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Following and tracing

“Following” and “tracing” are both exercises in locating assets which are or may be taken to represent an asset belonging to claimants and to which they assert ownership.

  • Following and tracing are proprietary remedies
  • Tracing is a process. Tracing itself is not a remedy (Boscawen v Bajwa 1996)
  • Therefore, 2 thing must happen: first, trace into the appropriate property; and, secondly, identify the best remedy to bring against that property
    • The court may order compensation (Target Holdings), order property be restored by transferring it to original owner (Foskett), order the property be held on resulting trust (Dollar Land Holdings), or constructive trust (Islington), or be subject to a charge (Barlow Clowes)

“Following” is a process of following the same asset as it moves from one person to another

  • So if there is a trust asset and the trustee gives it to somebody in breach of trust, this does not stop it from being trust property
  • The property can be followed into the hands of the other person and the beneficiary can assert a proprietary right
  • Lord Millett has described the notion of following as “the process of following the same asset as it moves from hand to hand” (Foskett v McKeown 2001)

“Tracing” is the process of identifying a new asset as substitute for the old — for example if money is used to purchase a car, the money can potentially be “traced” into the car.

  • Here the claimant is seeking to assert title to substitute property, which might take the form of sale proceeds, or of some composite property in which the original property has been combined in some way
  • They may also be able to take advantage of increased value of any property

Common Law Tracing

Introduction

Common law tracing: you can trace to third parties but only through clean substitutions of property. In other words, you cannot trace property at common law if the property has become mixed with any other property

  • The claimant must demonstrate the property is the very property which is to be restored or that the property claimed has not been mixed with any other property e.g. Banque Belge v Hambrouck: Provided money in bank accounts was held unmixed with other moneys, it was possible for common law tracing to be effected

In Taylor v Plumer (1815), Lord Ellensborough was clear that there must be a clean substitute to trace at common law, such that the substituted can be ascertained to represent the original property

  • So if you convert the property into money and mix that with other money you lose the power to trace at common law - this means that common law tracing is very rarely applied
  • So an equitable claim of tracing is much more powerful than a common law claim of tracing

The common law cannot trace property through a mixed fund

For example, in Agip (Africa) v Jackson [1991], the Court of Appeal found that the money could not be traced at common law, as it had passed through mixed funds

In FC Jones & Sons v Jones [1997], there was a significant development in the scope of common law tracing - the Court of Appeal held that the Official Receiver could use common law tracing to receive money loaned to someone PLUS the profits she made from that loan, on the basis that the money was clearly identifiable in a separate bank account

Tracing in Equity

Introduction

If the claimant is able to establish property was transferred in breach of a fiduciary duty they will be able to use equitable tracing → this allows the claimant to trace through mixed funds; and to take the increase in value of any assets bought with the funds. However, this is also, it appears, available in common law tracing (FC Jones & Sons v Jones [1997])

Equity can also trace money through electronic fund transfers, whereas common law cannot: see Agip (Africa) v Jackson [1991]

Requirements to trace in equity

The claim must be based on a pre-existing fiduciary relationship

  • It is a pre-requisite for an equitable tracing claim that the the claimant had some equitable interest in the original property, or that the person who transferred the property away had some fiduciary relationship to the claimant (such as being a trustee)

Property must be in a traceable form; (i.e. there must be some property to attach to) and

It must be equitable to trace.

Re Hallett's Estate 1879: this case clearly states the requirements needed to trace in equity

See the case of Sinclair v Brougham [1914] for an example of equitable tracing

In the case of In Re Diplock [1948], following the case of Sinclair v Brougham [1914], the Court of Appeal held that equity operates not only on those that acquire property through their own breach of trust, but also in hands of people who are volunteers: equity can follow property into hands of people who do not know there has been a breach of trust (i.e. innocent volunteers) (Lord Green)

There are, therefore, two main circumstances we will look at: 1) where the property remains in the hands of the defaulting trustee or fiduciary and used property for their own use; and 2) where the property has passed into the hands of a third party.

