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From: The Law of Tracing in Commercial Transactions

Magda Raczynska

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 07 June 2023

Property and title and choice of law — Interests and terminology and transfer of title — Passing of property

(p. 1) Introduction

Intro.01  Tracing gives rise to fundamental issues of property, power, and authority. The basic question is whether a person who has a claim in relation to one asset can assert the same or the same sort of claim in another (new) asset which is linked in some way to the first (initial). The most important practical application of tracing is to support the assertion of proprietary rights in the new asset. For example, where B wrongfully sells A’s car, which was deposited for repair at B’s garage, and uses the proceeds to buy a painting, A may wish to claim that she owns the painting. The ability to claim the new asset is particularly advantageous if asserting A’s original right in the car against the buyer is not workable and B is insolvent; a merely personal claim against B for wrongfully taking the car is unlikely to be met in full, while a proprietary right binds B’s insolvency officers.

Intro.02  The law of tracing has been developed by courts primarily with respect to claims brought by legal owners and trust beneficiaries to proceeds of wrongful misappropriation of assets, which were initially held or managed for claimants by others.1 It is not clear to what extent, and on what basis, proprietary interests in new assets can be asserted by those holding proprietary interests other than absolute or beneficial ownership, that is, interests such as security interests or title-based interests created under a contract of sale with retention-of-title clause, hire-purchase or lease agreement. There has been surprisingly little judicial and academic consideration of the area and the little there has been2 is unclear.3 This is unfortunate because, first, it generates unnecessary uncertainties and risks for commercial parties in practice, and second, it obscures the understanding of the law of tracing in this area and its relationship with property law. This book seeks to provide responses to those problems. On a practical level, it identifies the circumstances in which a holder of a security interest and a title-based interest may assert a proprietary claim to new assets which are derived from those in which the interest was initially held. It shows that there are some similarities between the approach taken by courts in the context of security interests in the Court of Appeal decision (p. 2) in Buhr v Barclays Bank4 and that taken by the majority in the Foskett v McKeown case in relation to trust beneficiaries’ claims to traceable proceeds of unauthorized dispositions.5 It is not however, generally appreciated that the analysis in Buhr can be read as suggesting that a secured creditor has a much wider right than a trust beneficiary: an automatic right to substitutes and accretions, fundamentally a form of ‘a super-tracing right’ to any new asset deriving from the original. In relation to title-based interests, courts at times seem to have taken a similarly broad approach, although contracts seeking to confer property rights to new assets on the financier have generally been construed against the financiers. This book argues that such ‘a super-tracing right’ has no basis in authority and principle, and is not justifiable; just because a person holds a proprietary interest in an initial asset does not mean that they will hold a proprietary interest in a new asset that derives in some way from the original. Instead, to establish whether such a right exists, it is necessary to take into account the contract and the structure of the proprietary interests created. On a theoretical level, the book provides a framework for asserting proprietary rights in new assets. In so doing, it proposes a new model of proprietary interests based on concepts of power and authority: power to dispose of the interest in the initial asset.

Intro.03  The new analysis of the relevant proprietary interests as conferring power and authority and its impact of this new analysis on tracing could make a difference to practical results. In Menelaou v Bank of Cyprus 6 the secured creditor (a bank) agreed to the release its security interest subject to a new security being created over a different asset. The fresh security was not validly provided. The Supreme Court held that the secured creditor was subrogated to an unpaid seller’s lien in the released loan money paid to discharge the vendor. The complex reasoning could likely be made simpler if the bank’s release of the first security interest were considered to be unauthorized, even though it conferred a power on the chargor to release it.7

What does tracing in commercial transactions mean?

Intro.04  This book considers the law of tracing in the context of the key forms of proprietary interests created consensually in commercial transactions. These interests are the retention of title by suppliers of goods under a contract of sale of goods with a (p. 3) retention-of-title clause8 and the holding of title under hire-purchase agreement, or lease (‘title-based interests’), as well as consensual security interests, of which pledge, charge, and mortgage are the most important. Security interests and title-based interests are not confined to companies or unincorporated businesses but they are very common between such parties, and discussion of the issues in this book is with commercial parties in mind.

Intro.05  In practice, the primary context in which such proprietary interests are used is that of asset finance. Unlike security interests, title-based interests have developed outside the context of providing a security function, so their legal structure is based on other transactions. In the case of the contract of sale with retention-of-title clause, the basic transaction from which it developed is the contract of sale, that is, a transaction whose primary objective is to transfer property to another for a price. In the case of hire-purchase or lease agreement, the underlying basic transaction is deposit of goods with another with a power to use. While title-based interests did not develop in order to secure performance of obligations, their economic effect is similar to that of security interests.9 Both security interests and proprietary interests confer on their holders rights exercisable against an asset, which are enforceable against third parties. The idea that the rights could be asserted in another asset which constitutes traceable proceeds of the initial asset is therefore potentially very important, particularly where rights in the initial assets have become lost.

