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Expansion Of The Constructive Trust Concepts
Many practitioners believe that the law of constructive trusts relates primarily to domestic relations and obscure estate litigation claims. In fact, the first reported constructive trust claim involved the acquisition for a secret profit by persons who were employed to act for others. This area of the law has been developing for over two centuries and is playing an extremely important role in virtually all areas of the law where equity will apply. This is particularly so in commercial litigation. The purpose of this paper is two-fold, namely to: Review the law of remedial constructive trusts, and Discuss how equitable principles such as constructive trusts, tracing,
and various equitable principles allow for claims against intermeddlers
or strangers arising out of a breach of trust or breach of fiduciary
duty. 2. THE REMEDIAL CONSTRUCTIVE TRUST Constructive trusts have been evolving for more than two centuries. However, it has only been in the last several years that it is now developed to the point where it is almost impossible to predict and define all the circumstances in which its equitable principles might apply . As Chief Justice McEachern stated only a few years ago in Clarkson v McCrossen Estate (1995) 13 R.F.L. (4th) 237 (BCCA): “I wish to mention that the law of unjust enrichment is in its early formative stages; it will continue to mature incrementally. The few cases that have been decided cannot be taken as the final word on any of these matters. They point the direction the law is taking, but not the many contours that must be traversed along the way.” The purpose of this article is to briefly review the development
of the law of constructive trusts, and to then focus on three significant
recent decisions that reflect where this important area of the law
has now reached. 3. WHAT IS A CONSTRUCTIVE TRUST ? “A constructive trust comes into existence, regardless of any party’s intent, when the law imposes upon a party an obligation to holds specific property for another. The person obligated becomes by force of law a constructive trustee towards the person to whom he owes performance of the obligation.” Law of Trusts on Canada - Donovan Waters, page 378 Lord Denning in Hussey v Palmer (1972) 3 All E.R. 70 (CA) described a constructive trust as: “by whatever name it is described, it is a trust imposed by law whenever justice and good conscience require it. It is a liberal process, founded upon large principles of equity, to be applied in cases where the defendant cannot conscientiously keep the property for himself alone, but ought to allow another to have the property or a share in it. It is an equitable remedy where the Court can enable an aggrieved party to obtain restitution”. The principle of “unjust enrichment” lies at the heart of the constructive trust. The principle of “unjust enrichment” has played a significant role in the development of this equitable remedy. Lord Mansfield in Moses v Macferlan (1760) , 2 Burr. 1005, 97 E.R. 676, stated: “the gist of this kind of action is the defendant, upon the circumstances of the case, is obliged by the ties of natural justice and equity to refund the money”. One of the earliest situations that a constructive trust was imposed
concerned the acquisition of a secret profit by persons who were
employed to act for others. Since then, it has been applied to countless
different fact patterns, though it is perhaps best known for its
application in matrimonial and cohabitation property cases. 4. WHAT IS A REMEDIAL CONSTRUCTIVE TRUST? A remedial constructive trust is a trust imposed by Court order as a remedy for a wrong. The entitlement to that remedy may be a matter of substantive law, but the trust itself is not created by the acts of the parties, or even by the obligation to make restitution, but by the order of the Court. As with other Court orders, the trust will come into being when the order is pronounced, unless, in an appropriate case, the order is made retroactive or its coming into force is deferred. It may be that in many cases where a remedial constructive trust is imposed, the Court will order that it be imposed with effect from the time when the situation arose which gave rise to the unjust enrichment. There must, of course, be a causal connection between the property in question and the unjust enrichment. See Sorochan v. Sorochan, supra, and Rosenfeldt v. Olson, 1 B.C.L.R. (2d) 108, [1986] 3 W.W.R. 403, 25 D.L.R. (4th) 472 (C.A.). The remedial constructive trust must be distinguished from the substantive constructive trust which the Court declares to have arisen, as a result of the conduct of the parties, and by the force of that conduct alone, at the earlier time when the relevant conduct occurred. If a substantive constructive trust is found to have arisen in that way, then there is no discretion remaining in the Court to refuse to declare the existence of the trust. The ordering of a remedial constructive trust is only one of the remedies which may be ordered as a result of a wrong committed by one person against another that is properly categorized as unjust enrichment. The available remedies include an order to pay money, as damages, and they include other remedies stemming either from legal origins or equity origins, as the circumstances of the case may require. “It must be emphasized that the constructive trust is remedial
in nature. If the Court is asked to grant such a remedy and determines
that a declaration of constructive trust is warranted, then the
proprietary interest awarded pursuant to that remedy will be deemed
to have arisen at the time when the unjust enrichment first occurred.”
