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Virgo, Graham --- "Judicial discretion in Private Law" [2016] OtaLawRw 4; (2016) 14 Otago LR 257

Last Updated: 12 January 2018



Judicial Discretion in Private Law

Professor Graham Virgo*

This article concerns the nature of legal cultures in New Zealand and England. Finn J has said, specifically of the legal culture in England and Australia (but New Zealand could be included as well), that there are “differing casts of mind, distinctive methodologies and markedly different contexts”.1 To some extent he is right. Certainly, since Australia and New Zealand abolished appeals to the Privy Council, the Australian and New Zealand legal systems have inevitably become distinct from English law. There has, however, been an important riposte to Finn J’s analysis of legal culture, as identified by Lord Neuberger in the UK Supreme Court where he said:2

As overseas countries secede from the jurisdiction of the Privy Council, it is inevitable that inconsistencies in the common law will develop between different jurisdictions. However, it seems to us highly desirable for all those jurisdictions to learn from each other, and at least to lean in favour of harmonising the development of the common law round the world.

It is in that spirit of seeking to learn from each other, and even seeking some degree of harmonisation, that this article examines the role of judicial discretion with particular reference to the defence of illegality and to the constructive trust, areas which betray at times significant divergence in New Zealand and England, but perhaps showing signs of increasing convergence.

Although a matter of gross simplification and caricature, the New Zealand judiciary, and legal commentators, appear much more content about the legitimacy of the exercise of judicial discretion than judges and commentators in England. This is reflected in the recognition of the remedial constructive trust and the explicitly discretionary approach to illegality in New Zealand as a consequence of s 7 of the Illegal Contracts Act 1970, by virtue of which the court may grant to any party to an illegal contract:

... such relief by way of restitution, compensation, variation of the contract, validation of the contract in whole or part or for any particular purpose, or otherwise howsoever as the court in its discretion thinks just.

In England, the approach to illegality has been rule–based and the remedial constructive trust has not been recognised. But this caricature

* Professor of English Private Law, University of Cambridge. A version of this article was presented at the “Law of Obligations: Issues in Restitution Symposium” held at the Faculty of Law, University of Otago in August

2016.

1 P Finn “Common Law Divergences” (2013) 37 MULR 509 at 511.

2 FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC

45, [2015] AC 250 at [45]. See also Patel v Mirza [2016] UKSC 42, [2016] 3

WLR 399 at [183] per Lord Neuberger: “... it is desirable, if not always

achievable, that all common law jurisdictions adopt the same approach”.


of English legal culture is increasingly open to challenge with recent private law decisions of the UK Supreme Court betraying fundamental divisions amongst the Justices about the legitimacy of judicial discretion. Two factions have emerged which, superficially at least, can be characterised as the anti– and pro–discretion camps. On one side are those Justices who wish to adopt a rule–based approach; one which is founded on reason, logic and the rule of law. For these Justices predictability of result is vital and the uncertainty of judicial discretion makes it unacceptable; they tend to come from the commercial practice tradition. The other faction appears more concerned with the desire to reach the just result on the facts by resorting to the exercise of judicial discretion. The identification of these factions is, however, an unsophisticated caricature. The reality is more complex and subtle, although it is clear that some Justices are more comfortable with the notion of judicial discretion than others. This article argues for a different approach. By focusing on what judicial discretion actually means, it is possible to reconcile rule and discretion. This middle way provides a structured solution for two of the most difficult private law problems which have faced the Supreme Court in the last two years, namely how the defence of illegality should operate and whether the remedial constructive trust should ever be recognised in English law.

The different approaches to judicial discretion can be illustrated by a range of Supreme Court authorities. The zenith of the rule–based approach, at least in contemporary private law jurisprudence, is the decision in FHR European Ventures Ltd v Cedar Capital Partners LLC, where the Supreme Court rejected the remedial constructive trust in English law, with its discretionary connotations, in favour of a rule–based institutional constructive trust, which arises by operation of law with no moderating role for judicial discretion.3 At the other extreme is the decision in Pitt v Holt, concerning the equitable jurisdiction to rescind a voluntary disposition for mistake.4 Lord Walker held that the equitable jurisdiction would be engaged if the mistake was sufficiently serious5 so that the assertion of the legal rights of donees under the deed would be unjust or unconscionable.6 This “unconscionableness”, as Lord Walker called it, is to be evaluated objectively,7 and requires close examination of the facts, including “the circumstances of the mistake and its consequences for the person who made the vitiated disposition”, change of position, and “other matters relevant to the exercise of the court’s discretion”.8

Lord Walker used the language of “unconscionableness” interchangeably with that of “injustice” and “unfairness”.9 This appears to turn simply

3 At [47] per Lord Neuberger.

4 Pitt v Holt [2013] UKSC 26, [2013] 2 AC 108.

5 At [114].

6 At [124].

7 At [125].

8 At [126].

9 At [126].


upon the exercise of judicial discretion without regard to any obvious underlying principles. Lord Walker rejected the suggestion that this is “susceptible to judicial manipulation” on the ground that the court ought to form a judgment about the justice of the case.10 On the facts of Pitt v Holt a deed was rescinded even though the mistake related to a liability to pay tax. A matter of particular significance was that the disposition did not form part of an artificial or abusive tax avoidance scheme and, indeed, had been authorised by the Court of Protection. Had the equitable jurisdiction been invoked in the consolidated appeal in Futter v Futter, which also involved a disposition to a trust, it is likely that the donee’s receipt would not have been characterised as unconscionable because the disposition formed part of an artificial tax avoidance scheme.11 Lord Walker described such schemes as “a social evil” and emphasised that the court might refuse to award equitable discretionary relief on the ground of public policy,12 suggesting that there are moral questions which need to be examined by the court in determining unconscionability. This is a fundamentally different approach to the rigidity of the Supreme Court subsequently in FHR, which also concerned the equitable jurisdiction, albeit in the context of breach of fiduciary duty.

1 What is discretion?

The language of judicial discretion appears to allow for the judge to secure what he or she considers to be the just result with reference to the particular facts of the case.

But the consequent lack of certainty and predictability has been a cause of concern. In Doe v Kersey in 1795 Lord Camden said:13

The discretion of a Judge is the law of tyrants; it is always unknown; it is different in different men; it is casual, and depends upon constitution, in temper and passion. In the best it is often times caprice; in the worst it is every vice, folly and passion to which human nature is liable.

This view was similarly reflected in Birks’s reasons for rejecting the

remedial constructive trust. He said:14

The law of remedies is not exempt from the demands of certainty and predictability: nor is the law as a whole intellectually respectable if, even at the level of remedies, it takes refuge in an inscrutable case to case empiricism. Practising lawyers need to be able to advise their clients as to the likely results of litigation. The judges on whom these results

10 C Mitchell, P Mitchell and S Watterson (eds) Goff and Jones: The Law of Unjust Enrichment (8th ed, Sweet & Maxwell, London, 2011) at [9–41] as cited in Pitt v Holt, above n 4, at [127].

11 Futter v Futter [2011] EWCA Civ 197, [2012] Ch 132. This had not been invoked initially and the Supreme Court refused to permit the appellants to raise it on appeal.

12 Pitt v Holt, above n 4, at [135].

13 Doe v Kersey (1795) (CP), quoted in Bower’s Law Dictionary (1839).

14 P Birks “The Remedies for Abuse of Confidential Information” [1990]

LMCLQ 460 at 465.


depend need the insulation from personal criticism which only objectively ascertainable rules and principles can provide.

But this simple equation of judicial discretion with arbitrary choice lacks sophistication. In an important and helpful analysis HLA Hart argued that discretion is fundamentally different from arbitrary choice: discretion by its nature is guided by rational principles, so that a decision which is not susceptible to principled justification is not an exercise of discretion at all but simply an arbitrary choice, and it is this which should be considered to be contrary to the rule of law.15 Hart rejected arbitrary choice as a basis for judicial decision–making. He was right to do so. Judges must, by virtue of their office, act judicially and not arbitrarily, but this does not prevent them from exercising discretion as long as that exercise can be justified by reference to recognised principles. The key question will then be what principles might be identified. This will depend on the particular body of law which is being considered.

