Tracing 

Tracing is not a remedy. It is the process of identification that makes a proprietary claim possible when the original property is gone. Getting this straight resolves most of the confusion in the area.

• Following — identifying the same asset as it moves from hand to hand.
• Tracing — identifying a new asset as the substitute for the original, through exchanges.
• Claiming — asserting a right against the asset so identified, whether by constructive trust, an equitable charge or lien, or subrogation.

The first two are evidential exercises. Only the third asserts a right, and the defences operate against it.

Common law and equitable tracing

At common law an asset can be followed and traced through clean substitutions, but the process fails at a mixture: money paid into an account with other money cannot be identified at law. That limitation is why equity's rules matter.

In equity tracing continues through mixtures. It has traditionally required an initial fiduciary relationship — a requirement widely criticised as a historical accident, since it does no work in the analysis, and one the courts have been ready to satisfy on slender material. Treat it as a requirement to be addressed, not defended, and note that its necessity is contested.

Equity also traces into the hands of third parties, subject to the defences below.

Mixed funds

Trustee's own money mixed with trust money. The wrongdoer bears the consequences of the mixture. The trustee is presumed to spend their own money first, and to have intended to preserve the trust fund. Where the mixed fund is used to buy an asset that rises in value, Foskett v McKeown [2001] 1 AC 102¹ confirms the beneficiary may elect: claim a proportionate share of the asset, capturing the increase, or claim an equitable charge over it for the amount taken, which is preferable where the asset has fallen in value. The election is the beneficiary's.

The lowest intermediate balance. A claim cannot exceed the lowest balance the account reached between the misappropriation and the claim. Money later paid in from an unrelated source does not replenish the trust fund unless the trustee intended it to, because it is not the traceable proceeds of anything.

Two innocent claimants' funds mixed together. Neither is a wrongdoer, so neither presumption applies. For an active current account the first-in-first-out rule has historically been applied, but it is widely regarded as arbitrary, and Australian courts have been willing to depart from it where it would produce an unjust or impracticable result, preferring rateable sharing in proportion to contributions, or a rolling proportionate approach. State the default and the readiness to depart from it.

Dissipation. Money spent on a holiday, a meal, or discharging an unsecured debt leaves no traceable substitute and the claim ends there — though payment of a secured debt may allow the claimant to be subrogated to the discharged security.

Backwards tracing — treating an asset acquired before the misappropriation as its substitute — is unsettled. It has been accepted in some jurisdictions where the transactions were part of a single coordinated scheme, and it should be argued as open rather than asserted as settled.

Claiming, and the defences

Once identification succeeds, the claimant chooses between a proprietary and a personal claim. Proprietary claims give priority on insolvency and capture increases in value, which is why they are worth the effort.

Defences:

• Bona fide purchaser of the legal estate for value without notice — an absolute answer to a proprietary claim, and the reason the character of each recipient must be examined.
• Change of position — a defence to personal restitutionary liability where an innocent recipient has irreversibly changed their position in reliance on the receipt. It is recognised in Australia, and it does not assist a wrongdoer.
• Innocent volunteer — a recipient who gave no value but acted innocently is not personally liable for what they no longer hold, though the property itself may still be traced.
• Delay and acquiescence.

Applying this in a problem question

1. Name the three steps and say which you are doing at each point.
2. Establish the fiduciary relationship for equitable tracing, and note the criticism.
3. Track the money account by account, applying the presumption against the wrongdoer and the lowest intermediate balance.
4. For funds of two innocents, state the default rule and argue for departure if it is unjust.
5. Elect between a proportionate share and a charge, and justify the election on the figures.
6. Test each recipient against the defences before concluding.

Where the authority sits

Case law, drawing on a long English line adopted and adapted in Australia, with Australian authority on departure from first-in-first-out and on change of position.