[CHANCERY DIVISION]

EAGLE TRUST PLC. v. S.B.C. SECURITIES LTD.

[1990 E. No. 1678]

Trusts - Constructive trust - Fraud - Payment of debt from alleged misapplication of trust money - Recipient's suspicion over payer's ability to raise payment - Duty to inquire whether money properly paid - Whether recipient personally liable as constructive trustee

The plaintiff company, in the course of a take-over bid for another company, made an issue of new shares, which the defendant company agreed to underwrite. The defendant then arranged for its liability to be sub-underwritten by others, including an employee of the plaintiff. The plaintiff subsequently alleged that the employee had misappropriated £13.5m. of its funds in order to meet his sub-underwriting obligations to the defendant, which had in turn used the money to discharge its obligation to the plaintiff as underwriters. It issued a writ alleging that the defendant was liable to account as a constructive trustee, on the grounds that it ought to have known, or to have been put on inquiry, that the sums paid to it were the plaintiff's own money.

On the hearing of a motion by the defendant to strike out the statement of claim as disclosing no cause of action: -

Held, that where a payment was made in the ordinary course of business in the discharge of a liability, the recipient could be made liable as a constructive trustee to restore the money if it could be shown that he had actual knowledge that the money had been misapplied in breach of trust, or had wilfully shut his eyes or had wilfully and recklessly failed to make such inquiries

as an honest and reasonable man would make; that such knowledge might be inferred in the absence of any evidence or explanation by the recipient if the circumstances were such that an honest and reasonable man would have drawn an inference that the payment was in probability misapplied trust money and would not have accepted it, or would not have applied it in discharge of the liability until satisfied that the payer was entitled to use the money; and that on the facts pleaded, since the defendant could be said to have had no more than a suspicion as to how the payment had been arranged, in circumstances where an honest and reasonable man would not have made further inquiry, the plaintiff's action would be bound to fail and the statement of claim would accordingly be struck out (post, pp. 489H - 490A, 506C-F, 508C-E).

In re Blundell; Blundell v. Blundell (1888) 40 Ch.D. 370; Thomson v. Clydesdale Bank Ltd. [1893] A.C. 282, H.L.(Sc.); Agip (Africa) Ltd. v. Jackson [1991] Ch. 547, C.A. and Baden v. Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France S.A. (Note) [1993] 1 W.L.R. 509 applied.

Per curiam. A stranger cannot be made liable for knowing assistance in a fraudulent breach of trust unless knowledge of the fraudulent design can be imputed to him. There must be something amounting to want of probity on his part. Constructive notice is not enough, though knowledge may be inferred in the absence of evidence by the defendant if such knowledge would have been imputed to an honest and reasonable man (post, p. 496B-C).

The following cases are referred to in the judgment:

Agip (Africa) Ltd. v. Jackson [1990] Ch. 265; [1989] 3 W.L.R. 1367; [1992] 4 All E.R. 385; [1991] Ch. 547; [1991] 3 W.L.R. 116; [1992] 4 All E.R. 451, C.A.

Baden v. Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France S.A. (Note) [1993] 1 W.L.R. 509; [1992] 4 All E.R. 161

Bailey v. Barnes [1894] 1 Ch. 25, C.A.

Belmont Finance Corporation Ltd. v. Williams Furniture Ltd. [1979] Ch. 250; [1978] 3 W.L.R. 712; [1979] 1 All E.R. 118, C.A.

Belmont Finance Corporation Ltd. v. Williams Furniture Ltd. (No. 2) [[1979] 2 Ch. 250;] [1980] 1 All E.R. 393, C.A.

Blundell, In re; Blundell v. Blundell (1888) 40 Ch.D. 370

Carl Zeiss Stiftung v. Herbert Smith & Co. (No. 2) [1969] 2 Ch. 276; [1969] 2 W.L.R. 427; [1969] 2 All E.R. 367, C.A.

English and Scottish Mercantile Investment Co. Ltd. v. Brunton [1892] 2 Q.B. 700, C.A.

Green v. Weatherill [1929] 2 Ch. 213

Karak Rubber Co. Ltd. v. Burden (No. 2) [1972] 1 W.L.R. 602; [1972] 1 All E.R. 1210

Manchester Trust v. Furness [1895] 2 Q.B. 539, C.A.

Montagu's Settlement Trusts, In re [1987] Ch. 264; [1987] 2 W.L.R. 1192; [1992] 4 All E.R. 308

Nelson v. Larholt [1948] 1 K.B. 339; [1947] 2 All E.R. 751

Reckitt v. Barnett, Pembroke and Slater Ltd. [1929] A.C. 176, H.L.(E.)

Selangor United Rubber Estates Ltd. v. Cradock (No. 3) [1968] 1 W.L.R. 1555; [1968] 2 All E.R. 1073

Thomson v. Clydesdale Bank Ltd. [1893] A.C. 282, H.L.(Sc.)

Westminster City Council v. Croyalgrange Ltd. [1986] 1 W.L.R. 674; [1986] 2 All E.R. 353, H.L.(E.)

Williams v. Williams (1881) 17 Ch.D. 437

The following additional cases were cited in argument:

Barclays Bank Plc. v. Quincecare Ltd., 1988 F.L.R. 166

Feuer Leather Corporation v. Frank Johnstone & Sons [1981] Com.L.R. 251

Greer v. Downs Supply Co. [1927] 2 K.B. 28, C.A.

Lipkin Gorman v. Karpnale Ltd. [1989] 1 W.L.R. 1340; [1992] 4 All E.R. 409, C.A.

Westpac Banking Corporation v. Savin [1985] 2 N.Z.L.R. 41

Williams and Humbert Ltd. v. W. & H. Trade Marks (Jersey) Ltd. [1986] A.C. 368; [1986] 2 W.L.R. 24; [1986] 1 All E.R. 129, H.L.(E.)

MOTION

The defendant, S.B.C. Securities Ltd., moved pursuant to R.S.C., Ord. 18, r. 19, to strike out the statement of claim, on the ground that it disclosed no cause of action, in proceedings brought by the plaintiff, Eagle Trust Plc., whereby the plaintiff sought an account and repayment of £13.5m., being money misapplied by its former chief executive and paid to the defendant, on the ground that the defendant was accountable as a constructive trustee, having dealt with the money with actual or constructive knowledge that it belonged to the plaintiff.

The facts are stated in the judgment.

Jonathan Sumption Q.C. and Mark Hapgood for the defendant.

Peter Goldsmith Q.C. and Michael Brindle for the plaintiff.

15 January 1991. VINELOTT J. read the following judgment. This is an application by a company now known as S.B.C. Securities Ltd. but known at the material time as S.B.C.I. Savory Milln Ltd. to strike out the statement of claim in an action brought against it by Eagle Trust Plc. on the ground that the statement of claim discloses no cause of action. I will refer to these companies as Savory Milln and Eagle respectively. Before describing the claim advanced in the statement of claim and the allegations on which it is founded, I should emphasise, to avoid any possible misunderstanding, that this is not the trial of the action and that the truth of those allegations has not been established. Many of the allegations and the inferences which it is sought to draw from them are disputed. The question in this application is whether, if this action were to proceed to trial and if Eagle were to establish the truth of all allegations made and if Savory Milln were to adduce no evidence, Eagle would be entitled to the relief claimed.

The allegations

The relevant allegations are: (a) on 14 October 1987 Eagle announced the terms of an offer for the acquisition of the entire issued share capital of Samuelson Group Plc. The offer was of six new Eagle shares for each Samuelson share. It was accompanied by (i) a cash alternative of 180p for each Samuelson share and (ii) a rights issue addressed to shareholders of Eagle of new shares of Eagle priced at 30p for each new share.

(b) By an underwriting agreement dated 12 October 1987 Savory Milln had agreed to underwrite the cash alternative and the rights issue. The total potential liability of Savory Milln under the underwriting agreement was £56m. - £35m. in respect of the cash alternative and

£21m. in respect of the rights issue, less the fees which Savory Milln were entitled to retain.

(c) On 19 October, before the offer documents had been sent out, prices on the London Stock Exchange fell heavily: it is commonly known as Black Monday.