1) Property remains with trustee

Mixed Funds – Mixed with trustee’s money

In other words, where the fiduciary/trustee takes money from the trust fund and mixes that money with their own money, how does equitable tracing operate in that circumstance?

The doctrine of the ‘honest trustee’ assumes that, where a trustee has mixed trust money with his own, and that some of the money is spent on items of value, such as shares, and other money diddipated, the trustee has invested the trust money and invested his own

  • In other words, the court may choose if it is a trust investment or from trustee’s own pocket (if investment is good it will be trust investment, if bad it will be from own pocket)

See the cases of In re Hallett's Estate (1879) and In re Oatway [1903]

Mixed Funds - Lowest Intermediate Balance

Where a mixed bank account contains trust funds and other money, whether the other money belongs to an innocent 3rd party or person in breach, then money which has been dissipated (and hence untraceable) cannot be replaced by money put in account later

  • So, let's say a trustee puts £1000 of trust money into his personal bank account and dissipates it, then places another £1000 of his own money into that account, the claimant cannot trace into the money deposited later → The maximum amount that can be reclaimed from that bank balance is the lowest intermediate balance. The claimant will, however, still have a personal claim against the trustee

For example, in James Roscoe (Bolton) Ltd v Winder [1915], a trust fund was mixed with private money in a bank account. The owner of the account spent most of it reducing the total credit in the bank to about £25 at one point. Money was later paid in, resulting in a balance of £358 at his death. It was held that the seller could not claim more than £25 from the deceased's bank account (as that was the lowest intermediate balance)

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CONTENT

Mixed Funds – The Rule in Clayton’s Case

In Clayton's case a ‘first-in, first out’ rule was adopted i.e. payments into and out of an account were set off against each other in order in which they occurred

  • If there is a mixed fund in a bank account representing the funds of two trusts this rule will apply → so let's say £100 of one beneficiary is paid into a bank account, and later £100 of a 2nd beneficiary is paid into that bank account. If the trustee then dissipates £100 for personal use the 1st beneficiary will have no equitable right to trace, but the 2nd beneficiary will be able to trace the remaining £100 (as the first in was the first beneficiary's money, so his was the first out too)
  • This rule is settled law and designed for convenience sake

In the Clayton's case there was a partnership that, in breach of its fiduciary duty, sold treasury bills worth £1035 deposited by Clayton and kept the proceeds for its own use. However, Clayton continued to deal with bank and drew out sums greater than the amount converted by the bankers. It was held that Clayton could have no claim against estate in respect of the £1,035, as that debt was set against the later drawings.

In Barlow Clowes [1992] the rule in Clayton’s case was reaffirmed as the prima facie rule, but it will not be applied it impracticable or would result in injustice

The ‘rolling charge’

An alternative means of allocating the property is the ‘rolling charge’: each payment out the account is allocated, pari passu, to the beneficial owners of property at the time of payment

  • This is seen as fairer → money is paid out in proportion to their contributions, taking into account length of time money was part of the fund
  • Issue is that it is very complex, requiring a reconstruction of every transaction

Dillon LJ in Barlow Clowes [1992] accepted the rolling charge, in principle, is a better way of doing things; but was too impractical to apply in the case

Although it’s been acknowledged as the theoretically most equitable way of determining each claimant's beneficial interest in remaining property, it has never been applied by English courts

Beneficiaries’ right of election

Where an asset has been bought by the trustee in breach of trust, then the beneficiaries may elect to accept the asset as trust property or take a lien (i.e. a right to take possession of property until one is paid what one is owed) over the property against the trustee.

  • E.g. in In re Oatway [1903] the beneficiaries were able to elect to have the valuable shares subsumed into the trust as opposed simply to taking rights over money

2) Property passes to Third Party

Introduction

In other words, if trust propery is misapplied such that it is mixed with property belonging to an innocent 3rd party (rather than with the trustee's own money), how does equitable tracing work in that cirucmstance?

