Learning Outcomes
This article outlines the principles governing claims against innocent volunteers who receive trust property transferred in breach of trust. It explains the remedies available to beneficiaries, focusing on proprietary claims and the process of equitable tracing. For the SQE1 assessment, you will need to understand the distinction between personal and proprietary claims, the rules for tracing trust property into the hands of an innocent volunteer (including into mixed funds), and the potential defences available to such volunteers. This knowledge will enable you to identify and apply the relevant legal rules to SQE1-style single best answer questions.
SQE1 Syllabus
For SQE1, you are required to understand the remedies available against third parties who receive trust property, including innocent volunteers. You should be able to distinguish between personal and proprietary claims and apply the rules of equitable tracing. Your understanding should cover:
- The definition of an innocent volunteer.
- The distinction between personal and proprietary remedies against third parties.
- The requirements and limitations of equitable tracing.
- The specific tracing rules applicable when trust property is mixed with an innocent volunteer's property.
- The potential defences available to an innocent volunteer, such as change of position and bona fide purchaser for value without notice.
- The principles established in key cases concerning claims against innocent volunteers, although specific case names are not usually required unless they define a core principle.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- True or False: An innocent volunteer who receives trust property in breach of trust is personally liable to compensate the beneficiaries for the value received.
- Which equitable remedy allows beneficiaries to assert ownership rights over property that represents misappropriated trust assets? a) Equitable compensation b) Account of profits c) Proprietary claim via tracing d) Injunction
- An innocent volunteer receives £10,000 of trust money and mixes it with £5,000 of their own money in a bank account. They then spend £6,000 from the account on living expenses. Which tracing rule traditionally applies to determine whose money was spent? a) Re Hallett's Estate (trustee spends own money first) b) Re Oatway (beneficiary has first charge) c) Clayton's Case (first in, first out) d) Proportionate sharing
- What defence might be available to an innocent volunteer who spent trust money received in good faith on home improvements, making it inequitable to force a sale?
Introduction
When trust property is misapplied by a trustee in breach of trust, it may end up in the hands of a third party. If that third party provided consideration and had no notice of the breach, they are generally protected as a bona fide purchaser for value. However, if the recipient gave no consideration (a volunteer) and was unaware of the breach (innocent), the beneficiaries may still have remedies against them, primarily through proprietary claims facilitated by equitable tracing. This article focuses specifically on claims against these innocent volunteers.
Understanding the position of innocent volunteers is essential because equity seeks to balance the protection of beneficiaries' interests with fairness towards recipients who were not party to the original wrongdoing.
Nature of Claims Against Innocent Volunteers
An innocent volunteer is a person who receives trust property (or its traceable proceeds) without giving consideration (value) and without knowledge of the breach of trust that led to the transfer.
Key Term: Innocent Volunteer A third party who receives trust property transferred in breach of trust, without providing consideration and without knowledge or notice of the breach.
Equity does not generally impose personal liability on an innocent volunteer simply for receiving the property. Unlike a recipient with knowledge (a 'knowing recipient'), the innocent volunteer's conscience is not considered affected at the point of receipt. Therefore, a personal claim to compensate the trust fund for the value received, akin to that against a defaulting trustee or a knowing recipient, is typically unavailable against an innocent volunteer whose position has not changed after becoming aware of the trust claim (subject to the limited exception established in Re Diplock for claims against recipients of assets wrongly distributed from a deceased's estate).
The primary remedy available to beneficiaries against an innocent volunteer is a proprietary claim to recover the specific trust property or its traceable proceeds.
Key Term: Proprietary Claim A claim asserting rights over specific property, allowing the claimant to recover the property itself or its traceable substitute, rather than seeking monetary compensation from the defendant personally.
A proprietary claim has significant advantages, especially if the innocent volunteer becomes bankrupt, as the claimed property does not form part of the volunteer's assets available to general creditors.
Equitable Tracing Against Innocent Volunteers
To bring a proprietary claim, beneficiaries must be able to identify the trust property or its proceeds in the hands of the innocent volunteer. This process of identification is known as equitable tracing.
Key Term: Equitable Tracing The process by which equity allows beneficiaries to identify and follow trust property as it changes hands or form, even when mixed with other property.
