UBS AG (London Branch) & Anor v Kommunale Wasserwerke Leipzig GMBH

Internal limits on a company’s managing directors generally do not invalidate contracts against third parties. Avoidance for abuse of authority requires objective facts making the lack of authority obvious; ambiguity or a possible need for approval is insufficient. A bank may be responsible where its agent bribes the counterparty’s agent in the course of procuring the transaction, even without the bank’s knowledge. An undisclosed conflict of interest affecting the counterparty’s adviser may likewise justify rescission where the other party knew of the conflict and there was no informed consent. Rescission is flexible and may require practical restitution. An intermediary bank’s liability under a back-to-back derivative depends on the counterparty’s liability, but not necessarily on actual payment. A portfolio manager must follow the agreed risk-management strategy and may be liable for losses caused by concentrated and inadequately monitored positions.

The judgment concerned four related actions arising from complex single tranche collateralised debt obligations and associated credit default swaps entered into by Kommunale Wasserwerke Leipzig GmbH, a German municipal water company, with UBS, LBBW and Depfa. The banks sought payment after defaults during the financial crisis. KWL alleged lack of capacity or authority, bribery, conflict of interest and fraudulent misrepresentation. It also claimed damages for negligent portfolio management by UBS Global Asset Management.

The LBBW Front Swap had been held valid and binding by the Leipzig Regional Court on 3 June 2013, subject to an appeal to the Dresden Court of Appeal. The English court determined the remaining disputes, including whether KWL could avoid the Balaba transaction, whether LBBW and Depfa could rescind their Back Swaps, the construction of the Back Swaps, and the portfolio-management claim.

1. Capacity and authority. Under German law, internal restrictions on a managing director’s authority ordinarily do not affect the company’s external power of representation. The abuse-of-power exception requires massive or solid objective facts making the lack of authority obvious. There is no general duty to investigate, and mere uncertainty about the need for Supervisory Board approval is insufficient. The STCDOs were objectively matters of fundamental significance under KWL’s Articles because of their scale, potential consequences and departure from KWL’s ordinary business. UBS was nevertheless not grossly negligent because it was entitled to rely on the Freshfields capacity opinion and KWL’s assurances. The capacity defence therefore failed.
2. Bribery and conflict of interest. Value Partners was KWL’s agent and, under the arrangement made with UBS’s employee Mr Bracy, was also UBS’s agent for procuring KWL’s STCDO business. The bribe paid to KWL’s managing director was within the scope of that agency. UBS was responsible in law for the bribe even though it was neither authorised nor known to UBS. Value Partners also had an undisclosed conflict of interest, known to UBS, and KWL had not given informed consent. KWL therefore validly rescinded the Balaba STCDO. The fraudulent-misrepresentation defence was rejected.
3. Consequences. KWL had to repay the net premiums and the payment received on unwinding the Balaba CDS, subject to deductions for the bribe and sums used to purchase additional subordination. Its claim for payment under the other CDSs was dismissed. UBS’s damages claim based on hedging losses failed because the losses were caused by the unenforceability of the tainted transaction.
4. Back Swaps. LBBW and Depfa were entitled to rescind their Back Swaps for fraudulent misrepresentations by UBS that it knew neither of dishonesty nor of the transaction’s taint. They had to return their intermediation fees, and Depfa had to return the payment received from UBS. Each intermediary had to undertake not to enforce its Front Swap against KWL and was entitled to return of collateral.
5. Alternative conclusions. If necessary, the court would have construed “paid” in the Back Swaps as “payable”, rejected rectification and estoppel, and found UBS GAM in breach of its portfolio-management obligations by concentrating risk in correlated financial entities and failing to monitor or exit deteriorating positions.

This was a first-instance trial of four related actions. The LBBW Front Swap had separately been held valid and binding by the Leipzig Regional Court on 3 June 2013, subject to an appeal to the Dresden Court of Appeal.

The jurisdiction of the English court over the Balaba transaction and the portfolio-management agreements had previously been determined by the High Court in [2010] EWHC 2566 (Comm). The present court decided the remaining claims and counterclaims.