Trustees' liability for breach: proprietary claims - Equitab...

Learning Outcomes

This article explains the distinction between personal and proprietary claims following a breach of trust, when proprietary claims are available to beneficiaries, and how these claims interact with personal remedies and insolvency rules. It covers the principal equitable remedies used to vindicate proprietary rights—constructive trusts, equitable liens, subrogation, and, where appropriate, an account of profits—and shows how to choose between them when assets have appreciated or depreciated. It details core tracing requirements and techniques for unmixed and mixed funds, including presumptions about spending, the Re Hallett approach, first in, first out, the lowest intermediate balance rule, and the modern rateable (pari passu) method. It examines practical tracing problems such as overdrafts, backwards tracing, and coordinated schemes, and the treatment of substitute assets and improvements to property. It analyzes typical exam scenarios involving innocent volunteers, knowing recipients, bona fide purchasers, dissipation, and laches, highlighting when proprietary relief will be denied or limited. It also reviews how courts exercise discretion to fashion equitable remedies that balance beneficiary protection with fairness to third parties.

SQE1 Syllabus

For SQE1, you are required to understand the circumstances in which beneficiaries may bring proprietary claims following a breach of trust, the nature of equitable remedies available for such claims, and the practical and legal consequences of asserting proprietary rights, with a focus on the following syllabus points:

• The distinction between personal and proprietary claims after a breach of trust
• The process and requirements for tracing trust property in equity
• The main equitable remedies available for proprietary claims (constructive trusts, equitable liens, subrogation)
• The rules and limits on proprietary claims, including defences (bona fide purchaser, laches, dissipation)
• The practical consequences of proprietary claims, especially in insolvency and asset appreciation scenarios
• Tracing in mixed funds: presumption that a trustee spends their own money first; claims to assets purchased with mixed funds; lowest intermediate balance
• Competing claims in mixed accounts: first in, first out (Clayton’s Case) and the court’s discretion to apportion rateably (pari passu)
• Limits on tracing through overdrafts and backwards tracing, and the coordinated scheme exception
• Proprietary claims against third parties: innocent volunteers (including Re Diplock principles) and knowing recipients; contrast with dishonest assistance where proprietary relief is not available

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. What is the main difference between a personal claim and a proprietary claim following a breach of trust?
2. Name two equitable remedies available to beneficiaries making a proprietary claim.
3. What is the significance of tracing in the context of proprietary claims?
4. Can a proprietary claim succeed against a third party who purchased trust property in good faith and without notice of the breach? Explain briefly.

Introduction

When a trustee misapplies trust property, beneficiaries may seek to recover their loss through either a personal claim (for compensation) or a proprietary claim (to recover the property itself or its traceable proceeds). Proprietary claims are a powerful tool in trust law, allowing beneficiaries to assert rights over specific assets and access a range of equitable remedies. Understanding when and how proprietary claims arise, and the remedies available, is essential for SQE1.

Proprietary Claims: Overview

A proprietary claim enables a beneficiary to assert an equitable right over specific property or its traceable substitute, rather than simply seeking monetary compensation from the trustee.

Key Term: proprietary claim
A claim by a beneficiary to recover specific trust property (or its traceable proceeds) following a breach of trust, asserting an equitable interest in that property.

Key Term: personal claim
A claim for compensation against the trustee personally for loss caused by a breach of trust.

Proprietary claims typically rest on the idea that the original property (or its substitute) can be identified—either in the hands of the trustee, with an innocent volunteer, or (subject to defences) with other recipients. If the property cannot be identified because it has been dissipated (e.g. spent on consumables with nothing to show), the proprietary claim will usually fail and the beneficiary is left with a personal claim.

Why Proprietary Claims Matter

Proprietary claims offer several advantages:

• Priority in insolvency: Beneficiaries can recover trust property ahead of the trustee’s personal creditors if the trustee is insolvent.
• Access to asset appreciation: If misapplied property has increased in value, beneficiaries can claim the higher value.
• No statutory limitation: Proprietary claims are generally not subject to the six-year limitation period for breach of trust claims, though they may be barred by laches (unreasonable delay) or where the defendant can raise other equitable defences.
• Tracing through substitutions: Beneficiaries can follow trust property into new forms or mixed assets, provided the property is identifiable.
• Flexibility in remedy: Equity allows a choice between remedies (e.g. a proportionate share via constructive trust or a fixed-value security via equitable lien) to deliver the most appropriate outcome in light of appreciation or depreciation.

When Can Beneficiaries Make a Proprietary Claim?

Proprietary claims arise where trust property has been misapplied and is still identifiable, either in its original form or as a substitute. If the property has been dissipated (e.g. spent on holidays or living expenses), a proprietary claim will usually fail, and beneficiaries are limited to a personal claim.

