Quistclose Trust and the Requirements for Its Creation - Report Example

Quistclose Trust and the Requirements for Its Creation Table of Contents Table of Contents 2 Definition of a Quistclose trust 3 First Issue: Nature of the Quistclose trust and the requirements for its creation 4 Second Issue: If the first is resolved adversely to the appellant, whether the conduct of the appellant renders him liable for having assisted a breach of trust. 6 Conclusion 8 References: 9 “My Lords, there are two issues in this appeal. The first is concerned with the nature of the so-called “Quistclose trust” and the requirements for its creation. The second arises only if the first is answered adversely to the appellant. It is whether his conduct renders him liable for having assisted in a breach of trust.” Lord Millett in Twinsectra Ltd v Yardley and Others [2002] 2 AC 164 at paragraph 52. Definition of a Quistclose trust A Quistclose trust is created when a creditor extends a loan to a debtor with the condition that the money lent should be used for a particular purpose. In commercial parlance, a Quistclose trust is “a means by which a lender of money can retain a ‘security interest’ in loan moneys only for specified purposes”.1 If the money is used by the borrower for a purpose other than that specified in the loan agreement, a trust is then imposed on the money in favour of the lender. How this works in the lender’s favour is best appreciated at such instance that the borrower is rendered insolvent. During insolvency or bankruptcy proceedings, the insolvent borrower’s estate is distributed according to the procedure specified by law. If a trust were not created on the loan amount, then the creditor who extends such loan is an unsecured creditor, and his claim on the borrower’s assets will be included and classified among the other claims from other creditors. It shall therefore be settled pursuant to the hierarchy of claims, of which such unsecured loans have a low priority and may remain unsatisfied due to insufficiency of the estate.2 On the other hand, the Quistclose trust creates a security interest on the loan, meaning that such may not be distributed in the insolvency proceedings from the borrower’s remaining estate. Even if the borrower is not rendered insolvent after the loan is contracted, the lender retains the right to recover the loan amount, even to trace the loan money into the hands of third parties to whom it was given in breach of the loan contract.3 First Issue: Nature of the Quistclose trust and the requirements for its creation The Quistclose trust (from the judgement rendered in Barclays Bank Ltd v Quistclose Investments, Ltd. in 1970) gives rise to several legal requisites: (1) It is important to precisely identify the sort of “security interest” the lender acquires. (2) It is important to know whether the lender “retains” a right in the original loan moneys throughout the life of the loan contract, or whether the right is created for the first time only at such time the borrower disobeys the terms of the loan contract, or whether the right comes into existence in some other ways. (3) It is important to categorize which kind of trust the Quistclose trust is – whether it is an express trust, resulting trust, constructive trust, or another type of construct. (4) It is important to consider how the precise terms of any loan contract alter the appropriate analysis on the facts of any given case.4 The difficulty with defining Quistclose trusts in terms of the foregoing is that Quistclose trusts are created by operation of law, arising out of any situation involving a loan where the creditor insists that the borrower use the money only for a stated purposes, in a manner which seems to imply that the borrowed sum is not at the borrower’s free disposal. If this were the case, then the determination of the three certainties of express trust (intention, subject matter and objects) which would normally justify a finding that a trust existed, would have to be proved. As it is, in finding that a Quitclose trust existed from the mere intention of having the funds dedicated to a particular purpose, it appears that there is no need to show that the creditor intended for the money to be held for him beneficially (intention to create a trust), or that the funds should be held separate from the borrower’s own funds, or that a certainty of objects existed. “This approach is a recipe for a largely unfettered discretion in the court to find trusts in commercial circumstances on flimsy evidence,” according to Swadling5, because the intention of the creditor in his mind is