Kaupthing Singer & Friedlander LTD (in administration) v. UBS AG  EWHC 2450 (Comm)
The Commercial Court (Andrew Smith J) has recently handed down judgment on an intriguing battle between UBS and Kaupthing Singer & Friedlander Ltd (in administration) (KSF) (the English subsidiary of the failed Icelandic bank Kaupthing hf (Khf)), in relation to the fate of US$ 65 million mistakenly paid by UBS to Khf in the first days of the financial crisis.
The judgment contains a number of instructive points both for banks and for their lawyers, but its practical assistance for the former must be in illustrating how an estoppel can arise where payments are misdirected, and by implication, how to avoid that happening. Along the way, the judgment also contains interesting conclusions on the meaning of "payment" in the ISDA Master Agreement.
UBS and KSF entered into a foreign exchange transaction (the FX trade), pursuant to which UBS was to pay US$ 100 million to KSF. The dispute related to US$ 65 million of that sum which UBS transferred by SWIFT to JP Morgan on 3 October 2008. Unfortunately, UBS's (mistaken) instructions to JP Morgan were to credit the sum to an account of Khf, rather than KSF.
Both KSF and Khf learned of the mistake that day. Neither of them alerted UBS. Instead, they adopted the reasonable (but ultimately ill-fated) course of attempting an internal reconciliation by means of a transfer of the funds from Khf to KSF. Some days passed in pursuing these discussions. In the end, it was decided that UBS needed to supply JP Morgan with instructions as to who the intended beneficiary of the payment was, so that Khf could then authorise the sum to be debited from its account and transferred to KSF.
On 7 October 2008, JP Morgan contacted UBS to say that Khf was unable to apply the funds with the details given, and asked for further information. On 8 October 2008, UBS realised its mistake and instructed JP Morgan that the payment was intended for KSF. Khf confirmed its agreement to the debit, and JP Morgan contacted both banks on 9 October 2008 to inform them that the debit would be made that day. UBS believed (as the Judge found) that the matter was closed, and that such belief continued until 2012.
In fact, by 9 October 2008 all parties had other things on their minds. There were insufficient funds in Khf's account for the debit to be made, and in any event on that day, the financial supervisory authority of Iceland took control of Khf's business. JP Morgan was told to put all pending transfers on hold. KSF had been put into administration the day before, and on 9 October 2008 UBS terminated its ISDA Master Agreement with KSF, under which the FX trade had been concluded.
KSF terminated its own ISDA Master Agreement with Khf in November 2008 and included the payment of US$ 65 million in its calculation of the close-out amount. It went on to prove for amounts including that sum in the liquidation of Khf at the end of the following year.
In early 2009, UBS calculated the close-out amount due to it from KSF under the terminated ISDA, and came to a figure of US$ 5,199,194.05. The US$ 65 million did not form part of UBS's calculations. KSF's administrators responded initially with a letter including KSF's general reservation of its right to challenge the basis of computation of the close-out amount. Some delay followed before UBS paid the close-out amount to KSF in October 2009 in the amount it had calculated.
In August 2012, KSF claimed payment of the US$ 65 million from UBS. The way in which its case was put changed shortly before trial (the procedural implications of this are considered below), but UBS defended its position in three ways:
- it said that it had discharged its payment obligations on 3 October 2008 by transferring the money to JP Morgan (referred to by the Judge as the "discharge defences");
- it claimed that the payment of the close-out amount in October 2009 effectively settled all claims between the parties (referred to as the "accord and satisfaction defences"); and
- it said that the parties' conduct and exchanges were such that KSF was estopped from seeking payment of the money, or had waived its right to do so (referred to as the "estoppel and waiver defences").
Had UBS paid the money?
This question required the Judge to consider the meaning of "payment" in clause 2 of the ISDA Master Agreement, and in particular whether payment had been made "in freely transferrable funds" as that clause requires. The Judge took the view that this meant funds had to be freely transferrable in the hands of the payee, i.e. KSF, and that in this case, they had not been.
This conclusion creates some margin for unfairness to payers. If they do all they reasonably can to discharge their obligations (as UBS belatedly did on 8 October 2008), but the receiving bank fails for whatever reason to apply the funds correctly, then it must on this basis be likely that payers will be held not to have discharged their obligations under ISDA. However, this is a risk which is inherent in transfers of this kind, and which must reside with either payer or payee. On the Judge's construction of clause 2 of the ISDA Master Agreement, it rests with the payer.
It is worth noting that in some circumstances, the relationship between the receiving bank and its customer will be relevant. In this case, the Judge did not accept the suggestion that JP Morgan (although described as "receiving agent") had any authority beyond that of a banker to receive funds on KSF's behalf. Had that not been the case, and JP Morgan had played a true agency role, it is possible that KSF would have been held to hold "freely transferrable" funds.
UBS also suggested (unsuccessfully) that KSF had appointed Khf as its agent to receive the funds, or had ratified UBS's payment to Khf. The judgment provides a succinct and useful summary of the doctrine of ratification, which the Judge held to be operative only where one party purports to do something on behalf of another without having the authority to do so. Applying that doctrine here, Khf had not had any positive role in accepting the payment, and had not purported to do anything on KSF's behalf.
The Judge also rejected an argument by UBS that KSF had elected to look to Khf for the US$ 65 million instead and that there was a binding agreement between UBS, KSF and Khf to that effect. The judgment is a useful reminder of the distinction between an election on the one hand, being a decision to abandon one avenue of recourse in favour of another, and waiver and estoppel on the other (considered below).
Had KSF agreed to accept the close out amount in satisfaction of all claims?
