Trust Law: When Things Get Nasty

Introduction

In their 1992 book Text, Commentaries and Cases on Trust (which is actually an excellent book), professors Oosterhoff and Gillese pretty much warn all and sundry to avoid the study of trust law unless they are certified masochists, with the following summary:

"The beneficiaries' primary remedy for a breach of trust is a personal one against the trustee in the form of a money judgment. However, if the trustees still have the property, the beneficiaries have a proprietary remedy as well in that they are entitled to recover the property itself.

"Moreover, if the trustees no longer have the property and are not personally liable, or where they are insolvent, the beneficiaries may have a right of action against the recipients of the trust property.

"This right of action is, in fact, two causes of action. First, a right in personam or personal action in equity against the recipients, and second, a right in rem, that is, a proprietary action, at law, in equity, or both, to follow or trace property into its product."

Well, that gobbledygook does not help anyone but the most hardy in legalese but you can surmise that it does happen that trustees, either dishonestly, or without wrongful intentions but in breach of trust, let the trust property escape their hands and into the hands of others.

This, of course, is a matter of immediate and utmost concern to the beneficiary, who retain, as we discussed in Trust Law in Canada: An Introduction, an equity-based interest in the trust property. The beneficiary of a trust has no common law interest in the trust property while the trust is ongoing.

But the beneficiary does retain a legal interest that is recognized in equity, a legal system which runs parallel to common law in Canada and which ranks higher than common law. Trust is a beast of equity. So the beneficiary has a right "in equity" in the trust property.

The common law supports a number of actions to follow misappropriated property and to force its return to the rightful owner (for example, conversion, detinue or replevin).

trust law brawlUnfortunately, the common law does not recognize the beneficiary's interest which, as we said above, is equity-based, so these remedies are not available to the beneficiary of a trust. And even if the common law did recognize the beneficiary, the common law's remedies for misappropriated property fail if the property has become mixed (such as deposited into a bank account with other money), which is often the case in breach of trust cases where the property is invested money. Not necessarily so with equity remedies as we shall see.

Going After the Trustee

Readers will want to acquaint themselves with the notes on trustee liability under the title of Trusts: The Players. If the trustee has misappropriated the trust property to their own personal benefit and title, the beneficiaries may trace the property (ie. reclaim it by court order). If the property has been converted to money and has been placed in a fund of the trustee, the beneficiary can place a lien on the entire fund, or on property bought by it, or they may endorse the trustee's conduct and claim their share of the fund as tenant in common.

More often then not, the trustee will have mixed the trust money with their own in a bank account. In these cases, the rule of an 1816 case once reigned (Clayton's Case): withdrawals to a bank account with more than one source of deposits, are deemed to be paid out to the source first deposited.

This became known as the "first in, first out" rule.

In 1880, the case of Re Hallett's Estate stated that the beneficiary cannot claim the whole account but only the share that can be attributed to the trust property.

The Re Hallett's case also changed the rule in Clayton's Case when the defendant was a trustee. In that case, the presumption was that the trustee draws his own money out first and is deemed not to draw on the trust money until his own money is spent, no matter in what order the moneys were deposited.

Another exception to the rule in Clayton's Case is where it is not possible to determine what amount belongs to what trust. In that case, the account balance is divided proportionately.

The 1986 Ontario Court of Appeal case, adopted by Canada's Supreme Court in Re: Ontario Securities Commission provides a useful and more contemporary review of these complex rules and shows that the Clayton's Case rule is not sacrosanct law in Canada but, rather is a prima facie rule only which can be set aside if impracticable or if it would create an injustice.

Tracing: Recovering the Property

In some cases, equity will allow a court to return property wrongly transferred by the trustees, to trust beneficiaries. This is known as the recourse of tracing and it is particular to equity. In essence it is a legal proceeding allowed under the law of equity where the beneficiary attempts to reclaim the trust property through the court, whether the property is still in the first acquirer's hands or it has passed onto others, and even if the property has been converted.

The Equity TankA few points on the tracing remedy:

  • Tracing is only available to those plaintiffs that can show that the property was lost by persons standing in a fiduciary relationship to them. This is not a problem for trust beneficiaries. For more on fiduciaries, please see "fiduciary gains" in Constructive and Resulting Trusts.
  • The tracing action can only be taken if the property was specific and "ascertainable" and in which the beneficiary has title, albeit equitable title. Writes Professor Philip Pettit in Equity and The Law of Trusts (London: Butterworths, 1993, at page 516):

"Tracing is only possible so long as the fund can be followed in a true sense, ie so long as, whether mixed or unmixed, it can be located and identified. It presupposes the continued existence of the money either as a separate fund or as part of a mixed fund as latent in property acquired by means of such a fund. If, on the facts of any individual case, such continued existence is not established, equity is helpless. Thus tracing is impossible where an innocent volunteer spends the trust money on a dinner or on an education or general living expenses."

