UBS AG (London Branch) & Anor v Kommunale Wasserwerke Leipzig GmbH, Court of Appeal - Civil Division, October 16, 2017, [2017] EWCA Civ 1567

Resolution Date:October 16, 2017
Issuing Organization:Civil Division
Actores:UBS AG (London Branch) & Anor v Kommunale Wasserwerke Leipzig GmbH

Case No: A3/2014/4221

Neutral Citation Number: [2017] EWCA Civ 1567





[2014] EWHC 3615 (Comm)

Royal Courts of Justice

Strand, London, WC2A 2LL

Date: 16/10/2017

Before :





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Between :

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Lord Falconer, Mr Stephen Moriarty QC, Mr Richard Slade QC, and Mr Edward Harrison (instructed by Mayer Brown International LLP) for the UBS parties
Mr Tim Lord QC, Mr Simon Salzedo QC, Mr Stephen Midwinter QC and Mr Craig Morrison (instructed by Addleshaw Goddard LLP) for KWL
Mr Andrew Mitchell QC and Mr Richard Power (instructed by Dentons UKMEA LLP) for DEPFA
Mr Nicholas Peacock QC, Miss Catherine Addy QC and Miss Fiona Dewar (instructed by Baker & McKenzie LLP) for LBBW

Hearing dates : 15, 16, 17, 18, 19, 22, 23, 24 & 25 May 2017

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JudgmentLord Briggs of Westbourne and Lord Justice Hamblen:

1. This is a joint majority judgment to which both Lord Briggs and Hamblen LJ have contributed, and with which we both fully agree.


2. The Appellants, UBS AG, a bank incorporated in Switzerland, and UBS Ltd, an English subsidiary of UBS AG (together "UBS"), are 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.

3. In 2006 and 2007 KWL was persuaded to sell credit protection to UBS and to two intermediary banks, Landesbank Baden-Württemberg ("LBBW") and Depfa Bank plc ("Depfa"), the other Respondents. It did so by means of complex derivative products known as Single Tranche Collateralised Debt Obligations ("STCDOs").

4. The effect of these STCDOs was that if a certain number of the entities in the reference portfolios defaulted during an eight or ten year period, KWL would be liable to pay the banks hundreds of millions of dollars. Defaults duly occurred following the global financial crisis of 2008-9 and the banks sought payment of the sums due, making claims in excess of €350 million.

5. KWL was persuaded to enter into the STCDOs by its corrupt financial advisers, Value Partners Group AG ("Value Partners") (a Swiss company), assisted by a bribe of around US$3 million paid by Value Partners to Mr Klaus Heininger, one of KWL's two managing directors. This bribe was paid out of the premium of just over US$30 million paid to KWL for providing credit protection under the STCDOs, all bar €4.5 million of which was siphoned off by Value Partners. The premium payments were funded, and UBS's booked profit of over US$25 million was made, by UBS selling equivalent protection to the market through collateral hedging contracts.

6. Although UBS was not aware of the bribe, it had 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 was the first client "delivered" under this arrangement. KWL was not aware of this arrangement.

7. The trial judge, Males J, held that KWL was entitled to rescind the STCDOs with UBS on the grounds of bribery and conflict of interest. The judge further held that Depfa and LBBW were entitled to rescind the STCDOs they had entered with UBS on the grounds of fraudulent misrepresentation.

8. In addition, the judge held that even if the STCDOs were valid and binding the losses on the portfolios were caused by their negligent management by the portfolio manager UBS Global Asset Management (UK) Ltd ("UBS GAM").

9. UBS and UBS GAM appeal the judgment on various grounds and there are 10 agreed issues to be determined on the appeal, including two grounds of cross appeal by KWL.

Factual background

10. A detailed narrative of events is set out in the judgment of Males J. It is not necessary to repeat that full account in this judgment since there is only one main factual finding which is challenged relating to the knowledge of Dr Andreas Schirmer, KWL's other managing director. Instead a brief summary of the key events relevant for the purposes of the appeal will be set out, drawing on and giving cross-references to the judgment. More detailed reference to the judge's findings will be made when considering the various issues which arise on the appeal.

KWL and Value Partners [50]-[54]

11. KWL is a German municipal water company. At all relevant times, its Executive Board consisted of two managing directors, namely Mr Heininger and Dr Schirmer. Mr Heininger took the lead on commercial matters while Dr Schirmer did so on technical matters. It also had a Supervisory Board to provide oversight of the Executive Board's activities.

