Tracing
Cameron Stewart
Sydney Law School
Proprietary remedies — tracing
• Tracing is available as a remedy in common
law as well as in equity. Common law tracing
differs from equitable tracing in that equity
recognises that a beneficiary retains his or her
property rights over trust property in cases
where the trust property is mixed with other
property or converted into a new type of
property
Proprietary remedies — tracing
• Foskett v McKeown [2000] [2001] 1 AC 102 at 128, Lord Millet:
Tracing is thus neither a claim nor a remedy. It is merely the
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. Tracing is also distinct from
claiming. It identifies the traceable proceeds of the claimant’s
property. It enables the claimant to substitute the traceable
proceeds for the original asset as the subject matter of his
claim. But it does not affect or establish his claim
Fiduciary duties?
• The existence of a prior fiduciary relationship
is an essential prerequisite to a claim of
tracing in equity
• The effect of grounding tracing in the exclusive
jurisdiction is to substantially limit its
availability. Many commentators have been
critical of this view of tracing’s origins
because, in the absence of a prior fiduciary
relationship, any person whose property is
stolen by a thief will be unable to trace that
property in common law or equity, if the thief
mixes the property
Fiduciary duties?
• In Foskett v McKeown both Lord Millett and
Lord Steyn were critical of the necessity for a
fiduciary relationship to exist as a
precondition to tracing, but their comments
fell short of removing the requirement. In
Shalson v Russo [2005] Ch 281, Rimer J stated
that even after Foskett the traditional
differences between common law and equity
remain and the requirement for a pre-existing
fiduciary relationship still existed.
Fiduciary duties?
• In Australia there appears to be more
movement towards jettisoning the
requirement.
• In Commonwealth Bank of Australia v Saleh at
[29], Einstein J said that `the better view' was
that tracing protects property rights, rather
than enforcing fiduciary relationships.
• But no case yet directly on point
Property
• In addition to the requirement that there
be a pre-existing fiduciary duty between
the parties, a claimant seeking to trace
trust property must also establish that he
or she had an equitable interest in the
property prior to the breach of fiduciary
duty and that the property now lies in
the hands of the defendant.
Property
• To that extent it is necessary to ascertain the
trust property and identify it as being held by
the defendant.
• In equity it does not matter, for the purpose of
identification, that the property has become
mixed with other property: Re Hallett’s Estate;
Knatchbull v Hallett (1880) 13 Ch D 696.
• Nor does it matter that trust funds have been
used to purchase other property.
• Equity presumes that the trust property
continues to exist in both situations: Re Diplock
[1948] Ch 465 at 531–2; [1948] 2 All ER 318 at
352–3.
Property
• To that extent it is necessary to ascertain the
trust property and identify it as being held by
the defendant.
• In equity it does not matter, for the purpose of
identification, that the property has become
mixed with other property: Re Hallett’s Estate;
Knatchbull v Hallett (1880) 13 Ch D 696.
• Nor does it matter that trust funds have been
used to purchase other property.
• Equity presumes that the trust property
continues to exist in both situations: Re Diplock
[1948] Ch 465 at 531–2; [1948] 2 All ER 318 at
352–3.
Raulfs v Fishy Bite Pty Ltd [2012]
NSWCA 135
• Raulfs entered into a partnership agreement with Fishy Bite Pty Ltd
(Fishy Bite).
• Fishy Bite was owned and controlled by Ajaka.
• Raulfs paid $400,000 as a contribution to the capital of the
partnership.
• Ajaka withdrew the money and used it to pay out a mortgage over a
house he owned with his de facto partner, Ablett.
• The commercial partnership broke down quickly and consent orders
were entered for a winding up.
• Around the same time, Ajaka and Ablett's relationship broke down
and they entered into a termination agreement in accordance with
Part 4 of the Property (Relationships) Act 1984 (NSW).
• Ablett became the sole registered owner of the house.
• Raulfs claimed that she could trace her partnership contribution
into the house and sought to secure her rights by way of a charge
over the house.
Raulfs v Fishy Bite Pty Ltd [2012]
NSWCA 135
• The New South Wales Court of Appeal found
that Raulfs could not trace the proceeds.
• When the money was paid to the partnership
it became a partnership asset and it was no
longer hers.
• Raulfs had no claim over the money once the
money was paid and, as such, she had no
property to trace.
Overdrafts
• When trust funds are placed in another
account and that account is exhausted or
overdrawn, equity treats the trust property as
being dissipated: Bishopsgate Investment
Management Ltd (in liq) v Homan [1995] Ch
211; [1995] 1 All ER 347; Viscariello v
Bernsteen Pty Ltd (in liq) [2004] SASC 266.
Overdrafts
• In Chong v Chanell [2009] NSWSC 765, large sums of money
held on trust had been gambled away leaving nothing to
trace into (although fortunately for the plaintiff some of the
moneys could be traced into a house).
