Secret commissions and bribes have unfortunately become an increasingly common feature of doing business in certain parts of the world. The Jersey and UK courts have now provided the answer to the vexing question of who owns a bribe. Once established, ownership gives rise to an ability to trace the proceeds of a bribe or secret commission into the hands of a third party. That calls for an understanding of the different approaches to tracing, particularly when Jersey's differs from that adopted in the UK.
- On 16 July 2014, the UK Supreme Court handed down its judgment in FHR European Ventures LLP v Cedar Capital Partners LLC ("FHR").1 This decision settles a long-running argument as to whether a principal has a proprietary or a merely personal claim against an agent who takes a bribe or secret commission.
- The significance of the distinction between a personal and proprietary remedy is twofold; if the agent becomes insolvent, the principal will maintain priority against the body of the agent's unsecured creditors to the extent of the asset over which a proprietary interest is claimed. Secondly, a proprietary remedy permits the principal to trace the proceeds of the bribe or secret commission into the hands of a third party.
- The issue in FHR was decided last year by the Jersey Royal Court, in Lloyds Trust Co (Channel Islands) Ltd v Fragoso ("Fragoso").2 In that case, the settlor of a trust, Carlos Fragoso, had told the trustee when he settled funds in 1999 that the assets were the proceeds of his work as a civil engineer in the US and Africa. It emerged in English criminal proceedings that the UK construction company, Mabey & Johnson, had bribed Mr Fragoso to secure construction contracts in Mozambique.
- The Jersey trustee became aware of the English criminal proceedings and conducted its own investigation, leading to the filing of a suspicious activity report with the Jersey Joint Financial Crimes Unit. Lloyds asked Mr Fragoso to provide evidence of the source of the funds that it was holding as trustee, but he failed to do so. The trustee then sought directions from the Jersey Royal Court as to what it should do.
- The Royal Court, having heard evidence that large "commission" payments had been paid to Mr Fragoso, found, on the balance of probabilities, that all of the funds within the trust represented the proceeds of bribes received by him in his position as a public official for Mozambique. Despite the paucity of the evidence, the Jersey court made clear that it was willing to draw appropriate inferences, for example, in circumstances where Mr Fragoso, as a full-time public official, could not possibly have set up the trust from his earned income.
- The Jersey court was faced with a choice between following a line of legal authority in English law3 that the commission payments were not the property of the Mozambique Government and that the Government merely had a personal right of action against Mr Fragoso or, following the Privy Council decision of Att‐Gen (Hong Kong) v Reid4 on the same point, that the Government did have a proprietary claim to the trust assets. The court declared and directed the trustee to hold the trust fund for the benefit of the Government of Mozambique and not Mr Fragoso.
- Having surmounted the threshold of establishing a proprietary interest (by way of constructive trust) in the bribe or secret commission, the possibility of tracing the proceeds then arises. The decision of the Royal Court in Federal Republic of Brazil v Durant Intl Corp,5 which was referred to obiter in Fragoso, significantly restated Jersey's rules on the practice of equitable tracing in support of a proprietary remedy. The combined effect of the Fragoso and Durant decisions is to enable defrauded principals better to recover assets misapplied by their fiduciaries through the Jersey courts.
BACKGROUND TO THE SUPREME COURT'S DECISION
- FHR European Ventures LLP ("FHR") purchased the share capital of Monte Carlo Grand Hotel SAM from Monte Carlo Grand Hotel Ltd. Cedar Capital Partners LLC ("Cedar") acted as FHR's agent in negotiating the purchase. Unknown to FHR, Cedar had a contract with Monte Carlo Grand Hotel Ltd under which Cedar would be paid a fee of €10m following the successful completion of the sale and of the share capital in Monte Carlo Grand Hotel SAM. FHR sought recovery of the €10m as an undisclosed secret commission contrary to Cedar's fiduciary duty as agent for FHR.
THE FIDUCIARY NATURE OF AGENCY
- In Jersey law, as in English law, an agent owes a fiduciary duty to his principal because he is someone who has undertaken to act on behalf of his principal in a particular matter in circumstances that give rise to a relationship of trust and confidence. An agent must not make a profit from this trust and must not place himself in a position in which his duty and interest conflict. A fiduciary who acts for two principals with actual or potentially conflicting interests without the informed consent of both is in breach of the obligation of undivided fidelity. Informed consent can only be effective if the agent gives full disclosure to each principal. An agent who receives a benefit in breach of his fiduciary duty is obliged to account to the principal for such a benefit and to pay a sum equal to the profit by way of equitable compensation.
- The rule that a fiduciary must not profit from his trust can be traced back to the 18th century English case of Keech v Sandford6in which a trustee held a lease on trust for a minor beneficiary and having failed to negotiate a new lease on behalf of the beneficiary, the trustee negotiated a new lease in his own name for himself. The beneficiary was entitled to an assignment of the lease and an account of profits made by the trustee.
