Learning Outcomes
This article explains proprietary claims against trustees for misapplied trust assets and the equitable rules for tracing trust property in mixed accounts, with an emphasis on SQE1-style application and problem-solving, including:
- Equitable tracing of trust assets through substitutions and mixtures, and the preconditions for tracing (fiduciary relationship, equitable proprietary interest, identifiability, and avoidance of inequitable outcomes).
- How the courts allocate withdrawals from mixed bank accounts where a trustee mixes trust funds with personal money, focusing on Re Hallett’s Estate and Re Oatway and the strategic choice between them.
- The operation and exam significance of the lowest intermediate balance rule (Roscoe v Winder) in capping proprietary recovery and distinguishing it from a personal claim in breach of trust.
- Methods for allocating losses and remaining balances between multiple innocent contributors to a mixed fund, contrasting Clayton’s Case (FIFO) with the pari passu approach and when each is displaced or preferred.
- The limits of tracing and the modern coordinated scheme exception to backward tracing (Federal Republic of Brazil v Durant International), including how to spot fact patterns suggesting a single scheme.
- Key defences and practical barriers to proprietary claims—bona fide purchaser, dissipation, change of position, and laches—and how these may defeat or reduce recovery in SQE1-style scenarios.
SQE1 Syllabus
For SQE1, you are required to understand the principles governing a trustee's liability for breach of trust, specifically concerning proprietary remedies available to beneficiaries. This includes the rules for tracing trust assets, particularly into mixed funds held by the trustee, with a focus on the following syllabus points:
- The distinction between personal and proprietary claims following a breach of trust.
- The concept of equitable tracing and its requirements (fiduciary relationship, equitable proprietary interest, identifiability, and equitable outcome).
- The rules for tracing into mixed funds held by a trustee, including the application of Re Hallett’s Estate, Re Oatway, and the lowest intermediate balance rule.
- The rules for tracing funds mixed from two trusts or with an innocent volunteer’s money, including Clayton’s Case (FIFO) and proportionate sharing (pari passu).
- When and why Clayton’s Case is displaced, notably in deposit accounts or where FIFO would be unjust or impractical (Barlow Clowes International Ltd v Vaughan).
- The coordinated scheme exception to backward tracing, allowing recovery where transactions form a single scheme of misapplication (Brazil v Durant).
- The circumstances where tracing may be limited or defeated (eg dissipation, bona fide purchaser, change of position, laches).
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.
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A trustee mixes £10,000 of trust money with £5,000 of their own money in their personal bank account. They then withdraw £7,000 and spend it on a holiday. Which principle generally determines how much trust money remains in the account?
- Re Oatway
- The lowest intermediate balance rule
- Clayton's Case (FIFO)
- Re Hallett's Estate
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Following on from Q1, the trustee then withdraws the remaining £8,000 and buys shares, which are now worthless. Which principle might allow the beneficiaries to claim the shares were purchased with trust money?
- Re Hallett's Estate
- Re Oatway
- The pari passu rule
- Dissipation
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A trustee mixes £5,000 from Trust A and £10,000 from Trust B in their current account. They withdraw £6,000. According to the rule in Clayton's Case, how much of the withdrawn money belongs to Trust A?
- £2,000
- £3,000
- £5,000
- £6,000
Introduction
When a trustee misapplies trust property in breach of trust, beneficiaries have potential remedies. One type is a personal claim against the trustee for compensation for the loss caused. However, if the trustee is insolvent, this claim may be ineffective. An alternative, often more valuable, remedy is a proprietary claim. This involves asserting rights over the original trust property or property that now represents it, even if it has been mixed with other funds or changed form. This process relies on the equitable doctrine of tracing. This article focuses on the rules equity applies when tracing trust money mixed in a trustee's bank account.
Proprietary Claims and Tracing
A proprietary claim allows beneficiaries to assert ownership rights over specific assets. It gives them priority over the trustee's general creditors in insolvency and allows them to capture any increase in the value of the traced asset. The process used to identify the trust property or its substitute is tracing. Tracing is available against trustees, constructive trustees (eg knowing recipients), and in some circumstances against innocent volunteers.