(d) After 12 October Savory Milln, for its own protection, arranged to sub-underwrite its liabilities to Eagle in respect of the rights issue. Paragraph 6 of the statement of claim contains a list of sub-underwriters said to have been introduced by or through John Ferriday, the chief executive of Eagle. The list includes a firm of solicitors practising in Birmingham, Martin Boston & Co., or its senior partner, Martin Boston, in respect of 11 million shares of Eagle, and a firm of provincial stockbrokers, Earnshaw Haes, in respect of 21 million shares. It is said in paragraph 7 of the statement of claim that in circumstances unclear to Eagle the list changed. In the revised list the reference to Martin Boston & Co. and Martin Boston is deleted, the number of shares underwritten by Earnshaw Haes is increased from 21 to 26 million, and Ferriday, whose name was not included in the original list, appears in the revised list as underwriting 25.5 million shares. There are other differences between the two lists. The liability of a company called Coast Securities Ltd. is reduced from 20 million to 3 million and the liability of a firm called Jeffries & Co. from 16,450,000 to one million. In the revised list two banks, Standard Chartered Bank and Bank of Bermuda appear as sub-underwriters in respect of two million and 10 million shares respectively. The total number of shares underwritten is slightly reduced from 69,450,000 to 69,050,000.

(e) The relevant changes are elaborated in paragraphs 8 and 9 of the statement of claim, where it is said, in paragraph 8, (a) that Martin Boston & Co. and Martin Boston were released from their sub-underwriting obligations pursuant to a letter written by them to Savory Milln in which it was alleged that Ferriday had agreed to indemnify Martin Boston & Co. and Martin Boston, that Ferriday had denied to Savory Milln and to Eagle's then solicitors that he had given any such indemnity and, when asked by Eagle's then solicitors, denied that he had acted on behalf of Eagle in giving such an indemnity, but (b) that nonetheless, by a letter dated 15 November 1987, Savory Milln released Martin Boston & Co. and Martin Boston from their sub-underwriting obligations, which were undertaken by Ferriday personally; and in paragraph 9, that Earnshaw Haes had denied that it was involved in the sub-underwriting and claimed that any participation in the sub-underwriting was the responsibility of one Michael Barnard, a business associate of Earnshaw Haes and an associate of Ferriday.

(f) Paragraph 10 then sets out details of payments made by Savory Milln in discharge of its obligations in respect of the rights issue, namely two payments of £3.5m. and £8m. respectively on 17 December 1987 and one of £8m. on 22 December 1987.

(g) It is said in paragraph 11 that these payments were funded in part by the receipt by Savory Milln of £13.5m. from a company called Anser General Investments S.A. (described in the statement of claim as "a Panamanian company administered from Jersey and controlled by Ferriday") and, in paragraph 12, that Savory Milln used these payments in or towards discharge of the liability of Earnshaw Haes and of Ferriday's own liability under the sub-underwriting agreements.

Although

not so stated, it is common ground that the moneys were so applied on the instructions of Ferriday.

(h) It is said in paragraph 13 that the moneys received from Anser were moneys of Eagle which had been misappropriated by Ferriday and paid, first by way of apparent loans by Eagle, to a company then known as Connect Parcels Distribution Plc. and now known as Eagle Express Plc., which is now, but was not at the date of the payment, a subsidiary of Eagle; secondly, by Connect to Hambros Bank (Jersey) Ltd., for the account of Anser; and lastly, by payment from that account via Hambros Bank (Jersey) Ltd. to Savory Milln's account at National Westminster Bank, 41 Lothbury, E.C. 2.

(i) Paragraphs 14 and 15, which are headed "Constructive Trust," I must read in full:

"14. The said £13.5m. was received by Savory Milln as aforesaid and dealt with as set out in paragraphs 10 and 12 above, in circumstances where Savory Milln ought to have known and/or were on inquiry that the said sums were or represented Eagle's own money. Further, Savory Milln applied Eagle's said money towards discharge of Savory Milln's own under-writing obligations in respect of Eagle's shares in contravention of section 151 of the Companies Act 1985 in circumstances where they ought to have known and/or were on inquiry that there was such a contravention. In the said receipt and/or dealing Savory Milln acted at all times solely as principal in their own right pursuant to the sub-underwriter's obligations to them and their own underwriting obligations to Eagle. In the premises they are accountable to Eagle in respect of the said sums and/or are liable as constructive trustees to return the said sums to Eagle.

"15. Savory Milln ought to have been aware of the matters aforesaid and/or were on inquiry of the same by virtue of the following facts and matters: (i) They knew that £23m. in sub-underwriting some 69 million shares was being arranged by or through Ferriday, the chief executive of Eagle. (ii) They took no or no adequate steps to check with the names listed in paragraph 6 or 7 above that they were genuinely sub-underwriting the share issues or that they were good for their obligations. They should have been particularly suspicious about this in the light of the significant changes in the sub-underwriting list set out in paragraphs 6 and 7 above. (iii) The circumstances surrounding Martin Boston & Co. set out in paragraph 8 above put them on notice that: (a) Ferriday might be indemnifying some or all of the said sub-underwriters in respect of their liabilities; and (b) that he might be doing so on behalf of Eagle. Savory Milln and their solicitors, S. J. Berwin & Co., considered the possible implications of section 151 of the Companies Act 1985 in this connection. (iv) They knew that Ferriday personally was liable for at least £7.5m. in respect of his own sub-underwriting obligations but did not believe that he had the funds to discharge such obligations. Mr. Gillams believed, in October 1987, that Ferriday's wealth was tied up in Eagle. After the stock market crash of 19 October 1987 Savory Milln thought that Ferriday would use his vote at the extraordinary general meeting of Eagle held on 25 November 1987 to approve the offer and the rights issue in such a way that he did not expose himself to

these liabilities. When he voted in favour of the transaction proceeding, Savory Milln thought that he was in effect voting to bankrupt himself. (v) In these circumstances Savory Milln should have been acute to the danger that Ferriday would seek to cover his liabilities from whatever fund he had access to, most obviously the funds of Eagle. (vi) Savory Milln made no inquiry as to the source from which the payments of £13.5m came. They made no or no adequate inquiry either of Hambros Bank (Jersey) Ltd. or of Anser as to which payments from Jersey related to which sub-underwriter's liabilities. They made no inquiries as to who Anser was, nor its relation with Eagle or Ferriday or the other sub-underwriters. (vii) Savory Milln made no or no adequate inquiry as to how Ferriday had managed to pay his sub-underwriting obligations if not from Eagle's own funds. (viii) Savory Milln did not contact Earnshaw Haes to check that the said £13.5m. should be applied towards discharge of Earnshaw Haes's obligations. Had it done so it would have discovered that Earnshaw Haes denied that it had any liability. This would have led them further to doubt the ability of the sub-underwriters introduced by Ferriday and of Ferriday himself to discharge their obligations without access to Eagle's own funds."

The question of law is whether, the £13.5m. having been applied in discharge of the liability to Savory Milln of Earnshaw Haes and Ferriday so that it can no longer be traced, Savory Milln can be made personally liable as constructive trustees to recoup this sum. Three propositions are advanced on behalf of Savory Milln. First, it is said that, in a case where it is not sought to trace trust property or identifiable proceeds into the hands of the defendant but to hold him liable for moneys he has received and disposed of, it is not enough to allege and prove that he had constructive notice that the moneys he received were trust moneys and were being misapplied; it must be shown that he knew that the moneys were trust moneys and that they were being misapplied. Secondly, it is said that even if constructive notice may suffice in some circumstances, for instance where immovable property is conveyed on sale, there is no room in the context of a commercial transaction of this nature for the importation of the concept of constructive notice. Thirdly, it is said that the particulars in paragraph 15, read in conjunction with paragraphs 6, 7, 8 and 9, do not suffice to found an allegation that Savory Milln knew, in any relevant sense of that word, that the £13.5m. was Eagle's money. Before turning to examine these contentions, it will be convenient to say something about what is meant in this context by "knowledge" and "notice."

Knowledge and notice

In Baden v. Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France S.A. (Note), post, pp. 575H - 576A, Peter Gibson J. accepted a submission by leading counsel for the plaintiffs that for the purpose of imposing liability as constructive trustee on a stranger to a trust, not on the ground that he has received that property for his own benefit but on the ground that he has "knowingly assisted" in a fraudulent design on the part of the trustee:

"knowledge can comprise any one of the five different mental states which [counsel for the plaintiff] described as follows: (i) actual knowledge; (ii) wilfully shutting one's eyes to the obvious;

(iii) wilfully and recklessly failing to make such inquiries as an honest and reasonable man would make; (iv) knowledge of circumstances which would indicate the facts to an honest and reasonable man; (v) knowledge of circumstances which would put an honest and reasonable man on inquiry."

