Backwards Tracing

Backward tracing trace into the property purchased by the recipient before he receives the
value which is traced.
Sometimes referred to as ‘tracing into the payment of a debt’, backwards tracing would allow
the process of tracing to occur in the situation where an asset has been acquired in exchange
for the creation of a debt and, subsequently, misappropriated trust assets are used to discharge
that debt.
Smith, in his book ‘Law of Tracing (1997)’ had given an illustration where a trustee buys a
car for RM 30,000 on credit, either by bank loan or overdraft facility or credit card, and use
the trust money to pay for the car. Here, there is a debt and the value of the car is traced
before the trustee pays off the car. He opines that the period of credit shall not change how
the property is traced. The money is therefore traceable proceeds of the debt; but since the
debt was the proceeds of the car, the money can be said to be the proceeds of the car, via an
intermediate step.
JE Penner held that backwards tracing is not recognised in UK because the law had not
logically accepted the compelling position in courts due to confusion arises in cases relating
to overdrawn bank accounts. Generally, in ‘series of debts view’, when there is no debt, there
shall be no right of tracing. However, he held that the tracing exercise shall not end
prematurely. He emphasized that one must think how the overdrawn facility come about. If it
is able to distinguished the money that use to pay the overdraft, then the object of the
overdraft shall be the trust property.
Law Society v Haider [2003] EWHC 2486 (Ch)

● Judge Richards QC allowed the claimant to trace from a payment discharging a

mortgage into the house which is purchased by a mortgage loan, and then proceed to
the sale of that house, and use that proceed to purchase another house.
● Here, the court had allowed the claimant to trace the property for three times.

Bishopgate Investment Management Ltd (in liquidation) v Homan [1995] Ch 211

● During the Court of Appeal, Dillon LJ held there was no particular asset into which
property could be traced, if an account were overdrawn. He further agreed with
Vinelott J that there might be backwards tracing.
● However, Leggatt LJ held that backwards tracing is impossible as ‘there can
ordinarily be no tracing into an asset which is already in the hands of the defaulting
trustee when misappropriation occurs’ because that asset ‘existed and so had been
acquired before the money was received and therefore without its aid’.
● For Henry J, he concurred with everyone. He neither agree nor disagree with anyone
of them.
Ralfo Ltd v Varsani [2014] EWCA Civ 360
 ● The Court of Appeal had implicitly applied backwards tracing. However, the Privy
Council’s approval is only persuasive to UK Courts and thus, the position of
backwards tracing is not really clear.
The Federal Republic of Bank of Brazil v Durant [2015] UKPC 35 (follow this enough)

● The Privy Council had allowed the law of tracing to include backwards tracing, but
only in some well-defined situations. In determining such situations, Lord Toulson
had proposed a test based on ‘coordination between the depletion of the trust fund and
the acquisition of the asset which is the subject of the tracing claim’.
The Fish Man limited (In Liquidation) v Hadfield [2016] NZHC 1750

● The New Zealand High Court recognised the concept of backwards tracing by
referring to Durant’s case.

Tracing Among Innocents/ 2 Trusts

Innocent: mindset very relevant
Volunteer: No consideration
2 trusts: mixed 2 trust assets
*Not relevant to a third-party recipient who knowingly assisted/ received trust property, as he
will be deemed as a trustee (wrongdoer).

GR: 1 ST in, 1st out rule (Clayton’s Case Rule)

Barlow Clowes International Ltd (In Liquidation) v Vaughn

● The court had described the application of Clayton’s Case Rule towards innocent as
capricious, arbitrary and inappropriate.
● Instead of overruling Clayton’s Case, Dillon LJ had come out with four ways to
avoid using FIFO.

1) Running bank accounts

Running bank accounts is not the same with saving/ deposit account. For a running bank
accounts, there must be a constant in and out (deposits and withdrawal). As such, FIFO is
avoided in cases not involving running bank accounts.
Example: Current account.
Re Goldcorp Exchange Ltd [1995] 1 AC 74
 ● The court held that the subject matter is uncertain. Therefore, the subject matter
cannot be traced.
Sinclair v Brougham

● The depositors wanted to recover sum which were deposited to a building society but
the contract of deposit entered into by them were ultra vires the building society.
Here, the court held that the depositors were not entitled to recover such sum due to
the ultra vires contract. This means that the money cannot be traced due to ultra vires
contract.
Re Diplock

● There was money being wrongly paid to various charities and the beneficiary claimed
for the repayment of money. The Court of Appeal held that for mixed funds not which
was not held in current accounts, the claimants held a proportionate share. For funds
held in current accounts, the first in first out rule was applicable.

