Nicola Sharp of Rahman Ravelli assesses a case that focuses on a developing area of law.
A person is liable for knowing receipt when they receive assets that have been disposed of in breach of trust or breach of fiduciary duty. A constructive trust arises such that the defendant holds the funds that were wrongfully received on trust for the beneficiary.
While the cause of action is settled law, claims in knowing receipt have a strange nuance when it comes to restitution. The question, which has sparked much debate, is how the beneficiary gets their money back.
On the face of it, it sounds straightforward. If £10,000 was wrongfully received by the defendant, it seems sensible that the defendant should return that £10,000 to the beneficiary. That would be the case if the £10,000 went into a ring-fenced account which contained no other funds. However, the situation is more complicated when that £10,000 goes into an account with other money that rightfully belongs to the trustee. Then the money goes into a ‘mixed fund’. If the trustee then spends money on a new house, does the beneficiary still get their £10,000 back from the mixed fund (if there are sufficient funds left)? Or does the beneficiary get an interest (a lien) in the property that was purchased partly with funds that are rightfully theirs?
The question is to what extent can a tracing beneficiary cherry pick their remedy against a wrongdoing trustee? Can they choose the money, or the lien?
Those were the questions brought before the court in Lapome Limited v Ross Kemp & Anor [2023] EWHC 1564 (Ch). This was an application to strike out the claim, which raised the question of whether the law is settled on this point: can the beneficiary trace into property acquired by the trustee from a mixed fund?
Case facts
The claimant bought a property for £3.7 million in October 2020. The defendants acted as their agents. In slightly unusual circumstances, the property was already under contract because the seller had previously acquired an option to purchase the property.
Unbeknown to the claimants at the time, it is alleged that the defendant agreed with the seller to share the costs and profits of buying the property and selling it on. The defendant allegedly paid £5,000 to the seller for this arrangement.
The seller then exercised his option to buy and bought the property for £2.9 million. When the property was sold to the claimants, the seller made £800,000 in profit which he shared with the defendants on a 50-50 basis that meant that the defendants made £400,000 in undisclosed profit, which amounted to £322,660 after costs.
The claimant alleged that in breach of fiduciary duty, Mr Kemp (the first defendant) caused the second defendant to obtain a secret profit from the sale. Mr Kemp is the sole shareholder of the second defendant, so by extension, the secret profit fell to him.
The mixed fund
The £322,660 was paid into a current account on 19 February 2021. The current account was linked with a reserve account and money was moved between accounts as needed. Accordingly, they were treated as one combined account.
There were other existing funds in the combined account. So the ‘mix’ is the alleged secret profit of £322,660 which is held on constructive trust for the claimant and the existing funds that are rightfully the defendants’.
The claimant suspected that the defendants acquired assets using money from the combined account. In order to seek recourse, the claimant wanted to trace into the investments for the purposes of pursuing a proprietary remedy i.e. the claimant alleged they were tricked out of £400,000 and now wanted a right over the property that the defendants bought with the money.
The question was whether the defendants could just give the money back. There were still sufficient funds in the account. In fact, the defendants offered (on an open basis) to give the claimants £500,000 plus costs. However, the claimant declined the offer and instead wanted to assert a proprietary right over the investment properties.
The arguments in this area of law
The defendants’ argument was that the money never fell below the value of the trust money, so the claimant could, just have the money back. The lowest that the balance of the combined accounts ever reached was £1,334,576. Essentially, they were saying that if the fund had fallen below £322,000 then the claimant might have rights in the property they bought - but it didn’t so they could have the money instead.
That follows the law as set out in Hallett1. The rationale in that case was that in a mixed fund the trustee’s own money is spent first. The trust money remains intact until all of the trustee’s money is gone. If the trust money is reduced, it is not replenished by further payments into the account of the trustee’s own money. The beneficiary’s claim is limited to the lowest value of the trust monies reached.
But there is also settled authority in Oatway2 that where mixed funds (trust and personal) are used to purchase an asset, and the trustee dissipates remaining funds, the trustee is deemed to have used trust money to buy the asset. In those circumstances, the beneficiary is entitled to a charge or lien on the property.
It is not clear what happens when the trustee purchases property from the mixed fund, but the value of the mixed fund never falls below the amount of the trust money. Can the beneficiary claim a proprietary right over the property or not? Do they just get their money back instead?
Why the claimant may prefer a lien
The issue is relevant when the trust money is used for an investment that increases in value. There may be an argument that the £322,000 becomes a percentage of the value of the property, which increases over time, rather than a flat sum.
There’s also a moral argument. In Goff and Jones on Unjust Enrichment, 10th ed (7-53), they suggest that “there should be a presumption made against defendants who knowingly create evidential uncertainty by mixing money received from a claimant wit their own money. That should extend to giving claimants the right to choose whichever presumption produces the best result for them.”
But there are also reservations about this ‘cherry-picking’ argument. Can you allow the beneficiary to cherry pick for the purpose of maximising the beneficiary’s share of what turns out to be the most profitable asset?
Lewin on Trusts says no: “The beneficiary should be able to locate the trust money in all or anything that survives from the trustee’s wrongdoing in mixing trust money with his own. The beneficiary cannot make a profit because the amount of recovery is limited to the amount secured by the lien.”
However, the authorities agree that the law on the tracing rules applicable to the quantification of the beneficiary’s proportionate share in assets bought from the mixed account has still to be fully developed.
The question remains unanswered and the application was dismissed. It might be answered on the basis of the facts found at trial.
Analysis
There are strong arguments on both sides of this argument. On the one hand, the right to cherry pick should be upheld against a wrongdoing trustee as the innocent beneficiary should have the right to choose the best result for them. On the other hand, if justice can be done by returning the sums from the mixed fund, should that not be a sufficient remedy?
The law is still developing in this area and we will watch the updates closely. Claimants should be aware that they will not necessarily be entitled to a proportionate share in investments purchased with trust money. Depending on the merits of the case, it may be more cost-efficient and expeditious to settle for the return of the funds.
1 Re Hallett’s Estate (1880) 13 ChD 696
2 Re Oatway [1903] 2 Ch 356
