Constructive trusts and constructive trustees

Two meanings of the word ‘constructive’

In English law, the word ‘constructive’ can mean one of two things. (For further exploration of this point, see Lionel Smith, ‘Constructive trusts and constructive trustees’ (1999) 58 Cambridge Law Journal 294.)

(1) ‘Imposed’ rather than ‘assumed’. The word ‘constructive’ is used in this way to indicate that something has been imposed by the law, rather than being deliberately created by someone. So we might (though we don’t) talk of someone having a ‘constructive obligation’ if they have an obligation that was imposed on them by the law rather than deliberately assumed by them through entering into a contract.

(2) ‘Fictional’ rather than ‘real’. The word ‘constructive’ is used in this way to indicate that we are going to act as though X is true, even though we all know that X is not true. So, for example, there is a story told by Peter Birks in his Introduction to the Law of Restitution (1989) about an Oxford college: ‘The college’s rules forbid the keeping of dogs. The Dean keeps a dog. Reflecting on the action to be taken, the governing body of the college decides that the labrador is a cat and moves on to next business.’ As Peter Birks observes, ‘That dog is a constructive cat.’ Obviously, everyone knows that the Dean’s labrador is not a cat, but the college has decided, for the sake of its rules, to act as though the labrador is a cat.

Let’s call something that is constructive in sense (1), ‘real, and imposed by law’; and something that is constructive in sense (2), ‘fictional’.

Constructive trusts

Are constructive trusts imposed, or fictional? To answer this question, let’s look at various different situations in which a constructive trust will arise.

(1) Specifically enforceable contract

If A enters into a contract to sell land to B, then he will hold that land on a constructive trust for B. Is that trust imposed, or fictional? It looks real enough: if A goes bankrupt after having entered into a contract to sell Blackacre to B, B will be entitled to say to A’s creditors: ‘Blackacre is held on trust for me, and so can’t be used to help pay off the debts A owed you.’

However, Bill Swadling (in ‘The fiction of the constructive trust’ (2011) Current Legal Problems 1) argues that the constructive trust over Blackacre that arises out of A’s contracting to sell it to B is (like all other constructive trusts, in his view) fictional. When we say that A holds Blackacre on trust for B, we don’t really mean that A holds on a real trust for B; all we mean is that A is liable to be ordered to convey his rights in Blackacre to B. However, this argument does not seem to work. It’s true that the only reason why A is held to hold on trust for B is that his contract to sell Blackacre to B is specifically enforceable, and A is therefore liable to be ordered to hand over Blackacre (or, more technically, the rights he has over Blackacre) to B. However, this shows that Swadling’s thesis does not work in this context. The trust arises out of the fact that A is liable to be ordered to hand over Blackacre to B; A’s liability to be ordered to hand over Blackacre to B does not arise out of the fact that are willing to say that A holds on trust for B. A would still be liable to be ordered to hand over Blackacre whether or not we said that he held Blackacre on trust for B.

(2) The stolen bag of coins

In Westdeutsche Landesbank v Islington LBC (1996), Lord Browne-Wilkinson considered the situation where a thief steals a bag of coins. If the coins are mixed with other identical coins and then withdrawals are made from the mixture, the legal owner of the coins will be unable – under the common law rules on tracing – to find out where his coins have gone, and who has got them. The rules on tracing used by the Courts of Equity to find out where trust money has gone were more flexible and allowed the beneficial owner of the money to trace his money even when the money was mixed with other money and withdrawals were made from the mixture. But those rules could only be taken advantage where the money was held on trust. Lord Browne-Wilkinson held that the legal owner of the bag of stolen coins could take advantage of the equitable tracing rules to find out where his money had gone: ‘stolen monies are traceable in equity’. The reason why is that he held that once the money was stolen it would be held on a constructive trust for the legal owner.

