Should the Courts Be Making Vesting Orders Against Banks in Email Fraud Cases?

In light of the increasing number of “email fraud” cases before the courts in Hong Kong, it is not surprising that victims of email fraud are increasingly seeking to rely on the “vesting order” procedure under section 52(e) of the Trustee Ordinance (Cap 29) to assist them in recovering the traceable proceeds of fraud, in preference to applying for garnishee orders over defendants’ bank accounts.

In contrast to garnishee proceedings, which require separate applications to and hearings before masters, a practice has developed in the High Court whereby, even if a bank takes a neutral stance, it can be joined as a respondent and a vesting order sought compelling it to transfer the plaintiff’s funds held, by way of constructive trust, in a defendant’s bank account, and in circumstances where disobedience on the part of the defaulting defendant is to be expected.

Such applications have typically been heard, before the same judge, at the same time as applications for default judgment (including applications for declaratory relief) and for continuation of proprietary and/or Mareva injunctions in aid of judgment. Proceeding on such basis, plaintiffs have been able to recover their funds more quickly and more cheaply than by using the traditional garnishee procedure.

The appropriateness of this procedure has, however, recently been thrown into doubt by two first instance authorities. There continue to be conflicting decisions in this area, with at least two judges noting that appellate guidance would be of benefit (Tokić DOO v Hongkong Shui Fat Trading Ltd & Ors [2020] 4 HKLRD 189 (CFI), [10]); Essilor Manufacturing (Thailand) Co Ltd v G Doulatram & Sons (HK) Ltd & Ors [2020] HKCFI 1790, [20] (DHCJ Rachel Lam SC)). It should be noted, however, that the likelihood of plaintiffs or defaulting defendants appealing these decisions is not high.

The question dividing the cases is whether Westdeutsche type trust claims create true trusts, or merely provide remedial formulae holding defendants to account as if they were trustees.

Declaratory Relief

Victims of email frauds have potential in personam causes of action in deceit, conspiracy to defraud, knowing receipt and unjust enrichment – but typically plead only the latter against defendants, and in particular second and third layer recipients, who might not themselves have been directly involved in the underlying fraud. But claims are infrequently defended, and fraudsters tend to lack assets for the purposes of enforcement. The most likely prospects of recovery therefore lie in proprietary claims over such monies as are frozen. Furthermore, claims for money had and received (Banque Beige v Hambrouck [1921] 1 KB 321, 328 & 335) are of no use once sums have been paid into accounts with credit balances, since law cannot identify property in fungible mixtures such as clearing systems and bank accounts (Agip (Africa) Limited v Jackson & Ors [1991] Ch 547 (CA), 563D). Equity, however, has long entitled the beneficiary of a trust to identify her interest in a fund, and well-prepared claims pray for declarations that defendants hold assets on constructive trust for plaintiffs.

Declarations of constructive trust are therefore sought under the well-known Westdeutsche principle, that equity imposes constructive trusts on the recipients of property obtained by or as a result of fraud (Westdeutsche Landesbank Girozentrale v Council of the LBI [1996] 2 AC 669 (UKHL), 716C); Michael Chen Kang Huang & Anor v Peter Lit Ma [2009] HKCFI 552, [3], [56] (Sakhrani J); Mesirow Financial Administration Corporation v Best Link Industrial Co Ltd [2016] HKCFI 92, [33] (Recorder Lisa Wong SC); JS Microelectronics Ltd v Achhada Dilip G [2016] HKCFI 519, [55] (Recorder Teresa Cheng SC); Jagdip Kaur Sadhu Singh v I Live Limited [2018] HKCFI 2830 at [10] (DHCJ Keith Yeung SC)). They are granted to reflect the underlying legal position that defendants hold stolen monies which can be traced to the underlying fraud on bare trust for plaintiffs, who are absolutely entitled to call for return of the funds (Hotung v Ho Yuen Ki [2002] 3 HKLRD 641 (CA), [15]; Concrete Waterproofing Manufacturing Pty Ltd v Changuan Co Ltd [2020] 4 HKLRD 166, [30]). They facilitate the tracing and following of monies into second layer and third layer accounts (Wismettac Asian Foods Inc v United Top Properties Ltd & Ors [2020] 3 HKLRD 732 (CFI), [15]); Essilor [2020] HKCFI 2357, [23] (DHCJ Le Pichon) and give priority to plaintiffs, “since an order for payment, without more, would only put the plaintiff in the position of an unsecured judgment creditor” (Essilor, [22]).

Vesting Orders

Of course, defendants are unlikely to honour plaintiffs’ requests to return stolen monies, and banks which maintain defendants’ accounts are bound by their customer contract and mandate though not (necessarily) bound by the terms of declarations of trust (Wismettac, [27], [45]; Essilor, [14]).

