Breach of Trust: Definition and Recent Case Law

Key takeaways

• A breach of trust occurs where a trustee fails to discharge their legal duties to beneficiaries
• A range of remedies are available to beneficiaries where a breach has occurred, including injunctions, compensation, an account of profits, constructive trusts, equitable liens and tracing of the property
• Beneficiaries may also be able to take action against third parties based on the principles set out in Barnes v Addy 
• A sham trust is a distinct legal concept from a breach of trust, and occurs where a legal arrangement that is claimed to be a trust, is instead a façade. Where a Court finds that an arrangement was a sham trust, the property will be deemed to have remained with the settlor. 

If a trustee breaches their obligations, what can a beneficiary do? Are there remedies that can be brought against third parties? And is there any connection between breaches of trust and sham trusts? We answer these questions and more in our guide to breaches of trust in Australian law. 

What is a breach of trust?

Trusts are an extremely common legal mechanism for doing business in Australia. They are popular both in the form of family trusts where individuals seek to better manage family assets, and in trading trusts where the property is owned by a corporate trustee for the benefit of others (read more about this in our complete guide to trading trusts). A breach of trust occurs when a trustee appointed under a trust fails to discharge their duties as stipulated by the trust instrument, or fails to perform their general duties under the law (See Re Spedding [deceased] [1966] NZLLR 447). Usually the beneficiary of a trust will have a case against the trustee for failure to discharge their duties. But in some cases third parties (such as successors of a beneficiary) may also have a case. 

A trustee may also be in breach of trust where they fail to discharge their duties “reasonably, in good faith and for the purposes for which they were conferred” (see Walker v Stones [2001] QB 902). Note, however, that this can differ by state. For example, in New South Wales, a trustee will not be liable for a breach of trust if the Court finds that under section 85 of the Trustee Act 1925 (NSW):

• They have acted honestly;
• They have acted reasonably; and
• They ought to be fairly excused.

Breaches of trust are different in character from breaches of other obligations in commercial law. For example, if we contrast trusts with the most common form of legal entities, limited companies, it is easy to say in the latter case what a ‘breach’ looks like: This is because companies are a statutory creation (regulated by the Corporations Act 2001 (Cth)), and only come into existence through intentional actions of those who set them up. When a company is created it is clear who is now a director and what duties that imposes on them under the law. 

Trusts can come into existence in many different ways, and don’t have the straightforward and transparent creation process of limited companies: They may be created by express intention of the creator (the settlor), by statute, or as an implied or constructive trust. With trusts taking such varied forms and not always requiring action from the trustee, it is no surprise that breaches of trust cover a very wide range of activity. 

Without exhausting the possible examples, some common examples of breaches of trust include:

• Not dealing with trust assets appropriately. This includes misappropriation of trust assets, ‘comingling’ trust assets with the personal assets of the trustee, or failing to protect trust assets;
• Acting contrary to the interests of the beneficiaries. In cases of ‘self-dealing’ this includes benefiting personally from trust assets;
• Favouring one beneficiary over another;
• Not taking due care in investing trust assets;
• Failing to account for trust activities/follow the terms of the trust.

It is usually the trustee or another person with some control over property who is the wrongdoer, but it can also be a third party (see discussion below with respect to ‘knowing assistance’ and ‘knowing receipt’). 

As a final point, the term ‘breach of trust’ can also be used in a way which has nothing to do with the Australian law of trusts. It can also be used colloquially to refer to corruption, fraud, abuse of public office or confidence (for example, see this term used in the recent Senate investigation into PwC’s activities). That is not the kind of breach of trust we are discussing in this article. 

What is the difference between a breach of trust and a breach of fiduciary duty in Australia?

In Australia, the concepts of ‘breach of trust’ and ‘breach of fiduciary duty’ are closely related — having a fiduciary duty is often liked to having a ‘trustee-like’ relationship to the other party. Whether a trustee or a fiduciary, the individual has obligations of good faith and loyalty to the other party, and a duty to put their best interests first. This holds the individual to a higher standard than the usual ‘standard of care’ applied at common law. 

A breach of trust always involves the breach of custodial obligations with respect to property. Whether an express, implied, constructive or statutory trust, the trustee owns or holds property for the benefit of another party. By contrast, a breach of fiduciary duty covers a wider range of obligations, including obligations that directors of companies have to the company, obligations of agents, and obligations that solicitors have to their clients. These duties may be stated in legislation (such as the Corporations Act 2001 (Cth) for company directors), common law and in professional rules of conduct (for example in the case of solicitors). 

The remedies for breach of fiduciary duty and breach of trust are similar including equitable compensation, an account of profits, an injunction, specific performance or a declaration. Of course, the remedy is less likely to be proprietary as there is less likely to be property involved in the case of non-trust-related fiduciary obligations. In the case of professionals, there will often be additional remedies relating to professional discipline. For example if a solicitor in New South Wales breaches their fiduciary obligations, action may be brought before the New South Wales Civil & Administrative Tribunal (NCAT)(see, for example, this recent case of a solicitor breaching their trust account obligations). 

