Recovery of Trust Property
Types of Proprietary Remedy
As part of a trustee’s breach, trust property or money may end up in the hands of a third-party. The parties to the trust may be concerned with the property’s return (particularly if an action against the trustee is inadequate), and there are various ways they can achieve this.
Equitable Remedies
A trustee cannot give a third-party better property than they themselves possess. Trustees only possess the legal title to trust assets (unless they also a beneficiary).
This means that while they can transfer legal title to a third-party, the beneficial title remains with the beneficiary. The third-party now holds the property on trust for the beneficiary. This puts them under a duty to return the asset to the original trust fund. The beneficiary can sue for specific restitution to enforce this.
There is an exception where the third-party is ‘equity’s darling’. Equity’s darling is a person who purchased the property in good faith for valuable consideration and without notice of the beneficiary’s interest: Pilcher v Rawlins (1872) LR 7 Ch Ap 259. Equity’s darling takes property absolutely and free of any prior equitable interests. A person has notice if the facts would have been apparent on a reasonably prudent examination: Papadimitriou v Credit Agricole Bank [2015] UKPC 13.
Specific restitution can also be used on property or money where the third-party has sold the trust asset or swapped it for a substitute item: Foskett v McKeown [2001] 1 AC 102. However, the claimant must be able to trace the value of the trust asset into that substitute item or money (see below).
If the trust asset was only part of the price paid, the claimant gets a proportionate share in the substitute asset: Foskett v McKeown [2001] 1 AC 102. So, if the trust contributed £200 and the third-party contributed £200, the claimant would have a 50% share in the substitute asset. The value of the claimant’s share will go up or down with the value of the substitute asset. If it goes down, their share may be less valuable than the original trust asset.
Alternatively if the third-party wrongfully used both the claimant’s property and his own to acquire a substitute, the claimant can instead gain an equitable lien over the substitute. This allows the beneficiary to sue the third-party for the full value of the trust asset. This remedy is valuable where the value of the substitute asset has gone down.
There are several advantages to an equitable claim:
- Interest accrues from the date the third-party took the property. By contrast, a common law claim generally only grants interest from the date of the court’s judgment.
- Since the beneficiary has a property right, they can recover property even if the third-party becomes insolvent. The property right also grants access to remedies such as freezing injunctions.
- There is no time-limit to equitable property claims: the Limitation Act 1980 does not apply.
Common Law Remedies
Trust beneficiaries cannot make claims at common law, since these are only available to those with a legal interest in property. However, a trustee who has lost control of trust property might seek one of these three common law remedies against a third-party:
The common law action of money had and received is available where a third-party acquires trust funds.
It does not matter that the third-party since spent or got rid of the money: Agip v Africa [1990] 1 Ch 265. They are liable to pay the money back regardless.
The torts of wrongful interference with goods may result in the third-party having to pay damages. These torts are conversion (unlawful dealing with the asset), trespass to goods (physical interference with or use of the asset) and negligence which damages the asset. The measure of damages is the amount by which the value of the asset has diminished.
If the claimant can establish the tort of conversion or trespass to goods against the third-party, they may ask the court for a ‘delivery up’ order: Tort (Interference with Goods) Act 1977, s.3. This requires the defendant to return the asset. The court usually only grants this remedy if compensation is inadequate.
Tracing
What is Tracing?
From an evidence perspective, complications may arise in tracking trust property and proceeds as they pass through different hands. Tracing is a set of evidentiary rules which allows the court to identify trust property in these circumstances. This allows the court to then apply any of the above remedies to the traced assets or money.
Tracing is not a remedy in itself. It solely establishes which assets and funds can be used to compensate the claimant or the trust. If the claimant cannot establish a cause of action against the individual who possesses a trust asset, it does not help them to be able to trace the asset into their hands.
For example, a trustee sells a trust asset to equity’s darling (‘ED’). ED keeps the asset and does nothing to it. That asset can be traced into ED’s hands. However, because ED takes the asset free of any equitable rights and is not liable for wrongful interference or money had and received, the claimant has no remedy against ED.
Bear in mind:
- If the claimant is suing using a common law action, they must show that they can trace the asset/money at common law.
- If they are suing in equity, they must trace the asset/money in equity. Since a beneficiary cannot use the common law actions, they will always need to show that the asset can be traced in equity.
Tracing versus Following
Following is the most simple form of tracing. It is where the asset passes to another, unchanged and unmixed. For example, X gives a vase to Y and Y puts it in their home. The vase can be ‘followed’ to Y, and if the claimant has a valid cause of action against Y they can get the vase back. Following is limited, however – it follows the specific asset only. So, if the asset is destroyed, following fails. If the asset is sold for money, the beneficiary can only follow the asset and cannot claim the money instead.
Tracing in its broader sense refers to the ability to identify the value of the trust asset or funds through more complicate transactions where following is not possible. Common problems for tracing include:
The defendant acquires a trust asset, and then sells it for money or swaps it for another asset. Does the beneficiary have a claim over the substitute asset or money?
The defendant acquires a trust asset, and then uses it and his own or someone else’s money/assets to acquire another asset. Does the beneficiary have a claim over the substitute asset?
The defendant acquires trust money, and then places it into a bank account with his own funds. He then spends money from the account. Has he spend his own money, or the trust’s money? Or a bit of both? What if the account contains an innocent third-party’s funds?
