The Tracing Rules - Essay Example

When a plaintiff attempts to trace, he is asserting that some new asset was acquired with the use of another. For example is the case in which the plaintiff's asset is exchanged by a defendant for some other asset, and the plaintiff wants to trace into the new asset. The only connection which the plaintiff has to the new asset is that it was acquired with the old asset. The defendant acquired the value inherent in the new asset with the value inherent in the old asset. The plaintiff must have something of value. Generally, he must have an asset; that is, a legal or equitable right, which is not held by everyone. It need not be a proprietary right. Often the tracing exercise begins with a bank account, which is a personal right against a bank.1 And sometimes, the repository of value with which the plaintiff begins is not a right at all, but is rather in the form of services. Services can enhance the value of assets, and in this way the value inherent in the services can be traced into the enhanced asset. It is sometimes said that a prerequisite to tracing in a court of equity is the establishment of a fiduciary relationship.2 If this were true, the consequences would be startling. A trustee sells trust land, and deposits the proceeds into a bank account into which he has earlier deposited some money of his own. A court of equity will allow the beneficiary to trace from the land, previously owned by the claimant in equity, into the balance in the bank account. It will also allow claimant to assert equitable proprietary rights in the bank account; that is a separate issue. On the other hand, a thief steals some money from claimant and pays it into a bank account into which thief has earlier deposited some money of his own. The tracing exercise would appear to be even simpler. But the thief does not owe fiduciary obligations to claimant. If it is true that a fiduciary relation is a prerequisite to tracing in a court of equity, then a court of equity is unable to trace into the bank account in the second situation. This seems absurd. What could possibly be the reason for such a requirement The standard explanation is that it is necessary to found the jurisdiction of equity: Agip ( Africa) Ltd v. Jackson. When a plaintiff wishes to conduct the exercise of tracing, he wishes to establish that the value inherent in his asset has been used to acquire another asset. That alone neither gives nor denies hearing jurisdiction to the Court of Chancery or its successor, a court exercising equitable jurisdiction. If the plaintiff is seeking specific performance or rectification, then the Court of Chancery would have hearing jurisdiction, and it would allow him to try to prove the making of the contract. If he was merely seeking damages for breach of contract, then the Court of Chancery had no order jurisdiction to grant that remedy and so it would decline hearing jurisdiction.3 The exercise of proving the existence of the contract is neither peculiarly equitable nor peculiarly legal.4 The fact that a plaintiff wishes to trace is not determinative of whether the court has hearing jurisdiction. It is an exercise which is neither peculiarly equitable nor peculiarly legal. Moreover, it is neither peculiarly proprietary nor peculiarly personal; tracing is not a right but an exercise. But equitable rights, properly so called, are different in many ways from common law rights, and so the relief sought by the plaintiff is peculiarly equitable or peculiarly legal. Whether or not there is equitable jurisdiction to hear a claim is determined by the relief which is sought. If the plaintiff asserts that she holds equitable proprietary rights in some new asset, then that is a claim which only a court of equity can evaluate; and that is the source of the court's hearing jurisdiction. But it makes no sense that a plaintiff should have to establish a fiduciary relationship merely to conduct the exercise of showing that her asset was used to acquire some other asset. When the Court of Appeal expressed its view that a fiduciary relationship was a prerequisite to tracing in equity, it cited no authority. It appeared to be agreeing with Millett J in the Court below; that learned judge was of the view that the requirement 'depends on authority rather than principle',5 but that it had been settled in Re Diplock.6 An examination of the history of this idea shows that it must be regarded not only as illogical, but also as unsupported by authority. All of the cases commonly cited in support of it are not concerned to impose prerequisites to the exercise of tracing, but rather to the ability of a plaintiff to assert equitable proprietary rights in the traceable proceeds of the plaintiff's value. The story begins with Re Hallett's Estate,7 the earliest case which is sometimes cited as authority for this supposed requirement. But it is important to observe that there are cases before Re Hallett's Estate in which courts of equity embarked on tracing exercises without any hint that there had to be a fiduciary relationship.8 Hallett was a solicitor who was a bailee of certain Russian bonds for Cotterill, one of his clients. He sold them without her authority and paid the proceeds into his bank account. Hallett also held some bonds of the same type on trust for the trustees of his marriage settlement. He sold some of these bonds without their authority, again paying the money into his bank account. When Hallett died insolvent, Cotterill and the trustees claimed that they could trace the value inherent in the bonds into Hallett's bank account. They argued that in consequence, they held equitable proprietary rights in the bank account, and that this required Hallett's executor to pay their claims in full out of the bank account. The executor argued that they did not have any proprietary rights and so did not have priority; they had to submit their claims along with other unsecured creditors of Hallett. The case is important because an issue arose as to whether the position of Cotterill was different from that of the trustees. The trustees' claim was based on an express trust in which Hallett was the trustee. Cotterill's claim was based on a bailment, under which she was the legal owner of the bonds in question. In these circumstances, the question was whether Cotterill could trace from her bonds into Hallett's bank account, and if so, whether she could establish equitable proprietary rights in the account. At first instance, Fry J decided that she could do both. In the Court of Appeal, Jessel MR said: 'Has it ever been suggested, until very recently, that there is any distinction between an express trustee, or an agent, or a bailee, or a collector of rents, or anybody else in a fiduciary position . . . Therefore, the moment you establish the fiduciary relation, the modern