If a beneficiary can identify trust assets in someone else’s hands, they can bring a proprietary claim to demand that it is handed back over to them.
In these types of claims, the beneficiary is claiming for a specific asset. This reflects the beneficiaries’ equitable title and can be asserted over third parties.
Bona fide Purchase:
Equitable title extends to anyone who receives the trust assets, except a bona fide purchaser without notice.
Once the property is received by a bona fide purchaser, the beneficiaries title is extinguished. Therefore bona fide purchasers (and subsequent persons who receive the asset) are immune from a claim brought by the beneficiary.
This limits what can be identified as trust property.
Following:
Following tracks the specific trust assets as they pass from person to person. A beneficiary may bring a claim against a third-party that ends up with the trust asset (unless they are a bona fide purchaser or are overreached).
Following is less flexible than tracing, so less desirable.
Tracing:
Tracing looks to what was acquired in return for the trust assets, rather than just following the trust assets as they pass between recipients.
A beneficiary may be able to establish an interest in assets other than those originally held on trust for them. Tracing therefore expands what can be identified as trust property.
Tracing becomes particularly important where following claims are no longer available because the original trust asset has passed to a bona fide purchaser for value without notice.
Generally, a beneficiary can claim as trust property anything that has been obtained through the exchange of (purchase by / use of) trust property using tracing.
EG: £1000 in trust fund is misappropriated and used to buy a car, which is then exchanged for a phone. Tracing can be used to make (ultimately) the phone trust property.
In Foskett v McKeown, M ran a ponzi scheme where he took money from investors but did not invest it as he should. M used the money to pay off a life insurance policy, paying three of the instalments using his own money and the fourth and fifth instalments using the trust money (40% overall). M committed suicide and the life insurance paid out £1m in proceeds.
The investors sought a 40% share of the proceeds, arguing they had a proprietary interest in the money; M’s children argued that they should only be owed what they had paid in (£20k).
The HL held that the investors were entitled to the 40% share of the policy, applying tracing rules. Beneficiary entitled to either assert beneficial ownership (the 40%) or to bring a personal claim (for £20k + interest).
Despite its usefulness, it is quite difficult to explain the legal justification for tracing and why it should be used.
Possible Justifications:
Unjust enrichment (rejected by court).
‘Hard-nosed’ property rights – it is just the way the law functions.
Clean Substitutions:
Where the trust asset is simply exchanged for another asset, the beneficiary can claim that the replacement item is held on trust for their benefit.
EG: using £10 from the trust fund to buy a horse. The horse will be held on trust for the beneficiary.
Mixed Substitutions:
Mixed substitution situations arise where the trust asset is misappropriated from the trust fund and is mixed with contributions of another party (either the trustee, another wrongdoer or an innocent party).
EG: using £10 from the trust fund to buy a horse worth £100, with £90 being paid by the trustee.
Difficulty can arise when property is mixed due to evidential uncertainty as to whose money was spent. The rules for dealing with this differ depending on whether the money being mixed with is the trustees own money or if it is another’s.
EG: putting £10 from a trust fund into a bank account that already has £90 in it and using £10 to buy a horse.
Trustee’s Own (or other Wrongdoer’s) Money:
The beneficiary is entitled to argue that the trustee did the right thing / what was in their best interest.
If the money is spent uselessly, the beneficiary is entitled to say that the trustee spent their own money first and not the beneficiaries.
In Re Hallett, 100 coins are stolen from a bag. T adds 100 coins (of his own money) into the bank. T then spends 100 coins. The beneficiary does not have to account for the loss.
If they spent the money usefully (in a way which is beneficial to the beneficiary), the beneficiary can say they are entitled to the benefit.
In Re Oatway, T buys shares from a mixed bank account. The shares rose in value. The beneficiary is allowed to claim the benefit.
Money of Another (Innocent Party):
Where property is mixed with another innocent person’s money, the position is different as one of the (innocent) parties will inevitably be left out.
