Trusts and Tracing

by David Debenham

A “trust” is a formal arrangement in which the donor or “settlor” of the trust places certain assets or rights he owns into a “trust” that is to be managed by the “trustee” for the benefit of trust beneficiaries, also called cestui qui trust.   Once transferred into trust by a trust deed, the settlor of the trust no longer has an interest in the trust assets he transferred, and the “legal” title in the asset is owned by the trustee and the “equitable title” is owned by the trust beneficiaries.  As far as outsiders to the trust are concerned, the trustee has the full right to deal with the trust assets as if the trustee owned the entire interest in them.  However, as between the trustee and the trust beneficiaries, the trustee must strictly observe the terms of the trust deed, and the trust beneficiaries have the right to sue the trustee for breaching his trust obligations to them. 

Where a fraudster has misappropriated funds, the courts often impose a “constructive” trust to protect the victims’ rights, such that they have all the rights of a trust beneficiary.

That the trust beneficiaries have a personal claim against their trustee for breach of trust is plain enough. What about if the trustee is insolvent such that a personal claim would be futile?  What about if the trustee conveyed the trust property to third parties in breach of trust, and the beneficiaries want the trust property put back into trust?  The case law speaks in terms of “proprietary” , or “in rem”, rights to recover the trust assets, and “personal rights” to sue individuals for participating in a breach of trust.

The proprietary claim is limited to those persons who have title to, or in possession of, the trust property. The trust beneficiary can recover the trust property, or property purchased with trust property, into whomever owns it, so long as tracing can make the connection to the present holder of the property. The fact that the holder of the property may be insolvent is irrelevant.   If title in the trust property passed because of a valid transaction with the trustee (even if it was in breach of the trust deed, unbeknownst to the purchaser), then the tracing is an equitable one, meaning that a court will not allow the proprietary claim to succeed against a bona fide purchaser for value without notice of the wrongdoing.[1] A creditor is unknowingly paid with trust property, the creditor is considered a bona fide purchaser for value without notice.[2] Being a proprietary remedy, if the bona fide purchaser for value without notice then “gifts” the trust property or its substitute to someone (called a “volunteer” in legal parlance), then the trust beneficiary can claim the property back from the volunteer so long as the volunteer owns it[3].

If the proprietary remedy is not available, the trust beneficiaries can assert personal remedies against these who (1) knowingly assisted in the breach of trust, (2) were, at one time, in knowing receipt of trust property, or (3) volunteers.  A personal remedy entitles the holder of a personal, possessory or proprietary right to damages for interference with his rights.

Change of Position Defence and Ponzi Schemes

What happens if the fraudster gives the proceeds of his fraud to his wife, who is unaware of his fraud, and she spends it on a vacation she would never have taken but for the receipt of this windfall?  A court find it inequitable for the victim of fraud to recover the money she received, because she is being forced to pay for a vacation she would never have paid for out of her own money.  This is called the “change of position” defence.

Where a trust beneficiary is engaged in a proprietary tracing, English courts have held that the change of position defence cannot be used.[4]  In Canada it is not so clear. The authorities are clear that the defence of change of position requires more than the mere spending of the monies received:[5]  Thus spending on everyday expenses would not suffice as these are not liabilities incurred specifically as a result of the receipt of the monies in question.  The volunteer must provide a full account of any expenditure alleged to be attributed to the windfall, and there must be (1) an exceptional expenditure (2) caused by the payment in question, or incurred in reliance of its receipt, (3) and spent in good faith. The defendant is required to show that his position “has so changed that it would be inequitable in all the circumstances to require him to make restitution,”[6]   It is hard to imagine a situation in which the equities will favor a Net Positive investor keeping their windfall in the face of the claim of a trustee-in-bankruptcy, receiver or other person acting for Net Negative investors in the context of a claw back claim. [7]  It would appear that the operating maxim is “equality is equity” and the courts will require cogent evidence to suggest any change of position would result in an oppressive inequity to the Net Positive Investor.[8]

[1] Re Diplock [1948] ChD 465;[1948] 2 All ER 318; Yorkshire Trust Co v. Empire Acceptance Co. [1983] CanLii 357, at para 10

[2] Williams v. Leonard & Sons [1896] 26 S.C.R. 406, at 410

[3] Royal Bank v. Safeco Ins Co. [1988] CanLii 3453 at para 48 (Alta, Master)

[4] Taylor v. Blakelock (1886) 32 ChD 560, atr 568

[5] International Longshore & Warehouse Union Local 502 v. Ford, 2016 BCCA 226 at para 47-9

[6] “Lipkin Gorman (a firm) v. Karpnale Ltd., [1991] 2 AC. 548 (UKHL) at p. 534(e).

[7] Samji (Trustee of) v. Whitmore [2107] BCSC 1917 at para 124; Den Haag Capital, LLC v. Correia [2010] ONSC 5339, at para 70; MGN Ltdf [2009} All ER 99, at para 33

[8] Re Titan Investments Ltd [2005] ABQB 637 at para 47; Principal Group v. Anderson (1997) AR 169, at para 47; RE Principal Group Ltd [1997] 200 A.R. 169, at para 11,`14, 16 (C.A>)