Tracing

From Uni Study Guides
Jump to: navigation, search

This article is a topic within the subject Equity and Trusts.

Contents

Required Reading

M.W. Bryan & V.J. Vann, Equity and Trusts in Australia (Cambridge University Press, 2012), pp. Chapter 21.

Lionel Smith, The Law of Tracing, 6-18, 24-30.

Evans v European Bank Ltd (2004) 61 NSWLR 75 (from [90]).

Foskett v McKeown [2001] 1 AC 102 (per Lord Millett).

Re French Caledonia Travel (2003) 59 NSWLR 361 ([1]-[17], [20]-[26], [79]-[86], [169], [173]-[193]).

Re Magarey Farlam Lawyers Trust Accounts (No 3) (2007) 96 SASR 337 (only [136]-[152]).

Introduction

[1]Tracing is the process of identifying a new asset as the substitute for the old. What is traced is not the trust property; it is the value of the beneficiaries’ property in the hand of a recipient that is traced. Tracing is distinguishable from following and claiming:

  • Following is the process of following the same asset as it moves from hand to hand.
  • If the property is returned to the plaintiff, the plaintiff cannot recover equitable compensation or proceeds of the sale as well because this constitute double recovery (Creak v James Moore & Sons Pty Ltd).[2]
  • Claiming refers to the process of recovering property, or the substitute for that property, from its recipient.
  • The plaintiff can bring a personal claim (for example, a ‘knowing receipt’ claim under the first limb of Barnes v Addy) or a proprietary claim (such as a constructive trust over the property or its substitute). Both can be claimed if no double recovery is involved (for example, a constructive trust over the property or its substitute and a personal claim to recover value lost in depreciation).

Tracing and claiming at common law and in equity

[3]The right to recover specific property at common law is limited:

  • Developed an action for the specific recovery of land.
  • Possession of chattels is protected through the actions of detinue, conversion and trespass, but these claims usually only result in an award of damages.
  • Specific restitution of a chattel can only be ordered in detinue. The order is usually only made where a plaintiff is unable to purchase a market substitute with a damages award (Whiteley Ltd v Hilt).[4]

Equity developed more sophisticated methods for tracing property and more effective remedies for its recovery:

  • Equity developed special rules for identifying the plaintiff’s property when it has been mixed with other property.
  • Equitable remedies are more flexible and effective than common law. Resulting and constructive trusts restore specific property and an equitable lien can be imposed over the defendant’s property as security for the return of money.
  • A constructive or resulting trust entitles the plaintiff to a share (and possibly all) of the property over which the trust has been imposed, whereas an equitable lien operates as a court-imposed mortgage, entitling the claimant to apply for sale of the property if their claim is not satisfied.
  • Limitations to equitable recovery include that a proprietary claim cannot be brought against a good faith purchaser for value without notice; proprietary claims can only be made to identifiable property; and if the plaintiff’s property has dissipated, the plaintiff will only be entitled to personal relief.

Technically there is no difference between tracing in equity and at common law, it is actually at the claiming stage that the difference between the jurisdictions assumes significance since proprietary remedies are almost exclusively the preserve of equity.


A fiduciary requirement?

[5]A plaintiff can trace their property even though they were owed no fiduciary obligations by the wrongdoer who misappropriated the property. The plaintiff must prove that they had equitable title in the property.

The equitable tracing rules

Mixing money in a bank account

[6]Equity has developed rules to determine when a claimant can trace the value of their property into other property to which the defendant has title. These rules apply to mixing of any kind of property but the cases are mostly concerned with the mixing of money in bank accounts. Three variables are relevant to determining the applicable tracing rule:

1. The identity of the party mixing the claimant’s money with other money. Most cases concern a wrongdoer but rules have also been developed to cover the situation of a recipient of money from the wrongdoer.
2. The title to the money mixed. The wrongdoer may mix their own money with that of the claimant or they mix money belonging to two or more claimants or both.
3. The history of the mixed fund after mixing. The important question here will be whether, by the time the tracing claim is made, the fund has increased or decreased in value, or has remained the same.