This constructive trust looks fictional. The reason why was identified by Rimer J in Shalson v Russo (2005) at [110]: ‘a thief ordinarily acquires no property in what he steals… If the thief has no title in the property, I cannot see how he can become a trustee of it for the true owner: the owner retains the legal and beneficial title.’ So if a constructive trust does arisen when a thief steals a bag of coins, that trust can’t be a real trust as the thief doesn’t have anything that he can hold on trust for the owner. We must be just saying that he holds the bag of coins on trust for its owner in order to allow the owner to take advantage of the equitable tracing rules to find out where his coins have gone when they have been mixed. But even if we accept that the constructive trust that arises when a thief steals a bag of coins is fictional, not real – and is intended to allow the owner of the coins to overcome the procedural limits on who can take advantage of the equitable tracing rules – Rimer J was still unhappy in Shalson v Russo at finding that the thief holds the bag of coins on trust for its owner:

‘The fact that, traditionally, equity can only trace into a mixed bank account [if the money being traced is trust money] provides an unsatisfactory justification for any conclusion that the stolen money must necessarily be trust money so as to enable [it to be traced]. It is either trust money or it is not. If it is not, it is not legitimate artificially to change its character so as to bring it within the supposed limits of equity’s powers to trace: the answer is to develop those powers so as to meet the special problems raised by stolen money.’

However, Rimer J’s unwillingness to find that stolen money is held on a fictional trust for its owner is hard to reconcile with his later willingness in the same case to find that money will be held on constructive trust in the situation where:

(3) Money is paid under a contract that is later rescinded for fraudulent misrepresentation

If A and B enter into a contract as a result of A’s having made various misrepresentations to B, then B will be entitled to rescind that contract – to make it null and void, as though it had never existed. Until B rescinds the contract, it will be perfectly valid. So if B pays money to A under the contract, A will acquire title to that money. But his title will be voidable: if B rescinds the contract before the money passes into the hands of a bona fide purchaser, legal title to the money will revest in B. In Shalson v Russo, Rimer J agreed (at [122]-[127]) that if B rescinds the contract, and A’s misrepresentations were fraudulent, then A will hold any money that B has paid him under the contract (and which is still in A’s hands) on a constructive trust for B. This constructive trust also looks fictional. Once the contract is rescinded, legal title to the money that A has paid to B will revest in B, so there is nothing A can hold on trust for B if the trust is supposed to really exist. It must be that in this case we are just saying that A holds on trust for B in order to allow B to take advantage of the equitable tracing rules to find out where in A’s holdings his money is now. Etherton J confirmed in London Allied Holdings Ltd v Lee (2007) (at [276]-[280]) that money paid under a contract induced by fraud that was later rescinded would be held on a constructive trust for the payor. But if we are willing to find a fictional trust in such a case, it is hard to understand why we wouldn’t in Lord Browne-Wilkinson’s stolen bag of coins case.

(4) Unconscionable receipt/retention of money paid under a mistake

Where A pays money to B by mistake, unless the mistake is sufficiently fundamental, B will acquire title to the money that A has paid over to B. So in such a case it is possible for B to hold that money for A on a real trust. But will B ever hold that money on trust for A, and if so, under what circumstances? The answer to this question is still very unclear.

In Chase Manhattan v Israel-British Bank (1981) (where money was mistakenly paid over twice by one bank to another), Goulding J found that money that had been paid over by mistake was held on trust for the payor, thereby allowing the payor to trace and recover that money even though the payee was by then insolvent.  In Westdeutsche Landesbank v Islington LBC (1996), Lord Browne-Wilkinson said two things:

(1) That the only way Chase Manhattan could have been correct is if we suppose (as was actually established in the case) that when the payee bank received the money that was mistakenly paid over to it, it was aware at the time it received the money, or shortly afterwards, that the money had been paid over by mistake: ‘Although the mere receipt of monies, in ignorance of the mistake, gives rise to no trust, the retention of the moneys after the recipient bank learned of the mistake may well have given rise to a constructive trust.’ (Note the ‘may’ in that sentence.)