- The effect of the judgments in Fragoso and now in FHR is that where an agent acquires a benefit as a result of his fiduciary position or pursuant to an opportunity which results from his fiduciary position, he is to be treated as having acquired the benefit on behalf of his principal. The benefit is beneficially owned by the principal and not the agent. This produces a two-pronged approach for a plaintiff who may pursue a proprietary remedy in addition to his personal remedy for an account. The principal may elect which remedy he wishes to pursue.
- The Supreme Court heard arguments from leading English counsel as to the correct treatment of bribes and secret commissions paid to agents. On behalf of Cedar it was argued that a bribe or a secret commission cannot be subject to a proprietary remedy in favour of a principal because it cannot properly be described as the property of the principal in the first place as it did not flow from an asset beneficially owned by the principal nor was it an asset that was intended for the principal that had been diverted from him. Nor can it said to be derived from an activity of the agent which if he chose to undertake it for himself in his own interests, he was under an equitable duty to undertake for the principal. On behalf of FHR it was argued that an agent ought to account in specie to his principal for any benefit he has obtained from his agency in breach of his fiduciary duty—the benefit is rightly to be regarded as the property of the principal. Equity should not permit the agent to rely on his own breach of fiduciary duty to justify retaining the benefit on the ground that it was a bribe or secret commission. The court must assume that the agent acted in accordance with his duty, so that the benefit must belong to the principal.
- The Supreme Court decided that where an agent takes a secret commission or bribe, a proprietary remedy was available (in addition to a personal one) on the basis of legal principle, decided cases, policy considerations and practicality.
PRACTICALITY, POLICY AND PRINCIPLE
- A considerable part of the Supreme Court judgment reviews the law as pronounced in previous cases. The court overturned the basis upon which the Court of Appeal in Sinclair Invs Ltd v Versailles Trade Fin Ltd7held that a proprietary remedy was not available. The court also departed from 19th century House of Lords authority to the same effect.
- The court decided FHR's arguments had the benefit of first being wholly consistent with the principles of the law of agency, and secondly having the benefit of simplicity: any benefit acquired by an agent as a result of his agency and in breach of fiduciary duty is held on trust for the principal. The decision also neatly aligns the rules of equitable accounting, which can encompass both personal and proprietary claims. The court considered that any other result would have left the relevant concepts somewhat incongruous. The same test (whether the benefit was acquired by an agent as a result of his agency and not disclosed) will therefore now apply to whether an agent has to account personally and to whether the principal has a proprietary interest in the proceeds of a bribe or secret commission.8
- This decision in FHR covers
both bribes and secret commissions. A secret commission is
conceptually distinct from a bribe in that it does not have to be
established that the person paying the commission was inducing the
recipient to breach his duty. In other words, when seeking a
proprietary remedy, it is not necessary to establish the purpose
for which the money was paid in order to be able to seek a
proprietary remedy. Nor is it necessary for a plaintiff to prove
that the payment actually resulted in the agent doing something he
would not otherwise have done. At para 42 of the judgment, the
"Wider policy considerations also support [FHR's] case that bribes and secret commissions received by an agent should be treated as the property of his principal, rather than merely giving rise to a claim for equitable compensation. As Lord Templeman said giving the decision of the Privy Council in Attorney General for Hong Kong v Reid  1 AC 324, 330H, '[b]ribery is an evil practice which threatens the foundations of any civilised society'. Secret commissions are also objectionable as they inevitably tend to undermine trust in the commercial world. That has always been true, but concern about bribery and corruption generally has never been greater than it is now . . ."That is a proposition as relevant to Jersey, as a leading centre for financial and fiduciary services, as it is to the United Kingdom.
RULES OF FOLLOWING, TRACING AND IDENTIFICATION IN ENGLAND AND JERSEY
- The effect of the Fragoso and FHR decisions is to imbue a principal, whose agent has taken a bribe or secret commission, with a proprietary interest in the same way as a constructive trust. In answer to the question "who owns a bribe?" the answer is now clearly the principal rather than the defaulting fiduciary. This is significant because in both the UK and Jersey,9 the beneficial owner of property may seek to enforce a proprietary claim against the proceeds of that property which can be identified using the rules of tracing. A third party into whose hands the proceeds of the misapplied property are followed or traced will hold it subject to a constructive trust in favour of the principal beneficiary if that person is not a bona fide purchaser for value. A third party recipient with notice of the breach of trust may be liable in knowing receipt. In circumstances where a liability exists that might be satisfied by both proprietary and personal claims, the value of any recovery on a proprietary claim against the trustee or from a third party must be taken into account in determining the amount of the constructive trustee's personal liability for losses incurred by the misapplication of the trust funds in order to ensure there is no double recovery by the principal beneficiary.
FOLLOWING OR TRACING?