This analysis of discretion identifies a basis for the recognition of a middle way between the operation of strict rules on the one hand and arbitrary choice, which is dependent on careful assessment of the facts, on the other. That model requires the identification of a rule which can then be modified by the application of recognised principles as determined by the particular facts of the case. It is this model which can provide the solution to the disagreement about the operation of the illegality defence and might be deployed to resolve the long–standing controversy as to whether the remedial constructive trust should be recognised in English law.

2 Illegality

Confusion about the operation of the illegality defence runs throughout the law of obligations in English law.16 The defence of illegality is formulated as a rule. It applies in the form of the maxim ex turpi causa non oritur actio (“no action can arise from a base cause”), meaning that the courts will not assist a claimant to obtain a remedy where the action is founded on illegal conduct.17 It is influenced by external considerations of public policy rather than securing justice between the parties.18


15 HLA Hart “Discretion” (2013) 127(2) Harv L Rev 652 (written in 1956 but

published posthumously).

16 For tort see G Virgo “Illegality’s Role in the Law of Tort” in M Dyson

(ed) Unravelling Tort and Crime (Cambridge University Press, Cambridge,

2014) 174. For unjust enrichment see G Virgo “The Defence of Illegality

in Unjust Enrichment” in A Dyson, J Goudkamp and F Wilmot–Smith

(eds) Defences in Unjust Enrichment (Hart Publishing, Oxford, 2016) 165.

17 Holman v Johnson [1775] EngR 58; (1775) 1 Cowp 341 at 343, per Lord Mansfield. See also

Muckleston v Brown [1801] EngR 241; (1801) 6 Ves Jun 52 at 69, per Lord Eldon LC.

18 Hounga v Allen [2014] UKSC 47, [2014] ICR 847 at [42] per Lord Wilson and

[55] per Lord Hughes; Les Laboratoires Servier v Apotex Inc [2014] UKSC

55, [2015] AC 430 at [13] per Lord Sumption.


As Lord Goff said in Tinsley v Milligan:19

...it is a principle of policy, whose application is indiscriminate and so can lead to unfair consequences as between the parties to litigation. Moreover the principle allows no room for the exercise of any discretion by the court in favour of one party or the other.

In Les Laboratoires Servier v Apotex Inc, Lord Sumption emphasised that the defence was not based “on the perceived balance of merits between the parties to any particular dispute”,20 thus squarely placing it within the external relationship between the court and the claimant,21 rather than the internal relationship between the claimant and the defendant.

But where the effect of rendering the claim unenforceable is wholly out of proportion to the illegal behaviour, “most people’s moral instincts”’ would be that the defence should not apply, such as where the illegality is minor or the defendant is more responsible than the claimant for participation in the illegal transaction.22 It was for this reason that the judiciary sought to temper the strict rule to secure justice. For a few years in the 1980s this was achieved through the reformulation of the illegality defence by reference to the public conscience test, whereby the defence would only be applied if the public conscience would be affronted if relief was granted. This test originated in Thackwell v Barclays Bank Plc, where an action for conversion failed by virtue of the illegality defence, but only after the court had considered all the circumstances of the case, including the nature of the illegality, to determine whether granting a remedy to the claimant would be seen to be indirectly assisting or encouraging his criminal act.23 A remedy was eventually denied because the claimant had been a knowing party to a fraudulent transaction. The public conscience test was, however, rejected by the House of Lords in Tinsley v Milligan,24 on the grounds that it was inconsistent with previous authority and that it would replace a principled system of rules with a discretionary balancing operation.25

The rejection of the public conscience test was surely correct. The application of the test resulted in inconsistent decisions,26 often turning on judicial outrage arising from the facts of the case.27 Justice is dependent on a high degree of predictability, which is lacking under

19 Tinsley v Milligan [1993] UKHL 3; [1994] 1 AC 340 at 355.

20 Les Laboratoires Servier v Apotex Inc [2014] UKSC 55, [2015] AC 430 at [13].

21 See Hounga v Allen [2014] UKSC 47, [2014] ICR 847 at [56] per Lord Hughes.

22 Lord Sumption “Reflections on the Law of Illegality” [2012] RLR 1 at 2.

23 Thackwell v Barclays Bank Plc [1986] 1 All ER 676. See also Saunders v

Edwards [1987] 1 WLR 1116; Howard v Shirlstar Container Transport Ltd

[1990] 1 WLR 1292 and Euro–Diam Ltd v Bathurst [1990] 1 QB 1.

24 Tinsley v Milligan [1993] UKHL 3; [1994] AC 340.

25 At 358–361 per Lord Goff and 363–364 and 369 per Lord Browne–

Wilkinson.

26 At 363 per Lord Goff.

27 Hewison v Meridian Shipping Services Pte Ltd [2002] EWCA Civ 1821, [2003]

ICR 766 at 788–789 per Ward LJ.


the public conscience test. But, even though subsequent cases have not resurrected the test, there remains a clear judicial desire to temper the rigidity of the ex turpi causa rule to avoid unjust results. But the ex turpi causa rule was never absolute; it has always been qualified. The flexibility of the rule was implicit in Lord Mansfield’s judgment in Holman v Johnson where he said:28

It is on that ground the Court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff. So if the plaintiff and defendant were to change sides, and the defendant was to bring his action against the plaintiff, the latter would then have the advantage of it; for where both are equally in fault, potior est conditio defendentis.

It is the recognition of this other principle, known as the in pari delicto est conditio defendentis defence (“in the case of mutual fault, the position of the defendant is the stronger one”), in pari delicto for short, that provides an important mechanism for qualifying the ex turpi causa defence. This in pari delicto principle enables the court to analyse the particular circumstances of the case to determine whether the claimant is less responsible for the illegality than the defendant, for then, as between them, the just result is that the claimant should not be denied relief, since the parties are not in pari delicto. But where the claimant is more responsible for the illegality or the parties are considered to be equally responsible, the in pari delicto principle applies and the claim will fail.

This balanced approach to illegality has not been recognised consistently in recent decisions of the Supreme Court. In Les Laboratoires Servier v Apotex Inc,29 although the Supreme Court held that a claim for damages should succeed on the ground that the illegality defence was not engaged on the facts, the Justices’ judgments reflected a fundamental division of approach.30 The Court of Appeal had approached the defence on the basis that:31

... what is required in each case isan intense analysis of the particular facts and of the proper application of the various policy considerations underlying the illegality principle so as to produce a just and proportionate response to the illegality.

This approach was specifically rejected by Lord Sumption, with whom Lords Neuberger and Clarke agreed. Lord Sumption emphasised that the defence was grounded on general rules of law and was not a mere discretionary power, involving fact–based evaluations of the effect of the rules in individual cases.32 He considered the only key issues to be

28 Holman v Johnson [1775] EngR 58; (1775) 1 Cowp 341 at 343.

29 Les Laboratoires Servier v Apotex Inc [2014] UKSC 55, [2015] AC 430.

30 Described by Lord Sumption as a “long–standing schism”: Patel v Mirza

[2016] UKSC 42, [2016] 3 WLR 399 at [226].

31 Les Laboratoires Servier v Apotex Inc [2012] EWCA Civ 593, [2013] Bus LR

80 at [75] per Etherton LJ.

32 Les Laboratoires Servier v Apotex Inc [2014] UKSC 55, [2015] AC 430 at [13]

and [22]. See also the judgment of Lord Mance.


whether the relevant conduct involved sufficient turpitude and whether this was sufficiently related to the claim.33

This strict approach to illegality can be contrasted with that of Lord Toulson in the same case, who refused to criticise the approach of the Court of Appeal and who considered that, when determining whether the illegality defence should apply, “it is right to proceed carefully on a case by case basis, considering the policies which underlie the broad principle”.34 This is also the approach which was adopted by a differently constituted Supreme Court in the earlier decision of Hounga v Allen.35

That Court held that a claim in tort for race discrimination,36 following wrongful dismissal from employment, succeeded, even though the claimant was an illegal immigrant who knew that it was illegal to work in the UK. This had been sufficient for the Court of Appeal to dismiss her claim. But the Supreme Court considered that the illegality defence was not engaged, explicitly for policy reasons. Crucially, Lord Wilson said, in the judgment of the majority, that it was necessary, first, to ask “[w]hat is the aspect of public policy which founds the defence?” and, second, “[b]ut is there another aspect of public policy to which application of the defence would run counter?”37 Lord Hughes, with whose judgment Lord Carnwath agreed, emphasised that in assessing what public policy requires, it is necessary to have regard to various factors, including the gravity of the illegality and the claimant’s knowledge of it.38

Subsequently in Jetivia SA v Bilta (UK) Ltd, the disagreement between the Justices was reinforced, with Lord Sumption again emphasising the rule–based interpretation and Lords Toulson and Hodge the policy–based, context–dependent interpretation of the defence.39 Lord Neuberger, with whom Lords Clarke, Carnwath and Mance agreed, identified the disagreement but refused to resolve it, preferring the matter to be considered as soon as appropriately possible and preferably by a panel of nine Justices.40 Lord Neuberger summarised the spectrum of views as “epitomising the familiar tension between the need for principle, clarity and certainty in the law with the equally important desire to achieve a fair and appropriate result in each case”, or, in other words,

33 At [22].

34 At [57]. See also Gray v Thames Trains Ltd [2009] UKHL 33, [2009] 1 AC

1339 at [30] per Lord Hoffmann; Stone and Rolls Ltd v Moore Stephens [2009]

UKHL 39[2009] UKHL 39; , [2009] 1 AC 1391 at [25] per Lord Phillips.