LeClair v Leclair Estate, May 1998, B.C.C.A 5. THE RESURRECTION OF “GOOD CONSCIENCE” Prior to the Supreme Court of Canada’s decision in Soulos v Korkontzilas (1997) SCR 217, it had become trite law that to support a finding of a constructive trust one had to prove an unjust enrichment comprised of :
(see inter alia Pettkus v Bekker (1980) 19 RFL (2d) 165, Sorochan v Sorochan (1986) 2 SCR 39 and Peter v Beblow (1993) 1SCR 980.) The decision in Soulos has radically changed what had been trite law by holding that despite the absence of an enrichment and a corresponding deprivation, the doctrine of constructive trust may still be imposed “to hold persons in different situations to high standards of trust and probity and prevent them from retaining property which in “good conscience” they should not be permitted to retain." In Soulos, a realtor Korkontzilas had negotiated a commercial building for his client, but then decided to purchase the property for himself, which he did. He lied to his client that the deal had fallen through, but three years later his client found out what had really occurred. The client sued Korkontzilas and alleged a breach of fiduciary duty that gave rise to a constructive trust. The problem for the plaintiff however, was that property values had fallen from the time of the purchase, so that the plaintiff could not prove actual damages. At trial, the Court found a breach of fiduciary duty, but declined to order a constructive trust because since the property value had fallen, Korkontzilas had not been enriched. The Ontario Court of Appeal reversed this decision, and the Supreme Court upheld the reversal. McLachlin J. reviewed the history of the remedy of constructive trust in detail, and found that the principle of “good conscience” has always been at the center of the doctrine of constructive trust, and lies at the very foundation of equitable jurisdiction. By applying the principle of “good conscience”, the Court found that it applies to constructive trusts where the defendant has not obtained a benefit or where the plaintiff has not suffered a loss. Justice McLachlin boldly stated that “It thus emerges that a constructive trust may be imposed where good conscience so requires. I conclude that in Canada, under the broad umbrella of good conscience, constructive trusts are recognized both for wrongful acts like fraud and breach of duty of loyalty, as well as to remedy unjust enrichment and corresponding deprivation.” The Court found four conditions that should be present for a constructive trust to be applied based on wrongful conduct, namely:
The doctrine of “good conscience” was subsequently applied by the B.C.C.A in the 1998 decision of Roberts v Martindale 21 ETR (4th) 475. The reasoning of Roberts v Martindale is in my view, a good example of a fact pattern where the application of a remedial constructive trust will increasingly be applied by the Courts. FACTS : The deceased and the defendant were formerly husband and wife. The deceased named the husband as the beneficiary of a group life insurance policy, and later divorced him due to his infidelity. The divorce was marked by great bitterness .The deceased intended that the plaintiff would be the beneficiary of the policy. Both the plaintiff and the deceased believed that steps had been taken to revoke the designation in favour of the husband and appoint the plaintiff as beneficiary in his place. The husband remained beneficiary, and the plaintiff claimed recovery of money paid to the husband. HELD: The Court held that the husband should not be allowed to keep the money because he had surrendered any right he might have had to property of the deceased in their separation agreement. The breach of their separation agreement by the husband was sufficient for the Court to invoke the doctrine of remedial constructive trust, and the money was declared to be properly owing to the plaintiff. Southin J. followed the maxim of equity that will not permit even an act of Parliament to be used as an instrument of fraud, and applied the notion of “good conscience” to impose a remedial constructive trust, because Mr. Martindale had, by the separation agreement surrendered any right he may have had to the property of the deceased. Another significant case that dealt with the imposition by the Courts of a constructive trust where there had been a breach of a fiduciary relationship is found in the case of Lac Minerals Ltd. v. International Corona Resources Ltd. (1989) S.C.R. 574 FACTS: International Corona Resources Ltd. (“Corona”) explored properties which held good potential for gold mining. Corona's chief geologist thought it appropriate to acquire property (the “Williams Property”) adjacent to the property already claimed. When news of Corona's exploration reached LAC Minerals Ltd. (“LAC”), LAC suggested a joint venture to