Remedies against third parties: recipient and accessory liability - Claims against wrongdoers and remedies

Learning Outcomes

This article outlines the potential liability of third parties who become involved in a breach of trust. It examines the distinctions between recipient liability (knowing receipt) and accessory liability (dishonest assistance). You will also learn the basic principles of tracing trust property into the hands of third parties and the equitable remedies available to beneficiaries. Understanding these concepts is essential for advising clients on recovering misappropriated trust assets or pursuing claims against those who facilitate breaches of trust in SQE1-style scenarios.

SQE1 Syllabus

For SQE1, you are required to understand the principles governing claims against third parties who are implicated in breaches of trust. This includes the circumstances in which such liability arises and the remedies available to beneficiaries. Your knowledge should cover:

• The distinction between recipient liability (knowing receipt) and accessory liability (dishonest assistance).
• The elements required to establish knowing receipt, focusing on the recipient's knowledge and unconscionability.
• The elements required to establish dishonest assistance, focusing on the nature of the assistance and the requirement of dishonesty.
• The basic principles of tracing trust assets into the hands of third parties, including into mixed funds.
• The availability of equitable remedies such as constructive trusts and equitable liens against third parties.
• Defences available to third parties, such as being a bona fide purchaser for value without notice.

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.

1. Which doctrine applies when a third party receives trust property transferred in breach of trust, knowing circumstances that would make retention unconscionable?
   1. Dishonest Assistance
   2. Resulting Trust
   3. Knowing Receipt
   4. Proprietary Estoppel
2. What is the primary focus when establishing liability for dishonest assistance?
   1. The receipt of trust property by the assistant.
   2. The state of knowledge of the trustee committing the breach.
   3. The dishonesty of the person assisting the breach.
   4. The value of the loss suffered by the trust.

3. True or false: Tracing is a remedy in itself, rather than a process to identify assets against which a remedy can be claimed.

4. Which defence completely protects a third party who acquired legal title to trust property transferred in breach of trust?
   1. Change of position
   2. Limitation Act expiry
   3. Bona fide purchaser for value without notice
   4. Consent of one beneficiary

Introduction

When a trustee breaches their duties, resulting in loss to the trust or misappropriation of trust assets, beneficiaries primarily have personal or proprietary claims against the trustee. However, if the trustee is insolvent or cannot be located, or if trust property has passed to others, beneficiaries may need to consider claims against third parties who were involved in or benefited from the breach. Equity provides mechanisms to hold such third parties accountable through doctrines like knowing receipt and dishonest assistance, and allows beneficiaries to follow or trace trust property into the hands of recipients.

Recipient Liability: Knowing Receipt

A third party may be personally liable to account as if they were a trustee if they receive trust property transferred in breach of trust. This liability arises under the doctrine of knowing receipt.

Key Term: Knowing Receipt
Liability imposed on a third party who receives trust property transferred in breach of trust with knowledge that makes it unconscionable for them to retain the benefit.

Establishing knowing receipt requires three elements:

1. A disposal of trust assets in breach of fiduciary duty: The property must have left the trust due to a trustee's breach.
2. Beneficial receipt by the third party: The third party must have received the property for their own use or benefit, not merely as an agent for another.
3. Knowledge making retention unconscionable: The third party must possess knowledge about the source of the property which makes it unconscionable for them to retain it.

The level of knowledge required was clarified in BCCI v Akindele [2001] Ch 437. The court held that the test is whether the recipient's state of knowledge is such as to make it unconscionable for them to retain the benefit of the receipt. This single test replaced previous categories of knowledge. Actual knowledge of the breach is sufficient, but constructive knowledge (e.g., wilfully shutting one's eyes to the obvious, or failing to make enquiries an honest person would) can also render retention unconscionable.

Worked Example 1.1

Fiona, a trustee, transfers £50,000 from the trust fund to her friend, George. She tells George the money is a "temporary loan" from a "special fund" she manages, but asks him not to mention it to anyone. George uses the money to buy shares. George suspects the money might not be Fiona's to lend but asks no questions. Is George potentially liable?

