Complex Commercial Fraud: Tracing and Following: Pens, Rulers, and Motorbikes

D Rosen  I read recently, a fascinating chapter of ‘Commercial Fraud in Civil Practice’ by McGrath QC, 2014, relating to Tracing. Let me start by saying I am a firm believer that a proprietary claim, leads to proprietary relief, in the absence of any clarity that it arises from a claim of unjust enrichment.  Tracing

Home » David Rosen » Complex Commercial Fraud: Tracing and Following: Pens, Rulers, and Motorbikes

D Rosen

 I read recently, a fascinating chapter of ‘Commercial Fraud in Civil Practice’ by McGrath QC, 2014, relating to Tracing.

Let me start by saying I am a firm believer that a proprietary claim, leads to proprietary relief, in the absence of any clarity that it arises from a claim of unjust enrichment.

 Tracing is effectively the act of seeking and locating monies or monies worth for evidential purposes.

 There used to be a common misconception that you referred to a tracing claim, or a tracing injunction. That is a colloquial referral, and not technically correct.

 Tracing is about locating value and not specific assets.

 The object of ‘follow’ is thing. The object of ‘trace’ is value.

 We all are acutely aware of how case law seeks to define and advance interpretation of the Law.

 In this particular subject, however, it seems that academic works have advanced a distinction as to the physical act of ‘following’ one’s assets, as opposed to a metaphysical act of ‘tracing’.

 Specifically, the works of Lionel Smith, the Late Professor Birks, and Lord Millett in Foskett v McKeown [2001] 1 AC 102, 127-8.

 This has had an effect on the consequences of following assets, how to define them, and what to do with them.

 Follow:

You ‘follow’ an asset, when it remains in its identifiable form. In Foskett v McKeown, the following scenario is considered:

 If my pen is taken by X, and transferred to Y, I can follow my pen into the hands of X, and from there to Y. Here, there is a physical act of following and identifying the local of the pen.

 Tracing:

You ‘trace’ an asset, when it is exchanged/converted for another product. The scenario then continues:

 If my pen is taken by X, and Y gives X a ruler in exchange for a pen, one can follow the pen into the hands of Y, and trace into its exchange product, the rules, now in the hands of X.

 Foskett v McKeown:

 Per Millett LJ ,p127:

‘The process of ascertaining what happened to the plaintiff’s money involves both tracing and following. These are both exercises in locating assets which are or may be taken to represent an asset belonging to the plaintiffs and to which they assert ownership. The process of following and tracing are, however, distinct. Following is the process of following the same asset as it moves from hand to hand. Tracing is the process of identifying a new asset as the substitute for the old. Where one asset is exchanged for another, a claimant can elect whether to follow the original asset into the hands of the new owner or to trace its value into the new asset in the hands of the same owner. In practice his choice is often dictated by circumstances’.

 It must be obvious as a proprietary claim to assert ownership over a pen which remains a pen, and can be followed. Can there be a proprietary claim to assert ownership over a ruler?

 You never owned the ruler. You owned the pen. Do you no longer own the pen? How can you claim to have a proprietary right over a ruler, which was never a pen?

Hang on! What happened to the pen, though, and does it really matter?

 Can you say the ruler is a substituted product for the pen?

 McGrath asks further: When did he lose ownership in the pen and gain in the ruler? Or does he have a choice as to which he now wishes to own?

 The Unjust enrichment school, and the Proprietary school.

 The Proprietary School:

There are broadly speaking, ideas stemming from the proprietary camp:

 1. The pen remains a pen, and I have an obvious claim to the pen, subject of course to a defence that you purchase the pen in good faith without notice. See Ecclestone v Elite Motors [2014] EWHC 29 (QB), (to which I was initialled instructed, and formulated the Defence), where a car remains a car, purchased by another who claims he was a bona fide purchaser for value without notice, and that Ecclestone had no right to claim the vehicle be returned having transferred it to her boyfriend, who then financed the vehicle by way of a log book loan, who defaulted: The log book loan company repossessed the vehicle, and the car was then purchased in good faith at full market value, without notice of its history. (I digress…).

 2. The pen was exchanged for another product (i.e. a ruler). A new proprietary right over the ruler by way of product exchange.

 The Unjust enrichment School:

In this school of thought, they say that the ruler is a traceable substitute, for my pen, and that X, who now has a ruler, because he exchanged my pen for it to Y, has been unjustly enriched for something he was never entitled to in the first place.

 To bring a claim for unjust enrichment, you need to show that the defendant has been enriched at the claimant’s expense, for he cannot be unjustly enriched if he had not been unjustly enriched at all.

Lord Millett, clearly from the proprietary school, said further in Foskett v McKeown:

 ‘The transmission of a claimant’s property rights from one asset to its traceable proceeds is part of our law of property, not of the law of unjust enrichment. There is no ‘unjust factor’ to justify restitution (unless ‘want of title’ be one, which makes the point). The claimant succeeds if at all by virtue of his own title, not to reverse unjust enrichment’.

 Birks argues that this was not a new proprietary right, and remained a remedy from unjust enrichment. He said, the claimant can assert ownership over the ruler simply because at some prior point the claimant had obtained ownership over the pen and the process of tracing identifies the value inherent in the pen, in the ruler. It is the non-consensual substitution as the new event which triggers the claimant’s entitlement to assert a proprietary right over the ruler, which gives rise to unjust enrichment.

