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Analysis & Insights

Proprietary claim case law

14 Apr 2014

This article was published in the April edition of the International Financial Law Review. 

In a recent decision, the Irish High Court held that if an investor has paid money to a firm based on a fraudulent misrepresentation, the payer has a proprietary claim to the payment (In re Custom House Capital; Scott v Wallace 2013 IEHC 559). This is obviously crucial where a firm is in insolvent liquidation. 

The Irish High Court (Justice Finlay Geoghegan) held that monies held on account by Custom House Capital Limited ("CHC") before its winding up were held on trust for one of its clients. The client of CHC had, between April and July 2009, transferred most of her personal savings and pension funds to CHC for investment, including a sum of €145,000 ($202,000), referred to as a deposit. The client had agreed that the latter sum would be invested by way of a subordinated loan agreement.

The key event in the case was a meeting at the client’s home in March 2010, at which the client met with a director of CHC and discussed her investment. The Central Bank of Ireland ("CBI"), (which regulates firms such as CHC), became concerned about CHC’s business. This information was in the public domain and the CHC representative told the client she had nothing to worry about and that her investment was safe. CHC offered her the option of either continuing to participate in the loan agreement, or to have CHC repay the loan together with interest. In reliance on CHC’s assurances, the client decided to leave her money with them.

The CBI became concerned about CHC's solvency. In particular, it appeared that the CBI's concerns focused on CHC's practice of raising finance from its customers through subordinated loans by them. In July 2011, the CBI appointed inspectors to the firm, and shortly after CHC went into insolvent liquidation. The inspectors' final report was admitted as evidence in the case.

CHC's liquidator sought to treat the client’s claim as an unsecured claim. The client claimed that the sum of €145,000 was held on trust by CHC before the liquidation and that she therefore had a proprietary claim to the repayment of the money. One of the arguments on which the client contended she had a proprietary claim was that CHC stood as a fiduciary to her. The court rejected this, and held that the client had entered into a commercial arrangement, in which it was clearly agreed that CHC had a contractual obligation to provide investment services.

The applicant also contended that the circumstances gave rise to a constructive trust due to fraudulent or unconscionable behaviour by CHC. The court held that CHC's statement to the client in 2010 as to the safety of the client’s loan amounted to a representation that it was not aware of any matters which caused a risk that the client's investment would not be repaid. The court found that CHC had not made this representation in good faith, or had made it recklessly (that is, careless as to whether it was true or false). The court took into account the CBI inspectors findings in this regard. These included admissions by CHC that it was, in fact, aware at the relevant time that client monies were at risk. Therefore, the assurances given by CHC to the client at the March 2010 meeting were found to have been false. The court held that this fraudulent conduct gave rise to a constructive trust.

One of the key findings of the decision was that there was no fiduciary relationship between the client and CHC. This is consistent with a large number of Irish High Court decisions, where it is held that, where the parties are in a commercial contractual relationship, there are no fiduciary duties.

Another, more significant finding, was that where a payment is induced by fraud, the payer will have a proprietary claim against the payee. This is obviously of considerable value, where, as with CHC, the payee is insolvent. The client in this case would still have to establish her claim by way of a tracing process, however she ranks above secured creditors of CHC. In comparison with UK case law, there is little modern Irish case law on the ingredients of a constructive trust. The CHC decision is therefore a landmark case in this regard. The decision underscores the remedial function of the constructive trust. If a payment is made based on a fraudulent misrepresentation, the payee holds the payment on trust for the payer. The case is also of immense practical significance to liquidators, and, particularly, liquidators of financial services companies.

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