- The classic statement of Lord Millett
in Foskett v McKeown10distinguishes the
concepts of "following", "tracing" and
"claiming" in the following terms—
"The processes of following and tracing are, however, distinct. Following is the process of following the same asset as it moves from hand to hand. Tracing is the process of identifying a new asset as the substitute for the old. Where one asset is exchanged for another, a claimant can elect whether to follow the original asset into the hands of the new owner or to trace its value into the new asset in the hands of the same owner. The rules of following and tracing are evidential in nature and are concerned with identifying property in the hands of another or property that has assumed another form . . . Tracing is thus neither a claim nor a remedy. It is merely the process by which a claimant demonstrates what has happened to his property, identifies its proceeds and the persons who have handled or received them, and justifies his claim that the proceeds can properly be regarded as representing his property. Tracing is also distinct from claiming. It identifies the traceable proceeds of the claimant's property. It enables the claimant to substitute the traceable proceeds for the original asset as the subject matter of his claim. But it does not affect or establish his claim. That will depend on a number of factors including the nature of his interest in the original asset. He will normally be able to maintain the same claim to the substituted asset as he could have maintained to the original asset. If he held only a security interest in the original asset, he cannot claim more than a security interest in its proceeds. But his claim may also be exposed to potential defences as a result of intervening transactions."
- In both Jersey and England, the rules of following and tracing are rules of evidence which allow a plaintiff to identify misapplied property or its proceeds.11 "Following" is the process of identifying the same property as it is transferred from one person to another. "Tracing" is the conceptually distinct process of identifying a new asset as the substitute for an original asset which has been misappropriated from the plaintiff beneficiary.12 Where one asset is exchanged for another, the plaintiff may elect to treat the substituted asset as representing the value contained in the original. He is said to trace the value represented in the original into the substitute.
LAW AND EQUITY
- Owing to the different historical basis upon which the courts of England and Jersey have approached their respective jurisdictions to grant equitable remedies, Jersey has not followed England in preserving what is now (even in England) a technical and increasingly arcane distinction between following at common law and tracing in equity.13 The principal difference between following at common law and equitable tracing as a matter of English law is that the common law rules do not allow money to be followed through a mixed fund whereas the equitable rules do permit this. While no Jersey decision following Durant has further explored how Jersey's rules of tracing unify the concept of following and "equitable" tracing into a single coherent doctrine, it is likely that what are currently the English rules of following at common law are essentially subsumed into a more flexible and sophisticated exercise of "equitable" identification and tracing, which itself differs in some material respects from the equivalent English approach.
FOLLOWING AT COMMON LAW—A BUSTED FLUSH?
- Following a misdirected asset imbued with a trust into the hands of a third party presents no great evidential difficulty to a plaintiff seeking recovery of that property. However, it is relatively rare in the modern era, particularly in fraud cases, for an asset to retain its identity in specie. It is far more common for the asset to lose its original discrete identity either by becoming mixed with other assets in the recipient third party's hands or by being converted into another form such as money which is then mixed, dissipated or used to purchase other assets. In reality, the process of following at common law is of limited practical utility. The vast majority of trust assets to which a following and tracing exercise can be applied do not retain their in specie identity for long once they are misappropriated, nor are they likely to remain of a character so as to be able readily to identify any proportion of the mixed whole as belonging to a beneficiary. Further, the vast majority of tracing claims are brought to recover money rather than specific assets. The English common law treats money as identifiable so long as it has not become mixed with other money. Accordingly, if a trustee pays the plaintiff beneficiary's money into a bank account which already contained money belonging to the trustee, the plaintiff beneficiary could not follow his money at law into any withdrawal from the account.14
- While English law continues to retain two distinct sets of rules of law (following) and equity (tracing), Jersey's approach has been to combined the two into a single doctrine of tracing which is of much greater utility to a beneficiary seeking recovery of an asset. Where the fiduciary has misapplied the principal's original asset and transferred it to a third person, the principal can elect whether to follow the original asset and enforce his equitable title to it, in so far as it remains identifiable, or trace into a substituted asset(s) in the hands of the trustee or a third party and enforce a proprietary remedy against it.15 If the original asset can no longer be identified, or where the principal's equitable title to it has been extinguished (as where the third party is "equity's darling", the bona fide purchaser for value of a legal estate without notice), the principal can only trace into the substituted asset in the hands of the defendant.
TRACING THROUGH A MIXED FUND
- Often, the proceeds of the plaintiff's original asset are mixed in a bank account. Money is then withdrawn from the account and used to acquire a new asset. Before the plaintiff can assert any proprietary claim to the substituted asset, it must be established whether the money used to acquire it is attributable to him or to any other contributor to the bank account. Under English law, formalised rules of identification are used to resolve the evidential uncertainty. They differ depending on whether the other contributor to the mixture is innocent of any fault, or whether the defaulting fiduciary or a person has received the money with notice of the breach of trust.