develop a gold mine on the Williams Property. Although negotiations proceeded for some time, no joint venture was ever concluded. LAC, however, acquired the Williams Property itself, and proceeded to develop a gold mine on it. Corona sued LAC for breach of fiduciary duty and breach of confidence. At trial, the Court held that LAC had received the information about the Williams Property in confidence and that LAC had breached that confidence in acquiring the Williams Property. The Court also held that LAC had a fiduciary duty to Corona because the information in question had been revealed in the course of their well-developed joint venture discussions. Furthermore, there was a general custom in the mining industry that information revealed in confidence between potential joint ventures should not be used by one party to the detriment of the other. The trial Judge considered that in the particular circumstances of the case, the appropriate remedy was to grant Corona the Williams Property after Corona paid LAC for its expenses in developing the mine. Both the findings regarding liability and the remedy were affirmed by the Ontario Court of Appeal. LAC appealed to the Supreme Court of Canada, alleging that there had been neither breach of confidence nor breach of fiduciary duty. LAC also appealed the remedy, alleging that even if there had been a breach, the appropriate remedy was damages, not the return of the mine. Corona cross-appealed to have the damages increased from the amount which the trial Judge had awarded in the alternative. HELD: The Court imposed a constructive trust over the Williams property in favour of Corona. But for the acts of LAC, Corona would have held the Williams Property. That property should be restored to Corona. Even though a restitutionary remedy is not always appropriate, it was appropriate in this case. It was appropriate to measure LAC's gain at Corona's expense rather than simply measure Corona's loss. Both the compensatory and restitutionary awards were equivalent, as Corona should have had the Williams Property all along. The Court should promote honest bargaining by having each party live up to the reasonable expectations of the other. Corona's reasonable expectations were that LAC would not misuse confidential information revealed during the negotiations. The Court could not enforce the reasonable expectations of the parties unless it deprived the offending party of all of its benefit flowing from the breach of those expectations. Damages would not properly compensate Corona for its loss, and damages would not deprive LAC of all that it gained. Restitution was the only remedy suitable in the circumstances. A two-stage test should be satisfied before a constructive trust can be declared:
The Court also dealt with the issue of Breach of Fiduciary Duty. The Canadian Frame v. Smith case sets out the criteria for determining when fiduciary duties arise:
In commercial contexts, the Court ought not to presume fiduciary relationships. Instead, the parties should protect themselves by contract. The drastic remedies available in equity should be reserved for special circumstances. Fiduciary duties are an integral part of certain relationships, such as those between directors and corporations. Even within these relationships, however, all duties are not fiduciary. In other relationships, fiduciary duties may also arise. Dependency or vulnerability is, however, necessary before any fiduciary relationship can arise. The basic criteria for determining when to imply fiduciary duties were stated in Frame v. Smith. Fiduciary duties have been found in three kinds of situations:
The third situation does not involve a legitimate use of the concept
and should be rejected. The Courts should be willing to grant appropriate
remedies on a principled basis without the need for specific characterizations. 6. CLAIMS AGAINST STRANGERS OR INTERMEDDLERS FOR BREACH OF TRUST OR FIDUCIARY DUTY I must say at the outset of part two of my paper that I am deeply indebted to Paul Perell and his paper on this same topic, published in the Advocates Quarterly, volume 21, page 94, in 1998. It is a very difficult and confusing area of the law, and I have referenced large portions of his article in order to prepare this paper. This portion of my paper looks at whether third parties such as lawyers, banks, employees, agents, strangers and so forth may be liable to the proper beneficiaries where they may have aided a trustee or fiduciary, or may have gained something from a breach of trust or fiduciary duty. This may be particularly important where the defendant trustee or fiduciary is without assets, and as a result of a breach of duty or trust, the beneficiary suffers a loss or misses the opportunity to make a gain. In order to answer this question, I will briefly examine three recent Supreme Court of Canada decisions, namely;
