In the recent case of IKEA Limited & IKEA Wholesale Limited v Hauxwell-Smith and others (unreported), Judge Finch considered the remedies available to the victim of a fraud in respect of the proceeds of that fraud. The Guernsey Court went on to declare that the fraudulently obtained money was held on a constructive trust for the victim. The effect of Judge Finch’s decision is that it now appears that Guernsey law recognises the existence of a discretionary proprietary remedy known as a remedial constructive trust. This article considers the impact of this radical new development in the law.
The dispute in the IKEA case arose out of procurement irregularities involving the Respondents in the course of which the well-known retailer IKEA was the victim of a substantial fraud. One of the Respondents subsequently pleaded guilty to 18 criminal charges of corruption for his part in the fraudulent scheme relating to the bribery of IKEA’s senior managers. The precise nature of the fraudulent scheme or the way in which the Respondents profited at IKEA’s expense is not explained in the judgment. IKEA initiated civil proceedings in various jurisdictions in order to recoup a loss of £15.6 million that it had suffered as a result of the fraud. IKEA eventually recovered approximately £12.7 million by tracing funds to Lichtenstein.
In the Guernsey proceedings, IKEA sought to recover smaller sums of £56,000 and £90,000 which had been deposited by the Respondents with a local bank and a local firm of Advocates, which IKEA claimed were held on a trust for its benefit as a result of the fraud. If IKEA’s claim was upheld then it would have a proprietary claim to the actual monies held by the bank and the Advocates rather than a purely personal claim for compensation against the Respondents. There was no personal claim against the bank or the Advocates as there was no evidence of any wrongdoing by either party.
IKEA’s primary contention was that a so-called “constructive trust” should be imposed by the Court on the monies held by the bank and the Advocates in such circumstances.
Judge Finch, with little reference to previous authority, held that “where acts lead to profit and are illegal under established legal principle, equity puts any property acquired thereby into a constructive trust. A constructive trust is frequently based on disloyalty or unconscionable conduct. The courts therefore use the concept to compel the person who has obtained property to transfer it to the applicant or Plaintiff.”i Applying this somewhat general approach to the law of property and trusts to the facts of IKEA, Judge Finch went on to hold that as the Respondents had obtained profits as a result of their bribery of IKEA staff, those monies had been obtained in “an unconscionable way”. Consequently, the learned Judge held that the funds in Guernsey, which had been derived from those profits, were held on a constructive trust for IKEA.
It seems that the Court’s decision has, for the first time, introduced the remedial constructive trust into Guernsey law as a remedy for “unconscionable conduct”. The most striking aspect of this decision is that it gives the Guernsey Court the power to award property rights as a matter of discretion which is something that courts elsewhere have generally refused to do.
Curiously, the learned Judge accepted IKEA’s submission that the newly recognised constructive trust was and English trust but that if it had been a Guernsey trust then the same principles would have applied.
The objections elsewhere to remedial constructive trusts
For instance, in the Westdeutscheii case before the House of Lords, Lord Browne-Wilkinson held that a remedial constructive trust had not yet been introduced into English law as “English law has for the most part recognised an institutional constructive trust.”iii He further explained the distinction between the two: “Under an institutional constructive trust, the trust arises by operation of law as from the date the circumstances which gave 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 an enforceable equitable obligation: the extent to which it operates retrospectively to the prejudice of third parties lies in the discretion of the court.”iv
More recently the English Court of Appeal in Sinclair Investments v Versailles held that “whether a proprietary interest exists or not is a matter of property law, and is not a matter of discretion… It follows that the courts of England and Wales do not recognise a remedial constructive trust as opposed to an institutional constructive trust.”v
Therefore the Guernsey Court’s finding in IKEA that a remedial constructive trust arose where payments are procured as a result of unconscionable conduct and the learned judge’s observation that “there is no need to go further into the concept of constructive trusts”vi represents a substantial departure from the orthodox position of the English courts. Given the learned judge’s acceptance that the trust in IKEA was an English trust, that departure is all the more remarkable. What is also remarkable is that neither Westdeutsche nor Sinclair were referred to in the judgment. Indeed, the sole English authority cited in support of the learned judge’s decision was the decision of the English Court of Appeal in Paragon Finance v Thakerar,vii a decision which does not appear to support the learned judge’s analysis and is in fact authority for the proposition that a remedial constructive trust would not be recognised in English law.
