Historical support for a pre-existing fiduciary relationship
57 There is historical support for the view that only a party with a pre-existing equitable proprietary interest derived from a fiduciary relationship might invoke the right to trace in equity. The decision of Sir George Jessel MR in In re Hallett's Estate (1879) 13 Ch D 696, 710 has been taken to stand for the proposition that in order to trace in equity it is necessary for the claimant to show that the property from which the right to trace originated was held by a fiduciary to the claimant. However, that early limitation of the right to engage in tracing has been significantly eroded and, it might be said, the requirement of a fiduciary relationship was not intended by the Master of the Rolls as a limitation but rather as a method by which an equitable interest was created which might be protected in a court of Equity.
58 Whilst the Court of Appeal's subsequent decision in In re Diplock [1948] Ch 465, 540 also held that the right of equitable tracing was predicated upon there being "some initial fiduciary relationship because the right to trace was founded upon the existence of a beneficial owner with an equitable proprietary interest in property in the hands of a trustee or some other fiduciary agent": Chase Manhattan Bank NA v Israel-British Bank (London) Ltd [1981] Ch D 105, 113, 118: its scope may not be so restrictive. That case was concerned with the unintentional wrongful disposition of the property of a deceased's estate in circumstances where the Will was subsequently held to be invalid. The estate had been distributed by the sending of cheques to 139 charitable institutions which paid them into their operating accounts, some of which retained sufficient funds to pay the claims against them whilst others had been drawn down and the funds used for the purposes of the charity, including building work. For present purposes it is not necessary to consider the Court's acceptance of the in personam claim against the recipients of property wrongfully distributed from a deceased's estate. The significant point was its conclusion that equity permitted tracing into and through a mixed fund, though the party that did the mixing did not owe any fiduciary duties to the original owner of the funds but had received them as a volunteer.
59 At first instance, it had been held that tracing could occur only where parties who had engaged in the wrongful disposition of property or the mixing of funds had themselves owed a fiduciary duty to the property's owner. That was rejected by the Court of Appeal, which held that the effect of the decision in Sinclair v Brougham [1914] AC 398 was that a person whose money has been wrongfully mixed with that of another was entitled to trace into the mixed fund so long as, inter alia, "there was originally such a fiduciary or quasi-fiduciary relationship between the claimant and the recipient of his money as to give rise to an equitable proprietary interest in the claimant".
60 The requirement of a fiduciary relationship was apparently necessary for two reasons. First, the circumstances where tracing is available has to be distinguished from those where legal ownership of the funds is simply placed in the hands of a third party, such as a debtor / creditor relationship or such other similar relationship. In those latter circumstances, tracing is not available as the party holding the property or funds would not be prevented from setting up their own title. Secondly, the claimant's right needed to be equitable in order to trace the funds into or through a mixed bank account which was not available in common law tracing. The Court of Appeal also found that relationships which carry an entitlement to trace include those between trustees and beneficiaries, executors and legatees, or quasi-fiduciary relationships such as those between principals and agents. Earlier, the Court had indicated that equitable tracing became available where the claimant was able to point to "the existence of a fiduciary or quasi-fiduciary relationship or of a continuing right of property recognised by equity" (at 520). That statement may be less than precise, but the words, "or of a continuing right of property recognised by equity", were obviously used to indicate that the right to trace was not limited to a trust or fiduciary relationship. To a similar effect are its observations at 525 where it referred to the powers of equity to "protect and enforce what it recognises as equitable rights of property which subsist until they are destroyed by the operation of a purchase for value without notice".
61 Then (at 526) the Court said:
The error into which, we respectfully suggest, the learned judge has fallen is in thinking that what, in Hallett's case was only the method (there appropriate) of bringing a much wider-based principle of equity into operation - viz., the method by which a fiduciary agent, who has himself wrongfully mixed the funds, is prohibited from asserting a breach of his duty - is an element which must necessarily be present before equity can afford protection to the equitable rights which it has brought into existence. We are not prepared to see the arm of equity thus shortened.
(Footnotes omitted).
62 Later in their Lordships' reasons (at 530) the general principle was stated as follows:
… equity may operate on the conscience not merely of those who acquire a legal title in breach of some trust, express or constructive, or of some other fiduciary obligation, but of volunteers provided that as a result of what has gone before some equitable proprietary interest has been created and attaches to the property in the hands of the volunteer.
