LAW OF EQUITY & TRUSTS II

GLUP 3063

DOCTRINE OF TRACING
Remedies
 DOCTRINE OF TRACING: Meaning of tracing

• The function of the law of tracing is to enable the owner of property

to recover that property in the event that it is taken from her
involuntarily.
• By ‘involuntarily’ is meant that the owner has not agreed to any
transfer of title in that property to the defendant.
• It may be that the property has been
stolen, or
taken in breach of trust, or
taken by mistake
• whatever the cause, the owner has not consented fully to giving that
property up to the defendant.
 DOCTRINE OF TRACING: Meaning of tracing

• Tracing operates on three levels.

1. At the first level it might be that all the owner is seeking to do is to

recover her original property from the defendant.
2. At the second level, the owner might be seeking to recover both her
original property and any profits which have been realized from the
defendant’s use of the property.
3. At the third level, the owner may not be able to recover her original
property because that property has been mixed with other
property, or it cannot be found, or some other person has acquired
good title to it by virtue, for example, of having purchased it in good
faith [Westdeutsche Landesbank Girozentrale v Islington LBC [1996]
AC 669]
 DOCTRINE OF TRACING: Meaning of tracing

• In such a situation, the owner may seek to establish property rights

against some other property which the defendant has acquired by
using the original property.
• Therefore, the claimant is seeking to assert title to substitute
property, which;

might take the form of sale proceeds received on the sale of the original
property, or
of property acquired with those sale proceeds, or
of some composite property in which the original property has been
combined in some way
 DOCTRINE OF TRACING: Meaning of tracing

• There is an important point of distinction to be made between

seeking to establish title-

I. in the original item of property which was previously owned, and

II. seeking to establish title to substitute property (or traceable
proceeds) which is not the exact property which was previously
owned

• My car was taken from me without permission- recovering my car

from the person who took it from me without my permission
• That person sold the car to a third party and kept the proceeds-
recover the sale proceeds
 DOCTRINE OF TRACING: Meaning of tracing

• To establish such a claim would require me to trace my property

rights from the car into the cash which the defendant has received.

a. the former situation is clearly a process that recognises my original

ownership, whereas
b. the latter situation involves the proposition that it is somehow
morally ‘correct’ for the defendant to give up the money which was
received from the wrongful sale of my car.

• That process of following and tracing rights in property in these ways

is our principal focus in this lecture.
 DOCTRINE OF TRACING: Meaning of tracing

• Tracing and following are both exercises in locating assets which are
or may be taken to represent an asset belonging to the plaintiffs and
to which they assert ownership.
I. The processes of following and tracing are, however, distinct.
Following is the process of following the same asset as it moves
from hand to hand.
II. Tracing is the process of identifying a new asset as the substitute
for the old.
• Where one asset is exchanged for another, a claimant can elect
whether to follow the original asset into the hands of the new owner
or to trace its value into the new asset in the hands of the same
owner. . . .
 TRACING: Under common law

• In situations in which the claimant seeks to identify a specific item of

property in the hands of the defendant in which the claimant has
retained proprietary rights, the claimant will seek a common law
tracing claim to require the return of that specific item of property.
• Common law tracing permits the claimant to identify that a particular
item of property belongs at common law to the claimant. What is
required is that the claimant is able to demonstrate that the property
claimed is the very property which is to be restored, or that the
property claimed has not been mixed with any other property.
 TRACING: Under common law

• Therefore, in a situation in which a partner in a solicitors’ firm took money

from a client account to gamble at a casino, the casino held some money
separately in an account for the partner. The partner’s firm sought to
recover the moneys paid to the casino which had come originally from its
client account through, inter alia , common law tracing. It was held that
there was a right to claim in common law tracing in respect of those
amounts of money which were identifiable as having come from that client
account. [Lipkin Gorman v Karpnale [1991] 2 AC 548]
• That is, the claimant could establish common law tracing rights against
sums of money held by the casino to the partner’s account which could be
proven to have come from the firm’s account and passed to the defendant
without being mixed with other moneys. Provided that money in bank
accounts was held unmixed with other moneys, it was possible for
common law tracing to be effected [Banque Belge pour L’Etranger v
Hambrouck [1921] 1 KB 321]
 TRACING: Under common law

