In a case that made headlines in the aftermath of the financial crisis, the Court of Appeal has dismissed UBS’s appeal against a 2014 High Court ruling in favour of KWL, the Leipzig Water Authority. In UBS AG (London Branch) v Kommunale Wasserwerke Leipzig GMBH  EWCA Civ 1567 the Court of Appeal reaffirmed the decision of Mr Justice Males (“Males J”) to grant rescission of derivative contracts between UBS and KWL, its customer, on the grounds of bribery and conflict of interests.
This is a ground-breaking ruling because UBS was required to bear the consequences of a bribe paid by advisers to one of KWL’s managing directors in circumstances where UBS itself was unaware of the bribe. The court defines and describes the broad reach of accessory liability and its consequent effect on the enforceability of the relevant contracts and as such, the decision has a number of important implications both for commercial parties dealing with agents, and practitioners alike.
The Appellant, UBS, an investment bank, had an agreement for credit protection with the main Respondent, Kommunale Wasserwerke Leipzig GmbH (“KWL”), the Leipzig municipal water company.
In 2006 and 2007, KWL was persuaded to sell credit protection to UBS and to two intermediary banks, Landesbank Baden-Württemberg (“LBBW”) and Depfa Bank plc (“Depfa”), the other Respondents, by means of complex derivative products known as Single Tranche Collateralised Debt Obligations (“STCDOs”). The effect of these STCDOs was that if a certain number of the entities in the reference portfolios defaulted during an eight or ten year period, KWL would be liable to pay the banks. Defaults occurred in 2008-2009 during the global financial crisis and UBS sought payment of the sums due under a debt obligation known as “Balaba”, making claims in excess of €350 million.
KWL was persuaded to enter into the STCDOs by its financial advisers, Value Partners Group AG (“Value Partners”) (a Swiss company), assisted by a bribe of around US$3 million paid by Value Partners to Mr Klaus Heininger (“Mr Heininger“), one of KWL’s two managing directors.
Although UBS was not aware of the bribe, it had entered into an arrangement with Value Partners whereby Value Partners would advise their municipal clients to enter into STCDOs with UBS regardless of the clients’ interests. KWL was the first client “delivered” under this arrangement of which KWL was unaware.
First Instance Decision of Males J
Males J held that KWL was entitled to rescind the STCDOs with UBS on the grounds of bribery and conflict of interest. He further held that Depfa and LBBW were entitled to rescind the STCDOs they had entered with UBS on the grounds of fraudulent misrepresentation. He held that even if the STCDOs were valid and binding, the losses on the portfolios were caused by their negligent management by the portfolio manage, UBS Global Asset Management (UK) Ltd (“UBS GAM”), and that Value Partners had been acting as the agent of UBS. UBS and UBS GAM appealed.
Court of Appeal Judgment
By a 2:1 majority (Gloster J dissenting in part) the Court of Appeal dismissed UBS’s appeal based on their consideration of the following five key questions:
- Had Value Partners been acting as UBS’s agent when they paid the bribe? No. UBS’s relationship with Value Partners arose not from any contract, but from the corrupt arrangement reached between them, whereby Value Partners undertook to deliver their “captive” clients to UBS for the purpose of entering into debt obligations, and UBS undertook to, secretly, assist them in that endeavour, knowing that Value Partners were the clients’ fiduciary agents and that they intended to abuse that fiduciary arrangement. The absence of any of the main characteristics of agency as described in Tonto Home Loans Australia Pty Ltd v Tavares  NSWCA 389 was a significant reason for not characterising the relationship as an agency. The existence of a fiduciary duty did not automatically give rise to an agency arrangement. Both UBS and Value Partners had been acting for their own financial benefit. Neither had been in a fiduciary relationship with the other. Value Partners had been KWL’s fiduciary agents before the corrupt arrangement with UBS was made, and UBS had known that (see paras 79-80, 82-84, 89-102, 331).