TRACING THROUGH MIXED FUNDS WHERE A CO-CONTRIBUTOR IS AT FAULT
- A punitive presumption of identification applies where the other contributor to the bank account is a wrongdoer. The mixed money in the bank account is deemed to belong to the innocent plaintiff to the extent that the wrongdoer cannot prove it is the wrongdoer's own money.16 Under this presumption, when money is withdrawn from the account and dissipated, it is presumed to have been drawn from the wrongdoer's share of the mixed fund.17 The presumption is made with the benefit of hindsight. There is no rule in English law that money first withdrawn from the account must be treated as the trustee's,18 unless it turns out that that money was dissipated. This mechanism preserves any benefit the beneficiary might have if some of the mixed money is withdrawn and invested favourably by the trustee in assets that then appreciate in value. The punitive presumption in Re Hallett's Estate that the wrongdoer spends his money first is not part of Jersey's law which approaches the question of identification without the use of rules or presumptions. Durant is clear that the identification of traceable funds is purely a matter of evidence with the initial burden being on the plaintiff to show a prima facie case that there is a clear link between his money and the funds to be traced. The burden then shifts to the defendant to refute that prima facie case to the contrary. It is only if a step-by-step attempt to follow the money at each stage of its journey is made impossible because the defendant has created a maelstrom that the burden falls on the defendant to demonstrate positively that the money is his rather than the plaintiff's.19
- The concept of reverse or
"backwards" tracing has arisen as a possible means to
combat two circumstances which are largely separate although they
can be interrelated and which are usually fatal (as a matter of
English law at least) to the possibility of tracing leading to a
proprietary claim at all:
- payment of trust money into an overdrawn account; and
- where the defaulting fiduciary deposits money into an account after the defaulting fiduciary has drawn against the plaintiff's money to acquire an asset.
- Both (i) and (ii) are techniques exploited by fraudsters who are able either to manipulate the timing of payments between bank accounts such that monies imbued with a trust are credited to an account after an equivalent or related amount has been debited from that account but also by interposing at least one overdrawn bank account into a chain through which trust money is in transit between its source and eventual depository. As a matter of English law, reverse tracing as a means to counter either (i) or (ii) is controversial because it violates the principle that a beneficiary can only trace into money that represents property that beneficially belonged to him. In Jersey, Durant has held that (ii) is not an insurmountable bar to a beneficiary being able to trace. The court did not endorse wholesale adoption of the concept of backwards tracing into Jersey law but suggested that any objection to the practice was indicative of the need to establish a sufficient link between the original property and its traceable proceeds. It follows that where a sufficient link can be found, a formal process of "backwards tracing" is not required.
- The rule in English law is that trust money cannot be traced into an asset bought before the money was misappropriated from the trust since the asset bought does not represent the trust money.20 Under English law, the plaintiff is limited to asserting a claim against the account for the "lowest intermediate balance" that his money has fallen to between the date of the deposit of his money and the subsequent deposit of the trustee's own money. Durant rejected that the lowest intermediate balance approach has the status of a formal rule and held that it was simply another aspect of requiring a beneficiary to establish a sufficient link between the original property and its traceable proceeds. In English law, the logical consequence of the lowest intermediate balance rule is that if withdrawals from a mixed account reduce the lowest intermediate balance to nil, or put the account into overdraft, there is nothing which can be said to represent the trust money paid into the account and nothing against which the beneficiary can claim. It makes no difference that the trustee subsequently replenishes the account with money of his own. A similar result follows if trust money is deposited into an account that is already overdrawn:21 there is nothing which can be traced since the money that is deposited goes to pay off the trustee's debt to the bank and is thus dissipated. This result is said to be consistent with the general presumptions operating in cases of mixture: the subsequent deposit of the trustee's otherwise "clean money" does not originate in the mixed fund, and so the trustee can easily displace the evidential presumption that it is attributable to the plaintiff beneficiaries.22
- While the English rule that tracing will be defeated by payments into an overdrawn account may be clear, it is not without controversy. One can readily imagine a situation, in which a fiduciary or other recipient, who is £5,000 overdrawn, pays £4,000 of trust money into the account and then next day buys an asset for £3,000 out of the account. As a matter of English law, notwithstanding the payment into the account enabled the trustee to use his overdraft facility to buy the asset, the money paid into the account went to reduce the debt to the bank and not to pay for the asset and therefore cannot be traced into the new asset.23
- Whether backwards tracing is or is not permissible, it seems tolerably clear that in a case where the purchase is made by a trustee, the no-profit rule24 will apply because the trustee has been enabled to make the acquisition by his use of trust money ("use" in this sense being to reduce his own debt rather in its direct application to acquire an asset) thereby allowing beneficiaries to claim that the asset that has been acquired is held on a constructive trust for them.
