LIABILITY FOR BREACH OF TRUST

Question 1

2

WAS THERE A BREACH OF DUTY?

Answer 1

1. Was the act one that the trust-ee was authorised to perform by the trust instrument or by law? If not, there is a breach of trust** regardless of the good faith, skill, and diligence** with which the trustee performed the act.
2. If the act was proper to perform, ask yourself whether the trustee acted in accordance with the relevant standard of care. In the case of investment choices, did they act with such care and skill **as reasonable in all the circumstances, taking into account any expertise they have or profess to have? **

Examples of breach of duty include:
*Failure to invest trust funds;
*Failure to take advice on investment or to take account of the standard investment criteria;
*Distributing trust funds to the wrong beneficiary;
*Failure to keep trust property under the trustees’ joint control; and
*Failure to act impartially between the benefciaries.

Question 2

LIABILITYOF TRUSTEES

Answer 2

Benefciaries may bring a personal claim against the trust-ees for losses resulting from trustees’ breach of trust, with interest on their liability from the time of breach. The benef-ciaries have the burden of proving loss.

Question 3

More than One Breach ofTrust—Losses
Cannot Be Offset

Answer 3

Generally, a trustee is not permitted to offset the loss from one breach by the gain that resulted from another breach.

exception:linked scheme of investment

Question 4

Which Trustee Is in Breach?

Answer 4

A trustee is not vicariously liable for the acts of their co-trust-ee, and only the trustee responsible for the breach and loss will be liable. However, where a breach of trust has been committed by one trustee, it may be that a co-trustee has committed another breach of trust by, for example, failing to supervise the actions of the trustee in breach.

Question 5

Liability Is Joint and Several

Answer 5

If more than one trustee is in breach, their liability is joint and several; that is, the benefciaries may sue any of the trustees for the whole loss, leaving the trustee to recoup some of the liability from the other trustee(s) if they can.

Question 6

4

Defences

Answer 6

a.Consent of Benefciaries
b.Limitation Period
c.Exclusion Clause
d.Relief in Court’s Discretion

Question 7

Defence
Consent of Beneficiaries

Answer 7

1. If a benefciary of full age and capacity has consented to the action that gave rise to the breach with** full knowledge** of all material facts, they may not later sue the trustees in relation to that breach.
2. If one benefciary gave consent but others did not, the trustees will be liable for losses caused to those benefciaries who did not consent.

Question 8

Limitation Period

Answer 8

1. The general limitation period for bringing an action againsttrustees is six years.
2. However, keep these exceptions in mind:
   *Time does not begin to run against a beneficiary with an interest in** remainder until her interest falls into posses-sion;
   *There is no limitation period if the trustee was party to a fraud; and
   *There is no limitation period in an action to recover trust property **or its proceeds from the hands of a trustee.

EXAMPLE
Trustees are holding funds on trust for Lisa for life, with remainder to Richard. Lisa has just died. Ten years ago, the trustees committed a breach of trust by making an unau-thorised investment, causing loss to the fund. Although the breach took place more than six years ago, Richard has six years in which to bring his claim because he just came into possession of his interest.

Question 9

3

Exclusion Clause

Answer 9

Clauses attempting to relieve a trustee of liability for breach of trust generally are strictly construed but are enforceable where** no bad faith, intentional breach, or recklessness** is involved

Question 10

Relief in Court’s Discretion

Answer 10

1. Courts have the power to award relief from liability if theyconclude that the trustee has acted honestly and reasonably and ought fairly to be excused.
2. This relief is rarely awarded, and it will not be applied if a trustee has failed to meet the necessary standard of care.

Question 11

LiabilityAmong Trustees

Answer 11

a.Contribution
Where more than one trustee is in breach of trust, their liability to the benefciaries is joint and several. However, as among the trustees, the court has power to apportion liability as it deems just and equitable in the circum-stances.

b.Indemnity
The court has the power to indemnify one trustee at the expense of another. This means that one trustee will be protected from the liability generated by the other. A trustee can claim an indemnity from a co-trustee: (1) who** alone **was guilty of fraud or who was the solicitor to the trust and advised the breach or (2) who is a professional trustee while the other
is a lay **trustee (unless the lay trustee has also caused the breach).