• Similarly, payment into an overdraft account will also
destroy the possibility for tracing, as an overdraft account is
a debit account: Re Rowena Nominees Pty Ltd [2006] WASC
69; Grocers of Wyong v Retech Global [2004] NSWSC 488;
Re Goldcorp Exchange Ltd [1995] 1 AC 74; [1994] 2 All ER
806.
• In Williams v Peters [2010] 1 Qd R 475, a purchaser of a
luxury car was unable to trace the purchase moneys as they
had been deposited in an overdraft account (in addition to
there being no intention for the moneys to be held on
trust).
Overdrafts
• In Re Global Finance Group Pty Ltd (in liq) at
408, McLure J found that subsequent deposits
by a trustee into a mixed fund will be
impressed with the trusts in favour of the
beneficiaries if the trustee intended to make
restitution to the trust by appropriating the
funds to the replacement of the trust moneys.
Overdrafts
• In Australian Receivables Ltd v Tekitu Pty Ltd
[2011] NSWSC 1306 at [154], Ward J agreed
and said:
• Insofar as the allocation of withdrawals and
treatment of payments out of a mixed account
of this kind is based on a presumption as to
the trustee's intention, an actual intention by
the trustee (or the third party) to treat
moneys subsequently paid in as replenishing
the trust fund would permit the conclusion
that the trust connection was not lost.
Backward tracing
• `Backward tracing' is where the moneys
placed into an overdraft are used to reduce
the overdraft so that further funds can be
withdrawn to purchase an asset. In backward
tracing the beneficiaries claim the ownership
of the asset purchase with the reduction in
overdraft.
Backward tracing
• In Hagan v Waterhouse (1992) 34 NSWLR 308 at
358, Kearney J said:
• Just as it is no answer to a beneficiary's claim to
an investment acquired with moneys drawn from
a mixed current account in credit to say that the
trustee's own moneys in the mixture could have
sufficed to effect the purchase, so it is no answer
in the case of such a purchase from an overdrawn
account for the trustee to rely upon the extensive
nature of his overdraft arrangements.
Backward tracing
• In Bishopsgate Investment Management Ltd (in liq) v
Homan [1995] Ch 211 at 216–7; [1995] 1 All ER 347 at
351, Dillon LJ, when referring with approval to the trial
judge's suggestion, said:
• The judge gave as an instance of such a case what he
called `backward tracing' where an asset was acquired
by [the defendant] with moneys borrowed from an
overdrawn or loan account and there was an inference
that when the borrowing was incurred it was the
intention that it should be repaid by misappropriations
of [the plaintiff's] moneys. Another possibility was that
moneys misappropriated from [the plaintiff] were paid
into an overdrawn account of [the defendant] in order
to reduce the overdraft and so make finance available
within the overdraft limits for [the defendant] to
purchase some particular asset.
Backward tracing
• Possible in Australia?
• In Conlan v Connolly [2011] WASC 160 at [80],
Simmonds J found similarly, agreeing that the
exception was available but finding that there
was insufficient evidence to support the claim.
Problems
• Prof Conaglen (2011). Difficulties with Tracing
Backwards. The Law Quarterly Review, 127,
432-455.
• Fairness to unsecured creditors?
The Federal Republic of Brazil v Durant International
Corporation (Jersey) [2015] UKPC 35
• Bribes paid to Channani account, a mixed fund
account
• Transfers then made into one account (Durrant
account)
• Transfer then made from Durrant account into
another account (Kildare account)
• Defendants claimed that the maximum amount
paid out of Channani account was $7.7m because
of the lowest intermediate balance rule
The Federal Republic of Brazil v Durant International
Corporation (Jersey) [2015] UKPC 35
• Jersey court applied backwards tracing
• Lord Toulson summarised:
• …Jersey law should not set its face against accepting that
“backward tracing” may be legitimate. It said that, at least where
the account remained in credit during the relevant period, so there
was no question of possible insolvency and prejudice to unsecured
creditors, and where there was no suggestion of an intervening
bona fide purchaser for value, the question should be whether
there was sufficient evidence to establish a clear link between
credits and debits to an account. If such a link were established, the
court did not consider that there was cause to diminish its effect by
introducing the concept of “a lowest intermediate balance rule”. It
considered that, as a matter of judicial policy, this approach would
accord most closely with considerations of justice and practicality.
The Federal Republic of Brazil v Durant International
Corporation (Jersey) [2015] UKPC 35
• Lord Toulson at [17]
• The appellants’ twin arguments have a common and simple logical
parentage. The doctrine of tracing involves rules by which to
determine whether one form of property interest is properly to be
regarded as substituted for another. It is therefore necessary to
begin with the original property interest and study what has
become of it. If it has ceased to exist, it cannot metamorphose into
a later property interest. Ex nihilo nihil fit: nothing comes from
nothing. If the money in a bank account has dwindled from £1,000
to £1, only the remaining £1 is capable of being substituted by
something else; the £999 has ceased to exist. This explains “the
lowest intermediate balance” principle. Similarly, a property
interest cannot turn into (or provide a substitute for) something
which the holder already has; the later acquisition cannot be the
source of the earlier. This explains the “no backward tracing”
principle.
