Synthetic CDOs in the English courts: Court of Appeal upholds New York jurisdiction

The market is rife with disputes arising out of complex financial transactions comprising a series of separate but interrelated agreements.  Where those underlying agreements contain conflicting jurisdiction clauses, a question arises as to which of those clauses applies to regulate the dispute.

In England the current approach to the interpretation of jurisdiction (and arbitration) clauses is to construe them widely and generously. However, as was held last week by the Court of Appeal in UBS Securities LLC v HSH Nordbank AG [2009] EWCA Civ 585, a jurisdiction clause in a contract which forms part of a broader commercial transaction must also be construed in light of the transaction viewed as a whole.

Where there are inconsistent and potentially overlapping clauses, it is to be presumed that rational commercial parties did not intend similar disputes to be governed by inconsistent jurisdiction clauses. In this case, the parties had entered into a complex transaction and must have intended that the jurisdiction clauses in the agreements which were "at the commercial centre of the transaction" should govern the issues in dispute between them.

The CDO transaction

The transaction which was the subject of dispute was entered into between UBS and the regional German bank Landesbank Schleswig-Holstein Girozentrale (known as "LB Kiel") in 2002. HSH Nordbank AG ("HSH") was established in 2003 as the result of the merger of LB Kiel with another regional German bank and HSH stepped into the shoes of LB Kiel for all material purposes.

The disputed transaction was structured, in outline, as follows.

• LB Kiel had invested in various categories of note issued by a Cayman Islands SPV established by UBS, North Street Reference Linked Notes, 2002-4 Ltd ("NS4"), including $500mof floating rate notes of classes A to D (the "NS4 Notes").
• The performance of the NS4 Notes was linked to a Reference Pool of asset-backed securities, principally commercial and residential real estate-backed bonds, to which NS4 took exposure via a Credit Default Swap with UBS. Assuming that the performance of assets in the Reference Pool remained stable, LB Kiel would benefit from a steady stream of interest payments on the NS4 Notes and an increase in their principal value. Assets in the Reference Pool were to be selected and managed by UBS. The NS4 Notes were originally issued by NS4 to UBS with a view to UBS selling them, in turn, to LB Kiel.
• The Credit Default Swap between UBS and NS4 afforded protection to UBS against credit risks in relation to the Reference Pool. In return for periodic payments of premium to NS4 during the life of the swap, UBS was entitled to receive credit protection payments to cover losses in the Reference Pool in the event of a default on the assets. Such payments would give rise to a corresponding reduction in the interest payable upon, and the principal value of, the NS4 Notes.
• To fund the purchase of the NS4 Notes, LB Kiel issued to UBS $500mofmediumtermnotes (the "MTN Notes") under an existing medium term note programme between LB Kiel and a group of banks (the "Dealers"), including UBS. The medium term note programme was governed by a Programme Agreement which contained the terms and conditions applicable in the event that LB Kiel agreed with any Dealer for the issue and purchase of notes. Upon their issue to UBS, the MTN Notes were instantly transferred to NS4 as consideration for the NS4 Notes and were held by NS4 as collateral for credit protection payments to UBS under the terms of the Credit Default Swap.
• The net commercial effect of these arrangements was that LB Kiel gained exposure to assets in the Reference Pool via the NS4 notes and provided credit protection to UBS, via the MTN Notes, in relation to those assets.

The relevant contractual documentation comprised:

• A Letter Agreement entered into between UBS and LB Kiel confirming the purchase (subject to acceptable documentation) of the NS4 Notes. The Letter Agreement was governed by New York law but silent as to jurisdiction.
• A Reference Pool Side Agreement (the "RPSA") entered into between LB Kiel and UBS which regulated the management, selection and substitution by UBS of securities in the Reference Pool and obliged UBS, amongst other matters, to establish a Commitments Committee to monitor the quality of the Reference Pool.  The RPSA was governed by New York law and contained a non-exclusive New York jurisdiction clause.
• An Offering Circular, which came to be embodied in an Indenture, describing certain features of the NS4 Notes, including how their performance was to be linked, via a credit swap with UBS, to the performance of assets in the Reference Pool. The Indenture provided that it, and the NS4 Notes, were governed by New York law and subject to the non-exclusive jurisdiction of the New York court.
• A Credit Swap entered into between UBS and NS4 by which UBS purchased credit default protection with respect to assets in the Reference Pool. The Credit Swap was governed by English law and contained a non-exclusive English jurisdiction clause by virtue of the incorporation of the ISDA Master Agreement.