Requirements for Equitable Tracing
For equitable tracing to be available against any recipient (including an innocent volunteer), certain prerequisites must generally be met:
- Fiduciary Relationship: There must have been an initial fiduciary relationship (e.g., between the trustee and beneficiaries). This relationship does not need to exist between the claimant and the defendant against whom tracing is sought.
- Equitable Proprietary Interest: The claimant (beneficiary) must have an equitable proprietary interest in the property being traced.
- Identifiable Property: The property (or its substitute) must still exist and be identifiable, even if mixed with other property. Tracing is not possible if the property has been dissipated (e.g., spent on general living expenses, a holiday, or unsecured debts) without leaving any traceable product.
Tracing Rules Involving Innocent Volunteers
When trust property is mixed with the innocent volunteer's own property, specific tracing rules apply, reflecting the fact that the recipient is blameless. These rules differ from those applied against a wrongdoing trustee ('everything is presumed against a wrongdoer').
Mixed Asset Purchases
If an innocent volunteer uses trust funds mixed with their own money to purchase an asset (e.g., a car, shares), the beneficiaries and the innocent volunteer share ownership of the asset rateably (proportionately) according to their contributions.
Key Term: Rateable Sharing (Pari Passu) A method of distribution where claimants share property or its value in proportion to their original contributions or claims.
This means both parties share any increase or decrease in the asset's value proportionately. Unlike claims against a wrongdoing trustee, the beneficiary cannot elect to take a charge (lien) over the asset to recover the full amount of the trust money if the asset has decreased in value.
Worked Example 1.1
An innocent volunteer, V, receives £10,000 of trust money mistakenly transferred by a trustee. V adds £5,000 of their own savings and buys shares for £15,000. The shares are now worth £18,000. What proprietary claim do the beneficiaries have?
Answer: The beneficiaries and V share the asset rateably. The trust contributed £10,000 (two-thirds) and V contributed £5,000 (one-third). The shares are now worth £18,000. The beneficiaries can claim a two-thirds share, which is £12,000. V is entitled to the remaining one-third (£6,000).
Worked Example 1.2
Using the facts from Worked Example 1.1, assume the shares are now worth only £9,000. What proprietary claim do the beneficiaries have?
Answer: The beneficiaries and V still share the asset rateably. The beneficiaries can claim two-thirds of the current value (£6,000). V is entitled to the remaining one-third (£3,000). The beneficiaries cannot claim a charge for the full £10,000 originally misapplied; they share the loss proportionately with the innocent volunteer.
Withdrawals from a Mixed Bank Account
If an innocent volunteer mixes trust money with their own funds in a bank account, the traditional rule for determining whose money is withdrawn first is the rule in Clayton's Case (1816), commonly known as 'first in, first out' (FIFO). This rule applies primarily to current accounts.
Key Term: Rule in Clayton's Case (FIFO) A tracing rule applicable to mixed funds in active bank accounts, presuming that money withdrawn is the money that was first deposited.
Worked Example 1.3
An innocent volunteer, V, has £2,000 in their bank account. On Monday, £4,000 of trust money is mistakenly paid in. On Tuesday, V deposits a further £1,000 of their own money. On Wednesday, V withdraws £5,000 and spends it on untraceable living expenses. What is the proprietary claim of the beneficiaries against the remaining balance?
Answer: Applying Clayton's Case (FIFO):
- Initial balance: £2,000 (V's) + £4,000 (Trust) + £1,000 (V's) = £7,000 total.
- Withdrawal of £5,000: The first £2,000 withdrawn is deemed to be V's original money. The next £3,000 withdrawn is deemed to be from the trust money paid in on Monday.
- Remaining balance: £2,000. This consists of £1,000 of the trust money (from Monday) and £1,000 of V's money (from Tuesday).
- The beneficiaries can trace £1,000 into the remaining balance.
However, the courts have recognised that the FIFO rule can operate arbitrarily and may lead to injustice. In Barlow Clowes International Ltd v Vaughan [1992], the Court of Appeal indicated that FIFO should not be applied if it is impractical, contrary to the parties' intentions, or unjust. In such cases, particularly where funds from multiple innocent parties are mixed, the court may prefer a proportionate sharing approach, where the remaining funds (or assets purchased) are shared rateably according to the contributions made.