7. THE DOCTRINE OF KNOWING ASSISTANCE A stranger to a trust or fiduciary relationship may be liable under this equitable doctrine if the stranger, with actual knowledge, assists the trustee or fiduciary in a dishonest and fraudulent scheme. The rationale for liability is that the stranger participated in something that equity finds “unconscionable’. The four essential elements of a claim for knowing assistance against a stranger are :
FACTS: In Air Canada, a travel agency was obliged to hold in trust the proceeds from its sale of Air Canada tickets, but the agency breached it’s trust and the airline was owed $25,000. Monies were to have been put into trust accounts that were set up, but instead the funds went into general accounts. The issues were whether the directors of the travel agency ( RV & PM) were personally liable, based on whether the relationship between the agency and Air Canada was one of trust or debtor-creditor. The directors are found personally liable. The case finds liability under the doctrine of “knowing assistance”. HELD: As it was the agency that was the trustee, liability as a constructive trustee could be imposed on RV, a stranger to the trust, only if he knowingly assisted in a dishonest and fraudulent design on the part of the trustees. This type of liability is called “knowing assistance”. Actual knowledge is required for a finding of knowing assistance liability; recklessness or wilful blindness are sufficient for a finding of actual knowledge. As the trust in this case was created by contract, whether RV knew of the trust depended upon his familiarity or involvement with the contract. The breach of trust by the agency was dishonest and fraudulent. It knowingly took a risk with Air Canada's moneys by failing to hold the moneys in trust. It commingled the trust funds with it’s general operating funds, knowing that any positive balance in its general operating account was subject to the bank's demand. RV participated in the breach of trust by dealing with the funds in question: he stopped payment on all cheques, opened another trust account and attempted to withdraw the stop payment orders and to transfer the funds into a new trust account. RV and PM directly caused the breach of trust by stopping payment on all cheques in order to protect their own interests. This action prevented payment to Air Canada and resulted in the seizure by the bank of the funds in the general operating account. While RV was not generally involved in the day-to-day activities of the agency, he knew of the terms of the agreement between the agency and Air Canada, and he knew that the trust funds were being deposited in the general operating account. Further, he personally benefitted from the breach of trust when his personal liability to the bank on the operating line of credit was extinguished. 8. THE DOCTRINE OF KNOWING RECEIPT A stranger to a trust or fiduciary relationship may be liable under this doctrine if the stranger receives trust property in his or her own personal capacity, that is beneficially and not merely as an agent, and with actual knowledge or constructive knowledge of the breach. The three requirements of this doctrine are:
FACTS: In Gold v Rosenberg, an executor arranged to have a corporation owned by the estate sign a guarantee to repay his own corporation’s indebtedness to a bank. The guarantee was secured by a mortgage of estate property. The plaintiff, who was a co-executor, authorized the guarantee but later said he had been mislead. The issue was whether the bank was liable under the “doctrine of knowing receipt” for breach of duty for failure to inquire. The trial judge found the bank liable for assisting the executor’s breach of trust. The SCC found the bank not liable. HELD: Assuming that the case should be treated as one of “knowing receipt,” when it was dealt with at trial and in the Court of Appeal as one of “knowing assistance,” the bank was not liable for breach of its duty to inquire. When a bank receives a guarantee supported by a collateral mortgage on trust property, it has not received the trust property to its own use and benefit. To receive trust property means, at a minimum, to take the property into one's possession. The bank did not receive the trust property into its possession simply because it held a guarantee supported by a collateral mortgage on the property. The bank at best had a contingent interest in the trust property, in that if the debtor defaulted and the guarantor could not make good the debt from its other assets, the bank would receive the property. The bank, knowing what it knew, acted reasonably in the circumstances. An honest person with knowledge of the facts would not have made further inquiries. Inquiries to G would not have alerted the bank to any facts which would have raised a doubt about the transaction. In certain circumstances, a third party in the position of the bank will not have discharged its duty to inquire unless the guarantor has been advised to obtain independent legal advice. When the transaction is clearly detrimental to the person offering security, and the relationship between that person and the debtor is particularly close, there is a presumption of undue influence on the part of the debtor. A relationship that is more distant will raise less suspicion of undue influence, even if the transaction appears unfavourable to the guarantor, and less will be required to satisfy an honest and reasonable person that the guarantor is aware of the legal implications of the transaction. 