2018 Law of Trusts Revision Materials (Set 1 of 2) PDF

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Law of Trusts Revision Materials (Set 1 of 2) Topics:     Breach of Trust, Constructive Trusts, Tracing 3 Certainties (Essay and Problems) Private Purpose Trusts (Problems) Formalities Note: I am extremely cautious with regards to providing students with sample answers to tutorial questions. The...

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Law of Trusts Revision Materials (Set 1 of 2) Topics:    

Breach of Trust, Constructive Trusts, Tracing 3 Certainties (Essay and Problems) Private Purpose Trusts (Problems) Formalities

Note: I am extremely cautious with regards to providing students with sample answers to tutorial questions. The fear is that students will uniformly reproduce memorised answers in examination on a similar topic. This is something that the University of London examiners strongly discourage. It is for this reason that I will keep sample answer handouts such as this one to a minimum. It would be more profitable for students to attempt the tutorial questions on their own and then consult with their lecturers/tutors for further guidance after they do so. The following sample answer is only provided to students as a guide in how they should structure their answers. In other words, it is more important to take note of how the sentences, paragraphs and arguments are structured below. Students should pay careful attention to the sequence of ideas and how arguments are substantiated with authorities from cases and academic writing. I do not make any pretensions to offering you a ‘perfect’ answer to the examination question above (indeed, in a discussive/reflective question, it is doubtful if there really is a ‘perfect’ answer at all!). Students are therefore encouraged to use the sample only as a guide. It is my firm belief that conscientious students should be able to produce better scripts than the one offered below.

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Breach of Trust, Constructive Trusts and Tracing 2010 Zone A Question 8 Carl was the manager of a large investment fund. For many years, he operated a fraudulent scheme to misdirect investment funds to his wife, Alison. Many of the investors contributed to the fund regularly by direct debit. They did so by signing instructions for money to be transferred electronically each month from their own bank accounts to one of the fund’s accounts. When Carl prepared a direct debit instruction for signing by an elderly investor, he sometimes listed the payee as the name and account of his own company, which had a similar name to that of the fund. Carl then transferred money from his company’s account to Alison’s bank account. Alison had no idea that this money had been obtained by fraud. She thought it was Carl’s money being paid through his company to avoid taxes. Carl’s fraud was uncovered and he absconded leaving no assets behind. Over the years, Alison received £1 million through Carl’s fraudulent scheme, £200,000 of which still remains in her bank account. The other £800,000 has been spent as follows: (a) £200,000 to discharge a loan secured on Alison’s title to her house; (b) £200,000 to purchase company shares; (c) £200,000 for travel, holiday, and ordinary living expenses; and (d) £200,000 to pay off a bank loan. With the loan monies, Alison had bought a car (now worth £30,000) and a boat (now worth £70,000), both of which she still has. Advise the defrauded investors. Suggested Solution: Carl: The investors are advised that Carl has breached his fiduciary obligations as well as committed a breach of trust. By having two similarly named bank accounts, Carl has put himself in a position where his own interest conflicts with his duties as a trustee. By encouraging the investors to pay into his company’s similarly named account, he has committed a breach of fiduciary obligations. Following that, he transferred the money from Law Of Trusts – Revision Materials (Updated: Feb 2018) Page 2 of 85

the company account to Alison’s bank account. As these transfers were clearly unauthorised by the terms of the investment, they would amount to breaches of trust. As a trustee, Carl would be strictly liable for his above breaches. He would also be personally liable to account for the losses caused to the investment trust funds caused by his breaches. However, as Carl has disappeared, the investors would have to consider if it would be possible to take any action against Alison.

