Substance over form in equitable tracing for victims of fraud – Privy Council

A recent Privy Council judgment may make it easier for victims of fraud to trace property through complex money laundering schemes and enforce against constructive trustees.

The decision is persuasive rather than binding but, if followed in New Zealand, has the potential also to affect third parties - in ways which may or may not be beneficial.

Tracing - the evidentiary process

Tracing is an evidentiary process that allows a beneficiary of a trust (including victims of fraud seeking the remedy of a constructive trust) to recover property that is an identifiable substitute for other property.

Because it is subject to strict rules of equity, including the need to demonstrate the property's continued existence, it is not possible to continue to trace an asset once it has ceased to exist and there is no longer any identifiable substitute property. Neither is it possible to trace into a pre-existing asset.

This has meant that:

funds cannot be traced into an overdrawn bank account, even if the account is subsequently put in credit, and 'backward tracing' - tracing property to an asset the defendant has previously acquired, rather than a substitute for the beneficiary's property - has not been permitted. A road to nowhere?

In Federal Republic of Brazil v Durant International Corporation (Jersey) [2015] UKPC 35, the former mayor of Sao Paulo had received US$10.5 million in bribes in connection with a major road building contract in Brazil. He sought to launder this money through a series of transfers through bank accounts held by BVI companies. The bribe proceeds were first paid into an account in New York and then on to an account in Jersey.

The issue arose due to the timing of the payments. The final US$2.8 million of bribe proceeds were paid into the New York account shortly after the final payment from New York to the Jersey account. The BVI companies, liable under a constructive trust, argued that only US$7.7 million could be traced from New York to Jersey. The BVI companies claimed that, under the 'no backward tracing' principle, the balance of the final US$2.8 million could not be traced into the existing funds in the Jersey account.

It's not the journey, it's the destination

The Board held that backward tracing could be permissible in certain situations. It recognised that this was a matter of policy:

the development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between...