In practice, proprietary claims depend upon successful tracing. Equity requires two threshold conditions: a fiduciary relationship (easily satisfied in trustee–beneficiary cases) and that the claimant has an equitable proprietary interest in the property being traced. The property must also be identifiable in its current form, and relief must not produce an inequitable outcome (especially against innocent volunteers).

Typical Scenarios

• The trustee still holds the original trust property.
• The trustee has exchanged trust property for another asset (clean substitution).
• The trustee has mixed trust property with their own funds or with funds from another trust.
• Trust property has been transferred to a third party, but is still identifiable.
• Personal representatives mistakenly distribute estate assets to non-beneficiaries; the recipients may be subject to proprietary claims (subject to defences) where the funds or their traceable proceeds remain identifiable.

Insolvency and Asset Appreciation

Proprietary claims are especially important if the trustee is insolvent, as beneficiaries can recover the property ahead of unsecured creditors. If the property has increased in value, a proprietary claim allows beneficiaries to claim the full value, not just the original amount. Conversely, where an asset has fallen in value, beneficiaries may prefer an equitable lien that secures repayment of the amount misapplied rather than taking an asset that has depreciated.

Equitable Remedies for Proprietary Claims

Where a proprietary claim is established, equity offers a range of remedies to restore the beneficiary’s rights. These remedies are discretionary and must be fair and practicable in the circumstances.

Constructive Trust

A constructive trust is imposed by the court where it would be unconscionable for the holder of property to deny the beneficiary’s interest. The property is treated as held on trust for the beneficiary. In many proprietary claims the constructive trust reflects continuing beneficial ownership (e.g. over a substitute asset or mixed asset) rather than creating an entirely new equitable right. Constructive trusts can also arise in response to certain wrongs (for example, bribes or secret commissions taken by a fiduciary are held on trust for the principal under current UK law).

Key Term: constructive trust
A trust imposed by equity to prevent unjust enrichment or to reflect the claimant’s continuing equitable interest, typically where property has been misapplied or retained in breach of trust.

Practical consequences of a constructive trust include entitlement to any increase in the value of the asset and the ability to assert priority over the trustee’s unsecured creditors or the general estate of a knowing recipient.

Equitable Lien

An equitable lien gives the beneficiary a security interest over property, allowing them to recover the value misapplied from the trust, especially if the property has fallen in value. It commonly arises where trust money has been used to acquire or improve another’s property, or as an alternative to a constructive trust over a substitute asset that has depreciated.

Key Term: equitable lien
An equitable right to have property sold to satisfy a debt or loss, usually where trust funds have been used to improve or acquire the property.

Electing a lien rather than a constructive trust is often sensible where the asset has fallen in value below the amount misapplied or where a fixed, secured repayment suits the beneficiary’s objectives better than co-ownership.

Subrogation

Subrogation allows beneficiaries to step into the shoes of a creditor whose debt was paid using trust assets, giving them the same security rights as the original creditor. It is especially useful where misapplied trust money has been used to discharge a secured debt (e.g. a mortgage), enabling beneficiaries to assert a charge equivalent to the discharged security.

Key Term: subrogation
The right of a claimant to assume the position and rights of another, typically where trust funds have been used to discharge a secured debt.

Subrogation is versatile: if trust money pays off all or part of a mortgage, the beneficiaries can be subrogated to the mortgagee’s erstwhile security to the extent of the payment. This can deliver a powerful proprietary security even if the trustee has no remaining asset in their name.

Account of Profits

If a trustee has made a profit from misapplied trust property, the court may order an account of profits, requiring the trustee to pay over any gains to the trust. Although primarily a personal remedy against a defaulting fiduciary, an account of profits frequently works alongside proprietary relief; for example, where a fiduciary has profited from misuse of opportunities or information acquired in a fiduciary capacity, the court may both strip profits and impose a constructive trust over specifically traceable assets.

Key Term: account of profits
An order requiring a trustee or fiduciary to pay over any profits made from a breach of trust or misuse of trust property.

Tracing: The Mechanism Behind Proprietary Claims

Tracing is the process by which beneficiaries identify and claim assets that represent the original trust property, even if it has changed form or been mixed with other property. It is the gateway to most proprietary claims.

Key Term: tracing
The process of identifying trust property (or its substitute) through various transactions, enabling a proprietary claim.

Equitable tracing has several key requirements:

• A fiduciary relationship at the outset (trustee–beneficiary suffices).
• The claimant must have an equitable proprietary interest in the property to be traced.
• The property must be identifiable in its present form (directly or as its traceable proceeds).
• Relief must not produce an inequitable result, particularly against innocent volunteer recipients.
• There must be no undue delay (laches can bar relief even where no statutory limitation applies).

