#3555 - Quitsclose Trusts - Trusts and Equity

QUITSCLOSE TRUSTS

• Definition – in some circumstances where money has been lent to the borrower for particular purpose, he’ll hold it on trust for the lender. This enables the lender to convert the debt into a trust & avoid becoming an unsecured creditor in case of borrower’s insolvency.

• A makes a loan for particular purpose to B + B holds on it trust for A

• Parallel/Alternatives in Contract

1. Romalpa clause – a contractual provision enabling the titleholder to retain common law rights in the property which remain his @ both common law & equity, unless it becomes mixed w/other property as to be indistinguishable, leaving only rights in equity for C. Retention of title under Romalpa clause would prevent another party to contract from passing good title to TP under nemodat principle.

2. A pledge – the owner of property parts w/ possession of the property by delivering it to a secured party w/out giving him the right to deal w/it as though he’s the absolute owner. The secured party is prevented from doing so until its proprietary rights crystallise thus vesting almost absolute title in him, at which point he becomes entitled to sell the pledged asset to make good the counterparty’s failure in performance of the principal contract.

• Nature of QuitscloseTrust

• It’s unconscionable for a man to obtain money w/terms as to its application & then disregard them - such conduct goes beyond mere breach of contract. Thus, duty isn’t contractual but fiduciary: it may exist despite absence of contract b/w parties &binds them as in Quitsclose. It’s fiduciary in character b/c a person who makes money available on terms that it’s to be used for a particular purpose places his trust & confidence in the recipient to ensure it is properly applied. Since the relationship arises in respect of a specific fund, it gives rise to a trust.

1. General Principle

• Barclays Bank v Quitsclose Investments – Rolls Razor was a company in serious financial difficulties whi had exceeded its overdraft w/Barclays; it declared a dividend on its shares but didn’t have resources to pay this, so approached Quitsclose for a loan which it agreed to provide on condition that a separate bank acc is set up into which money would be paid + money to be used only to pay off the dividend. However, b/f dividend was paid, RR went into liquidation &Quitsclose sought to recover money lent. Barclays opposed it, claiming a right of set off, enabling them to apply the money in reduction of overdraft sum owed to them by RR. Held money was held on RT for Quitsclose thus couldn’t use it to offset the debt of RR.

Lord Wilberforce: the mutual intention of Quitsclose& RR and the essence of the bargain was that the sum shouldn’t become part of general assets of RR but be used exclusively for payment of particular class of creditors. Necessary consequence of this must be that if, for any reason, dividend couldn’t be paid, the money should be returned to Q (words “only” & “exclusively” can’t have any other meaning). Arrangement of this character gives rise to a relationship of fiduciary character or an ordinary trust in favour, as a primary trust, of creditors, and, if the primary trust fails, of the third person. When the money is advanced, the lender acquires an equitable right to see that it’s applied for primary designated purpose and, when it’s carried out, lender has a remedy against the borrower in debt. If purpose can’t be carried out, question arises as to whether secondary purpose (i.e. repayment to lender) has been agreed expressly or by implication – if it has, remedies of equity may be invoked to give effect to it.

So 2 questions

1. Whether terms upon which the loan was made were such as to impress upon the money a trust in lender’s favour, in the event the dividend wasn’t paid?

2. Whether, in that event, the bank had such notice of the trust or circs giving rise to it as to make the trust binding upon it? (notice must be had when bank received the money)

• Webb: 3 issues

  1. Whilst secondary trust is clear (arose in favour of the lender), primary trust is more mysterious

  1. A trust in favour of shareholders entitled to payment of the dividend - but, if this was so, unclear why it should be viewed as having failed in order to enable Quitsclose to recover.

  2. A purpose trust (to pay the dividend) – but how to reconcile it w/general prohibition of non charitable purpose trusts & beneficiary principle

  3. On either view, there’s no trust for the lender until primary trust fails but then what’s the nature & basis of lender’s equitable right to see that borrower spends money as stipulated?