inferred from the situation rather than convincingly discerning the true intention of the parties. The effect is that a trust may be construed by the courts as long as a purpose is specified, even without proof of the other requisites of trust such as beneficial interest. There further arises a problem as to when the trust began to exist, because if the trust began only at the time the loan was used for a purpose for which it was not intended, then it becomes a kind of default trust known as a resulting trust6; however, many among the legal scholars agree that it must be an express trust and that the obligations of the parties thereto exist at the time of the creation of the contract. On the other hand, Lord Millett further mentioned in Twinsectra that the Quistclose trust is an “illusory trust” where the apparent beneficiary of the trust (the creditor) does not take an active role, the trust is created by the intention of either of the parties, and is revocable anytime.7 The emphasis given the fact that a purpose was specified for the loan, and that this was taken by the court as constituting the intention of the parties thus giving rise to a trust, has “confused the nature of the trust and the principal issues involved”.8 Second Issue: If the first is resolved adversely to the appellant, whether the conduct of the appellant renders him liable for having assisted a breach of trust. The peculiarity of this issue is whether a third party (in the case mentioned, the solicitor Leach) may be held liable for assisting in a breach of trust without knowing that he is a trustee. Another situation falling under the same considerations is whether or not a third party should be held liable as accessory where he is aware that he is dealing with a trustee, but has no indication or knowledge, or no reason to suspect, that the transaction of the trustee is inconsistent with the terms of the trust. There is a continuum of possibilities in regarding the liability assumed by the third party in the case of the improper use of funds held in trust. At one end is the position of no liability, that is, no third party should be held liable for property that has not passed through his hands, even if he has assisted the dishonest act. At the other extreme is strict liability where the third party is held liable even if he did not know the person he was dealing with was not a trustee, or that knew that person was a trustee but did not know that the trust amount was being misused as a result of his action or interference. In the first instance, it is not acceptable that no liability should attach at all because the third party had a personal obligation to give effect to the execution of the duties created by the trust, and not to interfere. Despite the property not passing through the third party’s hands, the basis of the liability proceeds from a personal obligation and not based on property rights. On the other hand, imposing a strict liability on the part of third parties who are unaware of the trust would be so severe that it would be impossible to conduct everyday business.9 Naturally, most persons would be wary of accepting the obligations to be discharged because they may be unwittingly assuming the risk of liability for situations they had never intended or of which they are not even aware. Adopting the two extremes would have simplified the application of this provision because it leave little room for interpretation. On the other hand, the extremes are not acceptable because they are neither equitable nor morally tenable. Somewhere in the middle, however, is fault-based liability, that is, a third party may be held liable based on a showing of fault on his part, the severity of his liability being commensurate to the degree of his fault. Assigning the test of such fault was first thought to be served by relating the circumstances to the standard that the requisite level of negligence was that which “an honest, reasonable man” would be prone to exercise. The practicality of this standard, however, was put into question for its difficulty in equitable application. Subsequent jurisprudence, however, identified “dishonesty” as the test of culpability. Dishonesty simply means “not acting as an honest person would” given the circumstances; in this sense it is taken as an objective standard.10 It was therefore doctrinally rules in Royal Brunei v Ming11 that dishonesty is a necessary ingredient of accessory liability. Where a third party dishonestly procures or assists in a breach of trust or fiduciary obligation, whether he knowingly does so or not, and regardless of whether the trustee