REJECTING THE CONCEPTUAL LIMITS OF BACKWARDS TRACING
- Mindful of the fact that a defendant
should not be able to benefit by creating a maelstrom so as to
obfuscate the ability of the plaintiff to follow the path of the
money and mindful of the need to avoid a perception that Jersey
affords any safe harbour to fraudsters or those who seek to hide
money from those who have a legitimate claim upon it, the Royal
Court in Durant resoundingly rejected the
"conceptual" limitations in the English tracing rules.
The Royal Court at para 219 of its judgment said—
"The appropriate way for the courts of this jurisdiction to address the subject is, we suggest, not by reference to any pre-conceptions of what is or is not conceptually possible or arguably supported by English authority, but . . . as a matter of evidence—at least in cases where, as here, the account in question remains in credit throughout the relevant period, there is no question of possible insolvency and prejudice to unsecured creditors, and there is no suggestion of any intervention by a bona fide purchaser for value. The question is, or should be, simply whether there is sufficient evidence to establish a clear link between credits and debits to an account, irrespective (within a reasonable timeframe) of the order in which they occur or the state of the balance on the account. It is unnecessary to posit any limitation on how, as a matter of evidence the necessary link can be proved: it might be by means of bank documentation . . . or by reference to the defendant account-holders' intentions or in some other way. Nor is there any cause to diminish the effect of such a link, once recognised, by introducing the concept of a 'lowest intermediate balance rule'. As a matter of judicial policy, this approach appears to us to accord most closely with considerations of justice and practicality. Apart from anything else, to do otherwise would . . . confer on any sophisticated fraudster the ability to defeat an otherwise effective tracing claim simply by manipulating the sequence in which credits and debits are made to his bank account."
- It remains to be seen how this broad statement of principle will be developed in future cases. By the court's own admission, the relevant accounts to which the tracing exercise was subject in Durant remained in credit throughout the relevant period, therefore the court's apparent endorsement of "reverse tracing" does not extend to situation (i) above (payment of trust money into an overdrawn account). If in a future case monies subject to a trust are deposited in an account that is overdrawn there will have to be a determination as to whether the deposit is the bank's money or the plaintiff beneficiary's, no matter how clear the evidence may be.
- As a possible alternative to backwards tracing, it seems at least arguable that where trust money is used to discharge a debt incurred by the trustee for the purpose of acquiring a specific asset, and the debt or the loan is repaid out of trust money, a beneficiary can trace into the repayment of a debt or loan so as to give him a remedy of a proprietary character by way of subrogation to the seller's lien (in the case of an asset provided on credit) or a lender's right of security.25 Whether it is possible for a plaintiff beneficiary to be subrogated to the rights of a creditor holding a hypothec over Jersey land in this fashion is unclear. English law principles do not readily apply to a system of real property that is unique to the Island. In Durant, it was suggested that, proving the implied intention of the defendant to reimburse the depleted trust fund or acquire an asset in the expectation of receiving money imbued with trust would be a sufficient, but not necessarily the only way of establishing a sufficient link between the original assets and their traceable proceeds.26
TRACING THROUGH MIXED FUNDS WHERE A CO-CONTRIBUTOR(S) NOT AT FAULT
- Under English law, where neither of the two contributors to the mixed fund in the bank account is a wrongdoer, different presumptions of identification apply. Such a situation would arise where a trustee misappropriates money of more than one trust and mixes them together. The so called rule in Clayton's Case27is that specific credits in the mixed account are matched against specific debits known as the "first in, first out rule", i.e. that the money first withdrawn from the account is drawn against the contribution of the party whose money was first deposited. Once that contribution has been exhausted, later withdrawals are deemed as made against the contribution of the party whose money was next deposited. The effect of applying the rule in Clayton's Case may prejudice or favour the contributor whose money was first paid into the account depending on whether the money withdrawn happened to be dissipated (and thereby becomes untraceable) or preserved in some other asset (which remains traceable). The rule also suffers from being time consuming and expensive to apply where the money in a mixed account derives from a number of different contributors, and where there has been extensive activity on the account, all of which must be specifically matched.28 Owing to its shortcomings, some recent English cases have acknowledged reasons to displace the rule in Clayton's Case, suggesting it would not apply where it was contrary to the actual presumed intentions of the contributors,29 or was unjust or impractical in its operation.30 It has been suggested that the court may instead treat the mixed fund as subject to a "rolling charge" in favour of each innocent contributor31 whereby debits from the account are borne rateably by each contributor according to the amount of their money in the account immediately before each withdrawal.32 An even simpler solution might be to ignore the sequence of deposits and withdrawals from the account and treat all withdrawals as borne rateably by all the contributors.33 However, the effect of this approach may be to allow a contributor to trace into a withdrawal from the account even though the withdrawal was made before his money had been deposited in the account, thereby breaking the necessary link between the traceable proceeds and the original property. Jersey operates no equivalent of the rule in Clayton's Case and has rejected it as being overly technical, and productive of capricious and arbitrary results.34 The court is solely concerned with whether the plaintiff can show a sufficiently clear link between the original funds and the funds to be traced even if it is not possible precisely to identify his money throughout its journey.