Answer: George may be liable for knowing receipt. He received trust property transferred (likely) in breach of trust. Although he didn't have actual knowledge, his suspicion combined with a wilful failure to make enquiries could make his retention of the benefit (using the money as his own) unconscionable. The beneficiaries could potentially bring a personal claim against him for the £50,000 or trace the funds into the shares.

Accessory Liability: Dishonest Assistance

A third party who does not actually receive trust property can still be held liable if they dishonestly assist a trustee or fiduciary to commit a breach of trust or fiduciary duty. This is known as accessory liability or dishonest assistance.

Key Term: Dishonest Assistance
Liability imposed on a third party who dishonestly assists or procures a breach of trust or fiduciary duty, causing loss to the trust.

The key requirements for dishonest assistance are:

1. Existence of a trust or fiduciary duty: There must be a trust or fiduciary relationship.
2. Breach of that trust or duty: The trustee or fiduciary must have acted in breach. The breach itself need not be dishonest.
3. Assistance by the third party: The third party must have assisted in the breach. This usually requires a positive act, not mere omission.
4. Dishonesty by the third party: The assistance must have been dishonest.

The test for dishonesty was established in Royal Brunei Airlines v Tan [1995] 2 AC 378 and confirmed in Barlow Clowes v Eurotrust [2005] UKPC 37. It is an objective test: did the person act as an honest person would have acted in the circumstances? The court will consider the defendant's actual knowledge and experience, but the standard applied is that of ordinary decent people. It is not necessary for the defendant to realise that their conduct was dishonest by those standards.

Worked Example 1.2

An accountant helps a trustee create false invoices to hide the fact that the trustee has been misappropriating trust funds for personal use. The accountant suspects wrongdoing but prepares the invoices as instructed to keep the client happy. Is the accountant potentially liable?

Answer: The accountant may be liable for dishonest assistance. There was a trust, a breach by the trustee (misappropriation), and the accountant assisted by creating false invoices. The key issue is dishonesty. An ordinary honest accountant, suspecting wrongdoing, would likely refuse to prepare false invoices or make further enquiries. By preparing them despite suspicions, the accountant's conduct likely falls below the standard of ordinary honest people, satisfying the objective test for dishonesty.

Tracing Trust Property

Where trust property has been misappropriated, beneficiaries may wish to recover the specific property or its substitute. Tracing is the process of identifying the trust property as it passes through different hands or changes form. It is not a remedy itself but enables beneficiaries to identify assets against which a proprietary remedy (like a constructive trust or equitable lien) may be claimed.

Key Term: Tracing
The process of identifying what has happened to misappropriated property and located either the original property or property substituted for it.

Equitable tracing is available where there is an initial fiduciary relationship (e.g., trustee-beneficiary) and the property remains identifiable. The right to trace is lost if the property is dissipated (e.g., spent on a holiday) or if it passes into the hands of a bona fide purchaser for value without notice ('Equity's Darling').

Tracing Rules

• Clean Substitution: If the trustee uses trust money exclusively to buy a new asset, beneficiaries can trace into the new asset and claim it or impose a charge over it.
• Mixed Funds (Trustee's Own Money): If a trustee mixes trust money with their own in a bank account:
  • Re Hallett's Estate (1880): Trustee is presumed to spend their own money first.
  • Re Oatway (1903): If Re Hallett leads to an unjust result (e.g., trustee buys shares with early withdrawals then dissipates the rest), the beneficiaries can claim a charge over the purchased asset. Beneficiaries can generally "cherry-pick" the rule that gives the best outcome against the wrongdoing trustee.
  • Lowest Intermediate Balance: The claim is limited to the lowest balance the account reached after the trust money was paid in (Roscoe v Winder [1915]). Subsequent deposits by the trustee are not automatically treated as replacing trust money.
• Mixed Funds (Two Trusts or Trust + Innocent Volunteer):
  • Clayton's Case (1816): The traditional rule is 'first in, first out' (FIFO). Money first deposited is deemed first withdrawn.
  • Rateable Distribution: Courts may depart from FIFO if it is impractical or unjust, instead sharing the remaining fund or assets purchased proportionally (Barlow Clowes v Vaughan [1992]).