Common Law vs. Equitable Tracing

• Common law tracing is limited to property that remains separate and identifiable. It cannot follow property through mixtures.
• Equitable tracing is more flexible, allowing beneficiaries to trace through mixed funds and substitutions, provided there is a fiduciary relationship and the assets are traceable.

In equity, certain presumptions and rules manage mixed funds:

• Where trust money is paid into a trustee’s personal account, the trustee is presumed to spend their own money first.
• Where mixed funds purchase an asset, beneficiaries have a first claim over the asset to the extent of the trust contribution or a proportionate share of the asset, whichever is more advantageous in the circumstances.
• Where two different trust funds are mixed, the court may apply the first in, first out rule or, if unjust, order a rateable (pari passu) division.

The Lowest Intermediate Balance Rule

If trust money is paid into a mixed account and the balance falls below the amount of trust money, the beneficiary’s claim is limited to the lowest balance reached before any new funds are added. Later deposits by the trustee do not replenish the beneficiary’s claim beyond that lowest point, unless the facts justify an exception.

Key Term: lowest intermediate balance rule
The principle that a claimant’s proprietary claim to a mixed fund is limited to the lowest balance the account reached after the trust money was paid in.

Additional core rules and refinements:

• Presumption about spending: Where a trustee mixes trust funds with their own in a personal account, equity generally presumes the trustee spends their own money first, protecting the trust’s contribution for as long as possible.
• Purchases from mixed funds: If a trustee uses a mixed account to buy an asset, beneficiaries can claim a first charge over the asset or a proportionate beneficial share. This ensures beneficiaries are not prejudiced by the trustee’s choice to mix funds before purchase.
• Overdrawn accounts: If trust money is paid into an overdrawn account, it is treated as immediately dissipated to the extent it reduces the overdraft; there is nothing to trace unless and until a positive balance is restored by further payments that can be linked to the trust.
• First in, first out and rateable sharing: Where two trust funds (or a trust and an innocent volunteer) are mixed in one account, the primary rule is first in, first out; however, where that would be impractical or unjust, the court may prefer rateable apportionment.
• Backwards tracing: Equity ordinarily does not trace backwards from an asset to earlier additions of value. However, where there is a coordinated scheme in which the acquisition of an asset and the subsequent application of trust funds are part of one integrated plan, the court may allow tracing to the asset despite the sequence of cash flows.

Key Term: first in, first out rule
In a mixed account, withdrawals are attributed to the earliest payments in; later withdrawals are treated as coming from later deposits.

Key Term: pari passu (rateable sharing)
A method of dividing a mixed fund or its proceeds proportionately between contributors when first in, first out would be impractical or unjust.

Key Term: backwards tracing
Tracing into an asset acquired before trust funds were used, permitted only exceptionally where the acquisition and misuse form part of a coordinated scheme.

Key Term: change of position
A defence for an innocent volunteer recipient who, in good faith, has so changed their circumstances in reliance on the receipt that it would be inequitable to require full restitution.

Worked Examples

Worked Example 1.1

A trustee uses £30,000 of trust money and £20,000 of personal funds to buy a car. The car is now worth £60,000. What can the beneficiaries claim?

Answer:
The beneficiaries can claim a 60% share of the car (reflecting their contribution) or a charge (lien) for £30,000. If the car has increased in value, claiming a proportionate share is usually preferable.

Worked Example 1.2

A trustee mixes £10,000 of trust money with £5,000 of personal funds in a bank account. The trustee spends £12,000 on a holiday and the remaining £3,000 is still in the account. What can the beneficiaries claim?

Answer:
Applying the lowest intermediate balance rule, the beneficiaries can claim the £3,000 remaining, but cannot claim the dissipated funds spent on the holiday.

Worked Example 1.3

Trust funds are used to pay off a mortgage on the trustee’s house. What remedy is available to the beneficiaries?

Answer:
The beneficiaries may be subrogated to the rights of the discharged mortgagee, giving them an equitable charge over the house for the amount of trust money used.

Worked Example 1.4

A trustee deposits £20,000 of trust money into a personal account with a credit balance of £10,000. Next day the trustee withdraws £15,000 from the account to buy shares, then later spends the rest of the balance on living expenses.

Answer:
The presumption is that the trustee spends their own money first. The £15,000 share purchase is treated as made with trust funds, so the beneficiaries can claim a first charge over the shares (or a proportionate share if advantageous). The balance later spent on living expenses is dissipated and not traceable.

Worked Example 1.5

Two trusts’ funds are mixed in one account: £8,000 (Trust A) paid in first; then £12,000 (Trust B). The trustee later withdraws £6,000 to buy a painting and then dissipates the remainder. How should the painting be attributed?

Answer:
Under first in, first out, the £6,000 withdrawal is presumed to come from Trust A, so the painting belongs to Trust A (subject to a proportionate share if competing equities require). If that outcome is impractical or unjust, a court may prefer a rateable division (Trust A 40%, Trust B 60%) and apportion the value of the painting accordingly.