The Federal Republic of Brazil v Durant International
Corporation (Jersey) [2015] UKPC 35
• But then….at[38]
•
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. If the court is satisfied that the various steps are part of a
coordinated scheme, it should not matter that, either as a
deliberate part of the choreography or possibly because of the
incidents of the banking system, a debit appears in the bank
account of an intermediary before a reciprocal credit entry. The
Board agrees with Sir Richard Scott V-C’s observation in Foskett v
McKeown that the availability of equitable remedies ought to
depend on the substance of the transaction in question and not
upon the strict order in which associated events occur.
The Federal Republic of Brazil v Durant International
Corporation (Jersey) [2015] UKPC 35
• 40. The Board therefore rejects the argument that
there can never be backward tracing, or that the court
can never trace the value of an asset whose proceeds
are paid into an overdrawn account. But the claimant
has to establish a coordination between the depletion
of the trust fund and the acquisition of the asset which
is the subject of the tracing claim, looking at the whole
transaction, such as to warrant the court attributing
the value of the interest acquired to the misuse of the
trust fund. This is likely to depend on inference from
the proved facts, particularly since in many cases the
testimony of the trustee, if available, will be of little
value.
Tracing property into the hands of trustees
• If trustees misappropriate trust property and
use it exclusively to purchase other property
in their own name, equity allows the
beneficiaries to trace the funds into the newly
acquired property
• The beneficiaries can choose to enforce their
beneficial interests in the new property by
either asserting beneficial ownership of it, or
by bringing a personal claim against the
trustee for breach of trust. This claim can be
enforced by an equitable lien or charge over
the new property
Lake v Bayliss [1974] 1 All ER 1114
• A trustee sold trust property and bought a ring
with the proceeds. The ring was then given to
a friend who sold it and banked the proceeds
into a savings account.
• The beneficiary was entitled to trace the trust
property into the proceeds, then the ring and
then into the savings account.
Election
• Beneficiaries can choose to enforce their
beneficial interests in the new property by either
asserting beneficial ownership of it, or by
bringing a personal claim against the trustee for
breach of trust.
• This claim can be enforced by an equitable lien or
charge over the new property: Foskett v
McKeown AC at 109; All ER at 122; Chong v
Chanell at [39]; Dennis Hanger Pty Ltd v Brown
[2007] VSC 495 at [36].
Profit
• If beneficiaries choose to keep the property,
and the newly acquired property has
appreciated, they are entitled to keep the gain
for themselves, as the trustee is not entitled
to retain any profit from a breach of trust.
Mixed property — the rule in Re Hallett’s
Estate
• Equity presumes in such circumstances that,
once funds are mixed in an account, any
following transactions come from the trustee’s
personal funds first. Any funds remaining in
the account are treated as trust funds
Re Hallett’s Estate; Knatchbull v Hallett
(1880) 13 Ch D 696
• A solicitor-trustee sold trust property and mixed the
funds from the sale with his own money in a bank
account.
• The solicitor later died insolvent and a dispute arose
between the beneficiaries and other creditors of the
estate over who was entitled to the funds remaining in
the account.
• Sir George Jessel MR found that the beneficiaries had a
right to trace the proceeds of sale into the remaining
account funds. Equity presumes in such circumstances
that, once funds are mixed in an account, any following
transactions come from the trustee's personal funds
first. Any funds remaining in the account are treated as
trust funds.
Brady v Stapleton (1952) 88 CLR 322
• The High Court said at 337–8, :
• [I]t would be a great mistake to suppose that the great case of Re
Hallett’s Estate … lays down a doctrine peculiar to money. On the
contrary, it extends to money paid into a bank account, and so
losing its identity as money, a doctrine which equity would never
have had the slightest hesitation in applying to money physically
existing or to any other kind of personal property to which it could,
as a matter of practical possibility, be applied. And there is no
difficulty, and we do not think that equity would ever have had the
least difficulty, in applying the same doctrine to shares or bonds …
Equities are not defeated if a trustee mixes trust moneys with his
own moneys and with the mixture purchases a grey horse and a
black horse, or a grey horse alone. In such a case equity imposes a
charge on the two horses or the one horse. But, where it is possible
to give effect to the rights of a cestui que trust by simply taking out
so much money or so many bonds or so many shares, the cestui que
trust may elect whether he will take property in specie out of the
mass or have a charge on the mass.
The lowest intermediate balance rule
• How do you calculate beneficial proprietary interests
in cases where deposits and withdrawals are made
over time to accounts of mixed funds?
• The lowest intermediate balance rule states that the
beneficiaries’ claim is limited to the lowest account
balance in the period starting from the date of
mixture to the date of the claim against the account.
James Roscoe (Bolton) Ltd v Winder
[1915] 1 Ch 62
• A debt collector deposited over £400 of his
clients' money into his own account.
