Construction And Rectification: The Consequences Of Rescission And Making Good The Defects In Drafting Of Back-To-Back Confirmations Under The ISDA Master Agreement

Author:Mr Richard Caird, Thomas Leyland and Alexandra Doucas
Profession:Dentons (United Kingdom)

Litigation between UBS, KWL, Depfa and LBBW - [2014] EWHC 3615 (Comm) (Part 2)

Our recent update " Fraudulent misrepresentation by a bank and the ISDA Master Agreement" dealt with the consequences of certain fraudulent misrepresentations impliedly made by UBS to Depfa in the litigation between them and the German water company Kommunale Wasserwerke Leipzig GmbH (KWL).

In this further article, we consider the decision of the Judge (Mr Justice Males), in relation to a further dispute between UBS and Depfa, as to the construction of a Single Tranche Collateralised Debt Obligation (STCDO). We also refer to the Judge's treatment of a difficult issue as to the practical consequences of rescission as a remedy.

Factual background

The full background is set out in " Fraudulent misrepresentation by a bank and the ISDA Master Agreement". In summary, UBS and KWL had already entered into a STCDO transaction directly when, in late 2006, UBS approached Depfa to ask it to intermediate in a further, similar, transaction.

UBS was unable to obtain internal approval to enter into this trade itself. The explanation given to Depfa for this was that UBS had no further credit lines available to KWL. Depfa agreed to intermediate between UBS and KWL, with the result that in March 2007, Depfa and KWL entered into two STCDO transactions with a total notional amount of approximately US$116 million (referred to at trial as the "front swaps"). Depfa and UBS also entered into so-called "back swaps" on the same terms. The effect was that the net payment flows under the STCDOs were to be between UBS and KWL, with Depfa taking a one-off fee of €1.3 million for its role.

The portfolio underlying the STCDO was hit badly by the financial crisis, leading to a complete loss for KWL of the notional amount at stake. While Depfa, UBS and LBBW (which had taken a similar role to Depfa) sought to recover the sums they alleged to be due from KWL contractually, KWL defended those claims and sought rescission of the various agreements into which it had entered, on the basis (among other arguments) of its directors' lack of authority, and of the bribery of one of them.

Status of the front swaps

For the reasons explained in our earlier article, the Judge determined that Depfa was entitled to rescind the back swaps on the grounds of UBS's fraudulent misrepresentation. He did not, however, find that KWL was entitled to rescind the front swaps with Depfa.

This left the possibility that Depfa...

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