• Note that it has been held that common law tracing cannot take
effect over telegraphic transfers between electronic bank accounts
because such insubstantial property will not be clearly identifiable [El
Ajou v Dollar Land Holdings [1993] 3 All ER 717; Nimmo v Westpac
Banking Corporation [1993] 3 NZLR 218; Bank Tejarat v Hong Kong
and Shanghai Banking Corporation (CI) Ltd [1995]].
 TRACING: Under common law

• In Taylor v Plumer [1815] the defendant handed money to a

stockbroker, Walsh, to purchase bonds. Walsh instead purchased
American investments and bullion and hurried off to Falmouth to sail
to America. He was apprehended, and the investments and bullion
were seized by the defendant. On Walsh's bankruptcy, his assignees in
bankruptcy sought to recover them from the defendant. They failed.
The investments were the ascertainable product of the defendant's
money and owned by him. If the parties had been reversed, and the
defendant had been suing for the recovery of the securities and
bullion, his action would have succeeded, but the assignees would
have had the choice of returning them or of paying their full value in
damages; just as if Walsh had taken the defendant's coach and horses
and had them in his possession on his bankruptcy.
 TRACING: Under common law: limitations

• As is obvious from the two cases considered immediately above, the

common law tracing process is very brittle. If the property becomes
unidentifiable, or if it becomes mixed with any other property, then
the common law tracing claim will fail.
• The usual tactic for the money-launderer is therefore to take the
original money, to divide it up into randomly-sized portions, pay it
into accounts which already contain other money, convert the money
into different currencies and move it into accounts in another
jurisdiction.
• This type of trick puts that property beyond the reach of common law
tracing. Instead, the claimant would be required to rely on equitable
tracing
 TRACING: Under equity or equitable tracing

• Equitable tracing is the only means by which a claimant can trace into
mixtures of property, where a part of that mixture represents or
comprises money in which the claimant previously held some
equitable proprietary right.
• Particular difficulties have arisen in relation to money passed through
electronically-held bank accounts.
• English law treats each payment of money as being distinct tangible
property such that, when a bank account containing such money is
run overdrawn, that property is said to disappear.
• Consequently, there can be no tracing claim in respect of property
which has ceased to exist.
 TRACING: Under equity or equitable tracing

• Tracing in equity (or ‘equitable tracing’) is a considerably more

extensive means of tracing property rights than is available at
common law.

• Equitable tracing permits property rights to be traced into mixtures of

property so that one of a number of different equitable remedies may
be used to reconstitute the claimant’s property rights.

• The fundamental pre-requisite for the bringing of an equitable tracing

claim is that the claimant must have had some equitable interest in
the property which is to be traced before equity will entertain the
claim. [Re Diplock’s Estate [1948] Ch 465]
 TRACING: Under equity or equitable tracing

• That pre-existing equitable interest may be a beneficial interest under

an express or a constructive trust.

• It is a two-stage process:

I. The first stage is for the detective work of the tracing process to be
carried out so that the claimant is able to identify the property
which stands as a substitute for her original property and against
which she therefore wishes to bring a claim.

II. The second stage, having traced the property, is to identify which
equitable remedy should be imposed over that property.
 TRACING: Under equity or equitable tracing

• Need for a prior equitable interest

The traditional rule

• It is a pre-requisite for an equitable tracing claim that the claimant
had some equitable interest in the original property, or that the
person who transferred that property away had some fiduciary
relationship to the claimant (such as being a trustee) [Re Diplock’s
Estate [1948]]
 TRACING: Under equity or equitable tracing

• The benefits of equitable tracing

The benefits
• The clear benefits of equitable tracing over common law tracing
appear in money-laundering cases like Agip (Africa) v Jackson , [1991]
which upheld the core principle that there must be a fiduciary
relationship which calls the equitable jurisdiction into being.
 TRACING: Under equity or equitable tracing

• Equity has developed more sophisticated methods of tracing.

• The rules have developed, and are usually applied, in the context of
property in the hands of trustees or other fiduciaries, and often on
the bankruptcy of the fiduciary.
• But the rules apply also in a commercial context; as where a vendor,
in order to protect himself in a customer's bankruptcy, provides
expressly that property shall not pass in goods supplied until
payment.
• Equity will assist in the location and preservation of traceable
property by disclosure and in-junctions
 Equitable tracing: Re Diplock (1951)

Fact
Caleb Diplock, by his will, directed his executors to apply the residue of
his estate ‘for such charitable institutions or other charitable or
benevolent objects in England as they may select in their absolute
discretion’. The executors assumed that the will created a valid
charitable trust and distributed £203,000 among 139 different charities
before the validity of the distribution was challenged by the next of kin.