TRACING BEYOND A MIXED BANK ACCOUNT
- Where a withdrawal from a mixed fund is used to purchase an asset, it would be inequitable to award the entire beneficial ownership of the substituted asset purchased with mixed funds to the plaintiff. Under English law, the plaintiff is entitled to enforce his interest in the mixed asset either by way of a lien for the amount of his contribution which can be proved to have been applied in purchasing the asset, or by way of a proportionate beneficial interest. In asserting a beneficial interest, the plaintiff bears the risk that the substitute asset will fall in value, whereas a lien fixes the plaintiff's recovery at the amount of the contribution and so bears the risk of a rise in the value of the substituted asset. Where the substituted asset is bought with money attributable to two innocent contributors, then the claims enforceable against the asset are different. Since the equities between the two contributors are equal, there is no policy of favouring one contributor over the other. They each share the beneficial ownership of the asset in proportion to their contributions and both then bear equally the risk of depreciation in the asset or the benefits of any increase in value.
TRACING INTO JERSEY IMMOVABLES
- An interesting issue of principle
(although perhaps not of much practical import35) arises
as to whether it is possible to trace into Jersey land. There is no
binding decision of the Royal Court as to whether or not there can
be a constructive trust (in a proprietary sense).36 In
Flynn v Reid, it was said:
"69 The matter was touched upon in In re Esteem Settlement (2002 JLR 53) where at para 92, Birt, D.B. said this:
'We appreciate that the recognition of constructive trusts in such circumstances may raise questions concerning art. 10(2)(a)(iii) of the 1984 Law [now art 11(2)(a)(iii)], which provides that a trust shall be invalid to the extent that "it purports to apply directly to immovable property situated in Jersey." That would be for a decision on another occasion but, as at present advised, we think it is strongly arguable that that provision does not apply to constructive trusts. Articles 29 and 50 [now arts 33 and 54 respectively] refer to "property" which is defined by art. 1(1) to mean "property of any description wherever situated." It is hard to envisage that Jersey law would accept that, if a trustee, in breach of trust, uses trust monies to purchase immovable property for his own benefit, he should be permitted to hold that immovable property free from any trust for the beneficiaries. In any event, any concerns about Jersey immovable property are not sufficient, in our judgment, to negate the general principle which we have described.' . . .71 The analysis of the Royal Court in the extract cited above comes in that part of the judgment which considers whether the victim of fraud has an equitable proprietary interest in the proceeds of the fraud. At para. 88 of the court's judgment, Birt, D.B. held that a beneficiary under a constructive trust does have an equitable proprietary interest in the assets which are the subject of that trust, and then applied himself to the question as to whether Jersey law should hold that a constructive trust existed in circumstances such as those in that case. The court concluded that when property is obtained by fraud, equity did impose a constructive trust on the fraudulent recipient so that the victim had a proprietary interest in that property. That is the background to para. 92 where the court expressed a provisional view that what is now art 11(2)(a)(iii) of the Trust Law did not apply in the case of constructive trusts, where the proceeds of fraud had been invested by the trustee in Jersey real estate for his own benefit.
72 This is not a case of trustee fraud, and therefore we do not have to decide whether there is some special category of constructive trust which could apply to Jersey real estate in the context of trustee fraud and the issue is left over should such a case ever arise. Nonetheless we do comment that the issue is not necessarily straightforward. Of course at one end of that spectrum, one could be faced with a trustee who has fraudulently deprived the beneficiaries of the trust estate, and purchased with the proceeds some real property in Jersey. There, equity may indeed demand that the beneficiaries should have recompense. More difficult is where there are competing equities, even in such circumstances. The fraudulent trustee may have other creditors and where there has been an insufficiency of assets, it would then be an issue as to whether, in effect, the beneficiaries who have been fraudulently deprived of the trust estate should be preferred to other creditors, who might also be the victims of fraud, albeit not as beneficiaries.
73 Like Birt, D.B. in In re Esteem, we do not have to decide this issue today because the factual circumstances are quite different. We are considering today only whether a constructive trust in relation to Jersey real estate can arise in the circumstances of this case."
- Being unable to trace into Jersey immovables either as a result of fraud37 or upon some other basis upon which a proprietary interest by way of constructive trust arises, risks creating something of a safe harbour for constructive trustees and, for that reason, it seems likely that if the matter ever required a decision, the court would fashion some remedy to vindicate the beneficiary's rights although the precise means by which this would be achieved would have to be shaped around the existing parameters of Jersey's law of immovable property as well as dealing satisfactorily with the protection of the rights of third party creditors of the fiduciary. It seems possible that a beneficiary might seek vindication of his interest by pursuing the constructive trustee for unjust enrichment38 to the extent of his contribution and then seeking to enforce that judgment. This is a somewhat unwieldy mechanism and does not provide the beneficiary with any priority against anterior hypothecary creditors, nor does it provide any security for the beneficiary if the trustee becomes insolvent prior to judgment.