2) Impossible/impracticable
FIFO will not apply in cases which it does not make sense to apply it.
Re Eastern Capital Futures Ltd [1989] BCLC 371

● Morritt J concluded that the rule in Clayton's Case was inapplicable since it was
impossible to presume any intention on the clients’ part that their payments into or
payments out of the account which was kept by the company on their behalf should
be, vis-à-vis other clients, treated on a first in and first out basis.
Barlow Clowes International Ltd (In Liquidation) v Vaughn

● The court held that the application of FIFP is impractical or would result in injustice
between the investors, because a relatively small number of investors would get most
of the funds, or would be contrary to the intention, express or implied, of the
investors. Also, FIFA also inapplicable when there is a preferable alternative method
of distribution.

3) Contra-indication
The court will look at the surrounding circumstances and evidence to determine whether
FIFO can be applied.
Barlow Clowes International Ltd (In Liquidation) v Vaughn
 ● The court held that FIFO is inapplicable because if applied, it would be inconsistent
with the presumed intention of the investors to distribute what remained from their
common misfortune.

4) Result in injustice
Barlow Clowes International Ltd (In Liquidation) v Vaughn

● The court held that the application of FIFP is impractical or would result in injustice
between the investors, because a relatively small number of investors would get most
of the funds to the exclusion or others, or would be contrary to the intention, express
or implied, of the investors. Furthermore, if applied FIFO, it would be inconsistent
with the presumed intention of the investors to distribute what remained from their
common misfortune.

Pari Passu/ Proportionate Shares Solution

Pari Passu literary means “with an equal step” or “on equal footing” or “share and share
alike”. There might be situation where the innocent may not get the claim due to FIFO.
Hence, Pari Passu is used to solve this kind of situation by dividing the claim proportionately.
By applying the principle Pari Passu, the court will identify the proportion to which each
individual had contributed towards the total value of value claimed. Then, the available assets
will be distributed according to the proportion contributed by the individual. If later got
others add money, then proportion will be calculated based on the initial contribution.
For example, in a Ponzi scheme, A had contributed RM 50 and B had contributed RM 100.
Here, A had contributed 1/3 and B had contributed 2/3 to the scheme. Later, the fraudster had
withdrawn RM 90. By applying FIFO, there might be unfair and uncertain situations.
However, by applying the principle of pari passu, the remaining RM 60 will be distributed
based on their proportion. As a result, A can claim back RM 20 while B can claim back RM
40. Meanwhile, C had contributed RM 100 to the remaining funds and there will be RM 160
in the scheme. Here, the proportion will be calculated based on the initial amount which A
and B contributed (RM 150). Therefore, the total amount will be RM 250 and the new
proportion will be A (1/5), B (2/5) and C (2/5). If the fraudster takes another RM 80 from the
RM 160, the remaining of RM 80 will be calculated based on the new proportion. As such, A
will entitle to RM 16, B and C will entitle RM 32 respectively. (Rolling Charge Solution/
North American Solution different, it calculates again every time specifically)
Barlow Clowes International Ltd (In Liquidation) v Vaughn

● The court held that under pari passu solution, it involves the establishment of the total
quantum of the assets available and sharing them on a proportionate basis among all
the investors who could be said to have contributed to the acquisition of those assets,
ignoring the dates on which they made their investment.
Rolling Charge Solution/ North American Solution
Rolling Charge Solution/ North American Solution is a much more sophisticated method and
more complex as compared to pari passu solution. By using this solution, the amount will be
recalculated every time when there is add in or take out of money.
However, this method requires a very details records of the transaction
For example, in a Ponzi scheme, A had contributed RM 50 during March and A owns the
scheme entirely. During April, B contributed RM 100. Now, A had contributed 1/3 and B had
contributed 2/3 of the money. The fraudster had withdrawn RM 90 during May. Here, A can
claim back RM 20 while B can claim back RM 40 according to their respective proportion.
During June, C adds in RM 100. When C adds in money, the total in the scheme will become
RM 160. By using pari passu solution, the proportion will be calculated based on the initial
amount which A and B contributed (RM 150) together with the RM 100 by C. However, in
North American Solution, the amount in June will be recalculated. A who has the remaining
RM 20 will own 1/8 towards the RM 160; B who has the remaining RM 40 will own 1/4
(2/8) towards the RM 160; and C who contributed RM 100 will has 5/8 towards the RM 160.
Therefore, if the fraudster had taken RM 80, A can claim back RM 10, B can claim back RM
20, and C can claim back RM 50.
Re Ontario Securities Commission & Greymac Credit Corporation (1986) 17 OAC 88

● The court held that “rolling charge” or “North American” method goes on the basis
that where funds of several depositors, or sources, have been blended in one account,
each debit to the account, unless unequivocally attributable to the moneys of one
depositor or source, should be attributed to all the depositors so as to reduce all their
deposits pro rata, instead of being attributed to the earliest deposits in point of time.
Barlow Clowes International Ltd (In Liquidation) v Vaughn

● The court held that under “North American” method, it treats credits to a bank
account made at different times and from different sources as a blend or cocktail with
the result that when a withdrawal is made from the account it is treated as a
withdrawal in the same proportions as the different interests in the account (here of
the investors) bear to each other at the moment before the withdrawal is made.

