1. Introduction
and An Easy Case
- Tracing is a process that allows one
right to be identified as a product of another. In some
situations, that identification process is very easy.
D4:Example
12d: B has some shares. B sells those shares to A
for £800. A later sells the shares for £800 and then uses
that £800 to buy a car from C.
In D4:Example
12d, B can identify A’s Ownership of the car as a
product of B’s initial right to the shares (ie of the initial
personal right of B represented by the shares). Of course,
this does not mean that B has a right against the car; or
against A’s Ownership of the car; or against A (see p 325).
2. Where
One of the Parties is a Wrongdoer
In other situations, the identification
process is more difficult.
Example 1a:
A holds a bank account (account 1) on Trust for B1. A also
has his own bank account (account 2): that account is £10,000
in credit. A, acting beyond his powers as trustee, transfers
£10,000 from account 1 into account 2. A then uses the £20,000
credited to account 2 to: (i) buy some shares for £10,000;
and (ii) buy a painting for £10,000. B1 then discovers what
A has done. A still holds both the shares and the painting.
The shares have increased in value to £20,000; but the painting
is a worthless fake. A has gone into insolvency.
In such a situation, B1 will wish to show
that he has a persistent right against A’s right to the
shares (see B:4.5.2).
To do so, B1 will need to show that A’s right to the shares
counts as the product of the right initially held on Trust
for B1 (account 1). B1’s argument is plausible: it is not
impossible that A’s right to the shares, acquired after
account 2 was credited with £10,000 from account 1, is the
product of account 1. However, there is a basic evidential
problem: we do not know whether the £10,000 spent on the
shares is the product of the value transferred from account
1. It could just as well be the case that the painting bought
for £10,000 is, instead, the product of the value transferred
from account 1.
In such a case, a clear general principle
applies: doubts are resolved against the wrongdoer. A is a wrongdoer as, when transferring
the £10,000 from account 1, he acted beyond his powers as
trustee. So, a court will find that the £10,000 spent on
the shares is the product of the £10,000 debited from account
1; and the £10,000 spent on the painting is the product
of the £10,000 initially credited to account 2. This means
that:
i)
A’s right to the shares is the product of account
1; and
ii)
That account was initially held by A on Trust for
B; and
iii)
There is no legal basis for A to have the benefit
of A’s right to the shares; so
iv)
A holds his right to the shares on a Resulting Trust
for B (see D4:4.4).
The principle of resolving doubts against
a wrongdoer can only apply if there is a doubt to be resolved.
So, a court cannot punish a wrongdoer by pretending,
in the face of evidence, that a particular right held by
A is the product of another right.
Example 1b:
A holds a bank account (account 1) on Trust for B1. A also
has his own bank account (account 2): that account is £10,000
in credit. A, acting beyond his powers as trustee, transfers
£10,000 from account 1 into account 2. A then uses the £20,000
credited to account 2 to buy a painting: that painting turns
out to be worthless. A then receives a £10,000 legacy from
his grandmother. That money is paid into account 2, which
is now £10,000 in credit. A goes into insolvency.
In such a situation, B1 cannot show that A’s right against his bank to £10,000 is a
product of the right initially held by A on Trust for B
(account 1). We know that the whole value of account 1 went
into buying the worthless painting; and that the £10,000
credited to account 2 came not from account 1 but from A’s
grandmother.
Example 1c:
A holds a bank account (account 1) on Trust for B1. A also
has Ownership of a car. A bought that car by borrowing £9,000
from a lender; A now owes that lender £10,000. Acting beyond
his powers as trustee, A transfers £10,000 from account
1 to the lender. A goes into insolvency.
In such a case, B1 may wish to show that
he has a persistent right against A’s Ownership of the car.
To do so, B1 needs to show that A’s Ownership of the car
is a product of account 1. However, A acquired his Ownership
of the car without making
any use of account 1: A had his right before transferring
£10,000 out of account 1. So, logically, A’s Ownership of
the car cannot be a product of account 1: this type of ‘backwards
tracing’ has not been accepted by the courts (although see
p 760 of the book).
So,
the first general tracing principle is that doubts are
to be resolved against a wrongdoer.
but
no doubts exist
if we know that the value of one right could not have contributed
to another right (eg because the value of the first right
was used up before the acquisition of the second right;
or because the second right was acquired before the first
right was used).
