Reclaiming funds following fraud

How can victims of fraud trace and claim monies they paid into an investment scheme which later became fraudulent? Ian Wilson and Pia Dutton, both barristers at 3 Verulam Buildings, discuss the Chancellor’s guidance on the means and mechanisms by which such monies should be recovered in his decision in the case of the National Crime Agency v Robb.

Original news

National Crime Agency v Robb [2014] EWHC 4384 (Ch), [2015] All ER (D) 39 (Jan)

Following frauds committed by the defendant, the Chancery Division made rulings on whether and how the lead claimants would be able to recover sums paid to him.

What was decided in this case?

A group of investors sought a declaration under the Proceeds of Crime Act 2002, s 281 (POCA 2002) that they had a proprietary claim to a fund in which they had invested as a result of a conspiracy to commit fraud.

After absconding to the Turkish Republic of Northern Cyprus during a drugs trial in 1997, the defendant established a property investment scheme in concert with a company called Aga Developments Ltd (the company), through which he amassed in excess of £3m from over 150 investors.

On 17 September 2009, Walker J made a property freezing order in respect of the funds pursuant to POCA 2002, s 245A. That order was extended by an order of Mackay J on 30 March 2012. Mackay J found that the investment scheme, although not intended to be fraudulent from the outset, became intentionally fraudulent as from 1 February 2005.

There were three key issues:

• whether certain investors (the claimants) had a proprietary claim to the frozen fund
• whether the claimants were entitled to any part of the fund to which they were unable to trace their investment payments
• whether the claimants’ share in the fund increased by virtue of other investors not having made claims under POCA, s 281

The Chancellor, Sir Terence Etherton, gave judgment for the claimants and held as follows:

• the claimants could establish a proprietary claim to part of the fund in one of two possible ways: either by virtue of constructive trust, or alternatively, by rescission. Accordingly, the claimants could trace money into the fund, and it was appropriate to adopt a pro rata approach to how the fund should be divided as between investors (applying Barlow Clowes International Ltd (in liq) and others v Vaughan and others [1992] 4 All ER 22)
• it could not be seriously argued, however, that the claimants were entitled to funds which did not directly or indirectly derive from money paid by them
• monies which were not claimed back by those investors who chose not to claim for rescission of their contracts were to be treated as dissipated and not part of the recoverable sums

In relation to the proprietary claim, the Chancellor held that the claimants might recover by virtue of a ‘fraud constructive trust’ or alternatively by a ‘rescission trust’. The fraud constructive trust would have arisen from the time that payments were made to the company and/or Mr Robb at a time when there was fraudulent intent (ie from any time after 1 February 2005). An immediate trust would arise as soon as monies were paid out. The rescission trust was said to arise, at the very latest, when the claimants joined the proceedings. Their transactions were then said to be rescinded and payments or traceable proceeds were held on trust for them.

The Chancellor drew support for the ‘fraud constructive trust’ from Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669, at 716, where Lord Browne-Wilkinson held that stolen monies are traceable in equity. The Chancellor, however, noted the difficulty with this analysis—ie of imposing a constructive trust in circumstances where the victim retains legal title and the relevant goods are still identifiable. He concluded that the judicial and academic consensus appears to be that where a transaction is voidable for fraud, as opposed to void, the fraudster acquires legal and beneficial title to the victim’s property which reverts on rescission, and not before. Prior to the point of rescission therefore the victim’s power to rescind ‘constitutes a mere equity’ (para [44]). Rescission occurs at the point where the innocent party clearly indicates that he or she is rescinding the contract (Car and Universal Finance Ltd v Caldwell [1965] 1 QB 525, [1964] 1 All ER 290).

The difficult question that then arose was whether the transaction is voidable for fraud even where not induced by fraud but is supervened by fraudulent action at a later stage. The Chancellor concluded:

‘…there are good policy reasons for enabling a victim of fraud, which supervenes in a transaction, to set aside the transaction so as to pursue a proprietary claim even though that will have priority over other unsecured creditors of the fraudster or of any other person who has received traceable proceeds.’ (para [51])

With regards to the tracing of the monies paid in by the claimants, nine possible routes were identified for how such monies ended up in the fund. The rules on tracing recoverable property are set down in of POCA 2002, ss 304–307 and 308(1). These rules, the Chancellor held, broadly mirrored those of law and equity. There are no similar provisions for tracing with regards to a declaration sought under POCA 2002, s 281. Accordingly, the Chancellor applied ordinary principles of law to show that part of the fund belonged to the claimants (para [56]).

The Chancellor further held that the claimants were only entitled to such sums which ‘derived directly or indirectly from money paid by them’ (para [70]). To hold otherwise would mean that:

‘…the State would never be able to recover under Pt 5 of POCA any part of a fund which was obtained by fraud, and in part of which victims of the fraud can establish a proprietary interest under s 281, if the Claimants would be left out of pocket, irrespective of whether the balance of the fund was in fact derived from their payments or not.’ (para [70])

What is the significance of this case?

The case is significant because the Chancellor gave clear guidance on the means and mechanism by which victims of fraud may trace monies paid out either induced by, or superseded by fraud, by virtue of POCA 2002, s 281.

The judgment also contains a helpful statement of principle to the effect that a proprietary claim exists even in circumstances where the fraud is not present at the point of entering into a transaction. Arguably, the case expands the boundaries of a claim for proprietary restitution and the circumstances in which a constructive trust can be imposed. Indeed, it is the first case in which a constructive trust, as opposed to a resulting trust, has been held to arise on rescission of the transaction.

What is the impact for practitioners and future civil recovery proceedings?

On a practical level, the case illustrates the potential importance of opting in to group actions for rescission of transactions superseded by fraud. At a directions hearing in May 2014, Chief Master Marsh set a deadline for joining the proceedings. The Chancellor subsequently held that the investors who did not elect to join the proceedings had not rescinded their agreements. Accordingly, those funds were assumed to have been dissipated first as an extension to the principle in Barlow Clowes. Practitioners should, therefore, be conscious of advising clients who have the opportunity to opt into such multi-party actions that their rights may be curtailed if they do not react promptly.

Interviewed by Barbara Bergin.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.