• Over a period of time a number of
withdrawals and deposits were made.
• The lowest balance recorded during the
period was £25. At the time of the claim there
was over £300 in the account.
James Roscoe (Bolton) Ltd v Winder
[1915] 1 Ch 62
• The beneficiaries sought to employ the rule in Re
Hallett’s Estate to claim the remaining funds.
• However, the court found it could not presume
that the deposits made after the mixture were
intended by the fiduciary to reimburse the trust.
• The only available balance was the lowest
balance in the intermediate period between the
breach of fiduciary duty and the claim, that being
£25.
Valuable purchases
• If the fiduciary makes a purchase of
valuable property from the mixed
fund and then proceeds to dissipate
the rest of the account the fiduciary
is not entitled to use the rule in Re
Hallett’s Estate to prevent tracing
into the valuable property.
Re Oatway [1903] 2 Ch 356
• A trustee misappropriated trust funds by
placing them in his account and then
proceeded to use two-thirds of the money to
buy shares.
• The rest of the account was then dissipated.
• The court found that the trust property
should be traced into the shares, overturning
the presumption in Re Hallett’s Estate that
transactions come from the trustee's
personal funds first.
Young v Lalic [2006] NSWSC 18
• A woman gave $50,000 to her fiancé and future
mother-in-law to contribute towards the costs of
construction of a new house on the mother-inlaw's land.
• The money was expended but the marriage later
broke down.
• The husband and mother-in-law refused to pay
back the $50,000.
• Brereton J allowed the woman to trace the funds
into the land and granted her a charge over the
land worth $50,000
Shepard v Mladenis [2011] NSWSC
1431
• Dr Wallman, a recently divorced obstetrician and
gynaecologist was defrauded by an introduction
agency, called Hearts United.
• Wallman paid $200,000 for personal relationships
counseling. Hearts United arranged for Wallman
to be introduced to `Lily', who was described as
being Australian/Chinese with blonde hair with a
surname `Bolivique'.
• She may or not have been a fictitious person.
Shepard v Mladenis [2011] NSWSC
1431
• Hearts United convinced Wallman to pay large
sums of money to enable him to marry Lily.
• Lily then requested larger sums ($200,000)
that she could borrow from Wallman to help
her organise the release of her father's estate
in Croatia.
• Further amounts were requested which
totaled two million dollars.
• All the moneys were paid to Hearts United.
Shepard v Mladenis [2011] NSWSC
1431
• Mladenis, the director and owner of Hearts
United used the funds to purchase a number
of items including real estate, a Porsche, a
Lexus, a BMW, and a Lamborghini.
• Pembroke J found that the money was held on
a Quistclose trust and that the funds could be
traced to the purchases.
Election
• Once funds have been traced into the newly
acquired property, the beneficiaries cannot elect
to take total beneficial ownership of the property
(like they may when property is purchased solely
with trust funds).
• Instead, the beneficiaries can only assert a lien or
charge over the property, which is equal to the
value of the trust moneys. The reasoning behind
this limitation is that the property was not solely
purchased using trust moneys.
Election
• In The Uniting Church in Australia Property Trust (NSW) v
Vincent [2009] NSWSC 375 at [9], Einstein J summarised the
position as follows:
• Where a trustee acquires property using exclusively trust
money, the beneficiary has a proprietary interest in the
property acquired, however, where a trustee acquires
property using trust money mixed with his own the
beneficial owner does not have a proprietary interest in the
property because it was not acquired only with trust
property. Instead the beneficiary is entitled to a charge
over the property to secure the amount of the fiduciary's
liability … The charge gives rise to an entitlement to have
the property restored to the beneficiary by restitution and
arises as soon as the wrongful conversion or mixing occurs
(references omitted).
Election
• But what about taking a proportionate share of the
appreciating property?
• In Foskett v McKeown at AC at 131; All ER at 123–4, Lord
Millett confirmed that beneficiaries could elect between
claiming proportionate beneficial ownership and asserting
a charge or lien:
• Where a trustee wrongfully uses trust money to provide
part of the cost of acquiring an asset, the beneficiary is
entitled at his option either to claim a proportionate share
of the asset or to enforce a lien upon it to secure his
personal claim against the trustee for the amount of the
misapplied money. It does not matter whether the trustee
mixed the trust money with his own in a single fund before
using it to acquire the asset, or made separate payments
(whether simultaneously or sequentially) out of the
differently owned funds to acquire a single asset
Election
• Can you elect to do this if there are funds still in the account?
• In The Uniting Church in Australia Property Trust (NSW) v Vincent
[2009] NSWSC 375 at [9], Einstein J thought that it should and said:
• Where a fund mixed with trust money is used to acquire other
property, the beneficiary is entitled to charge both the fund and any
property acquired from that fund, Re Oatway [1903] 2 Ch 356
at 361; Sutherland Re; French Caledonia Travel Service Pty Ltd (in
liq) (2003) 59 NSWLR 361 at 386. The charge may be asserted over
both the fund and the property to its full value in the sense that the
beneficiary must exhaust either first before recouping the full
balance out of the other … The rationale for this is that until the
trustee has fulfilled his fiduciary duty to restore the trust property
he will not be heard to claim his own interest in the acquired
property, Westpac Banking Corporation v Ollis [2007] NSWSC 956 at
[58].
