Equitable Interests



5.1   Introduction

This chapter considers the rules governing the creation and enforcement of equitable interests in property. Property law draws a fundamental distinction between legal and equitable interests. The distinction is a product of the organisation of the courts prior to the judicature legislation of the 19th century. Originating from the jurisdiction of medieval chancellors, the equity jurisdiction has survived the introduction of the Torrens system of establishing title to land by registration, which recognises established legal and equitable interests in real property while radically reforming the methods by which they can be transferred and enforced. (See further discussion on the Torrens system, Chapter 11.)

The most significant creation of the chancellors and courts of equity is the trust. This is a device enabling real or personal property to be held by the legal owner for the benefit of some other person. For example, A, a landowner, might want to leave all her property to her children, who are minors. A may decide to leave the property by will to a friend or relative, B, to be held on trust for the children. Upon A’s death, B will hold legal title to the property (historically a title enforceable in common law courts). However, a court administering an equity jurisdiction will compel B to administer the property solely for the benefit of the children. The children themselves are entitled to an equitable interest in the property, enforceable in a court of equity not only against B, but also against most persons who acquired the legal title to the property from B. The trust can therefore be used as a method of making provision for the children. Historically, the trust was often used as a means for providing for members of a family at a time when the common law rules of inheritance to real property on death permitted land to pass only to the eldest son.

The express trust is, according to a perceptive epigram, ‘a gift projected on the plane of time and subjected to a management regime’.1

A trust can be expressly created by a property owner. It is a flexible device, responsive to social change over the centuries, and has been adapted to promote a wide range of family, commercial and public purposes. The ability to fragment, or divide up, interests in property is often important to landowners, and the trust remains the primary mechanism for implementing such a fragmentation. Some reasons for fragmenting property interests are contrary to public policy, and the efficacy of the trust in these areas has largely been neutralised by legislation: they include the use of trusts to evade tax or the claims of creditors or family court orders. But trusts are created for many more worthwhile purposes, including provision for physically or intellectually disadvantaged members of a family, and the promotion of charitable purposes. Contemporary applications of the trust include the trading trust (an Australian mutation evolved from the system of taxing business activity) and the superannuation trust, where legislation has adapted the trust as the model for regulating the provision of superannuation.2

A trust is not always the deliberate act of creation of a property owner. A resulting trust is a transfer of property in circumstances in which the law compels the transferee to hold the property on trust for the transferor.3 For example, if A buys property and places it in the name of B, B will generally be presumed to hold the property on resulting trust for A. The resulting trust in this case is an evidentiary presumption and not a rule of law: it can be rebutted by B showing that A intended to make a gift of the property to her.

A constructive trust is a trust imposed by operation of law, irrespective of the intention of the legal owner of the property affected by the imposition of the trust. Australian law now recognises the principle that a constructive trust will be imposed upon a legal owner of property whenever it would be unconscionable for him to deny the plaintiff an equitable interest in property.4 This type of constructive trust has been applied in recent years to resolve property disputes between former de facto partners as well as other family property disputes, such as those arising between parent and child.

Disputes between spouses upon divorce are now determined under the Family Law Act 1975 (Cth), and state legislation is increasingly superseding constructive trust principles in providing a regime for the distribution of property upon the breakdown of a de facto marriage relationship. Nevertheless, it is important to bear in mind that the imposition of this form of trust is not confined to family property litigation: it is a formula for equitable relief applied to a wide array of commercial and family disputes.

As well as the trust, courts of equity have fashioned other interests in property which were not recognised at common law. They include:

(a)   the estate contract. This is a specifically enforceable contract for the sale or lease of property. The purchaser under such a contract is not only entitled to obtain an order of specific performance of the contract; she also has an equitable interest in the property which is enforceable against anyone to whom the property is later conveyed by the vendor who has notice of the contract;

(b)   the restrictive covenant.5 A landowner selling a plot of land may wish to restrict its use if she retains any adjoining land. A term, or covenant, may be inserted into the contract of sale prohibiting some use of the land (for example, not to build on the land). If the covenant is restrictive—in other words, if it is negative in substance—a court of equity will enforce the covenant not only against the purchaser but also against anyone who buys the land with notice of the covenant;

(c)   the mortgagor’s equity of redemption. At common law, a mortgage took the form of a conveyance of property by the borrower (mortgagor) to the lender (mortgagee), with a proviso that the property had to be reconveyed if the money lent, and interest, were paid by the stipulated date. A court of equity would allow the borrower to recover her property after the date for repayment was passed upon payment of the money due, and interest and legal costs. This is known as the equitable right to redeem the mortgage. The recognition of the equitable right to redeem a mortgage generated a proprietary interest, the equity of redemption, which arises as soon as the contract is made. The equity of redemption entitles the mortgagor to recover the land not only from the mortgagee, but from anyone to whom the mortgagee has conveyed the land, provided he takes with notice of the mortgage.