Counsel for the defendant conceded that "all five types of knowledge are relevant for the purposes of constructive trusteeship." After observing that neither counsel for the plaintiff nor counsel for the defendant sought to submit that there should be any distinction on this point between the "knowing receipt or dealing" and the "knowing assistance" category, and after a careful review of the authorities, Peter Gibson J. accepted that these concessions had been rightly made. He said, at p. 582E-H:

"It is plainly right that a person with Nelsonian knowledge or type (iii) knowledge should be treated as having knowledge for the purposes of constructive trusteeship. It seems to me, as it did to Ungoed-Thomas J. [in Selangor United Rubber Estates Ltd. v. Cradock (No. 3) [1968] 1 W.L.R. 1555, 1590] and Brightman J. [in Karak Rubber Co. Ltd. v. Burden (No. 2) 1 W.L.R. 602, 635] that there is a sufficient line of authorities to justify treating a person with type (iv) or type (v) knowledge as having knowledge for that purpose. It is little short of common sense that a person who actually knows all the circumstances from which the honest and reasonable man would have knowledge of the relevant fact should also be treated as having knowledge of the facts. The dividing line between Nelsonian and type (iv) knowledge may often be difficult to discern. If an objective test is appropriate to let in type (iv) knowledge, it would be illogical not to apply a similar objective test in circumstances where the honest and reasonable man would be put on inquiry (type (v) knowledge) . . . But in my judgment the court should not be astute to impute knowledge where no actual knowledge exists. In particular, it is only in exceptional circumstances that the court should impute type (v) knowledge to an agent like a bank acting honestly on the instructions of its principal but alleged to have provided knowing assistance in a dishonest and fraudulent design. It is not every inquiry that might be made that the court will treat the agent as having been under a duty to make even though the omitted inquiry would if made have led to the agent having knowledge of the facts."

In Agip (Africa) Ltd. v. Jackson [1990] Ch. 265, 292 Millett J. declined to follow Peter Gibson J. if and so far as he held that in a "knowing assistance" case constructive notice is sufficient. He pointed out, first, that the "knowing receipt" category, which he called the "receipt-based category," covers two distinct sub-categories. There is, first, the case where the defendant receives trust money for his own benefit with notice that it was trust property and transferred to him in breach of trust; and second, the case of the defendant who receives trust money lawfully and not for his own benefit but who then, having notice of the trust, misappropriates it or deals with it in a manner which is inconsistent with the trust. Both these sub-categories must be distinguished from the liability of a defendant who is a stranger to the trust and who knowingly assists in the furtherance of a fraudulent and

dishonest breach of trust: the "knowing assistance" category. As to that category Millett J. said, at pp. 292-293:

"The authorities at first instance are in some disarray on the question whether constructive notice is sufficient to sustain liability under this head. In the Baden case [1993] 1 W.L.R. 509, Peter Gibson J. accepted a concession by counsel that constructive notice is sufficient and that on this point there is no distinction between cases of 'knowing receipt' and 'knowing assistance.' This question was not argued before me but I am unable to agree. In my view the concession was wrong and should not have been made. The basis of liability in the two types of cases is quite different; there is no reason why the degree of knowledge required should be the same, and good reason why it should not. Tracing claims and cases of 'knowing receipt' are both concerned with rights of priority in relation to property taken by a legal owner for his own benefit; cases of 'knowing assistance' are concerned with the furtherance of fraud. In Belmont Finance Corporation Ltd. v. Williams Furniture Ltd. [1979] Ch. 250, the Court of Appeal insisted that to hold a stranger liable for 'knowing assistance' the breach of trust in question must be a fraudulent and dishonest one. In my judgment it necessarily follows that constructive notice of the fraud is not enough to make him liable. There is no sense in requiring dishonesty on the part of the principal while accepting negligence as sufficient for his assistant. Dishonest furtherance of the dishonest scheme of another is an understandable basis for liability; negligent but honest failure to appreciate that someone else's scheme is dishonest is not."

I should at this stage say a little more about the Court of Appeal decision there referred to. The Belmont case [1979] Ch. 250 was a decision in an interlocutory appeal from a decision of Foster J. who, at the close of the plaintiff's case, dismissed an action on the grounds, first, that on the pleadings the plaintiff company had been party to an alleged conspiracy to apply the plaintiff company's money indirectly in the purchase of its own shares in contravention of section 54 of the Companies Act 1948 and could not sue its fellow conspirators; and second, that the pleadings did not allege fraud or dishonesty sufficiently clearly to found a claim for knowing assistance in a dishonest breach of fiduciary duty. As to the second of these claims, Buckley L.J. stated two questions. The first was whether it was necessary that when a person is sought to be charged as a constructive trustee, the design of which he is alleged to have had knowledge, should be a fraudulent and dishonest design. He added, at p. 267:

"For this purpose I do not myself see that any distinction is to be drawn between the words 'fraudulent' and 'dishonest;' I think they mean the same thing, and to use the two of them together does not add to the extent of the dishonesty required."

He then stated the second question, whether the statement of claim alleged dishonesty with sufficient particularity, and continued:

"The plaintiff company has contended that in every case the court should consider whether the conduct in question was so unsatisfactory - whether it can be strictly described as fraudulent or dishonest in law - as to make accountability on the footing of

constructive trust equitably just. This, as I have said, is admitted to constitute an extension of the rule as formulated by Lord Selborne L.C. That formulation has stood for more than 100 years. To depart from it now would, I think, introduce an undesirable degree of uncertainty to the law because, if dishonesty is not to be the criterion, what degree of unethical conduct is to be sufficient? I think we should adhere to the formula used by Lord Selborne L.C. So in my judgment the design must be shown to be a dishonest one - that is to say, a fraudulent one. The knowledge of that design on the part of the parties sought to be made liable may be actual knowledge. If he wilfully shuts his eyes to dishonesty, or wilfully or recklessly fails to make such inquiries as an honest and reasonable man would make, he may be found to have involved himself in the fraudulent character of the design, or at any rate to be disentitled to rely on lack of actual knowledge of the design as a defence. But otherwise, as it seems to me, he should not be held to be affected by constructive notice. It is not strictly necessary, I think, for us to decide that point on this appeal; I express that opinion merely as my view at the present stage without intending to lay it down as a final decision."

The language used by Buckley L.J. is not strictly the language of decision. The Court of Appeal was asked to give leave to amend the pleadings to raise an allegation of dishonesty, and Buckley L.J. clearly intended to leave the question in what circumstances knowledge of a dishonest design should be inferred open in case there was a further appeal.

Millett J., after referring to the decision of Sir Robert Megarry V.-C. in In re Montagu's Settlement Trusts [1987] Ch. 264 (a case which I shall have to examine in some detail later) commented on the categories of knowledge identified by Peter Gibson J., in a passage which again I must read in full [1990] Ch. 265, 293:

"Knowledge may be proved affirmatively or inferred from circumstances. The various mental states which may be involved were analysed by Peter Gibson J. in Baden's case as comprising: (i) actual knowledge; (ii) wilfully shutting one's eyes to the obvious; (iii) wilfully and recklessly failing to make such inquiries as an honest and reasonable man would make; (iv) knowledge of circumstances which would indicate the facts to an honest and reasonable man; and (v) knowledge of circumstances which would put an honest and reasonable man on inquiry. According to Peter Gibson J., a person in category (ii) or (iii) will be taken to have actual knowledge, while a person in categories (iv) or (v) has constructive notice only. I gratefully adopt the classification but would warn against over refinement or a too ready assumption that categories (iv) or (v) are necessarily cases of constructive notice only. The true distinction is between honesty and dishonesty. It is essentially a jury question. If a man does not draw the obvious inferences or make the obvious inquiries, the question is: why not? If it is because, however foolishly, he did not suspect wrongdoing or, having suspected it, had his suspicions allayed, however unreasonably, that is one thing. But if he did suspect wrongdoing yet failed to make inquiries because 'he did not want to know' (category (ii)) or because he regarded it as 'none of his business'

(category (iii)), that is quite another. Such conduct is dishonest, and those who are guilty of it cannot complain if, for the purpose of civil liability, they are treated as if they had actual knowledge."

I respectfully agree with everything said by Millett J. in that passage. In In re Montagu's Settlement Trusts [1987] Ch. 264, 277, Sir Robert Megarry V.-C. said:

"In the books and the authorities the word 'notice' is often used in place of the word 'knowledge,' usually without any real explanation of its meaning. This seems to me to be a fertile source of confusion; for whatever meaning the layman may attach to those words, centuries of equity jurisprudence have attached a detailed and technical meaning to the term 'notice,' without doing the same for 'knowledge.' The classification of 'notice' into actual notice, constructive notice and imputed notice has been developed in relation to the doctrine that a bona fide purchaser for value of a legal estate takes free from equitable interests of which he has no notice."

