The Jersey Law Review - February  2003

TRACING, FOLLOWING, AND CLAIMING THE PROCEEDS OF STOLEN ASSETS

Charles Mitchell

THE FACTS

1     Grupo Torras SA is a company owned by the Kuwait Investment Office.  Between 1988 and 1990, the chairman of the company (and of KIO) was Sheikh Fahad Mohammed Al-Sabah.  During this period, Sheikh Fahad conspired with others to defraud the company of around US$430 million.  His personal share of the proceeds was around US$120 million, some of which he paid to the trustees of various trusts that he had previously established in different jurisdictions around the world.  Two of these trusts were situated in Jersey, in  the sense that the trustee was resident in the Island and the trusts were governed by Jersey law.  The first trust was called the Esteem Settlement, and the second was called the Number 52 Trust. The trustee of both trusts was a company, Abacus (CI) Ltd, and the beneficiaries were Sheikh Fahad and members of his family.  Sheikh Fahad’s legitimate purpose at the time of setting up the trusts had been to avoid the Kuwaiti laws of forced inheritance and to shield his assets from the impact of UK taxation.  To this end, he had lawfully transferred various assets to Abacus out of his personal estate.  It was only later that he paid further money into the settlements that he had misappropriated from Grupo Torras.

2     In 1999 Grupo Torras obtained judgment against Sheikh Fahad in the English High Court for a total, with accrued interest, of around US$800 million.^[1]  However, it could not enforce its judgment against Sheikh Fahad personally, as he was declared bankrupt in the  Bahamas, where he lives.  Grupo Torras therefore sought to recover some of its money by registering its judgment against Sheikh Fahad in  Jersey under the Judgments (Reciprocal Enforcement) (Jersey) Law 1960, and bringing various claims against Abacus to recover the assets in the two  Jersey trusts.  After some lengthy procedural manoeuvring,^[2]these claims came on for trial in the  Royal Court, whose decision was handed down at the beginning of 2002.^[3]

THE LEGAL ISSUES

3     The claims by Grupo Torras raised many new and interesting points of Jersey law.  It is not proposed to discuss all of these here, and in particular it should be noted that although Birt DB examined the nature and scope of Pauline actions in some detail,^[4]his views on these matters will not be considered in this note.  It is proposed instead to focus here on his treatment of the question whether the proceeds of stolen assets can be traced, followed, and claimed from third party recipients under  Jersey law.

4     So far as the law of tracing and following was concerned, Birt DB made findings of  law  with  regard to the following questions, each of which will be discussed here in turn.  Does Jersey law permit a victim of theft to follow his property or its traceable proceeds from the hands of the thief into the hands of a third party    recipient? Does Jersey law permit a victim of theft to trace the     value inherent  in  his  stolen property through mixtures and  substitutions, with a view to identifying some other property as representing the traceable proceeds of his stolen property?  If so, does Jersey law use a ‘first in, first out’ rule to resolve evidential uncertainty where the victim’s money has been followed into the hands of an innocent third party who has mixed the money with his own money in a current bank  account?  Where the victim’s money has been followed into the hands of an innocent third  party who  is  the  sole shareholder of a company, and who has  lent the money to the company, can the victim trace into the third party’s right to recover the amount of the loan from the company?  Alternatively, in this case, can the victim trace through the loan into property acquired by the company with the money?  Finally, where the victim’s money is followed into the hands of an innocent third party who has used it to improve property that he already owns, can the victim trace into the increased value of the property? 

5     Turning to the law of claiming, Birt DB made findings of law with regard to these questions, each of which will also be considered here in turn. Does a thief hold stolen property on constructive trust for his victim?  If so, does the victim have a proprietary interest in the stolen property sufficient to enable him to assert a proprietary claim to the property or its traceable proceeds in the hands of a third party recipient?  If the victim can assert a proprietary claim to the traceable proceeds of his money, what is the juridical nature of this claim?  Is it a claim in unjust enrichment, or some other kind of claim?  Does the victim also have a personal clam in unjust enrichment against the third party?  Can these claims be met by the defence of change of position?  If so, what kinds of expenditure can be relied on by the defendant as constituting a relevant change of position?