Worked Example 1.3

A trustee misappropriates £10,000 from Trust A and £20,000 from Trust B, paying both into their personal bank account which previously held £5,000 of their own money (Total £35,000). They then withdraw £15,000 to buy shares. Applying Re Hallett, whose money purchased the shares?

Answer: Applying Re Hallett, the trustee is presumed to spend their own money first. The trustee's £5,000 is deemed spent first. The remaining £10,000 withdrawn must be trust money. Applying FIFO (Clayton's Case), this £10,000 would be deemed to come from Trust A (as it was paid in first if we assume the £10k from Trust A went in before the £20k from Trust B, although the example doesn't specify the order of deposits - if the order was reversed, the first £10k withdrawn after the trustee's £5k would be from Trust B). A proportionate approach might also be applied if FIFO is unjust.

Equitable Remedies Against Third Parties

If tracing identifies trust property or its proceeds in the hands of a third party (who is not a bona fide purchaser), beneficiaries may seek proprietary remedies:

Key Term: Constructive Trust
A trust imposed by equity where it would be unconscionable for the legal owner to assert beneficial ownership, requiring them to hold the property for the benefit of another. A knowing recipient may be declared a constructive trustee.

Key Term: Equitable Lien
A charge over property securing a specific amount. Beneficiaries can secure a lien over assets acquired with misappropriated trust funds (or a mixed fund) to recover the value lost to the trust.

The choice depends on the circumstances. A constructive trust allows beneficiaries to benefit from any increase in the property's value. An equitable lien provides security for recovering the specific amount lost, useful if the property has decreased in value or if claiming a proportionate share is complex.

Exam Warning

Remember that proprietary claims (tracing followed by constructive trust or lien) give beneficiaries priority over the defendant's general creditors in bankruptcy or insolvency. Personal claims (like knowing receipt or dishonest assistance) rank alongside other unsecured debts if the defendant is bankrupt.

Defences

Third parties facing claims may raise defences:

• Bona Fide Purchaser for Value Without Notice: This is a complete defence. The purchaser must have given value, acted in good faith, and had no actual or constructive notice of the breach of trust.
• Change of Position: An innocent recipient who has irreversibly changed their position in reliance on the receipt may have a defence, making it inequitable to demand full repayment (Lipkin Gorman v Karpnale [1991]). This is not available to wrongdoers.
• Limitation: Personal claims are subject to limitation periods (usually six years under the Limitation Act 1980), though fraud postpones the start date. Proprietary claims are generally not subject to statutory limitation periods but may be barred by laches (unreasonable delay).

Revision Tip

Focus on distinguishing the elements required for knowing receipt (receipt + knowledge) versus dishonest assistance (assistance + dishonesty). A person can be liable for dishonest assistance even if they never received any trust property.

Key Point Checklist

This article has covered the following key knowledge points:

• Beneficiaries may have personal or proprietary claims against third parties involved in breaches of trust.
• Recipient liability (knowing receipt) requires receipt of trust property with knowledge making retention unconscionable.
• Accessory liability (dishonest assistance) requires dishonest assistance in a breach of trust, regardless of receipt. Dishonesty is judged objectively.
• Tracing is a process to identify trust property or its proceeds in the hands of trustees or third parties.
• Specific tracing rules apply depending on whether funds are mixed and with whose money (trustee's, another trust's, innocent volunteer's).
• Equitable remedies following tracing include constructive trusts and equitable liens.
• Key defences include being a bona fide purchaser for value without notice and, for innocent volunteers, change of position.

Key Terms and Concepts

• Knowing Receipt
• Dishonest Assistance
• Tracing
• Constructive Trust
• Equitable Lien