Judgments - Foskett (Suing on His Own Behalf and on Behalf of all Other Purchasers of Plots of Land at Mount Eden, Herradodo Cerro Alto Diogo, Martins, Algarve, Portugal (Original Appellant and Cross-Respondent) v. McKeown and Others (A.P.) (Original Respondents and Cross-Appellants)

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The cause of action

      As I have already pointed out, the plaintiffs seek to vindicate their property rights, not to reverse unjust enrichment. The correct classification of the plaintiffs' cause of action may appear to be academic, but it has important consequences. The two causes of action have different requirements and may attract different defences.

      A plaintiff who brings an action in unjust enrichment must show that the defendant has been enriched at the plaintiff's expense, for he cannot have been unjustly enriched if he has not been enriched at all. But the plaintiff is not concerned to show that the defendant is in receipt of property belonging beneficially to the plaintiff or its traceable proceeds. The fact that the beneficial ownership of the property has passed to the defendant provides no defence; indeed, it is usually the very fact which founds the claim. Conversely, a plaintiff who brings an action like the present must show that the defendant is in receipt of property which belongs beneficially to him or its traceable proceeds, but he need not show that the defendant has been enriched by its receipt. He may, for example, have paid full value for the property, but he is still required to disgorge it if he received it with notice of the plaintiff's interest.

      Furthermore, a claim in unjust enrichment is subject to a change of position defence, which usually operates by reducing or extinguishing the element of enrichment. An action like the present is subject to the bona fide purchaser for value defence, which operates to clear the defendant's title.

The tracing rules

      The insurance policy in the present case is a very sophisticated financial instrument. Tracing into the rights conferred by such an instrument raises a number of important issues. It is therefore desirable to set out the basic principles before turning to deal with the particular problems to which policies of life assurance give rise.

      The simplest case is where a trustee wrongfully misappropriates trust property and uses it exclusively to acquire other property for his own benefit. In such a case the beneficiary is entitled at his option either to assert his beneficial ownership of the proceeds or to bring a personal claim against the trustee for breach of trust and enforce an equitable lien or charge on the proceeds to secure restoration of the trust fund. He will normally exercise the option in the way most advantageous to himself. If the traceable proceeds have increased in value and are worth more than the original asset, he will assert his beneficial ownership and obtain the profit for himself. There is nothing unfair in this. The trustee cannot be permitted to keep any profit resulting from his misappropriation for himself, and his donees cannot obtain a better title than their donor. If the traceable proceeds are worth less than the original asset, it does not usually matter how the beneficiary exercises his option. He will take the whole of the proceeds on either basis. This is why it is not possible to identify the basis on which the claim succeeded in some of the cases.

      Both remedies are proprietary and depend on successfully tracing the trust property into its proceeds. A beneficiary's claim against a trustee for breach of trust is a personal claim. It does not entitle him to priority over the trustee's general creditors unless he can trace the trust property into its product and establish a proprietary interest in the proceeds. If the beneficiary is unable to trace the trust property into its proceeds, he still has a personal claim against the trustee, but his claim will be unsecured. The beneficiary's proprietary claims to the trust property or its traceable proceeds can be maintained against the wrongdoer and anyone who derives title from him except a bona fide purchaser for value without notice of the breach of trust. The same rules apply even where there have been numerous successive transactions, so long as the tracing exercise is successful and no bona fide purchaser for value without notice has intervened.

      A more complicated case is where there is a mixed substitution. This occurs where the trust money represents only part of the cost of acquiring the new asset. As Ames pointed out in "Following Misappropriated Property into its Product" (1906) Harvard Law Review 511, consistency requires that, if a trustee buys property partly with his own money and partly with trust money, the beneficiary should have the option of taking a proportionate part of the new property or a lien upon it, as may be most for his advantage. In principle it should not matter (and it has never previously been suggested that it does) whether the trustee mixes the trust money with his own and buys the new asset with the mixed fund or makes separate payments of the purchase price (whether simultaneously or sequentially) out of the different funds. In every case the value formerly inherent in the trust property has become located within the value inherent in the new asset.

      The rule, and its rationale, were stated by Williston in "The Right to Follow Trust Property when Confused with Other Property" (1880) 2 Harvard Law Journal at p. 29:

     "If the trust fund is traceable as having furnished in part the money with which a certain investment was made, and the proportion it formed of the whole money so invested is known or ascertainable, the cestui que trust should be allowed to regard the acts of the trustee as done for his benefit, in the same way that he would if all the money so invested had been his; that is, he should be entitled in equity to an undivided share of the property which the trust money contributed to purchase--such a proportion of the whole as the trust money bore to the whole money invested.