  • Courts will not grant the tracing action against a bone fide purchaser of the property (in this context, bone fide means that the defendant had no notice of the property being the subject of a trust). In other words, the property can be traced until bought by someone without notice. Conversely, as long as notice is given along the line of successive purchasers, the beneficiary can trace successfully.
  • Tracing gives the beneficiary a priority over the other creditors of the defendant. This is especially helpful if the defendant has gone bankrupt.
  • The successful tracing action gives the beneficiary two options: a lien can be put on the property or the beneficiary can elect to recover the property. In this way, if the property has increased in value, it can be recovered outright. If it has fallen in value, the action can result in judgment for the original value plus the lien on the property as security.

Where the property vests in a third-party who has bought or given value to the trustee for the trust property and not knowing that it was trust property (ie. bone fide purchaser for value), the beneficiary has no recourse to trace the property.

If the third-party has received the property as a gift (ie. without consideration), even if without notice that the property was subject to a trust, the beneficiary can trace and recover the trust property.

Strangers to the Trust

The trustee is the first person in the totem pole when it comes to seeking remedies for breach of trust.

But if the trustee is bankrupt or without sufficient assets to honour the trust, the beneficiaries have the equity remedy of tracing at their disposal to go after third-parties who may have possession of the trust property.

Recall that the purchaser for value, and without notice that the property was subject to a trust, shields the property from tracing. In that case, the only recourse left to the beneficiary is against the trustee. We have also covered the situation of a gift of the trust property, which allows for tracing even if the person receiving the gift without notice that it was subject to a trust (which the law calls the innocent volunteer) and we have said that this is vulnerable to tracing, although the innocent volunteer does not incur personal liability as might other strangers, as we shall see below. The reader may also want to see the discussion of this subject matter under Constructive Trusts.

There is yet another possibility available to the beneficiary. The equity remedy of tracing is primarily a means of determining the rights of property. A stranger to the trust can also be held liable to the beneficiary as a "constructive trustee" which creates personal liability above and beyond the trust property.

Trustee de son tort

bad faithWhere a stranger interferes, or takes it upon himself to intermeddle with trust matters or to do acts characteristic of the office of trustee, a court may find that person as a trustee de son tort or "trustee of his own wrong." Dishonesty is not a prerequisite for a court finding a person has become a constructive trustee in this fashion. It does require that the stranger was in a position to exercise some control over the trust property (usually by the possession and administration of trust property) contrary to the trust agreement.

Knowing Assistance in a Breach of Trust

A person who assists a trustee in committing a breach of trust can be held liable for losses incurred as a result of the breach. The key element is evidence of the stranger's actual knowledge that a dishonest and fraudulent design or breach of trust was transpiring.

In Re Montague, [1987] 1 Ch. 264, the judge adopted an earlier list of categories of "knowledge" which could constitute the stranger as constructive trustee, as follows:

"... actual knowledge; willfully shutting one's eyes to the obvious; and willfully and recklessly failing to make such inquiries as an honest and reasonable man would make."

The judge in Re Montague said that two other categories of "knowledge" offered in the 1983 Baden case (mentioned below): "... knowledge of circumstances which would indicate the facts to an honest and reasonable man; and knowledge of circumstances which would put an honest and reasonable man on inquiry", were inappropriate.

Re Montague also established that knowledge at one point in time does not necessarily mean knowledge for life, and that forgetfulness could be pleaded and could deny a finding of constructive trust.

Some Canadian cases have held that if the stranger knows of circumstances that would lead a reasonable person to make inquiries, then the stranger could be held liable.

Other cases have held that this would only be true if the stranger benefited from the breach of trust.

In Baden, Delvaux and Lecuit v. Societe pour Favoriser le Developpement du Commerce et de l'Industrie en France S.A., [1983] BCLC 325), the English judge said that there are four elements to establish the liability of a stranger to the trustee under "knowing assistance":

"(1) the existence of a trust; (2) the existence of a dishonest and fraudulent design on the part of the trustees of the trust; (3) the assistance of the stranger in that design; and (4) the knowledge of the stranger."

As may be obvious to you by now, this is not a well-settled area of the law. At the very least, we can see that courts are increasingly hesitant to impute knowledge from circumstances "where no actual knowledge exists."

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Published: Wednesday, June 11, 2008
Last updated: Friday, November 11, 2011
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