Key Term: Tracing
The equitable process of identifying trust property as it passes through different hands or changes form. It is a process of identification, not a remedy in itself, but it enables proprietary claims.
Equity allows tracing where there is an initial fiduciary relationship (like trustee-beneficiary) and the claimant has an equitable proprietary interest in the original property. The property must remain identifiable, even if mixed or substituted. Tracing will be refused if it produces an inequitable outcome (eg forcing an innocent volunteer to sell their home where trust money was innocently mixed with their funds and spent on improvements), and delay may prejudice relief due to laches.
Key Term: Equitable Lien
A proprietary security right that secures repayment of a fixed amount from a specific asset representing misapplied trust property. It permits sale of the asset, with the claimant paid in priority over unsecured creditors up to the amount of the loss.
Tracing into Unmixed Funds
If a trustee misappropriates trust property and keeps it separate, or uses it solely to buy a substitute asset (clean substitution), tracing is straightforward. The beneficiaries can claim the original property or the substitute asset. If the substitute has increased in value, they benefit; if it has decreased, they may choose a personal claim secured by a charge (equitable lien) over the substitute asset for the value lost.
This election is important where values have shifted. In Foskett v McKeown, the House of Lords confirmed that a proprietary claim allows the claimant to take a proportionate share of increases in value, while a lien fixes a capped recovery equal to the misapplied sum. Where a trustee bought an asset using both trust and personal money, beneficiaries can either claim a proportionate share (if the asset appreciated) or assert a lien (if it depreciated), reflecting equity’s aim to avoid letting wrongdoers benefit from their breach while preserving fairness.
Tracing into Mixed Funds: Trustee's Own Account
Complexity arises when a trustee mixes trust money with their own money in a bank account. Equity has developed specific rules to determine ownership of the mixed fund and any assets purchased from it. These rules generally operate to the disadvantage of the wrongdoing trustee.
The Rule in Re Hallett's Estate
Where a trustee mixes trust funds with their own money in an account and then makes withdrawals which are dissipated (spent in a way that cannot be traced, e.g., on general living expenses or a holiday), equity presumes the trustee spent their own money first. This presumption protects the trust fund as far as possible by pushing dissipation onto the trustee.
Key Term: Rule in Re Hallett's Estate
The presumption that a trustee who mixes trust funds with their own money in a bank account and makes withdrawals spends their own money first, preserving the trust fund.
This presumption aims to preserve the trust fund as far as possible. Any remaining balance in the account, up to the amount of the trust money paid in, can be claimed by the beneficiaries.
Worked Example 1.1
A trustee has £2,000 of their own money in a bank account. They wrongly deposit £4,000 of trust money into the same account, bringing the balance to £6,000. They then withdraw £1,500 and spend it on a weekend break (dissipation). What is the position regarding the remaining balance?
Answer:
Applying Re Hallett's Estate, the trustee is presumed to have spent their own £1,500 first. The remaining £4,500 in the account contains the full £4,000 of trust money. The beneficiaries can claim this £4,000.
The Rule in Re Oatway
The presumption in Re Hallett does not apply if it would prevent the beneficiaries from tracing into a valuable asset purchased from the mixed fund while allowing the trustee to keep that asset. Instead, Re Oatway establishes that the beneficiaries have a first charge over the mixed fund and any asset purchased from it, ensuring the trust can claim the valuable asset rather than watching it escape.
Key Term: Rule in Re Oatway
Where a trustee mixes trust funds with their own and buys an asset before dissipating the rest of the fund, the beneficiaries can claim the asset represents trust money, effectively reversing the Re Hallett presumption to achieve an equitable result.
This allows beneficiaries to cherry-pick – they can claim that any valuable asset purchased from the mixed fund was bought with trust money, even if the trustee's own money was technically available first according to the chronology. If the asset has appreciated, beneficiaries can claim a proportionate share of that increase; if it has depreciated, they can secure their recovery with an equitable lien.