• The fact that it was a loan didn’t prevent a trust being imposed upon the money – no reason why flexible interplay of law & equity can’t let in these practical arrangements and it would be a discredit to both systems if it were otherwise.

• NB: Wilberforce refers to primary & secondary trust instead of RT but perhaps RT is what he had in mind.

2. Preceding Debt

• Carreras Rothmans v Freeman Matthews Treasure - manufacturer of tobacco put money aside in an account to cover advertiser’s liabilities to media creditors; when advertiser went insolvent, creditors sued, manufacturer paid & took assignment of the action, then sought to declare money was held on trust for it. A trust was found. Peter Gibson LJ:the objective was to protect interests & rights of P &TPs. Equity fastens on the conscience of the person who receives from another property transferred for specific purpose so that hewon’t be permitted to treat it as his own/use it for other than the stated purpose. C here could be equated w/ lender in Quitsclose as having an enforceable right to compel the carrying out of the primary trust. NB: he analysed it as a purpose trust - A transferred to B but not beneficially + settlor has a right to enforce the carrying out of the purpose + beneficiaries of the purpose may have rights too.

• Suggested that persons intended to receive the money from the borrower had a right to enforce the arrangement which seems to suggest that primary trust was indeed a trust in their favour as Bs

3. Loan Paid – Purpose not Achieved

• RE EVTR – money lent to EVTR for sole purpose of purchasing machinery, asset leasing agreement entered into b/fmachinery was bought, EVTR went insolvent & equipment couldn’t be delivered. Creditors claimed it as part of general assets. Held it was held on trust for original lender. Bingham LJ: it would strike most people as very hard if C was confined to a claim as unsecured creditor of the company. The object of payment wasn’t achieved and that’s why the balance was repaid to respondents. Although no analogous case exists, it’s clear that the company held the fund on trust at 1^st instance. The purpose for which the fund was paid out partially failed. The repayment to respondent was a direct result of company’s original holding of the funds as trustee. The balance which was recovered may reasonably be regarded as not having been paid out at all.

• B/c money was loaned for purpose of buying equipment, there was nobody was in a position analogous to RR shareholders or someone who could be said to be Bs or at least have a right to enforce a primary trust

• Twinsectra Ltd v Yardley – Yardley wanted to purchase land and needed to borrow money to do this. Twinsectra agreed to loan it & paid the money to a solicitors firm, Sims, acting for T, who gave an undertaking that it would be used solely for the purpose of acquiring property for Y & that it would be retained until it was so used. S then paid money over to another solicitor acting for T, who paid it over to Y, w/out taking steps to ensure money is used only for that purpose, and Y didn’t use some of it in that way. Loan wasn’t repaid & T sued the solicitor + others on the basis of dishonest assistance in breach of trust. For claim to succeed, it needed to establish that S held the money on trust.

Lord Millett: difficulty in explaining Quitsclose trusts has always been in:

1. the nature of primary trust

2. location of beneficial interest prior to failure of purpose for which the money was lent

1. borrower couldn’t be beneficially entitled to the money since this would be inconsistent w/lender having any right to recover it in event of borrower’s insolvency

• Chambers & Ho and Smart disagree

2. money couldn’t be held on trust for those ultimately due to receive it b/c there wasn’t always identifiable people in that position (e.g. loan for equipment/acquiring property)

3. money couldn’t be held on purpose trust w/beneficial interest being in suspense b/c this was conceptually impossible – where no provision was made for the interest, it would revert back to transferor on RT

4. only possibility beneficial interest was vested throughout in the lender, meaning that the borrower holds it on trust for him throughout but also has a power or, depending on the agreement terms, a duty to apply money for stipulated purpose. As beneficiary of the trust, lender can restrain the borrower from using it for any other purpose & recover the money even where it may still be used for stipulated purpose, as in Quitsclose. If borrower uses it for stipulated purpose, the lender has a contractual right to repayment. If the borrower misapplies it, the lender can follow & claim money from TP recipients, as long as they aren’t BF purchasers for value w/out notice.

• explains Wilberforce’s statement that lender had an equitable right to enforce the arrangement even b/f purpose had failed

• accounts...