Published on 29/05/2007

Constructive Trusts

Definition

A constructive trust is imposed, regardless of any intention, by operation of law in circumstances where it would be unconscionable for the legal owner of the property to assert beneficial ownership

“Viewed in its modern context, the constructive trust can properly be described as a remedial institution which equity imposes regardless of actual or presumed agreement or intention (and subsequently protects) to preclude the retention or assertion of beneficial ownership of property to the extent that such retention or assertion would be contrary to equitable principle” – Deane J in Muschinski v Dodds (1985) 160 CLR 583 at 614

A constructive trust comes from the word “construe”, not “construct”

•    Although no formalities are required to create a constructive trust, there must exist specific trust property

•    A constructive trust may be regarded as either a substantive institution (a type of trust imposed by analogy with express, implied or resulting trusts) or a remedial device to effect restitution of property, remove unjust enrichment, enable property to be traced, or enforce the trustee’s equitable duty

Circumstances in which a person may be held to be a constructive trustee

•    The person acquired or retained property as a result of their own breach of a fiduciary duty (e.g. Keech v Sandford, Chan v Zacharia, Boardman v Phipps)
o    If someone is held to be a constructive trustee, they may have proprietary or personal obligations (e.g. they may have a personal obligation to account for profits)

•    “Knowing receipt” of trust property as a result of breach of trust or fiduciary duty by another
o    This is where you beneficially receive assets which have been transferred in breach of trust or fiduciary duty, with knowledge or notice of the breach

•    “Knowing assistance” in a breach of trust or fiduciary duty which deprives a beneficiary
o    This is where you help a trustee or fiduciary to commit a breach of trust or fiduciary duty, with knowledge that the trustee or fiduciary is committing a breach of duty
o    The assistant is said to be a constructive trustee, but is normally only personally liable to compensate the beneficiary of the trust or fiduciary duty for losses caused by the breach

•    Breakdown of a relationship or joint venture involving the co-ownership of property (e.g. Muschinski v Dodds)
•    Surplus in the hands of a mortgagee exercising a power of sale
•    Mutual wills and ‘secret’ trusts
•    The person is the vendor under a contract for land where the purchase price has been paid
•    Property has been acquired as a result of fraud or deliberate wrongdoing

(A)    Constructive Trusts Following Breach of Fiduciary Duty
Constructive trusts imposed on fiduciaries

•    Consider the remedies in:
o    Keech v Sandford (1726)
o    Boardman v Phipps (1967)
o    Chan v Zacharia (1984)

•    Hospital Products Ltd v Unites States Surgical Corporation (1984)

“A constructive trustee may be imposed as the appropriate form of equitable relief in circumstances where a person could not in good conscience retain for himself a benefit or the proceeds of a benefit, which he has appropriated to himself in breach of his contractual or other legal or equitable obligations” – Deane J (in dissent)

Constructive trusts imposed on third parties

•    Where a breach is committed, a beneficiary may be unable to sue the fiduciary (e.g. insolvent). Instead, the beneficiary may be able to sue a third party (‘constructive trustee’) implicated in the breach of duty

The Rule in Barnes v Addy

•    Barnes v Addy (1874) LR 9 Ch App 244
Facts:    Barnes (B) and Addy (A) were brothers in law. Two sisters had inherited property from a deceased father. B was married to one sister, and A was married to the other. They did not get along. Since A was a cousin of the family as well, he was trustee of the estate. B took exception to the fact that A was trustee for his wife’s estate. They came to a compromise where A said, “Fine, I don’t want to be trustee for your wife. You can be trustee for your wife and I’ll be trustee for my wife”. The solicitor acting for them said this was a very bad idea. The solicitor also wrote to B’s wife, advising her that it was a bad idea for her husband to act as the trustee of her estate. She returned a very icy response. Within twelve months of B becoming trustee of her estate, he took all of the money, put it into his own bank account and became bankrupt. Mrs B sued A and A’s solicitor for participating in a breach of trust. She argued that they knew this was a bad idea, but allowed the transaction to happen.