Exam Warning
For SQE1 purposes, be aware of both the traditional Clayton's Case (FIFO) rule and the possibility of the court applying a proportionate sharing solution, especially where FIFO would lead to an unfair result between innocent parties. The specific facts of the scenario will guide which approach is more likely.
Defences Available to Innocent Volunteers
Even if beneficiaries can trace trust property into the hands of an innocent volunteer, the volunteer may have defences that defeat the proprietary claim.
Bona Fide Purchaser for Value Without Notice
This defence is fundamental. If a person acquires legal title to property for value (not as a gift) in good faith, without actual, constructive, or imputed notice of any prior equitable interest (like that of the beneficiaries), they take the property free from that interest. This defence provides finality to commercial transactions. An innocent volunteer, by definition, has not given value, so this defence is not available to them. However, if the innocent volunteer subsequently sells the property to a bona fide purchaser for value without notice, the beneficiaries' right to trace into the original property is lost (though they may be able to trace into the sale proceeds received by the volunteer).
Change of Position
This defence, established in Lipkin Gorman v Karpnale Ltd [1991], may protect an innocent recipient (including a volunteer) who has changed their position in good faith in reliance on the receipt, such that it would be inequitable in all the circumstances to require them to make restitution.
Key Term: Change of Position A defence available to an innocent recipient of misdirected funds where they have, in good faith, irreversibly changed their circumstances in reliance on the receipt, making full restitution inequitable.
Requirements for the Defence
- Good Faith: The recipient must have acted honestly and without knowledge of the claimant's rights when changing their position.
- Change of Position: The recipient must have altered their position (e.g., spent the money, entered into new obligations). Mere spending on ordinary living expenses that would have been incurred anyway is usually insufficient. The change must typically be extraordinary or involve significant capital expenditure.
- Reliance: The change must have been made in reliance on the receipt of the funds.
- Inequitable: It must be unfair or unjust to require the recipient to make full restitution.
Application to Innocent Volunteers
An innocent volunteer might use trust money received to make a large charitable donation they would not otherwise have made, or undertake significant, non-value-enhancing home renovations. In such cases, forcing them to repay the trust might be deemed inequitable.
The Re Diplock Issue
A specific problem arises when an innocent volunteer uses trust money to improve their own pre-existing property (e.g., building an extension on their house). In Re Diplock [1948], the Court of Appeal held that tracing was generally not possible in such cases because:
- The improvements might not actually increase the property's value.
- Even if value increased, forcing a sale of the innocent volunteer's home to satisfy the beneficiaries' claim would be inequitable.
This specific application of the inequitability principle often prevents beneficiaries from tracing into improvements made by innocent volunteers using trust funds, although the original money might still be recoverable if the change of position defence does not fully apply.
Dissipation
Tracing is impossible if the trust property or its proceeds no longer exist in identifiable form. If an innocent volunteer spends the trust money on general living expenses, a holiday, or discharges an unsecured debt, the property is dissipated, and the proprietary claim fails.
Key Point Checklist
This article has covered the following key knowledge points:
- An innocent volunteer receives trust property without giving value or having notice of the breach of trust.
- Beneficiaries generally cannot bring personal claims against innocent volunteers but can pursue proprietary claims via equitable tracing.
- Equitable tracing requires a fiduciary relationship, an equitable proprietary interest, and identifiable property.
- Specific tracing rules apply when trust property is mixed with an innocent volunteer's property:
- Mixed assets are shared rateably (proportionately).
- Mixed bank accounts traditionally follow Clayton's Case (FIFO), but courts may apply proportionate sharing if FIFO is unjust.
- Tracing is impossible if the property has been dissipated.
- The defence of bona fide purchaser for value without notice is not available to volunteers.
- The defence of change of position may protect an innocent volunteer if they have altered their position in good faith reliance on the receipt, making restitution inequitable.
- Tracing into improvements made by an innocent volunteer to their own property is generally not permitted (Re Diplock).
Key Terms and Concepts
- Innocent Volunteer
- Proprietary Claim
- Equitable Tracing
- Rateable Sharing (Pari Passu)
- Rule in Clayton's Case (FIFO)
- Change of Position