63 The import of In re Diplock was that the equitable interest in respect of property, derived from an original fiduciary duty, generated a right to trace which persisted, even where the property or its proceeds had passed to a third party, such as a volunteer who may have mixed funds they had received. This enlarged scope of the right to trace tends to indicate that it does not necessarily rely upon the duties and obligations of only a trustee or fiduciary. This was a not insignificant departure from the previously assumed position which had been reflected in the reasons for judgment of Winn-Parry J, namely that the entitlement of the beneficiary to a proprietary remedy was steadfastly founded upon the continuing fiduciary obligations of the person in possession of assets of which another held an interest. This extension of tracing into property in the hands of a third person, other than a bona fide purchaser for value without notice, might suggest that the foundation of the right to trace is based more broadly on the continuing rights of property of the original owner.
64 The approach in In re Diplock had been presaged by the Australian High Court's decision in Black v S Freedman & Company (1910) 10 CLR 105. There, a husband had passed money he had stolen from his employer to his wife, who received it as a volunteer, and the employer claimed to trace it to funds remaining in the wife's account into which it had been placed. Griffith CJ (with whom Barton J agreed) appears to have applied the observations of Sir George Jessel MR in In re Hallett's Estate at 708 as to the tracing of property, including into the proceeds of the sale of that property, which had been wrongfully disposed of by a person in a fiduciary position. Griffith CJ also accepted that the proceeds can be traced into the hands of a person who takes them as a volunteer and mixes them in their own account. O'Connor J (at 110) held that the thief of the funds held them on trust for the owner and that they retained their character as trust assets when passed to a third person volunteer who was not a bona fide purchaser for value and it was irrelevant whether or not they had notice of the original misappropriation. There was, with respect, some paucity of express reasoning as to why the former fiduciary's obligations appeared to become owed by the recipient of the money.
65 Thus far, the development of an entitlement to trace was an expansion from the remedy against a person who owed the holder a relevant fiduciary duty, to a volunteer who was not a purchaser for value without notice when there was a relevant antecedent fiduciary relationship in respect of the property in the volunteer's hands.
66 The expansion of the scope of tracing continued through the speeches in the House of Lords in Foskett v McKeown [2001] 1 AC 102 and, in particular, through that of Lord Millett, where his Lordship reaffirmed the requirement of an antecedent fiduciary duty as a prerequisite to tracing, albeit casting serious doubt on its necessity. The facts of that case need be only briefly stated. The plaintiffs, who were resident in the United Kingdom, were investors in a property development in Portugal. A Mr Murphy was the promoter and controller of the development company. The investors paid approximately £2.6million in respect of their prospective plots of land in the development, which sum was to be held by Mr Murphy and an associate on an express trust until the development was completed. No development took place and the trust moneys were misappropriated. In particular, Mr Murphy had used £20,440 of the investors' trust funds to pay the final two of five premiums for a life insurance policy over his life and his children were the principal beneficiaries. Following his death, the insurer distributed a benefit of approximately £1million to the named beneficiaries and the investors claimed a right to trace their funds into the amount paid out under the policy. They claimed a proportionate interest in it corresponding to the proportion which the amount of the premiums paid with their trust moneys bore to the total premiums paid.
67 The Court of Appeal accepted that the misappropriated trust funds could be traced to the payment of the insurance premiums, but not to the policy or the amount paid out under it. The House of Lords allowed the appeal and the leading speech was delivered by Lord Millett. There was no question that a right to trace existed. The funds had been held on an express trust and had been misappropriated, so that a recognised right to trace existed. The major point of the decision concerned the nature of the "tracing links" which apply when money passes though accounts and is used to acquire substitute property.
68 In his analysis of the nature of tracing, Lord Millett explained (at 127) the process as one of locating assets which "may be taken to represent an asset belonging to the plaintiffs and to which they assert ownership", or as one "of identifying a new asset as the substitute for the old". He recognised that a claimant is asserting a "continuing beneficial interest" in the substituted asset as the result of a transmission of their property rights from the original asset to it. The process was part of the law of property rather than one of unjust enrichment.
