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(iv) Restrictions on Equitable Tracing

Equitable tracing enables the claimant to trace value into a specific asset or fund only where it is possible to say that some or all of the value of the asset or fund represents the value of the property in which the claimant originally had an equitable interest. Consequently, equitable tracing will fail or will be restricted in the following circumstances.

(1) Dissipation of the Asset or Fund

Where the asset in which the claimant has an equitable interest has been destroyed, or where the fund has been dissipated and no specific asset can be identified that derives from it, tracing will fail. So, for example, where the defendant buys wine with the trust money and then drinks it, there is nothing into which the value can be traced.[1] Similarly, where the original asset is destroyed or undergoes a change in chemical composition so that it becomes a different asset.[2] Tracing will also be defeated where the claimant’s money is used to discharge a debt, such as where it is paid into an overdrawn bank account, since there will be no asset that can be considered to represent the claimant’s property.[3] Consequently, it is not possible to trace through an overdrawn account. But it does not follow that it is not possible to trace into an overdrawn account to the discharged debt, since, exceptionally, a proprietary remedy involving the revival of the debt might be

available.[4]

(2) Lowest Intermediate Balance

If the claimant’s money is mixed with other money, for example in a bank account, and subsequently the balance of that account is reduced to less than the amount of the claimant’s money that had been deposited, the amount that the claimant can recover is necessarily limited to the maximum amount that can be regarded as representing his or her money.[5] So, for example, if the defendant trustee paid ?1,000 of the trust money into his own bank account, which already had ?1,000 credited to it, and the defendant then dissipated ?1,500, the maximum value that the claimant can claim is ?500. This is because the first ?1,000 that was spent is deemed to have been the defendant’s money, because of the presumptions relating to fiduciaries. But since another ?500 was spent, this must have been the claimant’s, leaving only ?500 left to satisfy the claimant’s claim. The lowest intermediate balance rule will apply even if the defendant trustee has subsequently paid in his or her own money to the fund so as to restore the original balance. This is because the trustee could not be considered to intend to clothe his or her own money with a trust in favour of the claimant. It would be different, however, if the subsequent payments were made to a separate trust bank account from which the trust funds had been dissipated, for then the payments could be considered to be a substitute for the trust money because there would then be a sufficient intention for the new money to be held on the old trust.[6]

The practical significance of the lowest intermediate balance rule is illustrated by James Roscoe (Bolton) Ltd v Winder,[7] in which over ?455 of trust money was paid into a bank account by a trustee. The balance of that account then fell to ?25, but, at the date of the trustee’s death, it had increased to ?358. It was held that the account could be charged only to ?25 for the benefit of the trust, since this was the lowest intermediate balance in the account after the trust money had been paid in. What had clearly happened was that the trust money must have been spent except to the extent of ?25. It was considered whether the amount that had subsequently been credited to the account could be regarded as being impressed with the trust. This was rejected because there was insufficient evidence that the trustee intended the subsequent payments to be subject to the trust. This aspect of the decision is difficult to defend and appears to be inconsistent with the general presumptions of intent relating to fiduciaries, as recognized in Re Hallett’s Estate463 in particular: the Court of Appeal accepted in that case that, where a trustee has acted, he or she should be regarded as acting in the best interests of the trust. It is for that reason that, when money is dissipated from a mixed fund, this is presumed to be the trustee’s money. So surely this presumption should work in the same way when money is subsequently credited to a denuded bank account: the trustee should be presumed to be returning trust money to the account?

(3) Backward Tracing

The orthodox view of the law of equitable tracing is that a claimant is not able to trace into property that was already in the defendant’s possession before the claimant’s money was received, because in such circumstances the defendant’s property cannot be regarded as representing the claimant’s money, even if the claimant’s money was used to pay for the property by discharging a debt that had been incurred in respect of it.464 In other words, so-called ‘backward tracing’ is not available as part of the tracing exercise. So, for example, if the defendant purchases a car and incurs a debt to the vendor, the money that has been received from the claimant might be used by the defendant to discharge the debt. Although the claimant’s money can be traced into the hands of the vendor of the car, to whom the debt was owed, it will not usually be possible to bring a proprietary claim against the vendor because he or she is likely to have a defence of being a good faith purchaser.465 But it is also not possible to trace into the car because the defendant had already acquired it, even though the claimant’s money has actually been used to pay for it. It follows that tracing appears to be concerned only with forward-looking exchanges of value and cannot be considered to have any retrospective operation. This has been defended by Conaglen466 as being consistent with precedent, and with the principles and policies that underlie the law of tracing.

