Landmark Ruling on ‘Backward Tracing’
Federal Republic of Brazil and anr. (Respondents) v Durant International Corporation (Appellants)
The effective plaintiff was the Municipality of Sao Paulo. The Federal Republic of Brazil was nominally a plaintiff because its Constitution required it to be a party to any action brought outside Brazil by a Brazilian public authority. The defendants (Durant and Kildare) were companies registered in the British Virgin Islands. Both companies were at the relevant time under the practical control of Paulo Maluf and/or his son Flavio Maluf. From 1993 to 1996 Maluf senior was mayor of the municipality. Durant and Kildare appealed to the Board against a decision of the Court of Appeal of Jersey, which upheld a judgment of the Royal Court that the companies were liable to the municipality as constructive trustees of ten million dollars representing bribes to Maluf senior in connection with a major public road building contract.
The appellants contended in appeal that the total amount which could be properly traced to them from the bribes was limited to seven miles dollars. The Royal Court had rejected the appellants’ arguments. After a thoughtful and thorough review of the authorities and academic writings, the court concluded that the law was uncertain on ‘backward tracing’, that at a conceptual level the subject seemed incapable of wholly satisfactory solution and that at the level of policy it was unlikely to be settled in English Law below the Supreme Court. Its own view was that Jersey law should not set its face against accepting that “backward tracing” may be legitimate. It said that, at least where the account remained in credit during the relevant period, so there was no question of possible insolvency and prejudice to unsecured creditors, and where there was no suggestion of an intervening bona fide purchaser for value, the question should be whether there was sufficient evidence to establish a clear link between credits and debits to an account. If such a link were established, the court did not consider that there was cause to diminish its effect by introducing the concept of “a lowest intermediate balance rule”. It considered that, as a matter of judicial policy, this approach would accord most closely with considerations of justice and practicality. It observed that otherwise any sophisticated fraudster would be able to defeat an otherwise effective tracing claim simply by manipulating the sequence in which credits and debits were made to his account. The Court of Appeal upheld the reasoning and conclusions of the Royal Court. The Board rejected the broad proposition of the respondents that money used to pay a debt can in principle be traced into whatever was acquired in return for the debt, as it would take the doctrine of tracing far beyond its limits in the case law to date. The courts should be very cautious before expanding equitable proprietary remedies in a way which may have an adverse effect on other innocent parties. If a trustee on the verge of bankruptcy used trust funds to pay off an unsecured creditor to whom he was personally indebted, in the absence of special circumstances it was hard to see why the beneficiaries’ claim should take precedence over those of the general body of unsecured creditors. However there might be cases where there was a close causal and transactional link between the incurring of a debt and the use of trust funds to discharge it. [Referring to Agricultural Credit Corpn of Saskatchewan v Pettyjohn (1991) 79 DLR (4th) 22 (Sask CA)].
The Board further observed that the development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, made it particularly important that a court should not allow a camouflage of interconnected transactions to obscure its vision of their true overall purpose and effect. If the court was satisfied that the various steps were part of a coordinated scheme, it should not matter that, either as a deliberate part of the choreography or possibly because of the incidents of the banking system, a debit appeared in the bank account of an intermediary before a reciprocal credit entry. The availability of equitable remedies ought to depend on the substance of the transaction in question and not upon the strict order in which associated events occur.
The Board rejected the argument of the appellants that there can never be backward tracing, or that the court could never trace the value of an asset whose proceeds were paid into an overdrawn account. But the claimant had to establish a coordination between the depletion of the trust fund and the acquisition of the asset which was the subject of the tracing claim, looking at the whole transaction, such as to warrant the court attributing the value of the interest acquired to the misuse of the trust fund. This would depend on inference from the proved facts. In the present case the Royal Court and the Court of Appeal were justified in concluding that the necessary connection between the bribes and the receipts was proved. The appeal was dismissed.