Tracing - Pauline Action

Tracing - Pauline Action

In Re The Esteem Settlement and The Number 52 Trust
Royal Court of Jersey - 17 January 2002

Brief facts

The Royal Court has given judgment on preliminary issues arising out of the longstanding litigation brought by Grupo Torras SA ("GT"), a company owned by the Kuwaiti Investment Office, against two Jersey trusts following frauds perpetrated by Sheikh Fahad and others between May 1988 and October 1990. The preliminary issues related to proprietary claims by GT over certain assets of the two trusts and
an allegation that transfers made by Sheikh Fahad to the trusts after the frauds began in 1988 were made with the intent of defeating creditors (what is known as the "Pauline Action").

The hearing gave the Royal Court the opportunity, with the benefit of full argument, to clarify the law in Jersey in relation to tracing and to develop and clarify the parameters of the Pauline Action.

Tracing claim

The Royal Court confirmed that the victim of a fraud has an equitable proprietary interest in the proceeds of the fraud and that Jersey law does permit tracing to assets into which the proceeds have been converted.

English rules of tracing were taken as a starting point but the Royal Court declined to follow the rule in Clayton's Case (first in, first out) preferring the alternative apportionment method used in the United States and Canada.

Where the proceeds had been expended on improving property owned by an innocent volunteer, the claimant can trace into the increased value of the property which is attributable to those funds. In so finding, the Royal Court declined to follow Re Diplock 1948 (AER 318).

As to defences the Royal Court held that, in principle, the claimant's equitable title is defeated and the right to trace is lost either in whole or in part if it were to be inequitable to allow the claimant to trace. The Royal Court observed that as suggested by Goff and Jones in The Law of Restitution 5th Edition, this is probably a different way of saying a change of position defence is available in tracing claims as it is in relation to restitutionary claims based on unjust enrichment.

In so far as remedies were concerned, the Royal Court found there is no insurmountable difficulty under Jersey law in fashioning remedies to ensure that effect can be given to a tracing claim including the imposition of an equitable charge.

On the facts, the Royal Court allowed GT to trace into two properties owned by the Jersey trusts.

Restitutionary claim

As an alternative to its tracing claim, GT brought a claim in restitution based on unjust enrichment. The Royal Court declined to follow English law under which no claim lies against a recipient unless he has been at fault in some way. The Royal Court held that under Jersey law, where property in respect of which a person (in this case GT) has an equitable proprietary interest (because property has been taken from GT by a person who is in a fiduciary position towards GT, ie Sheikh Fahad) is received by an innocent volunteer (in this case the trustee), GT has a personal claim in restitution against the trustee even where the trustee has not been guilty of any "fault" in receiving the property. It is a strict restitutionary liability based on unjust enrichment and accordingly, GT can only succeed to the extent that the trustee remains unjustly enriched. The trustee is not a constructive trustee for GT, and a change of position defence is therefore available.

Pauline Action

Following the case of Golder -v- Société de Magasins Concorde Ltd 1967 JJ 721, the Royal Court confirmed that Jersey law recognises an ability, in certain circumstances, to set aside a transfer undertaken in fraud of creditors, but clarified the parameters of the Pauline Action as follows:-

(i) The debt of the creditor must precede the transfer in question.

(ii) A person becomes a creditor when the facts giving rise to his cause of action occur.

(iii) The debtor must be insolvent at the time of the transfer or rendered insolvent by it. The plaintiff must establish insolvency at the date the Pauline Action is commenced with the burden then shifting to those seeking to uphold the transfer to prove solvency at the time of the transfer or as a result of the transfer. A broad common sense approach to the issue of insolvency must be taken. The Royal Court must be satisfied that there is a close connection in time and effect between the transfer and the subsequent insolvency.

(iv) It was assumed by the parties and accepted by the Royal Court that solvency was to be measured by the balance sheet test, although no argument was heard as to whether a cash flow test might have been more appropriate. GT's submission that inalienable, difficult to distrain or concealed assets should be excluded from the test was rejected by the Royal Court.

(v) There are two types of transfer to be considered: the first "lucrative" is where no consideration is given and where it is only necessary for the debtor to have an intention to defeat his creditor. The second "onereuse" is where there is
consideration commensurate and proportionate to the thing transferred, and where both the debtor and the recipient must have an intention to defeat the creditor.

(vi) It must be shown that the transfer in question was undertaken by the debtor with the intention (object) of defeating his creditor. There is no need for that intention to be the dominant purpose - it is sufficient for it to be a substantial purpose of the transfer.

(vii) The Pauline Action is a revocatory action and the creditor is not entitled to compensation from an innocent recipient beyond the enrichment which the  recipient still enjoys.

(viii) The limitation period for bringing a Pauline Action is 10 years from the time the creditor learns of the existence of the transfer in question.

On the facts, the Royal Court set aside transfers made by Sheikh Fahad to the Jersey trusts between March 1990 and September 1992, but adjourned the case to hear further argument on continuing unjust enrichment and in so doing reminded the parties of the essential rule that a claim under a Pauline action as with the law of unjust enrichment should not make an innocent recipient worse off as a result of the transfer than he would have been had these transfers not
happened.

About Ogier

Ogier is a professional services firm with the knowledge and expertise to handle the most demanding and complex transactions and provide expert, efficient and cost-effective services to all our clients. We regularly win awards for the quality of our client service, our work and our people.

Disclaimer

This client briefing has been prepared for clients and professional associates of Ogier. The information and expressions of opinion which it contains are not intended to be a comprehensive study or to provide legal advice and should not be treated as a substitute for specific advice concerning individual situations.

Regulatory information can be found under Legal Notice