The effective plaintiff was the municipality of Sao Paulo (the municipality). The Federal Republic of Brazil was nominally the plaintiff because its constitution required it to be a party to any action brought outside Brazil by a Brazilian public authority. The defendants were companies registered in the British Virgin Islands (the companies) which were, at the relevant time, under the practical control of Mr Paulo Maluf and/or his son Mr Flavio Maluf. From 1993 Mr Paulo Maluf had been mayor of the municipality.
The case concerned payments made to Mr Paulo Maluf, or others on his behalf, in early 1998. The Royal Court made the following findings of fact. That Mr Paolo Maluf, or others on his behalf, received 15 secret payments, representing bribes in connection with a major public road building contract, over a period from 9 January to 6 February 1998 and that funds equivalent to 13 of those payments (itemised in schedule 3), amounting to US$10,500,055.35, were converted to US dollars and paid into an account under the control of Mr Flavio Maluf in the name of Chanani (the Chanani account). From 14 to 23 January 1998 six payments from the Chanani account were made to an account held by the first defendant totalling US$13,120,000.00 (itemised in schedule 4). Over the period from 22 January to 23 February 1998 there were four payments, amounting to US$13,500,000.00 (itemised in schedule 5) from the first defendant’s account to an account held by the second defendant. Accordingly, the Royal Court found that the companies were liable to the municipality as constructive trustees of US$10,500,055.35 representing the bribes to Mr Paulo Maluf. The companies appealed to the Court of Appeal of Jersey which upheld the judgment of the Royal Court. The companies appealed to the Privy Council.
The companies did not challenge the findings of fact of the Royal Court but contended that the total amount that could be properly traced to them from the bribes was limited to US$7,708,699.10. The municipality claimed to trace the amount of the schedule 3 payments to the first and then second defendants’ accounts. It asserted that the full amount of these bribes was paid from the Chanani account to the first defendant’s account.
The companies’ case had two limbs.
First, that the last three payments into the Chanani account identified as proceeds of bribery were made on dates between 26 January and 6 February 1998 and so came after the final payment from the Chanani account to the first defendant’s account. Therefore those three payments could not be traced to the defendants because there was no sound doctrinal basis for ‘backwards tracing’.
Secondly, that the Chanani account was a mixed account and that where a claimant’s money is mixed with other property and drawings are made on the account which reduce the balance at any time to less than the amount which can be said to represent the claimant’s money, the amount which the claimant can thereafter recover is limited to the maximum that can be regarded as representing his money (the lowest intermediary balance rule). In this case it was said that on two occasions (20 and 23 January 1998) payments were made from the first defendant’s account which exceeded the maximum that could be said to come from the earlier bribes itemised in schedule 3 and must therefore have come from other sources.
It was agreed that if either limb was correct, the effect would be to limit the traceable amount to US$7.7m.
Held, dismissing the appeal:
- 1) The doctrine of tracing involves rules by which to determine whether one form of property interest is properly to be regarded as substituted for another. If the original property interest has ceased to exist, it cannot metamorphose into a later property interest. This explains the ‘lowest intermediate balance’ principle. Similarly, a property interest cannot turn into something which the holder already has; the later acquisition cannot be the source of the early. This explains the ‘no backward tracing’ principle.
- 2) The broad proposition that money used to pay a debt can in principle be traced into whatever was acquired in return for the debt was rejected. Courts should be very cautious before expanding equitable proprietary remedies in a way which may have an adverse effect on other innocent parties (at ).
- 3) However there may be cases where there is a close causal and transactional link between the incurring of a debt and the use of trust funds to discharge it.
- 4) Further, the development of increasingly sophisticated and elaborate methods of money laundering, often involving a web of credits and debits between intermediaries, makes it particularly important that a court should not allow a camouflage of interconnected transactions to obscure its vision of their true overall purpose and effect. If the court is satisfied that the various steps are part of a coordinated scheme, it should not matter that, wither as a deliberate part of the choreography or possibly because of the incidents of the banking system, a debit appears in the bank account of an intermediary before a reciprocal credit entry. The 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 occurred (at ) (Foskett v McKeown approved). It should not matter whether the account used for the purpose of providing a bridging finance was in credit or in overdraft at the time. An account may be used as a conduit for the transfer of funds, whether the account holder is operating the account in credit or within an overdraft facility (at ).
- 5) The argument that there could never be backwards tracing or that the court could never trace the value of an asset whose proceeds were paid into an overdrawn account was rejected. However the claimant has to establish a coordination between the depletion of the trust fund and the acquisition of the asset which is the subject of the tracing claim, looking at the whole transaction, such as to warrant the court attributing the value of the interest acquired to the misuse of the trust fund. This is likely to depend on inference from the proved facts, particularly since in many cases the testimony of the trustee, if available will be of little value (at  and ) (James Roscoe (Bolton) Ltd v Winder and In re Goldcorp Exchange Ltd distinguished).
- 6) In the present case, the Royal Court and the Court of Appeal were justified in concluding that the necessary connection between the bribes itemised in schedule 3 and the receipts itemised in schedule 5 was proved (at ).