Doctrine of Tracing - Trust Funds

 Article

Doctrine of Tracing

Definitions

According to Black‟s Law Dictionary Eight Edition;

• “Tracing is defined as the process of tracking property’s ownership or characteristics from the time of its origin to the present”

Tracing in English Law is a procedure to identify property (such as money) that has been taken from the claimant involuntarily. It is not itself a way to recover the property, but rather to identify it so that the court can decide what remedy to apply. The procedure is used in several situations, broadly demarcated by whether the property has been transferred because of theft, breach of trust, or mistake.

In the case of Foskett v. Mckeown (2001) AC 102, the House of Lords defined tracing as follows;

• “Tracing is thus neither a claim nor a remedy. It is merely a process by which a claimant demonstrates what has happened to his property, identifies its proceeds and the persons who have handled or received them, and justifies his claim that the proceeds can properly be regarded as representing his property.”

From the definitions above, tracing is a legal process, not a remedy, by which a claimant demonstrates what has happened to his property, identifies its proceeds and those persons who have handled or received them, and ask the court to award proprietary claim against the property, or an asset substituted for the original property or its proceeds. Tracing allows transmission of legal claims from the original assets to either the proceeds of sale of the assets to either the proceeds of sale of the assets or new substituted assets.

In many common law countries, there are two concurrent processes, tracing at common law and tracing at equity. However, because the right to trace at common law is so circumscribed, the equitable process is almost universally relied upon, as equitable tracing can be performed into a mixed fund. At common law, to trace, the property must be identifiable and distinguishable from other property. Taylor v. Plumer (1815) 3 M&S 562.

Tracing at common law

Common law tracing is where the claimant seeks to identify property that belongs to him at common law. This is where physical possession of the property passes, but not legal ownership. The problem with common law tracing is the that the property must be identifiable; if it has been mixed with other property, such as money paid into an account with other money from a different source, it cannot be successfully recovered.

See Edwards, Richards; Nigel Stockwell (2007) P. 477 & 478. Trust and Equity (8th ed.). Pearson Longman.

It is also essential that the involuntary transfer did not also transfer legal title, nor any succeeding transfer. If this has happened, the property is also not recoverable under the common law. Thus someone with an equitable interest in the property but no legal title, cannot recover under common law. MCC Proceeds v. Lecman Brothers (1008) 4 All ER 675.

Tracing in Equity

Equitable tracing is based not only on legal ownership but on claimant‟s possession of an equitable interest. There are several advantages of equitable tracing; first, it can trace property now mixed with other property. In Boscawen v. Bajwa (1995) 4 All ER 769 Millet justified this by saying that

• “Equity‟s power to charge a mixed fund with the repayment of trust moneys enables the claimant to follow the money, not because it is derived from a fund which is treated as if it were subject to a charge in his favour.”

A limitation is that where the property has been put into a bank account that no longer contains enough money to repay it, it cannot be traced. See Hudson, Alistair (2009) p. 822 Equity and Trusts (6th ed.). Routledge-Cavendish.

For equitable tracing to be valid, several things must be demonstrated.

• 1. The equitable title must exist; it can be brought into existence by the court, such as in constructive trusts. (Edwards Supra) P.481

• 2. There must be some kind of fiduciary relationship between the claimant and the defendant.

However, if the property is transferred through breach of trust, it will not be necessary to establish such a relationship, because it already exists. Again, property transferred through breach of trust may be traced to the third party (other than a purchaser in good faith), even if they did not previously have a fiduciary relationship with the claimant.

Example of judicial tracing claim’s authority:

Judicially, example of tracing claim is AG for Hong Kong v. Reid (1994) 1 AC 324 1 NZLR 1 (PC) where Mr. Reid, then the Solicitor-General for Hong Kong, received bribes for passing information to organized crime in Hong Kong. Under Hong Kong law, proceeds of those bribes were held on constructive trust for the government of Hong Kong. Mr. Reid then invested the proceeds of the bribe in land in New Zealand, and the land increased substantially in value. When he was caught, Mr. Reid admitted that the money was subject to a constructive trust, but argued that he should only be liable to repay the amount of the bribes, and then any profit attributable to the increase in the value of the land in New Zealand was not connected with his wrongdoing. However, the Judicial Commission of the Privy Council held that the government of Hong Kong‟s claim to the money could be traced to the land, and thus the claimant was entitled to the full value of the land, as without his wrong, Mr. Reid would never have made those profits and it would be grossly inequitable for him to keep them.

Advantages of tracing

• 1. Firstly, they are a proprietary remedy (as opposed to a simple personal claim) which means that, if the defendant is insolvent, then the claimant can take title to the goods, rather than just receiving an award of damages which may be of little value against a defendant in bankruptcy.

• 2. Secondly, as demonstrated in AG for Hong Kong v. Reid (Supra), where the wrong doer has made a profit, it allows the claimant to recover a greater amount than their original loss. The House of Lords applied the same reasoning Foskett v. Mckeown (2001) AC 102 where the claimants sought to enforce their rights against a third party.

• In Foskett v. Mckeown the deceased had paid two annual premiums of life insurance policies with money misappropriated from a trust fund. The deceased later committed suicide, and the court upheld the claim of the defrauded beneficiaries of the trust against the children of the deceased , even though the children would have been entitled to the same payout had the two relevant annual premiums not been paid.

Loss of the right to trace and defences available

• 1. Good faith purchaser for value without notice. A bona fide purchaser is a person who took in good faith and for reasonably equivalent value. Thus neither an equitable lien nor a constructive trust is available against a bona fide purchaser for value.

• 2. Innocent change of position. This is a defence where the defendant has received property and giving it back would change his personal circumstances. This is concisely defined by Lord Goff in Gorman v. Karpnaleas cited in Hudson (2009) p. 854

- “where an innocent defendants position is so changed that he will suffer an injustice if called upon to repay in full, the injustice of requiring him so to repay outweighs the injustice of denying plaintiff restitution.”

Such a defence is closely linked with unjust enrichment, and has limitations. Any bad faith on the part of the defendant will invalidate the defence; such as if the recipient of the property had encouraged the payer to transfer it or has received it by mistake and then used it without making inquiries. He defence is also not available to people who act illegally, See Barros Mattos v. MacDaniels Ltd (2004) 3 All ER 299.

• 3. Discharge of a debt (such that the proceeds are no longer traceable and there is no substitute asset)

• 4. Passing on; where the defendant has passed on to a third person without any benefit for the defendant; it is impossible to trace the property as the defendant has neither the property nor proceeds from transferring it.

Remedies

In common law countries there are variety of remedies that can be imposed when the court is satisfied that an equitable tracing claim has been made. The principal remedies are;

• 1. An election to take the property (or resulting trust)

• 2. An equitable charge over the property

• 3. An account of profits, secured by an equitable lien; a general doctrine of equity permits imposition of an equitable lien where the claimant‟s expenditure has benefited another‟s property under circumstances entitling the plaintiff to restitution.

• 4. A constructive trust is one that arises by operation of law against one who, by fraud, wrongdoing, or any other unconscionable conduct, either has obtained or holds legal right to property which he ought not to, in equity and good conscience, hold and enjoy.

If an asset appreciates in value, the claimant may be well advised to claim the proprietary right in the asset (no. 1 and 4). If an asset depreciates in value, the claimant would be better if he acquires a charge or lien over the asset (no. 2 and 3) as he can still enforce the whole amount of the charge against the asset and recover the balance via a personal action.

Prepared by:

Churchfields Solicitors Corporate Law team

Toyin Bashorun

Oliver Chuks Mbadiwe

Samuel C. Chukwuma

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