Intro.06  The concept of tracing is controversial and ambiguous. Courts and commentators use the term ‘tracing’ in two different senses. In one sense, ‘tracing’ describes circumstances in which a person who holds a proprietary interest in one asset obtains, by operation of law, a proprietary interest in another asset for which it has been substituted.10 This understanding of tracing indicates that a person obtains a proprietary interest in the substitute if the court considers that that the initial asset has been dealt with in an unauthorized way, and to the extent that the court considers the new asset to constitute a substitute for the initial asset.11 In another sense, ‘tracing’ refers to the process of identifying a new asset as linked in some way to the initial asset, separate from claiming it. Identification of new assets is seen as a purely evidential process, not compatible with the notion that rules of evidence might be different at law and in equity.12 Thus, the fact that an (p. 4) asset has been identified as the traceable proceeds of another (initial) asset does not mean that the person who held a proprietary right in the initial asset will also hold a proprietary right in the new asset. The conceptual separation of the processes of identifying assets and claiming, solidified in the seminal work of Professor Lionel Smith, The Law of Tracing,13 has been adopted by courts.14 In the oft-cited dictum in Foskett v McKeown Lord Millett said:

Tracing is merely the process by which a claimant demonstrates what has happened to his property, identifies its proceeds and the persons who have handled or received them, and justifies his claim that the proceeds can properly be regarded as representing his property. Tracing is also distinct from claiming. It enables the claimant to substitute the traceable proceeds for the original asset as the subject matter of his claim. But it does not affect or establish his claim. That will depend on a number of factors including the nature of his interest in the original asset. He will normally be able to maintain the same claim to the substituted asset as he could have maintained to the original asset.15

This book takes the description of ‘tracing’ set out by Lord Millett at the start of the passage just quoted as a working description, namely that tracing is ‘a process by which the claimant demonstrates what has happened to his property’, which is separate from asserting an interest. ‘His property’ is understood to mean a proprietary interest in the initial asset while ‘proceeds’ later in that sentence refers to the new asset, a possible substitute. Adoption of such a definition means that tracing refers to the process of derivation of new assets from the initial asset, encompassing not only proceeds of disposition, whether authorized or unauthorized, but also products and any fruits or income. It is not common to give Lord Millett’s definition such a wide reading but it is useful to do so in order to better understand the issues in this area. The broad reading requires, however, conceptual separation of the process of identifying an asset and claiming it.

Intro.07  What is called here ‘tracing’ could well be labelled using a different word, for example, ‘derivation’. The word tracing could then be employed to describe the process of generating proceeds of unauthorized dispositions, which is how it is currently used by some. On that view, tracing would be part of a wider concept of derivation.

Why is tracing in commercial transactions important?

Intro.08  Security interests and title-based interests in commercial transactions facilitate provision of credit, and so the pursuit of various activities and exploitation of (p. 5) resources, which would otherwise not be possible. This helps businesses flourish economically. The key advantages from the perspective of the credit-provider who holds a security interests or a title-based interest rests in the right to discharge the debtor’s obligation by exercising rights and powers over the asset which are enforceable against third parties and, crucially, against the insolvency officers of the credit-taker. The rights and powers cannot be asserted unless there is an asset with respect to which it can be asserted.

Intro.09  During the currency of the parties’ relationship various events might affect the subject matter of the proprietary interest. Some of those events lead to creation of new assets without affecting the proprietary right in the asset in which the right was originally created, for example when leased ewes give birth to new sheep, while other events may lead to loss of the proprietary interest. For instance, a proprietary interest held in fibre is extinguished when the fibre is manufactured into a carpet. It may also be extinguished if property in the asset in which it is held is disposed of to an innocent third party. Of particular practical concern, for obvious reasons, are those events which potentially lead to loss of proprietary interests. The holder of a proprietary interest can be protected from losing the powerful advantage in the other party’s insolvency if provided with a proprietary interest in an asset which is linked to (or derived from) the asset originally subject to the proprietary interest. This is where tracing becomes particularly important to the holders of security interests or title-based interests, but even where there is no loss of proprietary interest in the asset in which it was originally created, tracing remains of relevance.

