Remedies Against Trustees: Proprietary Claims

Question 1

What is a proprietary claim, and when would you advise bringing such a claim?

Answer 1

A proprietary claim is a legal action where beneficiaries seek the return of specific trust property (or its substitute) that has been misappropriated or wrongfully used by a trustee. Unlike personal claims, proprietary claims assert ownership over assets rather than seeking monetary compensation.

Key Characteristics of a Proprietary Claim:
1. ‘In Rem’ Claim:
* Focuses on recovering the property itself rather than compensation from the trustee’s personal funds.

• Property is traced and claimed regardless of who holds it.

2. Priority over Trustee’s Creditors:

• If the trustee is insolvent, the trust property (or its traceable substitute) is not part of the trustee’s bankruptcy estate.

3. No Statutory Limitation Period:

• Proprietary claims are not subject to the six-year limit under the Limitation Act 1980 but can be barred by the equitable doctrine of laches (unreasonable delay causing prejudice).

When to Advise a Proprietary Claim:

1. Trustee Insolvency:
   * Proprietary claims prioritize the trust’s recovery over other creditors.

• Example: A trustee becomes bankrupt but still holds assets purchased with trust funds. Beneficiaries can recover those assets before creditors.

2. Asset Appreciation:
   * If trust funds were used to buy property that has increased in value, beneficiaries should bring a proprietary claim to benefit from the increase.

• Example: A trustee used £50,000 of trust money to buy shares that doubled in value to £100,000. Beneficiaries can recover the shares.

3. No Dissipation:
   * A proprietary claim is appropriate if there is still an identifiable asset. If the trust property has been dissipated (e.g., spent on holidays or debts), a proprietary claim is ineffective.
4. No Limitation Period:
   * If the breach occurred more than six years ago, a proprietary claim is still possible.

Key Example:

• A trustee misappropriates £20,000 of trust money and buys a painting. Beneficiaries can assert a proprietary claim over the painting. If the painting appreciates to £25,000, beneficiaries recover the full value.

Question 2

What happens if trust property changes form, and how do tracing rules help beneficiaries recover it?

Answer 2

If trust property is sold or exchanged for a different asset, tracing rules allow beneficiaries to follow their equitable interest into the substituted property.

1. Original Property:
   * If the property remains in its original form, no tracing is required.

• Example: A farm belonging to the trust is transferred to the trustee’s name. Beneficiaries can demand its return.

2. Substituted Property (Clean Substitution):

• When trust property is sold and replaced with another asset, beneficiaries can trace into the new asset.
• Example: A trustee sells trust shares and uses the proceeds to buy a car. Beneficiaries can claim the car.

Beneficiaries’ Options:
1. Claim the Substitute Property:
* Beneficiaries should claim the new property if it has increased in value.

• Example: A trustee uses £20,000 of trust funds to buy a painting, now worth £30,000. Beneficiaries should claim the painting.

2. Claim Compensation + Equitable Lien:

• If the substitute property has decreased in value, beneficiaries can claim monetary compensation and place a lien on the property.
• Example: A painting purchased for £20,000 is now worth £15,000. Beneficiaries can claim £20,000 and secure a lien on the painting.

Question 3

What happens when a trustee mixes trust property with their own funds to purchase an asset?

Answer 3

When trust funds are mixed with a trustee’s personal funds to purchase an asset (a mixed asset), tracing rules determine the trust’s equitable interest.

Options for Beneficiaries:
1. Claim a Proportionate Share:

• Beneficiaries claim a proportionate interest in the mixed asset, including any increase in value.
• Example: A trustee uses £10,000 of trust funds and £5,000 of their own money to buy shares worth £15,000. If the shares increase to £30,000, beneficiaries claim two-thirds (£20,000).

2. Equitable Lien:
   * Beneficiaries claim compensation and place a lien on the asset for the trust’s losses.

• Example: The shares decrease to £12,000. Beneficiaries claim £10,000 and secure a lien on the shares.

Principle:
Equity ensures beneficiaries receive the best result, regardless of whether the asset appreciates or depreciates.

Question 4

How do tracing rules apply when a trustee mixes trust funds with their own money in a bank account?

Answer 4

When trust funds are mixed with the trustee’s personal money in a bank account, tracing rules determine the allocation of withdrawals.

1. Re Hallett’s Estate (1880):
   * The trustee is presumed to spend their own money first.

Example:
* A trustee deposits £10,000 of trust funds and £5,000 of personal money into a bank account. They withdraw £5,000 for personal expenses and £10,000 to buy shares.