Alison: On the facts, Alison is a ‘stranger’ or third party outsider to the investment trust. The general rule is that she would not be liable for Carl’s breach of trust (Mara v Browne (1896)). The exception to the rule is where Alison either received the monies with knowledge of Carl’s breach of trust or, despite being initially ignorant of it, came to know about Carl’s breach of trust later and used the funds as if they were her own despite her knowledge (El Ajou v Dollar Land Holdings (1994)). Following the decision in Re Montagu’s Settlement (1987), Megarry VC confirmed that for a recipient such as Alison to be personally liable to restore the trust, it must be shown that Alison had ‘knowledge’ and not merely ‘notice’ of the breach. In other words, it must be shown that Alison had acted in want of probity by receiving and/or dealing with the trust property despite having actual knowledge of Carl’s breach or wilfully and recklessly failing to make such inquiries as a reasonable and honest man would make on the obvious facts known to her. It is hereby argued that Alison did not have ‘knowledge’ or Carl’s breach at all. On the facts, she also did not act recklessly or wilfully since she honestly thought that Carl’s money was paid through his company to avoid taxes. Despite the above, the Court of Appeal appeared to have adopted an alternative test in BCCI v Akindele (2000). According to Nourse LJ, the basis for liability should involve, on the above facts, Alison’s conscience – i.e. whether Alison’s state of knowledge was such as to make it unconscionable for her to retain the monies received. Here, it is argued that, on the available facts, Alison may not be liable at all since she acted on her own honest belief that Carl’s money was paid through his company to avoid taxes rather than involving a breach of trust. Finally, it should also be noted that Lord Nicholls of Birkenhead (‘Knowing Receipt: The Need For A New Landmark’ (1998)) suggested that a recipient such as Alison should be strictly liable for receiving property as a result of a breach of trust. The justification for this alternative basis for liability is to prevent unjust enrichment. Nevertheless, Alison would be afforded the ‘chang e-of-position’ defence – i.e. that it would be unjust for the court to compel her to restore the trust since her position has changed as a result of relying upon the gifts from Carl without knowing about the latter’s breach. Once again, it is argued that even with this alternative basis for liability, while Alison is prima facie liable for receiving the monies, her lack of knowledge with regards to Carl’s breach remains a relevant factor as a defence. Law Of Trusts – Revision Materials (Updated: Feb 2018) Page 3 of 85

On the above arguments, the investors are advised that it is unlikely that Alison will be held personally liable to account for the losses caused by Carl’s breach. She remains an ‘innocent’ recipient of monies as a result of Carl’s fraudulent transfers.

Follow/Trace + Claim: Despite not making out Alison’s personal liability to account for the losses caused by Carl’s fraud, the investors should still have an equitable right to follow and/or trace their monies into Alison’s bank account (should it be possible to do so on the circumstances). As there is still a balance of £200,000 in the bank account, it is argued that the investors should be able to follow that money in Alison’s account and claim them as theirs. Alison is not a bona fide purchaser without notice. She is only a donee who received the money as a gift. It is thereby argued that the investors would be able to claim the £200,000 balance in Alison’s account. As for the £800,000 that Alison has spent, it would depends on whether there are any traceable proceeds for the investors to claim: a) On the facts, it should be noted that Alison did not use £200,000 to purchase her house. The money was only used to pay off the secured loan on her house. Following the decision in Boscawen v Bajwa (1995), it is argued, that the rights of the original mortgagee should be subrogated by the investors. In other words, the investors should be allowed to take over as the new mortgagee and secure their loan to Alison with a charge on her house. b) The investors should also be allowed to trace into the company shares as they were purchased using the trust money (£200,000). Following Foskett v McKeown (2001), Alison’s knowledge is not a relevant factor. It is simply a question of the investors tracing into the company shares purchased using their money. c) The £200,000 expended on travel, holiday and living expenses are no longer traceable since there are no proceeds for the investors to trace into. d) Finally, it should also be possible for the investors to subrogate the rights of the bank to sue Alison for the £200,000 loan (using the principle from Boscawen v Bajwa above).. That being said, the investors would end up only as unsecured lenders. Should Alison not be able to pay back the loan, they would end up with nothing. Here, it is argued that a better solution is to simply allow the investors to trace into the car and boat bought with the loan monies (despite the depreciation in the value of the two properties). Professor Penner argued this ‘backward tracing’ approach is logical and offers protection for investors in situations such as this one affecting the investors. After all, but for Alison buying the car and boat, she probably would not

