Tracing: A remedial process to capture an unfaithful trustee

A brief history of tracing

Tracing is a complex and often misunderstood area of trust and property law. It is predicated on retrospective use of misapplied trust funds. It potentially allows the beneficiary of a trust to get trust funds back when the situation seems bleak.

A simple example of tracing can be seen with the following hypothetical:

• X takes $100 in breach of trust and buys a painting from a shop owner with the misappropriated money.

Tracing will allow the retrospective searching of the funds back into A’s hands, and not that of the shop owners, as the shop owner transacted without notice and in good faith, therefore, will not be liable.

However, there are shortcomings with the ability to trace; a further example can be seen with mixed funds:

• If $1000 of trust money is mixed with the trustees own money (lets say another $1000 totaling $2000) and the trustee withdraws $1200 and spends it on a holiday[1]

In this situation the beneficiary has a secured claim to the remaining $800, however, will need to get in line for the other $200.

What does the case law have to say?

The pivotal cases of Re Hallet’s Estate and Re Otaway suggest that there is a presumption of innocence when a trustee spends money from a mixed trust account, meaning that the money spent is presumed to be that other than belonging to the trust[2].

Furthermore, the case of Scott v Scott suggests that if a breaching trustee uses misappropriated funds to purchase an asset that appreciates, the beneficiary may be able to get a proportionate increase in value.

Are there any prohibitions to tracing?

Yes, the following situations will generally break the chain in tracing:

1. Dissipation – when money is spent on unrecoverable items or events;
2. Bona fide purchaser for value without notice;
3. Tracing into a debt[3];
4. Money spent on improvement,[4] but at most the beneficiary may be able to get a charge over the asset, however, the beneficiary does not get a proportionate share, he/she will only get the amount that was lost[5]; and
5. If it would be inequitable to allow tracing – if a party has changed their position.

Conclusion

The role of tracing is to assist beneficiaries in their endeavour to re-acquire some of their trust assets after a trustee’s bad behaviour. While tracing is a complex and often unclear area of law, it can yield great results for clients.

If you need any further information about tracing please do not hesitate to contact JHK Legal for advice.

[1] In this situation the holiday money would be considered dissipated.

[2] Re Otaway was a clarification and extension on the view in Re Hallet’s.

[3] Unless it is secured.

[4] Generally seen as dissipation.

[5] But if it would be inequitable the Court will not do it.

Paul Scagliotti
SENIOR ASSOCIATE