It is in some contexts, in particular where it is sought to make a defendant liable as a constructive trustee, important to distinguish between these terms. Actual or conscious knowledge gives rise to no difficulty and, as Buckley L.J. in the passage I have cited from Belmont points out, a defendant who wilfully closes his eyes to the obvious or who wilfully and recklessly fails to make such inquiries as an honest and reasonable man would make is disentitled to rely on the lack of actual knowledge.

The rule applies equally in criminal as in civil cases. The explanation is given by Lord Bridge of Harwich in Westminster City Council v. Croyalgrange Ltd. [1986] 1 W.L.R. 674, 684, which concerned a prosecution for knowing or using or causing or permitting the use of premises as a sex establishment without a licence, when he said:

"it is perhaps worth remarking, in the hope that it may further allay the anxiety of the council about the enforcement of licensing control of sex establishments, that it is always open to the tribunal of fact, when knowledge on the part of a defendant is required to be proved, to base a finding of knowledge on evidence that the defendant had deliberately shut his eyes to the obvious or refrained from inquiry because he suspected the truth but did not want to have his suspicion confirmed."

Knowledge may also be inferred, at least in civil cases, if the circumstances set out in paragraphs (iv) and (v) of Peter Gibson J.'s classification in the Baden case, post, pp. 575H - 576A, are established and if the defendant does not give evidence or offer any explanation of his conduct. If the circumstances are such that an honest and reasonable man would have appreciated that he was assisting in a dishonest breach of trust, the court may infer from the defendant's silence that he either appreciated the fact, or that he wilfully shut his eyes to the obvious, or wilfully and recklessly failed to make inquiries for fear of what he might learn. Whether in such circumstances a defendant can escape liability on the ground that he acted honestly but failed to draw the obvious inference by reason of his inexperience or because he was unusually or unreasonably trusting, or for some other reason, is a question which I

do not need to consider further. The passage I have cited from the judgment of Millett J. in Agip (Africa) Ltd. v. Jackson [1990] Ch. 265, 293, suggests that an affirmative answer should be given to this question. But it cannot be relevant in an application to strike out a statement of claim on the ground that it discloses no cause of action.

However "notice" is often used in a sense or in contexts where the facts do not support the inference of knowledge. A man may have actual notice of a fact and yet not know it. He may have been supplied in the course of a conveyancing transaction with a document and so have actual notice of its content, but he may not in fact have read it; or he may have read it some time ago and have forgotten its content. Sir Robert Megarry V.-C. observed in In re Montagu's Settlement Trusts [1987] Ch. 264, 284: "I suppose that there may be some remarkable beings for whom once known is never forgotten; but apart from them, the generality of mankind probably forgets far more than is remembered." So also by statute a man may be deemed to have actual notice of a fact which is clearly not within his knowledge. Constructive and imputed notice are most frequently, though not invariably, used in contrast to knowledge - to describe a situation in which a man is treated for some purposes as if he had knowledge of facts which were clearly not known to him. Lord Esher in English and Scottish Mercantile Investment Co. Ltd. v. Brunton [1892] 2 Q.B. 700, 708 described the doctrine of constructive notice as "wholly founded on the assumption that a man does not know the facts." Moreover, a man may be affected by constructive notice even if there has been not only no want of probity but no carelessness on his part. He may have imputed to him notice of matters of which his counsel, solicitor or other agent had notice, actual or constructive, in the same transaction in which the question of notice arises: see section 199 of the Law of Property Act 1925, re-enacting section 3(2) of the Conveyancing Act 1882 (45 & 46 Vict. c. 39) which in turn was largely declaratory of the law.

In the field of conveyancing the law has historically set a very high standard; so much so that Maitland observed that

"in reading some of the cases about constructive notice we may be inclined to say that equity demanded not the care of the most prudent father of a family but the care of the most prudent solicitor of a family aided by the skill of the most expert conveyancer:" see Maitland's Equity, 2nd ed. (1936), p. 119.

It is often said that man has constructive notice of matters which he would have discovered if he had made those inquiries which he ought reasonably to have made. But as Lindley L.J. pointed out in Bailey v. Barnes [1894] 1 Ch. 25, 35:

"'Ought' here does not import a duty or obligation; for a purchaser need make no inquiry. The expression 'ought reasonably' must mean ought as matter of prudence, having regard to what is usually done by men of business under similar circumstances."

The phrase "put on inquiry" suffers from a similar ambiguity. A man may be said to be put on inquiry if he knows of circumstances which point to the probability of fraud. He may then have to satisfy himself that there is an innocent explanation if he is to escape the charge that he wilfully or recklessly abstained from inquiry from fear of what he might have learned. But the phrase "put on inquiry" may be used to

describe the very different situation where a purchaser or his solicitor ought to make further inquiry "as a matter of prudence, having regard to what is usually done by men of business in similar circumstances." So, for example, if land contracted to be purchased is in the occupation of some person other than the vendor, the purchaser would in this sense be put on inquiry as to the rights of the occupier and has constructive notice of rights which he would have learned had he made a proper inquiry.

Knowing assistance

When I heard argument in the instant case, an appeal against the decision of Millett J. in Agip (Africa) Ltd. v. Jackson [1990] Ch. 265 had been heard in the Court of Appeal and judgment had been reserved. I accordingly delayed giving judgment until the Court of Appeal had given its decision [1991] Ch. 547, affirming the decision of Millett J. The leading judgment was given by Fox L.J. with whom Butler-Sloss and Beldam L.JJ. agreed. Fox L.J., having stated the principle that a person may be liable as a constructive trustee if he knowingly assists in a fraudulent design on the part of a trustee, including a constructive trustee, added, at p. 567:

"The degree of knowledge required was described by Ungoed-Thomas J. in Selangor United Rubber Estates Ltd. v. Cradock (No. 3) [1968] 1 W.L.R. 1555, 1590 as [knowledge of] circumstances which would indicate to an honest and reasonable man that such a design was being committed, or would put him on inquiry whether it was being committed."

Then, having set out what he described as "a more expanded description of the circumstances constituting the necessary knowledge" in the judgment of Peter Gibson J. in the Baden case, post, pp. 575H - 576A, he added: "I accept that formulation. It is, however, only an explanation of the general principle and is not necessarily comprehensive."

He did not in terms deal with Millett J.'s analysis of the different types of circumstances giving rise to a constructive trust or with his view that, to found a claim for liability as a constructive trustee under the "knowing assistance" head, constructive notice is not enough, that there must be something amounting to dishonesty or want of probity in the conduct of the defendant. However, it is, I think, implicit in his judgment that he accepted Millett J.'s conclusion that in a "knowing assistance" case something amounting to dishonesty or want of probity on the part of the defendant must be shown. At the beginning of his judgment [1991] Ch. 547, 553, he posed the question raised by the appeal as being whether the defendants "were guilty of wilful and reckless failure to make inquiries in order to satisfy themselves that they were not acting in furtherance of a fraud" and, after a careful review of the facts, he concluded, at p. 568:

"the judge rightly came to the conclusion that they must have known that they were laundering money, and were consequently helping their clients to make arrangements to conceal some dispositions of money which had such a degree of impropriety that neither they nor their clients could afford to have them disclosed."

In that case, of course, the defendants chose not to give evidence and the inference was drawn having regard to the circumstances which were proved by the plaintiff.

It can therefore, in my judgment, now be taken as settled law that, notwithstanding the wider language in which the test of liability as constructive trustee in a "knowing assistance" case is stated in the Selangor case [1968] 1 W.L.R. 1555, 1590 and in the Karak case [1972] 1 W.L.R. 602, 639, and, notwithstanding the concession made by counsel and accepted by Peter Gibson J. in the Baden case, post, p. 509, a stranger cannot be made liable for knowing assistance in a fraudulent breach of trust unless knowledge of the fraudulent design can be imputed to him on one of the grounds I have described. There must have been something amounting to want of probity on his part. Constructive notice is not enough, though, as I have said, knowledge may be inferred in the absence of evidence by the defendant if such knowledge would have been imputed to an honest and reasonable man.