Nevertheless, in Foskett v McKeown467 in the Court of Appeal, Sir Richard Scott V-C tentatively recognized the principle of backward tracing, although he declined to decide the point. He said that ‘[t]he availability of equitable remedies ought . . . to depend upon the substance of the transaction in question and not upon the strict order in which associated events happen’. Hobhouse LJ468 and Morritt LJ469 explicitly rejected the proposition that tracing could be used to identify value in a previously acquired asset.

Although the House of Lords in Foskett v McKeown470 did not expressly consider the backward tracing principle, the approach adopted by the majority as regards equitable tracing is certainly consistent with it: if tracing is not concerned with causation as such, in the sense that but for the receipt of the claimant’s property the substitute asset would not have been obtained, but is concerned with attribution of value, it is surely possible to attribute value from the original asset to the substitute asset if the claimant’s money has been used to discharge a debt incurred in respect of the substitute asset. Consequently, the backward tracing principle should be recognized in English law.471 If backward tracing was recognized, it would enable the claimant to trace into a previously acquired asset both where the defendant used the claimant’s money to discharge a debt that the defendant had incurred by borrowing money to acquire the asset, and where the claimant’s money is paid into an overdrawn bank account where the overdraft resulted from the defendant purchasing the asset. This has been advocated by Smith on the ground that a payment that discharges a debt is ‘just delayed payment, and the traceable proceeds are whatever was acquired in the past when the debt was incurred’.472 In Relfo Ltd v Varsani473 Arden LJ recognized that, in order to trace money into substitute property, it is not necessary that the payments should occur in any particular order. So, for example, where a third party pays money to the defendant in the expectation that the

Bishopsgate Investment Management Ltd v Homan [1995] Ch. 211, 221 (Leggatt LJ). See also Re Tilley’s Will Trust [1967] 1 Ch 1179, in which the trust fund was used to reduce an overdraft that had been incurred to purchase properties and it was not contemplated that the claimant could trace into those properties.

  • 465 See Chapter 23. 466 M Conaglen, ‘Difficulties with Tracing Backwards’ (2011) LQR 432.
  • 467 [1998] Ch 265, 283-4. See also Bishopsgate Investment Management Ltd v Homan [1995] Ch 211, 217 (Dillon LJ); Boscawen v Bajwa [1996] 1 WLR 328, 341 (Millett LJ); Jyske Bank (Gibraltar) Ltd v Spjeldnaes (unreported) 23 July 1997; Shalson v Russo [2003] EWHC 1637 (Ch), [2005] Ch 285, [141] (Rimer J).
  • 468 Foskett v McKeown [1998] Ch 265, 289. 469 Ibid, 296. 470 [2001] 1 AC 102 (HL).
  • 471 See Shalson v Russo [2003] EWHC 1637 (Ch), [2005] Ch 285, [142] (Rimer J).
  • 472 LD Smith, ‘Tracing into the Payment of a Debt’ (1995) 54 CLJ 290, 292.
  • 473 [2014] EWCA Civ 360, [2015] 1 BCLC 14, [63].

third party would be reimbursed from money transferred from the trust of which the claimant is a beneficiary, the claimant could trace the value of his or her money to the defendant. This is a potentially significant expansion of the tracing rules, which does not limit tracing to direct substitutional transfers. Whilst not expressly recognizing backward tracing, Arden LJ’s dictum is certainly consistent with the recognition of that principle.

There is, in fact, a decision of the Court of Appeal the result of which is consistent with the recognition of backward tracing. In Re Diplock[8] some of the money that should have been paid to the testator’s next of kin by the executors had been paid by mistake to the Heritage Craft Schools, which had used the money to pay a debt that had been incurred to enable it to improve a building. It was held that, even though the money had actually been used to discharge the debt, it had effectively been used to pay for the improvements and so it was possible to trace the value of the money into the improvements. This is consistent with the courts examining the substance of the transaction rather than being confined to a consideration of events in the exact order in which they occurred. But the proprietary claim did not succeed in that case, apparently because it was not considered to be just to allow such a claim where the recipient charity had innocently used the money to improve its own property.[9] Further, in Shalson v Russo[10] it was recognized that the claimant could, in principle, trace through the payment of an overdraft debt into a yacht for which the defendant had partially paid through the overdraft borrowing, although it was necessary for the claimant to show that the overdraft could not have been paid off without the misappropriated money.

