This article considers the latest contribution made by the House of Lords in Foskett v McKeown1 to the question of what happens when a person misappropriates money and uses it to pay for part of an asset. The issue arises in circumstances where one party gives control over certain funds to another. This happens every day; it is, therefore, important to know how far a true owner can look for a misappropriated asset.
Introduction
People steal. It is a fact of life as old as the scriptures, reflected in the Bible's eighth commandment 'Thou shall not steal'.2 Few questions arise as to who should have the stolen article if it is found in the hands of the thief; the owner gets it back. Some questions arise where the property is in the hands of a person other than the thief; generally, the law protects a bona fide purchaser for value without notice3 and otherwise the position is one of jealous protection of chattels and land.4 Difficult questions arise where there is money involved, for money is thought to be not easily identifiable and ordinarily passes into currency so that the holder is able to invoke a bona fide purchase defence.5 Similar questions arise with any objects that are not concrete but are instruments representing choses in action or rights.6 Yet more difficult questions arise in the case where money is stolen and mixed with other money. This is the focus of this paper. The common law developed complex rules as to the identification of such money. The rules have been the subject of much consideration and debate7 and even from the titles of certain publications, it was evident that the position was not clear.8
While the Foskett case represents a further voice9 for a unitary law of tracing assets (Foskett at 1324, per Lord Millett), there was no unanimity of view as to outcome, reasoning or result; there was disagreement between the majority and the minority and even within the majority. This is troubling for investors who entrust their money to others and need to know what their position is. There is some good news, though, for the position in the end seems tolerably clear. There is light at the end of the tunnel.
Facts
In 1986, Mr Murphy took out a whole life unit-linked insurance policy in his own name. The terms of the policy provided that in consideration of the first premium and further premiums, £1m would be payable on Mr Murphy's death. The nature of the policy allowed for investment and payment of premiums from the investment of earlier premiums.
In 1988, some purchasers contributed £2.6m towards a property development scheme in Portugal ('Investors'). The money was entrusted to Mr Murphy who was the dominant figure in the scheme. Unfortunately, the scheme was never carried out. In 1989, he divested his beneficial interest in the insurance policy, declaring it to be held on trust for his three children. £20,440 of the Investors' money was used to pay the fourth and fifth annual premiums in 1989 and 1990 respectively. The source of the 1988 premium was disputed and unconditional leave to defend on issues relating to this premium was granted. It was argued, on behalf of the children, that the premiums paid with the Investors' money did not increase the value of the policy in any way: the first and second premiums were, by themselves, under the terms of the policy sufficient to pay all the premiums due without any assistance from the fourth and fifth premiums, as even if these premiums had not been paid, the policy would have been in force at the time of Mr Murphy's death.
In 1991, Mr Murphy committed suicide and £1m was paid over to the trustees of the policy. The Investors then brought an action claiming a proportionate share of the proceeds of the policy (Foskett at 1302-1304, per Lord Browne-Wilkinson).
Judgments
Five judgments were delivered. The majority (Lord Browne-Wilkinson, Lord Hoffmann and Lord Millett) found that the Investors were entitled to a proportionate share of the proceeds from the insurance policy. The minority thought that the Investors were not entitled to a proportionate share of the proceeds, on the basis that the money stolen from the Investors was not causally relevant to any benefit to be received by the children. The divergence of views is striking and important for the light and shadows of doubt it casts on an owner's entitlement to money taken by another. Each judgment is considered in turn.
Lord Browne-Wilkinson
His Lordship confessed (Foskett at 1304) that he initially was going to find for
the children but decided for the Investors after reading Lord Millett's
judgment. Lord Browne-Wilkinson saw the case as involving the claim of a
proprietary interest, not dependent on proving unjust enrichment or on any
discretion in the court (Foskett at 1304). Lord Browne-Wilkinson found there was
no bona fide purchaser and that certain of the policy proceeds represented part
of the purchasers' money (Foskett at 1304). His Lordship added that it did not
matter that in the events which happened, the purchasers' money was not required
to keep the policy on foot, noting 'But at the times the fourth and fifth
premiums were paid ... it was wholly uncertain what the future would bring. In
my judgment, the beneficial ownership of the policy and therefore the policy
moneys cannot depend upon how events turn out. The rights of the parties in the
policy, one way or another, were fixed when the relevant premiums were paid when
the future was unknown' (Foskett at 1306). This leads to a startling result in
that owners are given the benefit of an uncertain future, for rights are fixed
by reference to the potential utility of the purchasers' premiums.
