The Municipality of Sao Paulo and the Republic of Brazil successfully defeated an appeal from two BVI registered companies to the Privy Council which considered what the circumstances are, if any, where backward tracing would be permitted.
The two appellants, “Durant” and “Kildare” are BVI registered companies, which were controlled by Mr Paulo Maluf who, between 1993 and 1996, had been the mayor of Sao Paulo. Mr Maluf had, over the course of a few months in 1998, received a number payments that were paid into an account belonging to Mr Maulf’s son in the name of Chanani (the “Chanani account”), and thereafter were transferred to an account held by Durant in Jersey (the “Durant account”) and then on to an account held by Kildare, also in Jersey. These payments represented bribes to Mr Maluf in connection with an infrastructure contract and amounted to over US$10.5m.
The appellants were appealing the decision of the Court of Appeal of Jersey, upholding the Royal Court’s decision, that the appellants were liable as constructive trustees to the Municipality of Sao Paulo for the payments. The appellants disputed the amount that could properly be traced back to them, arguing that it was limited to around US$7.7m.
The arguments put forward by the appellants were two-fold, that:
1. the last three payments into the Chanani account were made after the final payment into the Durant account and therefore these three payments could not be traced as there was “no sound doctrinal basis for ‘backwards tracing’”.
2. the Chanani account was a mixed account and where a claimant’s money is mixed with other money and drawings are made which at any time reduce the balance to less than the amount claimed, the claimant can only recover up to the maximum that can be regarded as representing his money (“the lowest intermediate balance rule”). In this instance, on several occasions drawings had been made out of the Chanani account into the Durant account which exceeded the amount that would have been available from the bribes and, therefore, must have come from other sources.
In support of their appeal, the appellants referred to the cases of James Roscoe (Bolton) Ltd v Winder and In re Goldcorp Exchange Ltd, which both supported the principle of the “lowest intermediate balance rule”. Other cases and academic writings referred to, while in large part supporting the appellants’ arguments, did leave scope for attack, with several cases containing dissenting judgments and/or reservations by judges and academic writers.
The respondents based their arguments on a speech from Lord Millett in Foskett v McKeown, in which he said that what a claimant seeks to trace “is not the physical asset itself but the value inherent in it” and this could be traced if there are a series of transactions which are “casually and transactionally linked”. The respondents referred to the Canadian case of Agricultural Credit Corpn of Saskatchewan v Pettyjohn. There it was found that an approved bank loan (but not yet advanced) enabled the defendants to acquire rights in property. While the approved bank loan did not finance the purchase of the property it did give value to the defendants which enabled them to obtain other financing. The claimants were able to trace their claim by showing a close casual and transactional link between the various transactions.
Given the facts of the case, the Privy Council also considered public policy implications and noted that as a matter of policy a “court should not allow a camouflage of interconnected transactions to obscure its vision…[and] that the availability of equitable remedies ought to depend on the substance of the transaction in question and not upon the strict order in which associated events occur”.
The Privy Council upheld the Court of Appeal of Jersey and rejected the argument that there can never be backward tracing, or that the value of an asset whose proceeds are paid into an overdrawn account could never be traced. It is on the claimant to establish a co-ordination between any outward and inward movement of assets.
While this is a Privy Council case, it is persuasive and of relevance given the number of English authorities referred to therein and it will be interesting to see how this case is applied in the English courts.
It is worth noting that the Privy Council rejected the respondent’s submission that money used to pay a debt could be traced into whatever was acquired in return for the debt. This was considered to be too broad a proposition.
The Privy Council also stated that it did not doubt the correctness of the James Roscoe and Goldcorp decisions, but that in neither case was there evidence of an overall transaction embracing the coordinated outward and inward movement of assets. It is clear that the Privy Council was persuaded by the facts of this case evidenced the necessary coordination.
  1 Ch 62
  1 AC 74
 (1991) 79 DLR (4th) 22 (Sask CA)