We cannot yet say that backward tracing is recognized in English law, but the recognition of such a principle is logical and is consistent with the fundamental principles of tracing, as recognized by the House of Lords in Foskett v McKeown, particularly where it can be shown that the purchase of an asset and the discharge of a consequent liability is part of the same transaction in which the asset is obtained first and then the debt to the vendor is discharged.[11] But where money has been borrowed from a third party to enable the defendant to purchase property from the vendor,[12] [13] and the claimant’s money is used to discharge this debt, it might be considered to be too great a jump to trace into the asset that the defendant purchased, because the contract of purchase and the contract of loan are distinct transactions. But if the loan were incurred to enable the defendant to purchase the property, it would be appropriate to conclude that the discharge of the loan could be attributed to the purchase of the property, so that the claimant could then trace into it, regardless of whether the loan was provided by the vendor or a third party. Consequently, the key justification for the recognition of backward tracing is that the purchase of the property and the discharge of the loan incurred to purchase that property can be considered to form part of the same series of events. The key question of policy then is whether it should make any difference whether the money was borrowed from a third party or the vendor, which will turn on how wide the notion of ‘the same transaction’ should be interpreted, which will be dependent on the question of policy as to whether the restitutionary claims of beneficiaries or principals should receive more protection than the interests of the insolvent defendant’s unsecured creditors.4

(4) Inequitable to Trace

In Re Diplock,[14] the Court of Appeal recognized that tracing would be defeated where it would be inequitable to allow the claimant to trace into property held by the defendant. This will occur, for example, where an innocent volunteer has used the money received to improve or alter his or her land.[15] So, for example, one of the charities that received the mistaken payment was Guy’s Hospital, which spent ?14,000 on reconstructing two children’s wards. It was held that it was not equitable to enable the next of kin to trace into this property. A number of reasons were identified as to why tracing should be barred in such a case, including that the value of the property might not have increased by the improvement, it might be difficult to determine whether the charge should attach to the whole property or just the part improved, and, most significantly, it may simply be unfair to expect an innocent volunteer to sell the property to discharge the liability. Similarly, where one of the charities had used the money paid by mistake to pay off a secured bank loan, it was held to be inequitable to compel the hospital to sell the land to discharge

the charge.[16]

This apparent bar to tracing should be rejected, or at least analysed more subtly. The better view is that this ‘bar’ does not defeat tracing. So, for example, the claimant should be able to trace into the defendant’s improved property. Rather, the ‘bar’ operates at the subsequent claiming stage, when determining whether the claimant can assert a right against the traceable asset. Further, rather than being a simply matter of judicial discretion as to whether it is fair that a remedy should be awarded, the bar is better analysed as being a defence to the claim, specifically in the form of the defence of change of position,[17] although this raises a further issue as to whether it is appropriate for a proprietary claim to be defeated by the defendant’s innocent change of position.[18]

  • [1] 823 (HL Sc). 456 Re Diplock’s Estate [1948] Ch 465, 521.
  • [2] Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25.
  • [3] Shalson v Russo [2003] EWHC 1637 (Ch), [2005] Ch 281, [140] (Rimer J); Serious Fraud Office v LexiHoldings plc [2009] EWCA Crim 1443, [2009] QB 376, [50] (Keene J); Re BA Peters Ltd [2008] EWCA Civ1604, [2010] 1 BCLC 142, [15] (Lord Neuberger).
  • [4] See the remedy of subrogation, discussed p 636, below. See also the discussion of backward tracing,p 624, below.
  • [5] James Roscoe (Bolton) Ltd v Winder [1915] 1 Ch 62; Re Goldcorp Exchange Ltd [1995] 1 AC 74;Bishopsgate Investment Management Ltd v Homan [1995] Ch 211; Campden Hill Ltd v Chakrani [2005]EWHC911 (Ch).
  • [6] James Roscoe (Bolton) Ltd v Winder [1915] 1 Ch 62, 69 (Sargant J). See also Re Diplock’s Estate [1948]Ch 465, 552 (unmixing of money by placing it in a separate bank account).
  • [7] [1915] 1 Ch 62. 463 (1880) 13 Ch D 696.
  • [8] [1948] Ch 465, 548-9. 2 See further p 627, below.
  • [9] 476 [2003] EWHC 1637 (Ch), [2005] Ch 285, 328.
  • [10] 477 See R Chambers, ‘Tracing and Unjust Enrichment’ in J Neyers, M McInnes, and S Pitel (eds), Under
  • [11] standing Unjust Enrichment (Oxford: Hart Publishing, 2004), 298-9.
  • [12] As in Boscawen v Bajwa [1996] 1 WLR 328.
  • [13] See Conaglen, ‘Difficulties with Tracing Backwards’, 455.
  • [14] [1948] Ch 465, 546. 2 Ibid, 548.
  • [15] 482 Ibid, 5 50. 4 See p 696, below. See Boscawen v Bajwa [1996] 1 WLR 328, 340 (Millett LJ).
  • [16] 484 See p 697, below.
  • [17] 485 See, in particular, Space Investments Ltd v Canadian Imperial Bank of Commerce Trust Co (Bahamas)
  • [18] Ltd [1986] 1 WLR 1072, 1074 (Lord Templeman).
 
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