Tracing and Equitable Remedies

Question 1

What are the traceable proceeds of trust property?

Answer 1

When a trustee misapplies trust property, the beneficiaries have a number of potential options available to them. Broadly, they may be able to:
· Sue the trustee for breach of trust.
· Sue a third party who has assisted the breach of trust.
· Make a claim against the misapplied property or its traceable proceeds.
· Sue a third party who knowingly received the traceable proceeds of the breach.

Question 2

What is following?

Answer 2

is the process of ‘following the same asset as it moves from hand to hand’: Foskett. It is the process for locating misapplied trust property. Thus, if T misapplies £1,000 (cash) of the trust fund and gifts it to X, and X gifts it to Y, the beneficiaries can follow the £1,000 from T to X and then to Y.

Question 3

What is tracing?

Answer 3

Tracing is the process of ‘identifying a new asset as the substitute for the old’: Foskett. Generally, one asset is the traceable proceed of another if there is ‘a series of direct substitutions’ between them: Relfo Ltd (in liquidation) v Varsani [2014] EWCA Civ 360.

Question 4

What is claiming?

Answer 4

· Claiming is the assertion of a personal or proprietary right in relation to misapplied trust property or its traceable proceeds: Foskett.

Question 5

When can a beneficiary make claims for a property interest for tracing/equitable remedies?

Answer 5

A beneficiary may wish to make claims in respect of:
· the misapplied trust property
· assets purchased exclusively with misapplied trust money (or its traceable proceeds)
· assets purchased with a mixed fund
· assets which have been improved or maintained using misapplied trust money or its traceable proceeds

Question 6

When may a beneficiary make a claim for tracing?

Answer 6

· The beneficiary claims beneficial ownership of the asset itself: This will only be possible in the simple case where the asset is acquired exclusively with the traceable proceeds of the breach.
· The beneficiary claims a share of the asset: This may be possible in cases where the asset has been acquired using a mixed fund.
· The beneficiary claims an equitable lien over the asset: This may be possible in both types of case. Generally a beneficiary will want to do this where the asset has decreased in value, meaning that claiming the asset would result in a loss. It effectively turns their personal claim for breach of trust into a secured claim.
· Subrogation: This is a claim that can be made where misapplied trust funds (or their traceable proceeds) are used to pay off a debt. It allows the beneficiary to step into the shoes of the creditor, treating the beneficiary as if they had loaned the money. This is particularly useful in the case of a secured debt.

Question 7

True or false: Only trust beneficiaries can utilise the equitable tracing and claiming rules.

Answer 7

False

The equitable tracing and claiming rules can be utilised by persons other than trust beneficiaries; for example, the beneficiaries of a deceased person’s estate and companies.

Question 8

Which of the following is not an asset over which a beneficiary may be able to make a claim?

An asset purchased with a mixture of trustee money and money belonging to an innocent third party

An asset purchased with a mixture of misapplied trust money and money belonging to an innocent third party

An asset purchased exclusively with the traceable proceeds of misapplied trust money

An asset purchased exclusively with misapplied trust money

An asset purchased with a mixture of misapplied trust money and the trustee’s own money

Answer 8

An asset purchased with a mixture of trustee money and money belonging to an innocent third party

The beneficiary has no right to make a proprietary claim over assets which do not represent the traceable proceeds of a breach of trust (or fiduciary duty)? All the other options involve the use of misapplied trust money, over which the Re Diplock conditions for tracing are satisfied.

Question 9

A trustee withdraws £1,000 from the trust bank account and gives it to their sister. The sister uses the cash to buy a computer from a friend. Neither the sister nor the friend knows about the breach of trust. The friend still has the £1,000 cash.

Which of the following is the most accurate description of the following, tracing and claiming process?

The beneficiary can trace the £1,000 from the bank account into the computer and make a personal claim against the trustee’s sister.

The beneficiary can trace the £1,000 from the bank account into the hands of the trustee’s sister and then trace again into the computer and make a proprietary claim over the computer.

