e.g. 15 ed. N°330 et seq.) and is in line with the position of the French Cour de cassation, as described by the French doctrine (see Droit des obligations P. Malaurie, L. Aynès, P. Stoffel-Munck op. cit. N°495: «The unity of the group is easily admitted when the contracts are entered between the same parties or by the intermediary of the same pilot company». Other authors (Droit civil Les obligations Y. Buffelan-Lanore, Virginie Larribau-Terneyre), 17 ed. N°997 et seq. states that when the goal of the parties is the achievement of a global contractual operation using several contracts, reference is made to a contractual scheme (ensemble contractuel). For these later authors, « these contractual schemes are now a reality which is used by case law all the more than contracts are more and more driven by economy » (Droit civil Les obligations op.cit. N°998).
Ordinance Macron N°2016-131 dated 10 February 2016 (as ratified by Law N°2018-287 adopted on 11 April 2018, with an entry into force on 1 October 2018) gives the possibility for the judge to use the caducity (caducité), giving rise to the end of a contract with a potential halo effect on the contractual scheme, as a whole (not to mention the latitude for the judge to allow restitutions).
In this perspective, article 1186 alinea 2 of the French civil Code (as created by Ordinance Macron), states that «When execution of several contracts is necessary to the achievement of a single operation and when one of them disappears, other contracts which performance is then impossible by this disappearance and those for which the performance of such disappeared contract was a condition precedent of the willingness of one party are caduc ». Alinea 3 of such article states that « Caducity however only applies if the counterparty against which the caducity is opposed knew the existence of the single global operation when his willingness was given ».
As such, it can be argued that there is no specificity applied in the fields of capital markets, as common civil principles and rules apply the same way, whereas ordinance Macron excludes derivatives (contrats financiers) from the unforeseen theory (théorie de l’imprévision), secular in administrative law and new in civil law (article L211-1 of the French monetary and financial Code), avoiding a potential disruption of the international recognized existing legal scheme based on the material adverse change (MAC) provisions.
The import of this case law on the capital markets, as a whole, remains to be determined. It is common practice that a bank offers a package composed of a loan and a hedge, resulting in the corporate paying a fixed interest amount and be covered against the increasing of a floating rate (to be paid under the loan). In this perspective, the case law of the French Cour de cassation may be applied with possible adjustments, offered by French regulation i.e. cancellation (nullité), resolution (resolution), caducity (caducité) of contract(s) and / or non-divisible contractual scheme (ensemble contractuel non divisible) with retroactive effect or not (article 1187 of the French civil Code).
It is reasonable to think that this case law may rather be considered as a reference for market participants rather than a decision not subject of amendments or evolution depending on the context of the case. If this is common practice that a bank be at the same time the lender and the hedger, it cannot be excluded that a corporate may enter into a hedge agreement with another bank. In this perspective, a non-divisible contractual scheme (ensemble contractual non divisible), may also be characterized.
Another question is the import of this decision on other non-divisible contractual schemes. This case law should apply to OTC derivatives (forward) or derivative admitted on markets (futures). In addition, it cannot be excluded as well that the hedging bank (or the corporate) has also entered contracts with other financial institutions. Should a non-divisible contractual scheme have an impact on other transactions, and on other non-divisible contractual schemes, such other transactions and other non-divisible contractual schemes may have to be unwind (or assigned), potentially ad lib.
As alinea 3 of article 1186 of the French civil Code states that « Caducity however only applies if the counterparty against which the caducity is opposed knew the existence of the single global operation when his willingness was given », other legal tools will have to be used by the judge.
Considering this, the current tools provided for by French regulation (e.g. caducity, nullity, resolution), as amended by Ordinance Macron put the judge in a situation to rule efficiently the cases brought before his Court (with also the possibility to declare a contractual relationship not enforceable against third parties – inopposabilité, or to declare a provision of a single contract of the non-divisible contractual scheme as non-written – clause reputée non écrite).
In this perspective, a distinction can be proposed based on the identification of the relevant contracts underpinning the non-divisible contractual scheme. When the judge can easily identify these contracts and can ‘close’ the non-divisible contractual scheme, a solution should be given accordingly (based on the current legal tools). If this is not the case (the end of the non-divisible contractual scheme cannot be identified), the parties may have indirectly to contractually apply a pragmatic decision of the judge, negotiating with their counterparties, based on the ratio decidendi of the case and inter alia article 1186 of the French civil Code alinea 3.
One should be confident on the pragmatism of the French Cour de cassation (especially the commercial Chamber), not only to apply the French civil Code (and French regulation, as a whole), but also previous case law architecture, based on concepts created and revealed by French doctrine.
Up to date as of 08 September 2021.