TWINSECTRA LTD v YARDLEY

Penelope Reed looks at where the law now stands on Quitclose trusts and knowing assistance
for breaches of trust
(taken from Issue No 20 –  July 2002

Background
The recent decision of the House of Lords in Twinsectra Ltd. v Yardley and others
1gave their Lordships the opportunity to clarify two very troubled and quite different areas of the law of trusts. The first was the nature of a Quistclose trust2, and the case undoubtedly introduces some clarity into this area. The second, quite distinct issue which their Lordships had to decide was the test of dishonesty required in relation to what has over the years become known as `knowing assistance`. In that area, the law has certainly been clarified, but somewhat unfortunately perhaps it is the strong dissenting judgement of Lord Millett which appears to reach the right result.

The Facts
In essence the salient facts for the purposes of understanding the decision are as follows. Twinsectra decided to make a loan of £1,000,000 to a property developer known as Mr. Yardley. In fact it was decided that the loan would be paid to a Mr. Sims who was a solicitor associated with Mr. Yardley and personally indebted to him. He was not in fact acting as solicitor to Mr. Yardley in the transaction. That role fell to a Mr. Leach.

The loan was made to Mr. Sims on his giving the following undertaking:-

1.     The loan monies would be retained by his firm until such time as they were applied in the acquisition of property on behalf of their client (Mr. Yardley)

2.     The loan monies would be utilised solely for the acquisition of property on behalf of Mr. Yardley (again described as the `client`) and for no other purposes

3.     He would repay the sum of £1,000,000 together with interest.

Mr. Sims did not comply with his undertaking and paid the monies over to Mr. Leach, the solicitor acting for Mr. Yardley. Mr. Leach in turn paid the monies over to Mr. Yardley, only part of which was used to acquire property. When the loan was not repaid, Twinsectra sued everyone in sight, and joined Mr. Leach on the basis that Mr. Sims had been in breach of trust in paying the monies over to him in breach of his undertaking, and Mr. Leach in turn was liable as having dishonestly assisted in that breach of trust.

The Course of the Action
Carnwath J at first instance did not accept that there was any trust imposed on Mr. Sims. Consequently he did not find there to have been a breach of trust, and therefore knowing assistance did not arise. Although it was not strictly necessary for him to decide the point, he did decide that Mr. Leach had not been dishonest.

The Court of Appeal came to a different conclusion. Their Lordships held that the undertaking did create a trust, and that Mr. Leach had been dishonest.

The House of Lords held unanimously that the undertaking created a Quistclosetrust. However, the majority considered that Carnwath J’s finding that Mr. Leach had not been dishonest should not be disturbed.

Quistclose Trusts
Ever since the House of Lords decision in Quistclose Investments Ltd. v Rolls Razor Ltd, debate has raged in academic circles as to the nature of this type of trust. The case itself involved a loan made to a company on the express condition that it would be used only to pay a dividend which the company had already declared. It was held that in such a case a trust arose. Lord Wilberforce said
3:-

`That arrangements of this character for the payment of a person’s creditors by a third person, give rise to a relationship of a fiduciary character or trust, in favour, as a primary trust, of the creditors, and secondarily, if the primary trust fails, of the third person, has been recognised in a series of cases over some 150 years`

Carnwath J rejected a trust in the Twinsectra case because, first of all he did not consider that the terms of the undertaking were sufficiently clear to create a trust (in particular the reference to `property` was too uncertain) and secondly that Twinsectra did not intend to create a trust. All the Law Lords rejected those arguments as the Court of Appeal had done before them. The undertaking did make it clear that the monies paid to Mr. Sims were only to be used for a specific purpose, and it was entirely irrelevant what those controlling Twinsectra had in mind-everything depended on the construction of the undertaking as to whether it created a trust or not.

Lord Millett however, went further than merely to reject the reasons why a trust was not created and analysed the very nature of the Quistclose trust. Lord Wilberforce saw the trust (as is apparent from the quotation set out above) in two parts: a primary trust for payment to identifiable beneficiaries (i.e. creditors, as in many of the old cases; or shareholders as in Quistclose) with a secondary trust in favour of the lender if the purpose should fail.

It is however, difficult to fit the facts of Twinsectra within that analysis. The monies were not of course lent to Mr. Yardley so that he could pay them to identified beneficiaries. They were lent to him so that he could purchase properties. In such a case where is the beneficial interest in the monies pending the fulfilment of the purpose, or the failure of the trusts?

Lord Millett suggested that there were four possibilities:-

  1. the lender
  2. the borrower
  3. the contemplated beneficiary
  4. in suspense.

He plumped for the first option. The second option which would involve the borrower being free to dispose of the monies as he wished would defeat the whole arrangement which was designed to ensure that the monies were only used for a specific purpose. The third option meant that trusts for a specific abstract purpose, rather than for identified persons would not fall within the rule and there was no good reason for that distinction. As for the fourth option he described the result as `unorthodox` and looked to the law of resulting trust to fill the gap. In other words, equity does not allow a beneficial interest to be in suspense and will impose a resulting trust to the lender.

Lord Millett concluded by stating:-

`As Sherlock Homes reminded Dr. Watson, when you have eliminated the impossible, whatever remains, however improbable, must be the truth. I would reject all the alternative analyses, which I find unconvincing for the reasons I have endeavoured to explain, and hold the Quistclose trust to be an entirely orthodox example of the kind of default trust known as a resulting trust. The lender pays the money to the borrower by way of loan, but he does not part with the entire beneficial interest in the money and insofar as he does not it is held on resulting trust for the lender from the outset`.