The beneficiary can follow the £1,000 from the bank account into the hands of the trustee’s sister, then trace into the computer and make a personal claim against the sister.

The beneficiary can follow the £1,000 from the bank account into the hands of the trustee’s sister and then continue to follow it into the hands of the friend, then make a proprietary claim against the £1,000 cash.

The beneficiary can follow the £1,000 cash into the hands of the trustee’s sister, then trace into the computer and make a proprietary claim over the computer.

Answer 9

The beneficiary can follow the £1,000 cash into the hands of the trustee’s sister, then trace into the computer and make a proprietary claim over the computer.

The beneficiary is able to follow the £1,000 cash into the hands of the trustee’s sister and trace into the substitute (i.e. the computer). The friend is a purchaser for value without notice of the trust so has a defence against proprietary claims. The sister does not have such a claim as she has not given value.

Question 10

The Hallett model?

Answer 10

When a trustee takes out money from a mixed account which is full of there money and the misapplied trust money - the money that is not withdrawn is the money from the trust

Question 11

The Oatway model?

Answer 11

If the last amount of money withdrawn from a mixed account (containing the trustee’s money and the misapplied trust money) is dissipated - it is assumed the money was the trustee’s

Basic rule: Where a trustee makes withdrawals from a wrongful mixture, some of which (or their traceable proceeds) are dissipated, the beneficiary can treat the dissipation as the trustee’s money and attribute the identifiable funds (or traceable proceeds) to the trust, regardless of the order in which the withdrawals are made.

Question 12

The Shalson model?

Answer 12

Basic rule: Where a trustee makes withdrawals from a wrongful mixture, some of which (or their traceable proceeds) are dissipated, the beneficiary can treat the dissipation as the trustee’s money and attribute the identifiable funds (or traceable proceeds) to the trust, regardless of the order in which the withdrawals are made.
Cherry picking: In cases where withdrawals from a wrongful mixture result in the identification of multiple assets into which a beneficiary could potentially trace:
· In cases where the only contest is between the beneficiary and the trustee, the beneficiary can attribute the most profitable applications of the mixed fund to the trust money.
· In other cases (e.g. cases in which the beneficiary is competing with the unsecured creditors of a bankrupt trustee) the basic rule still applies (i.e. the beneficiary can attribute any part of the mixed fund which is dissipated to the trustee) but the beneficiary cannot attribute the most profitable applications of the fund to the misapplied trust money.

Question 13

Tracing: withdrawals from innocent mixtures?

Answer 13

The general rule applying to withdrawals from an innocent mixture is that withdrawals are attributed rateably to the contributors to the mixture: Re Diplock.

This general rule does not apply to withdrawals from an innocent mixture in a current bank account

Question 14

Innocent mixtures in current accounts?

Answer 14

If the withdrawal is made from a current account, the rule in Clayton’s case applies unless it would be unfair, in which case either the pari passu ex post facto method or a rolling charge should be used instead.

Question 15

rule in Clayton’s case?

Answer 15

· T misapplies £1,000 of trust fund A and pays it into a current bank account (‘the account’)
· T misapplies £1,000 of trust fund B and pays it into the account
· T withdraws £1,000 from the account and uses it to purchase shares
· T misapplies £1,000 of trust fund C and pays it into the account
· T withdraws £1,000 from the account and dissipates it
· £1,000 is still credited to the account
·
If Clayton’s Case is applied, the shares are the traceable proceeds of fund A because fund A was paid into the account first and the shares were purchased with the first £1,000 withdrawn. The second £1,000 withdrawn from the account (and dissipated) is attributable to fund B. And the sum credited to the account is the traceable proceed of fund C.

Question 16

The pari passu ex post facto method?

Answer 16

This involves identifying the amounts contributed to the account by each individual contributor attributing all the withdrawals from the account fractionally to all the contributors, regardless of the order in which the payments were made. This method is called the ‘ex post facto’ method because it is static. It involves a single calculation after the event.

Question 17

The rolling charge method?

