Remedies against third parties: recipient and accessory liability - Equitable proprietary claims against third parties

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Overview

Understanding remedies against third parties in trust law is vital for success in the SQE1 FLK2 exam. This guide delves into the specifics of recipient and accessory liabilities and the role of tracing in equitable proprietary claims. These principles are key to protecting beneficiaries' interests in situations involving breaches of trust. Understanding these concepts is crucial for aspiring solicitors to effectively handle trust law issues in their future practice.

Recipient Liability

Recipient liability occurs when a third party receives trust property transferred in breach of trust. The main elements are:

  1. Receipt of Trust Property: The third party must have received the trust property or its traceable proceeds.
  2. Knowledge: The court assesses the recipient's awareness of the breach.

The Baden Scale of Knowledge

The Baden scale, from Baden v Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France SA [1993] 1 WLR 509, outlines five levels of knowledge:

  1. Actual knowledge
  2. Wilfully ignoring the obvious
  3. Recklessly failing to inquire as a reasonable person would
  4. Awareness of circumstances suggesting the facts to an honest person
  5. Awareness prompting a reasonable person to inquire

Levels 2-5 constitute constructive knowledge. In BCCI (Overseas) Ltd v Akindele [2001] Ch 437, the test is whether the recipient's knowledge makes retaining the benefit of the receipt unconscionable.

Example: Business Acquisition

Apex Corporation acquires equipment from Trustee Ltd at a heavily discounted price. Unaware that Trustee Ltd is selling trust assets in breach of duty, if it’s shown that the price should have raised suspicions and Apex failed to inquire, they may be liable under level 3 or 4 of the Baden scale.

Accessory Liability

Accessory liability, or dishonest assistance, involves third parties who aid a breach of trust. The key elements are:

  1. Breach of Trust or Duty: There must be a breach by the trustee or fiduciary.
  2. Assistance: The third party must have aided the breach.
  3. Dishonesty: Assistance must be dishonest by objective standards.

Dishonesty Test

The dishonesty test in accessory liability has evolved through case law:

  • Royal Brunei Airlines v Tan [1995] 2 AC 378: Judged by an objective standard.
  • Twinsectra Ltd v Yardley [2002] UKHL 12: Initially proposed a combined test.
  • Barlow Clowes International Ltd v Eurotrust International Ltd [2005] UKPC 37: Focuses on objective standards, judging conduct by ordinary standards.

Case Study: Financial Misrepresentation

An accountant, Ms. Smith, helps a trustee falsify records to hide misuse of funds. Though she claims ignorance, evidence indicates she ignored obvious warning signs. Using the Barlow Clowes objective test, a court would likely find her liable, as her actions would be deemed dishonest by typical standards.

Equitable Proprietary Claims

Equitable proprietary claims let beneficiaries trace and recover misused trust assets, even if transformed or mixed with other property.

Tracing Rules

There are two tracing types:

  1. Common Law Tracing:

    • Follows the "same asset" through direct exchanges
    • Does not trace through mixed or overdrawn accounts
  2. Equitable Tracing:

    • Allows tracing through mixed funds and various transactions
    • Focuses on value rather than specific assets

Tracing Through Mixed Funds

When trust funds mix with others, several rules apply:

  1. Rule in Clayton’s Case: "First in, first out" principle
  2. Lowest Intermediate Balance Rule: Limited to the lowest balance since mixing
  3. Pari Passu Approach: Proportional distribution for mixed funds

Key Case Law: Foskett v McKeown [2001] 1 AC 102

This case shows equitable tracing's power:

  • Trust funds paid life insurance premiums
  • Upon death, beneficiaries claimed a share of proceeds
  • The House of Lords allowed tracing into the payout, showing equitable tracing follows value through complex financial products

Example: Real Estate Investment

A trustee misuses £100,000 in trust funds for a property deposit on a £500,000 purchase. If property value rises to £750,000:

  1. Beneficiaries can claim the property
  2. They receive a proportional share of the increase: (100,000 / 500,000) * 750,000 = £150,000
  3. This claim takes priority over personal creditors

Equitable tracing and proprietary claims can protect beneficiaries' interests, even when trust assets have changed form.

Conclusion

Understanding remedies against third parties in trust law is vital for SQE1 FLK2 success. Key points include:

  1. Recipient liability hinges on the recipient's knowledge, evaluated by the Baden scale.
  2. Accessory liability requires dishonest assistance, judged objectively.
  3. Equitable proprietary claims help trace misused assets through changes.
  4. Tracing rules, both common law and equitable, are powerful tools for following trust property.
  5. Cases like Foskett v McKeown highlight equitable tracing's flexibility.

By mastering these concepts and their applications, candidates will be equipped to handle complex trust law situations and offer sound legal advice in their careers.