SUMMARY OF POINTS OF CONTRAST BETWEEN JERSEY AND ENGLISH TRACING RULES
No distinction between common law and equitable rules of tracing
- Owing to the different historical basis upon which the courts of England and Jersey have approached their respective jurisdictions to equitable remedies, Jersey has declined to follow England in preserving what is now a technical distinction between following at common law and tracing in equity.
No "first in, first out" rule
- Jersey has declined to follow the English rule that where an innocent volunteer mixes misappropriated trust funds with his own money in a current bank account the "first in, first out" rule should be used to identify the source of withdrawn funds.
A "clear" link is not always required
- While the principle that there should be a clear "clear link" between the plaintiff's property and the assets in the hands of the wrongdoer remains good law, a tracing exercise should not fail because the wrongdoer has acted particularly dishonestly or cunningly by creating a maelstrom.39 Once a plaintiff can prove that his or her assets have moved into a so-called maelstrom, the burden of proof shifts to the defendant to show what part of the mixed fund is in fact his or hers. The Court of Appeal endorsed this approach noting that "in appropriate cases, the necessary links can be inferred from the circumstances, even in the absence of direct evidence". It is to be noted that English law40 posits a similar punitive presumption of identification where the other contributor to a mixed bank account is a wrongdoer. The mixed money in the bank account is deemed to belong to the innocent trust plaintiff to the extent that the wrongdoer cannot prove that it is attributable to his own contributions to the account.
- Under Jersey law, where there is a paucity of evidence to prove the contrary, it is possible to trace fraudulent payments which are made into an account after relevant payments had already been made out of the same account. The appropriate way to address the subject was not by reference to "what is or not conceptually possible or arguably supported by English authority", but as a matter of evidence. The question is "simply whether there is sufficient evidence to establish a clear link between the credits and debits in an account, irrespective (within a reasonable timeframe) of the order in which they occur or the state of balance of the account". There is no limitation on how, as a matter of evidence, that link can be proved. Jersey does not restrict the scope of this test by applying the "lowest intermediate balance" principle, on the basis of justice and practicality. It considers that the principle may give a sophisticated fraudster the ability to defeat an otherwise effective tracing claim by manipulating the sequence in which credits and debits are made to and from the fraudster's bank account.
- A bribe or secret commission accepted by an agent is held on trust for his principal. The principal is entitled to pursue the agent personally for an account of the amount of bribe. To the extent that the agent still holds the proceeds of the bribe, the principal may claim a proprietary interest in it. The principal is also entitled to trace the proceeds of the bribe or secret commission into the agent's other assets that represent the substituted proceeds of the bribe. The availability of a proprietary remedy also means it is possible to trace into the hands of third parties who may also be knowing recipients, thereby broadening the net in terms of recovery.
- The Supreme Court's judgment is eminently sensible, practical and in accordance with sound policy considerations and legal principles. The judgment is a strong endorsement of the approach already adopted in Jersey following Fragoso to aid in the recovery of the proceeds of bribes and secret commissions. For trustees holding what may be the proceeds of bribes or secret commissions, advice needs to be sought at an early stage and an application may have to be made to court for a determination as to who the true beneficiary of those proceeds is.
- The strong message from Jersey, and now the United Kingdom, is that a fiduciary who makes an undisclosed profit, has nowhere to hide.
First published in the Jersey and Guernsey Law Review, October 2014
1  UKSC 45.
2  JRC 211.
3 Sinclair Invs (UK) Ltd v Versailles Trade Fin Ltd (in administrative receivership)  EWCA Civ 347.
4  UKPC 36.
5 2012 (2) JLR 356, later affirmed on appeal  JCA 071.
6 (1729) Sel Cas Ch 61.
7 Sinclair Invs (UK) Ltd v Versailles Trade Fin Ltd (in administrative receivership)  EWCA Civ 347.
8  UKSC 45, at para 36.
9 In re Esteem Settlement 2002 JLR 53, at para 102—"Tracing offers an effective method of vindicating and safeguarding proprietary rights, particularly in cases of fraud."
10  1 AC 102, see also the English decision of Boscawen v Bajwa  WLR 328, at para 334.
11 Foskett v McKeown  1 AC 102, at paras 127–128, per Lord Millett and Federal Republic of Brazil v Durant Intl Corp 2012 (2) JLR 356, at para 204.