(2) That if the courts are going to find that people who have been paid money by mistake hold it on trust for the people from whom they received that money, then they should do it via a remedial constructive trust, so that if A has paid money to B by mistake, then A has to go to court and ask the court to create and impose a trust over the money paid to B, thereby enabling him to get it back from B. Such a remedial constructive trust, Lord Browne-Wilkinson thought, would only be available ‘where a defendant knowingly retains property of which the plaintiff has been unjustly deprived’ and in deciding whether or not to create and impose a trust over the property, the courts would tailor the trust ‘to the circumstances of the individual case, [so that] innocent third parties would not be prejudiced and restitutionary defences, such as change of position, [would be] given effect.’

Since Westdeutsche Landesbank was decided, the courts have rejected suggestion (2), holding that they have no jurisdiction to create and impose a trust over property, as opposed to recognising that property is already held on trust (either under an express trust, or what is known as an institutional constructive trust): see Re Polly Peck International (No 2) (1998). That leaves suggestion (1). If A pays money to B under a mistake, and while the money is still in B’s hands, B becomes aware that the money was paid under a mistake, will B hold that money on a constructive trust for A?

This question has divided the courts since Westdeutsche Landesbank was decided. Box v Barclays Bank (1998, Ferris J) and Shalson v Russo (2005, Rimer J at [118]) say ‘no’. On the other side, in Re Farepak (2006), Mann J – after hastily reviewing the authorities (the case was decided under severe time pressure) – ruled (at [40]) that:

‘If and in so far as it could be established that moneys were paid to Farepak by customers at a time when Farepak had decided that it had ceased trading, and indeed at a time when it had indicated that payments should not be received, then there is a strong argument for saying that those moneys would be held by the company as constructive trustee from the moment they were received.’

The reference to the company holding the money as ‘constructive trustee’ is unfortunate (as we will see, we shouldn’t equate the concepts of holding money on a constructive trust for someone with being a constructive trustee) but there is no doubt that Mann J meant here that the moneys were held on a constructive trust, and that that constructive trust was a real trust, giving the customers who had paid over money after the company had decided to cease trading a proprietary interest in that money which allowed them to recover that money in priority to the company’s huge number of unsecured creditors.

In the subsequent case of London Allied Holdings Ltd v Lee (2007), Etherton J noted (at [272]) that there had not been a chance for proper argument in Re Farepak over whether money paid by mistake to someone who was aware (at the time or subsequently) of the mistake should be held on constructive trust for the payor, and he declined to express an opinion on the issue.

For what is worth, the Australian courts have been more enthusiastic about finding that a constructive trust arises in this kind of case. So, for example, in Wambo Coal Pty Ltd v Ariff (2007), the New South Wales Court of Appeal held that monies that had been paid by the plaintiff to the defendant in the mistaken belief that the plaintiff owed the defendant money were held on trust by the defendant for the plaintiff when the defendant became aware (or would have become aware had the defendant not refused to inquire whether the money was really owed for fear of finding out that it was not) that they had been paid by mistake. White J held at [43] that ‘once the recipient is aware that, by a mistake, he has got something for nothing, a proprietary remedy is appropriate.  The fact that the company is insolvent does not affect this conclusion.  It would be an unwarranted windfall for the company’s creditors to share in the payment…’ The fact that the trust found in this case allowed the plaintiff company to recover the money they had paid in priority to the defendant’s other creditors shows that the trust in Wambo was real, not fictional.

(5) Reliance on an assurance of having an interest in land

It is well-established that if A, who owns Blackacre, assures B that he holds Blackacre on trust for her in some proportion, and B relies on that express assurance, then B will be able to argue that A holds some proportion of Blackacre on trust for her. That trust is a real trust: it is capable of binding third party purchasers of Blackacre, and allows B priority in the event that A goes bankrupt. That trust is also conventionally classified as ‘constructive’: as arising not because anyone intended that it should arise, because the law seeks to protect B’s reliance on A’s assurance by giving her an interest in Blackacre. However, Bill Swadling has interestingly argued that this trust is not constructive at all. Rather, it is express. It arises to give effect to the declaration of trust that A made when he assured B that he held Blackacre on trust for her. The fact that A’s declaration of trust might have been made orally is not a problem. While s 53(1)(b) of the Law of Property Act 1925 says that declarations of trust over land must be evidenced in writing if they are to be admissible in court, a defendant will not be allowed to rely on his provision to prevent the claimant entering into court evidence of an oral declaration of trust if doing so would allow the defendant to defraud the claimant in some way. Swadling’s argument is, on the whole, convincing though one slight weakness in it is that a claimant who has relied on assurances that land is held on trust for her may end up, depending on the extent of her reliance, getting less of an interest in the land than she was told she had. See, for example, Eves v Eves (1975), where the claimant moved in with her boyfriend and he told her the house he owned was as much hers as his; but the Court of Appeal ended up holding that the boyfriend only held one quarter of the house on trust for her.