TRACING AND FOLLOWING

The distinction between tracing, following, and claiming

6     In his discussion of tracing, Birt DB referred to Lord Millett’s analysis of the English law of  tracing in Foskett v McKeown^[5]and also to Lionel Smith’s authoritative book on the subject,^[6] and he purported to adopt the distinction which they both make between ‘tracing’ and  ‘following’.^[7]  Unfortunately, however, it seems that he did not fully appreciate the nature of the            distinction which they  both  also make between ‘tracing’ and ‘claiming’.  As a result, his discussion of the question of whether Jersey law permits tracing is confusedly intertwined with his discussion of the conceptually separate question of whether Jersey law permits the assertion of proprietary claims to assets once these have been identified as the traceable proceeds of the claimant’s stolen property.

7     To explain why this is important, we must go back to Lord Millett’s speech in Foskett, where he distinguished between tracing, following, and claiming - not because the  Jersey law in this area is necessarily the same as the English law, but because one cannot meaningfully compare the two without first establishing a stable definition of what these terms mean.  Lord Millett held as follows -

‘[Tracing and following] are both exercises in locating assets which are or may be taken to represent an asset belonging to the plaintiffs and to which they assert ownership.  The processes of following and tracing are, however, distinct.  Following is the process of following the same asset as it moves from hand to hand.  Tracing is the process of identifying a new asset as the substitute for the old.  Where one asset is exchanged for another, a claimant can elect whether to follow the original asset into the hands of the new owner or to trace its value into the new asset in the hands of the same owner.  ... Tracing is also distinct from claiming.  It identifies the traceable proceeds of the claimant’s property.  It enables the claimant to substitute the traceable proceeds for the original asset as the subject matter of his claim.  But it does not affect or establish his claim.  That will depend on a number of factors including the nature of his interest in the original asset.  He will normally be able to maintain the same claim to the substituted asset as he could have maintained to the original asset. ... But his claim may also be exposed to potential defences as a result of intervening transactions.”^[8]

8     In the words of another English judge, Moore-Bick J, Lord Millett therefore understood “the rules of following and tracing ... [to be] essentially evidential in nature”, and he considered them to be essentially distinct from “rules which determine substantive rights: the former are concerned with identifying property^[9] in other hands or in another form; the latter with the rights that a claimant can assert against the property in its present form”.^[10]

9          Reverting to Birt DB’s discussion, we can see that his understanding of ‘following’ was consistent with Lord Millett’s analysis, since he observed that following is “the process whereby property is identified and pursued in its original form as it moves from person to person”.^[11]  However, Birt DB failed similarly identify tracing as an evidential process, and instead he blurred the boundaries between tracing and claiming, referring at several points in his judgment to Grupo Torras’ claim against Abacus as a “tracing claim” or “proprietary tracing claim”.^[12]

Does Jersey law permit tracing and following?

10    This was not simply a terminological problem of minor importance.  The judge’s failure to distinguish clearly between claiming, on the one hand, and tracing and following, on the other, led him to make a false assumption about the nature of tracing and following that in turn caused him some difficulty when he came to consider whether the processes of tracing and following should be recognized in Jersey law.  Thus, he took as his starting point a passage of Lord Millett’s speech in Foskett which he construed to mean that “under English law, tracing is part of the law of property, not part of the law of unjust enrichment”.^[13]  Once he had accepted this premise, he was then obliged to take seriously counsel’s argument that Jersey law should not permit tracing because ‘the court should be very slow to adopt rules concerning the English law of property ... [as the] Jersey law of property has wholly different origins to that of  England.’^[14]  The only way for Birt DB then to reach the conclusion that he wished to reach, that Jersey law should indeed permit tracing and following, at least in the context of cases involving the misappropriation of assets held on express or constructive trust, was to hold that Jersey law should incorporate these concepts even though they derived from a foreign system of property law with very different roots from the Jersey law of property, and even though unforeseeable problems of ‘fit’ might therefore arise at some time in the future.