9. LIABILITY AS A TRUSTEE DE SON TORT When a person , although not appointed a trustee or a fiduciary, goes ahead to control and administer a trust property and to act as a trustee, the person will be liable as a trustee de son tort if he commits a breach of trust. Having assumed the responsibility, the stranger as a trustee de son tort is subject to the same liabilities as an expressly appointed trustee. The major problem in determining the liability of a trustee de son tort is differentiating between a person who has taken on a trustee’s responsibility and a person who is merely acting as an agent for the real trustee. Lord Selbourne L.C. in the much quoted passage from Barnes v Addy (1874) 9 Ch. App. 244, stated: “But, on the other hand, strangers are not to be made constructive trustees merely because they act as agents for trustees in transactions, 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 the knowledge in a dishonest and fraudulent design on the part of the trustee.” In Citadel General Assurance Co. v Lloyds Bank of Canada, an insurance company was obliged to hold in trust the proceeds from its sale of the plaintiff’s insurance policies, but the funds were transferred into the bank account of the agency’s parent company. The transfer reduced the parent company’s overdraft. The issue was whether the bank was liable to pay the plaintiff over $600,000, being the outstanding amount payable to it for the premiums. The bank was found liable as a constructive trustee under the “doctrine of knowing receipt”. HELD: There are three ways in which a stranger to a trust can be held liable as constructive trustee for breach of trust:
The bank was not liable as a trustee de son tort, as it had never assumed the office or function of trustee, and did not administer the trust funds on behalf of the beneficiary insurer. The bank also could not be liable under the “knowing assistance” category of constructive trusteeship, as it did not meet the knowledge requirement for that type of liability, namely actual knowledge, recklessness, or wilful blindness. The only basis upon which the bank might be held liable as a constructive trustee was under the “knowing receipt” or “knowing receipt and dealing” head of liability. It is generally recognized that there are two types of cases under this category of constructive trusteeship:
Liability on the basis of “knowing receipt” requires that strangers to the trust receive or apply trust property for their own use and benefit. In this case, the bank received the trust funds for its own use and benefit when it applied the deposit of insurance premiums as a set-off against the parent company's overdraft. The bank's argument that it could not be liable on the basis of “knowing receipt,” because it had not received trust property but had simply transferred credits from one account to another, was without merit. A debt obligation is a chose in action, and, therefore, property over which one can impose a trust. The receipt requirement for liability on the basis of “knowing receipt” is best characterized in restitutionary terms. The bank was enriched at the insurer's expense. Thus, in restitutionary terms, there could be no doubt that the bank received trust property for its own use and benefit. The second requirement for establishing liability on the basis of “knowing receipt” relates to the degree of knowledge required of the bank in relation to the breach of trust. The distinction between the two categories of liability, “knowing assistance” and “knowing receipt”, is fundamental: whereas the accessory's liability is “fault-based,” the recipient's liability is “receipt-based.” Given the fundamental distinction between the nature of liability in assistance and receipt cases, it makes sense to require a different threshold of knowledge for each category of liability. In “knowing assistance” cases, which are concerned with the furtherance of fraud, a higher threshold of knowledge is required of the stranger to the trust, and constructive knowledge is excluded as the basis for liability. In “knowing receipt” cases, which are concerned with the receipt of