It should also be observed that trustees and other fiduciaries may have different defences available based on the legislation that applies. For example, as observed in section one, the Trustee Act 1925 (NSW) provides distinct defences for trustees that do not apply to other fiduciaries in New South Wales. 

What can beneficiaries do where there has been a breach of trust?

Generally, a claim for breach of trust may only be brought by a beneficiary, or someone who stands in their place like a personal representative or trustee in bankruptcy (See Occidental Life Insurance Co of Australia Ltd v Bank of Melbourne (1991) 7 ANZ). In some cases, successor trustees and co-trustees will also have standing to bring action for breach of trust. 

Where a beneficiary suspects there has been fraud, or some other criminal activity, they could report this to the Police. At the same time, the beneficiaries can bring a civil action. Civil action in a breach of trust case usually begins with an ex parte application for an injunction, meaning that the other doesn’t know about the application. This is essential to freeze accounts and ensure that any trust property can’t be move before the Court has made a ruling. 

Usually, the focus in a breach of trust action is obtaining assets,  preferably real property if money can be traced into —people and cash can easily cross borders. Where company-hedl assets are of a high value, the Court may also appoint provisional liquidators to protect the assets before they can be moved. 

Note, in some cases civil action might be difficult: For example, with cryptocurrency it is likely that the injunction will need to be in personam, so it may not be that useful.

Following a possible injunction, there are a range of civil remedies that may be available to a beneficiary who has been disadvantaged by a breach of trust:  

• Personal remedies against the trustee —the beneficiary could bring action for breach of fiduciary duty, or a failure to carry out their fiduciary duties with reasonable care. The usual remedy would be compensation to put the trust’s estate in the position it would be in if it were not for the breach. Where the individual has improperly profited from the trust’s estate, they may be required to provide an ‘account of profits’ to the trust (and therefore the beneficiaries). This is sometimes known as ‘disgorgement’;
• Proprietary remedies — as mentioned earlier, in most cases a beneficiary will attempt to claim an interest in property where a connection can be traced to the breach of trust. A constructive trust might be imposed by the courts in order to prevent unjust enrichment of the trustee. For example, where a trustee has misappropriated trust assets and used them to buy a separate piece of property, the court might impose a constructive trust on that property. An additional possibility is that the court imposes an equitable lien on the property. This would allow the aggrieved party to approach the court for an order to sell the property;
• Specific performance — in some cases, a beneficiary can apply to the court to compel the trustee to act in accordance with their duties. For example, where the trustee is refusing to act as the trust deed requires, the court may order that the trustee do so.  

How does tracing work?

Another way that trust property may be recovered after a breach of trust is via tracing.  This can be used to follow property which has been mixed with other property, transformed in some way, or transferred to another person. Tracing may be available where the assets are still held by the trustee, or where they are held by a third party. 

When tracing money from a breach of trust that has become mixed with other property, be mindful of the following rules:

1. Lowest intermediate balance/nil balance rule – the trust is not entitled to any more than the lowest intermediate balance in the relevant account for the period between funds being mixed and legal action being brought. If the account is overdrawn, tracing is not possible (the nil balance rule);
2. First in first out– where mixing has occurred with the trustee’s own property, the trustee is usually assumed to have spent their own money first;
3. Beneficiaries share rateably — where there are multiple beneficiaries whose funds have been transferred, the beneficiaries will ‘share rateably’ in the available funds to ensure a fair distribution of available assets;
4. Successful investment – where misappropriated trust funds have been successfully invested, beneficiaries will be entitled to a proportion of the return which can be connected to the original trust property. 

Tracing may be defeated in several cases, including where: 

• The assets have been dissipated;
• Where a personal property security has been perfected over the assets, and the holder of the security had no knowledge of the breach of trust; 
• Where the assets have been acquired by a bona fide purchaser for value without notice. 

One situation in which tracing often arises is in following funds that have been transferred offshore in breach of trust or fiduciary duty. For example, in the widely publicised litigation regarding Saad Investments (Ahmad Hamad Algosaibi and Brothers Company v SAAD Investments Company Limited, Maan Al Sanea and others (Cayman Islands Court of Appeal, unreported 21 December 2021), tracing was one of the key issues in consideration. This was part of litigation that lasted over a decade and concerned assets which had allegedly been misappropriated in Saudi Arabia and transferred to an investment vehicle in the Cayman Islands. 

The plaintiffs alleged that they did not need to prove transactional links to the misappropriated fund as there was ‘knowing assistance’ by the defendants (see discussion below) which reversed the burden of proof. The Court reiterated that it is an absolute requirement of tracing that an unbroken chain of transactions be shown between the original misappropriation and the funds in their current ‘resting place’. 

Another situation involving tracing arose with the collapse of the Axiom Legal Finance Fund. This was a UK litigation fund started in 2009, designed to provide loans to law firms engaging in ‘no-win-no fee’ lawsuits. The founder was convicted for siphoning off nearly 20 million pounds of investor money. Much of this was used to buy luxury properties and cars and money was diverted into offshore bank accounts for this purpose. 