Held: Lord Selborne:    “Those who create a trust clothe the trustee with a legal power and control over the trust property, imposing on him a corresponding responsibility. That responsibility may no doubt be extended to others who are not properly trustees, if they are found either making themselves trustees de son tort, or actually participating in any fraudulent conduct of the trustee to the injury of the cestui que trust. But, on the other hand, strangers are not to be made constructive trustees merely because they act as agents of trustees in transactions within their legal powers, transaction, perhaps of which a Court of Equity may disapprove, unless those agents receive and become chargeable with some part of the trust property, or unless they assist with knowledge in a dishonest and fraudulent design on the part of the trustees.”

•    Hence, there are two limbs to the rule in Barnes v Addy
1)    A stranger receiving trust property with knowledge
2)    A stranger knowingly assisting a trustee in a fraudulent or dishonest design

1)    “Knowing receipt”

•    This is where a constructive trust is imposed on a third party to a fiduciary relationship, who has received trust property as a result of a breach of the fiduciary’s obligations, and with knowledge of the wrongful nature of the fiduciary’s conduct
•    The recipient of trust property is held to be a constructive trustee, if the recipient has knowledge, actual or constructive, of the breach of trust or duty.
•    Elements:
1.    Actual receipt (i.e. beneficial ownership)
2.    Trust property
3.    Requisite knowledge

•    The question then becomes: What constitutes knowledge?
•    Is it the same as the doctrine of “constructive notice” in real estate law?

•    Nelson v Larholt [1948] 1 KB 339
Facts:    A “turf accountant” (bookmaker) cashed some cheques for betting arrangements. He saw that the cheques were drawn on a trust account (and this is unusual). He made some enquiries and was told that this was fine because the trust owed him some money.

Held:    The court held that he was liable as a constructive trustee. He was on notice that the person giving him these cheques was giving him money that was held on trust.

He was put to an objective standard of knowledge. An honest and reasonable person would have been put on enquiry and would not have been fobbed off by unconvincing excuses.

•    Re Montague’s Settlement Trust [1987] Ch 264
Facts:    Here, the 9th duke died and the 10th duke received property. He was told by the trustee that certain chattels were his. These chattels were released from the estate, and he gave them to his wife to sell. The 10th duke then died, and the 11th duke sued the widow of the 10th duke for knowing receipt of trust property in breach of trust. He argued that she should be held liable as a constructive trustee (to personally replenish the trust fund to compensate the beneficiary for the loss of trust property).

Held:    The tenth Duke was not a constructive trustee of chattels wrongfully released to him from the estate and which had now passed to others – it was “an honest muddle”. There is a distinction between a right to trace property, and holding someone liable as a constructive trustee – “Tracing is primarily a means of determining the rights of property, whereas the imposition of a constructive trust creates personal obligations that go beyond mere property rights” – Sir Robert Megarry VC at 272

Continued on page 2

continued

•    BCCI v Akindele [2001] Ch 437
Facts:    BCCI was a famous bank that operated around the world in tax havens and collapsed under corruption. Before BCCI fell apart, and before it was known that it was corrupt, a particular Nigerian businessman entered into a transaction with the Cayman Islands operation of the bank. As far as he was concerned, he would lend the bank 10 million pounds, and after two years, the bank would pay him back the money plus 10% interest. This was an extraordinarily good deal. Two years later, Akindele redeemed the loan and got back some 16 million pounds. The trouble was, it came to light that the bank was corrupt and it went into liquidation. Liquidators decided to investigate this deal to see where they could get some money from. The documentation of the deal demonstrated that this was an overall scam. The argument made against Akindele was that he signed these documents and knew the nature of what the bank was trying to do (committing a fraud against the regulators and other borrowers). Hence, it was argued that he had knowledge of a breach of fiduciary duty by these bank directors.

Held:    He was not held liable as a knowing recipient.

Although he knew the facts and knew the structure of the transaction, it was legitimate for him to adopt the views he held. He had no reason to assume that the people acting with him were not authorised to act for the bank. He did not have to make further enquiries (under the indoor management rule) as to whether the directors were breaching their fiduciary duties.

The test for liability proposed by the English Court of Appeal is that the recipient must have a “state of knowledge such as to make it unconscionable for him to retain the benefit of the receipt.”

