Quistclose Trusts and their importance in banking

There is a long list of authority that supports the view that where a creditor, such as a bank, has advanced money to a debtor on terms that the money should be used by the debtor for a specific purpose, and the debtor does not use the money for that purpose, the money is then held by the debtor for the benefit of the creditor

One method of achieving this outcome is by virtue of the Quistclose trust.

Quistclose trusts enable a party to a commercial contract to retain its equitable interest in property provided as part of a commercial agreement. It operates by virtue of a condition being applied on the purposes for which the money loaned may be used.

In Barclays Bank v Quistclose [1970] AC 56, a resulting trust was created with regard to a loan made for a specific purpose which was not carried out. It must be emphasized that in order to implement the law of trusts the specific loan to the borrower must be such that the sum does not become the general property of the borrower. The specific purpose of the loan identified by the lender must be sufficient to impress an obligation on the borrower to use the amount solely for the purposes as stated by the lender.

In this case the defendant, Quistclose Ltd, loaned £209,719 to Rolls Razors Ltd subject to an express condition that the latter would use the money to pay a dividend to its shareholders. Q Ltd’s cheque for the relevant sum was paid into a separate account opened specifically for this purpose with Barclays Bank Ltd, which knew of the purpose of the loan. Before the dividend was paid, Rolls Ltd went into voluntary liquidation and Barclays Ltd claimed to use the amount to set off against the overdrafts of Rolls Ltd’s other account at the bank. The House of Lords held that the terms of the loan were such as to impress on the money a trust in favour of Quistclose Ltd in the event of the dividend not being paid, and since Barclays had notice of the nature of the loan it was not entitled to set off the amount against Rolls Ltd’s overdraft.

• It is important to note that the money loaned in Quistclose was kept in a separate earmarked account
  • Lord Wilberforce held that there was a mutual intention of Rolls Razor and Quistclose to create the trust
  • Barclays Bank was also aware of the existence of the trust (they had notice)
• This case confirms that trusts can be used as a security device
• where equity impresses a trust on property, the trust may also be enforced against someone who subsequently acquires the legal title to the property through tracing (Quistclose)
• At present the Quistclose trust arrangement has been applied only to moneys however there is no reason in principle why it should apply only to money and not to other forms of property (Worthington, 1996, 63)
• This is different from a Romalpa clause which allows the lender to retain absolute title to the property
  • This is a clause generally used in sale of goods contracts which allows the Vendor to retain title to the goods until full payment is received (Aluminium Industrie Vaasen B.V. v Romalpa Aluminium Ltd. [1976] 1 WLR 676)

Issues

• What is complex about this form of trust is that it is unclear precisely how the lender’s rights arise
  • Causes difficulty in theory, however it is suggested, in practice the source of the lender’s rights will be best explained by the precise terms of the loan contract
  • In theory it is not clear whether:
    • the lender has rights in the loan moneys throughout the contract;
    • or whether the lender has rights in the loan moneys which are held in suspense in some way during the life in the contract;
    • or whether the lender’s rights arise for the first time when the borrower uses the money for an unspecified purpose

The time sequence operates as follows:

Day 1 Loan contract entered into between the lender and the borrower, including a provision that the borrower must use the money only for a specific purpose

Day 2 Loan moneys are transferred at common law to the borrower

Day 3 The borrower breaches the term in the loan contract by using the money for an unspecified purpose

Day 4 Lender seeks to recover the loan moneys as a result of the breach of the term in the contract

• the question therefore which follows:
  • does the lender retain some equitable interest in the loan moneys from Day 1?
  • or are the rights given up on day 2 with the transfer of the moneys?
  • or does the lender acquire rights in the money on day 3?

There are several theories attempting to explain the Quistclose trust:

(a) there is an express trust first for the creditors and then for the lender when the purpose of the loan fails;

(b) there is an express trust for the creditors, but a resulting trust for the lender on the failure of the express trust;

(c) there is an 'illusory trust', ie, the arrangement creates an express trust for the lender, who (as beneficiary of the trust) authorizes the payment to the creditors (see General Communications and Twinsectra Ltd v Yardley, below);

(d) it is 'a new creature ... invented to protect from risk of failure a secret commercial venture for profit by two parties at the ultimate expense of general creditors' (Hackney, p 51);

(e) the loan of money to be used for a purpose gives the lender a right to prevent the borrower from using the money for any other purpose, which becomes a resulting trust if the money is not used for that purpose, because the borrower was not intended to enjoy the benefit of the money for any other purpose.

• For there to have been a trust it cannot be that the lender acquires rights in the loan moneys only on day 4 because that would be to make the trust remedial
  • Not possible in English law (Westdeutsche Landesbank v Islington [1996] AC 669)

NB

• There is an important difference between a payment of money for a specific purpose and a payment of money to be used for a specific purpose.
  • When money is paid for a purpose which cannot be carried out, the payment can often be recovered at common law as money had and received
  • this is a response to 'failure of consideration';
    • e.g., I pay a deposit for the purchase of shares and the company goes into receivership before the shares are issued: Moseley v Cressey's Co (1865) LR 1 Eq 405.
  • However, the Quistclose trust is only possible in situations where the money was paid to be used for a purpose: Guardian Ocean Cargoes v Banco do Brasil [1994] 2 Lloyd's LR 152 (CA).