Section 52(1)(e) of the Ordinance, on the other hand, empowers a court to vest in any person a right to sue for and recover a “thing in action” (which includes a defendant’s right to withdraw from its bank account), where that thing has “vested in a trustee by mortgage or otherwise”. Section 2 of the Ordinance defines “trust” and “trustee” to extend to constructive trusts.

Plaintiffs have therefore sought vesting orders in addition to declaratory relief in applications for judgment in default of defence, to compel defendants’ banks to transfer sums subject to constructive trusts. Relief of this nature was granted in a series of first instance decisions (helpfully summarised in 800 Columbia Project Company LLC v Hong Kong Bosing Trade Ltd & Anor. [[2020] 3 HKLRD 674, [15] and Essilor, [14]) and a practice emerged whereby banks (who usually take a neutral stance) were joined to these applications, so that they could be heard and so that vesting orders would bind them (although, typically, banks seek to be excused from attendance at the hearing) (Cardone Industries, Inc v Haonigen Trade Co Limited & Anor [2020] HKDC 70, [24] (DDJ YW Hew); Essilor, [14]).

800 Columbia and Tokić

The jurisdiction to grant this relief was put into issue, however, in 800 Columbia. The plaintiff obtained default judgment including declarations of trust against both the first layer and second layer defendants. Vesting orders were refused, though, the Court reasoning that it was incorrect to say that “the right to call for repayment from the Bank was vested in the defendants by virtue of my giving of the default judgments” (800 Columbia, [16](9)).

800 Columbia was subsequently applied, in Tokić, in which it was held that declarations of constructive trust in these cases do not create true trusts, but rather expose recipients of stolen monies to trust-like remedies. The Court reasoned that, as the latter are not caught by the Ordinance, section 52 could not be relied upon, and garnishee orders would have to be sought. At [14]:

‘[these defendants] are merely required by equity to account as if they were trustees or fiduciaries, although they are not. It is purely remedial. Like the dishonest assister or knowing recipient of trust assets in breach of trust, their sole obligation of any practical significance is to restore the assets immediately to the plaintiff.’ [Emphasis original)].

Thus, the question that has divided the authorities has been whether a Westdeutsche claim creates a true trust, or simply a remedial formula and liability as a constructive trustee. In the former case, vesting orders are available. In the latter, they are not.

Westdeutsche Claims Create True Trusts

The difficulty in placing Westdeutsche claims clearly on one side of the true trust/constructive trust line arises because the applicable criterion has traditionally required a fiduciary relationship. Fiduciaries were considered true trustees, whereas non-fiduciaries were (mere) constructive trustees. And a thief is not her victim’s fiduciary. There are, nonetheless, three good reasons why a Westdeutsche claim ought to be considered a “true” trust claim, and not an imposition of mere trustee-like or remedial liability.

1. Proprietary interests

First, this position best reflects Westdeutsche itself. Lord Browne-Wilkinson was discussing the hypothetical but highly analogous scenario of a stolen bag of coins, and asking whether equity compelled their return. His Lordship went on, using the words “tracing”, “proprietary” and “recoverable” to indicate that the trust is imposed over the property not merely against the individual:

“the stolen monies are traceable in equity ... the proprietary interest which equity is enforcing in such circumstances arises under a constructive ... trust ... when property is obtained by fraud equity imposes a constructive trust on the fraudulent recipient: the property is recoverable and traceable in equity.”

This makes perfect sense, since the touchstone of a constructive trust is unconscionability, and since it is unconscionable for a thief to acquire equitable title in the monies that she has stolen:

“A constructive trust arises by operation of law whenever the circumstances are such that it would be unconscionable for the owner of property ... to assert his own beneficial interest in the property and deny the beneficial of another. [Such a] trustee really is a trustee.” (Paragon Finance v DB Thakerar & Co [1999] 1 All ER 400, 409b-d).

Thus, Westdeutsche claims create proprietary or in rem rights which are enforceable against property (choses of action against banks). They are not mere in personam rights enforceable against defendants in whose name bank accounts are held.

Further, Westdeutsche claims permit tracing, or “the process of identifying a new asset” (a credit in the ledger of a second layer account) “as the substitute for the old” (a debit in a ledger of a first layer account) (Foskett v McKeown [2001] AC 102 (UKHL), 127). They are therefore actionable against successive recipients of stolen monies (subject to the usual bona fide purchaser without notice defence), because “equity treats the money in such accounts as charged with the repayment of their money” (Commerzbank Aktiengesellschaft v IMB Morgan plc & Ors [2004] EWHC 2771 (Ch), [36]).