Closer to home is the Jersey case of Esteemviii where the Royal Court of Jersey declined to impose a remedial constructive trust as to do have done so would have amounted to the improper creation of property rights by judicial discretion rather than by operation of law. Furthermore, the Royal Court held that there was no evidence of either unjust enrichment or unconscionable behaviour that would be treated elsewhere as prerequisites for imposing such a remedy. The Royal Court emphasised that to introduce the remedy into Jersey law would vary existing proprietary rights without statutory authority.ix “It would not be appropriate to invent new causes of action to deal with the perceived injustice of individual cases, as the public interest demanded that it would be possible to rely on apparently valid transactions. This was particularly true in the context of trusts and gifts into trusts which formed such an important part of Jersey’s financial and commercial life.”x Once again, it seems odd that Esteem was not referred to by the learned judge in IKEA.
At first blush the imposition of a remedial constructive trust appears to be a simple and just remedy. It is no doubt tempting to approach the matter from the perspective that a person whose conduct has been “unconscionable” should not be allowed to profit from his wrongdoing and the notion of allowing the victim to lay claim to the wrongdoer’s profits through a proprietary remedy provides a superficially appealing method of responding to the injustice.
In the development of the law, however, it is important not to lose sight of fundamental principles out of haste to do justice in individual cases, for such an approach can
have unforeseen consequences that may be ultimately be undesirable.
There can be no doubt that a fraudster should be personally liable for any loss he has caused to his victim and, in certain circumstances, to hand over any profit that he has made of his activities. It is far less obvious that the victim of a fraud (or any “unconscionable conduct”) should always have a proprietary remedy directly against identifiable assets in the hands of innocent recipients.
It is in the public interest that the cornerstones of most systems of property rights are reliability and certainty as was emphasised in Esteem.xi To impose such a remedy based on subjective views of unfairness, injustice and good conscience would mean that property rights would no longer be easily ascertainable in advance but would instead be dependent upon the exercise of a discretion by the Court.
Moreover, the recognition of a remedial constructive trust may have wide-ranging impacts that the learned judge in IKEA may not have previously considered. For example, where a plaintiff is granted a proprietary remedy this would give the plaintiff priority over the a wrongdoer’s other creditors in an insolvency as the plaintiff would be entitled to the whole of the property that was subject to the remedial constructive trust and it would not be available for distribution to unsecured creditors. The rights of innocent third parties may therefore be adversely be affected by the recognition of a remedial constructive trust but, in our view, there is no good justification for the subordination of the general creditors’ claims.
The introduction of an element of discretion also has the potential to create a high degree of uncertainty. In Ikea a remedial constructive trust was imposed on the Respondents based on their unconscionable conduct but this raises a number of difficult questions: How unconscionable must the wrongdoer’s conduct be? Are there degrees of unconscionability before the remedy is imposed? Will this depend on the individual judge’s perceptions of unfairness, justice and good conscience? Should the wrongdoer have been convicted of a crime or fraud before the remedy is imposed? What are the rights of existing creditors to the wrongdoer’s assets?
It is, perhaps, unfortunate that the English decisions in Westdeusche and Sinclair and the Jersey decision in Esteem were apparently not cited to or referred to by the learned judge in IKEA. It therefore appears that the full ramifications of the learned judge’s radical reformulation of the law of trusts and property in Guernsey was not as fully analysed as it might have been.
It may be that the result in IKEA could have been justified on the basis of a traditional institutional constructive trust depending upon the provenance of the monies received by the Respondents and in particular whether such monies were beneficially owned by IKEA prior to the Respondents’ wrongdoing. Unfortunately the underlying facts of the case are not identified in the judgment for us to determine whether an institutional constructive trust arose.
In concluding, we take the view that the desirability of the recognition of the novel concept of a remedial constructive trust in Guernsey law in IKEA is open to serious doubt. This development may well have substantial unforeseen consequences which may undermine the certainty of the property rights upon which our economic system is founded and may prejudice the rights of innocent third party creditors in the event of an insolvency. It is to be hoped that the Guernsey Court will have another opportunity to consider these issues in the near future.