Privy Council confirms that illegal payments may be recovered through 'backwards tracing'

The decision by the Judicial Committee of the Privy Council ('Privy Council') confirms the legality of the doctrine of "backwards tracing" as a method of asset recovery, depending on the facts of the case. The Privy Council acts as the highest appeal court for several independent Commonwealth countries, and in this case was ruling on an appeal brought by two companies based in the British Virgin Islands (BVIs) against a decision by the Jersey courts.

Litigation expert Craig Connal QC of Pinsent Masons, the law firm behind Out-Law.com, said that the ruling would "perhaps disappoint the legal purists", due to the court's decision to adopt an "intermediate position" on the legality of backwards tracing.

"The court rejected any wide and general rules while at the same time also rejecting the notion that backwards tracing can never happen," he said. "Having every case turn on its own facts and circumstances means that the outcome will remain difficult to predict - or advise on."

However, civil fraud and asset recovery expert Alan Sheeley said that the decision was an encouraging one for victims of fraud and specialist civil fraud solicitors, as it potentially gave them another route through which to recover misappropriated assets.

The BVI companies, Durant and Kildare, appealed a decision by the Royal Court of Jersey that they were liable for the return of over $10 million in bribes paid to the former mayor of the Municipality of Sao Paulo, Brazil in connection with a major public road building contract. The decision had been upheld by Jersey's Court of Appeal. Kildare was a wholly-owned subsidiary of Durant and both companies had been under the practical control of the former mayor, Paulo Maluf, at the time that they events in dispute took place.

The courts had already established that Maluf, or others acting on his behalf, received 15 secret payments in early 1998 and that funds equivalent to 13 of those payments had been converted to US dollars and paid into an account in New York in the name of Chanani, which was under the control of Maluf's son. The funds were then redistributed to accounts held by Durant and Kildare in Jersey. The companies claimed that only $7.7m of the bribe money could be properly traced to them.

Tracing is an equitable doctrine used to establish when one form of property interest can properly be substituted for another. General rules include that if the original property interest ceases to exist, it cannot then be transformed into a later property interest; and that the original property interest cannot turn into or be substituted for something that the holder already has. Previous case law had suggested that when money was paid into an overdrawn bank account, that money was used to settle the account holder's debt to the bank and did not exist separately.

In this case, the defrauded public authority tried to argue that money used to pay a debt could "in principle be traced into whatever was acquired in return for the debt". Both the Jersey courts and the Privy Council resisted what the latter described as a "very broad proposition" that "would take the doctrine far beyond its limits in the case law to date". However, the Privy Council said that "there may be cases where there is a close causal and transactional link between the incurring of a debt and the use of trust funds to discharge it".

"The development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, makes 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," said Lord Toulson on behalf of the Privy Council.

"If the court is satisfied that the various steps are 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 appears in the bank account of an intermediary before a reciprocal credit entry. The [Privy Council] agrees ... that 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," he said.

In this case, the Jersey courts were right to conclude that the "necessary connection" existed between the bribed paid and the money in the Chanani account.

"Overall, in the fight against fraudsters, this is a really good decision by the Privy Council that is bound to be followed further in Commonwealth jurisdictions around the world," said Alan Sheeley, Pinsent Masons' civil fraud and asset recovery expert. "Yes, it is true that the decision does cause some uncertainty because the Privy Council did not reject the arguments in the previous case law. However, this is a good thing as it means cases will be fact-specific to avoid possible unjust decisions, i.e. a victim usurping legitimate creditors' rights."

"This does mean, though, that victims need to seek advice of specialist civil fraud solicitors without delay if they are to maximise their chances of benefiting from the equitable doctrine of tracing. Failure to do so may prejudice a victim's ability to recover their stolen monies that have passed through various bank accounts or been used to buy various assets. Now, more than ever before, victims need to take control of the recovery of their assets, otherwise they could face losing out completely," he said.