Answer 17

Each individual withdrawal is attributed fractionally to the contributors to the account immediately before the withdrawal: the fraction attributed to any specific contributor being equivalent to their fractional contribution to the account immediately before the withdrawal. This is called the ‘rolling charge’ method because it is dynamic. It requires the contributors’ fractional contributions to be recalculated every time a sum is credited to the account. The order in which the payments were made can therefore affect the amounts attributed to individuals.

Question 18

A trustee takes £1,200 from a trust fund and pays it into their personal account, which already contains £600. The next day, the trustee withdraws £1,200 from the account and uses it to buy shares in a company. The trustee then withdraws £600 from the account and dissipates it.

Which of the following represents the best advice to the beneficiary?

The first £600 withdrawn from the account must be treated as the trustee’s own money, meaning the trustee spent £600 of their own money and £600 of trust money on the shares. The trustee then dissipated £600 of trust money.

The money in the account is shared equally between the trustee and beneficiary. The trustee is treated as spending £600 of their own money and £600 of trust money on the shares. The money which was dissipated is attributed in the same proportions, meaning £300 of the money in the account is trustee money and £300 is trust money.

The money withdrawn from the account can all be treated as trust money, meaning the trustee spent £1,200 on the shares and dissipated their own £600.

The money in the account is shared rateably between the trustee and beneficiary. The trustee is treated as spending £400 of their own money and £800 of trust money on the shares. The money which was dissipated is attributed in the same proportions, meaning £200 of the dissipated money is trustee money and £400 is trust money.

The money withdrawn from the account can all be treated as trust money but only if there are no competing creditors, meaning the trustee spent £1,200 on the shares and dissipated their own £600. If there are competing creditors, the first £600 withdrawn from the account must be treated as the trustee’s own money, meaning the trustee spent £600 of their own money and £600 of trust money on the shares (and then dissipated £600 of trust money).

Answer 18

The money withdrawn from the account can all be treated as trust money, meaning the trustee spent £1,200 on the shares and dissipated their own £600.

This is a wrongful mixture, part of which has been dissipated. The basic rule (in Hallett and Oatway) is that the trustee is treated as dissipating their own money and using the beneficiary’s money to acquire a traceable asset. Cherry picking does not come into play here because there is a straight choice between the beneficiary’s money being used to acquire an asset or being dissipated. This falls squarely within the basic rule.

Question 19

A trustee takes £600 from Trust A and pays the money into their personal current account (which was previously empty). The next day, the trustee takes £1,200 from Trust B and pays it into the same account. The next day, the trustee withdraws £1,200 from the account and uses it to buy shares in a company. The trustee dissipates the remaining £600 in the account.

What is the most likely way in which the withdrawals from the account will be attributed to the beneficiaries of the two trusts?

The withdrawals from the account should be shared equally by the beneficiaries. The trustee should be treated as spending £600 from Trust A and £600 from Trust B on the shares.

The trustee should be treated as withdrawing the money from Trust B before Trust A. The shares were bought exclusively with money from Trust B. Trust A’s money was all dissipated.

The trustee should be treated as withdrawing the money from Trust A before Trust B. The first £600 withdrawn from the account is Trust A’s money. The remainder of the £600 withdrawal comes from Trust B.

The withdrawals from the account should be shared rateably by the beneficiaries. The trustee should be treated as spending £400 from Trust A and £800 from Trust B on the shares.

Answer 19

The withdrawals from the account should be shared rateably by the beneficiaries. The trustee should be treated as spending £400 from Trust A and £800 from Trust B on the shares.

The withdrawals from the account should be shared rateably by the beneficiaries. The trustee should be treated as spending £400 from Trust A and £800 from Trust B on the shares.

Question 20

Proprietory claims in mixed funds?

Answer 20

Where an asset is purchased exclusively with trust money (or its traceable proceed) the beneficiary can choose between (Foskett):
Asserting beneficial ownership of the asset itself.Making a personal claim against the trustee for breach of trust and enforcing an equitable lien on the asset. (In other words, the beneficiary becomes a secured creditor.)
The beneficiary will normally exercise the option in the most advantageous way. If the traceable proceeds have increased in value, it will usually be preferable to claim them. If they have decreased in value, it will usually be preferable to make the personal claim.