35 Hounga v Allen [2014] UKSC 47, [2014] ICR 847. The decision of the majority

in Hounga was considered to provide “the best guidance on the relevant

analytical framework” by Sales LJ in Best v The Chief Land Registrar [2015]

EWCA Civ 17 at [51].

36 Contrary to the Race Relations Act 1976, s 4(2)(c). See now the Equality

Act 2010, s 39(2)(c).

37 Hounga v Allen [2014] UKSC 47, [2014] ICR 847 at [42]. Baroness Hale and

Lord Kerr agreed.

38 At [55].

39 Jetivia SA v Bilta (UK) Ltd [2015] UKSC 23, [2015] 2 WLR 1168.

40 At [14].


rule versus what might be considered to be arbitrary choice.41

A nine–panel Supreme Court resolved this disagreement finally in Patel v Mirza.42 The Court of Appeal had held that the defence of illegality was inapplicable on the facts involving a claim in unjust enrichment for payment made on a basis which had failed completely.43

The Respondent had transferred £620,000 to the Appellant, a City trader who had suggested the scheme, so that the Appellant could use the money to bet on share price movements based on inside information. Such insider dealing is a crime under Part V of the Criminal Justice Act 1993. The inside information was not forthcoming and so the agreement was not carried out. The Respondent sought restitution of the money paid on the ground that the Appellant had been unjustly enriched at his expense, the ground of restitution being that the basis for the transfer had failed totally.

The trial judge had dismissed the restitutionary claim on the basis that the illegality barred the Court from granting any remedy. This was rejected by the Court of Appeal. The majority, Rimer and Vos LJJ, did so on the ground that the Respondent had sufficiently withdrawn from the illegal transaction, even though he had not repented of the illegality nor acted voluntarily, but withdrawal could be established simply because the scheme had been frustrated once it was clear that the information would not be provided. Gloster LJ agreed that the illegality defence was not engaged, but considered that this was because the illegality was collateral and not an essential ingredient of the restitutionary claim, in that it was not necessary for the Respondent to rely on the illegality to establish the claim, since he only needed to show that the money had been paid for a purpose which had failed and this did not require any reference to the terms of the contract, including the agreement to exploit inside information.44 Rimer and Vos LJJ disagreed with this latter point, concluding that the Respondent had relied on the agreement and its frustration in his pleadings, but also that he needed to rely on the illegality to establish that the agreement was no longer operating. Consequently, he could not keep “the illegal cat secure in the bag”.45 This did not, however, defeat the claim because of his withdrawal which removed the taint of illegality.

In the Supreme Court the nine Justices unanimously held that the Respondent should recover the money he had paid to the Appellant. The general approach of the Supreme Court was that it was appropriate to return the parties to the status quo ante despite the illegality of the transaction because, as Lord Sumption recognised, “an order for restitution would not give effect to the illegal act or to any right derived

41 At [13].

42 Patel v Mirza [2016] UKSC 42, [2016] 3 WLR 399.

43 Patel v Mirza [2014] EWCA Civ 1047, [2015] Ch 271.

44 At [78]–[93].

45 At [22] per Rimer LJ.


from it”.46 It follows that there is very little role for the defence of illegality in the law of restitution, since the courts will be willing to unwind the transaction because the claimant will not profit from it. Illegality will be much more significant within the law of contract, since the courts will typically not enforce an illegal transaction. The role of illegality in the law of tort is more controversial, but it is likely that it too will not have a significant impact where the claimant is compensated for harm suffered because, again, this does not involve profiting from the illegality.

But just below the surface of this apparent consensus, the continuing tensions between rule versus discretion are easy to identify. On this issue the Justices split six to three, with the majority preferring a ‘range of factors’ approach to that of a strict rule, and so appear to have opted for a discretionary approach to respond to illegality. This was reflected in the leading judgment of Lord Toulson, with whom Lady Hale and Lords Kerr, Wilson and Hodge agreed. The ratio of the case is as follows:47

... one cannot judge whether allowing a claim which is in some way tainted by illegality would be contrary to the public interest, because it would be harmful to the integrity of the legal system, without a) considering the underlying purpose of the prohibition which has been transgressed, b) considering conversely any other relevant public policies which may be rendered ineffective or less effective by denial of the claim, and c) keeping in mind the possibility of overkill unless the law is applied with a due sense of proportionality. We are, after all, in the area of public policy. That trio of necessary considerations can be found in the case law.

These “trio of considerations” involve examination of the reason for making the conduct illegal, identification of the policies which would be adversely affected by denying the claim, and proportionality. Whilst on their face these considerations may seem clear, they are subject to significant uncertainty. This was exacerbated by Lord Kerr who, whilst purporting to deliver a concurring judgment, interpreted consideration (a) to mean “the reasons that a claimant’s conduct should operate to bar him or her from a remedy which would otherwise be available”.48

But this is significantly different from determining the policy underpinning the illegality. Lord Toulson said that various factors will be relevant to determine whether it is disproportionate to refuse relief, although he did not consider that it was possible to produce a definitive list because of the infinite variety of cases which might raise illegality. Factors he identified include the seriousness of the conduct, its centrality to any contract, whether the conduct was intentional and whether there was a marked disparity in the parties’ respective culpability.

This “trio of considerations” was identified as discretionary and the approach to illegality which is adopted in New Zealand and Australia was specifically identified in support. Lord Kerr considered it to be a “structured approach to a hitherto intractable problem [that would]

46 Patel v Mirza [2016] UKSC 42, [2016] 3 WLR 399 at [268].

47 At [101] per Lord Toulson. See also [120].

48 At [124].


promote rather than detract from consistency in the law”.49 But for Lords Sumption, Clarke and Mance the basket of factors approach was rejected for reasons of uncertainty, with Lord Mance describing it as “highly unspecific” and “non–legal”,50 and Lord Clarke as converting “a legal principle into an exercise of judicial discretion”51 and close to reviving the public conscience test.52 Lord Sumption considered the majority’s test to be:53

... far too vague and potentially far too wide to serve as the basis on which a person may be denied his legal rights. It converts a legal principle into an exercise of judicial discretion, in the process exhibiting all the vices of

‘complexity, uncertainty, arbitrariness and lack of transparency’ which

Lord Toulson attributes to the present law.

Lord Toulson responded as follows. First, he considered the law already to be doctrinally riven with uncertainties. Secondly, he emphasised that uncertainty did not appear to be a problem in other jurisdictions which have adopted a relatively flexible approach to the illegality defence.54

Thirdly, he considered that the absence of certainty was not a relevant consideration when dealing with people who were contemplating unlawful activity. A similar view was expressed by Lord Kerr who said:55

Certainty or predictability of outcome may be a laudable aim for those who seek the law’s resolution of genuine, honest disputes. It is not a premium to which those engaged in disreputable conduct can claim automatic entitlement.

Lord Toulson did not consider that the framework he was proposing would mean that:56

... the court is free to decide a case in an undisciplined way. The public interest is best served by a principled and transparent assessment of the considerations identified, rather than by the application of a formal approach capable of producing results which may appear arbitrary, unjust or disproportionate.

The effect of applying the “trio of considerations” to the facts of the case was that the Respondent’s participation in the illegality did not bar the claim for restitution. It appears that this will normally be the case once the elements of an unjust enrichment claim have been satisfied, although Lord Toulson acknowledged that there might be rare cases where the circumstances of the illegality were such that the court should refuse its

49 At [123].

50 At [206].

51 At [217].

52 At [219].

53 At [265].

54 Lord Mance specifically said, at [207], that the court had no idea or

information about whether the approach adopted in New Zealand and

Australia had “proved unproblematic for the profession or the courts”.

