UBS and others v KWL and others [2014] EWHC 3615 (Comm)

Mr Justice Males handed down a 162 page judgment on 4 November 2014 following a 14 week trial.

Broadly speaking, the case concerned the sale of credit protection for bond portfolios by a German municipal water company, Kommunal Wasserwerke Leipzig Gmbh (KWL), to an international investment bank, UBS AG (UBS), which ultimately resulted in KWL allegedly owing in excess of $300,000,000. This may seem like a surprising thing for a municipal water company to do.

The judgment answers how this extraordinary situation came about and how the fall out is to be dealt with. It contains several useful lessons for investment banks.

The Background

In 2007, KWL sold credit protection to UBS and two other banks on portfolios of investment grade bonds. The credit protection was provided by way of a derivative product known as Single Tranche Collaterised Debt Obligations (STCDOs).  The effect of STCDOs was that if a certain number of securities in the portfolio defaulted over a period of eight years then UBS could call on KWL to pay part of the default.  KWL was advised on the transaction by a Swiss company, Value Partners (who took a hefty proportion of the premium payable to KWL by UBS). It was common ground that Value Partners bribed the managing director of KWL to secure the deal. In the financial crisis of 2008-2009, a number of securities in the portfolios defaulted and UBS sought payment from KWL under the terms of the STCDOs.

The Issues

KWL denied it was liable on the following grounds:

  • the STDCOs were void because KWL did not have the capacity (or the directors who signed them did not have authority); and/or
  • the STDCOs were voidable and could be rescinded on the grounds of bribery; conflict of interest or fraudulent misrepresentation.

If contrary to its case, the STDCOs were binding, KWL claimed that the losses it suffered as a result were caused by the negligent mismanagement by UBS' asset management arm, UBS Global Asset Management (UBS GAM), which KWL had employed to manage the portfolios.

Capacity of KWL

The question of capacity was governed by German law and the judge found that the directors of KWL did have capacity to enter the arrangements.


It was an undisputed fact that Value Partners, who advised KWL to enter the deal, had bribed KWL's managing director. The Court found that, for this purpose, Value Partners were, on the facts, acting as an agent of UBS (under unofficial arrangements to direct business from KWL to UBS) and were acting within the scope of that agency when paying the bribe. Therefore UBS, as principal to the agent, must accept the consequences of the agent's bribe even if it was unaware itself of the bribe. This was the case notwithstanding that neither UBS nor Value Partners would have considered themselves to have an agency arrangement at the time. This was sufficient ground for KWL to rescind the STDCOs.

Conflict of Interest

The judge found that Value Partners were both advising KWL and helping UBS win KWL's business. Value Partners were therefore acting in conflict of interest in advising KWL to enter the deal and UBS was aware of this. Accordingly this was also a ground for KWL to rescind the STDCOs.

Fraudulent misrepresentation by UBS

  • KWL alleged that it was induced to enter the STDCOs as a result of fraudulent misrepresentations by UBS as follows:
  • that the risk of default from the STDCOs was virtually zero;
  • that the STDCO transactions reduced KWL's risk of suffering significant losses;
  • that there was no reason to believe the risks involved were greater than the credit ratings given to the portfolios in question; and
  • that the risks associated with STDCOs had been communicated by UBS in a clear fair way that was not misleading.

The judge decided that the first three alleged misrepresentations were not made as a matter of fact.

The fourth allegation was based on the proposition, which is of wider interest, that a statement in the contractual documentation stating that UBS was authorised and regulated in the UK by (what was then) the Financial Services Authority (FSA) amounted to a representation that the marketing of the deal to KWL had been done in a clear, fair and not misleading way. This was on the basis that the FSA requires that firms market its products in a clear, fair and not misleading way. In the event, the judge declined to opine on this as he did not consider, as a matter of fact, that the marketing by UBS to KWL had been misleading in the first place.

KWL's negligence claim against UBS GAM

KWL employed UBS GAM to manage the portfolios of its STDCOs.The intention was that UBS GAM would move risky entities out of the portfolio as appropriate to minimise the risk of defaults.In fact, if the portfolios had not been managed at all and the entities within the portfolios had remained the same, the liability of KWL under the STDCOs would have been much lower.

The Judge found that UBS GAM's duty was not simply to exercise reasonable care by the standards of a reasonably competent portfolio manager but, given the nature of the pitch given to KWL, to follow a particularly conservative strategy, to maximise diversification, minimise risk concentration, to avoid "big bets" on any particular sector and to ensure continuous monitoring of potential defaults. He found that, in reality, the approach adopted by UBS GAM was not a diversification strategy but rather amounted to a concentrated bet on financials, bond insurers, risky lenders and banks with rising leverage.

UBS GAM argued that, at the time, concentration in the financial sectors was not seen as particularly risky prior to the 2008 crash. However, the judge found that UBS GAM was not applying the approach it had pitched to KWL that it would of diversifying risk and focussing purely on minimising the risk of default. He also found that inadequate records were kept of the monitoring of credit risk and the rationale behind investment substitution decisions and, in these circumstances, it was hard to give UBS GAM the benefit of any doubt.

While it was not necessary to measure loss in this instance (because the STDCO's were, in any event, considered rescinded), the judge determined that he would have taken a broad brush approach to measuring loss. This would have involved an assessment of the difference between the loss actually suffered by KWL in relation to each portfolio and the loss which would have been suffered had there been no portfolio management at all, rather than considering each and every transaction undertaken by UBS GAM individually.The judge considered that this was a realistic approach, which did not involve making unduly generous assumptions in favour of KWL.


The case does not break new ground in terms of law. However, it does provides a useful case study of how the court can find an agency relationship, even where the parties do not consider themselves to be in a principal/agent relationship. This is something banks should be wary of when dealing with third parties when negotiating deals.

Some may see this case as an example of the cultural values from which many (certainly larger) banks are now working hard to move away, through investment in ethics and cultural training. The court found that, in pursuit of a profitable deal, UBS ignored the opinions of its compliance team, who were, unsurprisingly, unconvinced of the appropriateness of the deal for a municipal water company. The court also found that UBS inappropriately encouraged Value Partners to obtain business from KWL for UBS, notwithstanding that they were KWL's advisors.

For now, we can do no better in summing up than turn to the concluding words of the judge, who said: "For UBS it has been a case study in how not to conduct investment banking in a fair and honest way.  It is to be hoped that the events described belong to a bygone era."