trust property for one's own benefit, there should be a lower threshold of knowledge required of the stranger to the trust. More is expected of the recipient, who, unlike the accessory, is necessarily enriched at the plaintiff's expense. Because the recipient is held to this higher standard, constructive knowledge (that is, knowledge of facts sufficient to put a reasonable person on notice or inquiry) will suffice as the basis for restitutionary liability. This lower threshold of knowledge is sufficient to establish the “unjust” or “unjustified” nature of the recipient's enrichment, thereby entitling the plaintiff to a restitutionary remedy. In “knowing receipt” cases, relief flows from the breach of a legally recognized duty of inquiry. Relief will be granted where a stranger to the trust, having received trust property for his or her own benefit and having knowledge of facts which would put a reasonable person on inquiry, actually fails to inquire as to the possible misapplication of trust property. It is this lack of inquiry that renders the recipient's enrichment unjust. Section 206(1) of the Bank Act, which negates any duty on the part of a bank to see to the execution of any trust to which a deposit is subject, does not render a bank immune from liability as a constructive trustee or prevent the recognition of a duty of inquiry on the part of a bank. In certain circumstances, a bank's knowledge of its customer's affairs will require it to make inquiries as to the possible misapplication of trust funds. The degree of knowledge required is constructive knowledge of a possible breach of trust. The bank should have inquired whether the use of the premiums to reduce the account overdrafts constituted a breach of trust. By failing to make the appropriate inquiries, the bank had constructive knowledge of the agent's breach of trust. In these circumstances, the bank's enrichment was clearly unjust, thereby rendering it liable to the insurer as a constructive trustee. Where the original property has been mixed with other property or where it has been converted into another form of property, then the rules of tracing may allow the beneficiary’s claim to survive the mixing of the property. The stranger’s liability depends on the beneficiary having an ownership interest in an identifiable and traceable item of property that is recognized by the law of property or the law of unjust enrichment. Where there is a breach of an equitable duty, such as a breach of trust or fiduciary duty, and the beneficiary’s property, in its original or converted form, comes into the possession of a stranger who is not a bona fide purchaser for value, or has no equitable defense, then the stranger may be obliged to restore the property to the beneficiary. It is a fundamental rule of the law of property that an equitable title is good against the world except for a bona fide purchaser for value without actual or constructive notice of the equitable interest. Equity will then assist the beneficiary in reclaiming the identifiable property , and will assist the beneficiary in retaking any property that has been acquired by conversion or substitution for the property being pursued. Where property cannot be restored to the beneficiary, the doctrine of unjust enrichment may instead substitute a compensatory remedy where money is substituted for the property. The Courts have the power to order the defendant to pay compensation, or to instead declare that the defendant holds specific property as a constructive trustee for the plaintiff. Further, it is a rule of tracing that where the beneficiary’s property is mixed with the property of a stranger who had notice of the beneficiary’s claim, then the stranger has the burden of proving what proportion of the property is free of the claim. However, if the stranger is a “volunteer”, who is not a bona fide purchaser for value, but who had no notice of the plaintiff’s claim, then the burden is on the beneficiary to prove what portion of the mixed property is derived from the breach. If the plaintiff is unable to so, then generally speaking there will be an equal sharing between the beneficiary and the stranger. Donovan Waters, The Law of Trusts In Canada, pp. 1051-1052. 11. QUESTIONS TO ASK
12. CONCLUSION Constructive trust concepts have been with us for over two hundred years, and have recently become muck more common place in virtually all areas of law where equity may play a role. Several recent Supreme Court of Canada cases have breathed new life into these long established equitable principles to the point now that they have gained prominence as the “remedies of choice” to obtain favourable plaintiff results. The re-establishment of “good conscience” will significantly help expand these remedies into more and more notoriety. |
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