Proportionate share?
• Why should the trustee get any profit at all?
• Shouldn’t fiduciaries have to disgorge all their profits?
• This indeed has been the finding in some cases where
fiduciaries have made profitable purchases with a mixture
of trust funds and bank loans: Paul A Davies (Australia) Pty
Ltd v Davies [1983] 1 NSWLR 440; Australian Postal Corp v
Lutak (1991) 21 NSWLR 584.
• However, the general position outside of this type of case
appears to be that only a proportionate share of profit will
be made available to beneficiaries and specific evidence
has to be led regarding the nature of the contributions
made by the defaulting trustees before the proportionate
approach is displaced: Mavaddat v Lee [2007] WASCA 141.
Tracing mixed funds into appreciating
property
• In cases where trustees mix funds and
profitably invest the mixture, beneficiaries will
ordinarily be entitled to a proportionate share
of any gain made by the investment
Re Stillman and Wilson (1956) 15 ABC
68
• Clyne J said at 72 :
• I think, though with some hesitation, that where a
trustee has the control of a mixed trust fund belonging
to a number of beneficiaries and he purports to
withdraw from this fund money on behalf of one of the
beneficiaries and then uses this money not on behalf
of the beneficiary but for his own purposes, the money
so withdrawn should be regarded as that of the
beneficiary on whose behalf it purported to be
withdrawn. The matter depends upon the intention of
the trustee.
Re Global Finance Group Pty Ltd (in liq)
(2002) 26 WAR 385
• McLure J said at 424 that there were three reasons for
following the trustee's intention in the case before her:
• First, and most importantly, the trust ledger records are
reliable … Prima facie, they provide a substantially
accurate factual foundation for moulding an
appropriate solution to the competing proprietary
claims. All payments into and out of the trust account
can be tracked. Secondly, the trust account records
reflect the trustee's contemporaneous intentions.
Thirdly, reliance on the record is consistent with the
statutory framework in which the trustee is permitted
to mix trust funds coupled with a requirement to
account separately for the moneys the subject of
different trusts.
Re Magarey Farlam Lawyers Trust
Accounts (No 3) (2007) 96 SASR 337
• A clerk working for a firm of solicitors stole
over four million dollars from one of the firm's
trust accounts over 13 years.
• The accounts were reliable and accurate and it
was clear which beneficiaries had lost money.
• Given the degree of certainty, Debelle J
ordered that the funds be distributed as
according to their balances.
Re Magarey Farlam Lawyers Trust
Accounts (No 3) (2007) 96 SASR 337
• Debelle J, at 373, said:
• There are instances where a pro rata distribution is
appropriate. I have already mentioned the case where
money has been misappropriated from a trust account
but not debited against the ledger of any particular
client or clients. In that case, there is no other course
available. It is also the only available course where
records are not available so that it is impossible to
identify the money belonging to each person who has
contributed to a common or mixed fund. A typical
example is an investment scheme where it is
impossible to identify the funds of any particular
investor with a particular investment …
Re Magarey Farlam Lawyers Trust
Accounts (No 3) (2007) 96 SASR 337
• The pro rata distribution was approved in Keefe v Law Society of
New South Wales (1998) 44 NSWLR 451 at 461. I do not understand
the reasoning in that case to stand in the path of a distribution
according to the balances shown in the trust account ledgers in a
case where misappropriations have occurred over as long a period
as 13 years. In some cases, it is possible to trace the moneys
invested to one or more particular investments but it is not possible
to do so in the case of most investors. In that instance, the court
will attribute an investment to those whose money can be
identified with an investment but distribute the balance of the fund
remaining pro rata among the remaining investors: see Australian
Securities Commission v Buckley (19967) 7 BPR 15,024 and RussellCooke Trust Co v Prentis [2003] 2 All ER 478…. It is clear that the
remedy must be tailored to the facts of each individual case. There
is no principle of universal application. By contrast with the cases
just mentioned, the record-keeping in this case was so complete
that the only proper method is to distribute according to those
records
Mixed property in the hands of trustees
from more than one trust
• Unfortunately, it is not unusual for defaulting
trustees to mix funds from more than one
trust. In this situation two rules can be applied
to apportion whatever property remains
between the different beneficial interests
traced into the mixed fund.
Mixed property in the hands of trustees
from more than one trust
• The general approach — pari passu
For example, if $3000 from Trust A together
with $2000 from Trust B were used to
purchase 500 shares of equal value, 300
shares would be held in favour of Trust A and
200 shares in favour of Trust B.