11     To be fair to the judge, he does not seem to have been particularly worried that such problems would arise, since he took the firm line that “there would appear to be no practical difficulty or any objection of principle to recognizing tracing of movable property ... [which] offers an effective method of vindicating and safeguarding proprietary rights”.^[15]  However, he could have dealt with counsel’s argument more elegantly - and more summarily - had he appreciated that Lord Millett never held that the English rules of tracing and following constitute part of the English law of property, in the sense that they are rules which govern the substantive content of claims to “vindicate proprietary rights”.  It is true that in the passage of his speech in Foskett that led Birt DB astray, Lord Millett held that “the transmission of a claimant’s property right from one asset to its traceable proceeds is part of our law of property, not of the law of unjust enrichment”.^[16]  But this was an observation about the law of claiming, not about the law of tracing - which is why we shall have to return to it later, when  we  come to discuss the juridical basis of proprietary claims to the traceable proceeds of stolen money.  But so far as tracing was concerned - and following for that matter - Lord Millett was perfectly clear in Foskett that although these may certainly be necessary evidential preliminaries to the assertion of a proprietary claim to the traceable proceeds of  misappropriated trust assets, they  do  not “affect or establish” the claimant’s substantive entitlement to assert a proprietary claim to these traceable proceeds.^[17]  Moreover, it is also plain as a matter of English law that tracing and/or following may be necessary evidential preliminaries to other types of claim than proprietary claims: for  example,  personal claims in unjust enrichment,^[18] and personal claims for dishonest assistance in a breach of trust.^[19]  Thus, whatever the rights and wrongs of Birt DB’s decision to adopt the House of Lords’ view in Foskett, that a proprietary claim to the traceable proceeds of stolen money lies against a third party recipient to vindicate the claimant’s continuing property rights, it could never have formed a serious objection to the reception of tracing and following into Jersey law, that these evidential processes were uniquely the creation and tool of English property lawyers.

12     The same point can also be made with regard to Birt DB’s treatment of the Jersey authorities that were cited to him by counsel for Grupo Torras, for the proposition that Jersey law permits tracing and following, at least in the context of a case concerning the recovery of stolen assets which were previously held on express or constructive trust.  Two cases were relied on for this proposition - Re PKT Consultants (Jersey) Ltd^[20] and Royal Bank of Scotland Ltd v Khan^[21]- in both of which the Royal Court had considered that the law of tracing formed part of its inherent equitable jurisdiction to remedy fraud.  Given that tracing (and following) are essentially evidential processes, there was nothing objectionable to the Royal Court’s findings to this effect, but again Birt DB was persuaded that these cases could not simply be taken at face value because “tracing is to be regarded as part of the law of property, not part of equity’s ability to do justice.”^[22]  For the reasons already stated, this was to misunderstand the function and juridical nature of the tracing rules.

13     Counsel for Grupo Torras also referred Birt DB to the Trusts (Jersey) Law 1984, article 50(3), the amended form of which states that “trust property ... alienated or converted in breach of trust or the property into which it has been converted” can be ”followed and recovered”.  Birt DB interpreted this to mean that Jersey law “recognizes the ability to trace assets into which trust property has been converted”, and considered that in principle this should be allowed not only “in cases of a constructive trust arising from breach of an express trust [but also] ... in cases of a constructive trust arising from fraud by a person owing another type of fiduciary obligation, e.g. a company director”.^[23]  Taken in combination with the cases mentioned above, this led him to conclude that “the principle of tracing forms part of the law of Jersey where there is an underlying proprietary interest on the part of the claimant”,^[24] a statement of the law that was sufficient to resolve the issues in the present case, but which left open the question whether Jersey law should also permit tracing (and following) by claimants whose ultimate purpose is not to assert a proprietary claim to assets in a defendant’s hands, but which is to make a personal claim of some kind, for example, a claim in unjust enrichment.

The content of the Jersey tracing and following rules

14     Having held that Jersey law permits tracing and following, the next question for Birt DB to decide was the content of the tracing and following rules that the Jersey courts should apply.  He began with the statement that ‘the rules to be applied should, as a starting point, be those established in English law’, but he then added straight away that ‘the court is not bound by any English rule of tracing and is free to depart from such a rule if convinced that there is a better alternative’.^[25]  Approaching the matter in this light, he then proceeded to make a series of important and interesting holdings with regard to the content of the Jersey rules.

(a)    Different rules at common law and in equity?

