Most Read Contributor in New Zealand, September 2016
A recent Privy Council judgment may make it easier for
victims of fraud to trace property through complex money laundering
schemes and enforce against constructive trustees.
The decision is persuasive rather than binding but, if
followed in New Zealand, has the potential also to affect third
parties – in ways which may or may not be
Tracing – the evidentiary process
Tracing is an evidentiary process that allows a beneficiary of a
trust (including victims of fraud seeking the remedy of a
constructive trust) to recover property that is an identifiable
substitute for other property.
Because it is subject to strict rules of equity, including the
need to demonstrate the property's continued existence, it is
not possible to continue to trace an asset once it has ceased to
exist and there is no longer any identifiable substitute property.
Neither is it possible to trace into a pre-existing asset.
This has meant that:
funds cannot be traced into an overdrawn bank account, even if
the account is subsequently put in credit, and
'backward tracing' – tracing property to an asset
the defendant has previously acquired, rather than a substitute for
the beneficiary's property – has not been permitted.
A road to nowhere?
In Federal Republic of Brazil v Durant International Corporation
(Jersey)  UKPC 35, the former mayor of Sao Paulo had
received US$10.5 million in bribes in connection with a major road
building contract in Brazil. He sought to launder this money
through a series of transfers through bank accounts held by BVI
companies. The bribe proceeds were first paid into an account in
New York and then on to an account in Jersey.
The issue arose due to the timing of the payments. The final
US$2.8 million of bribe proceeds were paid into the New York
account shortly after the final payment from New York to
the Jersey account. The BVI companies, liable under a constructive
trust, argued that only US$7.7 million could be traced from New
York to Jersey. The BVI companies claimed that, under the 'no
backward tracing' principle, the balance of the final US$2.8
million could not be traced into the existing funds in the Jersey
It's not the journey, it's the destination
The Board held that backward tracing could be permissible in
certain situations. It recognised that this was a matter of
the development of increasingly
sophisticated and elaborate methods of money laundering, often
involving a web of credits and debits between intermediaries, makes
it particularly important that a court should not allow a
camouflage of interconnected transactions to obscure its vision of
their true overall purpose and effect.
The Board also held that, where there is a sufficiently close
causal connection, it could be possible to trace the value of an
asset the proceeds of which are paid into an overdrawn account.
Chapman Tripp comments
Fraudsters can often exploit discrepancies in the regulatory
regimes between jurisdictions to transform assets and place them
out of reach. The decision is a further signal of the courts'
willingness to adapt in order to deal with such complex
The New Zealand High Court has previously been willing to
exercise its discretion in favour of a plaintiff by impressing a
defendant's property with a remedial constructive trust.
However the Court of Appeal confirmed in Fortex v
MacIntosh that this discretion is limited by considerations of
third parties and statutory insolvency regimes.
A more flexible interpretation of the rules of tracing will not,
on the face of it, include any such consideration of any effect on
other creditors. If a plaintiff is more easily able to assert a
proprietary claim then this would give them priority over unsecured
creditors if the defendant is insolvent.
It is not clear what the test of a 'close causal
connection' will entail and this will potentially lead to
uncertainty. However it seems apparent that any claim for backward
tracing will come with a high evidentiary threshold: the claimant
must establish clear coordination between the depletion of the
trust fund and the acquisition of the asset which is the subject of
the tracing claim.
This may be difficult to demonstrate. For example, the Board
considered the case of Re Goldcorp Exchange Ltd,
previously heard by the Privy Council from the New Zealand Court of
Appeal. In that case, an equitable lien over stocks of mixed
bullion was limited to the lowest balance of bullion held at any
time, as stock had been depleted with no identifiable substitute
and there was no evidence to link later purchases of bullion with
earlier depletion of stock. The Board did not doubt the correctness
of that decision: in that case there was no evidence of an overall
transaction embracing the coordinated outward and inward movement
While this high threshold may not necessarily protect
creditors' interests, it will restrict proprietary claims to
cases where a corrupt transaction is self-evident on the facts.
The information in this article is for informative purposes
only and should not be relied on as legal advice. Please contact
Chapman Tripp for advice tailored to your situation.
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