When wrongdoing was suspected, receivers obtained a worldwide freezing order over assets. In the UK, Panama, the Cayman Islands, Isle of Man and the Marshall Islands. Receivers attempted to trace assets, but to date this has not been adjudicated (and in many cases is likely to have been settled outside of Court). 

Can beneficiaries pursue third parties for breach of trust?

As mentioned, beneficiaries don’t only have remedies against trustees. In some cases they may also have remedies against third parties, as was in issue in the Saad Investments litigation. 

The origin of third party liability in breach of trust cases is the English case of Barnes v Addy (1874) LR 9 Ch App 244. This was a decision by the English Court of Appeal in Chancery. There it was established that individuals could be liable for a breach of trust where there was ‘knowing receipt‘ or ‘knowing assistance‘ in that breach of trust: 

• Knowing receipt occurs means a third party received property despite that property being held in trust or by a fiduciary, with knowledge that it was given in breach of trust or fiduciary duty;
• Knowing assistance, on the other hand,  happens where there was a breach of trust or fiduciary duty, and the third party/defendant assisted the breach with a ‘dishonest state of mind’. 

Note that while the case law is not entirely clear, the third party may not need to be consciously aware of the wrongdoing, and instead be liable based on possessing ‘constructive’ knowledge. 

What are some examples of breach of trust in action?

It is worth considering in further detail some concrete examples of a breach of trust or fiduciary duty:  

• Professionals breaching their fiduciary obligations or obligations as a trustee. For example, in the UK Supreme Court case of AIB Group (UK) Plc v Mark Redler & Co Solicitors [2014] UKSC 58, solicitors were found to have breached their custodial duties in relation to money held on trust for the purpose of a loan. The loan was to be secured by a charge over property, however the funds were released before ensuring that a prior charge was discharged. This caused the plaintiff to lose money due to only being able to register a second charge. The defendants were found liable to compensate the plaintiffs to restore them to the position they would have had if they had the first charge; but they were not required to reconstitute the original amount held on trust. In Breen v Williams (1996) 138 ALR 259, the High Court of Australiaconsidered whether a doctor had a fiduciary relationship with a patient meaning that the Doctor must produce medical records. The court found that while a doctor and a patient could stand in a fiduciary relationship for certain purposes, the patient was not a beneficiary for the purposes of demanding their medical records be returned;
• Insolvency. A breach of trust can occur in insolvency cases in two types of situation: 1) Where the assets were only held on trust by the insolvent company (for example, where the company was a corporate trustee for a trading trust); 2) Where assets have been transferred on to a third party as a consequences of a director’s breach of fiduciary duty. On the latter case, consider the discussion in Farah Constructions Pty Ltd v Say-Dee Pty Ltd [2007] HCA 22 (Farah Constructions), where the High Court of Australia recognized that there could be ‘knowing receipt’ by a third party with respect to a breach of fiduciary duties (see discussion of Barnes v Addy above). Note, however that the Court also found, on the facts of that particular case, that no breach of fiduciary duty had actually occurred. Read more about these cases in our guide to liquidator recovery via Barnes v Addy. 

What is the difference between a breach of trust and sham trust?

A breach of trust requires that a trust exists, and that the trustee breaches their obligations with respect to that trust. By contrast, a ‘sham trust’, is not a trust at all, but a structure that is presented to the world as a trust, but is, in fact, a façade. In a sham trust, the settlor does not intend that assets be transferred to the trust at all and wishes instead to retain full control of the trust assets. A sham trust requires an act of dishonesty on behalf of the settlor or other individuals who are claiming to put assets into a trust.

Why would someone create a sham trust? The motivation is usually asset protection and tax advantages: If an arrangement is perceived as a trust by other parties (including the Court), assets may be protected from creditors and also the ultimate tax bill may be reduced (by dispersing money to beneficiaries of the trust that would otherwise be personal income of the settlor). Where an arrangement is found to be a sham trust, the Court and other parties will proceed as if there is no trust and that the property in question is still the settlor’s. 

Creating a sham trust is not itself a breach of trust as there is no bona fide trust involved. Of course, in some cases there could be fraud or a breach of trust by creating a sham trust. For example, if a struggling corporate trustee attempts to transfer trust funds into an overseas trust in order to defeat the interests of the original beneficiaries, there could be a breach of trust AND a sham trust (in which case, the Court would find that there was no second trust to defeat the beneficiaries of the original trust).

Conclusion  

With trusts being a particularly common business structure in Australia, it is unsurprising that breach of trust — trustees breaching their obligations to beneficiaries — is an important cause of action that individuals need to be aware of. Most commonly, beneficiaries will pursue a proprietary remedy or tracing in order to get hold of misappropriated trust property. It is worth noting that, in some cases, individuals will also have a cause of action against third parties who knowingly assisted or received goods in breach of trust.