Learning Outcomes
This article examines trustees’ liability for breach when trust property is mixed with other assets, tracing and proprietary claims, and the key rules applied to mixed funds, including:
- Tracing principles in equity and requirements for proprietary claims
- Re Hallett and Re Oatway presumptions for mixed accounts and asset purchases
- Clayton’s Case rule and departures in favour of pari passu sharing
- The lowest intermediate balance rule (Roscoe v Winder)
- Proprietary remedies (constructive trust and equitable lien) and beneficiary election
- Limits on tracing: overdrawn accounts, dissipation, and bona fide purchaser protection
- Proportionate proprietary claims against innocent volunteers
- The limited circumstances permitting backwards tracing in coordinated schemes
SQE1 Syllabus
For SQE1, you are required to understand the legal consequences when trust property is mixed with other property, and how beneficiaries may trace and recover assets, with a focus on the following syllabus points:
- the principles of tracing in equity and the requirements for a proprietary claim
- the key rules and presumptions applied when trust property is mixed with a trustee’s own funds or with other trusts’ funds (Re Hallett, Re Oatway, Clayton’s Case, and related doctrines)
- the remedies available to beneficiaries (constructive trust, equitable lien, pari passu sharing)
- the limitations and practical issues that arise when tracing into mixed funds or dissipated assets
- application of the lowest intermediate balance rule (Roscoe v Winder) to replenished bank accounts
- situations where courts depart from Clayton’s Case and apply pari passu sharing (e.g. Barlow Clowes v Vaughan), and how to choose the fairest approach
- election between proprietary remedies (constructive trust vs equitable lien) depending on asset appreciation or depreciation
- the effect of overdrawn accounts, dissipation on services, and protection of the bona fide purchaser for value without notice
- the limited scope for backwards tracing where the transactions form part of a coordinated scheme
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.
- What is the main difference between the Re Hallett and Re Oatway tracing rules when a trustee mixes trust funds with their own money?
- When two trusts’ funds are mixed in a single account and withdrawals are made, which rule is usually applied to determine whose money is spent first?
- What proprietary remedies are available to beneficiaries when trust funds have been used to purchase an asset that has increased in value?
- What is the effect of the “lowest intermediate balance” rule on a beneficiary’s ability to trace into a bank account?
Introduction
When a trustee breaches their duty by mixing trust property with other assets, beneficiaries may seek to recover their property or its traceable proceeds. English law provides specific tracing rules and proprietary remedies to protect beneficiaries in these situations. For SQE1, you must be able to identify the correct tracing rule, apply it to a scenario, and explain the consequences for both the trustee and the beneficiaries. In particular, you must be able to apply the presumptions and limits the courts use to allocate withdrawals from mixed accounts, select the remedy that maximises recovery, and recognise when proprietary claims are unavailable.
Tracing and Proprietary Claims: The Basics
When trust property is misapplied or mixed with other assets, beneficiaries may trace their property into its new form and assert a proprietary claim. Tracing is the process of identifying trust property (or its substitute) in the hands of the trustee or a third party. Equitable tracing is available where the claimant has an equitable interest (e.g., as a beneficiary under a trust), and the court is prepared to follow the value of trust property into other assets acquired through substitution or mixed with other money.
Tracing is conceptually different from the proprietary claim itself. Tracing is evidential and neutral; it identifies the asset that represents the trust value. The proprietary claim is the legal action that follows once the trace succeeds, seeking a specific remedy over the identified asset or fund.
Key Term: tracing
The process by which a claimant identifies trust property (or its substitute) as it passes through different forms or hands.Key Term: proprietary claim
A legal action asserting a right to specific property or its traceable proceeds, rather than a claim for compensation.Key Term: constructive trust
An equitable remedy imposed by the court requiring a person (often a trustee or recipient of trust property) to hold property for the benefit of another due to wrongdoing or unconscionable conduct.
If a trustee has used trust money directly to buy an asset (“clean substitution”), tracing is straightforward: the beneficiary can claim that asset, or assert an equitable lien over it if it has fallen in value. Where the trustee mixes trust funds with other funds, presumptions guide how withdrawals are allocated and how assets purchased from the mixed account are treated.
Mixing of Trust Property: Why It Matters
When trust property is mixed with other property—such as a trustee’s own funds or the assets of another trust—special rules determine how much, if any, of the mixed fund or asset the beneficiaries can recover. The law aims to prevent trustees from profiting from their wrongdoing and to maximise recovery for beneficiaries. The overarching policy is protective: equity strives to put the beneficiaries in the best position consistent with fairness to other innocent parties.
