Remedies against third parties: recipient and accessory liability - Establishing recipient liability (knowing receipt)

Learning Outcomes

This article outlines the equitable remedy against a third party known as recipient liability, often referred to as knowing receipt. It explains the essential elements required to establish liability, particularly focusing on the nature of receipt, the necessity of a breach of trust or fiduciary duty, and the different levels of knowledge that may suffice. By the end of this article, you should understand the requirements for establishing recipient liability, including the role of unconscionability, and be able to apply these principles to SQE1-style problem scenarios.

SQE1 Syllabus

For SQE1, you are required to understand the principles governing liability for knowing receipt as a remedy against third parties who have received trust property transferred in breach of trust or fiduciary duty. You will need to identify the elements required to establish a claim and recognise the different types of knowledge that might affect a recipient's liability.

As you work through this article, remember to pay particular attention in your revision to:

• The core requirements for establishing recipient liability (knowing receipt).
• The types of knowledge that can make a recipient liable, including actual and constructive knowledge.
• The concept of unconscionability as established in case law.
• The distinction between personal and proprietary claims against recipients.
• Defences potentially available to a recipient, 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 of the following elements is NOT strictly required to establish recipient liability?
   1. Receipt of trust property by the defendant.
   2. A breach of fiduciary duty by the trustee.
   3. Dishonesty on the part of the recipient.
   4. Knowledge by the recipient making retention unconscionable.
2. A third party receives assets transferred in breach of trust but provides full market value and has no notice of the breach. Are they likely to be liable for knowing receipt?
   1. Yes, because they received trust property.
   2. Yes, unless they can prove they acted reasonably.
   3. No, because they are likely a bona fide purchaser for value without notice.
   4. No, because the trustee is solely liable for the breach.
3. In the context of knowing receipt, what level of knowledge makes it 'unconscionable' for a recipient to retain trust property?
   1. Only actual knowledge of the breach.
   2. Suspicion of a breach is always sufficient.
   3. Knowledge derived from any source, regardless of reliability.
   4. Knowledge which makes the recipient's conduct contrary to normally acceptable standards of honest behaviour.

Introduction

When trust property is misapplied by a trustee or fiduciary, beneficiaries may seek remedies not only against the trustee but also against third parties who have become involved. One such remedy targets third parties who have received the misapplied trust property. This is known as recipient liability or, more commonly, knowing receipt. It is an equitable, fault-based liability. Establishing a claim requires demonstrating that the third party received assets originating from a breach of trust or fiduciary duty and possessed a level of knowledge about the breach that makes it unconscionable for them to retain the benefit of the receipt. This article explores the key elements required to establish this liability.

Elements of Recipient Liability (Knowing Receipt)

To succeed in a claim for knowing receipt, a claimant (typically a beneficiary or a successor trustee) must establish three core elements:

1. A disposal of assets in breach of fiduciary duty or trust.
2. The beneficial receipt by the defendant (the third party) of assets which are traceable as representing the assets of the claimant.
3. Knowledge on the part of the defendant that the assets received are traceable to a breach of fiduciary duty, making it unconscionable for the defendant to retain the benefit of the receipt.

We will examine the nature of receipt and the required level of knowledge in more detail.

Receipt of Trust Assets

The defendant must have received the trust property (or its traceable product) for their own use and benefit. Simply acting as an agent for another party in a transaction involving misapplied trust funds (e.g., a bank processing a payment or a solicitor acting on instructions) does not typically constitute beneficial receipt for the purposes of this liability. The defendant must have received the property in a way that benefits them personally.

Key Term: Knowing Receipt
An equitable cause of action rendering a third party personally liable to account as if they were a trustee, where they have received trust property transferred in breach of trust with the requisite degree of knowledge that the transfer was a breach.

Key Term: Recipient Liability
The liability imposed on a person who receives trust property transferred in breach of trust with sufficient knowledge of the breach. It is synonymous with 'knowing receipt'.

Breach of Fiduciary Duty or Trust

There must have been a fundamental breach of trust or fiduciary duty which resulted in the misapplication of the trust assets received by the defendant. The breach does not need to have been dishonest on the part of the trustee or fiduciary; an innocent breach is sufficient.

Knowledge

This is often the most contested element. The recipient must possess knowledge that makes it unconscionable for them to retain the property. The courts have moved away from rigid categories of knowledge (e.g., the Baden scale) towards a single test of unconscionability.

In Bank of Credit and Commerce International (Overseas) Ltd v Akindele [2001] Ch 437, the Court of Appeal 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.

Key Term: Unconscionability
In the context of knowing receipt, conduct by the recipient in retaining the trust property that is considered contrary to acceptable standards of honest behaviour, given their state of knowledge about the source of the property.