Question 12

3

Tracing
Definition

Answer 12

1. **The right to sue a trustee for breach of trust is a personal claim; that is, the trustee is personally liable to make good the loss to the trust.
2. However, where trust property or its proceeds can be identifed in the hands of a trustee, the benefciaries may make a proprietary claim to the property. This claim is advantageous where the trustee is insolvent, because the benefciaries will be able to claim the trust property from the trustee ahead of other creditors. Further, if the value of the trust property or its proceeds has increased, a proprietary claim enables the benefciaries to claim the increase.
3. The process of** identifying the trust property** in the hands of the trustee is known as ‘tracing

Question 13

5

types of trust property

Answer 13

a.Trust Property Not Mixed with Other Property
b.Assets Purchased from Mixed Funds
c.Trust Funds Mixed with Trustee’s Funds in Bank Account
d.Assets Purchased from Mixed Funds ofTwo Trusts
e.Funds ofTwo Trusts Mixed in Bank Account

Question 14

2

Trust Property Not Mixed with Other Property

Answer 14

1. If the original trust property is in the hands of the trustee, the beneficiaries may simply claim it back.
2. If the trustee has directly substituted the trust property for another asset, the beneficiaries may claim that asset, or may claim a charge over the asset up to the amount of their loss. (A charge is a proprietary right similar to a mortgage which enables the claimant to sell the asset and take a proportion of the pro-ceeds of sale.)

EXAMPLES
1) A trustee has withdrawn £5,000 from the trust bank account and used it to buy a diamond ring. The ring is now worth £6,000. The benefciaries may choose whether to claim the ring, including its increase in value, or claim a charge over the ring for £5,000 to recover the misappropri-ated funds. Since the ring has increased in value, they will
claim the ring as trust property.

2) The facts are as in 1), above, except that the ring is now worth £4,000. The beneficiaries will not claim the ring as trust property, but instead will claim a charge over the ring for £5,000. They will be able to have the ring sold and claim the proceeds as trust funds, gaining priority over any other creditors the trustee may have. The beneficiaries will still be able to claim the balance of £1,000 from the trustee personally but will rank alongside other creditors in this claim.

Question 15

Assets Purchased from Mixed Funds

Answer 15

If a trustee has combined trust funds with their own to purchase an asset, the benefciaries may claim a proportionate part of that asset, or they may claim a charge over the asset for the amount of trust property used.

EXAMPLES
1) A trustee has withdrawn £10,000 from the trust bank account and used it, together with £10,000 of his own money, to buy a painting. The painting is now worth £24,000. Since the painting has increased in value, the benefciaries will
claim a proportionate share (one-half) of the painting, and will recover £12,000.
2) The facts are as in 1), above, except that the painting is now worth £18,000. The benefciaries may claim a charge over the painting for their missing £10,000. They may require the painting to be sold and recover their loss from its proceeds. If the trustee has other creditors, the benefciaries will have priority over their claims.

