Tracing

Enduring Title

Where assets such as goods are obtained by fraud, the title does not pass to the wrongdoer. The same principle applies to the other limited categories of case, where there the contract is wholly negated. The title endures and may be recovered as such.

The claim to take back the asset is a proprietary claim. The right to resume possession on foot of the title is clear while the goods/property is still held by the recipient (usually a wrongdoer).

Where the asset itself is not held but a substitute or representative asset has been purchased with its sale proceeds, common law substitution and equitable tracing may apply.

Common Law Tracing

At common law, it must be shown that the substituted asset belongs or belonged to the claimant or derives from something which belonged to him. There must be a common law title to it, rather than an equitable title. The property must be identifiable and must be approved the claimant’s property. The link must be direct, although it may be by a series of exchange.

There is no direct right to the substituted asset at common law. A claim of conversion may not be asserted directly against such property. Otherwise, the owner of the original goods would have an absolute claim for the substituted goods against all third parties forever.

However, it appears clear the original owner has a common law proprietary interest by which he may claim immediate possession as against the wrongdoer. However, the right is as against the third-party.

The position is different at common law where the substituted asset is money. Where a person who has wrongfully taken assets, makes a payment derived from those assets to a third-party, then presumptively, an action for money had been received may be taken against that third-party because the third-party has been unjustifiably enriched.

Common law substitution here is a personal right for monies had been received. It continues to subsist even though the substituted asset is not in the hand of the third-party.

Limits on Common Law Tracing

Of necessity, there are limitations to the common law right of recovery of substituted assets. The claim does not hold good against a third party who is a bona fide purchaser for value.  Where a solicitor fraudulently embezzled client money from his firm and used it for gambling, the monies were recoverable from the casino because value was not given by the unenforceable gaming contract. The casino acted in good faith but did not give valuable consideration.

Common law substitution does not apply to the extent that the third party has changed his position in reasonable reliance on the receipt. An innocent change of position will limit or preclude recovery. Where the person has incurred expenditure on the faith of receipt of monies, there may be a change of position for this purpose.

There must be no mixing at any stage. Mixing destroys the identity of the original asset and common law substitution and trespass are no longer applicable. However, the courts of equity developed the separate and more flexible remedy of tracing, which may apply. Since the union of the common law courts, both the common law and equitable remedy are available in all courts with jurisdiction in this area.

Tracing in Equity

Tracing in equity (unlike its above common law equivalent) is available in respect of assets to which there is an equitable title only. It is also available in respect of assets to which legal title is held.  Equitable tracing has two elements. One is a personal claim against third parties for repayment of value received. The second is proprietary and attaches to assets from which the original assets, to which the claimant had the title, derived.

Equitable tracing may take effect against a third-party recipient, who does not payable value. Accordingly,  in a famous case involving distribution on foot of a will, which turned out to be invalid, benefits, were recouped against charities and third party apparent beneficiaries, who had received assets. The personal representatives were also held personally liable. The principle is likely to apply to other representative office holders, who distributive assets, such as liquidators and receivers.

Where a person wrongfully diverts assets which he is not entitled, he may be subject to equitable tracing. He may accept receivables due to another. The receivables are likely to be still owed. However, the person entitled has a direct remedy in restitution against the interceptor.

The principle applies where a will is later found. The administrator of assets must repay the executor sums which he has received on behalf of the estate. The claimant must show that he has an entitlement to the sums concerned which were wrongfully belonged to the respondent.

Scope of Claim

The precise scope of the remedy is unclear, but practical necessity requires there must be limitations. The claim must yield to that of a bona fide purchaser for value from the recipient. However, it appears the innocent recipient (who has not given value) may retain personal liability, at least if he knew that the assets were trust assets. However, this liability is likely to be subject to limitations to the extent that the recipient has changed his position on the faith of the receipt.

The proprietary claim in equity arises most commonly in relation to assets which have been distributed in breach of trust or fiduciary duty. The equitable claim to substituted property requires the claimant to point to a distinct asset which is held by the respondent.  There must be a sufficient link between the substituted asset and the original asset. There must be a proprietary claim which derived from the trust or fiduciary duty which continues to apply to the assets in the hand of the recipient.

Tracing is in the nature of an equitable right rather than an equitable interest. It is said to be a mere equity. It is defeasible by an innocent purchaser without notice of either a legal estate or interest or an equitable estate  Being a mere equity, it has a lower ranking than an equitable interest and may be defeated by the holder of an equitable interest without notice.

Proprietary Base

In order to succeed in a claim of tracing, there must be a proprietary base. The lending of money by way of a loan does not create a proprietary interest in the loaned money. The lender and borrower are in a debtor-creditor relationship and in the absence of other (highly unusual) factors, the lender has no proprietary interest in the funds.

A proprietary interest most commonly derives from a trust or fiduciary duty on the party of the payer or transferor. The interest continues to bind the assets in the hands of the recipient. In the case of the misapplication of assets by a trustee, there is a clear proprietary interest. Similarly, in the case of the misuse by a fiduciary of assets, the requisite proprietary interest will be present, at least in many cases.

The interest may arise from a resulting trust, which arises classically were one person contributes money to the purchase by another of a particular asset. In a famous Irish case, monies paid by investors for the purpose of purchase of specific stamps were held subject to a resulting trust to the extent that stamps were purchased with them.

The fiduciary relationship usually requires a prior relationship. Fiduciary relationships may arise in a range of cases, such as directors as regard their company, employees as regards their employers, agents as against their principals and bailees as against the bailor. The requisite proprietary element will usually be found in most such cases.

The connections required between the original assets and the substituted asset is similar to that required at common law. There must be a direct or indirect exchanged asset. Unlike the position at common law, mixing does not preclude tracing in equity. Equitable tracing is more flexible and may be applied to mixed funds.

Tracing into Accounts

With tracing in equity, assets may be more readily traced into bank accounts. Where assets or their proceeds are lodged in a bank account, which is subsequently drawn and subject to further lodgements, the presumption is that the claim may be extinguished or reduced to the level of the minimum balance.  In strict terms, first in first out applies to running accounts, which are generally current accounts, subject to a contrary intention.

Where the account is operated by a party in default, the payments may be deemed to be made from their own money and not that of the claimant/beneficiary. The general last in first out does not apply.

Where a defaulting trustee has blended monies with his own, he may not claim that he withdrew the trust monies and left his own. Where assets are put into a mixed account, the general presumption is that of last in first out. It is presumed that the defaulting trustee has taken his own monies and the trust monies are left.

The position becomes more complicated where assets are bought from the fund. This can be, in principle traced into further substituted assets which increase or decrease in value. The decrease in value is charged as against a defaulting trustee.

It may be impossible to trace the trust monies into the successive investments.