69 This view was emphasised by his Lordship's observation that the right to trace derives from the plaintiff's property rights (at 127):
A beneficiary of a trust is entitled to a continuing beneficial interest not merely in the trust property but in its traceable proceeds also, and his interest binds everyone who takes the property or its traceable proceeds except a bona fide purchaser for value without notice. In the present case the plaintiffs' beneficial interest plainly bound Mr Murphy, a trustee who wrongfully mixed the trust money with his own and whose every dealing with the money (including the payment of the premiums) was in breach of trust. It similarly binds his successors, the trustees of the children's settlement, who claim no beneficial interest of their own, and Mr Murphy's children, who are volunteers. They gave no value for what they received and derive their interest from Mr Murphy by way of gift.
70 His Lordship held (at 128) that the interest which attaches to substitute property follows the "value" inherent in the original property; and that tracing was merely the process by which the claimants demonstrate what has happened to their property and its inherent value, and identify it as such by reference to the persons who have been involved in its transmission. That allowed them to substitute identifiable property (the proceeds) as the subject matter of their property claim.
71 That analysis is founded solely upon the preservation of rights in or in respect of property despite unauthorised dealings with the property in question and, in no way, relied upon the existence or nature of any fiduciary duty owed to the owner of the right. It is, therefore, not surprising, that in relation to the issue of whether it was necessary that there be a fiduciary relationship between them and a person who misappropriated property his Lordship observed at 128 - 129:
Given its nature, there is nothing inherently legal or equitable about the tracing exercise. There is thus no sense in maintaining different rules for tracing at law and in equity. One set of tracing rules is enough. The existence of two has never formed part of the law in the United States: see Scott on Trusts, 4th ed (1989), section 515, at pp 605-609. There is certainly no logical justification for allowing any distinction between them to produce capricious results in cases of mixed substitutions by insisting on the existence of a fiduciary relationship as a precondition for applying equity's tracing rules. The existence of such a relationship may be relevant to the nature of the claim which the plaintiff can maintain, whether personal or proprietary, but that is a different matter. I agree with the passages which my noble and learned friend, Lord Steyn, has cited from Professor Birks's essay "The Necessity of a Unitary Law of Tracing", and with Dr Lionel Smith's exposition in his comprehensive monograph The Law of Tracing (1997): see particularly pp 120-130, 277-279 and 342-347.
72 His Lordship, however, considered that, given that it was clear that the beneficiaries' interests were the subject of a fiduciary relationship, the case before the House was not the occasion to explore those matters further.
73 The speech of Lord Browne-Wilkinson identified that the plaintiffs' claim was based upon their equitable proprietary interest in the identified property, and (at 108) that the proprietary interests which existed in the funds in the trust "now exist in any other property which, in law, now represents the original assets". Those equitable interests were enforceable against whoever held those assets. The tracing rules were to be applied to ascertain whether there was any property which represented or consisted of any part of the original trust assets so that any equitable interests in them would apply to the substitute asset. His Lordship described (at 108) this process as being concerned with "hard-nosed property rights". Lord Hoffman who generally agreed with Lord Millett's reasons, also recognised the process as simply a vindication of property rights (at 115).
74 The concept of tracing "value" has persisted since Lord Millett's mention of it, though questions have been raised as to its precise meaning. It is sufficiently clear that it does not refer to "market value" or the dollar equivalent value of the property at the time of substitution. Rather, value "reifies that which inheres in an asset and which can be seen as passing into another form when that asset is exchanged for another asset": Professor Lionel Smith, The Law of Tracing (Oxford University Press, 1977) 16. See also the discussion of the nature of value in Claims to traceable proceeds: Law, Equity and the Control of Assets by Dr Aruna Nair, (Oxford University Press, 2018) 57 - 82. This would appear to be self-evidently correct. Were a trustee to misapply $10,000 of trust funds to acquire a painting which then increases in value, the trust's beneficiaries should be entitled to trace their interest to the painting's worth rather than merely $10,000.
75 In his reasons at [290] the primary judge referred to the earlier decision of Lord Millett, then Millett LJ, sitting as a member of the Court of Appeal in Boscawen v Bajwa [1996] 1 WLR 328. His Lordship there expressed the opinion (at 33) that it was "still a prerequisite of the right to trace in equity that there must be a fiduciary relationship which calls the equitable jurisdiction into being: see Agip (Africa) Ltd. v. Jackson [1991] Ch. 547, 566, per Fox L.J." Whilst that appears to remain the position in England, there is a degree of tension with the later observations in Foskett v McKeown.
