Oxford University Press's
Academic Insights for the Thinking World

Backward tracing

Some of the controversies in contemporary equity are of both theoretical and practical significance. This is particularly true of the controversy concerning so-called “backward tracing”.

If a defendant misappropriates trust money in order to buy a car, then the beneficiary can trace the value of his equitable proprietary interest in the money into the car. This is straightforward, since each stage of analysis goes “forwards” in time. But what if the car has already been purchased by the defendant by taking out a loan, and the defendant only later misappropriated the trust money in order to pay off the loan. Can the beneficiary still trace into the car? (It will not usually be possible to bring a proprietary claim against the lender because of the defence of bona fide purchaser). The traditional approach of English law has been to say that the beneficiary cannot trace into the car because this would involve “backward tracing”: a beneficiary is not able to trace into property that was already in the defendant’s possession before the beneficiary’s money was received, because the defendant’s property cannot then be regarded as representing the beneficiary’s money. On this view, tracing does not go backwards in time.

However, this traditional understanding of tracing appears to have been departed from in recent cases. This was implicit in the decision of the Court of Appeal in Relfo Ltd v Varsani and explicit in the advice of the Privy Council in The Federal Republic of Brazil v Durant International Corporation. In the latter case, the municipality of Sao Paolo brought claims against companies controlled by its former mayor and his son. The defendants had accepted bribes and then laundered the money received. The bribe money had been received by the controller of the companies and paid into a bank account in New York, from which payments were made to the defendant’s bank account in Jersey. The difficulty in this case was that some of the money paid into the New York account was credited only after money had been transferred to the Jersey account. It was necessary for the Privy Council to decide whether it was possible to trace from the New York account into the Jersey account even though the Jersey account had been credited before the New York bank account had been debited. It was acknowledged that this was typical of modern banking practice, and common in instances of money-laundering.

the Privy Council clearly held that there are limits to backward tracing.

Lord Toulson, giving the advice of the Board, recognised that backward tracing would be possible where there was “a close causal and transactional link between the incurring of a debt and the use of trust funds to discharge it”. The focus should be on the substance of the transaction and not on the strict order in which associated events occur: “the claimant has to establish a coordination between the depletion of the trust fund and the acquisition of the asset which is the subject of the tracing claim”. On the facts of the case it was possible to establish the necessary connection between the payment of the bribes from the New York account and the credit to the Jersey account, regardless of the precise order in which the debit and the credit occurred.

The recognition of backward tracing in Brazil v Durant is helpful in helping to combat fraud and money laundering. As a decision of the Privy Council on appeal from Jersey, it is, strictly, merely persuasive and not binding upon English courts (although the status of Privy Council judgments is currently being considered by the Supreme Court in Willers v Joyce). Nevertheless, it is highly likely that Brazil v Durant will be followed by English judges. Yet the Privy Council clearly held that there are limits to backward tracing. The Privy Council did not wish to expand equitable proprietary remedies in ways which may have adverse effects on innocent parties, such as the unsecured creditors of the defendant.

Where a defendant incurred a debt in order to acquire an asset, and always planned to discharge the debt with a beneficiary’s property, then this seems likely to satisfy the “coordination” and “close causal and transactional link” requirements demanded by the Privy Council. In these circumstances, allowing the beneficiary to assert a proprietary interest in the acquired asset might not unfairly prejudice the defendant or other creditors since the asset would never have been acquired by the defendant had he or she not known that he or she would be able to exploit the beneficiary’s property. The situation might be considered to be different where the trustee unwittingly misappropriated a beneficiary’s money in breach of duty, and discharged a debt that he or she had acquired long before. For example, if the trustee paid off the entirety of a mortgage taken out many years ago to purchase a house, it might seem unsatisfactory to allow the claimant to trace backwards through the debt, into the house, and then assert beneficial ownership of the house.

This is because, if the house has risen in value, the claimant would, fortuitously, receive the benefit of this increase. Such an outcome might be considered to be harsh on the trustee who made the sound investment decision to purchase the house long before, and who might have been able to pay off the mortgage with other funds anyway.  In such a situation, it is unlikely that there is any “coordination” or “close causal and transactional link” that would enable the claimant to trace backwards. The boundaries of backward tracing still need to be made clear, but it is suggested that the judgment in Brazil v Durant International Corp is to be welcomed since it allows courts to provide remedies for fraud and money laundering more effectively and in a principled way.

Featured image credit: Credit card, by jarmoluk. CC0 public domain via Pixabay.

Recent Comments

  1. Lambertha McCarrell

    If someone was deceived into signing for a L.O.C. As a cosigner to purchase a house, then the house was mortgaged 6 months later into someone else’s name, then sold 1 1/2 years later for double the profit. Does this person have any rights?

Comments are closed.