This is all quite different in nature to remedial trust claims or claims against “constructive trustees”. Constructive trustees are dishonest assisters, knowing recipients and inconsistent dealers (Charles Harpum, “The stranger as constructive trustee” (1986) 102 LQR 114; Lionel Smith “Constructive trusts and constructive trustees” (1999) 58 CLJ 294, 298-9; Paragon Finance, 409e; Peconic Industrial Development Ltd v Lau Kwok Fai (2009) 12 HKCFAR 139, [24]; Williams v Central Bank of Nigeria [2014] AC 1189 (UKSC), [9]). They are subject to in personam claims for intermeddling with trust assets, but their property is not subject to anything in the nature of an in rem claim.

Indeed, it does not seem to us that the courts have been granting mere remedial trust-like relief in email fraud cases. The purpose of declarations of constructive trusts has been (as noted above) to confer proprietary remedies, typically in respect of unjust enrichment claims, and the courts in 800 Columbia and Tokić granted declarations in respect of balances in the second layer accounts as well as in the first layer accounts. If the Westdeutsche claims in those cases existed in personam only, the granting of declarations would not have conferred priority or tracing rights, and would appear to have been superfluous.

2. Fundamental Mistake

The second reason why a Westdeutsche claim ought to be considered a “true” trust claim is that payment caused by a fundamental mistake can create a true constructive trust (Chase Manhattan Bank NA v Israel-British Bank (London) Ltd [1981] Ch 105; Commerzbank, [36]; Re Farepak Food and Gifts Limited [2008] BCC 22, [39]-[40]; Bailey & Anor v Angove’s PTY Limited [2016] 1 WLR 3179 (UKSC), [30]). Email fraud cases are typically pleaded on the premise of the plaintiff’s payment of the defrauded sum by mistake as a result of the fraud. It would be odd and anomalous if focus on the plaintiff’s error gave rise to a true trust and in rem remedies, including the right to trace through accounts, but a focus on the defendant’s fraud did not.

The better view, supported by authority, is that the unconscionability of the underlying fraud creates the in rem trust in respect of the first layer account, and binds second layer account holders and subsequent recipients once their conscience is affected by knowledge of unconscionable circumstances (Westdeutsche, 705E; Guaranty Bank and Trust Co v ZZZIK INC Ltd [2016] HKCFI 1161, [33] (DHCJ Cooney SC, citing Lewin on Trusts); Heitkamp & Thumann KG v Living Profit Trading Develop Ltd & Ors [2018] HKCFI 1006, [69] (DHCJ Marlene Ng); Onscale, Inc v Liuhuan Trade Co, Ltd [2019] HKDC 236, [10](2)(a)(ii) (HHJ MK Liu).

3. Consistent with Authority

The third point of note is that the limitation cases relied on in Tokić did not concern true trusts and do not compel a conclusion that Westdeutsche claims are remedial only. In the first, Paragon Finance, the claim was expressly not based on a breach of trust but the intermeddling by solicitors with pre-existing trust assets (Paragon Finance, 409h). The second, Peconic Industrial, at [15], concerned dishonest assistance by third parties to the trust, as did the third Williams, at [4]. Knowing receipt was also invoked. These are orthodox constructive trustee situations, and in none did the question of unjust enrichment, proprietary remedies or tracing arise.

Lord Sumption’s exposition in Williams, at [9] is also of assistance. True trusts arise where conduct implies that persons intended to act as trustees. That is how equity will construe the acts of a thief: to hold the property for her victim. Constructive trustees, by contrast, participate in the unlawful “misapplication of trust assets”. That does not happen in Westdeutsche claims, since there are no trust assets to misapply when the payment is made, it being the unconscionability of the fraud that gives rise to the trust over the first account.

In this regard, it is respectfully suggested that the analogy to dishonest assistance or knowing receipt in Tokić, at [14], is inapposite when considering a proprietary claim under Westdeutsche principles, and in particular in circumstances where, as is typical, plaintiffs in email fraud cases simply plead both unjust enrichment and proprietary claims in respect of monies paid to defendants, by mistake, as a result of an underlying fraud (amongst other reasons, in order to avoid the fraud exception being raised in defence of subsequent summary judgment applications - see Zimmer Sweden AB v KPN Hong Kong Ltd & Anor (No 2) [2016] 2 HKC 282 (CA), [18]).

Conclusions

Successful Westdeutsche claims give rise to true trusts, because plaintiffs can trace their stolen monies through accounts and clearing systems and enforce against all but bona fide purchasers for value without notice. Westdeutsche relief is not personal, and does not, therefore, render recipients of trust monies mere constructive trustees. Consequently, Westdeutsche claims ought to be enforceable by vesting orders.

There ought neither, we suggest, to be imposed a further procedural hurdle whereby plaintiffs have to prove their tracing claims in evidence (contrast Wismettac), [53], [55]-[56]). Applications for vesting orders ought to be assessed on pleadings, as applications for judgment in default of defence are. 

Jurisdictions: 

Barrister, Prince’s Chambers

Barrister, Prince’s Chambers