15     Birt DB referred to the English debate “as to whether the time has come for the common-law tracing rules to be subsumed into the more flexible rules of equitable tracing”,^[26] and although he did not take the point that Lord Millett and Lord Steyn both expressly said in obiter dicta in Foskett that the time for this has indeed come as matter of English law,^[27] he did express the ‘preliminary view” that -

“the differences between the two systems of tracing in England have an historical origin which has no application in Jersey.  On the face of it, there would seem to be little reason to incorporate such technical distinctions into Jersey law and there would seem to be some advantage in applying the more flexible rules of equitable tracing (as constituting the Jersey rules of tracing) to all tracing actions.”^[28]

16     This was an eminently sensible approach, and it is to be hoped that the Jersey courts will take the same line in future cases, since the traditional English bifurcation of the tracing rules has had very little to recommend it, whether considered as a matter of principle or as a matter of authority.

17     The  traditional English view prior to Foskett was that there are different tracing rules in equity and at common law, and  that  the equitable tracing rules are more favourable to claimants than the common law tracing rules, most noticeably because the common law does not permit claimants to trace through mixtures of money in  bank  accounts at common law, something which the equitable tracing rules allow.^[29]  The English courts also said for many years that a claimant must show that his property was held on trust or that it was subject to some other fiduciary relationship before he can take advantage of the equitable tracing rules with a view to tracing through mixtures in bank accounts.^[30]  In principle it was undesirable for the English courts to restrict the availability of the equitable tracing rules in this way, since the restriction could operate to keep common law claimants out  of their rights for no good reason, and  therefore  created a pressure on the courts to recognize fiduciary relationships in circumstances where such a finding was hard to justify on the facts.   So, for example, the courts were prompted to hold that a thief owes a fiduciary duty to his victim even though the two have previously had no kind of relationship at all,^[31] a finding which debased the currency of the fiduciary concept, and ran counter to Sopinka J’s salutary warning in the Supreme Court of Canada, in Norberg v Weinrib,^[32] that “equitable doctrines cannot be   imported  simply in order to improve the nature and extent of the remedy”.

18     Moreover, as Lionel Smith has lucidly explained,^[33] the view that different rules should be applied at common law and in equity was always suspect as a matter of authority, since it was inconsistent with a long line of cases in which the courts did not require claimants to establish a fiduciary relationship before invoking the equitable tracing rules with a view to showing that their money had been used to pay off securities to which they sought to be subrogated.^[34] It was also inconsistent with  Marsh v Keating,^[35] in which the House of Lords, advised by twelve common law judges, was willing to accept that the common law could trace through a mixed bank account.  It also depended on Viscount Haldane LC’s finding in Sinclair v Brougham^[36] that there can be no tracing at common law where money has been lent and placed in a bank account, which was founded on a misunderstanding of Thesiger LJ’s previous, undoubtedly correct, statement in Re Hallett’s Estate,^[37] that a claimant who makes an unsecured loan to a defendant cannot as a general rule make a proprietary claim to the defendant’s assets to secure repayment of the loan.

(b)    The ‘first in, first out’ rule

19     A further rule of the English law of tracing which Birt DB chose not to adopt into Jersey law - and which, again, he was surely right to reject - was the rule that where an innocent volunteer mixes stolen trust funds with his own money in a current bank account, with the result that it becomes impossible to identify subsequent withdrawals as representing the traceable proceeds either of the trust money or of the volunteer’s money, then the ‘first in, first out’ rule should be used to identify the source of withdrawn funds.

20     The authority which the English courts generally cite for this rule is Clayton’s case,^[38] although as Lionel Smith has observed,^[39] Clayton’s case was not itself a case that concerned a dispute between two innocents whose money had become mixed in a bank account as a result of a third party’s wrongdoing, but was instead concerned with the allocation of deposited funds as between a banker and customer.  Moreover, although ‘first in, first out’ was still regarded by the English Court of Appeal as the basic English rule in Barlow Clowes International Ltd (in liq) v Vaughan,^[40] the court accepted there that the rule could be displaced if the terms of the parties’ relationship were inconsistent with its application, in which case a ‘proportional allocation’ method would be used instead - i.e. each withdrawal should be treated as “a withdrawal in the same proportions as the different interests in the account ...      bear to each other at the moment before the withdrawal is made”.^[41] Since then, the view that ‘first in, first out’ represents the basic English rule has been weakened still further by the fact that it is predicated on an understanding of the nature of a bank account - that it consists of stacked units of value - that is inconsistent with Lord Millett’s view in Foskett that a bank account consists of a uniform mixture of value.  Thus, in Lord Millett’s words -

