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Chaim Saiman
Wed, 5 Dec 2007 01:32:11 -0500
Restitution, tracing and judicial discretion


Dear RDG Friends,

Thanks so much for answering my call to what must sound like a strange inquiry. I thought I might just summarize what I have learned in the past 24 hours and, with your indulgences, redirect the question a bit.

A number of readers (thank you) pointed me to such cases as Commerzbank Aktiengesellschaft v IMB Morgan [2004] EWHC 277, which rely on US holdings such as Learned Hand's decision in Re Walter J Schmidt & Co, 298 F 314, 316 (1923) dispense with the rule of Clayton's case and allow for pro rata distribution in Ponzi scheme type cases.

At the very least, these cases instruct that English courts are not categorically opposed to the idea of scrapping the tracing/restitution rules and doing rough justice, at least in cases where the court feels that the fairness and efficiency gains justify doing so. (Though Lionel Smith has taught me that in his view, this has nothing to do with tracing, but I'll leave that debate for those more knowledgeable than me). In other words, at least some of the elements standing behind the Cunningham line of cases is to be found in the English law.

On the other hand, other readers (thank you) pointed me to the House of Lord's decision in Foskett, and especially Lord Millett's speech, statement where he says (in the midst of a somewhat complex tracing analysis) "It is, of course, always open to the parties in any case to dispense with complex calculations and agree upon a simpler method of apportionment. But in my opinion the court ought not to do so without the parties' consent. If it does, anomalies and inconsistencies will inevitably follow."

I cannot overstate how different Lord Millett's assumptions are from the dominant view found amongst US courts. American lawyers would find Lord Millett’s Foskett opinion unnecessarily technical and complex, overwrought and way over theorized given the stakes at issue in the case. But such is the difference between the judicial cultures, an issue I hope to return to in future writing.

Nevertheless, when looking at American cases decided on similar facts to Foskett, (the overwhelming majority are prior to WW2), I found that while the cases are far less interested in the technicalities of tracing the forms of property through the transactions, since these cases pit innocent victims against family members of the fraudster, the court does not simply treat everyone equally. See, e.g. Lackey v. Lackey, 691 So.2d 990 (Miss., 1997).

However the differences between US and English/commonwealth approaches show up at the margins. Specifically, when it comes to determining when a court will forgo tracing and property based claims and throw it all up to pro rata distribution – all shielded under a differential standard of review.

American case will argue for the pro rata formula (under the equity= equality syllogism) even in cases where tracing is not particularly contentious, and where is perfectly obvious that money which moved through various bank accounts all stemmed from one identifiable source. U.S. v. Durham, 86 F.3d 70; U.S. v. Real Property 89 F.3d 551 (9th Cir. 1996). Other courts are willing go even further to cases that involve identifiable shares of stock, SEC v. Credit Bancorp, 290 F.3d, 325, and there are even some cases that deny tracing where the funds of various investors were never even commingled, e.g., Forex, 242 F.3d 325.

As best I can tell from the English cases, the courts at the very least require that a common fund exist and that the assets were truly commingled. Similarly, even the English courts that avoid the rule of Clayton's case justify their departure on the basis that a proper accounting would be extremely time consuming and difficult, e.g., Commerzbank at paras 38, 39 and 49. The American courts on the other hand tend to justify departing from the tracing rules because the pro rata method is more fair, even if the tracing is rather straight forward.

One final question I'd pose is what is the relevant standard of review in such cases. Can a court rely on a broad range of discretion in these matters, or will it be forced to justify its decision on the basis of solid legal arguments. I'd note that many US cases leave this matter to the discretion of the court, saying that as a matter of law the district court would have been within its rights to follow either the pro rata method or the "tracing fictions." See U.S. v. Durham; SEC v Forex. (Side note, almost without fail, when a court calls them "tracing fictions" it will go for a pro rata distribution).


Thanks for your time.

Chaim Saiman
Assistant Professor
Villanova Law School

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