Knowing receipt

The first question identified by Mr. Sumption in his very full argument is whether a defendant who has received trust property but who does not have the property or identifiable proceeds in his hand is free from liability as a constructive trustee unless it is similarly shown that knowledge that the property was trust property, and was transferred to him in breach of trust, can be imputed to him at a time when he still had the property or identifiable proceeds in his hand. It is not, of course, in dispute that if the trust property or identifiable proceeds are still in his hand the true beneficial owner can require their restoration unless the defendant can prove that he or his predecessor took the trust property as bona fide purchaser for value. Subject to that exception he has no right to retain the property against the true owners. The question is whether the defendant can be made personally liable to make good the value of property which he no longer has. For reasons which I will give later I do not think this question requires to be decided. However, as the question has been fully argued, I should say something about the authorities that have been cited.

Mr. Goldsmith submitted that the decision of the Court of Appeal in the substantive appeal in Belmont Finance Corporation Ltd. v. Williams Furniture Ltd. (No. 2) [1980] 1 All E.R. 393 is authority for the proposition that a defendant remains personally liable as a constructive trustee if he receives trust property with notice, actual or constructive, of a breach of trust. He relied upon the finding that Belmont had made out a case of knowing receipt against the second defendant, City Industrial Finance Ltd.: £0.5m. of Belmont's money had been paid to a Mr. Grosscurth in unlawful contravention of section 54 and the payment was thus a misapplication of Belmont's money and a breach of duty by its directors. £489,000 of that sum found its way into the hands of City. City was held liable as a constructive trustee. I do not think that decision assists Mr. Goldsmith. One of the directors of Belmont, a Mr. James, was also a director of City. He was one of the architects of the scheme for the application of Belmont's money indirectly in the purchase of its own shares. His knowledge could be imputed to City, which accordingly knew the whole circumstances of the transaction: [1980] 1 All E.R. 393, 405, per Buckley L.J. Mr. Goldsmith relied upon two passages in the judgment of Goff L.J. First, at p. 410:

"I turn next to the first limb of Belmont's case on constructive trust, that is to say, 'knowing receipt.' This is now relevant as against City only. As I have said, this does not depend on proof of fraud, nor in my judgment is Mr. James's belief that 'the agreement was a good commercial proposition for Belmont to purchase Maximum's shares for £500,000' any answer. What Belmont has to show is that the payment of £500,000 was a misfeasance, which for this purpose is equivalent to a breach of trust, that City received all or part of this money, and that it did so knowing, or in circumstances in which it ought to know, that it was a breach of trust. In fact City received £489,000 and that is the basic measure of any liability under this head. It is true that City received this through Grosscurth as a payment for the shares in Belmont, but this was intended by all parties and made pursuant to the agreement of 3 October 1963. In my judgment, therefore, the money received by City was clearly part of the original £500,000 of Belmont's money."

Then, at p. 412:

"Then did City know, or ought it to have known, of the misfeasance or breach of trust? In my judgment the answer to that question must plainly be Yes, for they are fixed with all the knowledge that Mr. James had. Now, he had actual knowledge of all the facts which made the agreement illegal and his belief that the agreement was a good commercial proposition for Belmont can be no more a defence to City's liability as constructive trustees than in conspiracy."

What the decision in Belmont (No. 2) shows is that in a "knowing receipt" case it is only necessary to show that the defendant knew that the moneys paid to him were trust moneys and of circumstances which made the payment a misapplication of them. Unlike a "knowing assistance" case it is not necessary, and never has been necessary, to show that the defendant was in any sense a participator in a fraud. But the passages I have cited go no way to establish that in a "knowing receipt" case it is sufficient for the plaintiff to show that the defendant had constructive notice that the moneys paid to him were trust moneys and of facts which made the payment a misapplication of them.

The decision of the House of Lords in Reckitt v. Barnett, Pembroke and Slater Ltd. [1929] A.C. 176, another case relied on by Mr. Goldsmith, illustrates the same point. Lord Terrington had a power of attorney authorising him to act as the appellant's attorney in the management of his affairs. He drew a cheque on the appellant's account, signed it as attorney and used it to pay what the respondents knew was his own debt. In the words of Lord Hailsham L.C., at p. 182, "It is a simple case of receipt by the respondents of the appellant's money with the knowledge that it was the appellant's money in payment of Lord Terrington's debt" and to succeed the burden was accordingly on the respondents to show that Lord Terrington had in fact the authority to use the appellant's money in payment of his, Lord Terrington's, debt.

I was referred by Mr. Goldsmith to other cases at first instance in which the test of liability as a constructive trustee for "knowing receipt" of trust property has been widely stated, in particular Nelson v. Larholt [1948] 1 K.B. 339. I do not propose to refer to them; the cases were, as Sachs L.J. observed of Nelson in Carl Zeiss Stiftung v. Herbert Smith &

Co. (No. 2) [1969] 2 Ch. 276, 298, cases where "there was an obvious shutting of eyes."

Mr. Sumption relied on the decision of the Court of Appeal in the Carl Zeiss case. The plaintiff's claim was a very remarkable one. The plaintiff, which I will call the East German foundation, claimed in another action (the main action) that all the assets of the defendant to that action, another company with the same name, which I will call the West German foundation, were held in trust for the East German foundation. In the case before the Court of Appeal (the second action) the plaintiff claimed that the defendants who had acted as solicitors to the West German foundation in the main action were constructive trustees of sums paid to them on account of fees, costs and disbursements. They sought an account and payment of all fees, costs and disbursements paid to the defendant's solicitors and an injunction to restrain further payments. Pennycuick J., on the application of the defendant solicitors, struck out the statement of claim on the ground that the claim was contrary to public policy. His decision was affirmed in the Court of Appeal, but on the ground that it could not be said that the defendant solicitors had knowingly received trust moneys. There are observations of the Court of Appeal which, taken in isolation, strongly support Mr. Sumption's argument. Sachs L.J., having summarised the argument for the East German foundation as "once it was shown that the moneys were in law being used in breach of trust the section 199 test was once more decisive when considering whether a stranger is fixed with liability," said, at p. 298:

"It does not, however, seem to me that a stranger is necessarily shown to be both a constructive trustee and liable for a breach of the relevant trusts even if it is established that he has such notice. As at present advised, I am inclined to the view that a further element has to be proved, at any rate in a case such as the present one. That element is one of dishonesty or of consciously acting improperly, as opposed to an innocent failure to make what the court may later decide to have been proper inquiry. That would entail both actual knowledge of the trust's existence and actual knowledge that what is being done is improperly in breach of that trust - though, of course, in both cases a person wilfully shutting his eyes to the obvious is in no different position than if he had kept them open."

Then, having referred to decisions of Stirling J. in In re Blundell; Blundell v. Blundell (1888) 40 Ch.D. 370 and Kay J. in Williams v. Williams (1881) 17 Ch.D. 437 in support of that analysis, he said:

"these cases tend quite strongly to the conclusion that negligent, if innocent, failure to make inquiry is not sufficient to attract constructive trusteeship."

Edmund Davies L.J. similarly said [1969] 2 Ch. 276, 301:

"Concepts may defy definition and yet the presence in or absence from a situation of that which they denote may be beyond doubt. The concept of 'want of probity' appears to provide a useful touchstone in considering circumstances said to give rise to constructive trusts, and I have not found it misleading when applying it to the many authorities cited to this court. It is because of such a concept that evidence as to 'good faith,' 'knowledge' and 'notice'

plays so important a part in the reported decisions. It is true that not every situation where probity is lacking gives rise to a constructive trust. Nevertheless, the authorities appear to show that nothing short of it will do. Not even gross negligence will suffice."

Then, having cited passages from the decision in In re Blundell and Williams v. Williams, described them as:

"two illustrations among many to be found in the reports of that want of probity which, to my way of thinking, is the hallmark of constructive trusts, however created."