Scenario 1(a) a trustee mixes trust money with his own in his bank account and subsequently spends some of the money in the account

Equity allows the beneficiary to trace their money into the mixed fund or into any property purchased from the mixed fund, or both. • If there are sufficient funds in the trustee’s account, the court can order that the trust money be repaid directly to the trust. • Where trust property has been combined with the trustee’s own property to constitute a new asset which has not appreciated in value, the trust will be entitled to an equitable lien over the asset to secure repayment of the value of its property. • If there are insufficient funds to pay both the trust and the trustee (or his creditors if he is bankrupt), there is an ‘irrebuttable presumption’ that the trustee has preserved trust money and spent his own first (Re Hallett’s Estate[7] and approved by the High Court in Brady v Stapleton).[8]


Scenario 1(b) the trustee mixes trust money with his own in his bank account, and later purchases property with some of the money in the account before exhausting the money in the account

To solve the problem encountered by applying the ‘irrebuttable presumption’ above, which would lead to the conclusion that the trust money was exhausted, courts apply a policy of preserving trust assets through substitutions of property (Re Oatway).[9]


Scenario 1(c) the trustee mixes trust money with his own in a bank account, and makes payments in and out of that account

The rules stated above are subject to the application of the ‘lowest intermediate balance’ rule. The rule provides that the trust cannot claim more than the lowest intermediate balance credited to the trustee’s bank account in the period between the mixing of the money and the bringing of the tracing claim.

  • This rule can operate harshly to deprive claimants of full recovery. If the defendant’s bank account is overdrawn at any time after the mixing occurred, it will prevent the plaintiff from obtaining a proprietary remedy (this is often referred to as the ‘nil balance rule’).
  • In Loftus v MacDonald,[10] a builder paid to cheques into his account, totalling $1600 (they were supposed to have been held on trust until the work had been completed). The account was later reduced to $8.42 but further deposits were made, taking the balance to $2824.50. the plaintiffs sought an equitable lien over the account for $1600 but the court awarded them a lien for $8.42, according to the lowest intermediate rule.
  • The plaintiff will still be able to a personal remedy against the defendant for the full amount misappropriated, although this will be useless if the defendant is bankrupt.
  • The rule is subject to an exception. The plaintiff can claim any money the defendant has paid into the account, after it has been reduced to its lowest intermediate balance, if the defendant paid the money into the account with the intention of benefiting the plaintiff.
  • The money is ‘new money’ and therefore not based on tracing. It gives effect to the defendant’s intentions, assuming the transfer satisfies the legal or equitable requirements for perfecting the gift.
  • If the defendant is bankrupt, the plaintiff cannot claim this later payment if it would constitute a preference for the plaintiff over the defendant’s other creditors under the Bankruptcy Act 1966 (Cth) s 121.


Scenario 2 the trustee mixes the money of more than one beneficiary in a bank account and spends some of the money in the account

Applying Re Hallett, the trustee will be taken to have spent his own money first. • In sharing the loss amongst the beneficiaries, equity’s original approach was to apply the rule Clayton’s Case,[11] which was a ‘first in, first out’ principle.

  • Recent authority has rejected the application of the rule Clayton’s Case to cases where there are insufficient funds to repay multiple beneficiaries (Re French Caledonia Travel).[12] The principle now applied in most cases is that the beneficiaries will share rateably[13] in the money remaining in the account.
  • There are cases where one class of beneficiary will be awarded a larger share of the money remaining in the bank account than other classes of beneficiaries. For example, where a solicitor mixes client funds together with partnership money, the clients may be held to be entitled to a greater share of the money in the account than the solicitor’s co-partners.

