Trusts - Equitable Remedies and Tracing

What are equitable remedies?

Remedies available in circumstances where common law damages would not be adequate, often involving equitable interests.

What are examples of equitable remedies?

Specific performance, injunctions, search orders, and freezing orders.

What is the nature of equitable remedies?

They are discretionary and depend on the circumstances of each case.

What are personal remedies in equitable law?

Monetary remedies such as equitable compensation and an account of profits - remedies against a person

What are proprietary remedies?

Remedies that award the claimant a proprietary right

e.g. asserting a constructive trust

What is a constructive trust?

A remedy that allows a claimant to assert a proprietary right over profits made from a breach.

Why is the option to claim a constructive trust useful?

gives the claimant the ability to utilise the following and tracing rules, identifying what the profit has been spent on.

Can beneficiary assert their proprietary rights against a purchaser of trust assets who did not know they were trust assets?

No - they have valid legal title to them now

What can beneficiaries do when a trustee misapplies trust property?

1. They can sue the trustee for breach of trust,

2. sue a third party who assisted the breach,

3. make a claim against the misapplied property or its traceable proceeds, or

4. sue a third party who knowingly received the traceable proceeds.

What are the three principal advantages of establishing an equitable proprietary claim?

1) It is not affected by the defendant's bankruptcy or insolvency.

2) It enables beneficiaries to capture increases in the value of traceable proceeds.

3) It does not depend on fault. - i.e. can be maintained against the defaulting trustee and against innocent recipients

What are the three methods that underpin equitable proprietary claims?

1. following

2. tracing

3. claiming

What is the process of 'following' in the context of misapplied trust property?

Following is the process of locating misapplied trust property as it moves from hand to hand.

What does 'tracing' refer to in relation to trust property?

Tracing is the process of identifying a new asset as the substitute for the old asset.

e.g., where there have been a series of direct substitutions between them

What is 'claiming' in the context of misapplied trust property?

assertion of a personal or proprietary right in relation to misapplied trust property or its traceable proceeds.

What are the two conditions that must be satisfied for a claimant to use equitable following, tracing, and claiming rules?

1) The claimant must have a right of property recognised by equity in the asset.

2) The asset was held by a person in a fiduciary relationship with the claimant.

n.b. these are the conditions under Diplock

When can the Diplock conditions be easily satisfied?

- express trusts

- trusts arising by operation of law (constructive trusts)

- company director misapplying company property

(n.b. here the company has full legal ownership and not an equitable interest)

- executor misapplying estate property

(n.b. here, those entitled under a will do not have any sort of proprietary interest)

What kind of assets can the beneficiaries go after when making a proprietary claim?

• The misapplied trust property

• Assets purchased exclusively with misapplied trust money (or its traceable proceeds)

• Assets purchased with a mixed fund.

What types of claims can beneficiaries make regarding misapplied trust property?

1. Beneficiaries can claim beneficial ownership of the asset - n.b. only available where asset is acquired solely by traceable proceeds of the breach

2. a share of the asset - possible where asset acquired using a mixed fund

3. an equitable lien over the asset, or

4. subrogation.

What is an equitable lien?

- a claim that allows a beneficiary to secure their personal claim for breach of trust against an asset that has decreased in value.

What is subrogation in the context of misapplied trust funds?

Subrogation allows the beneficiary to step into the shoes of the creditor when misapplied trust funds are used to pay off a secured debt.

the beneficiary then takes equivalent security to that previously held by the original lender

What is the principal defense to an equitable proprietary claim?

The defence is that of a 'bona fide purchaser for value without notice' of the trust,

they can then deal with trustees as if they are the full legal owner and take clean title to the trust property, even if misapplied

What is the simplest tracing exercise?

When an asset is acquired exclusively with misapplied trust money or its traceable proceeds.

this can be traced into multiple transactions - e.g. trust fund, used to purchase shares, later sold to purchase a property - can trace all the way into the property

What are the two principal types of mixed funds in tracing?

1) A wrongful mixture (trustee's own money mixed with misapplied trust money).

2) An innocent mixture (misapplied trust money mixed with innocent third-party funds).

In a wrongful mixture, what is the basic rule when there has been a dissipation of some of the mixed money?

- for when there is a withdrawal from a wrongful mixed fund and some of the money is dissipated (i.e. no traceable proceed e.g. if its spent on services)

- B can treat the dissipation as the trustee's money - thus prioritising any money left over or in stored in assets for the B

What is 'cherry picking' when a wrongful mixture has been used to purchase multiple traceable assets?