A Pricing Supplement and a Dealer's Confirmation produced in accordance with the Programme Agreement which contained terms and conditions regulating the issue of the MTN Notes. Both conferred on the English court "exclusive jurisdiction to settle any disputes which may arise out of or in connection with" those agreements (the "English Exclusive Jurisdiction Clause").

The litigation: concurrent proceedings in New York and in England

In February 2008, credit defaults having occurred on assets in the Reference Pool (and faced with the likelihood of further defaults), HSH initiated proceedings against UBS in New York. In essence, the claims advanced by HSH in New York were (i) that UBS had mis-sold the investment and had induced it to purchase debt securities in NS4 by its fraudulent and negligent misrepresentations; and (ii) that it had subsequently mismanaged the Reference Pool underlying the NS4Notes and had thereby breached its contractual obligations to HSH under the RPSA and related documents.

On the same day and shortly before HSH initiated the New York Proceedings, UBS commenced proceedings against HSH in England seeking declarations that it was not liable to HSH with a view to pre-empting a decision of the New York court. HSH applied for an order that the English court had no jurisdiction to try UBS' claims for negative declaratory relief, alternatively for a stay of the English proceedings on the basis that New York (and not England) was clearly the more appropriate forum for the resolution of the dispute.

It was accepted on both sides that HSH was domiciled in Germany and that the English court could only exercise jurisdiction on the basis of a binding jurisdiction agreement between the parties sufficient to engage Article 23 of the Brussels I Regulation. The issue, therefore, was whether the parties' dispute fell within the scope of the English Exclusive Jurisdiction Clause contained in the Dealer's Confirmation (the choice of English jurisdiction in the Pricing Supplement was largely disregarded on the basis that upon issue to UBS the MTN Notes had been instantly transferred to NS4).

The decision at first instance

Walker J at first instance held that the dispute did not fall within the scope of the Exclusive English Jurisdiction Clause. Had that clause stood alone he would have given it a wide construction, consistent with modern authorities on the interpretation of jurisdiction clauses (in particular, the decision of the House of Lords in Premium Nafta Products Limited & ors v Fili Shipping Company Limited & ors – also known as Fiona Trust).

However, a jurisdiction clause, like any other contractual provision, had to be construed against the relevant factual background or 'factual matrix' known to the parties at the time of contracting. In this case the relevant factual background included the existence of inconsistent jurisdiction clauses in other contracts forming part of the same overarching structure. Parties with that knowledge would anticipate the potential for a 'clash' and take steps to avoid any overlap by confining the scope of each jurisdiction clause to disputes relating directly to the contract in which it was found. In such a case, said Walker J, the relevant question is to which contract (and therefore to which jurisdiction clause) a dispute is properly to be allocated.

Here the dispute was in connection with the NS4 Notes.  The agreements relating directly to the NS4 Notes - the Indenture, the Letter Agreement and the RPSA – were governed by New York law and, with the exception of the Letter Agreement (which was silent on the point) contained non-exclusive New York jurisdiction clauses. Properly construed therefore, the English Exclusive Jurisdiction Clause was not broad enough to cover the dispute.

The Appeal

On appeal to the Court of Appeal, it was argued on behalf of UBS that the Dealer's Confirmation was the agreement by which HSH had made its investment. On proper (i.e. liberal) construction of the English Exclusive Jurisdiction Clause, any dispute about whether misrepresentations made by UBS had induced HSH to invest by means of the issue and transfer of the MTN Notes clearly arose "out of or in connection with" the Dealer's Confirmation and therefore fell within the scope of the English Exclusive Jurisdiction Clause.