These observations must be read in the light of the very exceptional circumstances of that case. Sachs L.J. was, in the passage I have cited, careful to restrict his view that the further element of dishonesty must be proved to "a case such as the present one." Carl Zeiss [1969] 2 Ch. 276 was not a case where the defendant solicitors had failed to make inquiries which they ought reasonably to have made. They knew as much about the case made by the East German foundation as anyone could know. What they did not know was whether or not the claim would succeed. The case was not therefore one where constructive notice, or what is described by Sachs L.J. as the "section 199 test," had any conceivable relevance. The question was whether, in all the circumstances, the defendant solicitors were liable on the footing that they had received moneys in payment of their fees knowing that the East German foundation claimed to be beneficially entitled to those moneys. It seems to me that the question whether the claim was good almost answers itself. Worldwide litigation between the East and West German foundations had been proceeding for some 13 years. No attempt had been made by the East German foundation to prevent the West German foundation from carrying on business, using allegedly trust assets, either by injunction or the appointment of a receiver. If the claim by the East German foundation against the defendant solicitors had been valid, anybody dealing with the West German foundation would have been at risk, at least if it could have been shown that they had notice, constructive or otherwise, of the claim. It does not follow that a defendant can never be made liable if he receives money knowing of a claim that it is trust money - at least if he is a volunteer: see Green v. Weatherill [1929] 2 Ch. 213. But to succeed the plaintiff must, I think, show that the claim is sufficiently clear to justify the court in preventing the person against whom the claim is made, by injunction or by the appointment of a receiver, from employing the alleged trust assets in his business or otherwise dealing with them, and must give some good reason why he had not taken such steps before proceeding against the third party. That is clearly what Edmund Davies L.J. had in mind when he said at the end of his judgment [1969] 2 Ch. 276, 304:

"The law being reluctant to make a mere agent a constructive trustee, as Lord Selborne L.C. put it in Barnes v. Addy (1874) L.R. 9 Ch.App. 244, 251-252, mere notice of a claim asserted by a third party is insufficient to render the agent guilty of a wrongful act in dealing with property derived from his principal in accordance with the latter's instructions unless the agent knows that the third party's claim is well founded and the principal accordingly had no authority to give such instructions. The only possible exception to such exemption arises where the agent is under a duty to inquire into the

validity of the third party's claim and where, although inquiry would have established that it was well founded, none is instituted. But, as it is conceded by the plaintiffs that the defendant solicitors are under no such duty of inquiry, that further matter does not call for consideration."

The facts in Williams v. Williams, 17 Ch.D. 437, one of the two cases relied upon by Sachs and Edmund Davies L.JJ. are fully set out in the judgment of Brightman J. in Karak Rubber Co. Ltd. v. Burden (No. 2) [1972] 1 W.L.R. 602, 637-638, which I will read in full:

"Edward Williams married in 1863 in India. He made a marriage settlement, which was executed by him and his wife. By the settlement he conveyed his undivided share in certain land to trustees in trust for himself for life, with remainder to his wife for life, with remainder to the children of the marriage. The settlement was handed over to the wife. The parties returned to England. The husband had occasion to consult a solicitor, Mr. Cheese, about his will. Mr. Cheese asked the husband if there were a marriage settlement, and the husband assured him there was none. Something, the husband said, had been prepared but it arrived too late for execution. In 1868 the land was partitioned, and 700 acres were conveyed to the husband. In 1869 the husband sold part of the land. Mr. Cheese acted as his solicitor. The purchase money was about £8,000 and was used to pay the husband's debts. Six years later the husband asked his wife for the settlement. He gave her some excuse and she handed it to him. The settlement was never seen again. In 1877 the husband made another will. He appointed his wife the sole executrix and gave her a life interest, with remainder to the children. In 1879 he died. His wife, as his executrix, sold the remainder of the land in lots, Mr. Cheese acting as her solicitor. The land realised about £3,500. In 1880, in the course of dealing with a requisition which had been raised by a purchaser, Mr. Wood, a clerk in Mr. Cheese's office, wrote to the wife and inquired if there was a settlement. The wife replied that there was, and enclosed a note made by the solicitors who had prepared it. Mr. Wood reported this to Mr. Cheese, but did not show him the wife's letter or the note enclosed with it. Mr. Cheese answered that . . . 'it was all nonsense, that she was referring to a promise only, and that there had been no settlement.' Later, a copy or the draft of the settlement was found. Mr. Cheese had used half the proceeds of sale to pay the husband's debts, including some money due to himself. The remainder of the money remained intact. The children of the marriage sued the wife, the trustees of the marriage settlement and Mr. Cheese. The claim against Mr. Cheese was that he 'might be declared liable to account for and make good the purchase money arising from the sale of the hereditaments comprised in the indenture of settlement received and disposed of by him with notice of the trusts of the said indenture.' Two matters were conceded. First, it was admitted that Mr. Cheese had no wrong motive in anything which he did. Secondly, it was admitted that notice to Mr. Wood of the wife's claim that a settlement existed was not of itself a notice to Mr. Cheese. It was held that Mr. Cheese did not have such notice of the

settlement as to be treated constructively as a trustee, so as to be liable for money which had passed through his hands."

Kay J., in Williams v. Williams, 17 Ch.D. 437, 445-446, while expressing the opinion that he could not acquit Mr. Cheese of "very great negligence towards his client," decided that he did not have:

"such notice as to mean his concurring as [the wife's] solicitor in the sales of the property and allowing the money to pass through his hands sufficient to affect him personally so as to make him liable to repay the money. The case, again, would have been different if I had been satisfied that Mr. Cheese had wilfully shut his eyes - if there had been any motive whatever fairly suggested for supposing that Mr. Cheese was desirous of thinking that there was no settlement. If it were proved to me upon the evidence that he had wilfully shut his eyes, and was determined not to inquire, then the case would have been very different. . . . If he had . . . a bona fide conviction that there was no settlement whatever . . . I cannot hold that he is affected with such notice as to make him personally liable for the purchase moneys which passed through his hands as solicitor."

Brightman J. explained this decision as being, on analysis, concerned with the "knowing receipt" category. He said, at p. 639:

"The claim against Mr. Cheese was that trust money was wrongfully in his hands by the direction of one who had no title thereto and that he proceeded to dispose of it in defiance of the beneficiaries' title of which he had been given due notice. That is not the type of case with which the second category of constructive trusteeship [the 'knowing assistance' kind] is concerned."

I feel considerable doubt whether that is the correct analysis. The facts do not fall within either of the two sub-categories identified by Millett J., in his penetrating analysis in the Agip case [1990] Ch. 265, as giving rise to a receipt-based liability. Mr. Cheese received the proceeds of sale of the property, sold after the husband's death, as agent, and, save as to a small sum which he retained on account of his own fees, which is not dealt with separately by Kay J., he applied them as agent in discharge of the liabilities of the husband's estate. It is not easy to see why it should have made any difference to his liability that his principal, the wife, was not, as he believed, entitled to the property as executrix of the husband's estate. The case, therefore, seems to me to fall within the "knowing assistance" category. Nor is it easy to see why, if it had been a receipt-based case, a stricter standard should have been applied than was appropriate in a "knowing assistance" case. In my judgment in In re Blundell, 40 Ch.D. 370, also, is not authority that constructive notice can never give rise to personal liability in a "knowing receipt" case. I shall return to this case a little later.

I turn next to the case most strongly relied on by Mr. Sumption, the decision of Sir Robert Megarry V.-C. in In re Montagu's Settlement Trusts [1987] Ch. 264. The facts of that case are complex. It is sufficient to say that chattels the subject a family resettlement were transferred to the 10th Duke of Manchester in breach of trust. The trustees, before transferring chattels to him, ought to have made an inventory of those suitable to included in the settlement. He would then have been entitled

to the residue. No inventory was made. All the chattels were handed over to him. The tenth duke sold a number of them. In the action the eleventh duke claimed against the tenth duke's personal representatives an inquiry and account of the proceeds of the chattels that had been sold. The tenth duke was a party to the resettlement and so it could be said that at some time he had had actual notice of the precise terms of the trust. So had his solicitor. But the tenth duke's solicitor had assured him that he was free to sell the chattels. The case, therefore, was one where at one time the tenth duke and his solicitor had had actual notice of the trust. But Sir Robert Megarry V.-C. found that, at the relevant time, he did not know that the chattels he was receiving or dealing with were chattels that were subject to any trust and that he believed that they had been lawfully and properly released to him. When the matter first came before the Vice-Chancellor [1987] Ch. 264, 271, he expressed doubts whether:

"the rules about what constitutes 'notice' for the ancient doctrine of purchaser without notice apply, without more, in determining whether a person holds as a constructive trustee. I doubt whether one can state the rules about what creates a constructive trust in terms of the doctrine of purchaser without notice."

A little later he said:

"I have considerable doubts about whether it should be applied without at least some modification to cases where the issue is whether liability as a constructive trustee is to be imposed, cases in which the investigations apt for a purchaser are not normally required."