55 At [137].

56 At [120].


assistance to the claimant.57 Lord Kerr considered the facts more carefully. He balanced the wrongful retention of the money by the Appellant against the Respondent’s illegality in entering into the transaction. He emphasised the importance of adopting a rounded assessment of the various public policy considerations at stake rather than simply returning the parties to their original position.

Lord Neuberger adopted a more nuanced approach. He identified a

‘Rule’ within the law of unjust enrichment by virtue of which the claimant

is entitled to the return of money paid despite the taint of illegality, even

where the contemplated illegal activity has been performed in whole or

in part. He considered this Rule to be applicable to any contract where

the illegality would prevent the court from being able to order specific

performance or award damages for breach.58 Although Lord Neuberger

considered that the Rule would establish a “degree of clarity and

certainty”59 he went on to adopt Lord Toulson’s “trio of considerations”

to determine how the illegality defence should operate. He considered

this to be a structured approach which was not akin to the exercise of

judicial discretion and which provided the best guidance which could be

offered. He considered that it was consistent with the approach adopted

in Australia and Canada. Significantly he said:60

Once a judge is required to take into account a significant number of relevant factors, and the question of how much weight to give each of them is a matter for the judge, the difference between judgment and discretion is, I think, in practice pretty slight.

But does this not collapse discretion into arbitrary choice such that all his good work in developing the Rule and focusing on the need for certainty and clarity is dissipated? He continued to emphasise that the “trio of considerations” created a structured approach which was not akin in practice to a discretion, but he was using “discretion” in a pejorative sense and, in that sense, that is exactly what the “trio of considerations” becomes.

Lords Clarke, Mance and Sumption on the other hand adopted a narrow but much more focused approach to illegality. For Lord Mance it was important for the court to recognise:61

... a limited approach to the effect of illegality, focused on the need to avoid inconsistency in the law, without depriving claimants of the opportunity to obtain damages for wrongs or to put themselves in the position in which they should have been.

But it is the approach adopted by Lord Sumption which draws out

most significantly the difference between the minority and the majority.

57 At [116].

58 At [159].

59 At [157].

60 At [173].

61 At [192].


He said:62

When the law of illegality is looked at as a whole, it is apparent that although governed by rules of law, a considerable measure of flexibility is inherent in those rules. In particular, they are qualified by principled exceptions for (i) cases in which the parties to the illegal act are not on the same legal footing and (ii) cases in which an overriding statutory policy requires that the claimant should have a remedy notwithstanding his participation in the illegal act.

This is surely the preferable approach, which reflects the “middle way” and consequently judicial discretion properly defined, because the judge is not exercising an arbitrary choice but is making a decision with reference to identified principles. The “trio of considerations” of Lord Toulson might be analysed in similar terms as involving principled discretion rather than arbitrary choice, but the language of the tests is so vague it cannot properly be analysed as discretionary in the proper sense. Rather, it leaves open the possibility of judges resorting to arbitrary choice to determine how illegality should operate. For how is it possible to identify in a principled way the policies which militate against or in favour of awarding a remedy and determining whether the denial of relief is disproportionate? These three considerations will readily collapse into one and take English law perilously close to resurrecting the public conscience test and the arbitrary choice which inexorably followed.

3 The constructive trust

Whereas there has been a fundamental difference of opinion amongst the Supreme Court Justices as to the appropriate way to approach the illegality defence, there appears to be unanimity as regards the nature and operation of the constructive trust in England: it is an institution which arises by operation of law on the occurrence of a particular event where a constructive trust has previously been recognised. In New Zealand,63 Australia64 and Canada,65 however, the remedial constructive trust is recognised, through the exercise of the judge’s discretion, whenever it is considered to be just to recognise that the claimant has an equitable proprietary interest in property received by the defendant.66

(a) The nature and function of the constructive trust

It is important at the outset to identify the nature and function of the

62 At [264].

63 Commonwealth Reserves I v Chodar [2001] 2 NZLR 374, although Glazebrook

J also recognised the institutional constructive trust.

64 Muschinski v Dodds (1985) 160 CLR 583; Grimaldi v Chameleon Mining NL

(No 2) (2012) 200 FCR 296 at [569] per Finn J.

65 Pettkus v Becker (1980) 117 DLR (3d) 257; Soulos v Korkontzilas [1997] 2 SCR

217 at [34] per McLachlin J; Kerr v Baranow 2011 SCC 10, [2011] 1 SCR 269

at [50] per Cromwell J.

66 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 at 714

per Lord Browne–Wilkinson.


constructive trust. In England and New Zealand it is a genuine trust, the creation of which does not depend on the intention of the parties.67

Property is held on trust by the constructive trustee for the beneficiaries, who will have an equitable proprietary interest in the trust property. The creation of this equitable proprietary interest has three significant advantages for the beneficiary. First, if the constructive trustee becomes insolvent, the beneficiary will gain priority over the trustee’s creditors as regards claims to the trust property. Secondly, if the value of any asset which is held on constructive trust has increased, the beneficiary will gain the benefit of that increase. Thirdly, the beneficiary of the trust can assert his or her equitable proprietary rights against innocent third parties who have received and retained the asset or its traceable substitute, as well as recipients who received but have not retained the asset or its traceable substitute, but who knew or should have known that the property had been held on trust.68

The essential difference between the institutional and remedial constructive trust was identified by Lord Browne–Wilkinson in Westdeutsche Landesbank Girozentrale v Islington LBC:69

Under an institutional constructive trust, the trust arises by operation of law as from the date of the circumstances which give rise to it: the function of the court is merely to declare that such trust has arisen in the past. The consequences that flow from such trust having arisen (including the possibly unfair consequences to third parties who in the interim have received the trust property) are also determined by rules of law, not under a discretion. A remedial constructive trust, as I understand it, is different. It is a judicial remedy giving rise to an enforceable equitable obligation: the extent to which it operates retrospectively to the prejudice of third parties lies in the discretion of the court.

In other words, whereas an institutional constructive trust arises by operation of law from the date of the event which gives rise to it, the remedial constructive trust arises through the exercise of the judge’s discretion, whenever it is considered to be just to recognise that the claimant has an equitable proprietary interest in property received by the defendant. As a consequence, the court could require the transfer to the claimant of an asset which otherwise belongs to the defendant and in which the claimant did not have a pre–existing legal or equitable right. In Commonwealth Reserves I v Chodar Glazebrook J described the remedial constructive trust as a mechanism which operates to enforce personal accountability with proprietary consequences and without creating an

67 Commonwealth Reserves I v Chodar [2001] 2 NZLR 374 at [36] per

Glazebrook J.

68 By means of a claim for knowing receipt. See Bank of Credit and Commerce

International (Overseas) Ltd v Akindele [2001] Ch 437; Farah Constructions

Pty Ltd v Say–Dee Pty Ltd [2007] HCA 22.

69 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 at 714.

See also Fortex Group Ltd v MacIntosh [1998] 3 NZLR 171 at 172–173 per

Tipping J; Commonwealth Reserves I v Chodar [2001] 2 NZLR 374 at [39]

per Glazebrook J.


on–going trust relationship.70

In FHR European Ventures LLP v Cedar Capital Partners LLC the Supreme Court rejected the remedial constructive trust in English law.71 In FHR, the claimant had purchased the share capital of a company which owned the lease of the Monte Carlo Grand Hotel. The defendant acted as the claimant’s agent in negotiating the purchase of the shares and, as an agent, owed fiduciary duties to the claimant. The defendant had earlier entered into an agreement with the vendor of the hotel by virtue of which the vendor would pay it €10 million following the successful sale of the shares, but the defendant failed to disclose this payment to the claimants in breach of fiduciary duty. It was held that the defendant held the secret commission on constructive trust for the claimants, and this trust arose automatically, because the payment had been received by the defendant in breach of fiduciary duty, and not through the exercise of judicial discretion.

