In international trade liquidity is king, and it is not uncommon for bad actors to advance nefarious schemes to secure that coveted liquidity. The seduction of the trade is often in the returns, with traders promising lenders or investors tantalizing high returns to participate in trades apparently backed by actual goods. The pretext of a trade is often a convenient way to raise liquidity, which might in fact be deployed for other purposes or other jurisdictions, thereby arbitraging on the costs of financing; or it may be used to plug a financial loss in the business. Sometimes, it is just a naked money grab – a simple diversion to third parties to “hold” on the fraudsters’ behalf. Perhaps the most appalling scam in recent times is the nickel trading scam where high profile investors were defrauded out of a staggering $1.2 billion, hoodwinked into believing that they could secure incredible returns out of nickel trades that turned out to be entirely bogus.
There are several challenges victims face when dealing with the fallout of a scam. The first is to ascertain where the monies went to. In cases of fraud or dishonest dealings, the law offers tools to compel the disclosure of the movement of monies from bank accounts used in the financing and extending the imposition of trusts over diverted funds to allow the victim to trace its assets to third parties. But defaults tend to affect several victims at the same time so there may be multiple victims with monies commingled in the fraudsters’ bank account – how do you tell which monies belong to a particular victim and if a pool of money was used to wrongly purchase other assets, what rights do varying creditors have against these assets?
Following the bread crumbs with tracing
The first step in any recovery exercise is making disclosure applications in Court, to permit victims to follow the breadcrumbs and identify all third parties associated with the crime. This facilitates the process of tracing, which is an evidentiary exercise allowing victims to identify the proceeds of the victims’ property and where they lie, which in turn justifies the victims’ claim that the proceeds can be regarded as the victims’ misappropriated property.
An order for pre-action disclosure, or a Norwich Pharmacal order, allows victims to obtain information from third parties mixed up in the wrongdoing. Bankers’ Trust orders are similar to Norwich Pharmacal orders, but permits victims to “lift the latch of the banker’s door” and trace the flow of misappropriated funds. For a Bankers’ Trust order, victims must first demonstrate that the funds in fact belonged to them, so that they may assert a proprietary claim or interest over tracing those funds. The bank(s) involved must be compelled to disclose key documents and information relating to the impugned transactions, including the account opening forms that the fraudster completed to open the account, all documents relating to the banks know your client/due diligence checks on the fraudsters, account information relating to the dissipation of assets, the identities of third party recipients and (where available) the stated purpose of the transactions to third parties.
The imposition of a freezing and/or proprietary injunction over the bank and other persons to prevent the further dissipation of the victims’ assets might be necessary, although this is a costly exercise and victims may face difficulty in enforcing injunctions worldwide. A key limiting factor of such injunctions is that it doesn’t give the creditor priority over other creditors: the defendant’s ability to dispose of assets is frozen but this is invariably for the benefit of all creditors, rather than just one. Disclosure orders and injunctions are however temporary measures, and victims must ultimately obtain final relief against the fraudster in an action for breach of trust and/or fiduciary duties, misrepresentation and unjust enrichment.
Assets mixed or comingled with other funds
Pursuing the fraudster, even successfully, is often not the end of the debacle. Victims are often left with the unenviable task of following their money to third parties in different jurisdictions involved in the wrongdoing. Where evidential difficulties exist over how funds have been applied, the law recognises punitive presumptions aimed at preserving misappropriated trust monies at the expense of the wrongdoer. For instance, when a fraudster mixes a victim’s funds with his own, the law assumes that the whole account is subject to the victims’ trust. More pertinently, a fraudster who has mixed trust money with money in his own account is taken to have dealt with his own money first where sums are withdrawn from that account (i.e. the presumption in re Hallet’s Estate; Knatchbull v Hallett (1880) 13 Ch D 696 (“re Hallet’s”)). Where monies belonging to equally innocent victims are mixed together, victims will generally have equally strong claims to a rateable share of gains, and equally weak claims to avoid taking a rateable share of losses to the mixed funds. Gains and losses are therefore shared between victims in proportion to their contributions to the mixture.
Another key presumption, and an exception to re Hallet’s is the presumption that trust monies can be traced to assets purchased by the fraudster, and it cannot be argued that it is the fraudster’s monies that had first been dissipated (i.e. the rule in Re Oatway; Hertslet v Oatway  2 Ch 356). The law may therefore presume that assets were purchased using the victims’ monies first (instead of the fraudster’s funds), allowing victims to claim a proprietary interest over assets. Where a fraudster used the victims’ monies to pay off a loan towards an asset, the victims may be entitled to trace “backwards”, claiming an interest in the asset that was purchased using the victims’ monies.
Where third parties received victims’ monies, victims may mount a claim against third parties for knowing receipt, which concerns the liability of a person who has received assets (which are subject to a trust), with the requisite level of knowledge that the assets in question are trust assets belonging to the victims. Actual knowledge of the fraud is not required, and the surrounding facts must demonstrate that the conscience of the recipient third parties is so affected by the transfer that they cannot retain the benefit of the property received. While the law would protect bona fide third parties who have received diverted assets, legal tools are still available to ensure that recovery does not end at the fraudster’s door.