It is an interesting point as to whether a resulting trust can really arise where the beneficial interest never leaves the lender or whether perhaps it is better described as an express bare trust with certain rights in the borrower to use the money for a specific purpose4. However, this is really to start the `rose by any other name argument` and it is unlikely to be of any great importance in practice.

Dishonesty
The majority of their Lordships held that the Court of Appeal was wrong to consider that Mr. Leach was dishonest when Carnwath J had made a specific finding that he was not. Everything turned on what `dishonest` meant.

It had been established in the Privy Council case of Royal Brunei Airlines Sdn Bhd v Tan5 that dishonesty was a necessary ingredient in establishing liability for knowing assistance in a breach of trust. What is more Lord Nicholls there set out the test of dishonesty in an opinion which Lord Millett described as `magisterial`6.

What is undoubtedly unfortunate is that while all their Lordships were content to rely on the opinion of Lord Nicholls in the Royal Brunei Airlines case, and adopt his test for dishonesty, they could not agree on what he meant.

The most convenient starting point in their Lordships’ speeches is that of Lord Hutton who identified three possible standards which could be applied in seeing if someone had been dishonest:-

  1. The purely subjective or `Robin Hood` standard, which only characterises a person as dishonest if he transgresses his own standard of honesty. Therefore robbery from the rich to pay the poor did not offend Robin Hood’s standards of honesty and therefore according to this test he could not be regarded as dishonest.
  2. The purely objective standard whereby a person will be dishonest if his conduct is dishonest by the ordinary standards of reasonable and honest people.
  3. A combined objective/subjective test, which requires a finding that the Defendant’s conduct was dishonest by objective standards and he realised that his conduct was dishonest.

Lord Hutton considered that Lord Nicholls had propounded the combined test, which required both the Defendant’s conduct to fall short of what honest and reasonable people would regard as honest and also the Defendant to appreciate that was the case.

Lord Hoffman agreed with the analysis of Lord Hutton. He said7:-

`[Those principles] require a dishonest state of mind, that is to say, consciousness that one is transgressing ordinary standards of honest behaviour.`

However, a careful reading of Lord Nicholls in Royal Brunei Airlines does not, at least at first sight appear to support the conclusions of Lords Hutton and Hoffman. Having distinguished the approach taken in some criminal cases8 where the combined approach was adopted, he said:-

`..in the context of the accessory liability principle acting dishonestly, or with lack of probity, which is synonymous, means simply not acting as an honest person would in the circumstances. This is an objective standard. At first sight this may seem surprising. Honesty has a connotation of subjectivity, as distinct from the objectivity of negligence. Honesty does indeed have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a persons actually knew at the time as distinct from what a reasonable person would have known or appreciated, Further, honesty and its counterpart dishonesty are mostly concerned with advertent conduct and not inadvertent conduct. Carelessness is not dishonesty, thus for the most part dishonesty is to be equated with conscious impropriety. However, these subjective characteristics of honesty do not mean that individuals are free to set their own standards of honest in particular circumstances.`

While Lord Nicholls clearly recognised that there was a subjective element in dishonesty, he does not seem to adumbrate the combined test whereby the Defendant has to know that his conduct breaches the standards by which reasonable and honest people would judge honesty. Instead the subjective element involves looking at what the Defendant knew and what he intended to do.

This was the line taken by Lord Millett and he stressed that Lord Nicholls’ comments all go to the conduct of the Defendant and not his state of mind. He also pointed out that on the facts of Royal Brunei Airlines (the controlling mind behind a company was found to have dishonestly assisted in a breach of trust by his company when it applied monies which it held on trust for improper purposes) there was no evidence that the Defendant knew that his conduct was dishonest by other people’s standards. It was enough that he had caused or permitted the company to apply monies in a way which he knew was not authorised by the trust. That of course is applying an objective standard albeit with some subjective elements, such as what the Defendant knew, but not the combined test.

Conclusions
The following points emerge from the Twinsectra decision which will have considerable importance in this area where equity meets the commercial world:-

1. Where a lender lends monies on condition that they are to be applied for a specific purpose, those monies will be held on resulting trust for the lender subject to the right of the borrower to apply them for the specified purpose;

2. In order to establish liability on the part of a Defendant for the now misnamed `knowing assistance` it must be shown not only that the Defendant acted in a manner which objectively fell short of the standard of honesty which reasonable and honest people would maintain, but also that the Defendant knew that his actions had fallen short of that standard.

Bearing in mind how difficult it can be to prove state of mind, the decision is good news for anyone accused of knowing assistance in a breach of trust, but bad news for anyone attempting to establish liability.

Penelope Reed
Barrister
5 Stone Buildings
Lincoln’s Inn

1 [2002] UKHL 12
2 See: Quistclose Investments Ltd. v Rolls Razor Ltd. [1970] AC 567
3 at page 580
4 See Alistair Speirs `Escape from the Tangled Web` Newcastle Law School Working Papers 2002/01, available on http://www.ncl.ac.uk/
5 [1995] 2 AC 378
6 [2002] UKHL 12, para 113
7 [2002] UKHL 12, para 20
8 he referred to Reg. v Ghosh [1982] QB 1053