The next-of-kin wanted to retrieve (i.e. to trace) the money given to the
benevolent organizations. The problem was that some of the
benevolent organizations, on good faith, used Diplock's money to build
on land they owned, thus mixing the trust money with property of their
own.
 Equitable tracing: Re Diplock (1951)

Held
The court refused to allow the tracing to attack this endeavour, stating
that the trust assets were no longer identifiable.

• The general principle laid down in Re Diplock Estate is that whenever

there is an initial fiduciary relationship, the beneficial owner of an
equitable proprietary interest in property can trace it into the hands
of anyone holding the property except a bona-fide purchaser for
value without notice.
 TRACING: Effect
• Who is Entitled to Trace?
• The remedy in equity is not con-fined to claims between trustee and
beneficiary. Re Hallett3' decided that the remedy was not restricted
to such a case but was available against other fiduciaries (much
depends on whether the agent is under a duty to keep separate his
own money from his principal's money)

(a) Requirement of Fiduciary Relationship:

The courts have insisted that the existence of a fiduciary relationship is
a prerequisite to tracing in equity, although this relationship need not
exist between the parties to the action. In Re Diplock the action was
not against the executors, but against the innocent volunteers (the
charities) to whom they handed the money.
 TRACING: Effect
(b) Requirement of an Equitable Proprietary Interest:

In the days before the fusion of the jurisdiction of law and equity, it
was only possible to obtain equitable remedies if the litigation were
"in equity." It is not therefore surprising that the test which has been
laid down historically for the availability of equitable tracing is that
the claimant should be entitled to an equitable proprietary interest;
and this requirement of an equitable proprietary interest is distinct
from absolute ownership at law. There seems to be no reason at all
on the merits why the equitable tracing process should not be
available also to the beneficial legal owner.
 Backward tracing & the right to subrogation

Subrogation:

• This is a doctrine with common law and equitable origins whereby

one person is entitled to stand in the shoes of another and assert that
other's rights. The most common examples are insurance and
suretyship. An insurer who pays the loss is entitled to stand in the
shoes of the insured and assert his rights against the wrongdoer.
• In the context of tracing, the question is whether the claimant may be
subrogated to the position of a secured creditor paid off by the
defendant with the claimant's money.
 Backward tracing & the right to subrogation

Backward tracing
• If a defendant misappropriates trust money in order to buy a car, then the
beneficiary can trace the value of his equitable proprietary interest in the money
into the car. This is straightforward, since each stage of analysis goes “forwards”
in time.
• But what if the car has already been purchased by the defendant by taking out a
loan, and the defendant only later misappropriated the trust money in order to
pay off the loan. Can the beneficiary still trace into the car? (It will not usually be
possible to bring a proprietary claim against the lender because of the defence of
bona fide purchaser).
• The traditional approach of English law has been to say that the beneficiary
cannot trace into the car because this would involve “backward tracing”: a
beneficiary is not able to trace into property that was already in the defendant’s
possession before the beneficiary’s money was received, because the defendant’s
property cannot then be regarded as representing the beneficiary’s money. On
this view, tracing does not go backwards in time.
 Backward tracing & the right to subrogation
• However, this traditional understanding of tracing appears to have
been departed from in recent cases. The Federal Republic of Brazil v
Durant International Corporation (2015).

Fact
• 1.The municipality of Sao Paolo brought claims against companies
controlled by its former mayor and his son. The defendants had
accepted bribes and then laundered the money received.

• 2.The bribe money had been received by the controller of the

companies and paid into a bank account in New York, from which
payments were made to the defendant’s bank account in Jersey.
 Backward tracing & the right to subrogation
• However, this traditional understanding of tracing appears to have
been departed from in recent cases. The Federal Republic of Brazil v
Durant International Corporation (2015).
Fact
• 3.The difficulty in this case was that some of the money paid into the
New York account was credited only after money had been transferred
to the Jersey account.
• 4.It was necessary for the Privy Council to decide whether it was
possible to trace from the New York account into the Jersey account
even though the Jersey account had been credited before the New
York bank account had been debited.
• 5.It was acknowledged that this was typical of modern banking
practice, and common in instances of money-laundering.
 Backward tracing & the right to subrogation
• Lord Toulson, giving the advice of the Board, recognised that backward
tracing would be possible where there was “a close causal and
transactional link between the incurring of a debt and the use of trust
funds to discharge it”.
• The focus should be on the substance of the transaction and not on
the strict order in which associated events occur: “the claimant has to
establish a coordination between the depletion of the trust fund and
the acquisition of the asset which is the subject of the tracing claim”.
• On the facts of the case it was possible to establish the necessary
connection between the payment of the bribes from the New York
account and the credit to the Jersey account, regardless of the precise
order in which the debit and the credit occurred.
 Backward tracing & the right to subrogation