Key Term: mixed fund
A fund or asset comprised of both trust property and other property (such as a trustee’s own money or another trust’s money).
Tracing into Mixed Funds: Key Rules and Presumptions
Re Hallett’s Rule: Trustee’s Money Spent First
When a trustee mixes trust money with their own funds in a bank account and makes withdrawals, the law presumes the trustee spends their own money first. This maximises the amount available for the beneficiaries. The presumption derives from Re Hallett’s Estate and reflects the equitable assumption that a fiduciary acts honestly and does not spend trust money when they can spend their own.
Key Term: Re Hallett's rule
The presumption that, when a trustee mixes trust funds with their own money and makes withdrawals, the trustee is deemed to spend their own money first.
Worked Example 1.1
A trustee deposits £8,000 of their own money and £12,000 of trust money into a single account. The trustee then withdraws £10,000 for personal expenses. How much of the remaining £10,000 in the account is presumed to belong to the trust?
Answer:
Under Re Hallett’s rule, the trustee is presumed to have spent their own £8,000 first, and £2,000 of trust money. The remaining £10,000 is treated as trust money.
This presumption helps beneficiaries trace into the remaining balance or into assets purchased later. However, beneficiaries are not confined to Re Hallett if another approach better protects their interests.
Re Oatway Rule: Maximising Recovery for Beneficiaries
If the trustee spends money from a mixed account to buy an asset and then dissipates the rest, the beneficiaries can claim the asset up to the value of the trust money used. This prevents the trustee from keeping valuable assets at the expense of the trust. Re Oatway modifies the Re Hallett presumption where necessary to prevent injustice.
Key Term: Re Oatway rule
The principle that, when a trustee buys an asset from a mixed fund and dissipates the rest, beneficiaries may claim the asset up to the value of the trust money used.
Worked Example 1.2
A trustee mixes £5,000 of trust money with £5,000 of personal funds and uses £8,000 to buy shares, then spends the remaining £2,000 on a holiday. The shares later rise in value. Can the beneficiaries claim the shares?
Answer:
Yes. Under Re Oatway, the beneficiaries can claim the shares up to £5,000 (the amount of trust money used), including any increase in value.
Re Oatway ensures that trustees cannot shield valuable acquisitions by arguing that they spent their own money on them; beneficiaries can “cherry-pick” the rule (Hallett or Oatway) that provides the better outcome.
The “Lowest Intermediate Balance” Rule
If the balance in a mixed account falls below the amount of trust money paid in, the beneficiaries’ claim is limited to the lowest balance reached before new money is added. This reflects the reality that once trust money has been dissipated, later replenishments (from the trustee’s own funds) do not automatically restore the trust’s property unless the trustee can show an intention to do so.
Key Term: lowest intermediate balance
The smallest balance in a mixed account after trust money is paid in; sets the maximum amount beneficiaries can claim if the account is later replenished.
The rule is often attributed to Roscoe v Winder. It caps what can be treated as surviving trust value within the account and prevents beneficiaries from claiming later deposits as trust money absent evidence of replenishment intended for the trust.
Worked Example 1.3
A trustee pays £6,000 of trust money into an account with £2,000 of personal funds. The balance falls to £1,000 before the trustee pays in another £5,000. How much can the beneficiaries claim?
Answer:
Only £1,000—the lowest intermediate balance—unless the trustee can show the later deposit was intended to restore the trust money.
Tracing into Assets Purchased from Mixed Funds
If a trustee uses a mixed fund to buy an asset, beneficiaries may choose the remedy that gives them the best result:
- If the asset has increased in value, they may claim a proportionate share (constructive trust).
- If the asset has decreased in value, they may claim an equitable lien (a charge for the amount misapplied).
Key Term: equitable lien / charge
A right to have a specific asset sold to satisfy a debt or claim, such as the amount of trust money used to acquire the asset.
This election mirrors the mixed asset rule: equity allows beneficiaries to capture gains when the asset appreciates but avoids leaving them worse off when it depreciates.
Worked Example 1.4
A trustee mixes £7,000 of trust money with £7,000 of personal funds and buys a painting for £14,000. The painting is now worth £20,000. What can the beneficiaries claim?
Answer:
The beneficiaries may claim a 50% share of the painting (worth £10,000), or an equitable lien for £7,000. They will usually choose the option that gives them the highest value.
