2015 A Question 6

Oscar is the trustee for Felix of a bank account with Unger Bank. In January, there was
£50,000 on deposit in that trust account.

Vinnie is Oscar’s closest friend. Vinnie lost his job and was struggling to make the monthly
payments due on the mortgage over his house. In February, Oscar withdrew £25,000 from
the trust account and used it to discharge Vinnie’s mortgage. Vinnie was unaware of
Oscar’s breach of trust and thanked him for his generosity.

In March, Oscar withdrew £10,000 from the trust account and used it to discharge his own
personal loan from Madison Bank. Oscar had obtained the loan last November in order to
buy a new car. The loan was unsecured.

In April, Oscar received a cheque for £200 as a birthday gift from his aunt. He deposited
that cheque in the trust account. He then withdrew £10 from the trust account and used it
to buy a lottery ticket. Oscar wrote a note to himself that the lottery ticket was purchased
using the money he received from his aunt and not from the money held in trust for Felix.
Oscar won £20,000 with the lottery ticket and deposited that money in his own bank
account with Madison Bank.

In May, Oscar became bankrupt. His only significant assets are his car (now worth
£8,000), the £20,000 in his bank account with Madison Bank, and the £15,190 remaining
in the trust account.

Felix has discovered what has happened and seeks your advice. He knows that his
personal claim against Oscar for breach of trust may have little value now that Oscar is
bankrupt. What proprietary claims, if any, does Felix have? Advise Felix

1. Oscar clearly is in breach of trust, Felix is advised that he may be able to bring
proprietary claims based on withdrawals made by Oscar directly from the trust
fund in Unger bank with regards to the moneys used to discharge Vinnie's
Oscar's loan mortgage, and the proceeds from the lottery and the balance in Unger
bank. Further Felix would be able to avail himself to the process of tracing in equity
for all substitutions/exchanges arising from the withdrawals made since there was
an initial fiduciary obligation between him and Oscar and due to the fact Felix would
be able to assert an equitable interest with regards to the moneys (Re Diplock).
Further proprietary claims can be made even if the recipients were innocent/had no
knowledge of Oscar's breach
A. Vinnie's mortgage

2. It was Felix's 25k that was used to pay off his mortgage, but F would not be able to
follow that money into the account since it was in debit, the money extinguished the
loan and no asset remains that can be claimed. Instead F is advised that his interest
could be traced into the house that was purchased by Vinnie or he could avail
himself to subrogation instead

Subrogation

3. There is clear authority (Boscawen v Bajwa) that since the 25k used to pay off the
mortgage was Felix's money, Felix can now step into the position of the bank prior
to the discharge. Effectively this would make Felix a secured creditor for 25k as
against Vinnie for that amount with security over the house. However, his interest
will only be for 25k and he would not be able to make a claim for a higher amount if
the value of the house increases (the same will apply if the value decreases)

House

4. The issue here is since F's 25k was used to pay of the mortgage, could F claim co-
ownership of the house itself proportionate to his contribution to the total purchase
price? A claim for ownership if successful is likely a better remedy for F since he will
be able to claim proportionately for any increases in the value of the house (being
landed property this is likely)

5. However the difficulty with this claim is that the house was bought first by Vinnie
before Felix's money was used to pay the mortgage, therefore tracing into the
house will have to go back in time and is known as backward tracing. The
authorities have historically been unclear whether backward tracing is allowed in
English law

6. In Agip v Jackson, El-Ajou v Dollar Holdings, Foskett v McKeown and Law Society v
Haidar the courts have seemingly allowed claims for backward tracing but in none
 of these cases the courts discussed backwards tracing or they were unaware that
the situations involved backward tracing. Particularly in Law Society v Haidar Judge
Richards allowed the claimant to trace from a payment discharging a mortgage into
the house that was purchased with the mortgage loan, and thence into the proceeds
of the sale of that house and into another house purchased with those proceeds.
The decision is clearly inexplicable if not for backwards tracing

7. In Bishopsgate Investment Management Ltd_v Homan (1995) CA actually

considered the issue of Backwards Tracing;

a) J. Dillon : “Backward tracing allowed If an asset was acquired by defendant with

moneys borrowed and there was an inference that when borrowing
was incurred there was an intention that it was to be repaid by the use
of misappropriated money of the Plaintiff”

Clearly this will not apply here since the house was purchased by Vinnie, and not
Oscar and Vinnie had no idea that this was going to be paid by misappropriated
trust money by Oscar

b) J. Legatt : “It was simply impossible for a claim to be made in respect of an asset
acquired before the misappropriation took place”

8. However in Federal Republic Of Brazil v Durant the PC has now confirmed that
backward tracing was possible. The general rule was that backward tracing will not
apply, but there may be cases where there is a close causal and transactional
link between the incurring of a debt and the use of trust funds to discharge it,
then backward tracing may be allowed.

