Ensuring entire agreement clauses are fit for purpose

Summary: The global financial crisis of 2008-09 generated significant litigation and indeed continues to do so. The facts behind some of these disputes can be surprising - like this recent case, the background to which was the sale by a German utility of credit protection on portfolios of investment grade bonds and other securities. Commercial lawyers will be interested in the entire agreement clauses relied upon by UBS in relation to a misrepresentation claim, and the court's approach of construing the wording of such clauses to see if it squarely covered the facts. In the end, it was held that one litigant was entitled to rescind various transactions and recover various fees: UBS AG (London Branch) v Kommunale Wasserwerke Leipzig GmbH [2014] EWHC 3615 (Comm).

"A sorry story of greed and corruption". In 2006-07, the Leipzig Municipal Water Company (KWL) sold protection to UBS and the two defendant banks, on four portfolios of investment grade bonds and other securities. It did so by means of a series of complex derivative products known as Single Tranche Collateralised Debt Obligations (STCDOs). Under the terms of these STCDOs, if any of the entities in the portfolios defaulted, KWL would be liable to pay the banks significant sums. When the defaults occurred following the events of 2008-09, the banks sought payment, which KWL resisted, claiming that the STCDOs were void.

Entire agreement clauses: effective as a contractual estoppel? This is a long and complex judgment covering a number of areas, but this summary will focus on the entire agreement clauses in documents made between UBS and Depfa Bank Plc. Depfa alleged that UBS had made misrepresentations in connection with two STCDOs known as "front swaps" and "back swaps", either fraudulently or negligently under s2(1) of the Misrepresentation Act 1967. In particular, it alleged that UBS misrepresented the following:

• the opportunity it presented to Depfa was a proper and viable one;
• it did not have any significant concerns as to the validity and enforceability of the front swaps;
• it was not aware that the managing directors of KWL were abusing their power of representation in entering into the front swaps; and
• it believed a corrupt intermediary (and a key individual) to be honest and did not have any significant doubts as to their honesty.

There was no debate that the entire agreement clauses would be useless against fraud (which was eventually proved) but the court considered their effect regarding negligent or innocent misrepresentation. The clauses read as follows:

"This agreement constitutes the entire agreement and understanding of the parties with respect to its subject matter and supersedes all oral communication and prior writings with respect thereto." (ISDA master agreement)

"Non-Reliance. Each party is acting for its own account, and has made its own independent decisions to enter into this Transaction and that the Transaction is appropriate or proper for it based upon its own judgment... Each party is not relying on any communication (written or oral) of the other party as investment advice or a recommendation to enter into this Transaction... this information... shall not be considered investment advice or a recommendation... No communication (written or oral) received from the other party shall be deemed to be an assurance or guarantee as to the expected results of this Transaction." (Depfa back swap confirmations)

The question for the court was whether these clauses took effect as a contractual estoppel preventing Depfa's reliance on any non-fraudulent express or implied representations not found in the contract documents.
Clauses did not cover the representations and risks in question. The court was clear that the clause in the ISDA master agreement did not exclude responsibility for misrepresentation at all. Following Rix LJ in AXA Sun Life -v- Campbell Martin Limited [2011] EWCA Civ 133, it was held that the clause is concerned "only with matters of agreement, and not with misrepresentation at all". The former, as would be expected, deals with matters which the parties have mutually agreed, whereas misrepresentation concerns inaccurate statements made by one party to the other.

The non-reliance clause was limited to the exclusion of statements made by way of investment advice or recommendation. It did not go beyond that and would therefore not apply to more general statements. It was held that Depfa had not relied on anything said by UBS as investment advice; it recognised that it had to do its own due diligence and decide for itself whether to go ahead with the transaction. However, it never accepted the risks of: (i) dealing with parties whom UBS were aware were dishonest; and (ii) UBS's knowledge of a conflict of interest on the part of the corrupt advisers. Even reading the two clauses together could not make them effective to exclude liability from misrepresentation generally. The court had no doubt that Depfa relied on the misrepresentations and the transaction would not have gone ahead if it had known about the issues. Depfa was therefore prima facie entitled to rescind the two back swaps it had entered into and to recover various fees paid to UBS.

Court has "a degree of flexibility ... to ensure that practical justice is achieved". The court emphasised that rescission as possible redress for misrepresentation is an equitable remedy and that the court has a degree of discretion in order to achieve what is fair. This was achieved in this case by requiring Depfa not to seek to enforce the front swaps against KWL as a condition of its entitlement to rescind. This gave effect to its rights as the victim of a fraudulent misrepresentation while at the same time ensuring it did not receive an unjust windfall.

Please click on the links below for the other articles in the February 2015 commercial contracts newsletter:

• Higher standard of care expected from specialist provider
• Construing payment obligations on breach of contract
• Court of Appeal confirms decision on repudiatory breach
• The importance of clear wording regarding "direct/indirect loss"
• Liquidated damages, penalties and the dangers of renegotiating the contract price
• Personal guarantor bound by signature machine