Recognizing No Further Inquiry Rule in Trust Law

Definition of the No Further Inquiry Rule

The no further inquiry rule has its origins in a stringent principle of trust and fiduciary law. The rule, which arises in relation to certain kinds of fiduciary relationships, prevents a trustee who has committed a breach of trust from being permitted to avoid the consequences of that breach by claiming that it would be unreasonable to require them to make restitution (the well-known defence of non-exoneration). The rule is directed to detering or preventing self-dealing in fiduciary relationships.
This has been the general rule since at least the 1903 House of Lords decision in Tudor v Watson. Lord Lindley, with whom the other members of their Lordships’ Bench concurred, explained in the context of the appeal of a Court of Appeal decision refusing to allow the defendant to plead non-exoneration, that: the true ground of the rule is public policy, and the application of it must depend on the circumstances of each case and the exigencies of justice. In some cases it may turn out that a beneficiary has no actual loss , and ought not to recover anything because the property has gone to satisfy his claim. But that does not necessarily mean that he ought not to recover more than any loss he may have sustained where the nature of his injuries is such that the trustee is not thereby placed in any worse position than if the breach of trust had not occurred.
There are a number of statutory provisions in the various Australian jurisdictions that have codified the version of the "no further inquiry" rule stated by Lord Lindley, and that rule has been recognised and applied in a number of judgments including from the High Court (i.e. the Australia’s highest court) such as Foreman v Midland Petroleum Pty Ltd.
Although there are a number of occasions when the "no further inquiry" rule will apply, it is important to note that this rule will only apply to the extent that the breach of trust has caused the specific loss sued upon, e.g. only if the inequitable conduct was the cause of the plaintiff holding less than will be required to satisfy the plaintiff’s interest in the trust property will the trustee be held liable for the entire loss suffered by the plaintiff (assuming this was foreseeable).

Impact of the Rule on the Case Law

A further legal implication of the no further inquiry rule is that a trustee who makes a payment to a beneficiary in breach of trust will generally be unable to recover that payment from the beneficiary unless the beneficiary can be shown to have been unjustly enriched by it. Indeed, the no further inquiry rule applies irrespective of whether the beneficiary had notice of the trustee’s breach of trust when made the payment: Keech v Sanford [1726] 3 P. Wms. 229; Barker v R. (No 2) [1959] 1 F.L.R. 328.
These two legal implications of the no further inquiry rule mean that both trustees and beneficiaries can be very substantially affected by it; its application has a substantial impact on the letting off, or not, of liability in damages to a plaintiff who has suffered loss by reason of a breach of fiduciary duty.
Essentially, fiduciary duties are to be self-enforcing; third parties, including the beneficiaries, have little or no ability to claw back, or insist on the repayment of, payments made (or profits made) under a breach of those duties, so long as the rule applies. Additionally, the beneficiaries and third parties do not have the legal ability to require such payments to be notified to them so that they can take the appropriate action. Hence the application of the no further inquiry rule can, and does, generate an injustice.
Where the trustee derives a benefit or profit from a breach of trust, the trustee must account for that benefit or profit to the beneficiaries (or the estate), and in doing so show that he was acting in the proper performance of his duties: In re Wilson [1895] 2 Ch 63. This principle applies even if the beneficiaries have suffered no damage, or have actually gained by the trustee’s breach of duty: Re F and S Building Ltd (in liq) (No 2) [1970] 1 WLR 716.
The sum which the trustee will be liable to account to the beneficiaries (or estate), will be equivalent to the value of the profit gained. This does not mean a particular sale or disposal price, but its net value to the trustee: Keech v Sanford [1726] 3 P. Wms. 229.
It is important to note also that institutions such as banks, investment firms and building societies may well appear in these circumstances, as they often allow their professional staff discretion, and may use the staff’s discretion when dealing with the client concerned. Where that happens and there has been any breach of duty, the institution itself may be found liable.
Clearly many of the above issues may also apply to relationships beyond those between a trustee and a beneficiary in many contexts, and may frequently impact on shareholders, directors, and officers of a company, as well as other contractual relationships where one of the parties stands in the position of a fiduciary to the other (or others).