The equity of redemption will arise in equity whenever a secured loan contract amounts, in substance, to a mortgage. Unlike any right to redeem contained within the actual mortgage contract, the equitable right is proprietary. A mortgagor may resort to the equitable proprietary right where the date for repayment under the loan contract has passed, so that the contractual right is unenforceable. The equity of redemption was justified in equity on the basis that it was against good conscience to permit the mortgagee to retain both the property and the loan repayments simply because the legal date for repayment of the loan had passed. Equity gives effect to the substance of a mortgage as a security device and will not allow the form of an absolute conveyance to prevail. Where a mortgagor seeks to enforce the common law right of redemption, the appropriate relief will be specific performance in aid of a contractual right; where, on the other hand, a mortgagor seeks to enforce the equity of redemption, she will be enforcing an equitable proprietary right. Six months’ notice of an intention to redeem must be given to the mortgagee. The rationale for this under the equitable jurisdiction is that the six month period gives the mortgagee a chance to replace the investment. If, however, the mortgagee expressly agrees to accept the repayment over a shorter period, the six month period will not apply. (See further discussion on this in Chapter 14.)

Equitable proprietary interests are distinguishable from legal interests in two primary respects:

(a)   The application of the doctrine of notice

The holder of a legal interest in property is entitled to enforce it against anyone into whose hands the property comes; it is no defence to an action for interference with a legal property right that the interferer was unaware of the legal owner’s title.

Equitable property interests, on the other hand, confer a more fragile protection on the interest holder. Whereas legal rights are said to be ‘good against all the world’, equitable rights are enforceable against all persons except a good faith purchaser of the legal estate in the property for value and without notice of the equitable interest. ‘Value’ does not, for this purpose, mean ‘full value’: it refers to any consideration, not being nominal consideration, in money or money’s worth.

There are three kinds of notice:

•   actual notice: a person has actual notice of all facts of which he or she has actual knowledge;

•   constructive notice: a person has constructive notice of all facts which he would have discovered if he had made reasonable inquiries. Where the property is land, a purchaser of the land will be expected to inspect the land and the title to the land. The Torrens system of title registration has today superseded most of the inquiries formerly carried out by inspection of the title deeds (see, further, Chapter 11 and Chapter 9, para 9.4.3, for an examination of the operation of the doctrine of notice under old title land);

•   imputed notice: if a purchaser employs an agent, such as a solicitor, any actual or constructive notice which the agent receives will be imputed to the purchaser.

For example, V, who holds the fee simple of land, creates a restrictive covenant in favour of X. V later sells the fee simple to P. P will be bound by the restrictive covenant if she has actual, constructive or imputed notice of its existence.

(b)   The availability of equitable remedies

If a legal right is infringed, the person injured is entitled as of right to common law damages. Legal rights may be enforced by an equitable remedy if the damages are an inadequate or inappropriate remedy. The infringement of an equitable right, on the other hand, entitles the injured party to an equitable remedy. Equitable remedies include specific performance (an order that a contract, or a term of a contract, be performed); an injunction (an order compelling the wrongdoer to carry out some act or, more commonly, to refrain from carrying out an act); or equitable rescission (an order setting aside a contract or other transaction and substantially restoring both parties to their original position before the contract was entered into).

For example, if V enters into a valid contract to sell land to P, P has an estate contract, an equitable interest affecting the land. P can obtain the equitable remedy of specific performance of the interest. P can additionally obtain an injunction to prevent an improper disposition of the property to a third party.

Whereas a legal remedy is available as of right to an injured party, the award of equitable remedies is discretionary. This does not mean that a court enjoys an unfettered discretion to award or withhold relief. The circumstances in which specific performance, for example, will be awarded are governed by a reasonably clear body of judicial precedent, and the grounds for refusing a remedy, such as the plaintiff’s delay in applying for the remedy or the hardship the award would cause the defendant, are also regulated by judicial decision.