Question 21

Claims: Wrongful mixtures?

Answer 21

Similarly, where an asset is purchased with misapplied trust money (or its traceable proceeds) and the trustee’s money the beneficiary can choose between:
Claiming a proportionate share of the asset.
Enforcing a lien upon it to secure his personal claim against the trustee for the amount of the misapplied money.
The rationale is that, since the trustee is a wrongdoer, their interest must be subordinated to the beneficiaries’ interest: the trustee cannot claim their interest in the asset until the beneficiaries’ claim has been satisfied in full.
Where beneficiaries claim a proportionate share of an asset which has increased in value, they capture a corresponding proportion of the increase.

Question 22

Claims: Innocent mixtures?

Answer 22

Where an asset is purchased with misapplied trust money (or its traceable proceed) and money derived from one or more innocent third parties, the beneficiaries can only claim a proportionate share of the asset: Diplock.

Question 23

What happens if the misapplied trust money is dissipated by the payment of a secured debt?

Answer 23

Where misapplied trust money (or its traceable proceed) is dissipated by the payment of a secured debt, the beneficiaries can be ‘subrogated’ to the rights of the creditor.

Question 24

What happens if there are no identifiable assets?

Answer 24

If there are no identifiable assets at the end of the tracing process, no proprietary remedies will be available.

Question 25

Is a proprietary claim the only claim beneficiaries can claim for misapplied trust property?

Answer 25

Beneficiaries do not have to make a proprietary claim even in cases where they are available. They can still elect to simply sue the trustee and make a personal claim.

Question 26

True or false: Proprietary claims can be made against any person who receives misapplied trust property.

Answer 26

False Proprietary claims cannot be made against a purchaser for value without notice of the trust. The beneficiary can trace into the sale proceeds but has no recourse against the purchaser.

Question 27

In breach of trust, a trustee misappropriates £15,000 of the trust fund. The trustee uses £5,000 to purchase shares, £5,000 to purchase a car, and £5,000 to purchase a painting. The trustee sells the shares and dissipates the proceeds of sale: The purchaser does not have any knowledge of the trust. The trustee gifts the car to his son: The son does not have any knowledge of the trust. Which one of the following statements describes the beneficiary’s rights? The beneficiary can make a proprietary claim to the shares and the car but not to the painting. The beneficiary can make a proprietary claim to the car and the painting but not to the shares. The beneficiary can make a proprietary claim to the car, the painting and the shares. The beneficiary can make a proprietary claim to the painting but not to the shares or the car. The beneficiary cannot make any proprietary claims.

Answer 27

The beneficiary can make a proprietary claim to the car and the painting but not to the shares. Generally, a beneficiary can make a proprietary claim against assets acquired exclusively with trust money or its traceable proceeds. However, a beneficiary cannot make any claim against a purchaser of a legal interest who does not have knowledge of the trust. Thus, the purchaser of the shares can successfully defend the beneficiary’s proprietary claim.

Question 28

In breach of trust, a trustee misappropriates £10,000 of the trust fund. He uses the money to purchase shares in a company. Which one of the following statements describes the beneficiary’s rights? The only claim available to the beneficiary is a personal claim against the trustee for £10,000. The beneficiary can make a personal claim against the trustee for £10,000 or a proprietary claim to the shares, as the trustee determines. The beneficiary may elect between an ownership claim to the shares and a security claim to the shares. The only claim available to the beneficiary is a proprietary ownership claim to the shares. The only claim available to the beneficiary is a security claim to the shares.

Answer 28

The beneficiary may elect between an ownership claim to the shares and a security claim to the shares. When a trustee misapplies trust money and uses it to purchase an asset, the beneficiaries can bring: (a) a personal claim against the trustee for the misapplied money, or (b) a personal claim against the trustee for the misapplied money coupled with a proprietary security claim to the asset, or (c) a proprietary ownership claim to the asset: Foskett v McKeown [2001] 1 AC 102.