The structure of the book

Intro.10  This book is organized around three goals. The first is to show, at a more general level, the structure of the proprietary interest selected to be examined here and of proprietary claims to derived assets. The second is to examine, at a practical level, the extent to which the holders of security interests and title-based interests can claim proprietary protection when the proprietary interest in the original subject matter was destroyed, but rendered new assets in relation to which the proprietary protection can be asserted. The new, derived assets are grouped in three categories of proceeds, products, or fruits (income). The third objective is to consider the shape of the ‘best’ default rule in a legal system that would govern proprietary claims to derived assets using basic law and economics and comparative law analysis. Most of the book is then the pursuit of the first two goals. This is done by identifying the proprietary interest discussed in this book and their structure (Chapter 1), examination of the ways in which those proprietary interests are lost (Chapter 2), discussion of ways in which new assets can derive from other assets (Chapter 3), analysis of the law to find out the default rules governing proprietary interests in derived assets outside contract and outside misapplication (p. 6) of assets (Chapter 4), analysis of the issues with contracts that provide for proprietary interests in derived assets (Chapter 5) and the outline of issues in relation to proprietary claims to derived assets where the originally held asset was misapplied (Chapter 6). The quest for the third goal is confined to the last chapter, which will see comparisons with key aspects of the relevant provision under Article 9 of the Uniform Commercial Code and arguments based on basic economic efficiency analysis.


1  See e.g. Taylor v Plumer (1815) 3 M&S 562; Re Hallett’s Estate (1880) LR 13 Ch D 696 (CA); Banque Belge pour l’Etranger v Hambrouck [1921] 1 KB 321 (CA); Re Diplock [1948] Ch 465 (CA); Agip (Africa) v Jackson [1990] Ch 265 (CA); Lipkin Gorman v Karpnale [1991] 2 AC 548 (HL); Foskett v McKeown [2001] 1 AC 102 (HL).

2  Buhr v Barclays Bank Plc [2001] EWCA Civ 1223.

3  Menelaou v Bank of Cyprus Plc [2015] UKSC 66 [53] (Lord Clarke); and see [2013] EWCA Civ 1960 [51] (Floyd LJ).

4  Buhr v Barclays Bank Plc [2001] EWCA Civ 1223.

5  Foskett v McKeown [2001] 1 AC 102 (HL).

6  [2015] UKSC 66.

7  At first instance David Donaldson QC (sitting as Deputy High Court Judge) held that the transaction on the facts was authorized because the bank agreed to release of the security: [2012] EWHC 1991 [15]. For that reason, the analogy with Buhr v Barclays Bank Plc [2001] EWCA Civ 1223 was rejected. There is also discussion of Buhr on appeal but it is less clear why the analogy is rejected: [2014] 1 WLR 854 [51] (Floyd LJ). There is a suggestion that the fact that the transaction was not authorized was not essential to the decision in Buhr. If that is so, it should strengthen the position of the bank, not weaken its claim to traceable proceeds, but Floyd LJ rejected this.

8  A contract of supply of goods under which title is retained but which does not constitute a contract of sale of goods (e.g. the contract in PST 7 Shipping LLC v OW Bunker Malta [2016] UKSC 23) are not of particular interest here since the proprietary interest retained in the assets is, by the nature of the contract short-lived, as goods are consumed.

9  L Gullifer (ed), Goode and Gullifer on Legal Problems of Credit and Security (6th edn, Sweet & Maxwell 2017) paras 1-04, 3-05.

10  R Calnan, Proprietary Rights and Insolvency (2nd edn, OUP 2015) para 7.03.

11  Ibid, paras 7.05–7.04.

12  P Birks, ‘The Necessity of a Unitary Law of Tracing’ in R Cranston (ed), Making Commercial Law, Essays in Honour of Roy Goode (OUP 1997) 239, 257: ‘[a unified regime of tracing] allows tracing to be cleanly separated from the business of asserting rights in or in relation to assets successfully traced’.

13  L Smith, The Law of Tracing (OUP 1997), see in particular 120–30, 277–79, and 342–47.

14  See e.g. Foskett v McKeown [2001] 1 AC 102 (HL) 113 (Lord Steyn): ‘in truth tracing is a process of identifying assets: it belongs to the realm of evidence’ and 127–28 (Lord Millett); Boscawen v Bajwa [1996] 1 WLR 328, 334 (Lord Millett); Triffit Nurseries (a Firm) v Salads Etcetera Ltd (in administrative receivership) [2001] BCC 457 (CA) 462 (Robert Walker LJ): ‘Basically following is the process of identifying property; tracing involves one or more substitutions’; Ultraframe v Fielding [2005] EWHC 1638 [1464] (Lewison J).

15  Foskett v McKeown [2001] 1 AC 102 (HL) 128.