UBS, KWL, Depfa and LBBW – [2014] EWHC 3615 (Comm) (Part 3)

Our recent updates "Fraudulent misrepresentation by a bank and the ISDA Master Agreement" and "Construction and rectification: the consequences of rescission and making good the defects in drafting of back-to-back confirmations under the ISDA Master Agreement" considered aspects of the judgment of Mr Justice Males (the Judge) in litigation between the banks UBS, Depfa and LBBW, and the German water company Kommunale Wasserwerke Leipzig GmbH (KWL).

In this further article, we consider one of the key aspects of the Judge's findings as between UBS and KWL, namely that UBS was legally responsible for a bribe paid to one of KWL's directors despite having no actual knowledge of it. The case sheds light on the law in relation both to bribery and agency.

Factual background 

The full background is set out in "Fraudulent misrepresentation by a bank and the ISDA Master Agreement". In summary, the dispute between the parties centred around various STCDOs entered into by KWL with each of the banks. Of these, the transaction which was the subject of much of the judgment was the STCDO agreed between UBS and KWL. KWL was advised and introduced to UBS by a Swiss entity, Value Partners.

KWL received an upfront premium of US$21.1 million for entering into that transaction, a fact of which one of its directors, Mr Heininger, was aware, but which was not known to its other director or its Supervisory Board.

The premium was paid  into an account in the US in KWL's name, but over which Value Partners had complete control. Value Partners appropriated the money, paying a proportion of it to Mr Heininger, who was therefore bribed by KWL's own adviser, with KWL's own money. This aspect of the story behind the litigation was uncovered some years ago, and has been the subject of criminal proceedings in Germany.

There was therefore no dispute between the parties at trial that Mr Heininger was paid a bribe in connection with the conclusion of the STCDO transactions, the Judge describing bribery as "an evil practice towards which the law takes a particularly stringent attitude."

Disputed issues in relation to the bribe

KWL asserted that the STCDO between it and UBS was voidable (and had been avoided) on the basis that the law should treat the key protagonists from Value Partners (Mr Senf and Mr Blatz) as agents of UBS for the purposes of bringing about the STCDO transaction, and that UBS was to be fixed with knowledge of the bribe on that basis, despite having no actual knowledge that it had been paid.

KWL initially put its case on an alternative basis, arguing that as a matter of law a contract procured through bribery is voidable whether or not the counterparty knows of the bribe. KWL did not pursue this case at trial (although it reserved the right to do so on appeal), and the Judge expressed some doubt as to whether a contract could be rendered unenforceable on general equitable grounds in the absence of any conduct affecting the conscience of the party seeking to enforce it.

Was there an agency relationship between Value Partners and UBS?

The Judge noted that where the agent of one party bribes the agent of another, the party whose agent was bribed is entitled to avoid the contract and claim damages from the other party. In order to do so successfully, however, that other party must be established to be vicariously liable for the bribe, although it need not have known of or authorised it. The bribing agent must have been acting in the course of his authority as agent. 

The starting point of KWL's case therefore had to be that despite the fact that, in the Judge's words "undoubtedly Value Partners was the agent of KWL", Value Partners was as a matter of law acting as UBS's agent. The Judge did not regard the two as being mutually exclusive.

The Judge found that UBS and Value Partners had indeed agreed to a relationship which, as a matter of law, amounted to an agency relationship. His reasons for doing so were rooted in the course of dealing between UBS and Value Partners (a chronological account of which was set out in the judgment) and in many respects, no summary can do full justice to the detailed reasoning.

However, there are two themes which emerge from the Judge's findings which may be instructive in future cases:

  1. UBS, through one of its employees in particular, was keen to foster a close relationship with Value Partners, because it was perceived as having "captive clients" such as KWL which it could "deliver" to UBS for future transactions (thus securing revenue both for Value Partners and UBS); and
  2. the contemporaneous documents showed that there was an alignment between UBS and Value Partners on the one hand, and KWL on the other, with the aim of pushing the transaction through.

