| Return to Contents Shorter Articles And Notes Constructive Trusts And All Crimes Money Laundering Legislation: Is There a Problem? Alan Binnington Introduction "There are topics of conversation more popular i houses than the finer points of the equitable doctrine of the constructive trust": so said Lord Lane C.J. in A-G’s Reference (No. 1 of 1985) [1] . The purpose of this article is to suggest that bankers who frequent the wine bars of jurisdictions which have all crimes money laundering legislation might find the topic somewhat more relevant than Lord Lane’s dictum would suggest. "All-crimes" money laundering legislation A number of offshore jurisdictions have either enacted, or are about to enact, "all crimes" money laundering legislation in a form which is broadly similar to the provisions of the Criminal Justice Act 1988 in England and Wales, as amended. Such legislation in effect requires financial institutions to "police" transactions, either by imposing a duty to report suspicious transactions or by providing that the making of such a report will act as a defence if the institution is charged with assisting another to retain the benefit of criminal conduct. In essence where a financial institution suspects that a person has engaged in criminal conduct and the institution is dealing with that person’s funds then it is under a duty to report its suspicions to the appropriate investigatory agency (in the U.K., the National Criminal Intelligence Service) and it should not thereafter deal with those funds without obtaining that agency’s consent. If it does deal with the funds without the agency’s consent then it risks committing an offence. In the majority of cases such consent is likely to be given, on the basis that if the funds were to be frozen the suspected person might be alerted to the fact that an investigation was under way and take steps to evade detection. Accordingly, the relevant agencies tend to allow the transaction to proceed and the funds to be transferred, possibly to another financial institution, but their destination would then be known to the investigatory agency. Compensating the victim Money laundering legislation deals with the proceeds of criminal conduct from the perspective of detecting, investigating and prosecuting criminals. It is not concerned to compensate the victim, which is the function of the civil courts. Whilst a significant proportion of the funds affected by this type of legislation are the proceeds of drug trafficking and will therefore not have readily identifiable "victims" of the criminal conduct there will be many cases where the funds have been generated by other criminal activities such as fraud, false accounting or forgery, in which case there are obvious victims who have suffered financial loss. English civil courts have, during the last decade, developed to a considerable extent the remedy of the constructive trust to assist victims in cases where there has been a breach of fiduciary duty giving rise to loss: a constructive trust being a trust which arises by operation of law rather than as a result of the express intention of the parties. The principle underlying the remedy is that where a person holds property in circumstances in which in equity and good conscience the property should be held or enjoyed by another, he will be compelled to hold the property on trust for that other. Such a trust is known as a constructive trust and if the constructive trustee parts with the funds to the prejudice of the beneficial owner he may be liable for breach of that trust. Knowing assistance and knowing receipt In the area of law dealing with breach of fiduciary duty constructive trusts tend to be applied on two bases, described as the "knowing assistance" basis and the "knowing receipt" basis. Where one is concerned with knowing assistance financial institutions have historically found themselves liable if they had merely helped another to carry out a fraud with the requisite degree of knowledge that they were helping the fraudster. In the case of knowing receipt the financial institution will have used the funds in question for its own benefit, perhaps by using them to repay a customer’s overdraft, and will be liable for the amount that it has received, rather than being potentially liable for the whole of the amount lost by virtue of the fraud, which would be the case in a knowing assistance case. These two categori liability stem from a dictum of Lord Selborne LC, sitting in the Court of Appeal in Chancery, in Barnes v Addy [2] . The essential elements in a knowing receipt ty of case were more recently stated by Hoffman L.J. in El Ajou v Dollar Land Holdings plc [3] : "For this purpose the Plaintiff must show, first, a disposal of his assets in breach of fiduciary duties; secondly, the beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiff; and thirdly, knowledge on the part of the defendant that the assets he received are traceable to a breach of fiduciary duty". Knowledge for these purposes goes beyond actual knowledge and may include what is described as "Nelsonian knowledge", involving the deliberate shutting of the eyes to what would otherwise be obvious, or knowledge in circumstances where the suspicions of an honest, reasonable man would have been aroused. In the case of knowing assistance the requisite elements under the Barnes v Addy formulation were first, a trust or other fiduciary relationship; secondly, a dishonest breach of fiduciary duty on the part of the fiduciary; thirdly, assistance by the defendant in that design; and fourthly, knowledge of some dishonest design. The potential problem What then, is the connection between all crimes money laundering legislation and the remedy of the constructive trust? The answer lies in the suggestion that reporting a suspicion under money laundering legislation may assist the victim to prove the necessary degree of knowledge or suspicion in order to fix the accessory or