This test encompasses various levels of awareness, including:

• Actual knowledge: The recipient actually knew the transfer was in breach of trust.
• Wilful blindness: The recipient deliberately shut their eyes to the obvious facts or refrained from making inquiries that a reasonable and honest person would make because they suspected the truth.
• Constructive knowledge: Knowledge of circumstances which would indicate the facts to an honest and reasonable person or put them on inquiry. While some debate exists, knowledge below the level of actual knowledge or wilful blindness (i.e., types of constructive knowledge) may be sufficient if the circumstances render retention unconscionable.

The focus is on the recipient's conscience. Did they know enough about the circumstances of the transfer to make their retention of the property contrary to acceptable standards of honest conduct?

Worked Example 1.1

A trustee, David, improperly transfers £50,000 of trust funds to his friend, Sarah, telling her it is a gift from a recent inheritance. Sarah knows David is a trustee and is aware he has faced financial difficulties recently. She finds the large gift surprising but accepts it without asking further questions and uses it to buy a car. The beneficiaries discover the breach. Can they establish recipient liability against Sarah?

Answer: The beneficiaries must show:

1. Breach: David breached his trust by improperly transferring funds.
2. Receipt: Sarah received the funds beneficially.
3. Knowledge: Sarah had actual knowledge that David was a trustee and knew of his financial issues. The large, unexpected gift might be considered circumstances that would put an honest and reasonable person on inquiry. By not asking questions despite these suspicious circumstances, Sarah might be deemed to have sufficient knowledge (potentially constructive knowledge or wilful blindness) to make her retention of the benefit unconscionable. A court would assess if her state of knowledge crossed the threshold of unconscionability. If so, she could be personally liable for the £50,000.

Nature of the Claim

A claim for knowing receipt is primarily a personal claim against the recipient. This means the recipient is liable to pay monetary compensation to restore the value of the property received, typically equivalent to the value of the property at the date of receipt plus interest.

However, if the recipient still holds the original trust property or its traceable proceeds (e.g., an asset purchased with the trust money), the claimant may also assert an equitable proprietary claim to recover that property. This is explored further in the context of tracing.

Worked Example 1.2

Continuing from Worked Example 1.1, assume Sarah is found liable for knowing receipt. The beneficiaries discover she used the entire £50,000 to buy the car, which is now worth £40,000. What remedies might the beneficiaries seek?

Answer: The beneficiaries have a personal claim against Sarah for £50,000 (plus interest). They can also potentially bring a proprietary claim against the car. Since the car was purchased entirely with trust funds (a clean substitution), they could claim ownership of the car. However, as it has decreased in value, they would likely prefer the personal claim for £50,000 and might assert an equitable lien (a charge) over the car to secure part of that personal claim up to the car's current value (£40,000).

Defences

A key defence against a knowing receipt claim is that the recipient is a bona fide purchaser for value without notice (BFPVWN), sometimes referred to as 'equity's darling'.

Key Term: Bona Fide Purchaser for Value Without Notice
A person who acquires legal title to property (i) in good faith (bona fide), (ii) for valuable consideration (value), and (iii) without actual, constructive, or imputed notice of any pre-existing equitable interests (without notice). Such a purchaser takes the property free from those equitable interests.

If a third party provides valuable consideration (not necessarily market value, but more than nominal) for the trust property and acts in good faith without the requisite knowledge of the breach of trust, they will take the property free from the beneficiaries' equitable claims. The beneficiaries' remedy would then lie primarily against the wrongdoing trustee.

Another potential, though less commonly successful, defence is that of 'change of position', where the recipient argues they have irreversibly changed their circumstances in reliance on the receipt, making it inequitable to compel restitution. This defence is typically more relevant to claims against innocent volunteers rather than recipients found liable for knowing receipt based on unconscionability.

Exam Warning

Do not confuse the requirements for recipient liability (knowing receipt) with those for accessory liability (dishonest assistance). Knowing receipt focuses on the recipient's knowledge regarding the receipt of property, whereas dishonest assistance requires dishonesty on the part of the third party in assisting the breach, even if they never received trust property.

Key Point Checklist

This article has covered the following key knowledge points:

• Recipient liability (knowing receipt) is an equitable claim against a third party who receives trust property transferred in breach of trust or fiduciary duty.
• Establishing liability requires proving (1) a breach of trust/fiduciary duty, (2) beneficial receipt of trust assets by the third party, and (3) knowledge making retention unconscionable.
• The test for knowledge is based on unconscionability, assessed objectively based on the recipient's actual and constructive knowledge and circumstances.
• The primary remedy is personal liability to account for the value received, but proprietary claims (tracing) may also be available if the property or its proceeds are identifiable.
• The defence of being a bona fide purchaser for value without notice can defeat a knowing receipt claim.

Key Terms and Concepts

• Knowing Receipt
• Recipient Liability
• Unconscionability
• Bona Fide Purchaser for Value Without Notice