“We speak of money at the bank, and of money passing into and out of a bank account. But of course the account holder has no money at the bank. Money paid into a bank account belongs legally and beneficially to the bank and not to the account holder.  The bank gives value for it, and it is accordingly not usually possible to make the money itself the subject of an adverse claim. Instead a claimant normally sues the account holder rather than the bank and lays claim to the proceeds of the money in his hands. These consist of the debt or part of the debt due to him from the bank. We speak of tracing money into and out of the account, but there is no money in the account. There is merely a single debt of an amount equal to the final balance standing to the credit of the account holder.”^[42]

21     Laying to one side the question of the present status of the ‘first in, first out’ rule under English law as a matter of authority, there is in any case a more fundamental reason why Birt DB’s decision not to receive the rule into Jersey law should be applauded, namely that the rule can produce capricious and arbitrary results.  Where money belonging to two innocents is mixed together in such a way that it becomes impossible to identify withdrawals from the mixture as representing the traceable proceeds of money belonging to one or the other, then the only fair way to resolve this  evidential uncertainty is to use the ‘apportionment method’.  The fact that the mixture takes place in a bank account should not affect this conclusion.  The courts of various other jurisdictions have previously rejected ‘first in, first out’ for this reason,^[43] Birt DB was right to do the same thing, and it is high time that the English courts followed suit.^[44]

(c)    Loans by a third party recipient to a wholly owned company

22     Where stolen money is paid to an innocent third party recipient, who then lends the money to an unconnected person, there would seem to be no objection in principle to the victim following the money into the hands of the third party recipient, and then tracing the value inherent in the money into the value inherent in the third party’s contractual right to recover the money from the borrower, with a view to acquiring this right from the third party by subrogation.  Moreover, if the borrower has not acted in good faith, and therefore cannot argue that he is a bona fide purchaser without notice of the money’s tainted source, then there would seem to be no objection in principle to the victim following the money into the borrower’s hands, and then tracing into assets purchased by the borrower with the money.

23     On the facts of the present case, however, Birt DB had a rather different question to decide.  After Sheikh Fahad had wrongfully paid money stolen from Grupo Torras to Abacus, Abacus had in turn lent some of this money to a Jersey company, Esteem Ltd, that was wholly owned by Abacus.  Esteem  Ltd  had  then used this money to purchase  property  in London.  In the English proceedings which prefigured the present action, Grupo Torras  had argued that it should be entitled to follow and trace its money into this property, with a view to asserting a proprietary claim to the property as the traceable proceeds of Grupo Torras’ money.  Mance J had held that Grupo Torras was entitled to do this, and that Esteem Ltd was not entitled to raise the defence of bona fide purchase to Grupo Torras’ claim.^[45]  In the present action, the question then arose whether Grupo Torras, having previously recovered property that had been purchased with some of the loan money in the English proceedings, should be entitled to recover the balance of the loan money from Esteem Ltd?

24     Birt DB held that Grupo Torras was not entitled to do this.^[46]  He gave two reasons for his decision.  One was that Grupo Torras had elected to trace into Esteem Ltd’s assets in the English proceedings on the basis that Esteem Ltd had provided no true value in exchange for the money it had received from Abacus, and in light of this fact, it could not now be heard to argue that the loan arrangement was a bona fide arm’s-length transaction after all.  The other, less convincing, reason was that allowing Grupo Torras to enforce the loan against Esteem Ltd would be to ignore the economic reality that Esteem Ltd was wholly owned by Abacus, and that when Abacus had lent the money to Esteem Ltd it was neither better nor worse off than it had been before.  In these circumstances, in Birt DB’s view, it would be ‘artificial’ to treat Esteem Ltd as a bona fide purchaser for value of the money, with the result that the tracing (and following) process would have to stop at the relationship between Abacus and Esteem.  And for this reason, he considered that as a general rule, “where there is a wholly owned company ... the tracing exercise must be continued into what the company did with the proceeds.”^[47]