Although the Supreme Court cited the judgment of Lord Browne– Wilkinson in Westdeutsche Landesbank Girozentrale v Islington LBC in support of its rejection of the remedial constructive trust, and it is certainly true that he did not formally recognise the remedial constructive trust in English law, he was not adverse to its recognition and considered that there may be circumstances where it might be beneficial to recognise it because it would enable proprietary relief to be tailored to the particular circumstances of the case.72

Lord Neuberger, who delivered the single speech in FHR, subsequently expressed his concerns about the recognition of the remedial constructive trust extra–judicially,73 and sought to provide detailed justification for its rejection, which was lacking in his judgment in FHR. He considered that “the notion of a remedial constructive trust displays equity at its flexible flabby worst”. He considered it to be “unprincipled, incoherent and impractical”. He was opposed to its recognition in England because it would render the law unpredictable; it would be an affront to the common law view of property rights and interests and it would involve the courts usurping the role of the legislature. But the real concern about the recognition of the remedial constructive trust is that the law needs clear and predictable rules as to whether or not equitable proprietary rights have been created, and the remedial constructive trust is considered to be antithetical to such clarity and predictability, being perceived to involve unrestrained judicial discretion.74


70 Commonwealth Reserves I v Chodar [2001] 2 NZLR 374 at [37].

71 FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45,

[2015] AC 250 at [47] per Lord Neuberger.

72 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 at 716.

73 Lord Neuberger “The Remedial Constructive Trust – Fact or Fiction”

(speech to the Banking Services and Finance Law Association Conference

New Zealand, 10 August 2014).

74 P Millett “Equity–The Road Ahead” (1995) 9 TLI 35 at 42.


(b) The modified constructive trust

In England, Australia and New Zealand we have got caught up in a sterile debate about the constructive trust where there are two camps, institutional versus remedial. It is time to ditch the intemperate language and lazy characterisation and acknowledge that there is just one constructive trust. Indeed, as Deane J said in Muschinski v Dodds: “for the student of equity, there can be no true dichotomy between the two notions”.75

There are examples in Australia76 and Canada77 of judges interpreting the constructive trust in a purely remedial sense and without reference to any obvious principles and there appears to be a greater willingness amongst the judiciary in these countries to embrace creative judicial decision–making with reference to the justice of the case, whereas the English judge is generally more likely to emphasise the need for certainty. But even so, when the New Zealand, Australian and Canadian cases are examined there are plenty of examples of principled reasoning. For example, in Australia McMillan J recognised that “[u]nstructured judicial discretion ... has no place in the law of constructive trusts in Australia”.78 And Deane J in Muschinski v Dodds emphasised that:79

The fact that the constructive trust remains predominantly remedial does not, however, mean that it represents a medium for the indulgence of idiosyncratic notions of fairness and justice. As an equitable remedy, it is available only when warranted by established equitable principles or by the legitimate processes of legal reasoning, by analogy, induction and deduction, from the starting point of a proper understanding of the conceptual foundation of such principles ... proprietary rights fall to be governed by principles of law and not by some mix of judicial discretion, subjective views about which party ‘ought to win’ ... and ‘the formless void of individual moral opinion’...

In Canada the remedial constructive trust has explicitly restitutionary principles to guide the exercise of judicial discretion.

It is in New Zealand that the principled approach to the operation of the remedial constructive trust is most apparent. In the important decision in Commonwealth Reserves I v Chodar Glazebrook J recognised that there



75 Muschinski v Dodds (1985) 160 CLR 583 at 614.

76 See especially Grimaldi v Chameleon Mining NL (No 2) (2012) 200 FCR 296

at [569] per Finn J.

77 See Pettkus v Becker (1980) 117 DLR (3d) 257 (where Cromwell J described

the remedial constructive trust as “a broad and flexible equitable tool”

used “to determine beneficial entitlement [to property]” at 843–844. See

also Soulos v Korkontzilas [1997] 2 SCR 217 (where McLachlin J, as she then

was, emphasised that the equitable remedy was flexible and turned on

“what is just in all the circumstances of the case” at [34].

78 State Trustees Ltd v Edwards [2014] VSC 392 at [143].

79 Muschinski v Dodds (1985) 160 CLR 583 at 615.


must be a principled basis for the recognition of the trust.80 She said that the remedial constructive trust was triggered by unjust enrichment or unconscionability. But she also recognised significant principles which are relevant to the exercise of judicial discretion, properly so described. She said:81

Reliability and certainty are primary considerations of any system of property rights, and the unprovoked alteration of these rights is to be avoided where possible. This is all the more true in a commercial rather than a domestic context. The court must carefully examine the reasons why other forms of relief are inadequate, the interests of any third parties and the other circumstances of the case, and consider whether proprietary relief can be justified.

In cases where the interests of third parties would be prejudiced by a proprietary remedy, particularly if those third parties are in a substantially similar position to the plaintiff, or where the plaintiff has accepted the risk of the defendant’s insolvency, then proprietary relief is likely to be inappropriate.

Even in England, where the constructive trust is characterised as absolutely institutional with no apparent role for the exercise of judicial discretion to modify its operation, such characterisation does not reflect the actual operation of the constructive trust. There are many significant examples of cases where the recognition or the operation of the constructive trust depends on the exercise of judicial discretion. First, where the elements of proprietary estoppel are satisfied, the claimant’s rights might be vindicated by recognising that the defendant holds property on a constructive trust.82 Secondly, in Boardman v Phipps, fiduciaries who profited from breaching their fiduciary duty were found to hold their profit on constructive trust for the principal.83 But this trust was modified in respect of one of them, who was awarded an equitable allowance to reflect the value of his work in making the profit. Thirdly, if a situation arose where a fiduciary had made a profit in breach of fiduciary duty and that profit would continue to accrue over a period of time as the result of the fiduciary’s continued work, surely the court would modify the constructive trust in some way, such as to limit it to the profits obtained over a restricted period of time.84 Finally, in England the problem of identifying beneficial interests in a house occupied by a cohabiting couple as the family home has been dealt with through the common intention constructive trust. This is an apparently institutional trust which is triggered by reference to the express, implied, or imputed intention of

  1. Commonwealth Reserves I v Chodar [2001] 2 NZLR 374. This had also been recognised by Tipping J in Fortex Group Ltd v MacIntosh [1998] 3 NZLR

171 at 175.

81 Commonwealth Reserves I v Chodar [2001] 2 NZLR 374 at [47]–[48].

82 Thorner v Major [2009] UKHL 18, [2009] 1 WLR 776.

83 Boardman v Phipps [1966] UKHL 2; [1967] 2 AC 46.

84 As in the Australian case of Warman International Ltd v Dwyer (1995) 182

CLR 544.


the parties as to whether they have a beneficial interest in the property and, if so, what the extent of that interest might be. As the jurisprudence relating to the common intention constructive trust has developed,85 a structured approach has been adopted involving presumptions which are rebuttable by reference to the parties’ common intention. So, where the property is registered in the name of one party, it will be presumed that the other does not have a beneficial interest in it. This can be rebutted by the other party showing that there was a common intention that he or she would have a beneficial interest in the property and, having done so, what proportion of the beneficial interest is appropriate. In Jones v Kernott the majority accepted that imputation of common intent was appropriate where it was clear that the parties intended to share the beneficial interest but it was not possible to determine any agreement as to the proportions in which the interest was to be shared.86 This does not involve proving an actual intent shared by the parties, but involves the attribution of an intention that they might not have shared, but which the court considers they would have agreed had they thought about the allocation of the beneficial interest. Where imputation of an intention is required, the court must consider what is “fair having regard to the whole course of dealing” in respect of the property, with reference to the claimant’s financial and non–financial contribution to the property.87

It is at this point that the proof of a common intention could disintegrate into a determination of an allocation of the beneficial interest that the court considers to be fair. Indeed, Etherton J, as he then was, said that “there is now a hair ’s breadth between the [common intention constructive trust] ... and a remedial constructive trust”.88 The nature of the common intention constructive trust is controversial but, whilst in form it appears to be institutional, in reality there is scope for modification of it with reference to what the court considers to be the just result.

It follows that, even in England, the institutional constructive trust is not as rigid as it is often perceived to be. This should give the English courts confidence to develop a new model of constructive trust which is principled but also flexible, without recourse to arbitrary choice. This model builds on the orthodox institutional constructive trust, but this trust should be capable of modification by the exercise of judicial discretion but in a principled way. The legitimacy of this model of trust depends on the identification of appropriate principles both as regards the identification of when the constructive trust should be recognised and when it should be modified.