76 Some assert that a similar, but less stringent, position seems to persist in Australia. Although where that view is accepted, it has been held that whilst a pre-existing fiduciary relationship is necessary, it is not imperative that the relationship be replete with the established duties of absolute loyalty. Rather, a relationship of a lesser nature may suffice which may be limited to specific elements of a broader relationship: see the discussion in Mohammud Jaamae Hafeez-Baig and Jordan English, The Law of Tracing (Federation Press, 2021) 153 [5.106].
77 In CFHW Pty Ltd v Burness [2014] VSC 451 [35] Warren CJ said that, "the authorities make it clear that in order to rely on equitable tracing and the subsequent constructive trust, the party seeking that remedy must show a breach of fiduciary duty". The Chief Justice cited In re Diplock in support of that proposition.
78 In the earlier decision in Grimaldi v Chameleon Mining the issue was whether tracing was available in relation to misappropriated corporate property which had not been held on a specific trust. The Full Court accepted (at 417 [560]) that if a party wishes to trace it must first establish proprietary rights in the asset lost, a "proprietary base", as the source of the proprietary right. It was further observed (at 417 [562]) that:
When trust property in the strict sense is transferred into the hands of a person other than a bona fide purchaser for value without notice, little difficulty arises in following the property into that person's hand and in tracing it into other property which is its substitute. The antecedent entitlement of the trust beneficiaries will in the usual case permit both following and tracing because it will establish the required property base in the asset in the recipient's hands.
(Emphasis as per original).
79 The reference to an "antecedent entitlement" was a reference to the plaintiff's entitlement or proprietary interest in the trust property which existed prior to the occurrence of any misappropriation of the property. The difficulty for the claimant in Grimaldi was that there was no antecedent trust relationship in relation to misappropriated corporate property which might have given rise to a pre-existing equitable beneficial interest. The disposal of property by the company's directors causes complete title to be taken from the company and vested in the third party recipients even when the transaction is within the authority of the directors albeit not in the company's interests or is in breach of the directors' fiduciary duty. In overcoming the absence of any antecedent equitable interest, the Court relied upon an analogy, drawn in Belmont Finance Corporation v Williams Furniture Ltd (No 2) [1980] 1 All ER 393, 405, between an existing trust and the creation of a trust relationship when a fiduciary misapplies property. In Belmont Buckley LJ had said:
A limited company is of course not a trustee of its own funds; it is their beneficial owner; but in consequence of the fiduciary character of their duties the directors of a limited company are treated as if they were trustees of those funds of the company which are in their hands or under their control, and if they misapply them they commit a breach of trust (Re Lands Allotment Co [1894] 1 Ch 616 at 631, 638, per Lindley and Kay LJJ). So, if the directors of a company in breach of their fiduciary duties misapply the funds of their company so that they come into the hands of some stranger to the trust who receives them with knowledge (actual or constructive) of the breach, he cannot conscientiously retain those funds against the company unless he has some better equity. He becomes a constructive trustee for the company of the misapplied funds.
80 This was applied in Grimaldi where it was found that the third party's knowing wrongful receipt of misappropriated company property had the consequence that it held the property as a constructive trustee for the company, with the result that there would be a corresponding equitable proprietary interest permitting the invocation of equity's tracing rules to trace the property and proceeds including through a mixed fund. Clearly, the Court did not regard the existence of an antecedent equitable proprietary interest as being a requirement for tracing. It concluded (at 418 [567]) that although it would ordinarily award such proprietary relief where a party has been knowingly involved in a breach of fiduciary duty, as a matter of principle it retained a discretion not to do so. See generally the discussion of the proprietary claims which arise consequent upon a breach of fiduciary duty in Twigg v Twigg [2022] NSWCA 68 at [203] - [244].
81 It was submitted for RnD that Grimaldi did not conclude that tracing in equity was only available where a party held a foundational property interest which arose out of a trust or fiduciary relationship. That would appear to be correct. It decided merely that an equitable interest in property arising consequent upon a breach of a fiduciary duty is one in respect of which the right to trace in equity arose. It did not conclude that the right was confined to only those types of interests. As the primary judge in the present matter noted, the Full Court in Grimaldi was concerned to ascertain whether the company whose property had been misappropriated, retained any equitable interest in it.