Parri passu
• Alternatively, if funds have been taken out of a
trust account in breach of trust but only part of
those funds taken can be attributed to particular
beneficiaries, then the court may attribute that
loss to the beneficial interests which can be
identified, but then distribute the balance of
the remaining funds on a proportionate basis:
Australian Securities Commission v Buckley (1996)
7 BPR 15,024; Russell-Cooke Trust Co v Prentis
[2003] 2 All ER 478.
Mixed property in the hands of trustees
from more than one trust
• The rule in Clayton’s case
It displaces the pari passu rule and states that
all beneficial interests in a mixed bank account
are subject to a ‘first in, first out’ rule.
Mixed property in the hands of trustees
from more than one trust
• Presume that a trustee mixes $1000 from Trust A
with $2000 from Trust B and $3000 from Trust C,
in successive days, totalling $6000.
• On the next day the trustee withdraws $2000
from the account, leaving a balance of $4000.
Under the rule in Clayton’s case the withdrawal is
presumed to come from Trust A’s funds and from
Trust B’s funds.
• The remaining funds in the account are therefore
said to be traced to Trust B for an amount of
$1000, and Trust C for an amount of $3000.
Mixed property in the hands of trustees
from more than one trust
• The rule in Clayton’s case is difficult to apply
where the facts concern large estates with
complex bank accounts. It also works unfairly
against the first victims of a breach of trust, by
practically eliminating their attempts to trace.
Mixed property in the hands of trustees
from more than one trust
• In Australia it has been found that if there are large
numbers of beneficiaries it is better to apply the pari
passu rule to prevent injustice: Re Australian Home
Finance Pty Ltd [1956] VLR 1.
• More recently, Campbell J overviewed the entire
history of the rule in Clayton’s case and decided that
it should not be applied in Australia:
Re French Caledonia Travel [2003]
NSWSC 1008
• A travel agency which had become insolvent and
placed under administration and then liquidation.
• The company had received funds held on trust,
but adequate records had not been kept.
• Claims totalled $1.43 million but the trust
account held only $97,000. The only other
account was a cash deposit account totaling
$75,000.
• The liquidator sought directions from the court as
to how to distribute the funds.
Re French Caledonia Travel [2003]
NSWSC 1008
• In the circumstances, Campbell J found against
the application of Clayton’s case as a matter of
principle, regardless of whether there was
enough information upon which to allocate
withdrawals to particular deposits.
• Additionally, Campbell J found that the rule was
not appropriate to the situation at hand where
money was drawn from the account to pay the
expenses of particular travellers, regardless of
whether that traveller's moneys had been the
first in, last in or somewhere in between.
Re French Caledonia Travel [2003]
NSWSC 1008
• In Re Magarey Farlam Lawyers Trust Accounts (No 3),
the breaches of trust had occurred over 13 years but
records as to trust balances were very accurate. In that
case the judge relied on the trust account ledger rather
than Clayton’s case to determine what trust monies
were still available. Debelle J, at 376–7, doubted the
utility of the rule:
• The rule in Clayton’s Case might have a limited utility in
respect of appropriating payments into bank accounts
as between trustee and beneficiary but it has been
held in a number of jurisdictions in Australia to have no
utility as between competing beneficiaries whose
moneys have been deposited in a mixed fund.
Tracing property into the hands of third
parties
• Bona fide purchasers for value without notice
of the breach of trust are immune from
tracing claims
• However, if a third party recipient has actual
or constructive knowledge of the breach of
fiduciary duty, or if the recipient is a volunteer,
the property may be traced into his or her
hands.
Commonwealth Bank of Australia v
Saleh [2007] NSWSC 903
• where trust property is transferred to a volunteer who takes
without notice, and there is no question of mixing, then the
volunteer will hold the property on trust for the
rightful beneficiaries;
• where the trust moneys were used to pay off a secured creditor, the
trust was not entitled to be subrogated to the rights of the secured
creditor who was repaid;
• if the volunteer purchased property with a mixed fund including
trust moneys then the beneficiary would be allowed a charge over
the property in order to secure repayment of the trust moneys used
for the purchase;
• if an asset is purchased with mixed funds and it increases in value,
the beneficiary will not be entitled to any proportionate share in
that increase in value. In this respect, careful consideration needs to
be given to renovations or improvements made upon real property.
Foskett v McKeown [2001] 1 AC 102
• Timothy Murphy was the main person in
charge of a development scheme where
people could buy plots of land in Algarve in
Portugal.
• Under the terms of the scheme people could
purchase the land and the proceeds would be
held on trust.
• If the land was not transferred to them within
two years the money had to be repaid with
interest.
Foskett v McKeown [2001] 1 AC 102
• Two hundred and twenty people purchased lots
but the lots were never developed.
• Murphy dissipated the funds.
• Part of the funds (£20,440) were used to pay
premiums on a life insurance policy.
• Premiums were paid in 1986, 1987, 1988, 1989
and 1990. The first two premiums had been paid
using Murphy’s own funds. There was a dispute
about what money had been used to pay the
third premium, but it was clear that the last two
premiums had been paid out of the purchasers’
trust.
