UBS AG (London Branch) & Ors v Landesbank Baden-Wurttemberg & Ors (2014)


A German municipal water company had made out two grounds on which it was entitled to rescind a single tranche collateralised debt obligation (STCDO) which it had entered into with a bank: there was an agency relationship between the company's financial advisers and the bank, and the advisers had paid a bribe to the company's managing director which was within the scope of the agency so as to make the bank liable for it in law; also the bank knew that the advisers were subject to a conflict of interest.


The claimant bank (U) sought payment of sums said to be due under certain single tranche collateralised debt obligations (STCDOs).

The defendants were a German municipal water company (K) and two banks (D and L). In order to raise finance K had entered into four cross-border leasing transactions which exposed it to the risk of default by the counterparty bank. It had then entered into credit default swaps (CDSs) with U by which it purchased credit protection from U against the risk of default by each of the counterparty banks. As part of the same transaction K also sold credit protection to U, D and L in respect of a diversified portfolio of assets by means of the STCDOs. U only entered into one of the STCDOs directly with K, as it could not obtain internal credit approval to enter into the others. U approached other banks to act as intermediaries and K subsequently entered into an STCDO with L and two with D, in which D and L acted as intermediaries and sold the same credit protection to U on back-to-back terms. The STCDOs between K and L/D were referred to as the "front swaps", and those between L/D and U were referred to as the "back swaps". U undertook to manage the underlying reference portfolios for K under a portfolio management agreement. The STCDOs were subject to the ISDA master agreement, except the K/L front swap which was governed by German law. The net effect of the CDSs and STCDOs was that K was entitled to an upfront cash premium. However, most of the premium was retained by K's Swiss financial adviser (V). Which had a corrupt relationship with one of K's two managing directors and had paid him a bribe. Following the global financial crisis a number of reference entities within the portfolios defaulted leading to early termination of the STCDOs. U claimed the sums said to be due from K, D and L, and D and L claimed against K. K defended the banks' claims on the grounds that the STCDOs were void because it did not have capacity, or its managing directors who signed them did not have authority, to enter into such contracts, and that they were voidable and had been avoided on grounds of bribery, conflict of interest and fraudulent misrepresentation. In addition, if the STCDOs were valid and binding, it contended that the losses suffered on the portfolios were caused by U's negligent management of them. In the alternative to its primary claim to recover from K the sum due pursuant to the STCDO, U sought to recover an equivalent sum as damages for breach of warranty and fraudulent misrepresentation by K.


(1) K's articles of association required approval of its supervisory board to be obtained for transactions "of fundamental significance". That involved an objective test. The transactions were "of fundamental significance" within the meaning of K's articles because of the sheer scale of the exposures which it was undertaking and the potential consequences for it if the relatively low risk of a total loss materialised (see paras 551-553 of judgment). (2) The requirement for supervisory board approval was not so obvious that there was "gross negligence" by U under German law in failing to appreciate that fact. It was entitled to rely on the fact that K's own solicitors had provided an opinion which did not indicate the need for such approval. It followed that K had capacity to enter into the transaction as a matter of German law (paras 562-575). (3) V acted as the agent of K, but the relationship of U and V also amounted in law to an agency relationship. U and V worked together in order to ensure the conclusion of the transaction regardless of K's interests. The relationship was consensual, if not contractual. The law would therefore impose the consequences that resulted from agency, Garnac Grain Co Inc v HMF Faure & Fairclough Ltd [1968] A.C. 1130 and Branwhite v Worcester Works Finance Ltd [1969] 1 A.C. 552 followed (paras.591-606). The correct approach where the agent was an agent of both parties to the transaction was 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. Applying that test, the bribe paid by V to K's managing director was paid in the course of its employment as an agent of U. Accordingly U was responsible in law for the consequences of the bribe, Armagas Ltd v Mundogas SA (The Ocean Frost) [1986] A.C. 717 followed (paras 615-620). (4) V was subject to a conflict of interest and U had created and knew of that conflict. For the purpose of the conflict of interest issue, U could not rely on the knowledge of K's managing director to show that K had consented to the conflict, Bilta (UK) Ltd (In Liquidation) v Nazir [2013] EWCA Civ 968, [2014] Ch. 52 followed, Moulin Global Eyecare Trading Ltd v Commissioner of Inland Revenue [2014] HKCFA 22 considered. Therefore K's conflict of interest defence succeeded (paras 625-641). (5) K failed to show that it had been induced to enter into the STCDO with U by fraudulent misrepresentation (paras 642-676). (6) Where U could not enforce the STCDO because of the bribery by V acting as its agent and its knowledge of V's conflict of interest, it could not rely on false statements made by K to recover damages, the effect of which would be to enable it to escape from the invalidity of the STCDO (para.696). (7) K was entitled to rescind the STCDO on grounds of bribery and conflict of interest and had done so (para.707). It would also be entitled to damages or an indemnity from U in the event that it was required to pay L and/or D under the front swaps with them (para.716). The purpose of rescission was to restore the parties, so far as possible, to the position in which they were before the contract in question was concluded. The court had a degree of flexibility in order to achieve practical justice. On rescission U was entitled to return of the net premium paid to K, less the amount of the bribe. K was not entitled to payment of the early termination amount due on the CDSs (para.731). (8) D had relied on fraudulent misrepresentations by U in entering into the two back swaps. It was entitled to rescind them and recover the sum paid to U, on condition that it returned its intermediation fee and did not seek to enforce the front swaps against K, although it would otherwise have been entitled to do so (paras 732-791, 812). L was in the same position and was entitled to rescind the back swap on condition that it returned its intermediation fee and undertook not to enforce the front swap against K (paras 795-799). (9) As a matter of construction of the back swaps, the liability of D and L to U in the event of early termination of the front swaps was dependent on K being liable to D and L under the front swaps, but did not depend on K actually making payment (para.835). The back swaps should not be rectified so as to achieve that result (paras 850, 856). (10) U's management of the portfolios failed to meet the relevant standard required and U was accordingly in breach of the portfolio management agreements. The losses suffered on the portfolios were caused by U's breaches (paras 906, 911).

Judgment accordingly