Scenario 3 the trustee mixes the beneficiary’s money with his own in his bank account, withdraws some of the money and invests it successfully

The beneficiary will be entitled to the proportion of the investment which represents their contribution to the making of the investment, which will include the appreciated value of the property (to prevent the defendant from profiting from their own wrong) (Scott v Scott).[14]

  • The beneficiaries in Scott v Scott only claimed an account of profits but they would have been entitled to the benefit of a constructive trust over the property, the equitable interest representing the share the trust had made to the appreciated value of the asset purchased with trust property.
  • In Foskett v McKneown,[15] the House of Lords imposed a constructive trust over the proceeds of a life insurance policy which the trustee, in breach of trust, had purchased partly with the plaintiff’s money.
  • The account of profits, secured by an equitable lien, in Scott v Scott entitles the beneficiaries to the profit assessed by the court at the date of judgement. The constructive trust in Foskett v McKneown entitles the beneficiaries to a proportionate share of the trust property. If the beneficiary considers that the invested trust money is likely to increase in value after the date of judgement, a constructive trust will allow them to benefit from that appreciation but they will also bear the risk of any depreciation.


Scenario 4 the trustee pays the beneficiary’s money to an honest volunteer who mixes the money with his own in his bank account

If the recipient is a good faith purchaser for value without notice of the initial breach of trust, the trust cannot trace the money. The trust can, however, trace property transferred by the purchaser to the trustee in exchange for the trust money. In Re Diplock,[16] charities were distributed money under a provision which was later declared void and had used the money in various ways:

a) Money used for 'improvement and alterations to the recipient’s property could not be traced because the alterations did not necessarily add to the value of the property.
b) Money used for payment of unsecured debts could not be traced after the debt had been extinguished.
  • It has been suggested that the claimant should be entitled to have an equitable lien imposed over an asset where the debt was contracted by the debtor in purchasing an asset but there is no direct authority for this ‘backwards tracing’ in Australian law.
c) The court in Re Diplock held that money could not be traced into payment of secured debts (i.e. mortgages) but later decisions have rejected this reasoning.
  • These decisions establish that where the claimant’s money has been applied in the discharge of a mortgage, the claimant will ‘stand in the shoes’ of the mortgagee and is entitled to enforce the mortgagee’s remedies against the mortgagor.
d) It is now likely that money mixed in the recipient’s bank accounts would be subject to the principle of rateable distribution, so that the claimant and the charity would share rateably in the money mixed in the account, as well as any property purchased from the mixed fund, unless it would be inequitable on the facts.
e) Money invested in securities was rateably apportioned between the next of kin and the charity.
f) Money used up in general operations had dissipated and could no longer be traced.

Defences to equitable tracing claims

[17]A claim to a proprietary remedy will be defeated if one of the following is established:

1. The plaintiff’s property is untraceable. Examples in Re Diplock[18] include money used for alterations and improvements, dissipated money and money used to discharge an unsecured debt.
2. The recipient is good faith purchaser for value without notice of the equitable interest. The claimant will still able to trace and claim property received by the trustee from the recipient as part of the good faith exchange.
3. Change of position applies where the recipient of property has in good faith irreversibly changed their position, relying on the validity of the receipt. This can protect donees who have in good faith applied the beneficiary’s money in circumstances in which it would be inequitable to allow tracing.
  • In Gertsch v Atsas,[19] the defendant had changed her position in the honest belief that she was entitled to a legacy received under a will, by giving up her job and becoming a part-time student. The defence succeeded to the extent that she had used the legacy to pay for her studies.


End

This is the end of this topic. Click here to go back to the main subject page for Equity & Trusts.

References

Textbook refers to M.W. Bryan & V.J. Vann, Equity and Trusts in Australia (Cambridge University Press, 2012).

  1. Textbook, pp 357-8.
  2. (1912) 15 CLR 426.
  3. Textbook, pp 358-9.
  4. [1918] 2 KB 808.
  5. Textbook, pp 359-60.
  6. Textbook, pp 360-8.
  7. (1880) 13 Ch D 696.
  8. (1952) 88 CLR 322.
  9. [1903] 2 Ch 356.
  10. (1974) 3 ALR 404.
  11. (1816) 1 Mer 572.
  12. [2003] NSWSC 1008.
  13. According to the proportion of the property misappropriated from them e.g. 30% of the original in the account → 30% of the remaining sum.
  14. (1963) 109 CLR 649.
  15. [2001] 1 AC 102.
  16. [1948] Ch 465.
  17. Textbook, pp 368-9.
  18. [1948] Ch 465.
  19. [1999] NSWSC 898.
Personal tools
Namespaces

Variants
Actions
Navigation
Toolbox