Question 16

3

Trust Funds Mixed with Trustee’s Funds in Bank
Account

Answer 16

1. If a trustee places trust funds into a bank account with the trustee’s own money, the beneficiaries may claim a charge over the account for the amount of the trust funds in it. If the trustee had drawn money out of the account, the basic rule is that the trustee is treated as withdrawing their own money first.
2. Exception for Asset Purchased Before Fund Dissipated
   If the trustee withdraws money from the account to purchase an asset and then dissipates the balance, the beneficiaries may claim a share of the asset or a charge over it.
   EXAMPLE
   Tessa, a trustee, has £5,000 in her bank account. She pays £10,000 of trust money into the account. She then draws out £5,000 from the account to buy shares and spends the rest of the money in the account on her rent and household expenses. The shares are now worth £7,000. Under the basic rule, the shares would represent the trustee’s own money, and all the trust money would have been dissipated. Under the exception, however, the beneficiaries are entitled to claim a charge over the shares for their lost £10,000, so they will receive the full sale proceeds of £7,000. They have a personal claim against the trustee for the remaining £3,000 lost, which will rank equally with the claims of the trustee’s other creditors.
3. Subsequent Receipts of Trustee’s Own Money
   If, despite following the rules above, the trust money has been dissipated, subsequent payments of the trustee’s own money into the account are** not** treated as replacing the trust money. However, if the trustee shows a clear intention to repay the trust money, then their subsequent payments can be treated as replacing the trust money.
   The limit of the benefciary’s claim is what is known as** the ‘lowest intermediate balance’**—the balance after the last payment out but before the next payment in. If the lowest intermediate balance is zero, then that is the limit of the benficiary’s claim.

Question 17

Assets Purchased from Mixed Funds ofTwo Trusts

Answer 17

If a trustee purchases an asset from the mixed funds of two trusts, the benefciaries of the two trusts share the asset proportionally.
EXAMPLE
A trustee takes £2,000 from Trust A and £3,000 from Trust B and uses the money to purchase company shares. The trusts own the shares in the proportion 2:3. If the shares have increased in value to £10,000, Trust A will be entitled
to £4,000 and Trust B to £6,000. If the shares have fallen in value to £2,500, Trust A will be entitled to £1,000 and Trust B to £1,500.

Question 18

2

Funds ofTwo Trusts Mixed in Bank Account

Answer 18

If a trustee mixes funds from two (or more) trusts in the trust-ee’s personal bank account, treatment of the funds depends on the type of bank account—a current account versus sav-ings account.
1. Current Account
“First In, First Out” Rule
If the funds are mixed in a current account, the tradition-al rule is that the frst money into the account is the first money out (“first in, first out”).

Proportionate Solution
If (1) applying the “first-in, first-out” rule is contrary to the express or implied intentions of the claimants, (2) it is im-practical to apply the rule, or (3) applying the rule would cause injustice to the parties, courts will displace the rule and divide the money proportionately.

2. Savings Account
   If the funds are mixed in a savings account, the proportionate solution operates as the default rule.

Question 19

LIABILITY OF THIRD PARTIES

Answer 19

If a third party or ‘stranger to the trust’ has become involved in a breach of trust, the beneficiaries may be able to bring a personal or proprietary action against the third party, based on either the fact that the third party has received property belonging to the trust or on their dishonest involvement in the breach.

Question 20

Transfer to Bona Fide Purchaser Cuts Off
Benefciary’s Rights
3rd party liability

Answer 20

A third party who acquires the legal title to trust property for value and** without notice** of the trust takes the property free of the equitable interests of the benefciaries.

Question 21

3

Innocent VolunteerRecipient
3rd party liability

Answer 21

1. If trust property has come into the possession of a third party who did not pay value for the property, but who nevertheless had no knowledge or suspicion that a breach of trust has occurred, the benefciaries** cannot bring a personal claim in equity **against the recipient as the recipient’s conscience is not affected.
2. However, the benefciaries may be able to make a** proprietary claim** to recover the property or its product using the equitable tracing process.
3. To establish a right to trace, the claimant must show that:
   *The property was the subject of a fiduciary relationship;
   *The property or its product is identifable using equitable tracing rules; and
   *The property is not in the hands of a bona fide purchaser for value without notice.

Question 22

Innocent Volunteer Recipient
Property Not Mixed

Answer 22

If the property is in its original form or has been directly substituted for another asset, the benefciaries may claim the asset.

Question 23

Innocent VolunteerRecipient
Assets Purchased from Mixed Funds

Answer 23

1. If an innocent recipient uses trust funds along with funds of their own to purchase an asset, the beneficiaries may claim a proportionate share of the asset.
2. As the recipient is an innocent volunteer, there is no option to claim a charge over the property, so any loss in value is shared proportionately between the trust benefciaries and the innocent volunteer recipient.