Constructive trustees

Let’s now look at the situations in which the law will hold someone liable as a ‘constructive trustee’ and try to make sense of what the courts mean when they use that phrase.

We can begin by making it clear that we should not equate holding property on a constructive trust for someone else with being a constructive trustee. The two concepts are entirely distinct. The question of what the duties are of someone who does hold property on a constructive trust for someone – assuming that by ‘constructive’ we mean ‘real, and imposed by law’ and not ‘fictional’ –  is a very difficult one. For example, if A contracts to sell his house to B, it is clear that he does not owe B all of the duties that a trustee would normally owe his beneficiary (such as a duty carefully to invest it, or a duty not to make a gain for himself from the way he manages the trust property): see Englewood Properties Ltd v Patel (2005). Saying that someone who holds property on a constructive trust for someone else is a constructive trustee will just obscure that point.

There are two basic situations where someone will be held liable as a ‘constructive trustee’:

(1) Dishonest assistance

If A dishonestly assists B to commit a breach of trust, A will be held liable for the losses arising from the breach of that trust as a ‘constructive trustee’. It is clear that the word ‘constructive’ is being used here in its fictional sense. A is not being held liable because he really was a trustee, who has committed a breach of trust. He is being held liable as though he were a trustee of the trust of which B was a trustee, and is accordingly held liable for the losses suffered by the trust as a result of B’s breach of trust. It is for this reason that Lord Millett said in Dubai Aluminium Ltd v Salaam (2003) (at [141]-[142]) that someone who is held liable for dishonestly assisting a breach of trust:

‘is traditionally (and…unfortunately) described as a “constructive trustee” and is said to be “liable to account as a constructive trustee”. But he is not in fact a trustee at all, even though he may be liable to account as if he were. He never claims to assume the position of trustee on behalf of others, and he may be liable without ever receiving or handling the trust property… I think that we should now discard the words “accountable as constructive trustee” in this context and substitute the words “accountable in equity”.’

(2) Unconscionable/knowing receipt of trust property disposed of in breach of trust

While Lord Millett’s words undoubtedly apply to the first case – of dishonest assistance – where someone will be held liable ‘as a constructive trustee’ there is no doubt that he also meant his words also to apply to the situation where A receives £1,000 in trust funds that have been given to him in breach of trust, and A acts unconscionably in accepting those funds or retaining them while they are still in his hands. This is the second situation – that of  ‘unconscionable receipt’ (previously known as ‘knowing receipt’) – where someone will be held liable as a ‘constructive trustee’.

To sharpen up our consideration of this situation, let’s make it more concrete. C holds £100,000 on trust for B. C then gives his girlfriend, A, £1,000 out of those trust funds as a birthday present. A has no idea that the money she is receiving is held on trust, and subsequently spends £250 of that £1,000 on dinner with her best friend in a quality restaurant. At that point, she learns that the money she received was held on trust for B. She doesn’t care: she goes on to spend the rest of the money on a luxury spa weekend at a hotel. In this situation, A will be held liable for £750 as a ‘constructive trustee’ on the basis that she was in ‘unconscionable’ or ‘knowing’ receipt of trust funds disposed of in breach of trust.