Possible Solutions:
FIFO - the money that is paid into the account first is paid out first. [1]
EG: £2k from trust A and then £4k from trust B. If £3k is spent by T, £2k of A is spent and £1k of B is spent (£3k remaining in B).
Convenient but problematic because it is arbitrary and can lead to inequality and unfairness between contributors.
First-in-first-out is the default rule where money of innocent parties is mixed in a bank account, but is subject to exceptions. [2]
Example Exceptions:
Contributors intended the account to be a common fund.
It would be ‘impracticable or result in injustice’.
Only applies to bank accounts.
‘taken at face value the rule will rarely, if ever, apply’ [3]
Simple parri passu – sharing according to the final proportions of contribution, irrespective of when their contribution is made.
EG: £2k from trust A and then £4k from trust B. If £3k is spent by T, A pays £1k (1/3) and B pays £2k (2/3).
Courts tend to prefer this method overall. [4]
Rolling parri passu - calculating parri passu shares at each withdrawal individually.
Arguably, rolling parri passu is more accurate and fairer, but more difficult and costly to work out.
There seems to be support for its use when the transactions concerned are not so complex that calculations become prohibitive. [5]
Where the trust asset is misappropriated from the trust fund and is mixed with contributions of other innocent parties, contributors can claim an equitable interest in the substitute asset proportionate to their contribution.
Tracing into Bank Accounts:
Money in bank accounts is legally different from coins and notes.
Where money is held in a bank account, the account holder has rights against the bank to be paid the credit balance. By paying coins and banknotes into the account, the payer exchanges the title to the physical tender for a right to the balance against the bank. [6] When the account is in credit, this creates a debt owed by the bank to the account holder.
Following into a bank account would not work since the bank gives the account holder value in the form of right to repayment plus interest (making it a bona fide purchaser).
Conversely, when the bank is overdrawn, the account holder owes money to the bank. If money is paid into the account, the debt is paid off / discharged.
Backwards Tracing:
Backwards tracing can sometimes be used when trust property is used to pay off a debt (tracing into property the defendant already has). Usually, the beneficiaries claim would be capped under the ‘lowest intermediate balance’ rule since the exchange does not leave substitute property.
Backwards tracing may be possible if transactions are part of a coordinated scheme regardless of their chronological order. [7] This is because there is still an exchange (albeit with a delay).
EG: if the debt was accrued through the purchase of a property, the beneficiary ought to be able to trace into that property when the trust money is later used to pay off the debt.
‘The development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, makes it particularly important that a court should not allow a camouflage of interconnected transactions to obscure its vision of their true overall purpose and effect … the availability of equitable remedies ought to depend on the substance of the transaction in question and not on the strict order in which associated events occur’ [8]
Resources:
References:
[1] EG: Devaynes v Noble (1816) 35 ER 781 (‘Clayton’s Case’) [2] Barlow Clowes v Vaughan [1992] 4 All ER 22 [3] Webb and Akkouh, Trusts Law (5th edn, Bloomsbury Publishing 2017) 345 [4] Barlow Clowes v Vaughan [1992] 4 All ER 22; also see Charity Commission v Framjee [2014] EWHC 14.10.2 Pari passu 2507 (Ch), [2014] WTLR 1489 [5] Barlow Clowes v Vaughan [1992] 4 All ER 22; also used and endorsed in Shalson v Russo [2003] EWHC 1637 (Ch), [2005] 691 Ch 281 (Rimer J) [6] Foley v Hill 342 (1848) 2 HL Cas 28 [7] (Privy Council - PERSUASIVE AUTHORITY) Federal Republic of Brazil v Durant International Corp [2016] AC 297 [8] Federal Republic of Brazil v Durant International Corp [2016] AC 297 at [38]
Cases Mentioned:
Foskett v McKeown [2000] UKHL 29
Re Hallett's Estate (1880) 13 Ch D 696
Re Oatway [1903] 2 Ch 356
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