25     With respect, this was false reasoning.  It does not follow from the fact that a claimant is entitled to follow his money into the hands of a borrower from a third party recipient that the claimant must be obliged to do this, and must be forbidden to halt the tracing and following process at an earlier stage even though it suits him to do so.  Moreover, the rules of company law suggest that Birt DB’s analysis was faulty for another reason as well.  It is a fundamental principle of company law that a company and its shareholders have separate legal personalities, and to persuade a court to depart from this orthodoxy it is generally necessary to show that the company law rules are being relied upon in furtherance of fraud.  But Birt DB has things the other way around. He has held that a victim of fraud cannot insist upon the separate legal personalities of the recipient and his wholly owned company, even though the effect of this is to prevent the victim from recovering his fraudulently misappropriated money, and even though the court should normally treat the company and the shareholder as legally separate entities in any case.

(d)    Improvements to property

26     The final question relating to the content of the Jersey tracing rules that Birt DB decided was this: if stolen funds are followed into the hands of an innocent recipient, who uses them to improve property that he already owns, then should the victim be entitled to trace the value inherent in his money into the resultant increase in the property’s value?  Birt DB gave an affirmative answer to this question.  He began by holding that Jersey law should adopt the English rule laid down in Re Diplock,^[48] that “where funds being traced are mixed with an innocent recipient’s funds and used to purchase real property, the funds can be traced into that property.”^[49]  He then reasoned that it would be inconsistent with this rule to hold that a claimant cannot trace into the increase in value to property already owned by an innocent recipient when the claimant’s money is used to improve the property.  There is an appealing fairness to this rule, although it can be foreseen that applying it in a case where there is a rising (or falling) property market will create some evidential problems, of the same sort, indeed, as those which Birt DB had to address elsewhere in his judgment when he had decide whether a  defendant’s expenditure on repairs to property that remains in the defendant’s hands should count as relevant expenditure for the purposes of a change of position defence, if the repairs do not cause the property to increase in value.^[50]

27     There is one aspect to Birt DB’s findings on this point that may require further thought, however.  In his view, tracing into repairs to pre-existing property should be permitted only where they have caused the property to increase in value, and where a claimant’s money has been used to pay for repairs to property that do not bring about an increase in value, then “there can be no tracing as the funds will have been lost.”^[51]  Laying to one side the evidential problems created by rising or falling markets, this limitation on the principle also leaves out of account the fact that real property does not hold its value even when the property market is steady.  If houses are not maintained they fall into disrepair, and they fall in value.  This suggests that Birt DB’s conception of the value of real property is too static.  To the extent that repairs to property prevent it from falling in value they should be regarded as leaving a traceable residuum in the owner’s hands, and they should not be treated as a dissipation of funds in line with Birt DB’s finding.

28     Finally, we may note that Birt DB approached the whole issue of repairs on the basis that English law does not allow claimants to trace into improvements to an innocent third party’s property even where these have caused the property to increase in value.  For this proposition he relied on the Court of Appeal’s finding to this effect in Re Diplock.^[52]  This does seem to have been the most recent English case in which the court’s remarks on the point have counted as ratio. In Foskett, however, Lord Browne-Wilkinsonmade the obiter observation that where -

“moneys of one person have been innocently expended on [maintaining or improving] the property of another ... [it is] clear that ... [this expenditure] normally gives rise, at the most, to a proprietary lien to recover the moneys so expended.”^[53]

29     Allowing a claimant a proprietary lien over a defendant’s assets, even though this is a security interest for a fixed sum of money rather than a pro rata ownership right, can only be justified in principle if the claimant is able to trace the value inherent in his money into the improvements to the defendant’s property.  Otherwise there is no link between the claimant’s money and the defendant’s property sufficient to justify the imposition of a lien on the property.^[54]  Hence Lord Browne-Wilkinson’s dictum is incompatible with the Court of Appeal’s view in Re Diplock that tracing is impermissible in the situation to which he refers, and it would therefore seem that the English law on this point is in need of clear judicial restatement one way or the other.

CLAIMING

30     The point has been made already that Birt DB’s discussion of the question whether Jersey law permits the victims of theft to assert a proprietary claim to the traceable proceeds of their money is unfortunately confused with his discussion of the question whether Jersey law permits tracing and following.  This makes it difficult to interpret some of things that the judge says about proprietary claims of this kind, and their connection with the personal claim in unjust enrichment to which the victim might also be entitled.