12 In re Esteem Settlement 2002 JLR 53, at para 93.
13 In re Esteem Settlement 2002 JLR 53, at para
"The rules to be applied should, as a starting point, be those established in English law. However, the court is not bound by any English rule of tracing and is free to depart from such a rule if convinced that there is a better alternative. When we talk of the rules of tracing, we are, for the purposes of this case, speaking of the rules of equitable tracing because we are dealing with an equitable proprietary interest . . . There is much debate in England as to whether the time has come for the common-law tracing rules to be subsumed into the more flexible rules of equitable tracing. In particular, this would allow tracing through a mixed fund. We have not heard argument on this and therefore offer no definitive view. We express the preliminary view, however, that the differences between the two systems of tracing in England have an historical origin which has no application in Jersey. On the face of it, there would seem to be little reason to incorporate such technical distinctions into Jersey law and there would seem to be some advantage in applying the more flexible rules of equitable tracing (as constituting the Jersey rules of tracing) to all tracing actions."
Federal Republic of Brazil v Durant Intl Corp  JCA 071, at para 51—
"In short, the law of Jersey should and does recognise tracing. In particular, it should and does recognise tracing as a unitary concept, unencumbered by the burden of history which has complicated the position in England with separate rules of equitable and common law tracing."
14 Lipkin Gorman v Karpnale Ltd  2 AC 548, at para 572.
15 Foskett v McKeown  1 AC 102, at paras 129–133.
16 El Ajou v Dollar Land Holdings plc  3 All ER 717, at paras 735–736.
17 Re Hallett's Estate (1879) 13 ChD 696, at paras 726–729.
18 Re Tilley  Ch 1179, at para 1185.
19 Federal Republic of Brazil v Durant Intl Corp 2012 (2) JLR 356, at paras 203–212.
20 Bishopsgate Inv Management Ltd v Homan  Ch 211, CA. Although in Durant it was open to the plaintiff to suggest that this was in fact the intention of the defendant in order to establish a sufficient link between the original property and its traceable proceeds notwithstanding the difficulties in being able to follow the precise path of the money because of the order of payments.
22 Compare El Ajou v Dollar Land Holdings plc  3 All ER 717, at paras 735–736.
23 Federal Republic of Brazil v Durant Intl Corp 2012 (2) JLR 356.
24 Keech v Sandford (1729) Sel Cas Ch 61.
25 Tucker, Le Poidevin, Brightwell, Lewin on Trusts (Sweet & Maxwell, 18th ed, 2012), pp. 41–110, Smith, The Law of Tracing (1997), at 146 et seq. This argument seems to have made an impression on Dillon, LJ in Bishopsgate Inv Management Ltd v Homan, at paras 216G–217B and on Scott, V-C in Foskett v McKeown, at paras 283G–284A in the Court of Appeal. In Jyske Bank (Gibraltar) Ltd v Spjeldnaes, 23 July 1997 (unreported), at 331–334, it was held that where there is evidence from which the court can infer that a fraudulent trustee intended to acquire an asset with money overdrawn from a bank account knowing that the overdraft would either be paid off or restored within its limit by money obtained in breach of trust over which the trustee had direct or indirect control, it is appropriate in those circumstances for the court to impose on the asset to be acquired a constructive trust on its acquisition. It is to be noted that the decision, although not the reasoning leading to it, turns on the existence of circumstances (including fraud on the part of the trustee) justifying the imposition of a constructive trust rather than an application of a backward tracing rule.
26 Federal Republic of Brazil v Durant Intl Corp  JCA 071, at para 69.
27 (1816) 35 ER 767.
28 See Barlow Clowes Intl Ltd (in liquidation) v Vaughan  4 All ER 22, itself an example.
29 Ibid; Russell-Cooke Trust Co v Prentis  EWHC 2227 (Ch).
30 Commerzbank AG v IMB Morgan plc  EWHC 2771 (Ch).
31 Ontario Secs Commn and Greymac Credit Corp (1985) 55 OR (2d) 673, discussed ibid at para 44.
32 This is in fact the preferred method in Jersey see In re Esteem Settlement 2002 JLR 53, at para 111.
33 Barlow Clowes Intl Ltd (in liquidation) v Vaughan  4 All ER 22.
34 In re Esteem Settlement 2002 JLR 53, at paras 105–111.
35 Practically, owing to the highly regulated nature of the Island's property market, the circumstances in which a trustee would invest the traceable proceeds of a breach of trust are likely to be infrequent.
36 Flynn v Reid 2012 (1) JLR 370, at para 69.
37 In re Esteem Settlement 2002 JLR 53, at paras 82–92 and Westdeutsche Landesbank Girozentrale v Islington LBC  AC 669, at para 716.
38 Flynn v Reid 2012 (1) JLR 370.
39 Federal Republic of Brazil v Durant Intl Corp 2012 (2) JLR 356, at para 208 and Sinclair Invs (UK) Ltd v Versailles Trade Finance Ltd (in administrative receivership)  EWCA Civ 347.
40 El Ajou v Dollar Land Holdings plc  3 All ER 717, at paras 735–736.