• Under Re Hallett, the trust funds are traced into the shares, which beneficiaries can claim.

2. Re Oatway (1903):
   * If Re Hallett disadvantages beneficiaries (e.g., attributing dissipated funds to the trust), beneficiaries can claim ‘first choice’ over remaining property.

This rule provides that the beneficiary has a first charge on the mixed fund (ie the amount sitting in the trustee’s bank account) or any property that is purchased from that fund. In essence, the beneficiary gets ‘first choice’ and can therefore generally choose how best to satisfy their proprietary claim.

Example:
* A trustee deposits £20,000 of trust funds and £40,000 of personal money, spends £20,000 on debts, and uses the remaining £40,000 to buy a house.

• Under Re Oatway, the trust’s interest is traced into the house, and beneficiaries can claim a lien.

3. Roscoe v Winder (1915):
   * Tracing is limited to the lowest intermediate balance in the account before new deposits.

Example:
* A trustee deposits £20,000 of trust money, spends £18,000, and later deposits £10,000 of personal funds. Beneficiaries can only trace £2,000, the lowest intermediate balance.

Question 5

What happens when a trustee mixes funds from multiple trusts?

Answer 5

When a trustee mixes funds from two or more trusts, tracing rules allow beneficiaries to claim their respective shares of the mixed property.

1. Mixed Asset Purchase:
   * Beneficiaries from each trust claim a proportionate interest based on their contributions.

• Example: £10,000 from Trust A and £20,000 from Trust B are used to buy shares worth £30,000. Trust A owns one-third, and Trust B owns two-thirds.

2. Mixed Bank Account:
   * If trust funds are mixed in a bank account, beneficiaries can trace into the remaining funds or property.

• Example: A trustee mixes £5,000 from Trust A and £10,000 from Trust B, spends £5,000, and buys shares for £10,000. Each trust can claim its proportionate share of the shares.

Question 6

What are the key case precedents for tracing rules?

Answer 6

1. Re Hallett’s Estate (1880): Trustee spends personal funds first.
2. Re Oatway (1903): Beneficiaries have first choice over property.
3. Roscoe v Winder (1915): Limited to the lowest intermediate balance.
4. Foskett v McKeown (2001): Beneficiaries claim a proportionate share of property and its appreciation.

Question 7

What happens when a trustee mixes funds from two or more innocent trusts to purchase an asset?

Answer 7

When a trustee wrongfully uses funds from multiple trusts to purchase an asset, the pari passu rule applies, ensuring each trust gets a proportionate share in the asset based on its contributions. This ensures fairness between trusts that are innocent of wrongdoing.

Key Principles:
1. Proportional Allocation (Pari Passu Rule):

• Each trust owns a share of the asset proportionate to its contribution. This applies regardless of whether the asset appreciates or depreciates.

2. Equity Protects the Innocent:
   * Tracing ensures that no innocent trust is unfairly disadvantaged by the trustee’s wrongdoing.

Detailed Example:
* Scenario:
* Stephan, a trustee, wrongfully uses £10,000 from the Allan Trust and £20,000 from the Barnes Trust to buy shares worth £30,000 in Sigma plc.

• If the Shares Increase to £36,000:
• Allan Trust contributed one-third of the purchase price (£10,000/£30,000). It now owns one-third of the shares’ value (£12,000).
• Barnes Trust contributed two-thirds (£20,000/£30,000). It now owns two-thirds (£24,000).
• If the Shares Decrease to £24,000:
• Allan Trust owns one-third (£8,000).
• Barnes Trust owns two-thirds (£16,000).

Principle Applied:
* The pari passu rule ensures fairness between trusts. If the asset’s value changes, each trust’s share adjusts proportionally.

Question 8

How do tracing rules allocate withdrawals when a trustee mixes funds from two trusts in a bank account?

Answer 8

When funds from multiple trusts are mixed in a bank account and withdrawals are made, tracing rules allocate the remaining balance or assets.

Key Rules for Allocation:
1. Clayton’s Case (FIFO):
* “First In, First Out” (FIFO) presumes that the first money deposited is the first money withdrawn.

Example:
* John, a trustee, deposits £10,000 from the Chapman Trust and £20,000 from the Dawson Trust into a bank account.