Worked Example 1.6

A trustee pays £10,000 of trust money into a personal account that is overdrawn by £7,000. The trustee immediately withdraws £3,000 for personal use.

Answer:
£7,000 of the trust money instantly reduces the overdraft and is treated as dissipated. Only £3,000 might be traceable if it can be followed into an identifiable asset; here it was spent on personal use, so there is nothing to trace and the proprietary claim fails on those facts.

Worked Example 1.7

A trustee takes out a short-term loan to buy a car, then shortly afterwards repays that loan using £25,000 misapplied trust money. Can the beneficiaries trace into the car?

Answer:
Ordinarily equity does not allow backwards tracing. However, if the loan-financed purchase and subsequent trust-funded repayment were part of a coordinated scheme to use trust money to acquire the car, the court may permit tracing into the car and impose a proprietary remedy up to £25,000.

Limits and Defences to Proprietary Claims

Proprietary claims are not unlimited. Key limits include:

Bona Fide Purchaser for Value Without Notice

A proprietary claim cannot succeed against a third party who acquires trust property in good faith, for value, and without notice of the breach. This person takes the property free of the beneficiary’s equitable interest.

Key Term: bona fide purchaser for value without notice
A person who acquires property for value, in good faith, and without knowledge of any prior equitable interest, taking it free of such interests.

Notice may be actual or constructive, and value must be given (volunteers cannot invoke this defence). This rule protects security in commercial transactions and explains why proprietary claims focus on recipients other than bona fide purchasers.

The Doctrine of Laches

Although proprietary claims are not generally subject to statutory limitation, they may be barred if the beneficiary has delayed unreasonably and the defendant has been prejudiced. The court asks whether the delay renders it inequitable to grant relief; for example, because documents have been lost, witnesses have died, or the defendant has altered their position to their detriment.

Key Term: laches
An equitable defence where a claim is barred due to unreasonable delay that makes it unfair to grant relief.

Dissipation of Assets

If the trust property has been spent on non-traceable items (such as holidays or living expenses), and cannot be identified, a proprietary claim will fail. The beneficiary is then limited to a personal claim against the trustee. Payments into an overdrawn account are likewise treated as immediately dissipated to the extent they reduce the overdraft.

Innocent Volunteer Recipients and the Change of Position Defence

Where an innocent volunteer (a recipient who gave no value and had no notice of the breach) receives trust property, a proprietary claim is in principle available while the property or its proceeds are identifiable. However, equitable defences may defeat or limit recovery where enforcement would be inequitable. For example, if the volunteer has in good faith spent the money improving their home and cannot be restored to their original position without undue hardship, a change of position defence may succeed in whole or in part.

Key Term: change of position
A defence allowing an innocent volunteer to resist or reduce restitution where, in reliance on the receipt and in good faith, they altered their circumstances such that repayment would be unjust.

Courts sometimes respond by recognising an equitable lien for the amount of trust money used to improve property rather than forcing a sale or awarding co-ownership, balancing fairness to both sides. Conversely, where a volunteer still holds a distinct asset (e.g. a painting gifted with misapplied trust funds), beneficiaries can ordinarily trace and claim the asset.

Knowing Recipients and Dishonest Assistance

A recipient who knew, or ought to have known, that they were receiving trust property in breach of trust can be liable personally for knowing receipt and may be ordered to restore the value received; proprietary relief may also be available if the property or its traceable proceeds remain in their hands. By contrast, a dishonest assistant who never received trust property is subject to a personal claim only; there is no proprietary claim because no property is held by the assistant.

Key Point Checklist

This article has covered the following key knowledge points:

• The distinction between personal and proprietary claims after a breach of trust
• The advantages of proprietary claims, including priority in insolvency and access to asset appreciation
• The main equitable remedies for proprietary claims: constructive trusts, equitable liens, subrogation, and account of profits
• The process and requirements for tracing trust property in equity
• The lowest intermediate balance rule and its effect on claims to mixed funds
• The presumption that a trustee spends their own money first, and beneficiaries’ rights where assets are purchased from mixed funds
• Competing claims in mixed bank accounts: first in, first out and rateable sharing where appropriate
• Limits on tracing through overdrafts and the narrow circumstances for backwards tracing within a coordinated scheme
• The main limits and defences to proprietary claims, including bona fide purchaser, change of position, laches, and dissipation
• Practical election between a constructive trust and an equitable lien depending on appreciation or depreciation

Key Terms and Concepts

• proprietary claim
• personal claim
• constructive trust
• equitable lien
• subrogation
• account of profits
• tracing
• lowest intermediate balance rule
• first in, first out rule
• pari passu (rateable sharing)
• backwards tracing
• change of position
• bona fide purchaser for value without notice
• laches