Lord Browne-Wilkinson's approach will allow for 'backward tracing', in that the
entitlement of an owner to obtain the return of money may not turn on the strict
order of payments out and into accounts, but on the substance of the
transaction.
Lord Steyn
Lord Steyn took the view that the purchasers were not entitled to a proprietary
claim.10 They were held to be merely entitled to recover the sum used to pay the
fourth and fifth premiums, by imposing a lien or charge over the proceeds of the
policy (Foskett at 1309). For Lord Steyn, the distinctive feature of the case
was that the fourth and fifth premiums did not cause or add to the amount paid
out to the children under the policy (Foskett at 1309). His Lordship reasoned
that the rights of the children had crystallised before any stolen money was
used - when Mr Murphy declared the policy to be held on trust for them (Foskett
at 1310). His Lordship said that '[I]t would be artificial to say that all five
premiums produced the policy money. The purchasers' money did not
"buy" any part of the death benefit. On the contrary, the stolen
moneys were not causally relevant to any benefit received by the children' (Foskett
at 1310). It would be 'an innovation to create a proprietary remedy' for an
asset which was acquired before the stolen money was used (Foskett at 1310).
Lord Steyn cited a policy reason arguing that the creation of such a proprietary
right could prejudice trade creditors (Foskett at 1310).
Lord Steyn's approach, while sensitive to the needs of creditors, is also not
supportive of backward tracing. Causation is seen as a mechanism to control
entitlement.
Lord Hoffmann
Lord Hoffmann saw the case as a straightforward one of mixed substitution (Foskett
at 1311), seeing the purchasers' entitlement as merely a vindication of a
proprietary right (Foskett at 1311). Lord Hoffmann, however, disagreed with Lord
Millett on the calculation of the proportion, holding that the fund should be
held simply in proportion to the contributions the parties made to the five
premiums (Foskett at 1312).
Lord Hoffmann specifically recognised, however, that where contributions were made at different times in consideration for a single item of property, the value of the earlier payments is greater than that of later payments (Foskett at 1311). This is suggestive of great complexity in ascertaining an entitlement, as today's world financial transactions are rapid and recurring.
Lord Hope of Craighead
Lord Hope saw it as a case of mixed substitution (Foskett at 1316), but
disagreed with Lord Hoffmann that this was a straightforward case (Foskett at
1316). The entitlement of the Investors was seen as tricky (Foskett at 1316).
His Lordship said that in the absence of any other basis for division, in
principle or on authority, the proceeds must be divided in an equitable manner (Foskett
at 1316). His Lordship found that the Investors were not entitled to a
proportionate share in the proceeds (Foskett at 1318). He reasoned, as Lord
Steyn did, that the purchasers were unable to show that the use of their money
had contributed to any increase in the death benefit (Foskett at 1318). In fact,
on the terms of the policy, the death benefit was fixed from the outset upon
payment of the first premium (Foskett at 1318). His Lordship distinguished the
present situation from that where funds were mixed before the investment was
made (Foskett at 1320). Hence, the purchasers were confined, in his judgment, to
an equitable right to recover the misappropriated sum (Foskett at 1320).
His Lordship further added that since the children were not part of Mr Murphy's
wrongdoing, and were not enriched by the payment of the fourth and fifth
premiums, the purchasers did not have a remedy in unjust enrichment (Foskett at
1321).
Such considerations, tied to conceptions of wrong and wrong-doing, may be
seductive for their capacity to allow for a remedy in a broad range of
circumstances, but they do not provide for the certainty that parties about to
embark on an investment would seek.
Lord Millett
Lord Millett regarded the case as a textbook example of tracing through mixed
substitutions (Foskett at 1322) and added that there was 'no sense in
maintaining different rules for tracing at law and in equity' (Foskett at 1324).