Foskett v McKeown [2001] 1 AC 102
• Two hundred and twenty people purchased lots
but the lots were never developed.
• Murphy dissipated the funds.
• Part of the funds (£20,440) were used to pay
premiums on a life insurance policy.
• Premiums were paid in 1986, 1987, 1988, 1989
and 1990. The first two premiums had been paid
using Murphy’s own funds. There was a dispute
about what money had been used to pay the
third premium, but it was clear that the last two
premiums had been paid out of the purchasers’
trust.
Foskett v McKeown [2001] 1 AC 102
• The policy provided for a death benefit which
was in favour of Murphy’s wife (who received
a 1/10th share) and his three children (who
received the rest in equal amounts). The right
to the death benefit arose after the second
premium was paid.
• Murphy killed himself in 1991.
Foskett v McKeown [2001] 1 AC 102
• The purchasers claimed that they were entitled to trace
their money through the policy into the sum paid out to the
children (they did not pursue the amount paid to Mrs
Murphy). They believed they were entitled to a
proportionate share of the policy money which was
equivalent to two-fifths.
• The majority of the Court of Appeal upheld the purchasers’
claim but limited it to an amount in restitution which was
equivalent to the amount of the two premiums together
with interest. The beneficiaries were denied a
proportionate share of the policy proceeds.
• The majority found no causal link between the
misappropriation of the funds and the right to the policy
proceeds, as the right to whole-of-life cover arose after the
first two premiums, and was not causally related to the
misappropriated funds.
Foskett v McKeown [2001] 1 AC 102
• A majority of the House (Lord BrowneWilkinson, Lord Hoffman and Lord Millet; Lord
Steyn and Lord Hope of Craighead dissenting)
found that the purchasers money could be
traced. The purchasers’ rights were
proprietorial and not based on restitution.
Foskett v McKeown [2001] 1 AC 102
• Lord Millett, at AC 137; All ER 129, dismissed the causal
arguments raised by the Court of Appeal as follows:
• In my opinion there is no reason to differentiate between
the first premium or premiums and later premiums. Such
a distinction is not based on any principle. Why should
the policy belong to the party who paid the first
premium, without which there would have been no
policy, rather than to the party who paid the last
premium, without which it would normally have lapsed?
Moreover, any such distinction would lead to the most
capricious results.
Foskett v McKeown [2001] 1 AC 102
• Lord Browne-Wilkinson said at 102:
Therefore the critical question is whether the assets now
subject to the express trusts of the purchasers trust deed
comprise any part of the policy moneys, a question which
depends on the rules of tracing. If, as a result of tracing, it can
be said that certain of the policy moneys are what now
represent part of the assets subject to the trusts of the
purchasers trust deed, then as a matter of English property
law the purchasers have an absolute interest in such moneys.
There is no discretion vested in the court. There is no room
for any consideration whether, in the circumstances of this
particular case, it is in a moral sense ‘equitable’ for the
purchasers to be so entitled
Foskett v McKeown [2001] 1 AC 102
• Lord Hoffmann also agreed with the speech of
Lord Millett
• Lord Steyn and Lord Hope dissented on the
grounds that the children's right to policy moneys
arose with the first premium and that there was
no link between the misappropriated funds and
the children's right to the policy money.
Re Diplock; Diplock v Wintle [1948] Ch
465
• Diplock had created a will giving his executors
discretion to distribute large sums to over 100
charities.
• The moneys had been mixed with the charities'
own funds or used to improve assets (by making
renovations or discharging debts).
• A settlement was reached with the executors but
the beneficiaries decided to bring recovery
actions against the charitable recipients.
Re Diplock; Diplock v Wintle [1948] Ch
465
• The beneficiaries were allowed to recover sums
against charities who still held the funds
separately and
• They were entitled to recover a proportionate
amount from mixed funds and valuable
purchases from the mixed funds
• The other moneys, which had been expended on
capital improvements or on debt reduction, were
not recoverable, as this would have worked an
inquity on the charities.
The rule against subrogation into
securities
• Subrogation is an equitable process whereby one
person is taken to have received the rights of another
without an assignment, because they have reduced
that liability and it would be unconscientious not to
allow the payer to take up the rights of the recipient.
• Unlike tracing, the beneficiary does not follow his/her
own property into the security, but rather is
substituted for the existing security holder.
• In cases of tracing, subrogation might allow
beneficiaries to stand in the shoes of the mortgagee
whose debt was paid with trust moneys
Boscawen v Bajwa [1995] 4 All ER 769
• Moneys were advanced to fund the purchase of
property on the condition that the funds were
only to be released to fund the completion of the
sale and were to be returned should the sale fall
through.
• The funds were released prior to sale and were
used to reduce a mortgage liability.