  • Therefore, rather than consider the issues which arose above concerning the obligations of the wrongdoing trustee, it is now necessary to decide how property belonging to innocent parties should be allocated between them

Third Party has Knowledge or Notice

If 3rd party knows property has passed in breach of trust, they are subject to the same liability (i.e. personal and proprietorial liability) as the original fiduciary, by the doctrine of knowing receipt

A party with notice of the trust cannot raise the defence of being equity’s darling (i.e. a bona fide purchaser of trust property for value without notice), and may have to restore the property, even if they have provided value

See, for example, Papadimitriou v Crédit Agricole Bank [2015] where it was held the art collector’s family were able to trace the property into the hands of the bank as the bank had notice of the claimant's proprietary interest (and therefore could not raise the defence of Equity's Darling)

Innocent Volunteers

An innocent volunteer is one who is not party to and does not have notice of the breach of trust; and who has not provided value for the property received.

Foskett v McKeown [2001] demonstrates that prima facie an innocent volunteer who receives property in breach of trust has to return it → but, if the innocent volunteer mixed it with their own property they can claim proportionally their own money from the mixed fund pari passu; whereas, a trustee in breach or 3rd party with knowledge/notice cannot do this

In In Re Diplock [1948], the trust failed as a purpose trust, so the property was held on resulting trust for the residuary beneficiaries. Accordingly, they were entitled to trace the money from innocent parties, including some charities. (Lord Greene)

Mixed Funds – where mixed with innocent party’s money

Lord Greene in In Re Diplock [1948] said the Innocent Volunteer and the beneficiary have equal pari passu mixed claims to a mixed trust → they have proportionate claims to the fund

  • So if the innocent volunteer has unmixed trust property the beneficiary can take it all back, but if it is mixed they share the property pari passu

Untraceable Property

Dissipated Money

If the property has been dissipated then there is no property to trace. In the case of bank accounts, when the account becomes overdrawn, there can be no further tracing.

See the case of Bishopsgate Investment Management v Homan [1995]

Backwards Tracing

The Privy Council has accepted that ‘backward tracing’ should sometimes be allowed → this is tracing into an asset acquired before the breach of trust e.g. if a trustee borrows money from the bank to buy a house, then takes money from the trust fund to pay off a mortgage on a house, the court can trace into the house, even though the loan account is never in credit

  • Strictly speaking the beneficiary's interest has been dissipated, but backward tracing allows the beneficiary to claim the asset acquired by the fraudster with the loan money

Federal Republic of Brazil v Durant International Corporation [2015] (Lord Toulson) → the court said backward tracing is not standard: what you have to show is some sort of link between the acquisition and the breach of trust

Unascertained Goods

Tracing cannot follow property into unascertained goods: see Re London Wine and Re Goldcorp

Used to improve real property

Although money can be traced into mixed accounts and assets bought partly with trust money, where money is used to improve real property, it is regarded as incapable of being disentangled from the D’s property and no longer traceable. Re Diplock [1948]

Equity’s Darling (i.e. bona fide purchaser for value without notice)

As a rule, you cannot trace property bought by someone who is equity’s darling

  • “Where the moneys are handed to a person who takes for value without notice, the claim of the owner of the moneys is extinguished.” Re Diplock

The claimant will, however, have a claim against the proceeds of sale, if they are in traceable form.

Defence of Change of Position

This defence will be available to a defendant who has received property and, on the faith of that property, suffered some change in her personal circumstances

In Lipkin Gorman v Karpnale [1991], Lord Goff held where an innocent volunteer’s position is so changed he will suffer an injustice if called to return the property, then he should not have to return the property to the claimant as “the injustice of requiring him so to pay outweighs the injustice of denying the claimant's restitution”

  • This case is not actually based on equitable tracing: it was a claim in restitution on the basis of unjust enrichment under the common law → as such, it is not binding authority for the defence of change in position as a defence to money received in breach of trust by an innocent volunteer

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