The Appellant, UBS AG is an investment bank. The main Respondent, Kommunale Wasserwerke Leipzig GmbH (“KWL”), is the Leipzig municipal water company responsible for the supply of water and sewage services to the people of Leipzig.
In 2006 and 2007 KWL acquired complex derivative products known as Single Tranche Collateralised Debt Obligations (“STCDOs”). The effect of the STCDOs was that, in return for a premium, if a certain number of the entities in the underlying reference portfolios defaulted, KWL would be liable to make payment to UBS and two intermediary banks.
The transaction between KWL and UBS was facilitated by two separate corrupt arrangements:
- Value Partners, KWL’s financial advisors, bribed one of KWL’s managing directors, Mr Heininger; and
- UBS, unaware of the bribe, entered into an arrangement with Value Partners whereby Value Partners would advise their municipal clients to enter into STCDOs with UBS regardless of the clients’ interests.
KWL appointed UBS’s global asset management business, UBS GAM, to manage the credit portfolios underlying the STCDOs. Defaults occurred following the 2008 global financial crisis and the banks sought payment from KWL of more than €350 million.
The court at first instance dismissed the claim and ordered rescission of the STCDOs.
The Court of Appeal dismissed the appeal by a majority.
Had the financial advisers been acting as the bank's agent when they paid the bribe?
The court at first instance had ruled that an agency relationship had developed between Value Partners and UBS under the second fraudulent collusion, and that the bribe given to Mr Heininger was something done within the scope of that agency so that UBS was responsible for the bribe even though unaware of it.
The Court of Appeal reversed the judge’s findings. The corrupt arrangement could only achieve its intended results if Value Partners purported in its dealings with its captive client to act loyally and exclusively on their behalf. This pointed against any suggestion that Value Partners was acting on UBS’s behalf. Both UBS and Value Partners had been acting for their own financial benefit; neither had been in a fiduciary relationship with the other. Value Partners did not have any authorisation to effect legal relations between UBS and any third party.
Did the bribe render the debt obligations unenforceable?
A contracting party is entitled to the undivided loyalty of its financial adviser. Therefore, a counterparty who deliberately and dishonestly undermines that fiduciary relationship in relation to an intended transaction cannot expect to be able to resist a claim by the counterparty for rescission, if the transaction is brought about by the fiduciary’s misconduct, and that misconduct included the payment of a bribe (Logicrose Limited v Southend United Football Club Limited  1 WLR 1256).
As to whether the transaction between UBS and KWL could be rendered unenforceable by the bribe paid to Mr Heininger by Value Partners, unbeknownst to UBS, depended upon whether UBS’s conscience could have been affected by the bribe.
The Court of Appeal ruled that as UBS was dishonestly assisting Value Partners to bring about a transaction between itself and KWL that was in breach of Value Partners’ fiduciary duties, UBS’s conscience was affected not merely by the corrupt arrangement it knew about, but also by any other abuse which Value Partners chose to employ to bring about the transaction, namely the bribe. It would therefore be inequitable for UBS to resist rescission of the debt obligations.
Was the judge right to have found that rescission was justified by the financial advisers' conflict of interests?
The court at first instance held that the rescission of the STCDOs was justified on the basis that Value Partners, in seeking to gain from the fraudulent arrangement between itself and UBS and its obligation to provide disinterested advice to KWL, was conflicted in its interests.
UBS appealed the decision on the basis that Mr Heininger knew of the corrupt arrangement between Value Partners and UBS and therefore impliedly consented to the conflict of interest.
The Court of Appeal set out the principle 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 (See the Supreme Court judgment in Bilta (UK) Ltd (In Liquidation) v Nazir  A.C. 1, approving Moulin Global Eyecare Trading Limited v Commissioner of Inland Revenue  HKCFA 22 per Lords Toulson and Hodge at )
Whilst accepting that the current case did not fit squarely with this principle, as a matter of policy, the Court of Appeal upheld the decision at first instance. It ruled that as Mr Heininger and UBS were both accomplices of Value Partners, albeit in difference aspects of the fraud upon KWL, and therefore Mr Heininger’s knowledge of the bribe should not be attributed to KWL.
Was the judge right to order rescission?
A claim for rescission is a claim for an equitable remedy, in relation to which the court exercises discretion.
UBS appealed against the ruling at first instance that the Court’s discretion should be exercised in favour of rescission. In its submissions, UBS argued that (1) rescission would be disproportionate and unfair, and (2) that KWL did not come with clean hands.
With regard to (1) the Court of Appeal held that, contrasting the profits UBS stood to make from the transactions with KWL’s significant exposure to downside risks with no recourse other than the Leipzig taxpayers, awarding rescission to KWL would not be disproportionate or unfair.
As to (2), UBS argued that as Mr Heininger had misrepresented to the bank that KWL was entering the transactions on good faith, it could not come to court with clean hands. The Court of Appeal rejected that argument on the basis that UBS’s fraudulent collusion with Value Partners played a role in inducing the statement from Mr Heininger. As UBS’s conscience thus had been affected in connection with this corrupt arrangement, the bank could not claim as a matter of equity that rescission should be refused.
The rescission of the STCDOs was therefore upheld.
Causation and loss
The court at first instance found that UBS GAM, who was enlisted to manage the portfolio of underlying entities, was negligent with respect to their contractual obligation to minimise risk in the portfolio and prevent losses reaching KWL’s tranche.
The Court of Appeal upheld the judge’s assessment of causation and loss and concluded that all of the losses were caused by UBS GAM’s negligent management, dismissing UBS’s appeal.
Lady Justice Gloster’s dissenting judgment
Lady Justice Gloster argued that a greater emphasis should have been placed on the collusion between Value Partners and Mr Heininger as a cause of KWL entering into the STCDO transactions. She stressed UBS’s lack of knowledge of the bribe paid to Mr Heininger and the fact that, had the arrangement between UBS and Value Partners not been made, it is likely that Value Partners along with Mr Heininger would have caused KWL to enter into a similar transaction with another bank.
Lady Justice Gloster therefore considered that:
- The Logicrose principle should not be extended so as to affect UBS’s conscience by the arrangement between Value Partners and Mr Heininger, which she considered to be entirely separate. Holding UBS responsible in doing so was in her view “commercially unreal”. In her view it was one thing to say that UBS knew that Value Partners had a conflict of interest, but another thing altogether to attach UBS with responsibility for Value Partners’ separate and calculated bribery of which it was unaware;
- Applying the test in Bilta, UBS could not be said to be an accessory to the breach of Value Partner’s fiduciary duty towards KWL;
- On the facts, due to the inequitable conduct of Mr Heininger, KWL did not come to the court with clean hands.
The ruling on bribery extends the application of the principle in Logicrose. Previously, a party was required to have actual knowledge of the payment of a specific bribe to bear the consequences of it. Now, a party might be forced to accept the consequences of corrupt payments involving its agent, even if it did not know that any bribes were being paid, provided that it was aware of and assisted in at least an aspect of that agent’s dishonest breach of fiduciary duty owed to the claimant.
Where a party has suspicions about the honesty of its counterparty’s agent, it should carefully consider disclosing its concerns to the counterparty to avoid any suggestion that the agent’s dishonesty could affect the enforceability of obligations between principals.
Practitioners can expect litigants to take up this decision so as to argue that defendants with deep pockets should be held responsible for dishonest activity of which they may not have been aware. However, given the persuasive points made by Gloster LJ in her dissenting judgment, it may be that on different facts this point will be revisited, possibly with a different outcome. This area of the law may therefore remain topical, and may not yet be entirely settled.