9. The PC rejected the argument that there can never be backward tracing, or that the
court can never trace the value of an asset whose proceeds are paid into an
overdrawn account. But 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, looking at the whole transaction. The courts however should be
very cautious before expanding equitable proprietary remedies in a way which may
 have an adverse effect on other innocent parties.

10. It is submitted however that these requirements will not be established here since
the purchase was by Vinnie and the breach was by Oscar, this was not a `
coordinated scheme since Vinnie did not even know the source of the money paid
by Oscar. Furthermore, Vinnie is innocent, the courts are likely to find it unfair/unjust
to compel him to 'share' ownership of his house with Felix, subrogation is the better
remedy

B. Oscar's personal loan

1. Again F will not be able to follow the 10k used to pay off Oscar's loan since it was in
debit, the money extinguished the loan and no asset remains that can be claimed.

2. Subrogation here into the position of the bank would be pointless since the bank
was an unsecured creditor (personal loan only) and this does not improve F's
position since he is already an unsecured creditor

3. The best remedy here would be again backward tracing, in which case since the
loan was used by Oscar to buy the car, and F's money was used to pay the loan, F
can claim that it was his money that ultimately was used to buy the car going back
in time. Although the car is worth less now, F is advised to still make a claim for it
since it still puts him in a better position than just being a mere unsecured creditor

4. The problem here would be the requirements stated in Durant above. Was there a
close transactional link or coordination? The PC was keen to point out that the
courts would be concerned with the substance of the transactions rather than the
procedural aspects and strict order of events.

5. It could be argued that when Oscar bought the car in November, he might not have
contemplated the fact that he would pay for it in March (4 months later) using
misappropriated trust fund money belonging to F. Furthermore, if such was his
intention, why then did he apply for the personal loan? However this kind of
reasoning would be exactly the reasoning used in J. Dillon's judgment above, but
such a restrictive approach was not advanced by the Privy Council in Durant
6. Durant was more concerned with substance and order of payments. It has to be
remembered that unlike Vinnie's situation above, here only Oscar was involved,
hence coordination is easier to see. When the PC discussed 'coordination' and
'causal/transactional' link they were not referring to the state of mind of the
wrongdoer, but rather at the logical sequence of events

7. For instance, had Oscar withdrawn the 10k first, and used it to buy the car (without
loan), then clearly the car would belong to F. Should it matter that events did not
take place in this order, is it not substantially the same outcome that he paid for the
car by loan and 4 months later paid off the loan with F's money? I believe that this
was the reasoning behind the Durant decision, and hence there is a good chance
Felix may be able to claim ownership of this car.

C) Lottery Ticket

1. F's remaining money of 15k is later mixed with $200 belonging to Oscar, in such
event this is now a 'mixture', F can no longer follow the money, instead the rules of
tracing have to be used to determine whose money was withdrawn from the mixture
to buy the lottery

2. The general rule in common law is the FIFO rule (Clayton's case) in which case the
$10 withdrawn would be F's money. However, since we are dealing with mixtures,
the courts may use rules of equity in tracing.

3. In Foskett v Mckeown it was held that in the case of mixtures containing

wrongdoer's money (Oscar) and innocent's money (Felix), equity provides for all
reasonable inferences would be drawn against the wrongdoer, he did the mixing
and it is the innocent beneficiary who determines the unmixing.

4. Here since the withdrawal of $10 proves to be beneficial, equity can use the
presumption of Investment (Re Oatway) whereby it is presumed that he cannot say
as a trustee he invested his money first, he must have invested the innocent's
money first. ( 'trustee always acts in the best interests of beneficiaries')
5. However, the question arises that since this is a presumption, it can always be
overridden by contrary evidence. Oscar could claim that the note he wrote is
contrary evidence to show that his intention was to withdraw the $10 from his share
of $200, and therefore the lottery was bought with his money

6. It is submitted that although these are called presumptions, and therefore rules to
resolve evidential difficulties (in reality it is impossible to know whose money is
withdrawn), nevertheless as stated in Foskett it is the prerogative of the innocent to
choose which presumptions apply. Even though he had written this note, equity is
not bound by this declaration since he was a wrongdoer.

7. It is likely therefore that the $10 belonged to F and therefore F can now trace into
the lottery ticket which the $10 was exchanged with and further into the bank
account in Maddison which now has 20k winnings. The entire winnings belong to F
in this event

D) Unger Bank Account

1. There is a remainder of $15,190 after the $10 was withdrawn and since this was F's
money, it would mean that $14,990 of F's money remains in the account and F can
follow and claim this sum

Note

Felix can recover the 50k which was originally in the Trust account through the claims
above. Since this is a proprietary claim, when tracing into substitutes the value of the
beneficiary's right is irrelevant, beneficiaries can claim title to the substitute even though
the substitute has higher value than the original (can exceed 50k) (Foskett v McKeown)
(2000) UKHL

Amerjit Singh