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have incurred the loan in the first place. Without the loan, she would not have used the £200,000 belonging to the investors. That being said, it is noted that the status of ‘backwards tracing’ as an equitable remedy is uncertain in English law. While ‘backwards tracing’ can be discerned in the reasoning of the House of Lords in Foskett v McKeown (2001) and also by the courts in cases such as Law Society v Haider (2003), it should also be noted that the courts refused to expressly admit that they were applying ‘backwards tracing’. The case that extensively examined ‘backwards tracing’ was Bishopgate Investment v Homan (1995). Vinelott J (at first instance) allowed ‘backwards tracing’ in limited circumstances, such as (i) when it can be shown that the trustee misused trust property with the intention to repay a loan incurred for the purchase of a specific property; and (ii) where the trustee misused trust property in order to make funds available (e.g. credit card or overdraft facility) to enable him to make a future purchase. Alas, when the case reached the Court of Appeal, the result was inconclusive as Henry LJ appeared to ‘agree’ with both the decisions of Dillon LJ (who approved of Vinelott J’s approach) and Leggatt LJ (who rejected the same). Despite the uncertainty in Bishopgate, it is argued that ‘backwards tracing’ does feature in the reasoning of the courts and, on the logic of the reasoning, it is likely that the courts may approve of it in the future. There is therefore a strong argument here that the investors may be allowed to ‘backward trace’ into the car and boat purchased by Alison using the loan monies.

2007 Zone B Question 4 Madeleine, trustee of the Chalmers and Redmayne family trusts, in breach of trust deposited £50,000 from the Chalmers trust into her own bank account, raising the balance to £75,000. She withdrew £25,000 from the account to pay off her mortgage. She then deposited £50,000 from the Redmayne trust into her account, raising the balance to £100,000 and made the following withdrawals: she invested £25,000 in shares now worth £10,000; paid a judgment debt against her of £25,000; gave £25,000 to her husband who used the money to buy a painting; and paid £25,000 to her travel agent for a world cruise she had booked. Advise the beneficiaries of the Chalmers and Redmayne trusts.

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Suggested Solution: Madeleine’s breach of trust: The beneficiaries of the Chalmers and Redmayne trusts should be advised that as Madeleine is a trustee who committed a breach of trust, she is strictly and personally liable to account for the unauthorised use of the funds from the two trusts. In other words, the beneficiaries are entitled to take an action against Madeleine compelling her to restore £50,000 to each of the trust. That being said, should Madeleine not be able to make good the losses caused by her breaches, the beneficiaries will then attempt to trace into particular assets or funds in order to claim them as properties belonging to their respective trusts.

Chalmers: It should be noted that £50,000 from the Chalmers trust was misappropriated by Madeleine and banked into her own bank account (which already had a balance of £25,000 of her own money). Madeleine later withdrew £25,000 in order to pay off her mortgage. The question that the beneficiaries of the Chalmers trust would like to have answered is whether the money used to pay off the mortgage was Madeleine’s own money (her balance in the account was sufficient for the mortgage payment) or money from the Chalmers trust. In Re Hallett’s Estate (1880), it was held that there was a ‘presumption of honesty’ on the part of the trustee when he withdraws money from a mixed fund. Therefore, it was held that the trustee will always be presumed to withdraw his own money first. This was to ensure that the wronged beneficiary could have a chance to claim whatever balance was left in the account after the trustee’s withdrawal. Furthermore, it was also held that any future deposits into the mixed account was the trustee’s own (Roscoe v Winder (1915)) unless he had expressly stated that the deposits were to replace the trust monies that he had previously misappropriated (Robertson v Morice (1845)). This was also known as the ‘Lowest Intermediate Balance’ approach in tracing – i.e. the wronged beneficiary was entitled to claim the lowest intermediate balance from the mixed account as representing his interest. Should this be the approach taken by the beneficiaries of the Chalmers trust, Madeleine would have been presumed to withdraw her own money in order to pay off her mortgage. The money from the Chalmers trust would have been untouched. That being the case, it is argued that this may not be the best approach to safeguard the interests of the beneficiaries of the Chalmers trust. On the facts, there were future withdrawals by Madeleine which further dissipated the monies in the account. Following the decision in Re Oatway (1903), the wronged beneficiaries would have the benefit to elect that the withdrawal of £25,000 came from the Chalmers trust. This approach was confirmed by Lord Millett in Foskett v McKeown (2001) as the correct one to safeguard the interests of the wronged beneficiaries as they had greater equity over that of the wrongdoing trustee. In other words, the wronged beneficiaries of the Chalmers trust would be allowed, in a manner of speaking, to ‘cherry-pick’ which is the approach that best protects their Law Of Trusts – Revision Materials (Updated: Feb 2018) Page 6 of 85