Exceptions and Restrictions

While the "no further inquiry rule" provides a strict basis on which to challenge the validity of a transaction by a trustee, it is not without exceptions and limitations.
The rule will not apply where there was no breach of trust in relation to the transaction that is being questioned. The transaction can also be set aside if it would result in unjust enrichment. For example, the power conferred on trustees by the Statutory Powers of Attorney Act 1998 (NSW) (or the powers under the Merchandise Marks Act) to sell an asset does not confer the power to sell the asset for less than its market value (Schulz v Schulz (1989) 19 NSWLR 681).
In Schultz v Mungrup Pty Ltd [2005] NSWCA 145, a trustee had a power to sell after giving notice to a specified percentage of beneficiaries. After providing such notice and receiving a counter-offer at a higher price, the trustee sold at the original price to a third party. It was held that the trustee did not owe a duty to a beneficiary to get the best price, but was required to exercise discretion and act honestly and reasonably to obtain ‘the best price against which to sell’. In this case, the absence of notice to the beneficiary and the failure to seek a confirmed higher sale price were sufficient to set aside the transaction. The trustee had committed a breach of trust and the no further inquiry rule therefore did not apply.
It has also been held that the sale should be set aside if the beneficiaries would have received a greater return on a sale at full market value than the trustee. In McGrath v McGrath (Unreported, NSW Supreme Court, 19.8.94), a trustee of a family settlement had a discretion to sell land and divide the proceeds between the beneficiaries. Prior to the exercise of the discretion, it was agreed by the family that it would be better to subdivide the land before sale in order to obtain a greater price. The court held that the failure to follow this plan constituted a breach of trust, and the no further inquiry rule could be displaced.
The no further inquiry rule can also be negated if the trustee’s conduct constitutes fraud or unconscionable conduct. If a breach of trust has been committed with knowledge of a third party, the third party’s transaction may be set aside as was decided in Reggen v Scott (1931) 31 SR (NSW) 258 and in Browne v Rogers (1936) 54 CLR 928. Transactions entered into with knowledge of a breach of trust are also voidable if they are not on market terms or remain unconscientiously induced (Anderson v Daniel [2014] NSWSC 959). If the transaction is in breach of trust, then the principal/agent relationship, as between the trustee and the beneficiary, has been breached through failure to discharge the trustee’s obligations.

Other Jurisdictions and Contexts

The ‘no further inquiry rule’ is a useful legal fiction when it comes to the drawing of inferences about intentions that involves too many imponderables. However, as with all legal fictions, the application of the ‘no further inquiry rule’ will depend on the context and the applicable law. In the civil law systems such as Germany, there is no concept of the ‘no further inquiry rule’ because the accounting rules in the code do not require enhanced scrutiny of transactions or disclosures in financial statements. Likewise, in common law countries such as Canada, the UK, Australia and New Zealand, the classical law of equity recognises the institutional role of the court as guardian of the legal sphere of the trust, and would find it hard to dispense with the need to inquiring into the workings of the trust by reference to what is realistically an evidentiary rule.
In South Africa, the application of the ‘no further inquiry rule’ can be illustrated by the facts of Haynes v King William’s Town Municipality, which concerned the validity of certain by-laws. Grant, J held that: I can conceive of no cogent reason why the inequitable enrichment of one person at the expense of another should, in one set of circumstances be sanitable and in another, unscrupulous and arbitrary in its severity, be unsanitable, for one it is an element of public policy.
In his judgment, Grant, J explains the distinct South African approach to this analogy: The passing of the trade or professional privilege from one party to another by the sanctioning of the deed purporting to effect that transfer has never been regarded by our Courts as an unconscionable gain to the transferee at the expense of the grantor. To me , it seems clear that the principle enunciated in this formula is merely a specific example of the more general principle, embodied in the Latin phrase which is so often quoted in our Courts that he who comes to equity must come with clean hands. This phrase does not state that the Courts are not prepared to aid a party to an unconscionable transaction at the expense of another where the rights of the latter are not affected or impeded thereby or where the circumstances render the subversion of the strict legal rights of the party unconscientious. The fundamental basis of this principle is public policy. Public policy does not limit or circumscribe the relief which would otherwise be granted to a party as being contrary to the interests of the administration of justice. It prohibits the Court from granting relief which the Court is satisfied would be contrary to public policy. When the grant of the relief would result in preference being given to the economic considerations of one litigant over the economic considerations of another, or the undue variation of rights constituted by the law or the enhancing of legal rights so as to deprive the latter of some or even most of the value of those rights, the courts would be acting contrary to public policy and the interests of the administration of justice were it not to refuse relief. The circumstances in which the Courts would be prepared to release the parties from contractual obligations to pay damages because the loss of the party seeking relief was unrecoverable from a person not a party to the contract, are, generically, contra bonos mores, against public policy. The bar to the recovery of damages is expressed in general terms in the well-known corollary to the maxim ex turpi causa non oritur actio.

Factors for Trustees to Consider

Once a trustee becomes familiar with this "no further inquiry rule", there are several practical considerations and best practices they may want to follow. This article does not intend to provide a detailed discussion of what unpracticed trustees should or should not do, but some issues may be quickly noted in hopes that experienced trustees can have their own discussion of the topic. Trustees should consider providing notice to prudent investors that they are intending to issue GPOs and instruct them to remove their associations (if any) with the GPO including any possible officer, manager, member, partner, or employee. Trustees should also be mindful of the fact that one of the goals of GPOs is to protect beneficiaries. Therefore, if you believe that a current beneficiary of the trust may attempt to bring a GPO against the trustee after your through either a specified time period or a special circumstance has run, you may want to encourage that beneficiary to complete the same or similar acts as a precaution because that commencement of a lawsuit would relate back to the earlier act. You may also encourage a beneficiary to perform some overt act indicating acceptance of the GPO.

Looking Ahead: Future Trends

The "no further inquiry" rule in constructive trust doctrine continues to evolve and courts apply the doctrine in different ways across jurisdictions. In future, courts may move toward applying a more permissive approach where they support the goal of restitution over technical application of the doctrine. In addition , courts may adopt a more interventionist approach where they exercise discretion to compensate plaintiffs for losses caused by wrongful conduct, notwithstanding the argument that the award of compensation equates to enforceable rights of the plaintiff. As well, a more technical approach might continue to prevail if it is deemed necessary to balance concerns in relation to wider legal principles, such as economic reliance and protection of property rights.