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

A counterparty which secretly and dishonestly assists a fiduciary adviser to procure a transaction by abusing its duty of undivided loyalty may be unable to enforce the transaction. Its conscience may be affected by a bribe which the dishonest adviser used for that purpose, even though the counterparty neither paid nor knew of the bribe.

The corporate victim is not attributed with a fraudulent director’s knowledge where that would artificially treat it as consenting to the fraud. Rescission remains discretionary and must achieve practical justice. Where separate contracts form one commercial transaction, the court may require all associated benefits to be restored. A portfolio manager instructed to minimise defaults must manage according to that objective, rather than ratings or other metrics which increase default risk.

Kommunale Wasserwerke Leipzig GmbH (KWL) entered into complex single-tranche collateralised debt obligations with UBS and two intermediary banks. Its financial adviser, Value Partners, procured the transactions while abusing its fiduciary duties and bribing one of KWL’s managing directors. UBS did not know of the bribe, but knowingly and dishonestly participated in a secret arrangement under which Value Partners would deliver municipal clients to UBS irrespective of their interests.

Males J held that KWL could rescind the principal transaction for bribery and conflict of interest. He also found that intermediary Back Swaps had been induced by UBS’s fraudulent misrepresentations and that UBS Global Asset Management (UK) Ltd had negligently managed the underlying portfolios: [2014] EWHC 3615 (Comm).

The appeals concerned agency, bribery, fiduciary conflict, attribution, rescission, deceit, indemnity, the linked swaps and credit default swaps, restitution, portfolio-management negligence, causation and loss.

1. Disposition. By a majority, UBS’s appeal was allowed on the agency issue but dismissed on the remaining issues. KWL’s additional ground concerning the bribe was accepted, while its cross-appeal concerning the associated credit default swaps and misappropriated premiums was dismissed. The appeal was therefore dismissed overall.

2. The corrupt arrangement did not make Value Partners UBS’s agent. Value Partners had no authority to alter UBS’s legal relations, owed UBS no fiduciary duty, and pursued its own interests while remaining KWL’s fiduciary. Its role depended upon appearing loyal to KWL, rather than representing UBS. Agency nevertheless depends upon the substance of the parties’ consensual relationship, and neither fiduciary duty nor authority to affect third-party rights is invariably essential.

3. UBS’s conscience was affected by the bribe. A person who secretly and dishonestly assists another party’s fiduciary adviser to procure a transaction through an abuse of undivided loyalty may be affected by additional abuses used for that purpose, including a bribe, despite lacking knowledge of that particular abuse. It was therefore inequitable for UBS to enforce the Balaba STCDO.

4. UBS’s knowing and dishonest assistance in Value Partners’ conflict of interest independently entitled KWL to rescind. The fraudulent managing director’s knowledge was not attributed to KWL. Attribution would absurdly treat the corporate victim as consenting to a fraud in which the director and UBS participated through different aspects of the adviser’s scheme. Causation was established concurrently and, in any event, inducement or loss is not required for rescission based on the deprivation of disinterested fiduciary advice.

5. Rescission was neither disproportionate nor barred by unclean hands. The transaction was an unusual and complex derivative outside KWL’s ordinary experience, and the corrupt arrangement was intended to deprive it of loyal advice. The director’s fraud could not sully the hands of the corporate victim. Practical justice required the linked credit default swaps to be treated as part of the same transaction. KWL therefore could not retain their benefits and had to restore premiums paid into its account but subsequently misappropriated by its agent.

6. UBS’s deceit claim failed because its hedging losses were caused by rescission of the STCDO, not by the managing director’s false statement. KWL would, if necessary, be entitled to an indemnity for liabilities under the intermediary Front Swaps. Rescission of the Back Swaps was properly conditioned upon the intermediary banks undertaking not to enforce the Front Swaps.

7. UBS GAM negligently managed the portfolios. Its sole objective was to minimise defaults through diversification, monitoring and early exit. Its concentration in correlated high-risk financial entities, focus on ratings and the Moody’s Metric, inadequate attention to spreads, deficient monitoring and late-exit approach breached that duty and caused the losses. The judge was entitled to assess loss by reference to what a competent manager would have achieved.

Gloster LJ dissented on the entitlement to rescind, attribution, indemnity and the assessment of portfolio-management loss. She would have allowed UBS’s appeal.

1. Court of Appeal (Civil Division): By a majority, allowed UBS’s appeal on the agency issue but dismissed its remaining grounds. It accepted KWL’s additional ground concerning the effect of the bribe and dismissed KWL’s cross-appeal: [2017] EWCA Civ 1567.
2. Commercial Court: Males J held that KWL could rescind the Balaba STCDO for bribery and conflict of interest, that the intermediary banks could rescind the Back Swaps for fraudulent misrepresentation, and that UBS GAM had negligently managed the portfolios: [2014] EWHC 3615 (Comm).