or fiduciary was likewise acting dishonestly or not, such party is liable in equity.12 Conclusion A Quistclose trust appears simple to understand from the point of view of commercial application, and one would tend to appreciate and agree with the soundness of the rationale of Lord Millett. However, problems arise when the Quistclose is sought to be placed in the legal context, because from its definition it is difficult to categorize, therefore difficult for the rights of the parties to be discerned by legal definition. From the development of cases, it is apparent that much lies in the wordings of the loan contract in order to construe the intention of the parties. That in itself, however, tends to deviate from the traditional understanding of trusts where it is necessary to prove the parties’ intentions to create a trust and to hold the object for the beneficiary’s interest. The problem is compounded in the second issue, as regards the third party who, knowingly or unknowingly, dishonestly procures or assists in a breach of trust. There is often confusion as to what point in time the Quistclose trust begins to exist. If it is on the occasion of the breach, then the third party who incurs accessory liability does so concurrent with the existence of the trust. Such third party would most likely not even be aware a trust existed, because it will require the court’s pronouncement that a trust was construed at that point. The fact of not knowing defies the requisite of mens rea where liability attaches because of the intention to do wrong. The very uncertainty in the definition and categorization of the Quistclose trust renders third parties vulnerable to the risk of unwittingly incurring an accessory liability, unwary of what is not evident at the time and only later construed. For reason of vagueness resulting in situations that innocent third parties are unduly compromised by such a doctrine, I disagree with Lord Millett’s arguments on the two issues mentioned. References: Burns, F R 1992 “The Quistclose Trust: Intention and the Express Private Trust,” Monash University Law Review, vol. 18, no. 2, pp. 147-168 Chambers, R 1997 Resulting Trusts. Clarendon Press, Oxford Edwards, R & Stockwell, N 2007 Trusts and Equity, 8th edition. Pearson Longman. Hayton, J D (n.d.) “A Review of Current Trust Law Issues”. Accessed 10 January 2012 from http://www.caribbeancourtofjustice.org/speeches/hayton/ReviewOfCurrentTrustLaw.pdf Hayton, D 2005 “The Distinctive Characteristics of the Trust in Anglo-Saxon Law”. Accessed 10 January 2012 from http://www.kcl.ac.uk/depsta/law/students/grad/llm/study/trust_law/resources/distinctive_characteristics_of_the_trust_paper1.pdf High Court of Justice Chancery Division 2008 Alan Blackburn Sports Ltd. v The Commissioners for HM Revenue and Customs. Case No: CH/2007/APP/0298 House of Lords 2002 Yardley vs Twinsectra Ltd. Judgement. Accessed 10 January 2012 from http://www.ipsofactoj.com/international/2002/Part11/int2002%2811%29-007.htm Hudson, A 2010 Equity and Trusts, 6th edition. Routledge-Cavendish, Abingdon, Oxon Judicial Committee of the Privy Council 1995 Royal Brunei Airlines Sdn. Bhd. v Philip Tan Kok Ming [1995] UKPC 4. Judgment. Accessed 10 January 2012 from http://www.ipsofactoj.com/archive/1995/Part03/arc1995%2803%29-011.htm Kiri, N 2006 “Recipient and Accessory Liability – Where Do We Stand Now?” Journal of International Banking Law and Regulation (JIBLR) Issue 11 pp. 611-620. Accessed 10 January 2012 from http://www.herbertsmith.com/NR/rdonlyres/FED6BF38-E55F-4439-B1D5-88388D971255/2735/KiriPress.pdf McCormack, G 1993 “Conditional Payment and Insolvency – The Quistclose Trust.” Denning Law Journal, vol. 9, pp. 93-115 Moffat, G; Bean, G M D; & Bean, G 2005 Trust Law: Text and Materials, 4th edition. Cambridge University Press, Cambridge Nield, R 1993 The Quistclose Trust. University of Auckland Ramjohn, M 2008 Text, Cases and Materials on Equity and Trusts, 4th edition. Routledge-Cavendish, London Rotherham, C 2002 Proprietary Remedies in Context. Hart Publishing, Oxford Swadling, W 2004 The Quistclose Trust: Critical Essays. Hart Publishing, Oxford Walker, R 2004 “Dishonesty and Unconscionable Conduct in Commercial Life – Some Reflections on Accessory Liability and Knowing Receipt.” The Sydney Law Review, vol. 27, number 2, p. 187 Watt, G 2007 Todd and Watt’s Cases and Materials on Equity and Trusts, 6th edition. Oxford University Press, Oxford. Webb, C & Akkouh, T 2011 Trusts Law. Palgrave Macmillan, Basingstoke, Hampshire Wilson, S 2007 Todd & Wilson’s Textbook on Trusts, 8th edition. Oxford University Press, Oxford. Read More