The basic rule was stated as follows. 'Where a trustee wrongfully uses trust
money to provide part of the cost of acquiring an asset, the beneficiary is
entitled at his option either to claim a proportionate share of the asset or to
enforce a lien upon it to secure his personal claim against the trustee for the
amount of the misapplied money.' (Foskett at 1327.) His Lordship added that
'[I]t does not matter whether the trustee mixed the trust money with his own in
a single fund before using it to acquire the asset, or made separate payments
(whether simultaneously or sequentially) out of the differently-owned funds to
acquire a single asset.' (Foskett at 1327.) The claimant need not show that in
addition, his property contributed to any increase in the value of the new asset
(Foskett at 1327).
His Lordship recognised that although the last two premiums were not needed to provide the death benefit (Foskett at 1333), it was paid out in consideration of all the premiums (Foskett at 1329). Ownership of the policy does not depend on who took out the policy, but the identity of parties whose money was used to pay the premiums (Foskett at 1332). To calculate the plaintiffs' share, Lord Millett drew a distinction between the cost and value of the contributions (Foskett at 1336). By taking account of the value of the units, it automatically weights the earlier premiums which should have bought more units than later ones (Foskett at 1340).
Such a process does suggest that the ascertainment of an entitlement could become complicated. Still, it provides broad comfort to an owner, empowered to elect his entitlement and enforce it, without reference to creditors' interests.
Analysis
Several points emerge from the decision of the House of Lords. The rule that appears to arise is that stated by Lord Millett: an owner who entrusts money to another, who misappropriates it, can choose either to take a proportionate share in the asset the wrongdoer acquires or to obtain a lien on it to secure the claim against the wrongdoer for the amount of the misapplied money. Ownership, it is now clear, accords certain benefits, including the right to choose what one owns.
Principle and policy
The metes and bounds of an owner's rights to money or rights ought to be clear. The feature of the case that is intriguing is the apparent rejection of the orthodoxy that a plaintiff cannot assert a proprietary interest in the defendant's possession where the defendant was already in possession of that property before receiving the plaintiff's money. This conventional view turned on the perception that, in such circumstances, the defendant's property cannot be held to represent the plaintiff's money, even if the plaintiff's money was used to pay for the property.11 The net effect of the House of Lords' decision in Foskett is to recognise backward tracing and allow the following of value into a previously acquired asset.
The majority took the view that all five premiums contributed to the death benefit.12 For them, it does not matter what, in actuality, Mr Murphy owned at the time he paid the fourth and fifth premiums. The fourth and fifth premiums were paid with the intention of keeping the policy alive. Only with the benefit of hindsight was it discovered not to be strictly necessary to produce the death benefit paid out (Foskett at 1333). The intention of Mr Murphy may have been a prime consideration, but it would seem that a principle clearly enabling backward tracing may be emerging.
The strongest argument against recovery of a proportionate entitlement by the Investors is the perceived noxiousness of the gain of a windfall. However, disallowing a proportionate recovery will result in a windfall to the wrongdoing trustee and those claiming under him. Policy dictates that errant trustees should never be allowed to benefit from their wrong.13
The honesty of the children in this case, or innocent recipients generally, was not a consideration of relevance to the majority. If honesty alone amounted to a defence, problems will arise as to determination of its existence, which can be a mammoth or even impossible task. This has certainly been the case in isolating the true test as to 'honesty' for the purposes of liability for 'knowing assistance'14 and 'knowing receipt'.15
The disregard of the dishonesty or honesty of the competing claimants is remarkable for in other areas, such as liability for 'knowing assistance' or 'knowing receipt', the position is otherwise. The law of property and the recognition of a proprietary entitlement should proceed with clarity. The rules as to tracing and the right of election, as to proceeds or a lien, does not always make for clarity, particularly if one recognises that some of the rules as to tracing arose in a time when technology did not assist in identifying or recreating an asset, when, for example, a fingerprint on a gold coin could not be isolated. An understanding of new technology and an appreciation that the tracing rules were constructs of reason and policy rather than ineluctable or naturally occurring rules, may provoke further converts to the cause of a unitary law of tracing.