 If so, when does unjust enrichment give rise to a proprietary claim, and when does it give rise only to a personal claim?

Lord Browne-Wilkinson said in Foskett v McKeown:

….A man under whose land oil is discovered enjoys a very valuable windfall but no one suggests that he, as owner of the property, is not entitled to the windfall which goes with his property right’.

 In the case of Foskett v Mckeown, there was a Trust. The Trustees fraudulently used trust monies to pay premiums on a policy of life insurance. The main issue in the case was as to whether from the trust moneys traced into policy proceeds, the trust beneficiaries were entitled to a share of the proceeds.

 The House of Lords held that they were so entitled to a share of the proceeds.

 So, a Party can assert a proprietary interest in a traceable substitute.

 The editors in Goff and Jones are diametrically opposed to such a view, favouring unjust enrichment.

 Who to pursue?

Do you pursue X who now has a ruler instead of a pen? Or do you pursue Y who now has a pen, and no longer a ruler which he exchanged for it?

Lord Millett identifies in Foskett v MKeown that you can elect/choose whether to follow the original asset into the hands of the new owner, or trace its value into the new asset in the hands of the same owner. The Claimant traces the value , and not the physical asset itself. (i.e the value of the ruler, and not the ruler itself).

 What if: the ruler was purchased partly with exchange of the pen, and partly with money or monies worth from elsewhere?

A conundrum!

 Now we are talking about the value of the ruler, and mixed funds.

 McGrath QC gives an example:

 X takes from a mixed fund of monies totalling £10,000 belonging to X and Y. The fraudster only could legitimately claim to £3,000 of the fund, and the remaining £7,000 belonging to the innocent party. If the fraudster purchases a motorbike for £5,000, he will be deemed to have spent the entirety of his own monies first, so £3,000 + £2,000.

 What if the motorbike turned out to be a valuable vintage model and the value of it went up considerably? Applying a variation of Hallett’s presumption, the innocent party will be deemed to have invested all of his monies first, and therefore benefit with a lion’s share of the benefit.

 The Common Law position is that you have no remedy to mixed funds. It is an enigma.

 In the Law of Equity, mixed funds are treated as follows:

 In Lupton v White (1805) 15 Ves 432 the draconian position taken was that is the trustee mixed trust funds with his own funds, so that it was not possible to distinguish or identify which was which, the entire mixed funds belonged to the beneficiary.

 This was considered a draconian approach by later authorities, but consider the Proceeds of Crime Act, whereby the Court can award a percentage of the entire amount punitively in favour of the complainant, rather than a percentage of what he ought to be entitled to by compensation/restitution.

 In Clayton’s case (1816) 1 Mer 529 this concerned monies either in a deposit account, or a current account. Where monies of innocent parties were blended with those of fraudsters.

 If it was a deposit account, with mixed funds with innocent parties monies blended into that account, the parties share rateably in proportion to their contributions.

 If it was a current account, the rule that applies is ‘first in, first out’.

 This seems unfair. Why should someone who was not entitled to funds, have the benefit or advantage of them if he put them into the account first?

 The application of Claydon’s case has been ignored in a number of cases for obvious reasons that those innocently affected, lose out. More recent cases have favoured a position of pari passu rule.

 In Hallett’s Estate (1880) 13 Ch D 696, the objective was to ensure that the innocent party was not prejudiced by the fraud of the defrauding trustee who spends the victim’s monies first whilst retaining his own funds.

 Halletts presumption deems that the Trustee intended to apply spending his own money first, and not that of the innocent victim. This is further premised on the basis that an individual can not claim to have acted wrongfully in order to defeat a legitimate claim.

 So, if the fraudster took the innocent party’s £3,000 and invested it, so that the investment was now worth £10,000 rather than to purchase a motorbike under Hallett’s Estate, the fraudster would benefit entirely because he used up to the value of his own money. The rule is therefore modified by Re. Oatway [1903] 2 Ch 356 so that the innocent victim can now trace whatever is beneficial to him. So Hallett’s Estate modified by Re Oatway would ensure that the £3,000 would be deemed as belonging to the innocent party and he would benefit entirely.

 McGrath QC says that tracing of mixed funds is in a state of flux, given the historic development and inconsistencies found in the Law of Equity, Common Law, and the Law of Property.

 One would hope that the Courts seek to find a way to recompense innocent parties, and to establish a better constructive way to punish fraudsters, and apply mixed funds always to the benefit of the innocent party.

David Rosen - Head of litigation and specialist in fraud law
David Rosen – Head of litigation and specialist in fraud law

 Professor David Rosen is Partner and head of Litigation at Darlingtons Solicitors LLP. He is a Solicitor-Advocate, a Certified Fraud Examiner, Strategic Director of the Association of Certified Fraud Examiners UK Chapter. A working member of the Fraud Advisory Panel, a member of the Royal United Services Institute, and a member of the Society of Legal Scholars. He is an associate Professor of Law at Brunel University where he lectures and specialised in Commercial Fraud and Criminal Fraud.

David Rosen • Fraud

Haven't found what you need yet?

Why not search the whole site?

Contact Us

Comments are closed.

Archives