The concept of equitable compensation is simple. It is a remedy available to beneficiaries to make good losses that have in fact been suffered by beneficiaries and which were caused by a breach of trust.[1]
However, I may not be the only person to find that this simple concept is submerged in impenetrable jargon which, if not entirely meaningless, often hides and conceals meaning in phrases which convey the opposite impression from that which they really mean.[2] Why is equitable compensation so often expressed in terms of a duty to account and “reconstituting the trust fund” when it is in reality often a payment by one party to another? Why are there two bases for accounting? What does wilful default mean and how “wilful” does the “default” have to be, if at all? Why does the account have to be “falsified” (and is that good or bad)? How is an account “surcharged”? And what does “substitutive compensation” and “reparative compensation” mean and how are they different, if they are both “compensation”?
It may be helpful in answering these questions to start with the basics.
The basic right of a beneficiary of a trust is “to have the trust duly administered in accordance with the provisions of the trust instrument, if any, and the general law. Where there has been a breach of that duty, the basic purpose of any remedy will be either to put the beneficiary in the same position as if the breach had not occurred or to vest in the beneficiary any profit which the trustee may have made by reason of the breach (and which ought therefore properly to be held on behalf of the beneficiary).”[3] Historically, the Court of Chancery gave effect to the rights of beneficiaries through orders for an account – that is, for the trustee or trustees to account for their trusteeship.
At his point it is important to bear in mind the context in which such orders for an account were made. As explained by Lord Browne-Wilkinson in Target Holdings Ltd v Redferns [1996] AC 421 HL at 434B-F, in many traditional trusts the fund is held in trust for a number of beneficiaries, each having different and often successive, equitable interests, (e.g. A for life with remainder to B). While all beneficiaries might have cause to complain about a trustee, any given beneficiary might or might not have an immediate right to receive some part of the assets of the trust. Many beneficiaries might have only rights, or contingent rights, to receive trust assets in the future. The only way in which all the beneficiaries’ rights could be protected in this situation, following a breach of trust, would be to restore to the trust fund what ought to be there. This is where “reconstituting the trust fund” comes in. If a trustee had depleted the assets of a trust which had multiple beneficiaries with different rights or expectations under the trust, the only fair way to compensate all beneficiaries would be to “reconstitute” the trust fund and let the trust instrument dictate which beneficiaries received what and when. A direct payment of compensation from the trustee in breach to some beneficiaries would likely work to the detriment of other beneficiaries, whose equitable interest might not fall into possession for many years.
That is why the primary obligation of a defaulting trustee is to restore the trust fund to what it should have been, had the breach not occurred.
However, if the trust were to have come to an end and the trust fund become absolutely vested in possession, there would be no point in “reconstituting” the trust. The difference between what the beneficiaries had in fact received and the amount they would have received (but for the breach of trust) can be quantified and the beneficiaries put in the position they are entitled to be by a direct payment of compensation. The measure of compensation, however, remains the same – the difference between what the beneficiary has in fact received and the amount he or she would have received but for the breach of trust.
Some Non-threatening Legal Archaeology
The Court of Chancery could order trustees to account to the beneficiaries. There were different modes of accounting. A small amount of legal history may assist here, because one of the clearest explanations of the different types of account comes from Vice-Chancellor Kindersley in Partington v Reynolds (1858) Drew 253; [1858] EngR 461; 62 ER 98. Speaking in the context of the accounts which might be ordered from an executor or administrator of a personal estate, the Vice-Chancellor explained the difference between the “usual” decree to account and “an account of what the administrator might, without his wilful neglect or default, have received.” These two types of account were “perfectly different” and “proceed on totally distinct grounds”, because: “The one supposes no misconduct; the other is entirely grounded on misconduct”. The “usual” decree to account follows from the mere duty to account for what the trustee has received. The account on the “wilful default” basis requires an allegation and proof that there had been, on the part of the trustee, “wilful neglect or default in getting in the assets, or of other misconduct”.