5.2   A brief history of equity

English common law, by the 13th century, had developed into a formulary legal system: a plaintiff was entitled to a remedy in the royal courts if the facts of the claim could be adapted to the formula of an established writ. Naturally, litigants alleged wrongs from time to time which did not fit the formula of a writ. The problem was aggravated by Chapter 24 of the Statute of Westminster II 1288, which provided that new writs could only be issued if they were substantially similar to established writs. Litigants left without a remedy petitioned the King for a remedy, and the King developed the practice of referring the petitions to his chief minister, the Chancellor. In this way, the Chancellor gradually developed a jurisdiction, later exercised by a Court of Chancery, to remedy wrongs for which no remedy could be obtained in the common law courts. The early chancellors were usually ecclesiastics, administering a court of conscience, but by the 17th century only lawyers were appointed to the office.

This was also the period in which the system of equity began to be systematised by precedent, very much as the common law already was, although individual chancellors, such as Lord Nottingham and Lord Hardwicke, still exercised their right to innovate from time to time.

The decrees of the chancellor would sometimes conflict with the judgments of the common law courts. For example, an injunction might be obtained forbidding a party from enforcing a common law judgment. The chancellor’s power to issue such injunctions was confirmed in the Earl of Oxford’s Case (1615) 1 Ch Rep 1, which thereby established the principle, later confirmed by 19th century Judicature Acts, that, in the event of a conflict between law and equity, the latter was to prevail.

The chancellor began to enforce the trust, then known as the ‘use’, from the 15th century. Under this device, if land was conveyed by A to B to the use of C, the common law courts refused to compel B (known as the ‘feoffee to uses’) to hold the land for C (known as the cestui que use). The chancellor, however, enforced B’s promise to hold land for the benefit of C, since uses were pre eminently matters of good faith and trust, and therefore appropriate subject matter of a court of conscience.

The use of land was popular with medieval landowners for a number of reasons: they enabled the common law rules of succession to land to be avoided in favour of flexible settlements, and they were also the means whereby the payment of feudal dues, for incidents of tenure, could be avoided. Many of the principles of modern trust law, including the doctrine of notice, were elaborated as part of the law of uses in the 15th and 16th centuries.

Although legislation, such as the Statute of Uses 1535, attempted to minimise the tax avoidance aspects of the use, the use itself, and later the trust, remained a pervasive feature of the legal system, and the ingenuity of conveyances ensured that it was adapted to meet the need of the property owning classes in later centuries. The use was a central feature of the ‘strict settlement of land’, whereby land was retained in aristocratic families for a number of generations, while at the same time income from the land was applied by the trustees to maintain the landowner’s children and other members of the family.

By the 19th century, the increasing inconvenience of administering the common law and equity in separate courts, combined with some inefficiency in the administration of equity itself, led to the enactment in England of the Judicature Act 1873. Henceforward, common law and equity were to be administered in one court; it was no longer necessary to prove the existence of a contract in a common law court and then to obtain an order of specific performance of the contract in a court of equity. Section 25(11) of the Act confirmed the superiority of equity in the event of a conflict between the common law and equitable rules. In practice, cases of conflict rarely arise, since the circumstances in which a conflict might occur have by now mostly been identified and the equitable rule is routinely applied.

The judicature legislation was received by the Australian states. This occurred in most states in the later years of the 19th century,6 although in New South Wales a separate Court of Equity existed, and maintained the old equity learning until 1972.7 The Supreme Court of each state and territory is empowered to apply both common law and equitable doctrine and remedies. Similar powers have also been conferred upon lower courts.8

It is important to appreciate that the judicature legislation did not achieve a ‘fusion’ of law and equity, in the sense of amalgamating legal and equitable doctrine. Law and equity remain distinct. A legal interest remains enforceable against any purchaser of the property, whereas an equitable interest continues to be unenforceable against a good faith purchaser for value without notice of the equitable interest in the property. The administration of common law and equity has been fused, but the actual law itself has not. Inevitably, however, the nature process of doctrinal evolution has brought the common law and equity closer together, and Sir Anthony Mason has suggested that, in a number of areas, a convergence of doctrine and remedies can be identified.9 Any convergence is not, however, a consequence of the judicature legislation, but, rather, of the tendency of the courts, particularly the High Court over the last 15 years, to reorganise and restate doctrine in a manner that emphasises the common features of law and equity and not their differences.10

5.3   The express trust

Real and personal property can both be held on trust. There are two basic types of trust. Under a ‘fixed’ trust, each beneficiary is entitled to a predetermined share of the trust property. For example, a settlor might settle $100,000 on trust, the fund to be invested and divided equally between each of the settlor’s children at a specified date, or upon the occurrence of an event, such as each child attaining 18. Under a ‘discretionary’ trust, the identity of the beneficiaries is determined by the instrument setting up the trust, but the share of the property, if any, that each beneficiary is to receive will be determined by the trustees. For example, a settlor might settle $100,000 on trust to be divided among such of the settler’s children as the trustees shall determine.