     "The reason in the one case as in the other is that the trustee cannot be allowed to make a profit from the use of the trust money, and if the property which he wrongfully purchased were held subject only to a lien for the amount invested, any appreciation in value would go to the trustee."

    If this correctly states the underlying basis of the rule (as I believe it does), then it is impossible to distinguish between the case where mixing precedes the investment and the case where it arises on and in consequence of the investment. It is also impossible to distinguish between the case where the investment is retained by the trustee and the case where it is given away to a gratuitous donee. The donee cannot obtain a better title than his donor, and a donor who is a trustee cannot be allowed to profit from his trust.

      In In re Hallett's Estate; Knatchbull v. Hallett (1880) 13 Ch. D. 696, 709 Sir George Jessel M.R. acknowledged that where an asset was acquired exclusively with trust money, the beneficiary could either assert equitable ownership of the asset or enforce a lien or charge over it to recover the trust money. But he appeared to suggest that in the case of a mixed substitution the beneficiary is confined to a lien. Any authority that this dictum might otherwise have is weakened by the fact that Jessel M.R. gave no reason for the existence of any such rule, and none is readily apparent. The dictum was plainly obiter, for the fund was deficient and the plaintiff was only claiming a lien. It has usually been cited only to be explained away (see for example In re Tilley's Will Trusts [1967] Ch. 1179, 1186 per Ungoed-Thomas J.; Burrows The Law of Restitution (1993) p. 368). It was rejected by the High Court of Australia in Scott v. Scott (1963) 109 C.L.R. 649 (see the passage at pp. 661-2 cited by Morritt L.J. below at [1998] Ch. 265, 300-301). It has not been adopted in the United States: see the American Law Institute, Restatement of the Law, Trusts, 2d (1959) at section 202(h). In Primeau v. Granfield (1911) 184 F. 480 (S.D.N.Y.) at p. 184 Learned Hand J. expressed himself in forthright terms: "On principle there can be no excuse for such a rule."

      In my view the time has come to state unequivocally that English law has no such rule. It conflicts with the rule that a trustee must not benefit from his trust. I agree with Burrows that the beneficiary's right to elect to have a proportionate share of a mixed substitution necessarily follows once one accepts, as English law does, (i) that a claimant can trace in equity into a mixed fund and (ii) that he can trace unmixed money into its proceeds and assert ownership of the proceeds.

      Accordingly, I would state the basic rule as follows. Where a trustee wrongfully uses trust money to provide part of the cost of acquiring an asset, the beneficiary is entitled at his option either to claim a proportionate share of the asset or to enforce a lien upon it to secure his personal claim against the trustee for the amount of the misapplied money. It does not matter whether the trustee mixed the trust money with his own in a single fund before using it to acquire the asset, or made separate payments (whether simultaneously or sequentially) out of the differently owned funds to acquire a single asset.

      Two observations are necessary at this point. First, there is a mixed substitution (with the results already described) whenever the claimant's property has contributed in part only towards the acquisition of the new asset. It is not necessary for the claimant to show in addition that his property has contributed to any increase in the value of the new asset. This is because, as I have already pointed out, this branch of the law is concerned with vindicating rights of property and not with reversing unjust enrichment. Secondly, the beneficiary's right to claim a lien is available only against a wrongdoer and those deriving title under him otherwise than for value. It is not available against competing contributors who are innocent of any wrongdoing. The tracing rules are not the result of any presumption or principle peculiar to equity. They correspond to the common law rules for following into physical mixtures (though the consequences may not be identical). Common to both is the principle that the interests of the wrongdoer who was responsible for the mixing and those who derive title under him otherwise than for value are subordinated to those of innocent contributors. As against the wrongdoer and his successors, the beneficiary is entitled to locate his contribution in any part of the mixture and to subordinate their claims to share in the mixture until his own contribution has been satisfied. This has the effect of giving the beneficiary a lien for his contribution if the mixture is deficient.

      Innocent contributors, however, must be treated equally inter se. Where the beneficiary's claim is in competition with the claims of other innocent contributors, there is no basis upon which any of the claims can be subordinated to any of the others. Where the fund is deficient, the beneficiary is not entitled to enforce a lien for his contributions; all must share rateably in the fund.