Warning: “wilful default” is a term of art; it need be neither “wilful” nor, indeed, a “default”. It is not necessary for there to have been conscious wrongdoing on the part of the trustee. “Wilful default” means “a passive breach of trust, an omission by a trustee to do something which, as a prudent trustee, he ought to have done—as distinct from an active breach of trust, that is to say, doing something which the trustee ought not to have done”[4]
More Terminology: Falsifying and Surcharging
So, a trustee has accounted to the beneficiaries for his or her trusteeship. The account discloses an unauthorised disbursement. The beneficiaries ask for the unauthorised disbursement to be disallowed. This is called (or used to be called), “falsifying” the account. To falsify a trustee’s account is simply to ask for the disbursement to be disallowed. There has still been a disbursement, but if disallowed it now appears as a deficit in the account, which the trustee will have to make good, usually by the payment of money. This payment of money to restore the account to balance is one type of equitable compensation. The principle underlying such a payment is restitutionary (not all equitable compensation is restitutionary, but this type is). “The amount of the award [of equitable compensation] is measured by the objective value of the property lost determined at the date when the account is taken and with the full benefit of hindsight.” (See Lord Millett NPJ in Libertarian Investments Ltd v Hall [2014] 1 HKC 368, at [168].) The trustee has done something he or she ought not to have done (made an unauthorized disbursement) and equitable compensation makes good the loss on a restitutionary basis.
But what if the trustee has omitted to do something which, as a prudent trustee, he or she ought to have done – ie “wilful default” in getting in the assets, or of other misconduct? The beneficiary then asks for the account to be “surcharged”, which means the account is taken on the (counterfactual) basis that the wilfully defaulting trustee had in fact performed his or her duty and obtained assets for the benefit of the trust (or in some other way added value to the trust fund). Since in reality these things have not happened, the account will show a deficit (between what has actually happened and what ought to have happened). The trustee will be ordered to make good this deficit by the payment of money as equitable compensation. However, unlike equitable compensation after “falsifying” an item in the account, equitable compensation after “surcharging” the account is not restitutionary, it is “akin to the payment of damages as compensation for loss” (Lord Millett in Libertarian Investments Ltd v Hall [2014] 1 HKC 368, at [170]).
Foreseeability & Causation
The two types of equitable compensation briefly outlined above have different rules insofar as foreseeability and causation are concerned. The rules are different in failure to perform cases from the rules in unauthorised disbursement cases. This is a complex area which requires a further article to explain; for the time being, anyone wanting further reading is recommended to search out the excellent judgment of Edelman J in the Australian case of Agricultural Land Management Ltd v Jackson (No 2) [2014] WASC 102, from paragraph 334 onwards.
Substitutive and Reparative Compensation
It can be seen from the above that the same phrase “equitable compensation” can be applied to two conceptually distinct things, ie:
(a) restitutionary payment after an unauthorized disbursement; and
(b) payment akin to the payment of damages as compensation for loss where there has been a failure to perform a duty.
Because of this, the terms “substitutive compensation” and “reparative compensation” have begun to be used – at first by academics, then textbooks, then increasingly by judges. The terms are not obviously self-explanatory (at least to me). You just have to learn that “substitutive compensation” follows falsification of the account and “reparative compensation” follows surcharging the account. It is particularly confusing because the terms are essentially meaningless and would make just as much sense if applied the other way around, but that is not how things have developed. The crucial difference between the two types of equitable compensation is not the terminology, but the rules as to foreseeability and causation. Confusing them leads to error – see Target Holdings Ltd v Redferns [1996] AC 421 HL, where the difference between classification of the case as an unauthorised disbursement, compared to classification as a failure to perform, was the difference between substantial recovery and zero.
[1] see Target Holdings Ltd v Redferns [1996] AC 421 HL, Lord Browne-Wilkinson at 439B: “In my view this is good law. Equitable compensation for breach of trust is designed to achieve exactly what the word compensation suggests: to make good a loss in fact suffered by the beneficiaries and which, using hindsight and common sense, can be seen to have been caused by the breach.”
[2] See Davies v Ford [2023] EWCA Civ 167 Sir Launcelot Henderson at [126] “This is an area of the law which is unfortunately bedevilled by confusing terminology and a lack of general agreement on how the underlying concepts should be analysed and labelled.”
[3] AIB Group (UK) plc v Mark Redler Associates & Co [2014] UKSC 58; [2015] AC 1503, Lord Toulson at [64]
[4] Bartlett v Barclays Trust Co (No.2) [1980] 1 Ch 515, Brightman LJ at 546B
Written by Jonathan Miller