Mixed Funds in Practice: Additional Scenarios
Understanding how the rules interact in real situations is important.
Worked Example 1.5
A trustee pays £10,000 of trust money into an account containing £5,000 of personal money. Several withdrawals reduce the balance to £500. The trustee later deposits £20,000 of personal funds and then buys a car for £10,000 from the account. What is the maximum amount the beneficiaries can trace into the account or the car?
Answer:
The maximum is £500—the lowest intermediate balance reached before replenishment. Later deposits are presumed personal funds unless intended to restore trust money. Absent evidence of restoration, the car cannot be claimed beyond £500 of trust value.
Worked Example 1.6
A trustee’s mixed account is overdrawn (negative balance). The trustee then pays in £15,000 of personal funds and immediately buys shares for £12,000. Can beneficiaries trace into the shares?
Answer:
No. Trust money cannot be traced into an overdrawn account; there is no identifiable trust value during the overdraft. The later deposit and purchase are treated as the trustee’s own funds, so the shares are not traceable trust property.
Worked Example 1.7
A trustee pays £6,000 of trust money into a mixed account and soon after buys a portfolio for £9,000. The account briefly shows a surplus, then falls to £0 and is later replenished by £10,000 of personal funds. The portfolio has risen to £12,000. Can the beneficiaries claim the portfolio?
Answer:
Yes, via Re Oatway. The portfolio was purchased while trust money was in the mixed account and before dissipation. The beneficiaries may claim a proportionate share reflecting the original contribution (up to £6,000), including the increase in value.
Mixing Funds from Two Trusts: Pari Passu and Clayton’s Case
When a trustee mixes funds from two or more trusts, the law aims to treat all innocent beneficiaries fairly. The default common law rule in “banker–customer” accounting is “first in, first out,” but equity can and often does depart from this where it would be unfair.
Key Term: pari passu
A method of sharing an asset or fund proportionally among claimants according to their contributions.Key Term: Clayton's Case rule
The “first in, first out” rule: when funds from different sources are mixed in a bank account, withdrawals are presumed to come from the earliest deposits first.
Worked Example 1.8
A trustee pays £4,000 from Trust A and £6,000 from Trust B into a single account. The trustee withdraws £7,000 to buy a car, then spends the rest. How are the interests allocated?
Answer:
Under Clayton’s Case, the first £4,000 withdrawn is from Trust A, and the next £3,000 is from Trust B. Trust A’s money is spent first, so Trust B has a remaining claim to £3,000. However, courts may instead apply pari passu sharing if it is fairer.
Courts frequently reject strict FIFO in modern multi-contributor settings (e.g., Barlow Clowes v Vaughan) and prefer proportional sharing, especially where applying FIFO would produce arbitrary or capricious results. The equitable focus is fairness between innocent contributors.
Exam Warning
The “first in, first out” rule in Clayton’s Case can produce unfair results. Courts may depart from it and apply pari passu sharing if strict application would be unjust.
Worked Example 1.9
Trust X and Trust Y both contribute £10,000 to a mixed account. The trustee withdraws £12,000 to buy jewellery and later dissipates the balance. Which allocation method better serves equity?
Answer:
Pari passu sharing is more equitable. Each trust contributed equally and should share the jewellery value proportionately. Strict FIFO could favour one trust arbitrarily depending on deposit timing, which courts often avoid.
Tracing into Property Held by Innocent Volunteers
If trust money is mixed with an innocent party’s funds and used to buy an asset, the beneficiaries can claim a proportionate share of the asset, regardless of whether it has increased or decreased in value. The volunteer did not give value, so equitable proprietary claims are not defeated. However, courts aim to be fair to all innocent parties, ordinarily granting a proportionate constructive trust or, where appropriate, an equitable lien.
Worked Example 1.10
A trustee pays £3,000 of trust money and £9,000 of an innocent volunteer’s money into a joint account. They buy a car for £12,000. The car is now worth £8,000. What can the beneficiaries claim?
Answer:
The beneficiaries can claim a 25% share of the car (worth £2,000), reflecting their contribution.
Worked Example 1.11
A trustee mixes £8,000 of trust funds with £12,000 from an innocent volunteer to buy a flat for £20,000. The flat is now worth £26,000. What is the appropriate remedy?
Answer:
A proportionate constructive trust over 40% of the flat (reflecting the trust’s contribution), now worth £10,400, or an equitable lien for £8,000. The constructive trust captures the increase and is the better option.
