First-instance decision
Rescission of Balaba STCDO
Other issues


In UBS AG v Kommunale Wasserwerke Leipzig GmbH(1) the Court of Appeal heard an appeal relating to whether complex, loss-making financial transactions were enforceable against the respondent (KWL) in circumstances where they had been entered into against the backdrop of a corrupt relationship between the appellant counterparty (UBS) and the respondent's agent (Value Partners).


KWL is a German municipal water company. Between 2000 and 2005 KWL entered into four cross-border leases (CBLs) in order to raise funds from its infrastructure assets. The CBLs exposed KWL to the risk of default of four financial institutions which were obliged to make certain payments under the CBLs. KWL was advised on these transactions by a financial advisory company called Value Partners. During this period, a corrupt relationship developed between Value Partners and one of KWL's managing directors, Klaus Heininger.

By 2006, KWL needed to raise further funds and Value Partners and Heininger were keen to find ways to profit personally at KWL's expense. Value Partners entered into discussions with a former colleague of two of its principals, Steven Bracy, who now worked at UBS. Value Partners and Bracy discussed possibilities for restructuring the CBLs and Bracy proposed a type of transaction called a single tranche collateralised debt obligation (STCDO). By the STCDOs proposed, KWL would sell UBS credit protection on a reference portfolio of companies, which would be managed by UBS to minimise the risk of defaults. KWL would receive a substantial premium in exchange for the risk of potentially having to pay hundreds of millions of dollars if enough companies in the reference portfolio defaulted. The STCDOs would be accompanied by conventional credit default swaps (CDS) under which UBS would protect KWL from the risk of default by the financial institutions with obligations under the CBLs.

Around this time, another corrupt arrangement developed between Value Partners and Bracy, whereby Value Partners and UBS would work together to:

  • persuade Value Partners' existing municipal clients to enter into STCDOs regardless of whether it was in those clients' interests to do so;
  • get Value Partners engaged with other municipal entities with CBLs so that the same could be done with them; and
  • keep the UBS/Value Partners arrangement secret from those clients and generate significant profits for both UBS and Value Partners.

In June 2006 KWL and UBS entered into an STCDO and CDS relating to one of the four CBLs (the Balaba STCDO). In September 2006 and March 2007 KWL entered into further transactions. As a result of a condition imposed by UBS's senior management on approving the transactions, KWL entered into the further STCDOs with intermediary banks, LBBW and Depfa (the front swaps), who in turn entered into identical, back-to-back trades with UBS (the back swaps). KWL and UBS continued to enter into the CDSs directly.

KWL paid total premiums under the CDSs of $7.8 million and received premiums of $42.3 million under the STCDOs. Of the net premium, only $4.5 million was retained by KWL, the balance being taken by Value Partners pursuant to its engagement letter. Unknown to UBS, the principals of Value Partners paid a bribe of $3 million to Heininger. UBS's anticipated profits were $20 million from reselling the STCDOs into the market and $7.5 million for managing the STCDO portfolios. KWL's total risk under the STCDOs was $346.4 million.

The risks to which KWL was exposed under the STCDOs eventuated during the global financial crisis. UBS sought to recover from KWL under the Balaba STCDO (giving credit for sums due from it to KWL under the CDSs, which were 'in the money' from KWL's perspective) and from LBBW and Depfa under the back swaps. LBBW and Depfa sought, in turn, to recover from KWL under the front swaps. The LBBW front swap was subject to the jurisdiction of the German courts and was held to be enforceable. All of the remaining transactions were subject to the jurisdiction of the English courts.

First-instance decision

The trial judge held as follows:

  • The Balaba STCDO was voidable:
    • on account of the bribe, which was paid by Value Partners as an agent of UBS to Heininger and within the scope of that agency relationship; and
    • as a result of Value Partners being subject to a conflict between its own interests and duties to KWL, such conflict being known to UBS and not consented to by KWL. UBS could therefore not enforce, and KWL was entitled to rescind, the Balaba STCDO.
  • UBS was not entitled to damages from KWL for breach of warranty and fraudulent misrepresentations in connection with the Balaba STCDO (eg, that KWL was entering into the transaction in good faith), because UBS's losses were caused by its own fraudulent conduct.
  • KWL was entitled to an indemnity from UBS, by reason of the bribery, conflict of interest and its dishonest assistance, for any sums which KWL was held liable to pay under the front swaps.
  • The back swaps should be rescinded for fraudulent misrepresentation by UBS (the representation being to the effect that UBS believed Value Partners and Heininger to be honest, when UBS in fact knew that they were not) on terms that LBBW and Depfa be required not to enforce the front swaps against KWL.
  • UBS's management of the STCDO portfolios was negligent and, in the event that the Balaba STCDO or the front swaps had been binding on KWL, KWL would have been entitled to damages from UBS for the full amounts due under the STCDOs.

UBS appealed on all of these points. It accepted that the back swaps should be rescinded, but appealed the imposition of the condition that LBBW and Depfa be required not to enforce the front swaps.

The court also held that, as a consequence of its findings, KWL had to return the premiums received under the STCDOs (including sums taken by Value Partners) and was not entitled to the sums which would otherwise be due to it under the CDSs. KWL cross-appealed on this point.