3. Where
there is a Dispute between Two or More Innocent Parties
Example 2a:
A holds a bank account (account 1) on Trust for B1. A also
has his own bank account (account 2): that account is £10,000
in credit. Under a separate Trust, A also holds a third
bank account (account 3) on Trust for B2. A, acting beyond
his powers as a trustee for B1, transfers £10,000 from account
1 into account 2. And, acting beyond his powers as a trustee
for B2, A also transfers £10,000 from account 3 into account
2. A then uses the £30,000 credited to account 2 to: (i)
buy some shares for £10,000; and (ii) buy a painting for
£20,000. B1 and B2 then discover what A has done. A still
holds both the shares and the painting. The shares have
increased in value to £20,000; but the painting is a worthless
fake. A has gone into insolvency.
Applying the general principle that doubts
are to be resolved against a wrongdoer, we can say that
all of the £10,000 initially credited to account 2 has been
spent on the worthless painting. However, we still have
a problem: a further £10,000 has been spent on the painting
and that value must be the product of: (i) account 1; or
(ii) account 3; or (iii) partly account 1 and partly account
3. So, B1 will claim that the further £10,000 spent on the
paining is the product of account 3; if so, A’s right to
the shares is entirely the product of account 1 and so A
will hold that right on Trust for B1. In contrast, B2 will
claim that the further £10,000 spent on the paining is the
product of account 1; if so, A’s right to the shares is
entirely the product of account 3 and so A will hold that
right on Trust for B2.
In resolving that dispute between B1 and
B2, we cannot use the general principle of resolving doubts
against a wrongdoer: neither B1 nor B2 is a wrongdoer. Instead,
we have to use the second general principle: innocent
parties are to be treated as equals.
Crucially, treating B1 and B2 as equals is not the same as treating them equally. So, in Example
2a, it is possible to treat B1 and B2 as equals without
necessarily deciding
that the shares are 50% the product of account 1 and 50%
the product of account 3. To treat B1 and B2 as equals,
we simply need to apply a rule that, in the abstract, does
not discriminate between any particular innocent party.
For example, if two parties are playing one game of chess,
we cannot treat them equally: one party must take the white
pieces and so get the advantage of the first move. However,
we can treat the parties as equals by ensuring that each
has an equal chance of taking the white pieces: eg by deciding
on colours by tossing a coin.
The courts have developed various different
rules that can be used to treat the parties as equals. We
can consider these rules by seeing their effect in Example
2a.
The ‘first in, first out’
rule: In Example 2a,
the first credit into account 2 came from account 1. That
credit is then viewed as first out: as A bought the shares
before the painting, this rule means that A’s right to the
shares is wholly the product of account 1.
So, A holds those shares on Trust wholly for B1. B2 has
no right against A’s right to the shares, as the credit
from B2’s account is viewed as going on the second purchase:
the painting. This ‘first in, first out’ rule is often referred
to as the rule in Clayton’s Case.
The ‘intention’ rule:
This rule depends on the intention (at the time of the relevant
transaction) of the party making that transaction. So, let
us say that, in Example 2a,
A’s conduct shows that he intended to use the value from
account 1 to buy the shares; and the value from account
3 to buy the painting. If A had such an intention,
a court can then follow it by viewing the shares as the
product of account 1 (and so held on Trust by A entirely
for B1’s benefit); and the painting as the product of account
3 (and so held on Trust by A entirely for B2’s benefit).
The ‘overall proportions’
rule: In Example 2a,
the accounts held on Trust for B1 and B2 each contributed
£10,000 to A’s account. As B1 and B2 made equal contributions
to the input into account 2, each is viewed as making equal
contributions to the outputs. So, A’s right to the shares
is viewed as 50% the product of account 1 and 50% the product
of account 3. So, A holds those shares on Trust 50% for
B1’s benefit and 50% for B2’s benefit. This rule is often
referred to as the ‘pari passu’ approach.
The ‘rolling proportions’
rule: This rule (often referred to as the ‘rolling pari
passu’ approach) is a refinement of the ‘overall proportions
rule’: it means that the contributions of the innocent parties
are calculated after each relevant transaction. In
Example 2a, this rule
is no different to the ‘overall proportions’ rule as there
is only one relevant transaction. However, in other situations,
the two rules can lead to different results (see Example
2b below).
