Tracing Trust Funds in a Commingled Bank Account: A Deep Dive into Applying the Lowest Intermediate Balance Test

Have you ever had the unfortunate experience of losing a smartphone? Has your car ever been taken for a joy-ride? Has your home been burglarized? Fortunately, in the digital age we have the benefit of sophisticated technology and software applications that can be used to track down the whereabouts of our prized possessions. We also often rely on law enforcement to help find and recover our lost and stolen property.

Let’s take the smartphone example. Imagine that you inform the police that you believe you’ve located your missing device using a reliable software tracking application. Once the police review and decide to act on this information, their search uncovers not one, but a large stash of smartphones. Recovering your smartphone now hinges on your ability to trace, proving to the police that your smartphone is one of the hundreds at the stash house. Thankfully, smartphones are earmarked with an international mobile equipment identity (IMEI), a unique number associated with one particular device usually printed on the device’s packaging.[1]

With the IMEI, the police can search each device to determine whether your specific smartphone was recovered. If the police match your smartphone’s IMEI to one of the smartphones recovered from the stash house, congratulations — tracing accomplished. But when the property involved is cash, tracing is anything but straightforward. For instance, financial institutions do not track paper currency by its serial numbers. And today, many transactions are settled electronically, further complicating direct tracing.

Challenges of Tracing Trust Funds Commingled with Non-Trust Funds

Financial institutions treat cash deposits as fungible property. Therefore, once cash is deposited into a bank account and mixed with cash from other sources, the cash can no longer be precisely traced. Consequently, it is impossible to link a specific dollar in a commingled bank account to its source. In other words, the exercise of tracing cash that’s been commingled is dead on arrival.

From a forensic accounting perspective, one of the more complex property-tracing analyses involves trust funds deposited into a trustee’s bank account that are mixed with other non-trust funds.[2]

The Lowest Intermediate Balance Test to the Rescue

Courts are often presented with the challenges faced by trust beneficiaries attempting to trace their trust funds that were commingled with other non-trust funds. In order to overcome the impossibility of tracing a specific dollar to its source after being mixed with other dollars, courts generally allow the use of a legal tracing fiction. One commonly accepted tracing fiction is referred to as the Lowest Intermediate Balance Test (LIBT),[3] which has long been a fundamental principle of trust law.[4]

LIBT is a tracing fiction that assumes that trust funds commingled with other non-trust funds in the same bank account are the last funds withdrawn from the account.[5] This tracing fiction pretends that trust funds are protected by sinking to the bottom of the account, and funds subsequently withdrawn are taken from the top first (i.e., non-trust funds). Trust funds deposited into a commingled bank account will only be withdrawn when the account balance falls below the amount of trust funds available in the account. In instances where the account balance dips below the amount of trust funds available, the shortfall will be treated as trust funds lost from the account forever.[6]

Applying LIBT

The following graphical representation illustrates the fundamental principles and application of LIBT:[7]

This example highlights the protection of trust funds over non-trust funds by applying LIBT. Here, $1 million of trust funds deposited into the account immediately sank to the bottom of the commingled bank account. Those trust funds remained untouched because there were sufficient non-trust funds (i.e., $3 million) available to satisfy payment of the $2 million disbursed from the account. As a result of applying LIBT, $1 million of trust funds was traced into and remained in the account, while $3 million of non-trust funds was traced into the account, but only $1 million of those non-trust funds remained.

A Deeper Forensic Accounting Dive into Applying LIBT

The following forensic accounting analyses further illustrate how to apply LIBT:

The above illustrates the application of LIBT to five days of hypothetical cash activity that occurred in a commingled bank account. On day 3, the total funds disbursed from the account exceeded the available non-trust funds by $0.2 million, resulting in a corresponding $0.2 million reduction in the trust fund balance. The $0.2 million reduction in trust funds is considered to be lost from the account forever. On day 4, new non-trust funds were deposited into the account, increasing the non-trust fund balance to $0.3 million. Finally, on day 5, $0.4 million of new trust funds were deposited into the account, increasing the trust fund balance to $1.2 million. Therefore, as a result of applying LIBT, $1.2 million of $1.4 million in total trust funds deposited into the account was traced to the remaining balance in the account at the end of day 5. In other words, $1.2 million represents the lowest intermediate balance of trust funds traceable to the account.

The Advantages of Experienced Advisors

Remember, when faced with the challenges of tracing trust funds commingled with cash from other sources, there’s no smartphone IMEI, automobile VIN or appliance serial number equivalent available to achieve direct property tracing. Consider retaining an experienced forensic accountant familiar with the many complexities of tracing commingled trust funds by applying appropriate legal tracing fictions, such as LIBT, or other methods permitted by law. Also consider consulting counsel and seeking guidance from the courts regarding the appropriate legal principles and tracing fictions that may be applicable in your situation.