This section is from the book "Popular Law Library Vol7 Equity Jurisprudence, Trusts, Equity Pleading", by Albert H. Putney. Also available from Amazon: Popular Law-Dictionary.
Constructive trusts always involve the question of fraud, either actually or potentially. A constructive trust is created by the courts, in order to do justice between the parties, either where there has been actual fraud in that particular transaction, or where the transaction is of a character that offers such temptation to fraud. Equity seeks to discover all transactions of the kind. Constructive trusts will arise in the following classes of cases (among others): where money-is received by one person which rightfully belongs to another;10 where a trustee (or other person in a fiduciary relation) purchases property with trust funds;11 where a partner, or other person holding a fiduciary position, renews a lease for his own benefit;12 where trust property is wrongfully acquired by a trustee or other person in a fiduciary position;13 or where property subject to a trust or lien is purchased by a person with notice of such trust or lien or is transferred to a person without consideration.14
4 Pomeroy on Equity Jurisprudence, Sec. 1038; Bailey vs. Henenway, 147 Mass., 326. 5 Morice vs. Bishop of Durham, 10 Ves 537
6 Nichols vs. Allen, 130 Mass., 211.
7 Pawson vs. Brown, L. R. 13 Ch.
8 Ackroyd vs. Smithson, 1 Brown
Ch.,503; 3 Keener, 977. 9 Pomeroy on Equity Jurisprudence, Sec. 1032.
The right to follow trust funds which have been used by the trustee (or other person in a fiduciary relation), was discussed at some length by the Court of Appeals of New York, in the case of Holmes vs. Gilman,15 the decision in which case was in part as follows:
"The claim of the plaintiff to recover the moneys arising from the payments of these policies is based upon the principle which allows a cestui que trust to follow trust funds, and to appropriate to himself the property into which such funds have been changed, together with the increased value of such property, provided the trust fund can be clearly ascertained, traced and identified, and provided the rights of bona fide purchasers for value without notice do not intervene. The right has its basis in the right of property, and the court proceeds on the principle that the title has not been affected by the change made of the trust funds, and the cestui que trust has his option to claim the property and its increased value as representing his original fund. The right to follow and appropriate ceases only when the means of ascertainment fail. It is a question of title. Van Alen vs. Bank, 52 N. Y., 1; Newton vs. Porter, 69 N. Y., 133; Ferris vs. Van Vechten, 73 N. Y., 119; Cavin vs. Gleason, 105 N. Y., 256, 260; 11 N. E. Rep., 504; In re Hallett's Estate, 13 Ch. Div., 696. It is somewhat akin to the principle decided in Silsbury vs. McCoon, 3 N. Y., 379, where corn was wrongfully taken from its owner and converted into whisky. The court held the property was not changed in the hands of the wrongdoer, and the whisky belonged to the owner of the original material, no matter how much it had been increased in value. The case of Pennell vs. Deffell, 53 Eng. Ch., 372, 388, 389, discusses the principle as thus stated, and agrees to it. That a partner occupies a fiduciary position with regard to his copartners and the funds of the firm, and will not be permitted to make a personal profit out of the use of such funds, is, I think, clearly established. 1 Lindl. Partn. (2nd Amer. Ed.), 303; Featherstonehaugh vs. Fenwick, 17 Ves., 298; Anderson vs. Lemon, 8 N. Y., 236; Mitchell vs. Reed, 61 N. Y., 123; Riddle vs. Whitehill, 135 U. S., 621; 10 Sup. Ct. Rep., 924. Although partners do not, in the strict sense of the term, occupy the position of trustees towards each other and toward the firm funds, yet the position is one of a fiduciary nature, calling for the maintenance and exercise of the greatest good faith between them. Such a relationship authorizes the same remedy on behalf of the wronged partner as would exist against a trustee, strictly so called, on behalf of a cestui que trust. Per Jessel,
10 Robinson vs. Pierce, 118 Ala., 273.
11 Ferris vs. Van Vechten, 73 N. Y., 113. 12 Trice vs. Comstock, 57 C. C. A., 646; 721 Fed., 620.
13 McDonough vs. O'Neil, 113
Mess 92 14 Union Pac. R. R. Co. vs. Mc- Alpine, 129 U. S., 305. 15 138 N. Y., 376; 34 N. E., 205.
M. R., in re Hallett's Estate, 13 Ch. Div., 696, 712. While legally incorrect to describe the fraudulent abstractions made by Gilman of the funds of the firm as embezzlements, the description is harmless. It was a monstrous and gross breach of the duty he owed the firm, and the right of the firm to follow the funds is not affected because the act could not be regarded in law as an embezzlement. The right to follow the funds springs from the fiduciary nature of Gilman's position with regard to them. These general positions are not really denied by the defendant. It is claimed, however, that the tracing and identification of the funds have not been sufficiently proved in fact, and it is also urged that there has been an actual mingling of firm funds with the private funds of Gilman in the purchase and maintenance of the policies. I have looked carefully through the evidence upon these questions of fact, and I think the findings of the referee are fully sustained, and that no exception can prevail on such grounds. If these preliminary questions be decided against him the counsel for defendant then urges that the rule clearly is, if the trust fund has become mingled with money or property of the trustees or others, equity impresses the proceeds with a trust to an amount equal to the original trust fund and interest, and will go no further. He then claims that the firm funds which went to the purchase of the policies and the payment of the annual premiums were mingled with the property right of the wife, called her 'insurable interest' in her husband's life, and so the policies were not wholly the result of the use of those firm funds, and therefore the plaintiff can have only a lien on the policies or the moneys arising from their payment, to the amount of the premiums paid with the firm funds, and the interest thereon. This is really the chief question in the case. "Where moneys have been misapplied, and have been used as a portion of a larger amount, which has been invested in other property, the property thus acquired does not, as a whole, belong to the owner of the moneys misapplied. It does not belong to him, because it has not been purchased or acquired wholly with his money or funds, and hence it is that such property is held charged with a lien at least to the amount of the trust funds invested in it. It is not necessary to here decide it, because we take another view of the facts, but I am not at all prepared to admit that under no circumstances is the cestui que trust entitled to recover back anything more than the amount of his property and interest, where there has been a mingling of funds. In case the trustee took a thousand dollars of trust funds and five hundred of his own, and purchased property, which advanced in value to twice its original sum, I have seen no case where the point has been determined that the whole increased value belongs to the trustee, and that only the original sum wrongfully taken, and interest, can be given to the cestui que trust, although it was by reason of the wrongful use of the trust funds that the trustee was enabled to realize such value. If, in such case, the cestui que trust were not allowed to at least participate in this increased value, it would appear to be a violation of the principle that the trustee cannot ever be permitted to make a profit out of the use of the trust funds. It seems to me to be a case for the application of the doctrine that the parties became co-owners of the property at the option of the cestui que trust, in the proportion which their various contributions bore to the sum total invested. In this case, however, the defendant is enabled to claim a mingling of funds and property only by treating the right of a wife to insure the life of her husband for her benefit as a species of property which has been mingled with the funds of the firm, the result of the combination being the procurement of the policies.