The defendant mixes a fungible trust asset with his own, such that it is no longer possible to identify the trust property. For example, a defendant might pour rice belonging to the trust into a box with his own rice. Can the claimant trace into the bulk? This is a similar problem to the ‘mixed accounts’ issue.
The defendant acquires the property, and then destroys or exhausts it. For example, a trust asset might burn to ash in a fire, or the defendant might spend trust money at a restaurant. Can the claimant trace the value of the trust asset into the rest of the defendant’s property?
The defendant acquires trust property and then applies to it some process which fundamentally changes its nature. For example, they might change a piece of leather into a handbag, or use flour to make a cake. Can the claimant trace into the end product?
Common Law Tracing
The common law can follow an asset, but only has limited power to trace its value.
The common law can only trace through an asset which still exists in an identifiable form.
This means that if the trust asset has been destroyed, exhausted, or subject to a fundamental change or nature, tracing is impossible.
If the third party exchanges the trust asset for another piece of property, the common law can trace into the substitute property: Jones & Sons v Jones [1996] 3 WLR 703. However, tracing is not possible in mixed substitution cases: Taylor v Plumer (1815) 3 M & S 562.
The common law can trace into mixed assets and mixed accounts only if the defendant does the mixing: Agip v Africa [1990] 1 Ch 265. Tracing is impossible if a third-party contributed to the mix or if part of the mixed bulk or fund ends up in the hands of a third-party.
Agip v Africa [1990] 1 Ch 265 also suggested that the common law will not trace money sent electronically, because only electrons transfer rather than the money itself. Whether a modern case would approve of this is unclear.
Equitable Tracing
Equity can only trace if the original property was subject to a fiduciary obligation. If this is established, however, it allows tracing in far broader circumstances than the common law.
If the third-party has substituted the trust asset for another piece of property, equity traces into the substitute. Tracing is possible in mixed substitution cases. The claimant gets a share in the substitute asset reflecting the value of the trust asset compared to what the defendant contributed: Foskett v McKeown [2001] 1 AC 102.
If the third-party has sold the trust asset, equity will trace into the proceeds of the sale: Foskett v McKeown [2001] 1 AC 102.
If the money is placed in a mixed account or trust assets are mixed into a bulk, the claimant gains a share in the account/bulk: Re Hallett’s Estate (1879) LR 13 Ch D 696. It does not matter who does the mixing or whether any of it ends up in the hands of third-parties.
If the property is destroyed or exhausted, the beneficiary no longer has any equitable claim against the third-party: Re Diplock [1948] Ch 465. No tracing is possible in this situation.
By contrast, if the asset undergoes a fundamental change, equity will trace into the end-product.
What if someone uses, spends or depletes a mixed account or mixed fungible assets?
If a wrongdoer spends the assets/money, then it is usually assumed they spent out of their own share first: Re Hallets (1880) LR 13 Ch D 696.
Note that the concept of a ‘wrongdoer’ goes beyond people who are strictly liable for their actions: Boscawen v Bajwa [1996] 1 WLR 328. Any absence of good faith will do.
If an innocent volunteer spends the money/assets, then each innocent person’s share is reduced equally: Re Diplock [1948] Ch 465.
If the balance in the account/bulk drops below the value appropriated from the trust, this is the most the trust can recover from the fund even if more money/assets later go into the account: Roscoe v Winder [1915] 1 Ch 62. There is an exception to this if the claimant can prove that the later payments into the account were specifically to credit the trust.
The assumption that a wrongdoer spends their money/assets first does not apply if it disadvantages the innocent parties’ rights. For example: the trustee withdraws money from the account to buy something valuable. They later waste the rest of the money. The court may conclude that the money used to buy the valuable asset was trust money: e.g. Re Oatway [1903] 2 Ch 356. This lets the beneficiary trace their interest into the valuable asset. It is also possible to trace value into assets the defendant acquired before misusing the trust money, if they use trust money to discharge a secured debt: Boscawen v Bajwa [1996] 1 WLR 328.
A complication to the above arises where multiple trust funds are in issue.
B is the trustee of Trust X and Trust Y. B takes £1000 out of Trust X, and puts it into a bank account which already contains £1000 of Trust Y’s money. Later, B withdraws £1000 and spends it on a lavish party. Which trust can trace into to the remaining money?
The rule in Clayton’s Case (1816) 1 Mer 572 applies here. It assumes that the money first paid into the account is taken out first, and the money paid into the account second is taken out second, and so on.
Since Trust Y’s money was in the account first, it is deemed to be spent first. This means that Trust X can trace into remaining £1000 and Trust Y cannot trace into the account at all – the courts will say the trustee spend all of Y’s money on the party. If instead B had only spent £800 on their lavish party, Trust X would trace £1000 of value into the account and Trust Y would trace £200 of value. The court would say the trustee spent £800 of Y’s money on the party.
Clayton’s Case only applies to simple bank balances. It also does not apply if:
- It is clearly not what the parties intended: El Ajou v Dollar Land Holdings [1993] 3 All ER 717.
- It leads to injustice and a practical alternative method of sharing the assets exists: Barlow Clowes v Vaughan [1992] 4 All ER 22.
Since the rule is usually very unfair to the first trust whose money was paid into the account, it is rarely applied in practice.