Boscawen v Bajwa (1995)

Fact
That case concerned a purported contract for the sale of land which
was not completed.
1. Bajwa had charged the land by way of a mortgage with a building
society (the Halifax Building Society) before then exchanging
contracts for the sale of the property with purchasers.
2. In turn, the purchasers had sought a mortgage with the Abbey
National (Bank).
3. The loan moneys provided by Abbey National were paid to solicitors
who were entitled to use the moneys only as part of the purchase.
Mistakenly, the solicitors thought that the sale was going ahead
properly, but in fact the sale was never completed.
 Backward tracing & the right to subrogation

Boscawen v Bajwa (1995)

Fact
4. This had the result that the solicitors used the Abbey National’s
money to pay off Bajwa’s mortgage with the Halifax, but did not
acquire a legal charge in favour of the Abbey National because the
purchase did not take place.
5. The issue arose how the Abbey National was to recover its money,
which had been held on express trust for it by the solicitors and then
used to pay off Bajwa’s debt with the Halifax Building Society.
6. The more precise legal question was whether or not the bank was
entitled to trace into the debt with the building society and claim a
right in subrogation to the debt owed to the building society
 Backward tracing & the right to subrogation

Limitations

The Court of Appeal, in Re Diplock, enunciated the limits surrounding the

right to trace:
• (a) The equitable remedy does not affect rights obtained by a bona fide
transferee of the legal estate for value without notice. All equitable claims
are extinguished against such persons.
• (b) Tracing will not be permitted if the result will produce inequity, for ‘he
who comes to equity must do equity’.
• Accordingly, if an innocent volunteer spends money improving his land,
there can be no declaration of charge because the method of enforcing the
charge would be by way of sale, thus forcing the volunteer to convert his
property. The modern expression for this concept is ‘change of position’.
 Tracing under common law and equity: differences
Tracing in common law
• Re Hallett’s Estate [1880]
Where T withdraws trust money and, without mixing it with his own, uses it to
purchase a specific asset, B has a right to trace into the asset. This right entitles B
either to claim the asset itself or to treat it as security for the trust money
expended on the purchase.
• Banque Belge pour l’Etranger v Hambrouck [1921] 1 KB 321,CA
Mr Hambrouck forged cheques so £6000 came out of the Belge Banque account
of Mr Pelabon, his employer, and was put into his own Farrow’s Bank account.
Then Mr Hambrouck took out money and paid his mistress Mlle Spanoghe, who
gave no consideration. She paid the money to her account at the London Joint
City and Midland Bank, where she had £315 credit. Banque Belge sued Mr
Hambrouck, Mlle Spanoghe and the London Bank for the money. The London
Bank paid the money into court.
 Tracing under common law and equity: differences
Tracing in common law

• Banque Belge pour l’Etranger v Hambrouck [1921] 1 KB 321,CA

• Held: The claimant’s fund was traceable into the bank account
“On these principles, it would follow that, as the money paid into the bank can be
identified as the product of the original money, the plaintiffs have the common
law right to claim it, and can sue for money had and received”
The property which is being traced must be identifiable in order for tracing to be
available.

• Agip (Africa) Ltd v Jackson (1990)

“Fox LJ held that a claim at common law could not succeed, because Agip’s
money had been mixed in the New York clearing system and could not therefore
be traced.
 Tracing under common law and equity: differences
Tracing in equity

• Re Diplock (1951)
Requirement of Fiduciary Relationship. The courts have in-sisted that
the existence of a fiduciary relationship is a prerequisite to tracing in
equity, although this relationship need not exist be-tween the parties
to the action.
• Re Diplock (1951); Boscawen v Bajwa (1995)
The property in question must be in a traceable form
• Re Diplock (1951)
Like all equitable orders, a tracing order is discretionary and will not
be awarded if, in the court’s view, to do so would lead to inequitable
results