Prevention and detection
Detection of fraud is getting increasingly difficult because of the sophistication of modern technology coupled with the surreptitious nature of illegal activities. It is impossible to eradicate fraud completely, but effective internal management controls will keep in check people working to invest other people's money. Thus far, the inadequacy of the systems in place for the prevention of fraud within an organisation and an investor's lack of vigilance are not factors pertinent to the attribution of entitlement. The owner is, thus, in a happy position.
One matter that is left hanging is how, in providing such security to the happy
owner who can trace far and with much power, the law may well be working against
another policy objective: that of encouraging parties not to carry out illegal
transactions, by allowing for recovery of money paid under a contract, where a
plan to do something illegal has not been carried out.16
If an owner, following Foskett, can elect his entitlement to either the amount
stolen from him or the proceeds of any fund obtained by the wrongdoer's actions,
there is a subtle encouragement for wagering. Unscrupulous owners may well wait
and see what a wrongdoer is doing with their money, to capitalise on their right
of election, rather than blow the whistle and deprive themselves of a potential
windfall. It is counter intuitive to suppose that dishonesty will reside only in
the hearts of the person to whom property has been entrusted. This, again,
invites further consideration of the limits of an owner's entitlement to trace
his property.
Conclusion
The rights of an owner to follow value into the hands of another where there has been misappropriation will always leave one party less happy, as ownership, axiomatically, is about exclusion. Someone is going to have to give up something. The House of Lords' decision in Foskett reveals the intricate and layered issues of policy and principle at stake in mapping the limits of an owner's entitlement to trace assets. Despite the differences in opinion and the spread of the spectrum of views held, it seems that the investing community will take heart from Foskett, for it shows that for the true owner, not unlike Dorothy in The Wizard of Oz, there is bound to be an asset into which the owner can trace, somewhere over the rainbow.
Kanaga Dharmananda
Mitsubishi Corporation, Tokyo
&
Adelene Tan
LLB (NUS)
Endnotes
1 [2000] 2 WLR 1299.
2 Exodus, ch 20, v 15.
3 Clarke v Shee (1774) 1 Cowp 197 at 200.
4 Goff and Jones, The Law of Restitution (1998) pp 94-96.
5 Miller v Race (1758) 1 Burr 452 at 457-458; see also Fox, 'Bona Fide Purchase
and the Currency of Money' [1996] CLJ 547.
6 Lipkin Gorman (a firm) v Karpnale Ltd [1991] 2 AC 548 at 573-574.
7 For a general discussion of the nature and scope of the common law right 'to
follow' property: see Scott, 'Tracing at Common Law' (1965-1966) 7 WALR 463;
Pearce, 'A Tracing Paper' (1976) 40 Conv 277; Goode, 'The Right to Trace and its Impact
in Commercial Transactions' (1976) 92 LQR 360 at 528; Khurshid & Matthews, 'Tracing Confusion' (1979) 95
LQR 78 and Matthews, 'The Legal and Moral Claims of Common Law Tracing' in
Birks, Laundering and Tracing pp 42-47. See also Indian Oil Corp Ltd v
Greenstone Shipping SA, The Ypatianna [1987] 3 All ER 893, applied in Re
Stapylton Fletcher [1995] 1 All ER 192, [1987] CLJ 369 (Stein) and Mercer v Craven Grain Storage Ltd (17
March 1994, unreported) (HL). For a comprehensive discussion of the authorities,
see Lionel Smith (1995) 111 LQR 10.
8 See Khurshid & Matthews, 'Tracing Confusion' (1979) 95 LQR 78.
9 Birks, 'The Necessity of a Unitary Law of Tracing' in Making Commercial Law
(1997) pp 234-258.
10 Bishopsgate Investment Management Ltd v Homan [1995] Ch 211 at 217. See also
Virgo, The Law of Restitution (1999) p 653.
11 Ibid at 221, per Leggatt LJ.
12 Foskett at 1306, per Lord Browne-Wilkinson, at 1312, per Lord Hoffmann and at
1329, per Lord Millett.
13 Re Tilley's Will Trust [1967] Ch 1179 at 1189.
14 Royal Brunei Airlines Sdn Bhd v Tan [1995] 2 AC 378.
15 Westdeutsche Landesbank Girozentrale v Islington London Borough Council
[1996] AC 669.
16 Tribe v Tribe [1996] Ch 107.