Limitations on Tracing and Proprietary Claims
Tracing is not possible if the property has been dissipated (e.g., spent on a holiday) or if the account is overdrawn. Beneficiaries cannot trace into funds received by a bona fide purchaser for value without notice. Where value has been given in good faith and without notice of the equitable interest, the equitable interest is extinguished as against the purchaser.
Key Term: bona fide purchaser for value without notice (bfpfvwn)
A person who acquires property for value, in good faith, and without knowledge of any prior equitable interest; takes free of the beneficiaries’ claim.
A few key limits should be kept in mind:
- Overdrawn accounts: trust value cannot be traced into a debt.
- Dissipated funds: spending on services (like travel or dining) leaves no traceable asset.
- Replenishment does not restore trust value unless there is evidence of an intention to replenish for the trust.
- Innocent volunteer recipients can be subject to proprietary claims, but innocent purchasers for value without notice cannot.
- Backwards tracing may be permitted in limited circumstances where the transactions form part of a coordinated scheme; otherwise, equity generally requires a forward path of trust value into the asset.
Key Term: backwards tracing
Limited equitable tracing of trust value where payments are made after acquisition, but the transactions form part of a coordinated scheme linking trust funds to the asset.
Worked Example 1.12
A trustee obtains a luxury watch on credit and later pays the bill using trust funds. There is no evidence of any coordinated plan linking the trust money to the acquisition. Can the beneficiaries claim the watch?
Answer:
No. Without a coordinated scheme, equity does not permit backwards tracing. The trust funds discharged a debt, but there is no forward trace of trust value into the watch.
Worked Example 1.13
A trustee uses a revolving credit facility to buy a yacht, intending from the outset to fund repayments using misappropriated trust money. The trust funds are later used to pay the credit. Can the beneficiaries assert a proprietary claim to the yacht?
Answer:
Yes, in principle. Where the acquisition and later payments are part of a coordinated scheme, backwards tracing may be permitted and the yacht may be subject to a proprietary claim reflecting the trust contribution.
Remedies Available to Beneficiaries
Beneficiaries may choose the remedy that gives them the best result:
- A constructive trust (proportionate share) if the asset has increased in value.
- An equitable lien (charge) if the asset has decreased in value.
- Pari passu sharing if multiple innocent parties are involved in a mixed fund.
- A personal claim for compensation against the trustee (distinct from proprietary claims) where appropriate, with interest as the court determines.
In mixed asset cases, equity permits beneficiaries to elect between a proportionate constructive trust and an equitable lien. Election ensures beneficiaries capture gains on appreciation while avoiding loss on depreciation.
Worked Example 1.14
A trustee mixes £9,000 of trust funds with £6,000 of personal funds to buy rare coins for £15,000. The coins are now worth £12,000. What should the beneficiaries seek?
Answer:
An equitable lien for £9,000 is preferable, as the coins have fallen in value. A lien ensures repayment of the misapplied amount without sharing the loss.
Key Point Checklist
This article has covered the following key knowledge points:
- Tracing allows beneficiaries to identify and recover trust property or its substitute, even after mixing.
- When a trustee mixes trust money with their own, Re Hallett’s rule presumes the trustee spends their own money first.
- Re Oatway allows beneficiaries to claim assets purchased from mixed funds if the rest is dissipated, preventing trustees from profiting from wrongdoing.
- The “lowest intermediate balance” (Roscoe v Winder) limits recovery if the account balance falls below the amount of trust money paid in before later deposits.
- When funds from multiple trusts are mixed, Clayton’s Case (first in, first out) or pari passu sharing may apply; courts often favour proportional sharing where FIFO is unfair.
- Beneficiaries may claim a constructive trust or an equitable lien, depending on whether the asset has increased or decreased in value, and may elect the remedy that maximises recovery.
- Tracing is not possible if the property is dissipated or acquired by a bona fide purchaser for value without notice; tracing into overdrawn accounts fails.
- Innocent volunteers can be subject to proportionate proprietary claims; bona fide purchasers for value without notice take free of equitable interests.
- Backwards tracing may be available only in limited, coordinated schemes that link the misapplied trust funds to the acquisition.
Key Terms and Concepts
- tracing
- proprietary claim
- constructive trust
- mixed fund
- Re Hallett's rule
- Re Oatway rule
- lowest intermediate balance
- equitable lien / charge
- pari passu
- Clayton's Case rule
- bona fide purchaser for value without notice (bfpfvwn)
- backwards tracing