Rescission of Balaba STCDO

The Court of Appeal unanimously reversed the finding that the bribe was paid by Value Partners as an agent of UBS, for the following reasons:

  • The fact that Value Partners was the fiduciary agent of its clients (including KWL) pointed against the existence of a second agency relationship between Value Partners and UBS, the latter being a party seeking to transact with Value Partners' pre-existing principals.
  • The corrupt arrangement between Value Partners and UBS (whereby UBS would secretly assist Value Partners in abusing its fiduciary relationship with its clients) could not be achieved by UBS holding out Value Partners as its agent or by Value Partners asserting an agency for UBS.
  • Value Partners was not authorised to affect legal relations between UBS and any third party, even by making representations or receiving information.
  • The trial judge did not find that Value Partners owed UBS any fiduciary duty.

However, the majority of the Court of Appeal held that UBS's conscience was sufficiently affected by the bribe that it would be inequitable for the Balaba STCDO to be enforceable (notwithstanding the lack of agency), which was an argument canvassed, but not pursued by KWL at trial. This was based on the principle, which the majority of the court derived from dictum in Logicrose Limited v Southend United Football Club Limited,(2) that:

"Where a party to an intended transaction deals with the other party's agent secretly and behind his back, and dishonestly assists that agent to abuse his fiduciary duties to the other party so as to bring the transaction about, then first party's conscience may be affected not merely by the particular form of abuse by the agent of which it actually knew, but also by any other abuse which the agent chose to employ to bring about the transaction with the first party."

The majority did not accept, as was suggested in the dissenting judgment that this was to "misapply the moral standards of the vicarage to a commercial transaction".

The majority of the court upheld the finding that KWL was also entitled to rescind as a result of Value Partners' conflict of interest, rejecting UBS's argument that Heininger's state of mind could be attributed to KWL and KWL had therefore consented to the conflict. In Bilta (UK) Ltd (In Liquidation) v Nazir(3) the Supreme Court held that where a company claims 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 will not be attributed to the company. The majority held that this principle applied in the present context, where the director and third party were both accomplices of Value Partners, albeit in different aspects of the fraud upon KWL.

The majority of the court rejected UBS's arguments that KWL should nevertheless not be entitled to rescind because it would be disproportionate and unfair and because, so UBS alleged, KWL did not come to court seeking equity with clean hands.

Other issues

The Court of Appeal upheld the decision of the trial judge on the remaining issues under appeal, either unanimously or by majority:

  • Although it was common ground between the parties that KWL was vicariously liable for Heininger's fraudulent misrepresentations (which caused the court some discomfort, given its finding on attribution), such as that KWL was entering into the transactions in good faith, UBS was not entitled to damages because the true cause of its loss was the vulnerability of the Balaba STCDO to rescission.
  • The trial judge's conclusion that the bribe and conflict of interest continued to affect the LBBW and Depfa transactions was "unassailable", so KWL was entitled to an indemnity from UBS for any liability to LBBW or Depfa.
  • The court rejected UBS's argument that, the back swaps having been rescinded, it should in effect be able to step into LBBW's and Depfa's shoes and enforce the front swaps against KWL, noting that within this was "the assumption that the court should exercise its discretion to achieve practical justice in relation to contracts induced by fraudulent misrepresentation so as to ensure that no loss is suffered by the dishonest representor as a result of contracts entered into by it [the back swaps] in reliance on the contracts it had fraudulently induced and in order to fund them [the front swaps]".
  • In relation to negligent management of the STCDO portfolios, the court held that UBS could not meet the high hurdle to overturn the trial judge's findings on breach and, in assessing loss, that it had been open to the trial judge to find that any competent manager would have done at least as well as no manager (with the effect that the Balaba and LBBW STCDO portfolio would have suffered no loss and the Depfa portfolio would have suffered a loss only as a result of two reference companies in fact removed by UBS).
  • The court agreed with the trial judge's finding that the STCDOs and CDSs were a single transaction for the purposes of rescission, so if the Balaba STCDO was to be rescinded, then KWL could not retain the premiums it received under the STCDOs (including the sums taken by Value Partners) or sums that would otherwise be due to it under the CDSs.


This is a long and complex decision which most would consider to preserve, at least on the facts as found by the trial judge, a fair outcome. Although the court unanimously removed a potentially unwelcome extension of agency principles, the majority relied on the arguably novel principle (at least at Court of Appeal level) that where a third party dishonestly sets out to undermine a fiduciary relationship, equity may fix that third party with responsibility for a bribe that it was not aware of paid by the fiduciary. Although this principle may be relevant in some complex frauds involving the payment of bribes, given the specific and unusual facts of this case, it is unlikely to be very wide in its application. However, this decision demonstrates that appellate courts are willing to apply equitable principles creatively in order to avoid what they perceive to be substantial injustice.

For further information on this topic please contact Simon Hart or Daniel Hemming at RPC by telephone (+44 20 3060 6000) or email ([email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.


(1) [2017] EWCA Civ 1567.

(2) [1988] 1 WLR 1256.

(3) [2016] AC 1.