recipient of the funds with constructive trust liability. An example should make the way in which the argument runs clear: consider the position of a bank which receives funds into a customer’s account and has instructions to pay them on immediately to a third party. The bank is suspicious about the transaction and decides to make a report to the relevant investigatory agency. That agency tells the bank that the customer is under investigation for money laundering and in order not to alert him to the investigation tells the bank to proceed with the transaction. The monies are paid away. In due course the customer is prosecuted and convicted for having perpetrated a massive fraud on the company of which he was a director and the company seeks to recover its funds. The funds have long since disappeared and are irrecoverable but the company learns, during the course of the criminal trial, of the bank’s report of its suspicions. It now has all the necessary elements for a constructive trust claim if one applies the Barnes v Addy test: i) a fiduciary relationship, ii) a dishonest breach of fiduciary duty, iii) assistance by the bank in that design, and iv) knowledge, in the form of suspicion, on the part of the bank. By reporting its suspicions the bank has effectively provided the victim company with the evidence necessary to bring the claim: evidence which might otherwise have been difficult to prove. Avoiding the problem What, then, could the bank have done to avoid this situation arising? It could, of course, have failed to make the report in the first place. However, if it did that and parted with the funds then given that it turned out that the customer was in fact a fraudster it would have committed the offence of assisting another to dispose of the proceeds of criminal conduct. Not having made a report of its suspicions it would have prevented itself from relying on the statutory defence. The bank could, perhaps, have made an application to the Court for directions when the investigatory agency told it to proceed with the transaction. Some support for sucurse is to be found in the decision of the English Court of Appeal in Finers (a firm) and others v Miro [4] . In that case a firm of solicitors who held in their client account funds which they suspected might have been the proceeds of a fraud went to Court for directions as to how they should deal with the assets and, in particular, whether they should notify the alleged victim of the existence of the application. The judge at first instance, whose decision was upheld on appeal, directed that the alleged victim should be notified of the application and refused to order a payment out of the funds held by the plaintiffs. The Court of Appeal did, however, order the release of a small amount to the client of the firm to enable him to meet his legal expenses. Whilst the Finers decision may at first glance appear to provide a solution there are difficulties in relying on that decision in our example. Firstly, the application was not concerned with all crimes money laundering legislation and there was, therefore, no risk of the firm of solicitors committing the offence of "tipping off" a suspect by making their application. In our example, if the bank were to make any disclosure which could prejudice the investigation, then it would risk committing the offence of prejudicing an investigation ("tipping off"). It would therefore have to persuade the Court to hear the proceedings in camera. The course of notifying both the customer and the alleged victim of the application would clearly not be appropriate. It is therefore difficult to see what order the Court could make given that it was effectively being asked, on an ex parte application, to authorise the payment away of funds, possibly to the prejudice of the alleged victim. Furthermore, it may well be difficult to arrange a hearing at such short notice that the customer would not be alerted by reason of a delay in movement of his funds. The Finers v Miro approach may therefore be superficially attractive but may present considerable practical difficulties. The pn is not helped by a recent decision of the Chancery division of the High Court in United Mizrahi Bank Limited v Doherty and others [5] . In that case lawyers acting for a defendant accused of fraud and whose assets had been frozen by worldwide Mareva injunctions which contained a proviso allowing expenditure for reasonable legal costs, were unwilling to act for the defendant without the Court giving them comfort that any fees received by them from the defendant would not be made subject to a constructive trust claim in due course. The Court was not prepared to provide the defendant’s solicitors with a guarantee that should the proprietary claim made against the defendant be successful a claim in constructive trust could not be made against them for the monies paid for their services in defending the action. The Court made it clear that it is unlikely that any court would be in a position to give such a guarantee without being given the fullest possible information and that would clearly be difficult in a case where only the potential constructive trustee was before it. A possible legislative solution? What further comfort can be given to the bank in this case? One answer is provided by a provision in the draft all crimes money laundering legislation proposed for Jersey. In the money laundering legislation of most jurisdictions a person who discloses his suspicion to the relevant body is given protection from liability for breach of any duty of confidentiality by the use of words such as "the disclosure shall not be ated as a breach of any restriction upon the disclosure of information imposed by statute or otherwise" [6] or "the disclosure shall not be ed as a breach of any restriction upon disclosure of any information imposed by contract" [7] . The draft Proceeds of Crime (Jersey) Law 199- extends this protection by using