      The primary rule in regard to a mixed fund, therefore, is that gains and losses are borne by the contributors rateably. The beneficiary's right to elect instead to enforce a lien to obtain repayment is an exception to the primary rule, exercisable where the fund is deficient and the claim is made against the wrongdoer and those claiming through him. It is not necessary to consider whether there are any circumstances in which the beneficiary is confined to a lien in cases where the fund is more than sufficient to repay the contributions of all parties. It is sufficient to say that he is not so confined in a case like the present. It is not enough that those defending the claim are innocent of any wrongdoing if they are not themselves contributors but, like the trustees and Mr. Murphy's children in the present case, are volunteers who derive title under the wrongdoer otherwise than for value. On ordinary principles such persons are in no better position than the wrongdoer, and are liable to suffer the same subordination of their interests to those of the claimant as the wrongdoer would have been. They certainly cannot do better than the claimant by confining him to a lien and keeping any profit for themselves.

      Similar principles apply to following into physical mixtures: see Lupton v. White (1808) 15 Ves. 442; and Sandemann & Sons v. Tyzack and Branfoot Steamship Co. Ltd. [1913] A.C. 680, 695 where Lord Moulton said: "If the mixing has arisen from the fault of B, A can claim the goods." There are relatively few cases which deal with the position of the innocent recipient from the wrongdoer, but Jones v. De Marchant (1916) 28 D.L.R. 561 may be cited as an example. A husband wrongfully used 18 beaver skins belonging to his wife and used them, together with four skins of his own, to have a fur coat made up which he then gave to his mistress. Unsurprisingly the wife was held entitled to recover the coat. The mistress knew nothing of the true ownership of the skins, but her innocence was held to be immaterial. She was a gratuitous donee and could stand in no better position than the husband. The coat was a new asset manufactured from the skins and not merely the product of intermingling them. The problem could not be solved by a sale of the coat in order to reduce the disputed property to a divisible fund, since (as we shall see) the realisation of an asset does not affect its ownership. It would hardly have been appropriate to require the two ladies to share the coat between them. Accordingly it was an all or nothing case in which the ownership of the coat must be assigned to one or other of the parties. The determinative factor was that the mixing was the act of the wrongdoer through whom the mistress acquired the coat otherwise than for value.

      The rule in equity is to the same effect, as Sir William Page Wood V.-C. observed in Frith v. Cartland (1865) 2 H. & M. 417 at p. 418:

     ". . . If a man mixes trust funds with his own, the whole will be treated as the trust property, except so far as he may be able to distinguish what is his own."

    This does not, in my opinion, exclude a pro rata division where this is appropriate, as in the case of money and other fungibles like grain, oil or wine. But it is to be observed that a pro rata division is the best that the wrongdoer and his donees can hope for. If a pro rata division is excluded, the beneficiary takes the whole; there is no question of confining him to a lien. Jones v. De Marchant 28 D.L.R. 561 is a useful illustration of the principles shared by the common law and equity alike that an innocent recipient who receives misappropriated property by way of gift obtains no better title than his donor, and that if a proportionate sharing is inappropriate the wrongdoer and those who derive title under him take nothing.

Insurance policies

      In the case of an ordinary whole life policy the insurance company undertakes to pay a stated sum on the death of the assured in return for fixed annual premiums payable throughout his life. Such a policy is an entire contract, not a contract for a year with a right of renewal. It is not a series of single premium policies for one year term assurance. It is not like an indemnity policy where each premium buys cover for a year after which the policyholder must renew or the cover expires. The fact that the policy will lapse if the premiums are not paid makes no difference. The amounts of the annual premiums and of the sum assured are fixed in advance at the outset and assume the payment of annual premiums throughout the term of the policy. The relationship between them is based on the life expectancy of the assured and the rates of interest available on long term government securities at the inception of the policy.

      In the present case the benefits specified in the policy are expressed to be payable "in consideration of the payment of the first premium already made and of the further premiums payable." The premiums are stated to be "£10,220 payable at annual intervals from 6 November 1985 throughout the lifetime of the life assured." It is beyond argument that the death benefit of £1m. paid on Mr. Murphy's death was paid in consideration for all the premiums which had been paid before that date, including those paid with the plaintiffs' money, and not just some of them. Part of that sum, therefore, represented the traceable proceeds of the plaintiffs' money.