He accordingly adjourned the case for further argument. At the adjourned hearing all the cases to which I have referred, except of course the Agip case, were cited. The Vice-Chancellor expressed his conclusion in a series of propositions, at pp. 285-286:

"(1) The equitable doctrine of tracing and the imposition of a constructive trust by reason of the knowing receipt of trust property are governed by different rules and must be kept distinct. Tracing is primarily a means of determining the rights of property, whereas the imposition of a constructive trust creates personal obligations that go beyond mere property rights. (2) In considering whether a constructive trust has arisen in a case of the knowing receipt of trust property, the basic question is whether the conscience of the recipient is sufficiently affected to justify the imposition of such a trust. (3) Whether a constructive trust arises in such a case primarily depends on the knowledge of the recipient, and not on notice to him; and for clarity it is desirable to use the word 'knowledge' and avoid the word 'notice' in such cases. (4) For this purpose, knowledge is not confined to actual knowledge, but includes at least knowledge of types (ii) and (iii) in the Baden case . . . i.e. actual knowledge that would have been acquired but for shutting one's eyes to the obvious, or wilfully and recklessly failing to make such inquiries as a reasonable and honest man would make; for in such cases there is a want of probity which justifies imposing a constructive trust. (5) Whether knowledge of Baden types (iv) and (v) suffices for this purpose is at best doubtful; in my view, it does not, for I cannot see that the carelessness involved will normally

amount to a want of probity. (6) For these purposes, a person is not to be taken to have knowledge of a fact that he once knew but has genuinely forgotten: the test (or a test) is whether the knowledge continues to operate on that person's mind at the time in question. (7)(a) It is at least doubtful whether there is a general doctrine of 'imputed knowledge' that corresponds to 'imputed notice.' (b) Even if there is such a doctrine, for the purposes of creating a constructive trust of the 'knowing receipt' type the doctrine will not apply so as to fix a donee or beneficiary with all the knowledge that his solicitor has, at all events if the donee or beneficiary has not employed the solicitor to investigate his right to the bounty, and has done nothing else that can be treated as accepting that the solicitor's knowledge should be treated as his own. (c) Any such doctrine should be distinguished from the process whereby, under the name 'imputed knowledge,' a company is treated as having the knowledge that its directors and secretary have. (8) Where an alleged constructive trust is based not on 'knowing receipt' but on 'knowing assistance,' some at least of these considerations probably apply; but I need not decide anything on that, and I do not do so."

The Vice-Chancellor thus took at least the tentative view that constructive notice is not enough to found a claim that a stranger, even a volunteer, who has received trust property, can be made personally liable to the true owner.

Mr. Sumption invited me to follow this decision. I would, of course, be reluctant to differ from a decision of Sir Robert Megarry V.-C. in this area of the law. However, although Mr. Goldsmith has not been able to persuade me that there is any contrary decision which is binding on me, I do not think it would be right to found a decision that the statement of claim in the instant case discloses no cause of action solely on the authority of In re Montagu's Settlement Trusts [1987] Ch. 264. As the Vice-Chancellor pointed out, the circumstances were not such as to call for any inquiry by the tenth duke into the trustees' right to distribute the chattels to him and although he and his solicitor had had actual notice of the terms of the resettlement, that was many years ago and was most unlikely to have operated on their minds. In the field of conveyancing, where a purchaser must make full inquiries into title if he is to take the property free from third party claims, other considerations may apply. For example, suppose that property is conveyed to A but A holds on a constructive trust for himself and B, who has contributed in some way to the purchase. That is a common enough situation. A leaves the property and B remains in sole occupation. A then sells the property to the defendant. The defendant fails to make any inquiry of B as to his or her rights. He or his solicitors may have been guilty of great carelessness in failing to do so. If the land is unregistered land, the defendant has constructive notice and B can enforce his or her rights against the property. If the property has been sold and if the proceeds can no longer be traced into A's hands, the decision in In re Montagu's Settlement Trusts, if applied in this field, leads to the conclusion that B cannot make the defendant liable as a constructive trustee. So if, at the time when the property is disposed of by the purchaser, B is no longer in occupation, he or she is without remedy. If the land is registered land, B will have an overriding interest. Questions of notice are then irrelevant. It would be surprising if, in the circumstances I have

described, B had no remedy against the defendant; and equally very anomalous if the rights of B were to depend on whether the land is registered or unregistered.

These cases will have to be considered when they arise. I find it unnecessary to express any opinion on the question whether a defendant who has received trust property in breach of trust but who has parted with it and who has no identifiable proceeds in his hands can never be made liable unless it is shown that he actually knew that the property was trust property and was being transferred in breach of trust or that such knowledge can be inferred. In my judgment, Mr. Sumption succeeds on his alternative ground.

Constructive notice and commercial transactions

The doctrine of constructive notice was developed in the field of property transactions and at a time when full and careful investigation of title was called for before a purchaser could be satisfied that the vendor had legal title to the property sold and that there were no legal or equitable encumbrances on it. Judges have frequently warned of the danger of extending the doctrine beyond these bounds. Lindley L.J. in an often-cited passage in Manchester Trust v. Furness [1895] 2 Q.B. 539, 545, said:

"as regards the extension of the equitable doctrines of constructive notice to commercial transactions, the courts have always set their faces resolutely against it. The equitable doctrines of constructive notice are common enough dealing with lands and estates, with which the court is familiar; but there have been repeated protests against the introduction into commercial transactions of anything like an extension of those doctrines, and the protest is founded on perfectly good sense. In dealing with estates in land title is everything, and it can be leisurely investigated, in commercial transactions possession is everything, and there is no time to investigate title; and if we were to extend the doctrine of constructive notice to commercial transactions we should be doing infinite mischief and paralysing the trade of the country."

The courts have been particularly reluctant to extend the doctrine of constructive notice to cases where moneys are paid in the ordinary course of business to the defendant in discharge of a liability. In Thomson v. Clydesdale Bank Ltd. [1893] A.C. 282 the appellants, who were trustees, instructed a broker to sell shares and to pay the proceeds into bank accounts in their names. He sold the shares in the ordinary course of business and paid the proceeds to the credit of his account with the respondent bank which was overdrawn. He later became insolvent. The bank knew that the cheque represented the proceeds of sale of shares entrusted to him for sale as broker but made no inquiry as to whether the moneys were in his hands as agent. Lord Herschell L.C. said, at p. 287:

"It cannot, I think, be questioned that under ordinary circumstances a person, be he banker or other, who takes money from his debtor in discharge of a debt is not bound to inquire into the manner in which the person so paying the debt acquired the money with which he pays it. However that money may have been acquired by the person making the payment, the person taking that payment is entitled to retain it in discharge of the debt which is due to him."

He added, a few sentences later, at pp. 287-288:

"No doubt if the person receiving the money has reason to believe that the payment is being made in fraud of a third person, and that the person making the payment is handing over in discharge of his debt money which he has no right to hand over, then the person taking such payment would not be entitled to retain the money, upon ordinary principles which I need not dwell upon."

There he clearly had in mind the case where the person receiving the money had grounds for more than mere suspicion but could be treated as knowing of the misapplication of the moneys. Lord Watson said, at p. 290:

"It is not enough for [the appellants] to prove that the respondents acted negligently; in order to succeed, they must establish that the respondents knew, not only that the money represented by the cheque did not belong to the broker, but that he had no authority from the true owner to pay it into his bank account."

So also Lord Shand said, at p. 291:

"Where questions arise with third parties into whose hands the money can be traced, as in this instance, liability against them for the recovery of the sums misapplied arises only where it can be shown directly, or as the reasonable inference from facts proved, that these parties were cognisant that the money was being wrongfully used, in violation of the agent's duty and obligation."

That, as I see it, was also the ground of the decision of Stirling J. in In re Blundell, 40 Ch.D. 370. In that case solicitors who acted for executors and trustees of a will knew or had strong grounds for suspecting that one of the trustees had bought part of the trust property in breach of trust and in disregard of a warning which they had previously given that such a purchase would be a breach of trust. The question was whether they were entitled to retain fees incurred in proceedings against the estate which had been paid or, as regards part, retained out of the proceeds of sale of assets of the estate. Stirling J. stated the principle in these terms, at p. 383:

"a solicitor dealing with a trustee, and having no notice of any breach of trust on his part, is, in my opinion, entitled to deal with him on the footing that he is executing the trust properly, and is doing nothing which is inconsistent with his duty. He is not bound before he accepts payment out of the trust estate to call upon the trustee to produce his accounts and satisfy himself that he has acted in all respects properly. But suppose that he does know of a breach of trust, can it be held that the mere knowledge of it is sufficient to preclude him from accepting payment? That would be a formidable doctrine, not merely as regards solicitors, but also as regards auctioneers and stockbrokers. Suppose a stockbroker had knowledge that part of a trust fund is improperly invested, and that the trustee might be called upon to make good any loss which was occasioned by the investment, would he be precluded from deducting his commission upon a proper sale of another part of the trust estate? I think it would be very difficult to come to such a conclusion; and to my mind, in order that the solicitor may be debarred from accepting payment out of the trust estate, he must be fixed with notice that at

the time when he accepted payment the trustee had been guilty of a breach of trust as would preclude him altogether from resorting to the trust estate for payment of costs, so that in fact the application of the trust estate in payment of costs would be a breach of trust."

