On 18 May 2021, Mr Justice Foxton handed down two judgments in the same proceedings:

Serious Fraud Office v Litigation Capital Ltd (in re Gerald Martin Smith) [2021] EWHC 1272 (Comm) and SFO v Hotel Portfolio II UK Limited [2021] EWHC 1273 (Comm) (the “HPII Judgment”). Few involved in litigating and funding disputes arising out of fraud or insolvency, or involving trusts or offshore property will be unaffected by the issues canvassed in Foxton J’s decisions, which include complex issues of the law of trusts, tracing and priority, and the unwinding of fraudulent transactions to name but a few.

This post focuses on one such issue, which has not otherwise received the systematic judicial consideration given to it by Foxton J in the HPII Judgment: in simple terms, whether it is possible to trace the value of misappropriated funds that have been used to pay a debt into whatever asset had earlier been acquired with that debt – what is commonly referred to as “backwards tracing”. That proposition runs contrary to the conventional English law position, where tracing has been conceptualised as a forward-looking, chronological exercise: the means by which a victim whose funds have been misappropriated can trace the value of her proprietary interest in those monies into an asset purchased with them.

The issue of backwards tracing came before Foxton J in the HPII Judgment. The factual background to the application was, in simplified summary, that a party owing fiduciary obligations had (it was said) breached the ‘no-profit’ rule, and had then used the ill-gotten profits to repay a loan facility. That loan facility had been obtained in order to fund, and was secured against, valuable property abroad. The ‘victim’, Hotel Portfolio II Limited (in liquidation) (“HPII”), argued that it should be allowed to trace the value of its interest in those wrongfully-acquired profits into the property that had earlier been acquired with the benefit of the loan facility.

Following careful consideration of the conceptual issues, and previous decisions that had considered similar claims (see paragraphs 20-48), Foxton J held that:

“… the present state of English law is that backwards tracing into assets acquired prior to the misuse of trust assets is not permitted, save in certain narrow (but, for all that, soft-edged and overlapping) exceptions where a strict insistence on chronological sequence would fail to reflect the substance of the position.” (Emphasis added)

Those exceptions included where (see paragraph 46):

1. One party pays another through the banking network, but at one or more stages in the process, a recipient account was credited before the paying account was debited;
2. The debit from trust assets and the credit which it is sought to be traced into “were effected as part of a single transaction intended to achieve that outcome through a series of co-ordinated elements, whatever the chronological ordering of those elements“;
3. An asset is acquired on the basis of an undertaking that the trust property will be (and then is) exchanged for it (referred to as “anticipatory substitution“); and
4. In an otherwise conventional transaction, payment (using trust monies) for an asset is made after title to the asset has passed to the purchaser.

On the claim before him in the HPII Judgment, and having decided that English law does not generally permit backwards tracing, Foxton J considered whether (relevantly) it could be argued that the second exception above applied. The Judge decided that it did not. He held that what was important was to have regard to the substance of the transactions, and not to fall into “too ‘minute’ an analysis of the different steps in a composite transaction”. In this case, Foxton J observed that, in substance, the wrong-doing fiduciary had not just repaid the lender under the prior loan facility, but was then immediately substituted as lender to the same borrowers under a new facility. Seeking to cut off the analysis at the point of repayment – so as to say that HPII should be entitled to trace into the property acquired with the original loan facility, rather than (e.g.) into the newly-created debt owed to the wrong-doing fiduciary by the borrowers – involved just such a ‘too-minute analysis’ (see paragraph 80).

The HPII Judgment will be instructive for those tasked with identifying trust assets and articulating (or defending) claims involving tracing. Parties seeking to have recourse to an asset acquired before the misappropriated funds were transferred will benefit from the clarity provided in Foxton J’s decision, and should now have close regard to the ‘exceptions’ framework in advancing any claim and setting out the relevant transactions giving rise to it.