That being the case, UBS argued, Article 23 of the Brussels Regulation was engaged and it was irrelevant that some claims may or may not also fall within a jurisdiction clause contained in another contract within the same framework.  Indeed, the fact that a transaction comprised a network of contracts made it more likely, it said, that certain claims might fall within the scope of more than one jurisdiction clause in those agreements. That did not mean that the jurisdiction clauses would 'clash'. The judge was wrong to have assumed that the jurisdiction clauses had to be construed such that there was no overlap and so that a dispute fell to be regulated by one jurisdiction clause within the structure.

The Court of Appeal decision

The Court of Appeal upheld the judge's decision and dismissed the appeal. Lord Collins, with whom Lord Justice Toulson and Lord Justice Ward agreed, re-iterated that assessing the scope of a jurisdiction clause is a question of contractual interpretation: the court will seek to ascertain the intention of the parties as revealed by the agreement.

In a case such as this, that assessment was to be carried out in light of the transaction, viewed as a whole. The relevant agreements were interrelated and formed "part of one package". In those circumstances, it had to be presumed that the parties, acting commercially and rationally, did not intend that disputes of this nature (i.e. disputes about misrepresentation in the inception of the transaction and about performance of the obligations central to the investment) should fall within the scope of two or more inconsistent jurisdiction clauses. That would have the wholly uncommercial result (which sensible business people could not have intended) that the same or similar claims would fall to be resolved in different jurisdictions in relation to different agreements within the framework.

The Court of Appeal held that where parties had entered into a complex transaction comprising numerous agreements containing multiple and inconsistent jurisdiction clauses, it was the jurisdiction clauses in the agreements "at the commercial centre of the transaction" which they must have intended to apply to regulate disputes of this nature. The transaction had its centre of gravity in the RPSA and other agreements containing nonexclusive New York jurisdiction clauses. The dispute, said Lord Collins, had nothing to do with the MTN Notes which were simply the means by which the HSH paid for and collateralised the NS4 Notes. The English Exclusive Jurisdiction Clause, properly construed, was a boiler plate bond issue jurisdiction clause which was intended primarily to deal with technical disputes and did not include within its scope claims in relation to the transaction as a whole.

Comment

In reading the Exclusive English Jurisdiction Clause consistently with the parties presumed rational commercial intentions, the Court of Appeal endorsed a broad brush and commercially minded approach to construction which echoes the approach taken by the courts in recent years to the construction of jurisdiction and arbitration clauses in cases such as Fiona Trust. In that important case the House of Lords held (in the context of construing an arbitration clause) that absent clear language to the contrary, rational businessmen are likely to have intended any dispute arising out of the legal relationship evidenced by their agreement to be decided by the same tribunal.

The decision of the Court of Appeal in UBS v Nordbank emphasises the importance of considering agreements on jurisdiction at a 'transactional' level, as well as on an agreement by agreement basis. Absent conflicting provisions on jurisdiction, a jurisdiction clause contained in one agreement might, in the circumstances, be broad enough in scope to cover disputes arising in relation to another contract within the same overall framework or in connection with the transaction as a whole. It will not be broad enough where the contracts at the 'centre of gravity' of the transaction contain inconsistent jurisdiction clauses.

HSH's secondary case was that, if the English court had jurisdiction under Article 23 of the Brussels I Regulation, it should nonetheless stay its proceedings on the basis that New York, and not England was the clearly more appropriate forum for the resolution of the dispute. It being held at first instance and on appeal that the English court had no jurisdiction under Article 23 of the Brussels I Regulation, HSH's secondary case did not arise for decision. That leaves open a controversial and important question: whether in a case where the English court has jurisdiction by reason of Article 23 of the Brussels I Regulation it has any power to stay its proceedings in favour of another, more convenient forum. Lord Collins, whilst noting that the prevailing view was that there was no such power, declined to express a view on this controversial subject where the issue did not arise for decision.