Worked Example 1.2
A trustee has £5,000 of their own money in an account. They wrongly deposit £10,000 of trust money, making the balance £15,000. They then withdraw £10,000 to buy shares. Subsequently, they withdraw the remaining £5,000 and spend it on general living expenses (dissipation). The shares are now worth £12,000. What can the beneficiaries claim?
Answer:
Applying Re Hallett would mean the shares (£10,000 purchase) were bought with the trustee's £5,000 and £5,000 of trust money, and the remaining £5,000 of trust money was dissipated. This isn't the best outcome. Applying Re Oatway, the beneficiaries can assert that the £10,000 used to buy the shares was trust money. They can claim the shares (now worth £12,000) as representing the trust fund. The trustee's own money (£5,000) is deemed dissipated.
The Lowest Intermediate Balance Rule
The beneficiaries' proprietary claim against a mixed bank account is limited by the lowest balance the account reached after the trust money was paid in but before any subsequent deposits of the trustee's own money.
Key Term: Lowest Intermediate Balance Rule
The principle that trust beneficiaries cannot trace more money out of a mixed bank account than the lowest balance the account held after the trust money was deposited and before subsequent personal deposits by the trustee (Roscoe v Winder). Later personal deposits do not replenish trust money unless there is a clear intention to repay the trust.
Subsequent deposits of the trustee's own money are not treated as repayments to the trust unless the trustee clearly intended them as such (eg explicit acknowledgment and repayment entries).
Worked Example 1.3
A trustee pays £40,000 of trust money into their personal account, which already contains £10,000 of their own money. They spend £20,000 on a luxury holiday and then £28,000 on private medical treatment, leaving £2,000 in the account. A few days later, a relative gifts the trustee £3,000, which is paid into the account. How much can the beneficiaries trace?
Answer:
The lowest intermediate balance between misapplication and later deposits was £2,000. The gift is not a repayment of trust money. The beneficiaries’ proprietary claim is capped at £2,000 from the account. They will have a personal claim against the trustee for the remaining £38,000.
Backwards Tracing and the Coordinated Scheme Exception
In principle, tracing follows the chronological path of value from trust asset to substitute (“no backwards tracing”). If a wrongdoer buys an asset on credit and later pays off the debt with trust money, the payment does not normally allow the beneficiaries to claim the earlier-acquired asset. However, an important modern exception applies where the transactions are part of a coordinated scheme designed to defeat tracing.
Key Term: Backwards Tracing
The concept of tracing value into an asset acquired before trust money was applied to discharge the purchase price. Generally not allowed unless the transactions are part of a coordinated scheme.Key Term: Coordinated Scheme Exception
Where the court is satisfied that multiple steps are part of a single coordinated plan (eg bribes, staged transfers, and debt repayments linked together), the beneficiaries can trace through the scheme and recover assets or proceeds notwithstanding the usual chronological limits (Brazil v Durant International).
Worked Example 1.4
A fiduciary agrees to purchase a car on finance, taking delivery when no trust money has yet been applied. Shortly afterwards, they discharge the finance using misapplied trust funds as part of a wider plan to conceal the misappropriation. Can the beneficiaries claim the car?
Answer:
Ordinarily, backwards tracing would fail. If the facts show a coordinated scheme linking the purchase and later trust-funded repayment as a single plan to misapply trust assets, the court may allow tracing into the car (Brazil v Durant), enabling a proprietary claim notwithstanding the ordering of steps.
Tracing into Mixed Funds: Two Trusts or Trust + Innocent Volunteer
Different rules apply when a trustee mixes funds from two separate trusts, or mixes trust funds with money belonging to an innocent third party (an 'innocent volunteer' – someone who received the trust property without giving value and without knowledge of the breach). Equity seeks to treat the innocent parties equally.
Clayton's Case (First In, First Out Rule)
The traditional rule for allocating withdrawals from a mixed current account containing funds of two innocent parties is 'first in, first out' (FIFO). It applies most naturally to active current accounts with a sequence of deposits and withdrawals.
