A recent decision by the Spanish Supreme Court struck down the super-priority that Spanish law grants derivatives contracts in insolvency. The decision raises a series of interesting questions about the treatment of these products in insolvency proceedings.
The implementation of the Financial Collateral Directive (FCD) into Spanish law has stirred a lot of debate among Spanish commentators. In particular, a modification of article 16 of the Real Decreto Ley nº5/2005, of 11 March, introduced in 2009 and subsequently reformed in 2011, grants the non-defaulting creditor under certain financial transactions a super-priority unparalleled in any other Member State: not only will the operation of a close-out netting mechanism be protected in the context of insolvency, but the resulting claim will also have a priority over any other unsecured claims when the non-defaulting party calls for an early termination of all outstanding transactions invoking an event of default that postdates the insolvency filing. When such an event of default predates, or coincides with, the insolvency filing, the claim for the close-out amount will not enjoy such a priority. This provision gives the non-defaulting creditor strong incentives to postpone the early termination of all outstanding transactions until the insolvent party defaults on her obligations after the insolvency filing. (I have previously published a more elaborate analysis of this incentive problem, available (in Spanish) here.)
For the past seven years, many retail clients (or their insolvency administrators) have challenged the validity of the derivative transactions they had entered into with a financial institution (typically, interest rate swaps) and the application of that super-priority. Moved, perhaps, by the difficult social situation in Spain as a result of the economic crisis, the vast majority of Spanish courts have sought an interpretation of article 16 that would allow them to avoid the application of such a super-priority. The prevailing opinion regarded the application of the super-priority as conditional upon either of two factors: a) that the master agreement contained more than one financial transaction, or b) that the financial transaction entailed mutual obligations for the two parties involved. Some courts had even gone so far as to limit the application of the super-priority to those transactions that are concluded after the filing for insolvency.
However, this interpretation ignores the parties’ express will to regard all outstanding transactions as one single agreement (the “single agreement principle”), and it misunderstands the economic functions of interest rate swaps. It also introduces considerable uncertainty in the markets, eg would this interpretation hold in more complex contractual relationships where two parties have entered into several financial transactions? Moreover, would the treatment of the same derivatives products, entered into with two counterparties of the same type (eg retail clients), be different if, in one case, the creditor financial institution had entered into only one transaction, and in the other it had entered into several?
In its decision nº 629/2015, of 17th November, the Spanish Supreme Court fixed its position in relation to the treatment of derivative contracts in insolvency proceedings. Although it supported the conditional application of the super-priority outlined above, it also defended a teleological interpretation of article 84.2 of the Ley Concursal (the Spanish Insolvency Act), which governs super-priorities, and rejected the possibility of its application to the type of master agreements covered in the Real Decreto Ley nº5/2005. As a result, any claim arising from the application of a close-out netting mechanism will stand in an insolvency proceeding as an ordinary unsecured claim, regardless of the moment when the event of default that leads to the early termination occurs.
This new approach must be welcomed, for it solves, at least in part, the incentives problem that article 16 of the Real Decreto Ley nº5/2005 had introduced. Nevertheless, the reach of this decision is somewhat limited, since the case brought before the Spanish Supreme Court did not involve various financial transactions concluded both before and after the filing for insolvency. Therefore, an important question remains unanswered: would the teleological interpretation presented by the Spanish Supreme Court hold in such a case? In other words, would the Spanish Supreme Court support the validity of the single agreement principle embedded in financial master agreements? The decision also raises an interesting question for the legal regimes in the other Member States for which the FCD does not provide an answer: when the non-defaulting party, upon the filing for insolvency, decides not to terminate the master agreement, and a new financial transaction is entered into with the insolvency administrator, should this new transaction receive a different, more protective, treatment in the insolvency proceedings? Finally, in the current context, where EU policy makers are considering the possibility of revisiting the FCD, the financial services industry might find in the unparalleled super-priority introduced in Spanish law a privilege worth fighting for.
A forthcoming article (in Spanish) in LA LEY mercantil explores these questions in greater detail.