What is Tracing?

Introduction

The purpose of tracing is to follow trust property into the hands of anyone to whom it has wrongfully passed.  If a bankrupt trustee misappropriates trust property it will not be possible to recover the trust money in a personal action due to the bankruptcy, but tracing gives rise to a proprietary action against the trust property free from the claims of creditors – it gives those tracing priorities over all other creditors. 

This is because the trustee holds the property on a constructive trust for those entitled to it at the moment of misappropriation.

Before any claim is made to trace property, the beneficiaries should ensure that all possible alternative courses of action have been considered.

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KEY POINTS

  • Limitations
  • The Five Issues

Limitations

The common law permitted a tracing action, but only within very narrow limits, by allowing the owner of an asset to follow it into the hands of any person who wrongfully received it and to claim it back as owner.

  • The main limitation to a common law action is that it is only available so long as the assets being traced remain in an identifiable form.  Thus, if a trustee misappropriates £2,000 this sum can be traced so long as it is not mixed with any other money or property
  • A further significant limitation in tracing at common law is that it is not available to trusts as the common law gives no recognition to equitable rights; in this context the equitable rights of beneficiaries against trustees. 

The principal difference between tracing at common law and tracing in equity is that none of the common law restrictions apply to equitable tracing.  Equity recognises fiduciary relationships enabling beneficiaries to trace against trustees, and it permits tracing into a mixed fund. 

Before tracing in equity can take place however, three conditions must be satisfied:

  • there must be an initial fiduciary relationship;
  • the property being traced must be in a traceable form; and
  • tracing must not produce an inequitable result.

The first of these conditions, the initial fiduciary relationship, is based on the need for a beneficial owner who has an equitable proprietary interest in the property held by the trustees or other fiduciary.  If there is no such person with an equitable proprietary interest the relationship may be that of debtor and creditor and no tracing will be permitted.  Clearly, an initial fiduciary relationship exists in such cases as trustee/beneficiary; principal/agent; solicitor/client but in other cases the position is less clear.

The second condition lays down that the property must be in traceable form for the tracing remedy to arise.  There must be some property which the beneficiary can follow into the hands of those who now wrongfully possess it.  Thus, if trust property of £15,000 is wrongfully paid over to a third party who uses it towards purchasing a house then tracing is clearly available; it will be available in equity, moreover, even if there is a mixture of the £15,000 with the recipient’s own money.  But if the £15,000 was dissipated there could be no tracing as there is nothing to trace

The third condition for tracing in equity is that tracing must not be inequitable in itself or produce inequitable results. 

There are five issues in this context that must be considered:

  1. bona-fide purchaser for value without notice of the breach of trust

            The bona fide purchaser for value of the legal estate without notice of the breach, or any person deriving title under him, is immune from a claim in tracing.  Thus, if a trustee sells trust property to a purchaser who has no knowledge, actual, constructive or imputed, that it belongs to the trust at the time of sale, the purchaser will take free from any equitable interests attached to the property and no tracing will be possible.  The only remedy for the beneficiaries is to try and recover the proceeds of sale from the trustee by an action in personam

  • volunteer with notice

            If a trustee wrongfully gives property to a volunteer who takes it with notice of the trust, tracing will always be available against that person as he/she takes subject to equitable rights

  • volunteer without notice

            This is someone who receives trust property gratuitously, without any knowledge that it is being given in breach of trust.  This may occur where a trustee distributes property to the wrong person, or where an executor distributes property under a will to the wrong person.  The general rule is that if money is handed to an innocent volunteer in breach of trust the rights of that innocent volunteer are subject to the beneficiaries’ entitlement to have their money restored to them

  • “change of position” defence

            This states that the right of a person to restitution from another because of a benefit received is terminated or diminished if, after the receipt of the benefit, circumstances have so changed that it would be inequitable to require the other to make full restitution.  This defence is thought to apply to equitable tracing although the matter remains open

            The earlier version of the defence was seen in Diplock, where some innocent volunteers (charities) had spent the plaintiff’s money on improvements and alterations to their own land.  In their regard it was held that no charge should be imposed, because a charge is enforceable by sale and it would be harsh to make the volunteers sell their land.  This has probably been subsumed effectively into the wider defence of ‘change of position’.

  • Subrogation – Boscawen v. Bajwa [1996] 1 W.L.R. 328

            This is a doctrine with common law and equitable origins.  The idea is that one person stands in the shoes of another and asserts that other’s rights.  It is commonly found in the context of insurance law.  In the context of tracing, the question is whether a plaintiff may be subrogated to the position of a secured creditor, paid off by a defendant with the plaintiff’s money (for example if the defendant has paid his mortgage using the plaintiff’s money).  If the creditor is unsecured subrogation will not improve the plaintiff’s position.

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This article is written by our legal writer Miss Martina Acciaro, LLB (International Law)