Question 29

True or false: Trustees are not vicariously, or automatically, liable for the defaults of their co- trustees.

Answer 29

True

Question 30

Defences available for trustee who is facing a personal claim for breach of trust?

Answer 30

The following defences might be available to a trustee who is facing a personal claim for breach of trust: (a) an exemption clause in the trust deed; (b) knowledge and consent of the beneficiaries; (c) s 61 of the TA 1925; or (d) limitation and laches.

Question 31

Trustee holds substitute property?

Answer 31

(a) to take the substitute property. The beneficiaries should take this option where the substitute property has increased in value; or (b) to sue the trustee for compensation for the loss to the trust and take a charge (or ‘equitable lien’) over the property for the amount that the trust has lost. The beneficiaries should take this option where the substitute property has decreased in value

Question 32

Clean substitution.?

Answer 32

If a trustee has taken trust money and used that money to buy an asset in their own name, that asset will belong to the trust

Question 33

Mixed asset?

Answer 33

If a trustee has taken trust money and used that money together with some of their own money to buy an asset, the beneficiaries can choose to assert either a proportionate share in the asset (especially helpful where the asset has gone up in value) or an equitable lien over the asset (especially helpful where the asset has gone down in value). If a trustee has taken trust money from two separate trusts and uses that mixed fund to buy an asset, the beneficiaries of each trust can assert a proportionate share in the asset (whether the asset has gone up or down in value).

Question 34

Withdrawals through a mixed bank account?

Answer 34

If a trustee pays trust money into their own bank account and mixes that money with their own money before making various withdrawals, the beneficiaries can use various different tracing rules (Re Hallett and Re Oatway) to identify what belongs to the trust. Under these rules, everything is presumed against the trustee and the beneficiaries can generally identify the more valuable items of property remaining as trust property. If a trustee pays money from two separate trusts into a bank account before making various withdrawals, the beneficiaries must use different tracing rules (Clayton’s Case and Barlow Clowes v Vaughan) to identify what belongs to each trust. Under these rules, the courts try to apply a ‘rough and ready’ justice to both sets of innocent claimants.

Question 35

Question 1 A trustee takes £40,000 from a trust fund without authorisation and pays this into a bank account newly opened in his own name. He subsequently transfers £20,000 of his own money from another account. He then withdraws (in order): £10,000 to buy company shares; £30,000 to spend on a painting; and £20,000 to pay off his debts. A month later, he receives the sum of £20,000 for completing some unrelated consultancy work. The company shares have subsequently increased in value to £15,000. Which of the following represents the best available result for the beneficiaries should they bring a proprietary claim? A Two- thirds of the painting. B The painting. C The painting and the company shares. D One- third of the painting and the full balance now sitting on the account. E The company shares and the full balance now sitting on the account.

Answer 35

Answer Option C is correct. The trustee has mixed trust funds with his own in a bank account and then made various withdrawals from that account. We must therefore use the tracing rules in Re Hallett and Re Oatway to work out the best result for the beneficiaries. Re Oatway enables the beneficiary to assert a charge over the mixed fund and any withdrawals made from that fund. The beneficiary can choose to trace their interests into those withdrawals or funds that provide best value. Best value here is represented by option C. The appreciating company shares and the painting therefore represent the best possible outcome for the beneficiary. Option A is wrong. This option identifies the end result if the beneficiary were to use Re Hallett to assert their proprietary claim. If the trustee is deemed to spend their own money first, the trustee will have paid for the company shares and one- third of the painting, meaning that some trust money has been used to pay off his debts (which means that money has been dissipated). This does not represent the best outcome for the beneficiary. Option B is wrong. The beneficiary is best advised to trace into the company shares so that they can take advantage of the shares’ increase in value. Options D and E are wrong. The beneficiary cannot trace beyond the lowest intermediate balance and cannot therefore trace into the subsequent payment of £20,000 for the unrelated consultancy work.