• He withdraws £15,000 to pay debts and spends the remaining £15,000 on shares.
• FIFO Result:
• Chapman Trust’s £10,000 is spent on debts (dissipated).
• Dawson Trust’s £15,000 is traced into the shares.

2. Barlow Clowes v Vaughan (Proportional Allocation):

• Courts may depart from FIFO if it causes injustice or is impractical. Proportional allocation is often used, giving each trust a share based on its contribution.

Example (Departure from FIFO):
* Chapman Trust (£10,000) and Dawson Trust (£20,000) funds were mixed. Shares worth £15,000 remain.

• Chapman Trust gets £5,000, and Dawson Trust gets £10,000.

Courts aim to achieve fairness between innocent trusts. FIFO is only applied if it aligns with the interests of justice.

Question 9

What happens when a trustee mixes funds from two trusts with their own money in a bank account?

Answer 9

When a trustee mixes funds from two trusts and their own money, tracing rules such as Re Hallett, Re Oatway, and Clayton’s Case apply to allocate withdrawals and remaining funds.

Step-by-Step Allocation:
1. Apply Re Hallett and Re Oatway:

• The trustee’s personal money is deemed spent first, maximizing recovery for the trusts.

2. Apply Clayton’s Case or Proportional Allocation:

• Any remaining funds or assets are allocated using FIFO (Clayton’s Case) or the pari passu rule (Barlow Clowes).

Detailed Example:
* Daniel, a trustee, deposits £20,000 from Trust A, £30,000 from Trust B, and £10,000 of his own money into a bank account.

Withdrawals:
* £10,000 on debts (dissipated).
* £30,000 on a kitchen renovation.
* £10,000 on artwork.
* £10,000 on a holiday (dissipated).

Allocation:
1. Re Hallett: Daniel’s personal £10,000 is spent on debts, pushing dissipation onto him.

2. Clayton’s Case (FIFO):
   * Trust A’s £20,000 is traced to the kitchen (£20,000 lien).

• Trust B’s £30,000 is traced: £10,000 to the kitchen, £10,000 to the artwork, and £10,000 dissipated.

Question 10

What does the principle “everything is presumed against the wrongdoer” mean in tracing?

Answer 10

This principle ensures that ambiguities in tracing are resolved in favor of beneficiaries and against the trustee. Equity maximizes recovery for the trust(s) while minimizing benefits for the wrongdoer.

1. Re Hallett’s Rule:
   * Trustee is deemed to spend their own money first, leaving trust funds intact for recovery.
2. Re Oatway Rule:
   This rule provides that the beneficiary has a first charge on the mixed fund (ie the amount sitting in the trustee’s bank account) or any property that is purchased from that fund. In essence, the beneficiary gets ‘first choice’ and can therefore generally choose how best to satisfy their proprietary claim.

Question 11

What is the “lowest intermediate balance” rule, and how does it limit tracing?

Answer 11

The lowest intermediate balance rule (from Roscoe v Winder (1915)) limits tracing to the lowest amount remaining in a bank account before new deposits. Replenished funds cannot be traced unless specifically intended to replace trust property.

Detailed Example:
* A trustee deposits £20,000 of trust funds into a bank account, spends £18,000, and later deposits £10,000 of personal funds.
* Result: Beneficiaries can only trace £2,000, the lowest intermediate balance.

Key Principle:
Beneficiaries cannot claim replenished funds unless they were explicitly intended to restore trust property.

Question 12

Can principals other than trust beneficiaries bring proprietary claims using tracing rules?

Answer 12

Yes. Any principal in a fiduciary relationship (e.g., a company and its director) can bring proprietary claims to recover misappropriated property using tracing rules.

*	A company director steals £50,000 of company funds to buy a car.
*	Result: The company can assert a proprietary claim over the car using tracing rules.

Principle:
The fiduciary relationship allows principals to recover property, ensuring wrongfully gained assets are returned.

Question 13

What happens when a trustee mixes funds from multiple trusts to purchase an asset?

Answer 13

When funds from multiple trusts are used to buy an asset, each trust is entitled to a proportional share in the asset based on its contribution.

Detailed Example:
* Stephan, a trustee, wrongfully uses £10,000 from Trust A and £20,000 from Trust B to buy shares worth £30,000.

Appreciation:
* If the shares increase to £36,000:
* Trust A: £12,000 (one-third).
* Trust B: £24,000 (two-thirds).

Depreciation:
* If the shares decrease to £24,000:
* Trust A: £8,000.
* Trust B: £16,000.