      It is, however, of critical importance in the present case to appreciate that the plaintiffs do not trace the premiums directly into the insurance money. They trace them first into the policy and thence into the proceeds of the policy. It is essential not to elide the two steps. In this context, of course, the word "policy" does not mean the contract of insurance. You do not trace the payment of a premium into the insurance contract any more than you trace a payment into a bank account into the banking contract. The word "policy" is here used to describe the bundle of rights to which the policyholder is entitled in return for the premiums. These rights, which may be very complex, together constitute a chose in action, viz. the right to payment of a debt payable on a future event and contingent upon the continued payment of further premiums until the happening of the event. That chose in action represents the traceable proceeds of the premiums; its current value fluctuates from time to time. When the policy matures, the insurance money represents the traceable proceeds of the policy and hence indirectly of the premiums.

      It follows that, if a claimant can show that premiums were paid with his money, he can claim a proportionate share of the policy. His interest arises by reason of and immediately upon the payment of the premiums, and the extent of his share is ascertainable at once. He does not have to wait until the policy matures in order to claim his property. His share in the policy and its proceeds may increase or decrease as further premiums are paid; but it is not affected by the realisation of the policy. His share remains the same whether the policy is sold or surrendered or held until maturity; these are merely different methods of realising the policy. They may affect the amount of the proceeds received on realisation but they cannot affect the extent of his share in the proceeds. In principle the plaintiffs are entitled to the insurance money which was paid on Mr. Murphy's death in the same shares and proportions as they were entitled in the policy immediately before his death.

      Since the manner in which an asset is realised does not affect its ownership, and since it cannot matter whether the claimant discovers what has happened before or after it is realised, the question of ownership can be answered by ascertaining the shares in which it is owned immediately before it is realised. Where A misappropriates B's money and uses it to buy a winning ticket in the lottery, B is entitled to the winnings. Since A is a wrongdoer, it is irrelevant that he could have used his own money if in fact he used B's. This may seem to give B an undeserved windfall, but the result is not unjust. Had B discovered the fraud before the draw, he could have decided whether to keep the ticket or demand his money back. He alone has the right to decide whether to gamble with his own money. If A keeps him in ignorance until after the draw, he suffers the consequence. He cannot deprive B of his right to choose what to do with his own money; but he can give him an informed choice.

      The application of these principles ought not to depend on the nature of the chose in action. They should apply to a policy of life assurance as they apply to a bank account or a lottery ticket. It has not been suggested in argument that they do not apply to a policy of life assurance. This question has not been discussed in the English authorities, but it has been considered in the United States. In a Note in 35 Yale Law Journal (1925) at pp. 220-227 Professor Palmer doubted the claimant's right to share in the proceeds of a life policy, and suggested that he should be confined to a lien for his contributions. Professor Palmer accepted, as the majority of the Court of Appeal in the present case did not, that the claimant can trace from the premiums into the policy and that the proceeds of the policy are the product of all the premiums. His doubts were not based on any technical considerations but on questions of social policy. They have not been shared by the American courts. These have generally allowed the claimant a share in the proceeds proportionate to his contributions even though the share in the proceeds is greater than the amount of his money used in paying the premiums: see for example Shaler v. Trowbridge (1877) 28 N.J. Eq. 595; Holmes v. Gilman (1893) 138 N.Y. 369); Vorlander v. Keyes (1924) 1 F. 2d. 67 (1924); Truelsch v. Northwestern Mutual Life Insurance Co. (1925) 202 N.W. 352 (1925); Baxter House v. Rosen (1967) 278 N.Y. 2d. 442; Lohman v. General American Life Insurance Co. (1973) 478 F. 2d. 719. This accords with Ames' and Williston's opinions in the articles to which I have referred.

      The question is discussed at length in Scott: The Law of Trust in section 508.4 at pp. 574-584. Professor Scott concludes that there is no substance in the doubts expressed by Palmer. He points out that the strongest argument in favour of limiting the beneficiary's claim to a lien is that otherwise he obtains a windfall. But in cases where the wrongdoer has misappropriated the claimant's money and used it to acquire other forms of property which have greatly increased in value the courts have consistently refused to limit the claimant to an equitable lien. In any case, the windfall argument is suspect. As Professor Scott points out, a life policy is an aleatory contract. Whether or not the sum assured exceeds the premiums is a matter of chance. Viewed from the perspective of the insurer, the contract is a commercial one; so the chances are weighted against the assured. But the outcome in any individual case is unpredictable at the time the premiums are paid. The unspoken assumption in the argument that a life policy should be treated differently from other choses in action seems to be that, by dying earlier than expected, the assured provides a contribution of indeterminate but presumably substantial value. But the assumption is false. A life policy is not an indemnity policy, in which the rights against the insurer are acquired by virtue of the payment of the premiums and the diminution of the value of an asset. In the case of a life policy the sum assured is paid in return for the premiums and nothing else. The death of the assured is merely the occasion on which the insurance money is payable. The ownership of the policy does not depend on whether this occurs sooner or later, or on whether the bargain proves to be a good one. It cannot be made to await the event.