interests. It is here argued that the beneficiaries should elect to treat the payment of £25,000 as coming from the Chalmers trust in order to allow them to subrogate the rights of Madeleine’s original mortgagee and place a charge over the title to Madeleine’s house following the principle in Boscawen v Bajwa (1995). This approach, it is argued, is more beneficial to the Chalmers trust as it allows for a proprietary claim immediately – the trust becomes the new mortgagee, with Madeleine’s loan secured against the title to her house. In effect, this makes the Chalmers trust a secured creditor so that even if Madeleine could not repay her loan, they would still be able to claim the title to her house.

Balance of £100,000 (after the mortgage payment): On the facts, it should be noted that Madeleine made a further deposit of £50,000 (from Redmayne trust) into the account bringing the balance up to £100,000. As it has been argued that the above mortgage payment was made with money from the Chalmers trust, both the Chalmers trust and Madeleine would still have shares in the balance of £100,000 (along with the Redmayne trust). The question is, how would the balance £100,000 be apportioned amongst Madeleine, the Chalmers and Redmayne trusts. This is important as the £100,000 was later withdrawn by Madeleine for more expenditures and purchases. In other words, whose money was used for which expenditure? Generally, should it be a current bank account, the general rule is that the balance would be dissipated on a ‘first-in, first out’ (FIFO) basis following the rule in Clayton’s Case (1816). Should that be the case, the subsequent withdrawals would be as such:    

£25,000 for the purchase of shares = Madeleine’s own money (first-in) £25,000 for the judgment debt = money from the Chalmers trust £25,000 as gift for Madeleine’s husband, who bought a painting with the money = money from the Redmayne trust £25,000 paid to the travel agent = money from the Redmayne trust

In Barlow Clowes v Vaughan (1992), the Court of Appeal confirmed the above FIFO approach as the general rule for tracing amongst ‘innocents’ in a current bank account. However, the court refused to apply FIFO on the facts of the case as it involved a deposit account. The ‘pari passu’ approach was applied instead whereby the ‘innocents’ were allowed to claim proportionate co-ownership of the whole account based on their respective contributions to the fund. Should that be the case, it is argued that the Chalmers trust would be entitled to 1/4 of the £100,000 (based on its contribution of £25,000) while the Redmayne trust would be entitled to 2/4 of the same (based on its contribution of £50,000). It is not clear on the facts whether or not Madeleine’s account was a current bank account or merely a deposit account. The discussion below on traceable claims, however, assumes that it is the latter (and the results should be adjusted accordingly should it be the former).

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Tracing and Claiming: a) The beneficiaries from both trusts should be able to trace their interests (in ‘pari passu’) into the shares that Madeleine purchased following the principle in Foskett v McKeown (2001). Despite the decline in the value of the shares, the beneficiaries are advised to claim the shares as traceable proceeds from the misuse of funds from their respective trusts. b) As for the judgment debt, it is not clear on the facts why Madeleine incurred the debt in the first place. Should the debt be incurred earlier on because Madeleine purchased an asset, the beneficiaries may be allowed to ‘backwards trace’ their interests into the asset. After all, but for Madeleine buying the particular asset, she probably would not have incurred the debt in the first place. Without the debt, she would not have used the £25,000 belonging to the trusts. That being said, it is noted that the status of ‘backwards tracing’ as an equitable remedy is uncertain in English law. While ‘backwards tracing’ can be discerned in the reasoning of the House of Lords in Foskett v McKeown (2001) and also by the courts in cases such as Law Society v Haider (2003), it should also be noted that the courts refused to expressly admit that they were applying ‘backwards tracing’. The case that extensively examined ‘backwards tracing’ was Bishopgate Investment v Homan (1995). Vinelott J (at first instance) allowed ‘backwards tracing’ in limited circumstances, such as (i) when it can be shown that the trustee misused trust property with the intention to repay a loan incurred for the purchase of a specific property; and (ii) where the trustee misused trust property in order to make funds available (e.g. credit card or overdraft facility) to enable him to make a future purchase. Alas, when the case reached the Court of Appeal, the result was inconclusive as Henry LJ appeared to ‘agree’ with both the ...