  1. Notably through the decisions in Stack v Dowden [2007] UKHL 17, [2007] AC 432 and Jones v Kernott [2011] UKSC 53, [2012] 1 AC 776.

86 At [31] per Lady Hale and Lord Walker.

87 At [51](4) per Lady Hale and Lord Walker and [64] per Lord Collins.

88 T Etherton “Constructive Trusts and Proprietary Estoppel: The Search

for Clarity and Principle” [2009] Conv 104 at 125.


(i) Recognition of the institutional constructive trust

The most important principle underpinning the constructive trust is that of unconscionability, which appears to require consideration of the defendant’s conduct and so is fault–based.89 Fault in Equity is typically determined objectively, albeit assessed with reference to the defendant’s knowledge or suspicion about the relevant facts.90 That standard is appropriate to justify the imposition of personal liability, such as where the defendant is liable for receipt of property transferred in breach of trust or dishonestly assisting a breach of trust or breach of fiduciary duty. But something more should be needed for the recognition of proprietary rights in Equity, which is why subjective fault should be the standard for the recognition of the constructive trust. This can be justified because a defendant who can be considered to have acted unconscionably should be deprived of all benefits arising from their unconscionable conduct, the claimant’s claim to the assets is stronger than that of the defendant, the defendant should have his or her conscience purged by disgorging all benefits obtained from the unconscionable conduct, and all those claiming through the defendant should likewise have their conscience purged from all possible unconscionability. Of course, these justifications become progressively more unconvincing, but that is why the constructive trust should not be absolute but should be capable of modification, with the type and extent of unconscionability of the defendant or a third party being a key factors to be taken into account.

(ii) Modification of the constructive trust

Once it is accepted that the constructive trust which has arisen by operation of law by virtue of the defendant’s unconscionable conduct might be modified, it is important to consider when such modification might be justified. In assessing this, the three key implications of recognising proprietary interests in Equity need to be borne in mind, namely: (1) priority over unsecured creditors when the defendant is insolvent; (2) obtaining the benefit of increase in the value of the property held on constructive trust; and (3) recovery of the property, or its identifiable substitute, from a third party even if he or she was unaware of the circumstances which triggered the constructive trust in the first place. It is important to consider whether each of these proprietary advantages is justifiable in each case.

Determining when and how the institutional constructive trust might be modified can be assessed by reference to three of the very difficult cases for the contemporary constructive trust. In each case it will be necessary to consider how the institutional constructive trust arises and whether the three advantages of having an equitable proprietary interest can be justified in the light of the state of the defendant’s conscience or

89 De Bruyne v De Bruyne [2010] EWCA Civ 519, [2010] WTLR 1525 at [49]

per Patten LJ.

90 This is sometimes described as “dishonesty”. See Williams v Central Bank

of Nigeria [2014] UKSC 10, [2014] AC 1189 at [64] per Lord Neuberger.


the conscience of a third party recipient.

1 Theft

It is recognised in both Australia91 and in England92 that a thief holds stolen assets on a constructive trust for the victim. This can be justified on the ground that, although the victim will typically have retained legal title to the stolen asset, the thief’s conduct in committing theft constitutes unconscionable conduct and this is sufficient justification for the thief to hold possessory title on constructive trust for the victim.93 But should this constructive trust ever be modified?

First, if the thief has become insolvent, should his or her creditors be able to assert a claim against the stolen assets in priority to the claim of the victim? Since the stolen property never legitimately formed part of the thief’s pool of assets, there is no reason why the creditors of the thief should gain priority over the victim, so the constructive trust should not be modified for this reason.

Secondly, if the stolen asset has increased in value there is no reason why the victim of the theft should be deprived of the benefit of this increase either, since the thief should not profit from his or her crime in any way. Consequently, the constructive trust should not be modified to enable the thief to keep the benefits of the increase in value. Even if, for example, money has been invested or used to buy a lottery ticket which has won a jackpot, all these profits, whether obtained directly or indirectly, should be considered to be the proceeds of the crime and should be held on the constructive trust, such is the extent of the defendant’s unconscionable conduct in stealing in the first place.

Finally, should innocent third parties who subsequently obtain possession of the stolen asset or its identifiable substitute be allowed to keep the asset, or must they give it up to the victim of the theft? It is a vital consequence of the stolen asset being held on constructive trust that, if the asset is received and retained by a third party, it continues to be held on constructive trust for the victim of the theft, regardless of the fact that the third party was unaware of the circumstances of the theft so that his or her conscience cannot be considered to have been tainted in any way. This position is, however, qualified in two situations. First, if the third party recipient of the stolen property or its traceable substitute had provided value and acted in good faith, the victim’s equitable proprietary claim will be defeated. Secondly, if the third party received but did not retain the stolen asset, he or she will be personally liable for the value of the asset but only if he or she should have been aware that it had been held on constructive trust, in the light of the facts known or

91 Black v S Freedman and Co (1910) 12 CLR 105.

92 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669.

93 Armstrong DLW GMBH v Winnington Networks Ltd [2012] EWHC 10 (Ch)

at [277]–[278] per Deputy Judge Morris QC. See J Tarrant “Property Rights

to Stolen Money” (2005) 32 UWAL Rev 234 at 245; J Tarrant “Thieves as

Trustees: In Defence of the Theft Principle” (2009) 3 J Eq 170 at 172.


suspected by the defendant. It follows that, where the third party did not provide value for what had been received and has retained the stolen asset or its traceable substitute, that asset will still be held on constructive trust so that the victim’s equitable proprietary right will defeat the third party’s possessory right. But is this defensible? Where the third party recipient of the stolen asset is unaware of its provenance, such that the third party’s conscience is not tainted in any way by the theft, why should the victim’s equitable proprietary right prevail? Would it not be preferable to conclude that as between the two innocent parties, their claims should be treated as equally good and possibly that the third party’s claim is stronger than that of the victim of the theft? There was even an indication in a recent decision of the English Court of Appeal which is consistent with such an approach. In Relfo Ltd v Varsani Arden LJ stated that money or its substitute could be recovered from a third party where the money was stolen by the fiduciary, if the money or its substitute was knowingly received by the third party.94 Whilst she did not elaborate on the significance of knowledge, and she might have been meaning to refer only to a personal claim for knowing receipt, her dictum might be considered to reflect the fact that, absent knowledge, the recipient’s conscience would not have been affected such that the constructive trust should be treated as terminated, with the victim of the theft confined to a personal claim against the thief.

It follows that the constructive trust of stolen property should not be modified to benefit creditors of the thief or the thief him or herself, but there might be a case to treat the constructive trust as revoked once the asset has been received by an innocent third party, albeit that he or she has not provided value for the receipt.

2 Mistaken payment

Where the claimant has paid money to the defendant as a result of a mistaken belief that the claimant was liable to pay the money, the defendant will be personally liable to the claimant, to restore the amount of money paid, by virtue of a claim in unjust enrichment. Legal title in the money will typically pass, so that it belongs to the defendant. Some cases in Australia,95 and in England96 recognise that, if the defendant knew of the mistake and failed to repay, the property will be held on constructive trust. The failure of the defendant to repay the money when he or she knew of the mistake constitutes unconscionable conduct which triggers the institutional constructive trust by operation of law. Crucially this trust is not triggered by the defendant’s unjust enrichment. In England, establishing the elements of the unjust enrichment claim will simply enable the mistaken payer to bring a personal claim against the

94 Relfo Ltd v Varsani [2014] EWCA Civ 360, [2015] 1 BCLC 14 at [1].

95 Wambo Coal Co Pty Ltd v Ariff [2007] NSWC 589.

96 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 at 709

per Lord Browne–Wilkinson and Armstrong DLW GMBH v Winnington

Networks Ltd [2012] EWHC 10 (Ch).


recipient, this being a strict liability claim which can be established even if the defendant was unaware that the money had been paid by mistake. To establish an equitable proprietary claim to the money paid by mistake, fault needs to be proved by showing that the defendant knew that the money had been paid by mistake, for then the defendant’s conscience will have been tainted. But will there ever be any circumstances where the proprietary implications of this constructive trust should be modified?

First, if the defendant has become insolvent, there is no reason why the defendant’s creditors should have a better claim to the money held on trust than the claimant. Since the money has been received from the claimant it should be restored to the claimant. If the defendant’s receipt is unconscionable, an equitable proprietary interest should be recognised. By virtue of the analogy with theft, there is no reason why the creditors of the defendant should obtain any advantage over the claimant.

