SIDRU Judgment: Hedging Transaction Not Rendered Speculative Even If It Exposes Party To Unlimited Risk

Author:Mr Frédéric Gros, Jayant W. Tambe and Philippe Delelis
Profession:Jones Day

In Short

The Context: In the wake of the Saint-Leu-la-Forêt decision of May 28, 2018, France's Court of Cassation issued an important decision on structured swaps concerning legal actions brought by public authorities against banks that had marketed these products.

The Outcome: The Court fully rejected the claims of Saint-Germain-en-Laye SIDRU (Syndicat Intercommunal de Destruction des Résidus Urbains) against Depfa Bank plc.

The Impact: The Court's September 5, 2018, judgment has many lessons on the concept of inherent risk derivatives transactions and the concept of speculation in the provision of investment services.

The SIDRU of Saint-Germain-en-Laye has finally lost its case. This household waste treatment syndicate of several municipalities in the western region of Paris took legal action against Depfa Bank plc in May 2011 and did not hesitate to publicize its case against so-called "toxic" swaps. France's Court of Cassation, however, has put an end to this legal action by dismissing SIDRU's appeal of the November 4, 2016, decision by the Paris Court of Appeal.

The Court of Cassation's September 5, 2018, ruling is a landmark ruling in derivatives litigation, focusing in particular on structured swaps and, more broadly, the provision of investment services by banks.

SIDRU had filed two actions against the swap marketed by Depfa in June 2007, a few months before the outbreak of the financial crisis: (i) an action to nullify the structured swap because SIDRU claimed it had mistakenly engaged in a speculative transaction and that the bank had committed a fraud by allegedly concealing an option embedded in the interest rate formula; and (ii) an action for damages, alleging that the bank had breached its obligation to disclose relevant information to an unsophisticated investor, which SIDRU claimed to be.

The Court denied SIDRU's claims in their entirety; instead, SIDRU was ordered to pay approximately €20 million, including both the unwinding costs of the swap and unpaid amounts owing to the bank. An examination of the evidence showed that the mayor of Saint-Germain-en-Laye himself had capped the rate of the swaps' structured formula by telephone. The telephone records also provided evidence that the mayor himself had set the risk coefficient that he considered reasonable for SIDRU.

In the lower courts and on appeal to the Court of Cassation, SIDRU argued that the swap transaction did not meet the criteria of a hedging transaction as...

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