Trusts are a fundamental component of equity law, designed to manage assets for the benefit of specific beneficiaries. Among the various types of trusts, constructive trusts are particularly complex and involve intricate legal principles, especially when it comes to third-party liability in cases of breach. This article delves into the nuances of constructive trusts and explores the circumstances under which third parties may be held liable for losses incurred by beneficiaries due to a breach of trust.

Constructive Trusts: An Overview

Constructive trusts are not formed by a formal agreement but are imposed by law to prevent unjust enrichment or fraud. They are often created when someone wrongfully possesses property that should belong to someone else. This type of trust ensures that the person who has been wronged, receives the property or its equivalent value.

A key area of concern in the realm of constructive trusts is the liability of third parties—those who are neither trustees nor fiduciaries—when they assist in or benefit from a breach of trust. The complexity arises from determining the extent of their knowledge and the role they played in the misappropriation of trust assets.

Third-Party Liability: Dishonest Assistance

One of the primary bases for holding a third party liable in cases of breach of trust is “dishonest assistance.” This doctrine applies to individuals who knowingly assist in a breach of trust, even if they never had possession or control of the trust property.

The landmark case Royal Brunei Airlines Sdn Bhd v Tan established the criteria for dishonest assistance. The court ruled that for a person to be held liable, three elements must be satisfied:

  1. Breach of Trust: There must be an initial breach of trust.
  2. Assistance in the Breach: The defendant must have assisted in this breach.
  3. Dishonesty: The defendant must have acted dishonestly.

Interestingly, the standard for dishonesty is objective. It is determined based on what a reasonable person would consider dishonest under the circumstances, rather than the defendant’s own perception of their actions. Subsequent cases, such as Twinsectra Ltd v Yardley and Dubai Aluminium v Salaam, have refined this test but maintained the emphasis on an objective standard.

The Case of Paul: An Example of Dishonest Assistance

Consider the example of Paul, a bank branch manager who allowed Robin, an agent managing finances for a principal, Oldbooks, to transfer funds from Oldbooks’ account into his own. Despite knowing about Robin’s financial troubles and previous misappropriations, Paul did not intervene or inquire further, allowing the transaction to proceed.

Applying the principles from Royal Brunei, Paul could be deemed a constructive trustee due to his dishonest assistance. He knew enough to be suspicious, but chose not to act, demonstrating a conscious disregard for the potential misuse of trust funds. Courts have held that such willful blindness can satisfy the dishonesty requirement, thus making Paul liable for any losses suffered by the beneficiaries of the trust.

Knowing Receipt: Another Avenue for Liability

Apart from dishonest assistance, third parties can also be held liable under the doctrine of “knowing receipt.” This concept applies when someone receives trust property, knowing it was transferred in breach of trust.

For liability under knowing receipt to be established, three conditions must be met:

  1. Disposal of Assets in Breach of Trust: The property must be disposed of in a way that breaches a trust or fiduciary duty.
  2. Beneficial Receipt: The defendant must receive some benefit from the transferred property.
  3. Knowledge of the Breach: The defendant must know or have reasons to suspect that the property was transferred in breach of trust.

If we consider the case of the bank managed by Paul, it could also be held liable for knowing receipt. If Paul, as the branch manager, is considered the “directing mind” of the bank, his knowledge and actions can be attributed to the bank itself. Thus, if Paul knew or should have known about the misuse of the funds, the bank could also face liability for failing to act on this knowledge.

Corporate Liability and the Role of Employees

The role of employees in corporate liability cases under trust law is another complex issue. As seen in Polly Peck International v Nadir (No 2) and MT Realisations Ltd v Digital Equipment Co Ltd, companies can be held liable for the actions of their employees if those employees are deemed to be the “directing mind” of the company.

In trust law, if an employee like Paul, acting within the scope of his employment, assists in a breach of trust or fails to act on suspicious transactions, the company may be held accountable for these actions under the principle of vicarious liability.

Conclusion: The Evolving Landscape of Trust Law

Trust law, particularly concerning constructive trusts and third-party liability, is a continually evolving field. Courts strive to balance the principles of fairness and justice, ensuring that beneficiaries are protected from losses due to breaches of trust while also recognizing the limits of liability for third parties who may not fully understand the implications of their actions.

As the cases discussed illustrate, the application of doctrines such as dishonest assistance and knowing receipt requires careful analysis of the facts and the extent of each party’s knowledge and actions. The law imposes a duty of honesty and reasonable conduct on all individuals and entities dealing with trust property, reinforcing the importance of acting with integrity in all fiduciary relationships.

Ioannis A. Pitsillos, LLB, MBA is Advocate – Partner at Polycarpos Philippou & Associates LLC (www.philippoulaw.com)