UBS AG v Kommunale Wasserwerke Leipzig GMBH (2017)
A judge had been right to grant rescission of derivative contracts between a bank and its customer on the grounds of bribery and conflict of interests. He had erred in holding the bank responsible for the bribe, because the third party making it had not, on the facts, been acting as the bank's agent at the time. However, the bank was responsible for the bribe in equity, because it had dishonestly assisted the third party in achieving its corrupt aims. The court examined the nature of fiduciary relationships, the concept of attribution, and the availability of equitable remedies.
The appellant bank appealed against a decision that the respondent customer was entitled to rescind credit protection arrangements entered into with the bank.
The customer had been advised in 2006 by its financial advisers to acquire complex derivative products known as Single Tranche Collateralised Debt Obligations from the bank and two intermediaries. Under the terms of the transaction, the customer would be liable to the bank upon certain defaults by entities in the reference portfolios. Defaults occurred in 2008 and the bank sought payment of the sums due under a debt obligation known as "Balaba". The relationship between the customer and its financial advisers had been corrupt: the latter had heavily bribed the customer's managing director to enter into the debt obligations. The bank was unaware of the bribe. However, it had reached its own corrupt arrangement with the financial advisers whereby the latter would advise the bank's clients to enter into the debt obligations regardless of the clients' interests. A judge held that the customer was entitled to rescind the debt obligations on the grounds of bribery and conflict of interests; that the two intermediaries were also entitled to rescind on the ground of fraudulent misrepresentation; and that even if the debt obligations were valid and binding, the losses on the portfolios had been caused by the bank's negligent management of them.
Had the financial advisers been acting as the bank's agent when they paid the bribe? (Gloster LJ dissenting in part) - No.The judge had been wrong to find that they had. His decision would be reversed. The bank's relationship with the financial advisers arose not from any contract, but from the corrupt arrangement reached between them, whereby the financial advisers undertook to deliver their "captive" clients to the bank for the purpose of entering into debt obligations, and the bank undertook to assist them in that endeavour, knowing that the financial advisers were the clients' fiduciary agents and that they intended to abuse that fiduciary arrangement. The judge had failed to set out a precise legal analysis of why the corrupt arrangement amounted to an agency. The absence of any of the main characteristics of agency as described in Tonto Home Loans Australia Pty Ltd v Tavares  NSWCA 389 was a significant pointer away from characterising the relationship as such. The existence of a fiduciary duty did not mean that an arrangement was an agency: in the instant case, the financial advisers had been the customer's fiduciary agents before the the corrupt arrangement with the bank was made, and the bank had known that. Both the bank and the financial advisers had been acting for their own financial benefit; neither had been in a fiduciary relationship with the other, Tigris International NV v China Southern Airlines Co Ltd  EWCA Civ 1649 and Plevin v Paragon Personal Finance Ltd  UKSC 61 applied, Tonto Homes considered (see paras 79-80, 82-84, 89-102, 331 of judgment).
Did the bribe render the debt obligations unenforceable? (Gloster LJ dissenting) - Yes. The bank had dishonestly assisted in the financial advisers' abuse of their fiduciary duty to the customer. Its conscience had been affected by the bribe so as to make it unconscionable for the Balaba transaction to be enforced, Logicrose Ltd v Southend United Football Club Ltd (No.2)  1 W.L.R. 1256 approved. Where a party to an intended transaction dealt with the other party's agent secretly, dishonestly assisting that agent to abuse his fiduciary duties to the other party so as to bring about the transaction, the first party's conscience might be affected not only by the particular form of abuse of which he actually knew, but also by any other abuse which the agent chose to employ. In equity therefore, the bank was responsible for the bribe. There was no injustice in such a finding, even though the issue had not been pursued in the court below (paras 106, 110-121, 331).
Was the judge right to have found that rescission was justified by the financial advisers' conflict of interests (Gloster LJ dissenting) - Yes. It was settled law that where a company claimed 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 fiduciary duty would not be attributed to the company. Therefore, if the customer in the instant case claimed against the financial advisers for their participation in the fraud with its managing director, the director's knowledge of the fraud, including his knowledge that the financial advisers had not delivered disinterested advice to the customer, could not be attributed to the customer, Bilta (UK) Ltd (In Liquidation) v Nazir  UKSC 23 applied. The instant case did not fall squarely within the Bilta analysis, but the principle preventing attribution nevertheless applied. Therefore the customer could not be taken to have consented to the conflict of interest (paras 122, 136-140, 143-156, 331).
Was the judge correct to have granted rescission? (Gloster LJ dissenting) - Yes.Rescission was neither unfair nor disproportionate, Hurstanger Ltd v Wilson  EWCA Civ 299 and Johnson v EBS Pensioner Trustees Ltd  EWCA Civ 164 considered. The judge had rejected the bank's clean hands defence mainly because of his view that part of the reason for the customer entering into the transaction was the corrupt arrangement between the bank and the financial advisers. He had also, wrongly, considered that the bank was legally responsible for the bribe on account of the financial advisers acting as its agent. Either of those reasons, on their own, was sufficient to justify his conclusion. The fact that the instant court had found the bank responsible for the bribe in equity rather than in law did not affect the lawfulness of the judge's decision to grant rescission (paras 158-164, 167-177, 332, 337).
Was UBS's deceit claim wrongly rejected? - No.The deceit had caused no loss to the bank. The customer was the victim. Its managing director's knowledge about the fraudulent aspects of the transaction was not to be attributed to it. Therefore it could not be vicariously liable for the director's fraudulent assertion about the bona fides of the transaction. The bank's losses on its hedging contracts had not been caused by the director's fraudulent misrepresentation, but rather by the rescission of the debt obligation, which had, in turn, arisen partly from the bank's dishonest assistance in the financial advisers' abuse of its fiduciary duties to the customer (paras 181-183, 185-189, 191, 193, 333, 377-378).
Other matters - The court considered that the judge had been right to conclude that the bank should indemnify the customer for any liability it had to the intermediary banks (Gloster LJ dissenting in part) (paras 194-200, 334). It also considered the enforceability of certain back swaps and front swaps (paras 201-229, 335), and determined (Gloster LJ dissenting in part) that, in the absence of rescission, the bank would have had a damages claim against its investment arm in respect of the negligent management of the investment portfolio (paras 276-304, 336).