- beneficiary can 'cherry pick' the most profitable applications of the mixed fund to attribute to the trust money e.g. taking the shares instead of cash in the bank

- n.b. cherry picking cannot be used where it would prejudice innocent TPs

- e.g. where B is competing with the unsecured creditors of a bankrupt trustee - they cannot cherry pick

What are the most common examples of innocent mixtures?

- Money from two or more trusts is mixed by a common trustee

- An innocent recipient of misapplied trust money mixes it with their own money

What is the general rule applying to withdrawals from innocent mixtures?

withdrawals are attributed rateably to the contributors to the mixture

e.g. if two equal contributions to the mixed fund, a dissipation of £1k would be attributed as £500 to each contributor

- but if one contributor put more in, this would be reflected in the share they get back

n.b. this does not apply to withdrawals from an innocent mixture in a current bank account

What is the general rule applying to withdrawals from innocent mixtures in a current account?

it is the sum first paid in that is first drawn out - AKA 'first in, first out' rule

n.b. - this rule has almost always been disapplied and instead, the pari passu or rolling charge methods are applied

When can the 'first in, last out' method be disapplied?

when its application is:

- contrary to the intentions of the parties who contributed to the mixture (eg investors in a scheme designed to share all profits and losses)

- impracticable (ie too complex or expensive to apply); or

- unfair

What are the alternatives to the 'first in, first out' rule for withdrawals from innocent mixtures in a current account?

1. The pari passu ex post facto method.

2. the rolling charge method

What is the pari passu ex post facto method?

Involves identifying the amounts contributed to the account by each individual contributor and attributing all withdrawals fractionally to all contributors, regardless of the order of payments.

this involves a single calculation after the event

What is the 'rolling charge' method?

A method where each withdrawal is attributed fractionally to contributors based on their contributions before the withdrawal.

this is dynamic and requires recalculating contributors' fractional contributions with each credit to the account.

n.b. as a matter of principle, this is to be used before the pari passu method unless it is too complex to apply - and it has not been used to this date!

What are the common claims beneficiaries can make regarding misapplied trust property?

Claims can involve:

a) the misapplied trust property itself,

b) assets purchased with misapplied trust money, and

c) assets purchased with a mix of misapplied trust money and the trustee's money.

d) Assets purchased with misapplied trust money and money derived from one or more innocent third parties.

What is the principle established in Foskett, regarding unmixed funds?

Beneficiaries can assert their equitable proprietary interest in the property, and the holder must restore it to the trust fund.

What options do beneficiaries have when an asset is purchased exclusively with trust money?

Beneficiaries can:

a) assert beneficial ownership (if increased in value) or

b) if asset has decreased in value:

- make a personal claim against the trustee for breach of trust

- OR enforce an equitable lien on the asset (becoming a secured creditor)

What can beneficiaries claim when an asset is purchased with a mix of misapplied trust money and the trustee's money?

They can claim a proportionate share of the asset or enforce a lien to secure their personal claim against the trustee.

What happens when beneficiaries claim a proportionate share of an asset that has increased in value?

They capture a corresponding proportion of the increase in value.

What is the outcome for beneficiaries when an asset purchased with misapplied trust money decreases in value?

They can claim an equitable lien over the shares to secure their personal claim.

What is the rule regarding innocent mixtures of funds in trust property cases?

- Beneficiaries can only claim a proportionate share of the asset when mixed with innocent third-party funds.

(n.b. the court has not considered whether beneficiaries can assert an equitable lien limited to the value of their proportionate share in the asset)

What must happen when beneficiaries' claims compete with those of other innocent contributors?

All claims must share rateably in the fund.

What happens when there is a wrongful and innocent mixture?

- Where assets are acquired using a mixture of trustee funds and funds from more than one innocent party the same rules apply - all parties share rateably

- if the property increases in value - this is fine to claim the proprietary interest

- if the property decreases in value - it is preferable to simply sue the trustee for the misapplied property - but if T insolvent, better to make proprietary claim

What is the principal defense against an equitable proprietary claim?

The defence of the purchaser for value of a legal interest without notice of the trust

- if this applies, beneficiary can only assert an interest in the sale proceeds (if these are not dissipated) and make a personal claim against trustee