Remedies
1) Equitable Charge
This remedy will entitle the claimant to seize property and seek a court order to sell the
property if the defendant does not pay the claimant.
The benefit of claiming equitable charge is that it grants property rights that will be
enforceable in cases of insolvency. However, the claimant who seek for equitable charge can
only seek for the amount due and not more. For example, the claimant cannot claim for any
profit from the property. It should also be noted that the claimant will not have absolute title
over the seized property.

2) A Lien
Under lien, the claimant is entitled to take possession of the property until the defendant pay
back what the defendant owned. However, the claimant cannot take property which will
affect the livelihood of the defendant.

3) Constructive Trust
Constructive trust is usually used in the situation where the asset is very intrinsic valuable.
Constructive trust enables the claimant to have the proprietary interest to the trace asset.
As differ from an equitable charge, under constructive trust, any interest arising out from the
property can be claimed by the claimant. For example, profits and increase in value.
Important thing to take note is that under constructive trust, the certainty of subject matter is
vital. This is because if the asset cannot be determined, the claimant cannot claim for the
property as he has no beneficial interest.

4) Subrogation
Subrogation is the opposite of backwards tracing. It allows the claimant to stand in the shoe
of other. Subrogation is the acquisition of another person’s rights against a third party upon
the making of a payment.
In an insurance context, if I am insured against injuries caused by the negligence of others,
my insurance company, upon paying me an insurance award compensating me for my loss, is
entitled to sue the tortfeasor, i.e., the negligent injurer, in my name for damages. Thus
acquiring my right to sue, the insurance company is said to be 'subrogated' to my claim
against the tortfeasor.
In the context of relationship between debtor and creditor, X pays off Y's debt to Z. By
paying off Y's debt, X extinguishes the debt and thus Z's right as a creditor. The right against
Y that X acquires by subrogation is a new right that arises by operation of law; in essence Y's
debt is revived in favour of X and, in consequence, this is known as a case of ‘reviving’
subrogation.
Subrogation is inconsistent with backwards tracing. In backwards tracing, one trace into
items purchased with the borrowed funds. In contrast, a subrogation claim allows the
claimant to stand in the shoe of lender.
Boscawen v Bajwa
 ● In this case, Bajwa wanted to sell his mortgaged land to discharged the mortgage
owned to Halifax. The purchaser then obtained a mortgage loan from Abbey National.
The money was being transferred to solicitor before the sale was completed. As a
result, Bajwa ended up with unmortgaged property, while Abbey National had the
advanced funds and received no mortgage on the property in return.
● The court held that Abbey National was entitled to be subrogated to Halifax’s
mortgage on the land, and thus entitling them to have priority over charge on the land.
Primlake Ltd (in Liquidation) v Matthews Associates

● Lawrence Collins J held that a company was entitled to be subrogated to a mortgage

loan owned by a dishonest de facto company director and his innocent wife following
its discharge by the latter using misappropriated company funds.

Limits to Tracing/ Right to Tracing is Lost

1) Bona Fide purchaser
If a bona fide purchaser for value gets the title of the property, then the claimant’s right to
tracing has been extinguished.
Credit Agricole and Investment Bank v Papadimimtriou [2015] UKPC 13

● The court held that the Bank will be regarded as a bona fide purchaser if it does not
have the notice of the proceeds of sale. Since the bank had failed to considered the
commercial purpose of the scheme before entering into the transaction, the bank is not
a bona fide purchaser for value.

2) Property Dissipated/ Not Identifiable

The right of tracing will be lost upon the disappearance of property. For example, the
property is dissipated, consumed of destroyed. The reason is that tracing is to trace the net
asset and if the asset cannot be ascertained, then tracing cannot be done.
Borden (UK) v Scottish Timber Products [1981] Ch 25

● The court held that since the resin had lost its identity in the manufacturing process,
the chipboard being a wholly new product, it could not be traced into the chipboard.

3) Change of position
If it will be inequitable, unfair, or unjust to allow tracing, the right to tracing will be lost.
Kleinwort Benson v Birmingham CC [1997] QB 380

● The court rejected the passing on defence since the claim is of unjust enrichment.

Lipkin Gorman v Karpnale Ltd

● The court held that the defence of inequitable to allow tracing will only be available
to innocent wrongdoer who does not guilty.

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