UBS AG (London Branch) and another v. Kommunale Wasserwerke Leipzig GmbH  EWCA Civ 1567
Kommunale Wasserwerke Leipzig GmbH (KWL) is the municipal water company of Leipzig. It was run at all relevant times by two individuals, Mr Heininger and Dr Schirmer. They became involved with two corrupt financial advisers acting through a Swiss company called Value Partners. As part of a restructuring of cross-border leasing arrangements, Value Partners induced KWL to enter into four single tranche collateralised debt obligations (STCDOs), all of which, in commercial terms, ultimately had UBS as their counterparty. Three of the STCDOs, however, were concluded with an intermediary procured by UBS (either Depfa Bank plc (Depfa) or Landesbank Baden-Württemberg (LBBW)), such that there was a "front swap" between KWL and Depfa/LBBW, and a "back swap" between Depfa/LBBW and UBS. Pursuant to the STCDOs, KWL sold credit protection in relation to a basket of reference entities either directly to UBS, or to Depfa/KWL who in turn sold it on to UBS for a relatively small intermediation fee. In exchange, UBS sold KWL credit protection in relation to the four institutions referred to as part of the cross-border leasing arrangements above.
The commercial outcome of the STCDOs was to release substantial sums to KWL in the form of premium payments (a net total of USD28.1 million plus €6.4 million), but expose KWL to a potentially massive liability if the reference entities underlying the STCDOs defaulted, as a number duly did during the financial crisis.
Underlying these complex transactions was a fraud on KWL, orchestrated by Value Partners. Value Partners succeeded in extracting almost the whole premium paid to KWL under the STCDOs, and bought Mr Heininger's complicity through bribes paid to him. At first instance, Mr Justice Males found that, while UBS did not know that Value Partners had bribed Mr Heininger, or how much of the proceeds of the STCDOs Value Partners extracted, UBS had been aware that Value Partners stood to make a large and disproportionate profit. He also found that UBS knew that Value Partners was dishonest, and UBS was content to use the services of Value Partners to bring "captive" clients such as KWL to it in order to conclude lucrative transactions, regardless of whether this was in the client's interests.
There were 10 issues on appeal. The key points of general interest are whether:
- Value Partners acted as UBS's agent in bribing Mr Heininger (as Males J held that it did);
- if not, the bribe meant that the STCDO with UBS was unenforceable in any event; and
- UBS's knowledge of conflict of interest on the part of Value Partners meant that KWL was entitled to avoid the STCDO with UBS and, specifically, whether Mr Heininger's knowledge that Value Partners was not acting as KWL's disinterested adviser was to be attributed to KWL in this context.
In relation to the first issue, the Court of Appeal considered the traditional elements of an agency relationship: the existence of a fiduciary duty owed by the agent to the principal; authority on the part of the agent to affect the principal's relationships with third parties; and control by the principal over the agent. The Court of Appeal accepted that the absence of any of these characteristics in this case was a "significant pointer" away from the existence of an agency relationship, but would not go so far as to accept that no agency could be found to exist where those three characteristics were not present. The Court of Appeal also noted earlier authority to the effect that the court should be wary of "forcing into an agency analysis a relationship better explained in some other way, in particular where the supposed agent is already an agent of another party to the contemplated transaction". In this case, of course, Value Partners was acting as KWL's agent, however poorly. In the circumstances, the Court of Appeal found that Value Partners was not UBS's agent.
The underlying question on the second issue was whether a party should be entitled to rescind a contract upon discovering that a fraud had been committed on him/her, on the basis that it would be inequitable for the other party to hold him/her to a contract procured in that way. It was common ground that the conscience of the party seeking to enforce the contract would need to be affected in some way in order for rescission to be possible. The issue was how to determine whether a party's conscience was affected, applying dicta of Millett J in Logicrose Limited v. Southend United Football Club Limited.4 The general position was held in Logicrose to be that a party's (A's) conscience is not affected by a bribe or other breach of fiduciary duty by its counterparty's (B's) agent, unless A actually knows or is wilfully blind to the fact of the breach. However, Millett J added, in what he described as a "reservation", that A's conscience would be affected, where A dealt secretly with B's agent, knowing that B was unaware of the fact, and that the agent might be looking to his own advantage.
In the view of the majority (Gloster LJ dissenting) in the Court of Appeal, UBS had demonstrably dealt with KWL's agent, Value Partners, behind KWL's back, and dishonestly assisted it in breaching its fiduciary duties to KWL so as to bring about the STCDO transactions. On that basis, having assisted in one aspect of Value Partners' breach of duty, UBS's conscience was sufficiently affected in relation to any other abuse (in this case the bribing of Mr Heininger) that Value Partners chose to employ. UBS could not say that its conscience was clear, and KWL was therefore entitled to avoid the contract.
In relation to the third issue, Males J found that UBS's arrangement with Value Partners, whereby Value Partners was to deliver captive clients to UBS for STCDO transactions, meant that Value Partners was subject to a conflict of interest and therefore in breach of its fiduciary duty to KWL. As UBS knew of and assisted in such breach, and KWL did not know of it, KWL had a right to rescind its STCDO with UBS. UBS challenged this conclusion, in part because Mr Heininger knew that Value Partners was not providing disinterested advice to KWL. UBS argued that, in the context of the STCDO between UBS and KWL, Mr Heininger's knowledge should be attributed to KWL, and KWL should therefore be taken to have consented to the conflict of interest on the part of Value Partners.
Lord Briggs and Hamblen LJ referred to Bilta (UK) Limited v. Nazir 5 and said that: "It can now be taken as settled law 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 who was in breach of his fiduciary duty will not, as a matter of policy, be attributed to the company". The majority in the Court of Appeal (Gloster LJ again dissenting) accepted that this case did not fall squarely within the categories of case described in Bilta, but found that the same policy considerations applied, such that Mr Heininger's knowledge of breaches of fiduciary duty by Value Partners ought not to be attributed to KWL.
In addition, there was extensive discussion in the judgment (which we do not cover here) of the way in which the court is entitled to exercise its discretion in relation to claims for rescission. While this case is unusual on its facts, the legal principles it raised are of more general application, and the case broke new ground in relation to each.