How will the court approach tracing claims?

How will the court approach tracing claims?

What does the recent case of Relfo Ltd (in liq) v Varsani tell us about the court’s approach to tracing claims? Peter Shaw and Joseph Curl, barristers at 9 Stone Buildings who represented Relfo, consider the issues raised by the case.

Original news

Relfo Ltd (in liq) v Varsani [2014] EWCA Civ 360, [2014] All ER (D) 59 (Apr)

The liquidator of a company had successfully brought a tracing claim against the defendant in his recovery of money paid by the company. The judge had further found that the defendant had benefited through unjust enrichment. The Court of Appeal, Civil Division, upheld the judge’s decision and decided that, in order to trace money into substitutes, it was not necessary that the payments should occur in any particular order, let alone chronological order.

How did the issue arise?

A company, Relfo, had an outstanding tax liability and about £500,000 in its bank account. Its director, Mr Gorecia, had decided that rather than leave the funds available to pay towards the liability, he would use the funds to make recompense to business associates of the Varsani family for losses suffered in Ukraine and Russia on joint investments. He arranged for the sum to be paid via what can only be described as a group of money launderers and ended up in the account of the defendant, the son of Mr Varsani, who was Mr Gorecia’s principal business associate.

The funds ended up in Mr Varsani’s bank account the day later than Mirren, a BVI intermediary, had received it from the company’s account in England.

We didn’t know any of this at the outset. It wasn’t until some time quite later that the liquidator received an anonymous unsolicited letter, with attached documents, from an individual in Eastern Europe, which tipped the liquidator off that the funds had ended up in Mr Varsani’s bank account. Proceedings commenced on the basis that Mr Varsani had had the company’s money—all the delicate issues of tracing weren’t really live at the outset. It was only when it became clear that the money had been laundered that things became complicated.

What did the Court of Appeal say about tracing generally?

The orthodox view of tracing, as stated in just about every decided case was that, in order to trace money or case assets there had to be an identifiable, chronological sequence in which one could show an asset being substituted for another asset and thereafter being substituted for another one, and so forth. What we submitted to the Court of Appeal, and it agreed, is that this is not how tracing works.

What tracing involves is an identification of substituted value, so that if there is not a complete chain of transactions in chronological order, but the party in the middle of the chain pays out money in the expectation that it’s going to be reimbursed, then that is sufficient to identify a chain of substitutions that will allow the court to trace substitute property through to the end.

That’s of great value in practical terms in dealing with money laundering cases, because the obvious device that was adopted by the money launderers in this case was to try and obscure their actions by having the payment being made to Mr Varsani from one company, and payment from Relfo to another company, and the process hiding in the evidence of intermediaries’ flow of payments.

What’s particularly important about this case is that even though there was no evidence of a complete chain of payments, the court accepted that one can make an inference where there are tracing gaps, and furthermore accepted the principle that if a payment is made by one intermediate party in advance of receiving any payment, that is sufficient to enable a party to trace, albeit filling the evidential gaps by inference.

The orthodox view held was that you cannot do what is colloquially known as ‘backwards trace’, that is, trace through where one party has paid out before they are reimbursed. This causes huge problems when someone tries to recover money that has been through the hands of money launderers, because one of the purposes of money laundering is to defeat processes precisely such as tracing.

Now that we live in an era of financial crime, where money laundering is a huge problem, what the Court of Appeal has done here is make an incremental development of tracing to take account of the process of money laundering.

To what extent must there be sufficient nexus, what’s the role of intention and are substitutions fatal to a tracing claim?

Sufficient nexus

One of the difficulties with the concept of backwards tracing is the idea that the property of the recipient has no connection or relationship with what’s been improperly paid away. One of the main cases against the principle is Serious Fraud Office v Lexi Holdings plc [2008] EWCA Crim 1443, [2009] QB 376 where the court moved against an attempt by the SFO to run a tracing claim against the director of the company against not just the assets that he acquired with the monies that had been paid away, but all of his assets regardless of whether he already owned them or not. One of the reasons for this was that there wasn't enough of a nexus between the money that had been misapplied and what the defendant had acquired.

Hence the issue of nexus is critical. It probably takes on an even greater significance in cases like Relfo because one has to demonstrate a real connection between the chain of payments in circumstances where there are tracing gaps in the evidence and the payments don’t have a chronological flow to them. Being able to build up an evidential picture that they are bound up with each other is very much at the heart of it.

Role of intention

In trying to identify whether there is a nexus or sufficiently close connection between the various stages in the payments, it’s rather difficult to keep out any concept of intention because you are having to demonstrate whether or not the payments are in some fashion linked.

What helped on the facts in Relfo is that the court rather sidestepped the issue of intention and said there were lots of factors that indicated that the various payments were bound up with each other (for example that the amounts were virtually identical and the payments took place within a day of each other).

It was accepted by the court that Mr Gorecia indeed did have the intention to pay the company’s money away for the benefit of the Varsani family. It’s difficult to pinpoint an answer on the role of intention. Intention does appear to have some relevance, but quite how far you can go with it is very much an open question. Orthodox tracing doctrine would be firmly of the view that intention is not relevant, so where this leaves the doctrine is also an open question.

Must there be direct enrichment for an unjust enrichment claim to succeed?

The court considered a line of cases that recognise that even where there is no direct enrichment, an indirect recipient can nonetheless succeed—Investment Trust Companies v Revenue and Customs Comrs [2012] EWHC 458 (Ch), [2012] STC 1150 a claim against HMRC to recover overpayments of VAT, a decision approved by the Court of Appeal in Menelaou v Bank of Cyprus UK Ltd [2013] EWCA Civ 1960, [2013] All ER (D) 33 (Jul). In Relfo, it applied the same principles, which is that essentially one is looking at the economic reality of whether there is an unjust enrichment of a party which is not the direct party, but some third party or subsequent party.

The problem with this is that it can be rather difficult to identify within a clear line those circumstances in which an indirect beneficiary will be entitled to a restitutionary remedy, because there will be many circumstances in which a third party will be unjustly enriched where the law will simply not go as far as to allow a claimant to add a remedy. The dividing line is unclear and the Court of Appeal have said it is not going to lay down any absolute principles regarding this.

What does this mean for practitioners in practice?

Good news, in that it’s going to make it easier to recover laundered funds (although this was only possible because we received that fortuitous ‘tip-off’ as to where the money ended up—see question 1, above). The Court of Appeal have made a positive incremental development of tracing to take account of the process of money laundering, subject to what the Supreme Court may have to say.

Interviewed by Duncan Wood.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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