- Did the bribe render the debt obligations unenforceable? Yes. UBS had dishonestly assisted in Value Partners’ abuse of their fiduciary duty to KWL. Its conscience had been affected by the bribe so as to make it unconscionable for the Balaba transaction to be enforced (Logicrose Ltd v Southend United Football Club Ltd (No.2)  1 W.L.R. 1256 approved). The Court held that where a party to an intended transaction dealt with the other party’s agent secretly, dishonestly assisting that agent to abuse his fiduciary duties to the other party so as to bring about the transaction, the first party’s conscience might be affected not only by the particular form of abuse of which he actually knew, but also by any other abuse which the agent chose to employ. In equity therefore, UBS was responsible for the bribe. There was no injustice in such a finding, even though the issue had not been pursued in the court below (see paras 106, 110-121, 331).
- Was the judge right to have found that rescission was justified by the financial advisers’ conflict of interests? Yes. It is settled law that where a company claimed against a third party in respect of that person’s involvement as an accessory to a breach of fiduciary duty by one of its directors, the state of mind of the director who was in breach of fiduciary duty would not be attributed to the company. Therefore, the court found that Mr Heininger’s knowledge of the fraud, including his knowledge that Value Partners had not delivered disinterested advice to KWL, could not be attributed to KWL. Although, the facts of this case did not fall squarely within the analysis set down in Jetivia SA and Another v Bilta (UK) Ltd (in liquidation) and others  UKSC 23, the principle preventing attribution nevertheless applied. Therefore, KWL could not be taken to have consented to the conflict of interest (see paras 122, 136-140, 143-156, 331).
- Was the judge correct to have granted rescission? Yes. The remedy of rescission was neither unfair nor disproportionate (Hurstanger Ltd v Wilson  EWCA Civ 299,  1 W.L.R. 2351 and Johnson v EBS Pensioner Trustees Ltd  EWCA Civ 164,  Lloyd’s Rep. P.N. 309 considered). Males J had rejected UBS’s clean hands defence mainly because of his view that part of the reason for KWL entering into the transaction was the corrupt arrangement between UBS and Value Partners. Although Males J had also considered that UBS was responsible for the bribe in law (as well as in equity) on account of his incorrect finding that Value Partners was acting as agent for UBS, this conclusion was separate from his conclusions in equity and therefore did not affect the lawfulness of the decision to grant rescission (see paras 158-164, 167-177, 332, 337).
- Was UBS’s deceit claim wrongly rejected? No. The deceit claim failed because the deceit had caused no loss to UBS. KWL, as the customer, was the victim. Mr Heininger’s knowledge about the fraudulent aspects of the transaction was not to be attributed to KWL and it could not be vicariously liable for his fraudulent assertion about the bona fides of the transaction. UBS’s losses on its hedging contracts had not been caused by Mr Heininger’s fraudulent misrepresentation, but rather by the rescission of the debt obligation, which had, in turn, arisen partly from UBS’s dishonest assistance in Value Partners’ abuse of its fiduciary duties to its customer, KWL (see paras 181-183, 185-189, 191, 193, 333, 377-378).
The court further considered that Males J had been right to conclude that UBS should indemnify KWL for any liability it had to the intermediary banks (see paras 194-200, 334). It also considered the enforceability of certain back swaps and front swaps (see paras 201-229, 335), and determined that, in the absence of rescission, UBS would have had a damages claim against its investment arm in respect of the negligent management of the investment portfolio (see paras 276-304, 336).
More generally, in considering questions of causation and loss, the decision is a useful reminder that an appellate court will be reluctant to interfere with evaluative judgments of lower courts.
Key Points for Practitioners:
- The ruling on bribery extends the application of the principle in Logicrose, which previously required a party to have actual knowledge of the payment of a bribe to bear the consequences of it. Now, a party might be forced to accept the consequences of a bribe paid by its agent, even if it did not know of it, provided that it was aware of and assisted in at least an aspect of that agent’s breach of fiduciary duty.
- Anyone dealing with a counterparty’s agent will need to be aware of the dangers of dealing with the agent behind the counterparty’s back.
- Where a party has suspicions about the honesty of its counterparty’s agent, it should disclose its concerns to the counterparty immediately.