82 Support for the above might be seen in the earlier decision in Robb Evans of Robb Evans & Associates v European Bank Ltd (2004) 61 NSWLR 75. A fraudster had deposited money in a Vanuatu bank which had been opened in the name of Benford Ltd. At the same time, the bank deposited an equivalent amount with Citibank Ltd in Australia in its own name which seemingly was to benefit Benford Ltd. The receiver of Benford's assets commenced proceedings alleging that the debt owed by Citibank to the bank in Vanuatu was held on trust for Benford. It was accepted that Benford held the debt in the bank in Vanuatu on trust for the defrauded individuals on principles akin to those referred to in Black v S Freedman & Co. Further, Spigelman CJ (with whom Handley and Santow JJA agreed), accepted that it was possible to draw a sufficient connection between the deposit of funds in the bank in Vanuatu by Benford and the opening of the account with Citibank. He noted that Benford's right to trace was one of property law which arose on the basis that it was the legal owner of the chose in action, being the debt owed by the bank in Vanuatu. However, he added that the concept of "a right to trace" was misleading and ought not to be confused with a "proprietorial right" (at 103 [134]). On the facts of the matter before the Court (at 103) Benford, by the receiver, did not claim to be a beneficiary seeking the property which its fiduciary acquired with trust property. Rather, it was seeking to make an election to recover property (being the debt owed by Citibank to the Bank in Vanuatu) held by a third party which was causally linked to the property to which it remained beneficially entitled. He concluded (at 104) that the asset, being the interest in the Citibank account, was not a substitute for the original asset, being the interest account with the bank in Vanuatu. The indebtedness of the Vanuatu bank, constituting Benford's chose in action, remained intact and there was no occasion on which the value inherent in it was transferred to or became represented by the deposit in the Citibank account. It was not possible, his Honour held, to separate an equitable estate from the legal interest in the deposit in the bank in Vanuatu and then trace it into the deposit with Citibank. In essence, this was merely a case about the inability of the plaintiff to establish a sustainable tracing link. Benford's asset, by way of its interest in the Vanuatu's bank's indebtedness to it, was not appropriately linked to Citibank's indebtedness to the Vanuatu bank to support a substitution of the latter for the former for the purpose of tracing. The Vanuatu bank's deposit to the Citibank account of funds which had come into its possession for value and without notice, was merely the use by it of funds in the ordinary course of its banking business and the use by it of its own funds. They did not bear the character of Benford's funds which had been received by the Vanuatu bank and exchanged for the chose-in-action.
83 For present purposes, however, the Chief Justice added (at 104 [141]), "The intervention of equity requires the identification of a duty or interest arising pursuant to the doctrines of equity". He then said (at 104 [143]):
In the present kind of case, in my opinion, the legal owner of property who has a good claim at law cannot elect to trace in equity, at least in circumstances in which no issue of solvency of the person who owes the obligation at law has arisen.
84 It was critical to the outcome in this case that Benford held no separate identifiable equitable interest in the chose in action, being the debt owed by the bank in Vanuatu. It held legal title to it and there had been no improper transfer of that chose in action or any part of it, and nor was any transfer the result of any breach of fiduciary duty. Nor did Benford have any continuing interest in the "funds" which it deposited with the Vanuatu bank which could be traced. Once deposited, they became the property of the Vanuatu bank which provided the consideration of the promise to pay the amount outstanding in Benford's account in accordance with the terms and conditions of that account. At the time the funds were deposited to the Citibank account they belonged solely to the Vanuatu bank and Benford had no interest in them.
85 Nevertheless, the Chief Justice's comment that in order for Benford to be entitled to trace it needed "a duty or interest arising pursuant to the doctrines of equity" (emphasis added) is effectively the equivalent of the observations in In re Diplock that what is required is "the existence of a fiduciary or quasi-fiduciary relationship or of a continuing right of property recognised by equity". Neither comment limits the availability of tracing only to where there is a pre-existing trust or fiduciary relationship. They each appear to accept that a sufficient equitable interest in property, regardless of the manner or method by which it was created, is enough in respect of the nature of the claimant's necessary equitable interest.
86 Thus far, on the issue of the nature of that interest, one can discern the two divergent approaches. On the one hand, that the party seeking to trace must have an equitable beneficial interest in property created by the existence of a trust or fiduciary duty owed to them. On the other hand, all that is required is a sufficient equitable interest in the property which has been misapplied, regardless of how it was created.