the following wording: "the disclosure shall not be treated as a breach of any restriction upon disclosure imposed by statute, contract or otherwise, and shall not involve the person making it in liability o kind" (emphasis added) [8] . This wording is consistent with Article 9 of the European Union Money Laundering Directive of 1991 which provides that "the disclosure in good faith to the authorities responsible for combatting money laundering .... shall not constitute a breach of any restriction on disclosure of information imposed by contract or any legislative or regulatory or administrative provision, and shall not involve the credit or financial institution, its directors or employees in liability of any kind". The intention of the new wording in the draft Jersey law is to address the constructive trust problem although it has become a matter of debate whether the wording actually provides the protection that institutions require. The debate centres upon the interpretation that will be given to the words "shall not involve ..... liability". The question is whether it is the disclosure that gives rise to the liability or the suspicion. On one interpretation if the fact that an institution has disclosed a suspicion represents an essential component in proving liability as a constructive trustee, without which it would not be possible to make the institution liable, then the mere fact of disclosure will not, as a result of the wording of Article 32(3), be capable of rendering the institution liable. On the other hand, it is argued that the fact of disclosure only provides the evidence of a state of mind which already existed and which was based on circumstances known to the institution which can be proved without reference to the disclosure itself. On this interpretation the wording would not assist the institution in avoiding liability because it is the institution’s knowledge that renders it liable not the disclosure of its suspicion. Until the matter is considered by a Court it remains to be seen which interpretation is correct. Is there a problem at all? There is, however, a ray of hope for financial institutions, which is that in the circumstances under consideration there may not be a constructive trust problem at all. This arises from the way in which the law relating to constructive trusts has recently developed. In the above example one is dealing with a knowing assistance type of claim rather than a knowing receipt claim in that the bank is paying the funds away to a third party rather than using them for its own ben the recent decision of the Privy Council in Royal Brunei Airlines v Tan [9] the Privy Council, in dealing with knowing assistance claims, made it clear that what matters is the state of mind of the accessory, not that of the person who has committed the breach of fiduciary duty and that to be liable, the accessory must be dishonest. In the words of Lord Nicholls, delivering the judgment of the Privy Council, "in the context of the accessory liability principle acting dishonestly, or with a lack of probity, which is synonymous, means simply not acting as an honest person would in the circumstances. This is an objective standard". As far as concerns the person who committed the breach of fiduciary duty he made clear that "it is not necessary that, in addition, the trustee or fiduciary was acting dishonestly, although this will usually be so where the third party assisting him is acting dishonestly. 'Knowingly' is better avoided as a defining ingredient of the principle.....". Accordingly, it must be arguable that if a bank i) makes a report of its suspicions to an agency to which it has a statutory duty to make a report ii) is unable to make an application to the Court for directions because in doing so it may well risk committing the tipping off offence, and iii) complies with the directions of the agency in paying monies to a third party in circumstances where the destination of the funds is known to the agency, it should not be regarded as dishonest on an objective standard. In the judgment delivered by Lord Nicholls in the Privy Council "in most situations there is little difficulty in identifying how an honest person would behave". It must therefore be arguable that an honest person would do precisely what the bank in our example did. The answer to the bank’s dilemma may therefore be to say that the honest person is likely to comply with the directions of the police rather than to take steps which could potentially frustrate an investigation into serious criminal conduct. Accordingly it should not be made liable as a constructive trustee. If the courts take this view then the potential for constructive trust liability may be significantly reduced and the bank in our example will not have to rely on the wording in the draft Jersey law, useful as it may be. Obiter dicta of Michael Burton Q.C., sitting as a Deputy Judge of the High Court Mizrahi Bank Ltd v. Doherty [10] suggest that such arguments may find favour: referring to counsel for the bank's arguments in that case he said "Mr Richards himself has conceded that the ambit of a claim in constructive trust against solicitors in the light of such authorities as there were, at any rate before such changes in the law as there have been recently as a result of Royal Brunei Airlines v Tan... is such that the risk of liability for solicitors is not overly great. I hope that is right". Nevertheless only time will tell and it remains to be seen whether the courts approach the matter in a way which encourages institutions to report their suspicions without fear of constructive trust liability rather than to penalise them for complying with their statutory duties. If that happens, wine bar conversation can perhaps return to more popular subjects. Alan Binnington is an advocate of the Royal Court and a commercial litigation partner of Mourant du Feu & Jeune, 22 Grenville Street, St. Helier, Jersey JE4 8PX. |