Key Term: Clayton's Case (First In, First Out Rule)
The presumption applied to mixed funds of innocent parties in an active current account, where the first sums paid in are deemed to be the first sums paid out.
This rule applies strictly based on the order of deposits and withdrawals, but it is a rule of convenience, not an immutable rule. Courts can displace it.
Worked Example 1.5
A trustee wrongly deposits £2,000 from Trust X into their current account. A week later, they wrongly deposit £3,000 from Trust Y into the same account (total £5,000). They then withdraw £2,500 for personal use (dissipated). How much can each trust claim from the remaining £2,500?
Answer:
Applying FIFO (Clayton's Case), the first £2,000 withdrawn is deemed to be Trust X's money. The next £500 withdrawn is deemed to be Trust Y's money. Therefore, the remaining £2,500 in the account belongs entirely to Trust Y. Trust X has a personal claim against the trustee for the lost £2,000.
Pari Passu Rule (Proportionate Sharing)
The FIFO rule can lead to arbitrary results depending on the timing of transactions. Courts may displace it in favour of proportionate sharing (pari passu) where FIFO is impractical, contrary to the parties' intentions, or would cause injustice (Barlow Clowes International Ltd v Vaughan). This is commonly applied for pooled deposit accounts or investment funds where the order of transactions is artificial or records are poor.
Key Term: Pari Passu Rule (Proportionate Sharing)
An alternative to FIFO, where funds from innocent contributors in a mixed account are shared rateably in proportion to their contributions. Often applied to deposit accounts or where FIFO is impractical or unjust.
If applied to Worked Example 1.3, Trust X contributed 2/5 (£2k/£5k) and Trust Y contributed 3/5 (£3k/£5k). The £2,500 withdrawal would be deemed taken 2/5 from Trust X (£1,000) and 3/5 from Trust Y (£1,500). The remaining £2,500 would belong £1,000 to Trust X and £1,500 to Trust Y.
Worked Example 1.6
A trustee mixes £12,000 from Trust A and £18,000 from Trust B and uses the entire £30,000 to buy a painting. The painting later appreciates to £36,000. How are the interests allocated?
Answer:
This is a mixed asset purchased entirely with funds from two innocent trusts. Each trust takes a proportionate proprietary share: Trust A contributed 40% and claims £14,400; Trust B contributed 60% and claims £21,600.
Worked Example 1.7
Two trusts’ funds are mixed in a deposit account with occasional withdrawals. Records are incomplete, making the chronological application of FIFO uncertain. The account contains a remaining balance of £20,000, and contributions were £8,000 (Trust M) and £12,000 (Trust N). What method is likely and how is the balance divided?
Answer:
Where the order of transactions cannot be reliably established, courts tend to displace FIFO in favour of pari passu sharing to avoid injustice. The £20,000 balance would be shared proportionately: Trust M receives £8,000 and Trust N receives £12,000.
Complex Mixing: Trustee + Multiple Trusts
Occasionally, a trustee mixes their own money with funds from multiple trusts. In such cases, apply Re Hallett/Re Oatway first to push the trustee’s own money into dissipation and preserve identifiable property for the innocent trusts. Then allocate between the trusts using Clayton’s Case or pari passu, as appropriate.
Worked Example 1.8
A trustee’s current account contains £10,000 of their own money. They then misapply £20,000 from Trust P and £30,000 from Trust Q into the same account. Withdrawals follow: £10,000 to pay a credit card bill, £30,000 to fit a new kitchen, £10,000 to buy artwork, and £10,000 on a family holiday. How should the interests be allocated?
Answer:
Apply Re Hallett first: treat the trustee’s own £10,000 as used to pay the credit card (dissipation). The kitchen (£30,000) and artwork (£10,000) represent trust value. Then allocate between Trust P and Trust Q using FIFO or pari passu. Under FIFO, £20,000 (Trust P’s earlier deposit) is attributed first to the kitchen purchase, and the next £10,000 to the kitchen is from Trust Q; the artwork (£10,000) is Trust Q’s. The holiday is dissipation. If FIFO is displaced as unjust, a pari passu split applies to the kitchen and artwork in proportion to contributions (2:3 between Trust P and Trust Q).