Does a thief hold the stolen property on constructive trust for his victim?

31     Birt DB began his discussion of proprietary claims with the bold assertion that under English law it is ‘clear’,^[55] following Lord Browne-Wilkinson’s speech in Westdeutsche Landesbank Girozentrale v Islington LBC,^[56]that “when property is obtained by fraud equity imposes a constructive trust on the fraudulent recipient: the property is recoverable and traceable in equity”.  Birt DB then proceeded to adopt the same rule into Jersey law, and to apply this rule to the facts of the present case to reach the conclusion that Sheikh Fahad had held the money he had defrauded from Grupo Torras on constructive trust for Grupo Torras.

32     It is of course true that Lord Browne-Wilkinson said  in Westdeutsche that a thief holds stolen property on constructive trust for his victim, but it would be overstating matters to say that English trust lawyers have all happily reconciled themselves to the truth of this statement.  His Lordship admitted that “it is difficult to find clear authority for the proposition”,^[57] and it seems to be connected in his speech with the further, highly controversial, proposition that personal restitutionary claims can be transformed into proprietary restitutionary claims whenever it can be shown that a defendant who was unjustly enriched at a claimant’s expense received the benefit with knowledge of its tainted source.^[58]  For these reasons, it may be that Birt DB has committed Jersey law to a rule about the imposition of constructive trusts that Jersey lawyers will come to regret, for reasons of ‘proprietary overkill’ - and in circumstances, moreover, where it was unnecessary for him to have done so, given that Sheikh Fahad was a company director who was in clear breach of his duties to his company, and given that a constructive trust could therefore have been imposed on the stolen money on this more limited ground.

Does the beneficiary of a constructive trust have a proprietary interest in the trust property?

33     The Jersey law of property is based on the civil law, which does not recognize differences between legal and equitable ownership.  It might therefore be argued - and indeed, in the present case it was argued - that Jersey law does not acknowledge that the beneficiaries of Jersey trusts have a proprietary interest in the trust assets, and instead confines them to a personal right against the trustees to compel due administration of the trust.  Birt DB rejected this argument, holding, first, that Jersey law has adopted the English rule that the beneficiaries of express trusts have a proprietary interest in the trust assets, albeit that in Jersey this is not styled an ‘equitable’ interest,^[59] and secondly, that by extension the beneficiaries of constructive trusts have the same thing,^[60] a reading of Jersey law that he considered to be consistent with the Trusts (Jersey) Law 1984, article 29 (3) of which provides that -

“a person who is or becomes a constructive trustee shall deliver up the property of which he is constructive trustee to the person properly entitled to it.”

Can the beneficiary of constructive trust assert a proprietary claim to the traceable proceeds of the trust assets against a third party recipient?

34     To this question Birt DB gave an affirmative answer, although this is not immediately apparent from his judgment, since his findings on the point are made under the heading ‘Does Jersey law permit tracing?’, which is a conceptually separate question.^[61]  It seems, though, from his comment that “tracing offers an effective method of vindicating and safeguarding proprietary rights”,^[62] that Birt DB meant to make findings with regard to claiming as well as tracing in this section of his judgment.  It also seems that he meant to adopt into Jersey law the rule of claiming laid down by the majority of the House of Lords in Foskett,^[63] that a trust beneficiary can assert a proprietary claim to assets in the hands of a third party recipient that are the traceable proceeds of misapplied trust property, not because the recipient has been unjustly enriched at the beneficiary’s expense, but because the law of property provides the beneficiary with the means of ‘vindicating’ his continuing proprietary entitlement to the trust property and its traceable proceeds.

35     The House of Lords’ reasoning in Foskett has not been universally accepted, and some commentators remain wedded to the view that the beneficiary’s entitlement derives from the law of unjust enrichment where a defendant has enriched himself by using the beneficiary’s property to acquire a new asset for himself without the beneficiary’s consent.^[64]  The main objection to their Lordships’ analysis is that they presume what they seek to prove, namely that the equitable owner of an asset always has an equitable proprietary interest in a substitute asset acquired with the original asset.  In their Lordships’ view, it lies in the nature of equitable property rights that the owner’s interest in the original asset always detaches itself from the original asset and re-attaches itself to the new asset whenever the assets are exchanged without the owner’s consent.  However, their Lordships do not explain why the owner’s interest should behave in this way, and their analysis runs counter to a more orthodox view of property rights, that a property right is a right in property that cannot be detached and re-attached to some other property and still be the same right.