Question 36

Question 2 A woman is a trustee of a family trust and a charitable trust. She takes £10,000 from the family trust without authorisation and pays this into a bank account in her own name, which already contains £20,000. She uses the balance of £30,000 to buy a car and subsequently closes the account. The car has depreciated in value and is now worth £24,000. She takes a further £5,000 from the family trust and then £10,000 from the charitable trust without authorisation, paying each sum in turn into a separate bank account in her own name from which she makes the following withdrawals (in order): £10,000 to buy company shares; and £5,000 on a holiday. Which of the following represents the best available result for the family trust? A 100% interest in the car and 50% interest in the shares. B One- third interest in the car and 50% interest in the shares. C One- third interest in the car. D An equitable lien for £10,000 over the car and 50% interest in the shares. E An equitable lien for £10,000 over the car.

Answer 36

Option D is correct The car represents a mixed asset (trust + trustee funds). As the car has gone down in value, the best result here is for the beneficiaries of the family trust to assert an equitable lien for £10,000 over the car so that the family trust can recover in full the £10,000 that was originally taken by the trustee. The company shares represent a withdrawal from a mixed bank account (trust + trust funds). Applying Clayton’s Case and FIFO, the £5,000 taken from the family trust will be allocated against the company shares giving the family trust a 50% interest in those shares. Option A is wrong. The car is a mixed asset and there is no way that the family trust can claim absolute ownership over it. Option B is wrong. The car has depreciated in value. Asserting a proportionate one- third share in the car therefore does not represent the best available result for the family trust. Options C and E are wrong. Both options omitted the possibility of claiming an interest in the company shares and therefore do not represent the best available result for the family trus

Question 37

Question 3 A management consultant and an insurance broker are trustees. The management consultant and insurance broker agreed that, in order to speed up the running of trust business, they should pay the trust fund into a bank account that allows withdrawals of any amount by only one signatory. The management consultant takes £50,000 from the trust’s bank account without authorisation and pays this into a newly opened bank account. He subsequently pays in £20,000 of his own money. From this account, he makes the following withdrawals (in order): £10,000 to pay for a luxury holiday; £10,000 to pay off personal debts; and £50,000 to purchase company shares. The management consultant is now bankrupt. The company, whose shares he purchased, is now in insolvent liquidation. Which of the following best describes whether the insurance broker can be named as a defendant to any claim that the beneficiaries might bring? A No claim will be brought against her because she did not commit a breach of trust. B No claim will be brought against her because she does not hold any property of value that the trust can trace into. C No claim will be brought against her because the beneficiaries are required to assert a proprietary claim against the company shares. D A claim could be brought against her for the £50,000 that the trust has lost plus interest. E A claim could be brought against her for the £50,000 that the trust has lost plus interest but she will be able to secure a sizeable contribution from the management consultant for the part he played in that loss.

Answer 37

Answer Option D is correct. This question is designed to remind you that beneficiaries can choose to bring personal and/ or proprietary claims against their wrongdoing trustees. Option D correctly identifies that the beneficiaries can bring a personal claim against the insurance broker for the full amount that her co- trustee stole from the trust. The insurance broker is in breach of trust. She agreed to pay the trust funds into an account that could be emptied by just one of the trustees. As such, she failed to act as an ordinary, prudent businesswoman and failed to supervise the activities of her co- trustee (see Chapter 9). This breach caused the loss that the trust has sustained. Option A is wrong. The insurance broker did commit a breach of trust. Option B is wrong. Whilst this option correctly identifies that the insurance broker is not holding any property of value that could form the basis of a proprietary claim, this does not prevent a personal claim being made against her. Option C is wrong. The beneficiaries do not have to bring a proprietary claim. Indeed, on the facts, there would be no value in them doing so. The money used to pay for the holiday and the management consultant’s debts has been dissipated. Given that the company is in insolvent liquidation, there is no value in the company shares, so there is no point in the trust seeking to recover them. Option E is wrong. The insurance broker is unlikely to get a sizeable contribution from her co- trustee, notwithstanding that he is more responsible for the losses sustained. A claim for contribution under the Civil Liability (Contribution) Act 1978 is a personal claim and there is very little point in making such a claim now that the management consultant is bankrupt.