Hence, simply knowing the facts, which if inquired into, would put you on notice of fraud or reveal breach of fiduciary duty, is not enough. You actually need to have a state of knowledge of your own, such as to make it unconscionable to retain the benefit of the receipt.

Hence, the view in Nelson is no longer the correct view. The view in Nelson is a stricter test than the view in BCCI.

2)    “Knowing assistance” (“accessory” or “dealing” cases)

•    This is where a constructive trust is imposed on a third party to a fiduciary relationship, who has assisted a fiduciary in a dishonest design, and with knowledge of the wrongful nature of the conduct
•    A person dealing with trust property or assisting in a breach of trust will become a constructive trustee if they do so “dishonestly”. Note that the duties of constructive trustee include personal obligations to account (even where the trust property itself has passed beyond that person’s hands)
•    These are situations where trust property has been dissipated, and we are looking for someone in our own jurisdiction who we can pin the loss on (e.g. a solicitor)
•    Elements
1.    Existence of a fiduciary duty (as trustee or otherwise)
2.    A dishonest and fraudulent design by the fiduciary
3.    The assistance by the third party in that design
4.    Knowledge

•    Consul Developments Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373
•    Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393
•    Royal Brunei Airlines v Tan [1995] 2 AC 378
•    Twinsectra v Yardley [2002] 2 AC 164

•    Consul Developments Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373
Facts:    An employee (who worked for a property development company) had information about property development opportunities. He told that to a clerk of a solicitor’s firm, and told him that his company would not pursue these opportunities, so they should pursue it themselves. This was a complete lie. The question was what level of knowledge did that solicitor’s clerk need to have? If he was tested against a constructive notice test (fifth category in Baden), he would have been held liable as a constructive trustee.

Held:    The court held that he was not liable. He did not have to make such enquiries.

Barwick CJ said courts should not be too ready to impose these onerous levels of constructive notice (as in real estate law) in commercial dealings. In these situations, we do not have to go to the extra level of constructive notice, which would put an honest and reasonable person on enquiry.

What kind of “knowledge” is required?

•    Baden, Delvaux & Lecuit v Societe General [1983]

Peter Gibson J (single judge, English):

The “Baden Delvaux five-scale classification of knowledge” (which Jacobs complains demonstrates the “zenith” of complexity):

(i)    Actual knowledge
o    To use the Consul Developments example, if you actually know that the particular opportunity has come to you because an employee is sneaking this information from his employer, you have actual (subjective) knowledge and are liable as a knowing assistant

(ii)    Deliberate ignorance (‘wilful blindness’)
o    This is where you do not want to avert your attention to something, because you know that if you look, you will see
o    It is where you deeply suspect something, but deliberately do not ask, because you do not want to say that you know (moral obtuseness)
o    This is still in realm of actual knowledge on the spectrum

(iii)    Wilfully and recklessly failing to make such inquiries as an honest and reasonable person would make
o    If this is the case, you will be held liable as a dishonest person

(iv)    Knowledge of circumstances which would indicate the facts to an honest and reasonable person
o    This is the BCCI situation. It is where you know circumstances that would indicate that there is something fishy to an honest and reasonable person (but you yourself do not actually know that you have done something wring)
o    Here, you already know the facts, and simply need to come to the conclusions

(v)    Knowledge of circumstances which would put an honest and reasonable person on inquiry
o    This is the real property standard (constructive notice)
o    It is where you do not actually know the facts, but you are under a positive obligation to make enquiries to ascertain those facts
o    This standard does not apply to these cases requiring a personal obligation to account

•    Royal Brunei Airlines v Tan [1995] (PC) 2 AC 378
Facts:    A travel agent received ticket money, but did not hold it on trust to pay the airlines (he used it to pay his personal expenses). The company went bust.

The travel agent is a separate legal person from the company (he is an assistant). The test for the liability of the knowing assistant does not depend on proving that the primary trustee had any kind of fraudulent conduct (i.e. it is not necessary to prove some intentional breach of trust by the travel company before you can have knowing assistance of it. We can go directly to the conduct of the assistant). The travel agent can be liable as a knowing assistant if he has the requisite level of knowledge.