The Judge held that Value Partners's role as UBS's agent was to procure KWL's entry into the STCDOs. Citing previous authority, he held that in order for such an agency role to exist, it did not need to be of a contractually binding nature, saying that a "consensual, not contractual" relationship was enough.

Did Value Partners act as UBS's agent in paying the bribe?

The Judge's next task was to determine whether Value Partners had acted within its authority as UBS's agent for the purposes of paying the bribe (and thus whether UBS was liable as principal for that payment). 

This involved consideration of a point in respect of which there was no applicable precedent, as to how the court should treat a case where the agent paying the bribe is the agent of both parties. The Judge determined that: "In my judgement the correct approach in a case where the agent is an agent of both parties to the transaction is to ask whether in paying the bribe the agent was acting within the scope of its agency as the agent of the party seeking to enforce the contract. That involves a consideration of the scope of the agency relationship. If it was so acting, however, the enforcing party must accept the legal consequences of the bribe even if the agent was also the agent of the other party and even if the payment of the bribe was also within the scope of that other agency. It cannot avoid those consequences on the ground that the agent paid the bribe in breach of the fiduciary duties which it owed to the other party, as Value Partners undoubtedly did on the facts of this case. That is so regardless of which agency relationship was first in time or more firmly established. It makes no difference, therefore, that KWL had an established relationship with Value Partners which ante-dated any contact with UBS. Nor does it matter that the relationship between Value Partners and Mr Heininger was already corrupt." 

Part of the Judge's express reasoning behind this formulation of a previously untested point of law was that it would be contrary to the policy of the law (to treat bribery with particular stringency) not to hold the principal of the bribing agent responsible, just because in paying the bribe the agent was also acting as agent of, and in breach of fiduciary duty to, his other principal.

Applying this statement of law to the facts, the Judge held that Value Partners was acting as UBS's agent in paying the bribe, because it had done so for the precise purpose of its agency relationship with UBS, namely to procure that KWL entered into the STCDOs.

Conflict of interest

KWL argued separately that it was entitled to rescind the STCDO with UBS because, by entering into a close relationship with Value Partners, UBS had not only deprived KWL of Value Partners's disinterested advice, but had caused or known that to be the case. 

The Judge found without difficulty that Value Partners was indeed conflicted and that UBS knew it, but devoted more time in his judgment to the question of whether KWL had also known of and consented to Value Partners's conflict of interest.

KWL's director, Mr Heininger, was obviously aware that Value Partners was not providing disinterested advice to KWL, and was himself a beneficiary of Value Partners's dishonesty. UBS argued that his knowledge in this regard should be attributed to KWL. The Judge held that it would be absurd to do so, in that this would involve a finding that KWL had consented to being defrauded by its director and its financial adviser.

It is hard to argue with the Judge's view on this. Nonetheless, UBS was unfortunate in that the issue of attribution of knowledge was considered at various points in the judgment, and went against UBS each time. UBS was held to be responsible for the actions of its own employee, but was unable to benefit from any attribution of knowledge as between KWL and Mr Heininger. 

Conclusions

If this judgment has a sound bite, it is the Judge's concluding remark that "it has been a case study in how not to conduct investment banking in an honest and fair way." It is only fair to UBS to point out that the Judge did not think those in charge of KWL had provided a shining example of how to run a water company either. 

It is resoundingly clear from the judgment that the relationship between UBS and Value Partners was inappropriate and ought not to have been so close, or so heedless of the interests of KWL as Value Partners's client. What emerges from the factual narrative which the Judge set out over the course of some 350 paragraphs is that UBS had the misfortune to employ an individual who the Judge described as a "maverick", who saw the opportunity to make money for the bank by fostering an inappropriate relationship with Value Partners, and to increase his own status within the bank as a result. Where the Judge clearly considered UBS to be culpable was in its encouragement and lack of oversight of that employee. The judgment sets out the consequences of poor supervision of their staff, both by UBS and KWL.

The facts of the case are (it is to be hoped) unusual, but the sins of the past have a habit of being exposed by a financial crisis. It is unlikely that this is the only tale of bribery which will emerge over the next few years. The judgment is a reminder to banks of the dangers of ignoring clear signals that their customers may be less than honest.