12. In 2002, KWL engaged Global Capital Finance ("GCF") as a financial adviser. The key principals of GCF were Mr Berthold Senf, and Mr Jürgen Blatz. In around April 2004, Mr Senf and Mr Blatz left GCF and formed another financial advisory company called Value Partners. A corrupt relationship developed between KWL and Messrs Senf and Blatz of GCF (and later Value Partners). This began with the giving of generous gifts and expenses paid luxury trips to Mr Heininger and others at KWL from 2002 onwards.

The cross-border leases [111]-[115]

13. Between 2000 and 2005, KWL entered into four cross-border lease transactions ("CBLs"), the provisions of which were materially identical for present purposes. Under each of these agreements, KWL leased certain of its infrastructure assets to a special purpose vehicle ("the Trust"). The Trust was funded by deposits from overseas investors and loans. It was domiciled outside Germany, allowing it to take advantage of depreciation provisions under foreign tax laws which KWL was not itself able to realise. This enabled the Trust to pay an upfront premium to KWL in return for the lease of the assets.

14. KWL used part of this payment to obtain a payment undertaking or bond from a highly rated bank or insurance institution ("the defeasance provider"). The four defeasance providers were: i) Balaba (which undertook to pay £96.2m in 2014 to support the "Balaba CBL"); ii) Merrill Lynch (which undertook to pay US$65m in 2025 to support the "Wastewater CBL"); iii) General Electrical Capital Corporation, or "GECC" (which issued a floating rate note pursuant to which it agreed to pay €77m in 2014 to support part of the "Freshwater (F1) CBL"), and; iv) MBIA Global Funding LLC (which issued a zero coupon bond pursuant to which it agreed to pay US$50m in 2033 to support the balance of the "Freshwater (F2) CBL").

15. The Trust then sub-leased the infrastructure assets back to KWL. Under the terms of that sub-lease, KWL was required to pay rent to the Trust, which in turn enabled the Trust to pay interest on its loans and to pay a return to its investors. KWL funded these rent payments with the proceeds of the bonds provided by the defeasance providers. At the end of the sub-lease term, KWL had the option to re-purchase the infrastructure assets at a predetermined price, such purchase to be funded by the remainder of the bond provided by the defeasance provider.

16. The overall result of these CBLs was the generation of funds for KWL, which it needed to upgrade its facilities, reduce running costs and lower the water premiums paid by Leipzig citizens. At the same time, the leases exposed KWL to the risk that the defeasance providers might default. This would render KWL unable to buy back its infrastructure assets when the sub-lease term came to an end, thereby preventing it from carrying on its business.

17. Value Partners had advised KWL in relation to at least three of the leases and in 2005, KWL made Value Partners responsible for the regular reporting on and monitoring of all concluded and future CBLs. The CBLs provided the opportunity for the corrupt relationship between Value Partners and Mr Heininger to escalate to outright cash payments. In May 2005, Value Partners made a cash payment to Mr Heininger of €945,945 in connection with the Balaba CBL, and made a donation of €150,000 to Mr Heininger's favourite football team [54].

Potential restructuring of the CBLs [161]-[181]

18. By 2006, KWL was cash-strapped and under pressure to raise further funds. At the same time, Mr Heininger, Mr Senf and Mr Blatz were keen to find new ways to profit personally at KWL's expense. KWL could not enter any new CBLs, as it had already leased all of its relevant infrastructure assets, and CBLs were in any case becoming less attractive as the tax loopholes of which they sought to take advantage were closed up. In early 2006, Mr Heininger asked Value Partners about the possibility of restructuring the existing CBLs. As part of their investigations into potential restructuring, Mr Senf and Mr Blatz contacted Mr Steven Bracy, a former colleague of theirs who now worked at UBS.

19. On 6 April 2006, a telephone conversation took place between Mr Senf, Mr Blatz and Mr Bracy, during which Value Partners made inquiries as to restructuring possibilities on behalf of a then-unnamed client (i.e. KWL). During this conversation Value Partners raised the possibility of restructuring the CBLs by means of a type of credit default swap ("CDS") known as a collateralised debt obligation ("CDO"), and asked for more information on the subject. Mr Bracy explained the way in which CDOs worked, and suggested a specific type of CDO known as a single tranche collateralised debt obligation ("STCDO") as being appropriate for Value Partners' purposes.

The nature of STCDOs [118]-[124]

20. A traditional CDO involves a number of investors contributing capital which is used to acquire a portfolio of income-generating assets. The portfolio is divided into a notional...

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