Held:    Criticised the Badens Delvaux classification as “best forgotten”. Lord Nicholls articulated a test of “dishonesty”.

Lord Nicholls:    The assistant is committing a wrong, and they are going to be imposed with personal liability to compensate for the wrong. Our law requires there to be some fault on behalf of the assistant. The fault here is dishonesty.

The courts have consistently rejected subjective moral standards of dishonesty. The view here is that there is an objective standard of dishonesty. You need to have acted in a way that the ordinary reasonable person would have regarded as dishonest. Here, the reasonable travel agent would have realised that it was dishonest to spend this money in breach of a trust which he knew was in place in favour of the airlines.

•    What does “dishonesty” involve?
•    Consider the majority (Hoffman LJ and Hutton LJ) in Twinsectra – the assistant must realise that the conduct would be dishonest by ordinary standards of honest and reasonable people. This is described as a “combined” test of subjective and objective elements. But see also Millett’s LJ vigorous assertion of a purely objective standard.

Continued on page 3

continued

•    Twinsectra v Yardley [2002] 2 AC 164
Facts:    Twinsectra lent money to Yardley, insisting that Yardley only use the money to purchase property (because Twinsectra wanted security for their loan). Twinsectra paid the money to Yardley’s solicitor, Sims, who signed an undertaking that the money could only be used to purchase property. Mr L, Sims’s partner, spent the money on something other than property. Mr L knew circumstances that would indicate the facts to an honest and reasonable person. The question was whether he was dishonest

Held:    The court held that he was not dishonest. Although he knew circumstances which would indicate the facts to an honest and reasonable person, he had not turned his mind to the question (he was being negligent). Hence, he was not liable as a knowing assistant.

The majority (Hoffman LJ and Hutton LJ) said dishonesty was a “combined” test of subjective and objective elements.

First, there has to be some conduct that the ordinary reasonable person would regard as dishonest (objective element). Second, the perpetrator must be aware that what they have done is against what the ordinary reasonable person would regard as dishonest. That is, even if the perpetrator does not subjectively believe that what they have done is dishonest, the subjective element is satisfied if they know that other people believe that what they have done is dishonest.

•    Is there (should there be) a distinction between “receipt” and “assistance” cases?

“The point of difference between the person receiving trust property and the person who is made liable, even though he is not actually a recipient of trust property, is that in the first place knowledge, actual or constructive, of the trust is sufficient, but in the second place, something more is required, and that something more appears to me to be the actual knowledge of the fraudulent or dishonest design, so that the person concerned can truly be described as a participant in that fraudulent, dishonest activity” – Stephen J citing Jacobs J in Consul Developments Pty Ltd v DPC Estates Pty Ltd (1975).

Is the constructive trust a remedy to reverse unjust enrichment?

•    Stephenson Nominees Pty Ltd v Official Receiver (1987) 76 ALR 485

“Whilst the constructive trust may readily be seen as a restitutionary remedy for unjust enrichment, this will by no means always be the case. The constructive trust may be imposed as a cautionary or deterrent remedy even where there has been no unjust enrichment. In such situations, the constructive trust operates not to restore to the plaintiff that of which it was deprived by the conduct complained of, but to enforce observance of the fiduciary duty not to prefer personal interest to duty.” (Gummow J)

(B)    Constructive Trusts Imposed to Prevent Unconscionable Conduct

Constructive trusts to prevent unconscionable conduct

•    The domestic context:    On what basis did the court impose constructive trusts in the following cases?

The common intention constructive trust

•    Green v Green (1989) 17 NSWLR 343
Facts:    He brings her (a minor) to Australia from Thailand in 1966, and they enter a de facto relationship. He persuades her to stay, with promises that he will look after her and provide a house. He bought a house in Kirrawee in the name of nominees and told her “this is yours”. He bought a house in Blakehurst, and persuaded her to move into it, saying “this will be yours”. He told solicitors that he planned to transfer the Blakehurst house to her. He died. She claimed that she owned either the Kirrawee house or the Blakehurst house.

Held:    The two parties intended that the property be enjoyed by both of them during their lifetimes, and that the surviving partner would have a home after the other’s death. Thus, the two held the beneficial interest as joint tenants, so that the surviving partner was entitled to absolute beneficial ownership on the other’s death.