It was an interesting feature of UBS's evidence that its key witness maintained that when she later saw KSF's reservation of rights in relation to computation of the close-out amount, her jaw dropped. The reason for her surprise was that in her experience, parties reviewed and agreed the amount of any close-out payment following termination of an ISDA Master Agreement in advance.
This commercial understanding of the nature and purpose of close-out was at the heart of UBS's second line of defence, that KSF had reviewed the close-out amount, and had (or should be treated as having) accepted it in satisfaction of all outstanding obligations under the Master Agreement.
The Judge was unwilling to imply a term into the Master Agreement to the effect that payment and acceptance of a close-out amount indicated acceptance on the part of the receiving party that no further sums were due. Further, in this case KSF's administrators had expressly reserved its position. It follows that if parties closing out an ISDA Master Agreement wish the resulting net payment to be made in full and final settlement, they should say so expressly.
Was KSF estopped from recovering the money?
This section of the judgment is an extremely useful point of reference for anyone needing a summary of the different types of estoppel and how they operate. UBS argued that KSF had waived its right to seek payment of the US$ 65 million, and that it was estopped by convention, acquiescence and representation from asserting otherwise.
In order to succeed, all of these defences required UBS to show that:
- it understood its payment obligation to have been discharged;
- KSF shared that understanding or at least did not indicate otherwise; and
- it would be unjust to allow KSF to assert a claim inconsistent with that understanding.
On the facts, the Judge accepted the first of these points. He also held that KSF too believed that UBS had discharged its payment obligations, and that KSF should look to Khf for the money. The critical words for any party finding itself in the position of KSF are perhaps these: "…KSF's understanding of the position is most clearly manifested in the fact that, having learned that the $65 million had been credited to Khf's account, they did not draw UBS's attention to the mistake. They thought, I infer, that there was nothing to concern UBS. If they had thought that UBS remained liable to them or might do so, they would surely have contacted them: to my mind that is what any reasonable bank in KSF's position would have done.". The lesson must be that practical commercial shortcuts to solving a mistaken payment can cut across legal remedies. Where there is any doubt in a party's mind that it has not received proper performance under a contract, it should bring that to the other party's attention.
In order to establish an estoppel by convention, UBS had to show some "communication to pass across the line between the parties", indicating their shared understanding. Interestingly, there was no direct communication between UBS and KSF as to the mistaken payment. Had there been, it seems less likely that the problem would have persisted. However, the Judge concluded that the communications on 7-9 October 2008 through the conduit of JP Morgan were sufficient for these purposes.
The Judge went on to consider whether UBS had acted to its detriment in relying on its understanding that it had discharged its payment obligations. He found that it had, referring to the close-out amounts it had calculated and paid to both KSF and Khf, and its failure to claim the US$ 65 million from Khf before the window for claims closed.
KSF argued that even if an estoppel were to operate (as the Judge held it did), then the protection it afforded to UBS should not be complete. It said, in effect, that the estoppel should only protect UBS to the extent that it had suffered detriment (referred to by the Judge as the "pro tanto argument". The Judge (obiter) rejected this argument, which he said was recognised only in cases where claims for unjust enrichment had been made on the basis of a payment by mistake, where it was unconscionable for the whole of a benefit to be retained. Here, UBS had paid the money away so was not in profit in any event, and it would be very difficult to quantify the benefit it had received.
KSF's amended case
The Judge's main reason for rejecting the pro tanto argument was not on its merits however, but because it had not been pleaded. The Judge also rejected an application made by KSF to amend its case.
KSF had argued until opening submissions that the money was due under the ISDA Master Agreement itself, but then accepted that this could not be the case from the point when the Master Agreement was terminated. On the second day of trial KSF sought to amend its statements of case to that effect, and by the time of its closing submissions, it sought (in effect) to attack instead UBS's calculation of the close-out amount due in three ways:
- on the basis that the calculation was a nullity because of its omission of the US$ 65 million, which meant that it did not calculate Loss as defined by ISDA;
- on the basis that a calculation of a close-out amount which omitted a trade was necessarily unreasonable; and
- on the basis that even if such a calculation were not necessarily unreasonable, it was in this case.
Taking into account the lateness of the amendment and the lack of clarity of the proposed amended wording, the Judge decided on balance not to allow it. He also took into account the fact that these questions raise issues of general importance to parties who use ISDA Master Agreements and should be properly argued. They therefore remain to be decided, and the Court's views on them, should they ever come before it again, will be interesting.
Conclusions – what could KSF have done differently?
The judgment in this case sets out a wealth of interesting legal and procedural points, but how might KSF have saved itself from its eventual failure to recover the payment?
First, it is tempting to reflect that KSF was too kind to UBS at the outset. It realised that UBS had made a mistake, but it tried to sort the problem out itself, it did not put it squarely back on UBS's plate.
Second, it was too passive in the early days. It did not speak to UBS directly, and even when it knew that there must be some doubt as to whether Khf would be able to transfer the money, it did not go back to UBS with any persistence, or alert it to the fact that it had still not received the money.
This delay was significant. In order for UBS's estoppel defences to succeed, it needed to show (as it did) that it had acted to its detriment in reliance on its understanding that it had discharged its obligations. Those actions all took place some months after KSF knew that it had not received the funds, so there might still have been time for KSF to defeat the estoppel had it acted promptly after the onset of the administration to notify UBS of the problem.
Thus the main lesson to draw from this judgment must be that it is never wise to suffer in silence if you have not received money which should have been paid. The Judge's construction of certain provisions of the ISDA Master Agreement should also be noted however.