Secondly, the defendant should not be allowed to benefit from any gain arising from retention of the money paid by mistake, save where that gain cannot be causatively linked to the receipt. So, if the asset is invested and increases in value, the defendant should hold that increase on constructive trust. But if the defendant used the money paid by mistake to buy a lottery ticket which wins the jackpot, to determine whether that jackpot is held on constructive trust should depend on whether it can be shown that, but for the receipt of the money paid by mistake, the defendant would not have bought the ticket. If the defendant would have bought the ticket anyway, and used the mistaken payment by chance, this would be an appropriate reason to modify the constructive trust so that the jackpot is not held on trust. If the defendant did not rely on the receipt to buy the ticket, there is no reason why the claimant should have a proprietary claim to the jackpot.

Finally, should the equitable proprietary right of the claimant be defeated by the innocent receipt of a third party who has not provided value for the property? Whilst the law assumes that the claimant should have a proprietary claim against such a third party recipient,97 this is difficult to defend. The claimant should be confined to a personal claim in unjust enrichment against the direct recipient of the mistaken payment, who has not retained that payment or its traceable substitute, and should not have a proprietary claim against an innocent third party recipient, at least where the only reason why the equitable proprietary right was created was because of the defendant’s unconscionable retention. If the third party’s receipt cannot similarly be characterised as unconscionable, there is no reason why the claimant should have a proprietary claim against that recipient.

3 Gains obtained in breach of fiduciary duty

Where a fiduciary has misappropriated an asset from the principal, it has

long been recognised that the asset will be held on constructive trust for

97 Re Diplock’s Estate [1948] Ch 465 at 539.


the principal.98 This includes where the fiduciary has obtained a bribe or a secret commission and it can be shown that this was derived from money which was paid by the principal to the fiduciary.99 The recognition of a constructive trust in such circumstances is defensible because the profits made by the defendant can be considered to represent the fruits of the claimant’s property. Consequently, it is appropriate that the claimant should have an equitable proprietary interest in those profits. In addition, it is justifiable that the fiduciary should hold property on constructive trust where the consequence of the breach of duty is that the fiduciary obtains property which the principal would have obtained had the defendant not breached his or her duty. Goode has described the property which the defendant obtains in such circumstances as a “deemed agency gain”, which should be held on constructive trust for the principal simply because the demands of the fiduciary relationship are such that it should be assumed that the defendant obtained the property for his or her principal rather than for him or herself.100 This is illustrated by Cook v Deeks where the directors of the claimant company were negotiating a contract with a third party on behalf of the company.101

Rather than signing the contract on behalf of the company some of the directors signed it on behalf of themselves. It was held that the directors were liable for a breach of fiduciary duty and held the profits they had made on constructive trust for the company. This can be justified because, had the defendants not breached their duty, the company would have obtained the contract so the defendants’ gain could be presumed to have been made on behalf of the company.

The most controversial issue arises where the fiduciary has obtained a benefit from a third party rather than misappropriating the principal’s property or depriving the principal of the opportunity to make a profit. This has proved to be particularly controversial where the fiduciary has received a bribe or a secret commission from a third party. In such circumstances the profit cannot be considered to have derived from the principal. Consequently, the orthodox view has been that only the personal remedy of an account of profits was available, and not a proprietary constructive trust. The leading English case was Lister

& Co v Stubbs in which the defendant was employed by the claimant company to purchase supplies for the claimant firm.102 He bought goods from another company, having received secret commissions of over

£5,000 to induce him to place orders with that company. The defendant invested this money in land. It was held that the bribes did not belong to the claimant, for otherwise the claimant would have priority over

98 See Primlake Ltd v Matthews Associates [2006] EWHC 1227 (Ch), [2007] 1

BCLC 666 at [334] per Collins J.

99 Daraydan Holdings Ltd v Solland International Ltd [2004] EWHC 622 (Ch),

[2005] Ch 119 at [60] and [87]–[88] per Collins J.

100 R Goode “Property and Unjust Enrichment” in A Burrows (ed), Essays

on the Law of Restitution (Clarendon Press, Oxford, 1991) 215 at 230.

101 Cook v Deeks [1916] 1 AC 554.

102 Lister & Co v Stubbs (1890) 45 Ch D 1.


the defendant’s unsecured creditors if the defendant were to become insolvent, and if the bribes were invested in property that increased in value, the claimant would get the benefit of that increase. Neither conclusion was considered to be appropriate. The relationship between the parties was consequently not one of trustee and beneficiary, but was simply one of debtor and creditor.

This was, however, rejected by the Supreme Court in FHR.103 It was held that, wherever a fiduciary is liable to account for profits made as a result of a breach of fiduciary duty, the profits will be held on constructive trust for the principal, even though they did not derive from interference with the principal’s property or from the exploitation of an opportunity which should have been exploited for the principal. Consequently, whenever a fiduciary receives a bribe or secret commission in breach of fiduciary duty, the money will be held on constructive trust. The decision in Lister

& Co v Stubbs was also overruled. The constructive trust recognised by the Supreme Court is institutional and was justified because the fiduciary is treated as though he or she had acquired the bribe or secret commission on behalf of the principal, who therefore has an equitable proprietary interest in it.104 This involves the creation of equitable rights in property which did not exist before.

The decision of the Supreme Court in FHR does at least resolve a long– standing controversy as to the role of the constructive trust where the fiduciary has profited from breach of his or her fiduciary duty. The real difficulty with it relates, however, to the Supreme Court’s emphasis that the constructive trust was institutional, arising by operation of law, rather than remedial. But might there be circumstances where the proprietary consequences of this constructive trust could be modified?

First, if the defendant fiduciary has become insolvent, should the principal have priority over the defendant’s unsecured creditors? This can be easily justified where the fiduciary has misappropriated the principal’s property, since it is not appropriate for the principal’s existing proprietary rights to be subject to the claims of the defendant’s creditors. In such circumstances the restoration of the principal’s property effects corrective justice by restoring to the principal what he or she had lost. It would also be appropriate to reach such a conclusion where the profit would have been made by the principal had the defendant not breached his or her fiduciary duty. This too can be considered to correct an injustice, by restoring to the principal what he or she had lost as a result of the breach of fiduciary duty. But, should the principal be accorded such priority where the profit was obtained from a third party and it would not have been obtained by the principal had the defendant not breached his or her fiduciary duty, such as where the defendant has obtained a bribe from a third party? Lord Millett has argued that the principal should

  1. FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45, [2015] AC 250.

104 At [7] per Lord Neuberger.


gain priority in such circumstances because the fiduciary’s creditors claim through the fiduciary and should have no better claim to property to which they are not entitled.105 In Grimaldi v Chameleon Mining NL (No 2) however, Finn J said that the bribe should be held on constructive trust but, if the fiduciary was bankrupt, he considered that a lien would be sufficient to ensure practical justice.106 This was obiter and is, anyway, an odd distinction to draw. Even if a lien was awarded, the principal would still have priority over the fiduciary’s creditors by virtue of the security interest, but would not obtain the fruits of the bribe, and it is difficult to see why the fact of the fiduciary’s insolvency should prevent the principal from claiming all the fiduciary’s profits. It is true that this would mean that those profits would be available to the fiduciary’s creditors, but this would be a blunt instrument for effecting such a result. The judgment of Finn J does, however, indicate a willingness to modify the constructive trust where the fiduciary was insolvent.

The possibility of such modification was even canvased in FHR.107 In a very significant dictum the Supreme Court recognised that concern about the position of unsecured creditors of the defendant fiduciary will have considerable force in some contexts, although it was considered only to have limited force in the context of bribes and secret commissions. The Court did not elaborate beyond this and it is unclear why the position of unsecured creditors might matter more in some contexts, although it is not obvious which, and why this should be less significant where the fiduciary’s profit took the form of bribes or secret commissions. But, acknowledging that the position of the unsecured creditors of the fiduciary might need to be considered in some cases is important. It suggests a willingness of the English court to recognise the existence of an institutional constructive trust, but to modify its effects to ensure that the relative positions of the principal and unsecured creditors are treated equally.