36     Without suggesting that Birt DB has reached the wrong result in the present case, we may therefore conclude that he has committed Jersey law to an understanding of the way in which property rights work that is at the very least controversial, if not unsound in principle.

Does the beneficiary of a constructive trust have a strict liability personal claim in unjust enrichment to recover the value of trust funds or their traceable proceeds from a third party recipient?

37     Birt DB gave a positive answer to this question, too, adopting the view expressed extra-judicially by Lord Nicholls that in principle it should be unnecessary to require a beneficiary to prove fault on the part of a third party recipient of misapplied trust funds before he can have a personal claim to recover the value of the funds.^[65]  In recent cases, various English judges have also hinted strongly that they are poised to move English law in this direction when the opportunity presents itself.^[66]  In the event that they do so, the question will arise for English lawyers that has now arisen for Jersey lawyers as a consequence of Birt DB’s various findings in the present case, namely whether a beneficiary’s proprietary claim to ‘vindicate’ his ‘subsisting’ property rights in the traceable proceeds of misapplied trust property should be lined up with his personal, strict liability claim to recover their value from a third party recipient, either on the basis that they should both properly be understood as claims to ‘vindicate proprietary rights’,^[67] or on the basis that they are both claims in unjust enrichment.

Change of position defence

38     At least to the extent that either claim is founded in unjust enrichment, it is now also clear following Birt DB’s judgment in the present case that it could be met by a change of position defence.^[68]  The judge had to consider various arguments in relation to the operation of this defence, two of which will be highlighted here.

39     First, the question arose whether a third party recipient of misapplied funds who uses these funds to improve or repair property should be entitled to raise a change of position defence in the event that he would not otherwise have spent money on the improvements or repairs.  Birt DB held that a change of position defence might be relied on in these circumstances, but only to the extent that the value inherent in the money was lost because the improvements or repairs did not produce an increase in the property’s value.^[69]  In line with the comments made earlier, this finding could usefully have been nuanced to recognize that repairs to real property should not count as dissipations to the extent that they slow or halt a decline in the property’s value.

40     Secondly, the argument was made by Grupo Torras that Abacus should not be entitled to rely on any changes in its position as a defence to Grupo Torras’ claim, because it would not be inequitable in all the circumstances to require Abacus to repay Grupo Torras in full, even though this would leave it worse off than it had been before Sheikh Fahad paid it the stolen money.  Grupo Torras argued that this would not be unfair because all of Abacus’ other assets had come from Sheikh Fahad as well, and that making Abacus repay in full would therefore be consistent with Lord Millett’s dictum in Foskett that -

“It is morally offensive as well as contrary to principle to subordinate the claims of the victims of fraud to those of the objects of a fraudster’s bounty on the ground that he concealed his wrongdoing from both of them.”^[70]

41     Birt DB rightly rejected this argument on the basis that Lord Millett’s comment was made -

“in the wholly different context of who should receive a windfall obtained as a result of the transaction in question.  We do not think that he was suggesting that one could strip a volunteer recipient of an earlier gift which was perfectly legitimate and not itself liable to be made on any grounds.”^[71]

42     In other words, forbidding Abacus to raise a change of position defence on the ground that it should be made to disgorge the money which it had legitimately received from Sheikh Fahad as well as the stolen funds he had handed over went beyond the restitutionary principle and was tantamount to awarding a punitive remedy where this was not justified on the facts.

CONCLUSION

43     The laws of tracing, following, and claiming raise many difficult points, not the least of which is the relationship between personal and proprietary claims in unjust enrichment, and claims to ‘vindicate’ a claimant’s ‘subsisting’ property right in the traceable proceeds of his assets.  It may well be that these matters will have to be revisited by the Jersey courts several times before clarity is finally achieved - the English experience certainly suggests as much - but Birt DB has begun the process in an interesting if controversial fashion, and at the same time he has decided several points of the Jersey law of tracing and following in a positive and sensible way.^[72]

Charles Mitchell is a Reader in Law, King’s College London

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