Now – Lord Millett and many other commentators would argue that A is not being held liable because she is really a trustee. Instead, they see liability for ‘unconscionable’ or ‘knowing’ receipt as being a bastard cousin of liability in unjust enrichment. The idea is that when A receives the £1,000 that was held on trust for B, she is unjustly enriched at B’s expense. As such, she should be held strictly liable to hand over the value of that money to B, though if she innocently dissipates some or all of the value represented by that money she will be entitled to a defence of change of position that will cut down her liability to the value that remained in her hands at the time she was no longer innocently in receipt of that value. Equity reaches the same result, but by a different route. Instead of making A strictly liable for the value of B’s money, subject to a defence of change of position, A is not held liable at all until she becomes aware that the money in her hands is B’s money, at which point she is held liable for the value of the remaining money in her hands.

One problem with this explanation of liability for unconscionable/knowing receipt is this: How can we say that A is unjustly enriched simply because she has got B’s money in her hands? We don’t say that someone who holds money on trust for someone else is enriched as a result – in fact being a trustee can be a real downer. And we don’t say that a thief who has stolen a bag of coins is enriched as a result, because he is liable to have those coins taken away if he is tracked down by the owner. So why should we say that a recipient of trust funds is enriched?

A more satisfying explanation of A’s liability for unconscionable/knowing receipt is suggested by Charles Mitchell and Stephen Watterson in their paper ‘Remedies for knowing receipt’ (in Mitchell (ed), Constructive and Resulting Trusts (2010)). (See also Peter Jaffey’s earlier paper, ‘The nature of knowing receipt’ (2001) 3 Trusts Law International 151.) They argue that when A is held liable as a ‘constructive trustee’, A is held liable because: (1) she really was a trustee of the £1,000 that she received from C; (2) after she had spent £250 of that £1,000, she knew enough about where the trust funds remaining in her hands to make it fair for the law to impose on her all the duties of a normal trustee, including a duty to preserve the trust funds in her hands; (3) she breached that duty when she spent the remaining £750 on a spa weekend; therefore (4) she is held liable for the loss suffered by B as a result of A’s breach of duty  – that is, £750.

Seen in this way, liability for unconscionable/knowing receipt is not restitutionary at all, but compensatory. And someone who is held liable for unconscionable/knowing receipt is not held liable as though they were a trustee, but is held liable because they really were a trustee (albeit a trustee who has had all the duties of a normal trustee imposed on them, rather than having agreed to assume those duties).

But does the argument stand up? None of the steps in the argument seem to be flawed. On (1), A was obviously held the £1,000 that C gave her on trust for B, because she was not a bona fide purchaser of that money. But at the time she received the money, it would have been unfair to impose on her all the duties of someone who has agreed to be a trustee as those duties are very onerous. That changed when, after she spent £250 of the money she received from C, she discovered that that money was held on trust for B. At that point, she had a choice. She could have given the money back to B. But instead she chose to retain it. As a result, she became what is known as a trustee de son tort (or what Lord Millett in Dubai Aluminium Co Ltd v Salaam (2003) would prefer to call (at [138] a ‘de facto’ trustee ) and was, in Lord Millett’s words, ‘treated in every respect as if [she] had been duly appointed.’ So (2) is made out. Once (2) is made out, steps (3) and (4) in the argument inevitably follow.

Against this, Bill Swadling sniffs (in his essay on ‘The fiction of the constructive trust’ at n 79) that: ‘there is little in the way of authority cited for [Mitchell and Watterson’s argument], just a few Australian cases and unchallenged assumptions in some English cases. No case is cited in which the point was argued and decided in favour of their view.’ This does not seem to be a very strong objection to Mitchell and Watterson’s view: legal argument would not progress very far or very fast if a lack of express authority in favour of an argument counted against its being accepted.

Conclusion

Our survey of the law on constructive trusts and constructive trustees indicates that not all constructive trusts are the same, and not all liabilities to account as a constructive trustee are the same. Some constructive trusts are real and imposed by the law. But others don’t really exist – we just say that property is held on a constructive trust to allow the owner of that property to take advantage of the equitable tracing rules. Someone who dishonestly assists someone else to commit a breach of trust is not really a trustee, but is held liable as though he were. Someone who is held liable for being in unconscionable or knowing receipt of trust assets is held liable because she really was a trustee, and her state of knowledge meant that the law imposed on her all the duties of a trustee, including a duty to preserve the trust assets in her hands.

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