Tracing and Equitable Proprietary Claims

Question 1

What are the beneficiaries’ options when a trustee misapplies funds?

Answer 1

1. Sue the trustee for breach of trust
2. Sue a third party who as assisted the breach of trust
3. Make a claim against the misapplied property or its traceable proceeds
4. Sue a third party who knowingly received the traceable proceeds of the breach

Question 2

What are equitable proprietary claims?

Answer 2

Can be valuable to establish an equitable proprietary claim against property or its traceable proceeds.

A proprietary claim as three principal advantages:

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: it can be maintained against the defaulting trustee and against innocent recipients of the trust property or its traceable proceeds.

Question 3

What is following?

Answer 3

Following is the process of ‘following the same asset as it moves from hand to hand’. It is the process for locating misapplied trust property.

If T misapplies £1000 cash of the trust and gifts it to X who gifts it to Y, the beneficiaries can follow the £1000 from T to X and then to Y.

Question 4

What is tracing?

Answer 4

Tracing is the process of identifying a new asset as the substitute for the old. Generally, one asset is the traceable proceed of another if there is a series of direct substitutions between them.

Question 5

What is claiming?

Answer 5

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

Question 6

What are the conditions for using the equitable following, tracing and claiming rules?

Answer 6

1. The claimant had a right of property recognised by equity in the asset which they seek to follow and/or trace
2. The asset was held by a person who was in a fiduciary relationship with the claimant

Question 7

What are the two principal types of mixed funds?

Answer 7

1. A mixed fund comprising misapplied trust money and the trustee’s own money
2. A mixed fund comprising misapplied trust money and money derived from one or more innocent third parties

Question 8

Is there a defence to an equitable proprietary claim?

Answer 8

Bona fide purchaser for value without notice.

Purchasers are entitled to deal with trustees if they are the full legal owner - if the purchaser has no notice of the trust they take clean title to the trust property even if it has been misapplied.

Question 9

What are the four types of proprietary claims?

Answer 9

1. 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
2. The beneficiary claims a share of the asset: this may be possible in cases where the asset has been acquired using a mixed fund
3. The beneficiary claims an equitable lien over the asset: this may be possible in both types of cases. 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.
4. Subrogation: this is a claim that can be made where misapplied trust funds (or 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 10

What are the three tracing rules in connection with wrongful mixtures?

Answer 10

1. The Hallett model - trustee spends own money first
2. The Oatway model - choice between dissipation and a traceable asset, trustees own funds are treated as dissipated, regardless of order
3. The Shalson model - beneficiary can attribute trust money to most profitable use made of the mixed funds (cannot be used in cases where it would prejudice third parties)

Question 11

What is the general rule applying to withdrawals from an innocent mixture?

Answer 11

Withdrawals are attributed rateably to the contributors to the mixture.

Does not apply to withdrawals from an innocent mixture in a current bank account: first sum paid in that is first drawn out.

Question 12

What is the rule for innocent mixtures in current accounts?

Answer 12

“First in, first out” rule.

Clayton’s case - usually disapplied if not considered fait and pari passu ex post facto method used instead (distributed in fractions of what is left based on fraction of contribution)

Question 13

Where an asset is purchased exclusively with trust money (or its traceable proceed) the beneficiary can choose between:

Answer 13

1. Asserting beneficial ownership of the asset itself
2. Making a personal claim against the trustee for breach of trust and enforcing an equitable lien on the asset.

Will normally exercise option in the most advantageous way. If traceable proceeds have increased in value - usually preferable to claim them - if decreased, usually preferable to make personal claim.

Question 14

What are the options where an asset is purchased with misapplied trust money and the trustee’s money?

Answer 14

Can choose between:

• claiming a proportionate share of the asset
• enforcing a lien upon it to secure personal claim against trustee for the amount of the misapplied money

Question 15

What are the options where an asset is purchased with misapplied trust money and money from innocent third parties?

Answer 15

Beneficiaries can only claim a proportionate share of the asset - innocent parties must be treated equally.

Question 16

What if trust property is used to improve a third party’s property?

Answer 16

Beneficiaries cannot assert any claim to the asset.

Question 17

Can proprietary claims can be made against any person who receives misapplied trust property?

Answer 17

No. 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.