• The sale fell through and the moneylender
sought to be subrogated to the rights of the
mortgagee
Millet LJ
• If the plaintiff succeeds in tracing his property, whether in its
original or in some changed form, into the hands of the
defendant and overcomes any defences which are put
forward on the defendant's behalf, he is entitled to a remedy.
The remedy will be fashioned to the circumstances. The
plaintiff will generally be entitled to a personal remedy; if he
seeks a proprietary remedy he must usually prove that the
property to which he lays claim is still in the ownership of the
defendant. If he succeeds in doing this, the court will treat the
defendant as holding the property on a constructive trust for
the plaintiff and will order the defendant to transfer it in
specie to the plaintiff.
Millet LJ
• But this is only one of the proprietary remedies which is
available to a court of equity. If the plaintiff's money has been
applied by the defendant, for example, not in the acquisition
of a landed property but in its improvement, then the court
may treat the land as charged with the payment to the
plaintiff of a sum representing the amount by which the value
of the defendant's land has been enhanced by the use of the
plaintiff's money. And if the plaintiff's money has been used
to discharge a mortgage on the defendant's land, then the
court may achieve a similar result by treating the land as
subject to a charge by way of subrogation in favour of the
plaintiff.
Cook v Italiano Family Fruit Company
Pty Ltd (in liq) (2010) 276 ALR 349
• Finkelstein J at 369–70,
• In my view, the Boscawen approach is to be
preferred to that in Diplock. I would only make a
few additional comments in relation to Diplock.
First, the reasoning in Diplock should be confined
to land and, perhaps, other property of a special
nature. Principles regarding specific performance
might be relevant by analogy. Thus, if, for
example, the subrogation claim related to paying
off a debt incurred to fund an investment, the
claim would have been allowed in Diplock.
Cook v Italiano Family Fruit Company
Pty Ltd (in liq) (2010) 276 ALR 349
• Second, as Millett LJ said in Boscawen (at 783), in Diplock an order
might have been framed to avoid the perceived injustice of forcing
a sale of land under a charge. For example, the charities might have
been given reasonable opportunity to obtain finance to meet the
beneficiaries' claims. This would have put the charities back as close
as possible to their original position and prevented them retaining a
windfall at the beneficiaries' expense. Third, there is much to be
said for the view that Diplock was not intended to create an
absolute rule, and should be confined to its peculiar facts: see eg
George v Biztole Corporation Pty Ltd (unreported, Supreme Court of
Victoria, Ashley J, 26 February 1996). Fourth, in applying Diplock it
is important to distinguish between tracing and subrogation. It is
undoubtedly the case that a claimant cannot trace into funds which
have been paid by a volunteer to discharge a debt - the assets have
ended up in the hands of a bona fide, for value and without notice,
creditor
Cook v Italiano Family Fruit Company
Pty Ltd (in liq) (2010) 276 ALR 349
• . But it is altogether a different matter whether there
remains a right of subrogation against the volunteer. Cases
establishing the non-entitlement to tracing are sometimes
cited, erroneously in my opinion, for similarly denying a
right of subrogation: see for example Re J Leslie Engineers
[1976] 2 All ER 85 … Fifth, there is considerable force in the
argument that if a volunteer has applied misappropriated
funds to discharge a debt, the volunteer should not be in a
better position than if he had applied the funds to purchase
an asset. In either case, the volunteer's assets have
effectively been swollen. This is not to suggest that the
circumstances in which subrogation and other equitable
remedies are available should be identical.
Heperu Pty Ltd v Belle (2009) 76
NSWLR 230
• A fraudster had misappropriated cheques and
deposited them into his wife's accounts.
• Funds were withdrawn from those accounts
and used to make mortgage repayments for
the wife (amongst other things).
• The victims of the fraud sought to recover the
funds from the wife who was innocent of
wrongdoing
Heperu Pty Ltd v Belle (2009) 76
NSWLR 230
• the Court of Appeal felt that there were actions in
both law and equity to trace the funds into the
wife's property to recover whatever value
remained in her hands, given her status as a
volunteer.
• Allsop JA, at NSWLR 262; ALR 759, giving the
judgment of the Court of Appeal, stated that the
views of Millett LJ in Boscawen v Bajwa were to
be preferred to the views expressed in Re Diplock.
Heperu Pty Ltd v Belle [2011] NSWSC
1151
• Slattery J examined the claims for tracing. During the relevant period a
total of $1,744,402.50 was misappropriated. During the same period the
total mortgage payments made out of the account totaled $211,040.23.
• Heperu sought to recover the whole amount of these payments on the
basis that it could be inferred that this amount was totally used to pay the
mortgages.
• Slattery J refused to make such an inference and said that he was bound
to use the ordinary rules of tracing to determine which payments were
made from the stolen monies to pay the mortgages.
• On that analysis only $118,932.10 could be traced from the stolen funds to
the mortgage payments. However, the mortgage payments included
amounts for interest as well payments for the principal debt. Slattery J, at
[51]–[54], found that Belle should only be liable for the reduced amount of
principal debt, not the interest payments