Question 24

Innocent VolunteerRecipient
Trust Funds Mixed with Volunteer’s Funds in Bank Account

Answer 24

1. If an innocent volunteer has placed trust funds in a bank account containing funds of their own, it may be necessary to apply tracing rules to determine the order in which funds are paid out of the account.
2. The traditional approach is to apply the “first in, first out” banking rule to identify which money has been paid out of the account. However, recent cases apply the proportionate solution where possible, on the basis that a more equitable result is achieved.

EXAMPLE
A trustee hands £20,000 to an innocent volunteer recipient in breach of trust. The recipient places the money in their bank account, which already contains a balance of £5,000.
The recipient uses £3,000 from the account to buy shares, then spends a further £6,000 on rent and general living expenses. The shares are now worth £5,000. The balance of £16,000 is still in the recipient’s bank account. Applying the “frst in, frst out” rules, the shares were bought wholly with the recipient’s own money, and she may retain them. The £6,000 spent on rent and living expenses consisted of the remaining £2,000 of the recipient’s own money plus £4,000 of the trust money. This £4,000 of trust money has been dissipated and is not traceable. The balance of £16,000 remaining in the account can be claimed by the trust. The efect is that the trust benefciaries can claim back only £16,000, while the recipient keeps the whole gain on the shares.

COMPARE
Same facts as above, but the court decides to use the pro-portionate solution. The trust can claim £16,800: The mixed fund represented money belonging to the trust and recipient in the ratio 4:1, so each payment, as well as the remain-ing balance, is treated in the same proportions. The trust could claim 4/5 of the value of the shares (£4,000), and 4/5 of the £16,000 balance in the bank account (£12,800).

Question 25

3

3rd party liability
knowing recipient

Answer 25

1. If a third party received money or property traceable to a breach of trust with knowledge of the breach, they will be treated as if they were a trustee.
2. The claimant must show that the recipient had sufcient knowledge as to make it ‘unconscionable’ for the recipient to retain the property.
3. Unconscionability will be found if the recipient’s knowledge falls into one of the following categories:
   Actual knowledge***
   *Wilfully closing one’s eyes to the obvious;
   *Wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make;
   *Knowledge of circumstances which would indicate the facts to an honest and reasonable person; or
   *Knowledge of circumstances which would put an honest and reasonable person on inquiry.

Question 26

Personal Claim Against Knowing Recipient

Answer 26

A knowing recipient is treated in equity as if they were a con-structive trustee, so the recipient will be personally liable to the benefciaries to make good the loss to the trust fund.

Question 27

Proprietary Claim Against Knowing Recipient

Answer 27

Since a knowing recipient is treated as if they were a trustee, the trustee tracing rules will apply to identify trust property or its product in their hands

Question 28

4

Dishonest Accessory

Answer 28

If a third party has facilitated a breach of trust, the third party is liable as if they were a trustee if their assistance was ‘dishonest’.
a.Passive Assistance May Suffice
Generally the courts require a positive act of assistance by the third party. However, it is conceivable that passive assistance would suffice.
b.Conscious Impropriety
‘Dishonesty’ has been described as ‘conscious impropriety’ or ‘not acting as an honest person would in the circumstances’. The dishonest accessory need not have known that they were participating in a breach of trust, merely that the scheme they were facilitating was in some way illegal.
c.Personal Claim in EquityAgainst Dishonest Accessory
Once it is shown that the person who facilitated the breach of trust was acting dishonestly, that person is treated as if they were** a constructive trustee.** The beneficiaries may sue the accessory personally for the losses resulting from the breach.
d.Proprietary Claim Not Relevant to Dishonest Accessory
The basis of the claim against a dishonest accessory is that the accessory facilitated the breach of trust. This is unlikely to have involved the accessory’s receiving trust property for their own beneft, so a proprietary claim is not relevant to such cases