Each of these approaches meets the basic
test of treating B1 and B2, two innocent parties, as equals;
but deciding the issue by tossing a coin would also meet
that test. So, which of the approaches is best?
Example 2b:
A holds a bank account (account 1) on Trust for B1. A also
has his own bank account (account 2): but that account is
not in credit (nor is it in overdraft). Under a separate
Trust, A also holds a third bank account (account 3) on
Trust for B2. A, acting beyond his powers as a trustee for
B1, transfers £10,000 from account 1 into account 2. A then
spends £10,000 from account 2 on buying shares that increase
in value to £20,000. A, acting beyond his powers as a trustee
for B2, then transfers £10,000 from account 3 into account
2. A then uses the £10,000 credited to account 2 to buy
a painting that turns out to be worthless. A then goes into
insolvency.
On the ‘first in, first out’ rule, as in Example 2a, account 1
is viewed as contributing only to the shares; and account
3 contributes only to the painting. This rule works well
for B1: as account 1 has contributed the cost of the shares,
A holds his right to the shares on Trust for B1. In contrast,
the rule works badly for B2: as account 3 has contributed
only to the painting, A holds his (worthless) right to the
painting on Trust for B2.
The ‘intention’ approach
cannot apply: A, when buying the shares and the painting,
had no particular intention as to whether he was using the
value of B1’s contribution or of B2’s contribution.
On the ‘overall proportions’ approach, it can be said that, overall, each of B1 and
B2 has contributed £10,000 to the value of account 2. As
a result, B1 and B2 could be seen as equally contributing
to the outputs from that account. So, A’s right to the shares
(like his right to the painting) is viewed as 50% the product
of account 1 and 50% the product of account 3. So, A holds
those shares on Trust 50% for B1’s benefit and 50% for B2’s
benefit.
The ‘rolling proportions’ approach leads to a different result. The first relevant transaction
was A’s purchase of the shares. At that point, B1 had contributed
£10,000 to the value of account 2. As a result, B1 can be
seen as contributing the money used by A to buy the shares:
so A holds those shares on Trust for B1. In contrast, as
account 3 did not contribute to the acquisition of the shares,
B2 has no right against A’s right to the shares.
From this example, the ‘rolling proportions’
approach can be seen to have important benefits. First,
it avoids the arbitrary results that may come from the ‘first
in, first out’ or ‘intention’
rules: an innocent party may reasonably feel that the
accident of A breaching one Trust before the other, or of
A’s intentions when making the relevant transactions, should
not affect his rights. The ‘overall proportions’
approach moves towards
a more rational position, as it is based on overall contributions
of the parties. However, it may seem odd that, in Example
2b, the shares (acquired before any value was taken
from account 3) should be seen as, in part, the product
of account 3. The ‘rolling proportions’ approach avoids that problem: it shows that the ‘overall
proportions’ approach
has its own arbitrariness. For it depends on how much value
each party contributes overall whenever the music happens
to stop: so the parties’ rights can depend on the accident
of when the transactions end. In contrast, the ‘rolling
proportions’ can consider
each transaction as an individual, complete event.
This analysis broadly fits with the conclusions
of the courts. First, a preference has been stated for the
‘rolling proportions’ approach. The problem may be that, in practice,
that approach is very difficult for a court to apply: it
may involve the unpicking and analysis of a large number
of individual transactions. So, for practical reasons, a
court may instead prefer the ‘overall proportions’
approach or the ‘intention’
approach. It may even be that, if it can be
used, the ‘intention’ approach will take priority over the ‘rolling
proportions’ approach. The ‘first in, first out’
approach was traditionally
applied where value was contributed to a current account:
so, in Example 2b, that
approach could apply if A’s account (account 2) is a current
account. However, given the arbitrary nature of the rule,
it has fallen out of favour and, it seems, should only be
used as a last resort if none of the other three rules can
provide a workable solution.
So,
the second general tracing principle is that innocent
parties should be treated as equals
That principle can be upheld through various means: the
best approach seems to be to apply a ‘rolling proportions’
rule. Practical problems may mean that, instead an
‘overall proportions’
rule should apply. If practical problems remain then, in
the case of a current account, the ‘first
in, first out’ rule may be used. And, in a case where the ‘intentions’
rule can be applied,
that rule may be preferred as providing a clear answer.