Such modification of the constructive trust is especially appropriate where the fiduciary’s profit was obtained from a third party in the form of a bribe or secret commission. This is because the rationale behind imposing liability on the defendant fiduciary in such circumstances is different from other situations where a profit is made. Where the fiduciary has profited by appropriating property from the principal, the fiduciary is liable to make restitution of that property or its value to the principal; this is justified as effecting corrective justice. Where, however, the defendant fiduciary’s profit is derived from a third party, requiring the defendant to disgorge that profit to the principal is not justified by correcting injustice through restoring to the principal what he or she has lost, since the principal has not lost anything. Rather, the imposition of

105 Lord Millett “Bribes and Secret Commissions Again” (2012) 71 CLJ 583.

106 Grimaldi v Chameleon Mining NL (No 2) (2012) 200 FCR 296 at [583] per

Finn J.

107 FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45,

[2015] AC 250 at [43].


liability on the fiduciary effects distributive justice, by ensuring that the fiduciary is deprived of the gain.108 Since the focus of Equity’s response is on the defendant’s gain rather than reversing loss, there is no reason why the principal’s proprietary claim should rank above the claims of the defendant’s unsecured creditors. The principal should simply be regarded as any other unsecured creditor, whose claim should rank equally with those of all the defendant’s creditors. It follows that the advantage of the constructive trust of obtaining priority over other creditors should be modified where the fiduciary’s profits derive from a third party. Indeed, rather than being a scenario where, as the Supreme Court suggested, modifying the constructive trust is less defensible, this is a situation where modification of the proprietary consequences of the constructive trust is much easier to justify. This focus on the distinction between effecting corrective and distributive justice must, however, be treated with some caution where the relevant profit obtained in breach of fiduciary duty is a bribe or secret commission. This is because there will be circumstances where the bribe or secret commission does reflect a loss suffered by the principal, such as where the fiduciary has induced the principal to enter into a transaction where the price paid by the principal was inflated to reflect the amount of the bribe or the secret commission received by the defendant.109 But, where the principal has not suffered loss, there is much greater scope for modifying priority as between the principal and creditors of the fiduciary.

Secondly, where the defendant has profited from the investment of the profit made in breach of fiduciary duty, he or she should not benefit from this indirect profit, so the institutional constructive trust should not be modified to exclude such profits because of the strict nature of fiduciary duties. So, for example, in Attorney–General for Hong Kong v Reid the defendant fiduciary held a number of public offices in Hong Kong, including that of acting Director of Public Prosecutions.110

He had accepted bribes to induce him to obstruct the prosecution of some criminals. He purchased land in New Zealand with this money and the claimant claimed that it had an equitable proprietary interest in this land. The Privy Council agreed and ordered that the land was held by the defendant on constructive trust for the claimant. This must be right. Fiduciary duties are strictly interpreted and enforced to ensure that the fiduciary complies with the strictest standards of loyalty and is not tempted to act against the principal’s interests.

Finally, should the equitable proprietary rights of the principal be

defeated if the profit which is held on constructive trust has been

108 K Barnett “Distributive Justice and Proprietary Remedies Over Bribes” (2015) 35 LS 302. See also M Harding “Constructive Trusts and Distributive Justice” in E Bant and M Bryan (eds) Principles of Proprietary Remedies (Lawbook Co, Sydney, 2013) 211.

109 Daraydan Holdings Ltd v Solland International Ltd [2004] EWHC 622 (Ch), [2005] Ch 119.

110 Attorney–General for Hong Kong v Reid [1993] UKPC 2; [1994] 1 AC 324.


transferred to an innocent third party who had not provided value for its receipt? Again, where the asset which is held on constructive trust has been appropriated from the principal, or would have been obtained by the principal had the fiduciary not intervened, the proprietary claim of the principal should prevail against all recipients. But this is much more difficult to justify where the profits derived from a third party rather than the principal. In such circumstances it would be appropriate to modify the institutional constructive trust so that the principal and third party volunteer share the property equally. Indeed, in FHR Lord Neuberger indicated that bribe money held on constructive trust by a fiduciary could be claimed from a knowing recipient,111 suggesting that an innocent recipient might not be liable to disgorge it to the principal. Where, however, the third party’s receipt and retention112 can be considered to be unconscionable, because he or she knew or suspected that the fiduciary had obtained the profit in breach of fiduciary duty, it is appropriate to enable the principal to assert his or her equitable proprietary rights against the third party, whose conscience has been tainted. So, for example, in Reid assets were transferred to the fiduciary’s wife and his solicitor who appear to have been aware that they had been purchased with bribe money.113 In such circumstances it is appropriate that the proprietary claim of the principal should prevail over such recipients whose consciences have been tainted by their knowledge of the breach of duty. But, as English law stands, the principal has a proprietary claim against the third party recipient who has received and retained the property or its substitute, which was held on constructive trust, regardless of the recipient’s ignorance of the breach of fiduciary duty. This is an unfortunate consequence of the recognition of the institutional constructive trust, which could be avoided if there was greater willingness to modify the proprietary impact of such a trust.

(c) One constructive trust

The appropriate model of the constructive trust in England and, it is submitted, in New Zealand as well, is one where the trust arises by operation of law, and preferably where the defendant’s receipt or retention of property is characterised as unconscionable, whether actual or deemed. This trust can be modified with reference to recognised principles, such that the proprietary nature of the trust might sometimes be defeasible, especially where innocent third parties have received the property which has been held on trust. This is an approach which

111 FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45, [2015] AC 250 at [44].

112 Where the third party has received but not retained the property in which the principal has an equitable proprietary interest, the third party will only be personally liable to the principal for the value of the property received if he or she should have realised that the property had been transferred in breach of fiduciary duty, in the light of the facts known by the third party.

113 Attorney–General for Hong Kong v Reid [1993] UKPC 2; [1994] 1 AC 324.


is, to quite a large extent, reflected in the decision of Glazebrook J in Commonwealth Reserves I v Chodar,114 albeit that she felt the need to distinguish between the institutional and remedial constrictive trust, whereas the preferable view is that there is just one form of constructive trust, which is open to modification in a principled way.

Whilst this modified constructive trust model has not yet been recognised in English law, its recognition is not necessarily inconsistent with authority including the decision of the Supreme Court in FHR itself. Crucially, the recognition of a modified constructive trust would assuage some of Lord Neuberger ’s judicial and extra–judicial concerns. This model of the constructive trust is not remedial in the sense that the judge creates equitable proprietary rights through the exercise of his or her discretion. Consequently, it should not be considered to subvert the statutory insolvency regime, for what Equity has created, Equity can take away, as long as this is done on a principled basis. Indeed, the very creation of equitable proprietary rights by operation of judge–made law might be regarded as upsetting the statutory insolvency regime, but there are numerous examples of Equity doing that. Modification of the institutional constructive trust is much less controversial than, for example, the Quistclose trust,115 which clearly has the potential to subvert the statutory insolvency regime.

A key benefit of recognising the modified constructive trust is that it is possible to move on from the old debate about whether the institutional or the remedial constructive trust should be recognised. The modified constructive trust should be classified as institutional in origin but with scope for the judge to modify it on a principled basis. This model of the constructive trust balances the need for certainty and predictability in the law, with the ability to achieve an equitable outcome on the facts of the case. It involves the exercise of judicial discretion properly defined.

4 Conclusions

The role of judicial discretion in private law reflects a battle about the very nature of private law itself. There is a spectrum of approaches. At one end is the pure logic of the law, founded on reason and principle and predictability; at the other is the desire to reach the just result on the facts. The former approach is reflected on the face of the decision in FHR, but scratch beneath the surface and it is readily apparent that even there the rigidity of the institutional constructive trust has been compromised. The latter approach is reflected in the decision in Pitt v Holt, with the uncertainty of “unconscionableness” likely to result in a significant amount of litigation until its meaning and application is clarified. The confusion relating to the operation of the defence of illegality ricochets between the two approaches depending on which Justice is pronouncing on the matter, but appears to have been resolved

114 Commonwealth Reserves I v Chodar [2001] 2 NZLR 374.

115 Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567.


now in favour of an unprincipled, policy–driven, basket of factors approach, which is dangerously close to inviting the judge to exercise arbitrary choice without the benefit of clearly defined principles.

The preferable approach falls somewhere between these two extremes and it is an approach which focuses on the role of judicial discretion, but discretion is not being used in the pejorative sense but in its principled incarnation. It follows that, in the areas of private law considered in this article, it is entirely appropriate to formulate the law with reference to a rule, but it must also be recognised that the rule can be modified with reference to recognised principles. This achieves the appropriate balance between certainty and justice and is consistent with the rule of law.


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