rules of Equity, as regards following trust money, apply.' This last sentence can be interpreted in different ways. In Sinclair v. Brougham,9 a building society carried on an ultra vires banking business. On its liquidation, the question was what claims could be made by the customers of the banking business. Viscount Haldane LC clearly approved of the decision in Re Hallett's Estate. He relied on it as authority for equity's ability to declare a charge on a bank account, and as establishing that this equity was not confined to cases of trust in the strict sense, but applied at all events to every case where there was a fiduciary relationship. Viscount Haldane LC was referring to the ability to establish a charge -- that is, an equitable proprietary right -- and not to the ability to undertake the tracing exercise. Lord Parker also referred to the presence of a fiduciary relationship and equitable ownership, not making clear whether he thought it was necessary or sufficient; but again, it seems that he was discussing the plaintiff's ability to establish a charge, not the plaintiffs ability to conduct the tracing exercise.10 In fact, even though Sinclair v. Brougham is often taken as one of the authorities for the requirement of establishing a fiduciary relationship to trace in equity, it rather appears to be authority for the idea that in order to establish an equitable proprietary interest in the traceable proceeds of an asset, one must have had an equitable proprietary interest in the original asset.11 In Re Diplock, a testator's will empowered his executors to pay money to bodies having certain characteristics, and the executors accordingly made a number of payments to charities. The House of Lords later decided that the direction was invalid. The testator's next of kin then sued the charities. They claimed that the receipt of money in these circumstances made the charities personally liable to the next of kin. They also claimed that they held equitable proprietary rights in the traceable proceeds of the money paid to the charities. The latter claim depended upon the exercise of tracing. In this context, the Court of Appeal considered Re Hallett's Estate and Sinclair v. Brougham and held that Sinclair was decided on the principle. And on this basis the defendant donees in Re Diplock could be liable to a claim based on equitable proprietary rights. Here, the Court of Appeal did what it failed to do in Re Hallett's Estate, and what the House of Lords largely failed to do in Sinclair. It separated the issue of tracing from the issue of the claims available in respect of the traceable proceeds. The gist of this statement is that once an equitable proprietary interest is established in an asset, equitable proprietary rights can be asserted against a donee in the traceable proceeds of the asset. The initial equitable proprietary interest is required in order to establish a similar interest in the traceable proceeds; it is not necessary to undertake the exercise of tracing. In Re Diplock, the claim was against donees, and so the case is supposed to show that while the plaintiff must show a fiduciary relationship to trace in equity, it need not be a fiduciary relationship between the plaintiff and the defendant.12 In the US, the courts have long ago given up this charade,13 and Canadian14 and Australian15 courts have generally followed suit.16 Hence, it is a misunderstanding to suppose that a fiduciary relationship must be established as a prerequisite to tracing in equity. This requirement is always said to be established by Re Diplock, but the case is silent on the issue. How did this misunderstanding arise It has been suggested that it is based on an inaccurate headnote to Re Diplock in the Law Reports.17 This is perhaps plausible, given that the report is about one hundred pages long. Other authorities can be deployed even more forcefully to show that a fiduciary relationship is not required simply to conduct the exercise of tracing in a court of equity. Consider the simple case of a purchase money resulting trust. A puts up the purchase money for property, directing the seller that title be transferred into the name of B. In the absence of evidence (possibly with the assistance of an evidentiary presumption) that A intended to make a gift to B, B will hold the property on a resulting trust for A.18 Although it might not ordinarily be noticed, this conclusion requires tracing: the subject matter of the trust is the traceable proceeds of the purchase money provided. The trust could not be established without showing that the money provided by A was exchanged for the property taken in the name of B. The tracing in such cases is so straightforward that it is not usually in issue; but the point is that in every case in which a purchase money resulting trust has been established, there has been an exercise of tracing in a court of equity. And no one would suggest that a pre-existing fiduciary relationship must be established in order to show the creation of a purchase money resulting trust. Consider also the cases in which a plaintiff appeals to the equitable doctrine of subrogation. Here, the plaintiff must trace its value; but it is not concerned to trace that value into some proceeds, so as to assert an equitable proprietary interest in those proceeds. Rather, the plaintiff is concerned to trace to show that its value was used to discharge a debt, so that the plaintiff can assume rights formerly held by the paid creditor. In these cases, all of the parties -- the plaintiff lender, the defendant borrower, and the paid former creditor of the defendant -- are generally in arm's-length, commercial relations with one another. There is no hint of a fiduciary relationship. This confirms that if such a relationship plays any role at all, it relates to the assertion of proprietary rights in traceable proceeds, and not to the exercise of tracing. It is to be hoped that courts will heed the weight of academic commentary and discard the notion that a fiduciary relation is a prerequisite to tracing in equity.19 There appears to be a single set of rules for tracing value. There are not separate systems for 'tracing in equity' and 'tracing at common law'. Both systems subordinate the interests of wrongdoers in the same way. The characteristic feature of tracing at common law is supposed to be that it cannot trace through mixtures of value or mixed substitutions. That, too, is based on the misunderstanding of Taylor v. Plumer20 propagated by the speech of Viscount Haldane LC in Sinclair v. Brougham. Indeed, not only was that speech responsible for the subsequent misinterpretation of Taylor v. Plumer, it appears also to have been the root of the idea that there are two sets of tracing rules. The idea that there are two sets of tracing rules simply did not catch on.21 Read More