Equitable tracing - mixed funds

Table of contents.

Overview , Where funds dissipated , Where funds used for investment , The law , True/false questions

This page was last updated on 21 Mar 96.

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Mail Paul Todd

SLAPNT@cf.ac.uk

Overview.

Part of the ratio of the Court of Appeal decision in Agip Africa v. Jackson [1991] Ch. 547 is that equity will, but the common law will not, allow tracing through mixed bank accounts. See also El Ajou v. Dollar Land Holdings plc [1993] 3 All ER 717, reversed on another ground [1994] 2 All ER 685. In principle, there are three ways in which this can be done, the rule in Clayton's case (1816) 1 Mer. 572, the North American rolling charge, and pari passu.

Note that this is only necessary where it is necessary to make a proprietary claim against a fund, for example where the defendant is bankrupt, such as in Barlow Clowes International (in liq) v. Vaughan [1992] 4 All ER 22. There is no need to apportion where the defendant is solvent and the claim is based on knowing receipt of the plaintiff's money, since it is necessary only to trace the money into the hands of the defendant, and not to apportion: El Ajou v. Dollar Land Holdings plc (No.2) [1995] 2 All ER 213.

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Where the funds are dissipated.

Where the funds are dissipated, Clayton's case benefits late investments, and pari passu benefits earlier, with the rolling charge taking an intermediate position. This can be seen from the following example.

Suppose Paul pays 10 into a fund, then Michael pays in 10, then 10 is spent, then Karen pays in 10, then a further 10 is spent, leaving 10 in the fund. Before the final 10 is spent, pari passu gives Paul, Michael and Karen an equal share of the 20 in the fund, or 6.67 each. After the final transaction, each has an equal share in the 10 remaining, or 3.33 each.

On the North American rolling charge method, the shares are considered at the time of each withdrawal. At the time of the first withdrawal, Paul and Michael each have a half share in the fund, and each will be treated as having withdrawn 5, leaving 5 in. When Karen pays in her 10, Paul and Michael each own a quarter, and Karen half the fund. Note that even at this stage, Karen's share is larger, and Paul and Michael's smaller, than under pari passu. The final withdrawal will be attributed to them all in the same proportions, leaving Paul and Michael with 2.50, and Karen with 5. Again, Karen does better, and Paul and Michael worse, than under pari passu.

If Clayton's case applies, the first withdrawal will be attributed to Paul alone, on the first in first out principle, leaving him with no share in the fund. When Karen pays in her 10, Michael and Karen will have a share of 10 each. So Paul is doing worse, and Michael better, than under the North American rolling charge. The final withdrawal is attributed to Michael, leaving Karen sole owner of the remaining 10. Clearly, then, Clayton's case benefits the late investor.

However, the positions are reversed if the 10 withdrawals, instead of being dissipated, are used for an investment which increases in value, say to 50. Here Clayton's case benefits the early investor into the fund, pari passu the later.

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Where the funds are invested.

If instead of being dissipated, each of the withdrawals is invested into a valuable investment, worth now 50, the position is entirely different from that above. Before the final withdrawal and purchase, pari passu gives Paul, Michael and Karen equal shares in the first 50 investment, and the 20 remaining in the fund, or a share worth 23.33 each. After the final withdrawal and purchase, they have equal shares in the two 50 investments and the 10 remaining in the fund, each therefore having a share worth 36.67.

Under the North American rolling charge, the first investment belongs equally to Paul and Michael, whose shares in the investment are therefore worth 25, and in addition each owns half the remaining fund of 10. After Karen has paid in her 10, therefore, Michael and Paul have shares worth 30, and Karen's share is worth 10. The second investment is quarter owned by Michael and Paul, and half by Karen, and they also have the same shares in the fund as where the money has been dissipated. The final shares are therefore:

Paul and Michael: 25 (first investment) plus 12.50 (second investment) plus 2.50 (fund) - total 40.
Karen: 25 (second investment) plus 5 (second investment) - total 30.

It is obvious, then, that Paul and Michael are better off, and Karen worse off, than under pari passu.

Under Clayton's case, the entirety of the first investment, worth 50, is owned by Paul, whose total share is therefore 50 (better than under the North American rolling charge). Michael is worse off immediately before the final purchase, with a 10 share in the fund, the same as Karen's. But the second investment will belong to Michael, who therefore ends up, like Paul, with an investment worth 50. Karen's share is the whole of the remaining fund, or 10. So Karen is far worse off under the rule in Clayton's case than under either of the other schemes.

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The law.

It is clear from Barlow Clowes International (in liq) v. Vaughan [1992] 4 All ER 22 that, although recognising that it is fairer than Clayton's case and (possibly) pari passu, the courts do not embrace the North American rolling charge. It is said to be too difficult to operate, even with modern powerful computers (this seems difficult to believe). Sarah Lowrie have argued that it will normally be the fairest distribution method, however, in [1998] Denning L.J. 43.

Generally speaking, pari passu is preferred, but it is not possible to distribute pari passu unless a starting date can be fixed, since it is not possible to ascertain shares in the fund. This is presumably why Clayton's case is used for tracing into running current accounts. Even here it is subject to contrary intention (Barlow Clowes), and has not been extended to analogous situations, such as where money is paid into an unincorporated association (see, e.g, Hobourn Aero).

These rules apply only where the parties are innocent. Where trust money is mixed with the trustee's own, Hallett's Estate and Oatway (probably) always operate in favour of the trust and against the trustee: in Hallett a trustee was unable to rely on Clayton's case, because this would have implied that he had dissipated trust money, which would have been unlawful, when the alternative explanation, that he had dissipated his own, was available. However, Hallett principles do not apply against a volunteer, even though he takes subject to the interests of the trust: Re Diplock's Estate. Diplock also shows that money which goes into improving the land of a volunteer, or to pay off the debts relating to that land, cannot be traced, as the equitable charge, which might force the volunteer to sell the land in order to make reimbursement, could operate unfairly on the volunteer.

The H.L. also managed to avoid applying Hallett's Estate principles in Sinclair v. Brougham, which would have led to the shareholders (as trustees) getting nothing.

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True/false questions.

These notes are not yet ready (21 Mar 96).

Point of true / false questions

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