Then, having referred to the occasion when the solicitor learned, or had strong grounds for suspecting, that one of the trustees had purchased trust assets in breach of trust, he said, at p. 384:

"No doubt they had notice, at the time when they received the payment, some of which were certainly made to their knowledge out of the trust estate, that the trustee had committed a breach of trust; but I do not think that they had notice that the transaction was such as to preclude the trustee from resorting to the trust fund for payment of his costs, or that any such amount as was ultimately certified to be recoverable from the trustee could be charged against him."

The ground of the decision seems to me to be that if, in the ordinary course of business, a payment is made in discharge of a liability to the defendant, the defendant cannot be made liable as a constructive trustee merely upon the ground that he knew or had reason to suspect that there had been a breach of trust disentitling the trustee to make the payment. It must be shown that the circumstances are such that knowledge that the payment was improper can be imputed to him.

In my judgment, therefore, in a case of this kind, in order to make a defendant liable as a constructive trustee, it must be shown that he knew, in one of the senses set out in (i), (ii) or (iii) of Peter Gibson J.'s analysis in the Baden case, post, p. 509, that the moneys were trust moneys misapplied; or the circumstances must be such that, in the absence of any evidence or explanation by the defendant, that knowledge can be inferred. And it may be inferred if the circumstances are such that an honest and reasonable man would have inferred that the moneys were probably trust moneys and were being misapplied, and would either not have accepted them or would have kept them separate until he had satisfied himself that the payer was entitled to use them in discharge of the liability.

If that is right, the only question is whether this test is satisfied in the instant case. The circumstances relied on in the statement of claim can be grouped under three main heads:

(1) The sub-underwriting was arranged "by or through Ferriday" and (a) (paragraph (ii) of the particulars) Savory Milln took no adequate steps to check with the sub-underwriters that they were genuinely sub-underwriting and were good for their obligations; they should have been particularly suspicious in the light of the changes in the sub-underwriting list; (b) (paragraph (iii) of the particulars). The circumstances set out in paragraph 9 put them on notice that Ferriday might be indemnifying some of the sub-underwriters and doing so on behalf of Eagle; it is said that Savory Milln and their solicitors in fact considered the implications of section 151 of the Companies Act 1985; and (c) (paragraph (viii)) Savory Milln did not contact Earnshaw Haes to check that the £13.5m. should be applied in discharge of Earnshaw Haes's obligation and, had they done so, they would have discovered that Earnshaw Haes denied that they were liable. This should have led them to doubt the ability of

the sub-underwriters introduced by Ferriday and his ability to discharge their obligations without recourse to Eagle's funds.

I find it difficult to see that any adverse inference can be drawn from the fact that Ferriday arranged the list of sub-underwriters or that the list was changed. The revised list includes a number of well known institutions, including two banks, which were introduced for the first time in the new list. As I understand it, it is not suggested that any of the sub-underwriters failed to meet their obligations; the allegation is that, in the case of Martin Boston & Co. and Martin Boston, the list was changed after they had denied that they were liable and was taken over by Ferriday and that (paragraph 8) Ferriday was asked by Eagle's solicitors whether in his dealings with them he had acted on their behalf and denied that he had. As regards Earnshaw Haes, I understand that it is accepted that the denial that that firm was involved in the sub-underwriting came after Savory Milln had received the £13.5m. Moreover, what is said in paragraph 9 is that the sub-underwriting in their name was the responsibility of a business associate of theirs who was also a business associate of Ferriday, not that the subunderwriting agreement had not been entered into at all.

(2) Ferriday was liable in the revised list for at least £7.5m. and (a) (paragraph (iv) of the particulars) Savory Milln did not believe that he had the funds to discharge that obligation, in particular because his wealth was tied up in Eagle; they thought that after Black Monday he would use his votes at the extraordinary general meeting of Eagle on 25 November 1987 against approval of the proposed acquisition and rights issue, and when he failed to do so thought he was "voting to bankrupt himself;" (b) (paragraph (v) of the particulars) Savory Milln should have been "acute [sic] to the danger" that Ferriday would meet his liabilities by recourse to Eagle's funds; and (c) (paragraph (vii) of the particulars) Savory Milln made no adequate inquiry as to how Ferriday had managed to pay his sub-underwriters' obligations if not from Eagle's funds.

Paragraphs (v) and (vii) seem to me to add nothing to paragraph (iv). The gravamen of paragraph (iv) is that following Black Monday, Ferriday no longer had the resources which would have enabled him to raise even £7.5m. It is not easy to see how the inference that he must have used Eagle's funds is supported by the fact that he did not use his votes at the extraordinary general meeting against the proposed resolutions. If he could have secured the defeat of the resolutions (and it seems implicit in the allegation of paragraph (iv) that he could have done so), his failure to do so would seem to indicate, if anything, confidence that he could find the necessary financial support. At best, from the point of view of Eagle, it is neutral.

(3) (Paragraph (vi) of the particulars) Savory Milln made no inquiry as to which payments related to which sub-underwriter and made no inquiry as to who Anser was or its relationship to Ferriday or the other sub-underwriters. As I understand it, it is accepted on behalf of Eagle that the instruction as to how the £13.5m. should be dealt with was given by Ferriday.

It seems to me that the most that can be said is that, given that the sub-underwriting list had been arranged by Ferriday and that it was altered, as I understand it, at a late stage and that after Black Monday Ferriday's resources were insufficient to meet his own liabilities, Savory Milln may have felt some anxiety, and even have entertained some suspicion, as to how Ferriday had managed to arrange for the £13.5m. to

be paid by Anser on his behalf. But it is to my mind going altogether too far to say that any honest and reasonable man would either have inferred that, despite the denial to Eagle's solicitors, he was indemnifying the sub-underwriters, or some of them, on behalf of Eagle or that the £13.5m. was Eagle's money which had been misappropriated by Ferriday in gross breach of his duty as a director and in contravention of section 151 of the Companies Act 1985; or that an honest and reasonable man would not have applied the money in discharge of the liabilities of Earnshaw Haes and Ferriday until he had been satisfied by inquiry that the moneys were properly paid. It is not easy to see what further inquiries Savory Milln could have made. If inquiry had been made by Ferriday and if he had been innocent of any wrongdoing, he might well have resented the inquiry; and if guilty, it is hardly likely that, faced with a second inquiry, he would have confessed all. And as Mr. Sumption pointed out, if he had refused to answer, what further inquiry could Savory Milne have made? It would hardly have been open to them to invite Eagle to play detective and investigate their own chief executive.

In my judgment, therefore, assuming in favour of Mr. Goldsmith (a) that knowledge on the part of a defendant that moneys paid to him in discharge of a liability were trust moneys and applied in breach of trust may be inferred if the circumstances known to the defendant are such that an honest and reasonable man would have drawn that inference and would either not have accepted the money or would not have applied the money in discharge of the liability until he had satisfied himself, by some inquiry it was open to him to make, that there was innocent explanation; and (b) that at the trial no other evidence is called by the defendant, this action would nonetheless be bound to fail. In these circumstances I think it should be struck out. It would be wrong to allow Eagle to pursue it merely in the hope that something may turn up on discovery or in the course of the trial which would justify an amendment alleging circumstances from which knowledge on the part of Savory Milln can be inferred.

Solicitors: Linklaters & Paines; Berwin Leighton.

26 September 1991. The plaintiff having given notice of appeal and having proposed to apply to amend the writ and statement of claim, the defendant applied by summons to the Court of Appeal for an order that the appeal be stayed or alternatively be adjourned until further order. The Court of Appeal (Lord Donaldson of Lymington M.R. and Sir Christopher Slade) (unreported), 26 September 1991; Court of Appeal (Civil Division) Transcript No. 864 of 1991, ordered (1) that the order of Vinelott J. be set aside; (2) that the plaintiff be granted liberty to amend the writ and statement of claim; and (3) that the costs of the hearing before Vinelott J. and of the appeal and incidental applications be reserved to the trial judge.

[Reported by EDWARD JACKSON ESQ., Barrister]