There are two elements for a common intention constructive trust:

1)    There must be a common intention by the parties that the claimant is to have a beneficial interest in the property

The common intention can be express (e.g. evidence of communications made) or inferred from conduct (e.g. the making of contributions to the cost of the property, or working to maintain it).

Here, the common intention was found from evidence of conversations between the parties (corroborated by a third party) and instructions he had given to his solicitor to transfer the property to the complainant.

2)    There must be conduct by the claimant to his or her detriment on the faith of that intention

Here, the wife’s actions in staying with her de facto, having his children and not returning to her native home were sufficient to demonstrate detrimental reliance.

The detriment does not have to be enormous. The fact that she did not spend money in acquiring or maintaining the property did not matter (even though this normally would be clear evidence of detrimental reliance).

Since there is a constructive trust, we can avoid the requirement of writing using s 23C(2).

•    Equity will impose a constructive trust in circumstances where it would be unconscionable for the other party to deny the existence of a proprietary interest

Constructive Trusts after Failed Joint Endeavours

•    Muschinski v Dodds (1985) 160 CLR 583
Facts:    Hilga Muschinski and Ronald Dodds bought a dilapidated cottage in the country with the intention of running an arts and crafts centre. They planned to erect a kit home elsewhere on the site. M paid the purchase price. D was to contribute the proceeds of a pending divorce settlement, and labour. The property was registered in both names as tenants in common on D’s insistence. Council refused development consent. D did not get the settlement he had hoped for. The venture failed, and the relationship soured. By separation, M had contributed $25,000 to the project, and D $2,000. M sought a declaration that she was the only beneficial owner of the property.

Legally, there was half ownership to each. Was it unconscionable for Dodds to assert half ownership, requiring the court to impose a constructive trust?

Held: Deane J:    There was a constructive trust here.

At the start, there was a shared intention that each should have a one half beneficial and legal interest in the property. Dodds should be precluded from asserting or retaining this half ownership to the extent that it would be unconscionable for him to do so.

If the relationship had been merely commercial, it would have been clearly unconscionable for Dodds to claim a half share without compensation, as at the time, he had contributed very little, while Muschinski had contributed almost all that she was supposed to.

Although not quite a joint venture or a partnership, the law relating to these enterprises may be appropriate here. In particular, where a joint venture fails, there should be a proportionate repayment of capital contributions. Here, each party should get back the contribution that they have made, and then any surplus should be distributed evenly (not 9:1). Since they agreed to go into the project 50:50, that was their intention, and that was what would have happened if the venture had succeeded.

•    Muschinski v Dodds leaves us with the proposition that only when you can identify these situations as commercial-like situations can you find this result, because Deane J does focus on the fact this was an enterprise (there was a commercial relationship side-by-side to the personal relationship).

•    What happens if there is no commercial relationship? See Baumgartner v Baumgartner

•    Baumgartner v Baumgartner (1987) 164 CLR 134
Facts:    He and she entered a de facto relationship in 1978. They lived in a unit owned by him. In 1979, he sold the unit and bought some land with the proceeds of the sale, and a loan taken out in his name. They pooled resources to meet mortgage repayments. Her income represented 45% of the combined earnings. They separated in 1982. She sought a declaration that she had a beneficial interest in the property.

Held:    A constructive trust could be imposed to give her a share of the proceeds of the property.

The land was acquired and the house built for the purpose of their joint relationship, and the pooling of earnings was for their mutual security and benefit. In these circumstances, the man’s assertion that he owned it all was enough to be unconscionable, so equity intervened to impose a constructive trust at the suit of Mrs B.
Equity favours equality and, in circumstances where the parties have lived together for years and have pooled their resources and their efforts to create a joint home, they should share the beneficial ownership equally as tenants in common, taking into account any disparity between the worth of their individual contributions either financially or in kind

The man was given back the deposit, and then the proceeds were divided 55:45.

•    Parij v Parij (1998) 72 SASR 153
Held:    The full court of the SA Supreme Court held that homemaker contributions can be taken into account in finding a constructive trust of the Muschinski, Baumgartner type.