Defences to Tracing Claims
Even if property can be traced, a proprietary claim may be defeated by certain defences:
Key Term: Bona Fide Purchaser for Value Without Notice
A person who acquires legal title to property by providing value (not a gift) in good faith, without actual, constructive, or imputed notice of any prior equitable interest (like a trust). They take the property free from the beneficiaries' equitable claims.
A bona fide purchaser breaks the chain of tracing where the trust property has passed into their hands, protecting transactional security. If later recipients are volunteers, tracing may resume against them (subject to equitable constraints).
Key Term: Dissipation
The trust property or its proceeds have been spent in such a way that they cease to exist and cannot be identified (e.g., spent on general living expenses, a holiday, or paying off an unsecured debt). Tracing ends here.Key Term: Change of Position
A defence available primarily to an innocent volunteer who receives trust property and, acting in good faith, subsequently changes their position (e.g., spends the money in an extraordinary way) in reliance on the receipt, making it inequitable to compel them to repay it (Lipkin Gorman v Karpnale Ltd).
Additionally, the general equitable defence of laches (unreasonable delay by the claimant causing prejudice to the defendant) may apply, particularly to equitable remedies, even though statutory limitation rules do not strictly apply to proprietary tracing claims.
Practical limits
- Mixed account caps: the lowest intermediate balance rule restricts recovery from a mixed account to the lowest balance after misappropriation and before later deposits unless an unequivocal repayment was intended.
- Innocent volunteer improvements: equity may refuse tracing where enforcing a proprietary claim would force the sale of an innocent volunteer’s home (Re Diplock considerations), and change of position may succeed.
- Chronology and coordinated schemes: while backward tracing is exceptional, Brazil v Durant allows recovery when the court is satisfied the steps are a single scheme to misapply trust funds.
Key Point Checklist
This article has covered the following key knowledge points:
- Proprietary claims allow beneficiaries to recover trust property or its traceable proceeds, offering advantages over personal claims, especially in insolvency.
- Equitable tracing is the process used to identify trust property through substitutions or mixing, requiring a fiduciary relationship and an existing equitable interest; tracing will be refused if it produces an inequitable outcome.
- When a trustee mixes trust funds with their own money:
- Re Hallett's Estate presumes the trustee spends their own money first, pushing dissipation away from the trust.
- Re Oatway allows beneficiaries to claim assets purchased with the mixed fund if advantageous, including proportionate shares of any appreciation or an equitable lien if the asset depreciated.
- The lowest intermediate balance rule limits recovery from the account to the lowest balance reached after misappropriation and before later deposits, absent a clear intention to repay the trust.
- Backwards tracing is generally not permitted unless the steps form a coordinated scheme (Brazil v Durant), in which case equity may allow recovery.
- When funds from two trusts or a trust and an innocent volunteer are mixed:
- Clayton's Case (FIFO) is the traditional rule for active current accounts.
- The pari passu (proportionate sharing) rule is often preferred where FIFO is unjust or impractical, or for deposit accounts and investment pools.
- Where a trustee mixes their own money and multiple trust funds, apply Re Hallett/Re Oatway first, then allocate between trusts using FIFO or pari passu.
- Tracing can be defeated by dissipation, transfer to a bona fide purchaser for value without notice, or by the change of position defence (for innocent volunteers), and may be limited by laches.
Key Terms and Concepts
- Tracing
- Rule in Re Hallett's Estate
- Rule in Re Oatway
- Lowest Intermediate Balance Rule
- Backwards Tracing
- Coordinated Scheme Exception
- Clayton's Case (First In, First Out Rule)
- Pari Passu Rule (Proportionate Sharing)
- Equitable Lien
- Bona Fide Purchaser for Value Without Notice
- Dissipation
- Change of Position