Explanation

• Lord Wilberforce in Quistclose held that the trust operated as a resulting trust
  • That is that whereas the money had passed from the lender to the borrower under the loan contract, the breach of the loan contract meant that the equitable interest in the moneys passed back to the lender on a resulting trust
  • Lord Wilberforce also considered that there was a primary trust under which the borrower was empowered to use the money for the specified contractual purposes
  • There was a secondary trust which then came into existence once the contractual provision governing the use of the loan moneys had been breached
  • This secondary trust gave effect to the resulting trust

Dissent

• Lord Millett suggested in Twinsectra v Yardley [2002] 2 All ER 377 that the lender in these situations could be considered to have retained some form of right in the loan moneys throughout the life of the transaction
  • The breach of contract caused those rights to crystallise
• Therefore the Quistclose trust did not arise by means of a resulting trust but rather resulted from some form of express trust under which the lender’s rights had existed throughout the life of the transaction
• Lord Millett considered the nature of the Quistclose trust as being ‘akin to a retention of title clause’ ([2002] 2 All ER 377 at p 398)
  • The lender can therefore be taken to have retained the equitable interest in the loan moneys throughout the life of the contract
• He stated that money normally advanced as a loan becomes the property of the borrower and, if no security is taken, the lender takes the risk of the borrower’s insolvency
  • Where the loan is given for a specific purpose it gives rise to a fiduciary duty on part of the borrower
    • An arrangement described as a “Quistclose trust”
• There is however a problem where Lord Millet states at p. 399 that ‘The property remains the property of the lender’
  • Can be taken to suggest that the loan moneys will remain the absolute property of the lender
  • If this were true then the borrower would not be able to spend the money as is the purpose of the loan contract
    • This is why a retention of title clause would not work for loan contracts
  • The least satisfactory analysis of the Quistclose trust would be that the lender retains absolute title to the money
    • Would deny the existence of a trust
  • A better reading of this expression would be that it is the equitable interest in the money which remains vested in the lender, except that the borrower must nevertheless still have the power to spend the money for the purpose identified in the loan contract
  • Consequently the lender’s equitable interest must be capable of defeat upon the proper use of the money by the borrower

• Lord Millett’s approach tries to give a universal answer to the nature of all Quistclose trusts whereas, in truth, the nature of such trusts will depend on the terms of the loan contracts which give rise to them
  • Will have to look at the clause in the contract or the undertakings given

View expressed by Business Report Online (www.busrep.co.za)

…there co-exists a contract and a trust institutional structure. A contract creates personal claims enforceable by and against parties to the agreement in question, who intended to create legal relationships thereby.

By contrast, a trust is an obligation creating an equitable proprietary interest in the beneficiaries, capable of binding third parties and enforceable by the beneficiaries though not party to the settlor-trustee arrangement.

The loan device may initially be a primary trust to facilitate a purpose. If the purpose is fulfilled then the agreement is purely contractual, resulting in a simple debtor-creditor relationship.

However, if the purpose of the loan is not achieved, a secondary trust operates in favour of the lender.

• It appears that the following conditions must be met before a resulting trust of money lent will be found:
  • The money lent must have been for an agreed specific purpose
    • In Carreras Rothmans Ltd v Freeman Matthews Treasure Limited [1985] Ch 207 a resulting trust was held to arise where a loan had been made by Rothmans to their advertising agency, who were in financial difficulty, for the purpose of paying third parties with whom Rothman’s adverts had been placed
  • The money must be kept in a separate bank account
    • In both Quistclose and Rothmans the money lent was kept in a separate bank account
    • In Re EVTR [1987] BCLC 646, however, a resulting trust was found even though the loan had been paid into the company’s general account
  • The purpose has filed
    • The meaning of failure was considered in Re EVTR
      • In this case the money had been lent to the company for the purchase of new machinery
      • The money was paid to the manufacturers but before the machinery could be bought EVTR went into receivership
      • The machines were never delivered and the manufacturers refunded the purchase price less an amount to compensate for their loss under the breach of contract
      • The Court of Appeal held that the purpose had not been completed at the moment the money was paid over to the manufacturer therefore excluding a resulting trust
      • Dillon LJ stated:

“True it is that the [money] was paid out by the company with a view to the acquisition of new equipment, but that was only at half-time, and I do not see why the final whistle should be blown at half-time.” ([1987] BCLC 646 at 651)

The Quistclose Trust concept is not that recent.

In an 1819 English case, Toovey v Milne, A advanced £120 to B for B to pay his creditors. B became insolvent and returned an unexpended £95 to A. The plaintiff, B's assignee in bankruptcy, sought to recover this money.

The claim failed, with the court holding that "the money was advanced for a specific purpose. [As such] it was clothed with a specific trust and no property in [the trust] passed to the assignee of the insolvent party.

"If the purpose has failed, there is an implied stipulation that the money shall be repaid."

The basis for the decision was that money advanced for a specific purpose did not become part of the insolvent estate.

This post is for your information only and is not intended to constitute a legal opinion.  If you require specific advice you should contact a Bahamian trust lawyer.  You can contact a Bahamian trust lawyer by clicking here.