      The windfall argument has little to commend it in the present case. The plaintiffs were kept in ignorance of the fact that premiums had been paid with their money until after Mr. Murphy's death. Had they discovered what had happened before Mr. Murphy died, they would have intervened. They might or might not have elected to take an interest in the policy rather than enforce a lien for the return of the premiums paid with their money, but they would certainly have wanted immediate payment. This would have entailed the surrender of the policy. At the date of his death Mr. Murphy was only 45 and a non-smoker. He had a life expectancy of many years, and neither he nor the trustees had the means to keep up the premiums. The plaintiffs would hardly have been prepared to wait for years to recover their money, paying the premiums in the meantime. It is true that, under the terms of the policy, life cover could if necessary be maintained for a few years more at the expense of the investment element of the policy (which also provided its surrender value). But it is in the highest degree unlikely that the plaintiffs would have been willing to gamble on the remote possibility of Mr. Murphy's dying before the policy's surrender value was exhausted. If he did not they would recover nothing. They would obviously have chosen to enforce their lien to recover the premiums or have sought a declaration that the trustees held the policy for Mr. Murphy's children and themselves as tenants in common in the appropriate shares. In either case the trustees would have had no alternative but to surrender the policy. In practice the trustees were able to obtain the death benefit by maintaining the policy until Mr. Murphy's death only because the plaintiffs were kept in ignorance of the fact that premiums had been paid with their money and so were unable to intervene.

The reasoning of the Court of Appeal

      The majority of the Court of Appeal (Sir Richard Scott V.-C. and Hobhouse L.J.) held that the plaintiffs could trace their money into the premiums but not into the policy, and were accordingly not entitled to a proportionate share in the proceeds. They did so, however, for different and, in my view, inconsistent reasons which cannot both be correct and which only coincidentally led to the same result in the present case.

      The Vice-Chancellor considered that Mr. Murphy's children acquired vested interests in the policy at its inception. They had a vested interest (subject to defeasance) in the death benefit at the outset and before any of the plaintiffs' money was used to pay the premiums. The use of the plaintiffs' money gave the plaintiffs a lien on the proceeds of the policy for the return of the premiums paid with their money, but could not have the effect of divesting the children of their existing interest. The children owned the policy; the plaintiffs' money was merely used to maintain it. The position was analogous to that where trust money was used to maintain or improve property of a third party.

      The Vice-Chancellor treated the policy as an ordinary policy of life assurance. It is not clear whether he thought that the children obtained a vested interest in the policy because Mr. Murphy took the policy out or because he paid the first premium, but I cannot accept either proposition. Mr. Murphy was the original contracting party, but he obtained nothing of value until he paid the first premium. The chose in action represented by the policy is the product of the premiums, not of the contract. The trustee took out the policy in all the recorded cases. In some of them he paid all the premiums with trust money. In such cases the beneficiary was held to be entitled to the whole of the proceeds of the policy. In other cases the trustee paid some of the premiums with his own money and some with trust money. In those cases the parties were held entitled to the proceeds of the policy rateably in proportion to their contributions. It has never been suggested that the beneficiary is confined to his lien for repayment of the premiums because the policy was taken out by the trustee. The ownership of the policy does not depend on the identity of the party who took out the policy. It depends on the identity of the party or parties whose money was used to pay the premiums.

      So the Vice-Chancellor's analysis can only be maintained if it is based the fact that Mr. Murphy paid the first few premiums out of his own money before he began to make use of the trust money. Professor Scott records only one case in which it has been held that in such a case the claimant is confined to a lien on the ground that the later premiums were not made in acquiring the interest under the policy but merely in preserving or improving it: see Thum v. Wolstenholme (1900) 21 Utah 446, 537. The case is expressly disapproved by Scott (loc. cit.) at section 516.1, where it is said that the decision cannot be supported, and that the claimant should be entitled to a proportionate share of the proceeds, regardless of the question whether some of the premiums were paid wholly with the claimant's money and others wholly with the wrongdoer's money and regardless of the order of the payments, or whether the premiums were paid out of a mingled fund containing the money of both.