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What is the equity of exoneration, and when is it important?

27/02/2014

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United Kingdom

The legal concept "equity of exoneration" is essentially an indemnity coupled with a proprietary interest.

Finance brief - February 2014

 

The legal concept "equity of exoneration" is essentially an indemnity coupled with a proprietary interest.  Although the term will not be immediately familiar to everyone, the recent decision in Day v Shaw and another [2014] EWHC 36 (Ch) shows that it is alive and well, and can make a significant difference when there is competition between secured creditors against the same asset.

The facts and decision

Mr Day made a loan to a company controlled by Mr Shaw and his daughter.  He obtained judgment against the company for a sum which, with costs exceeded £22,000, and obtained a charging order over Mr Shaw's interest in a property jointly owned by Mr Shaw and his wife.  The order ranked behind a first mortgage in favour of Lloyds TSB Bank plc, and a second mortgage securing facilities advanced by Barclays Bank plc to the company, and guaranteed by Mr Shaw and his daughter.  The property was sold and from the proceeds of sale of £145,500, sums of £27,300 and £70,000 respectively were paid to the first and second mortgagees, leaving approximately £45,000 after the costs of sale. 

No issue arose from the repayment of the first mortgage debt as Mr and Mrs Shaw agreed that they were jointly liable for it.  But Mrs Shaw argued that in the case of the second mortgage debt, she was entitled to be indemnified by her husband, and that this right of indemnity amounted to a proprietory interest in the property in the form of an equity of exoneration, thus increasing the extent of her beneficial interest in the property.  This depended on whether it was the joint intention of Mr and Mrs Shaw that the burden of securing the indebtedness should fall on his share of the property alone.  Put another way, the issue was between two sets of people with secondary liability (the primary liability for the loans being with the company), namely between Mr Shaw and his daughter, as joint and several guarantors on the one hand, and Mr Shaw and his wife, as third party mortgagors on the other hand. 

The court held that they could not all be treated as sureties with equal liability.  In substance, Mr Shaw and his daughter were co-sureties, but Mr Shaw and his wife were sub-sureties, and Mr Shaw could not deny his liability to indemnify his wife. Mrs Shaw was entitled to an equity of exoneration against her husband, which was a proprietory right binding his share in the property and with priority to Mr Day's charging order.  It meant that the liability under the mortgage to Barclays fell first on Mr Shaw's share of the property.  After the first mortgage had been repaid, leaving £118,000, all of Mr Shaw's half share of the debt, being £59,000, should be paid to Barclays, which exhausted Mr Shaw's interest in the property.  Only £11,000 had then to be found from his wife's share of the property, leaving her with £45,000.  Mr Day received nothing under its charging order against Mr Shaw's interest in the property from the proceeds of sale, because that interest had been wholly used up in repayment to the second mortgagee.  Had Mrs Shaw's claim to an equity of exoneration failed, she and her husband would have been equally entitled to the remaining equity in the property after repayment of the first and second mortgages, and Mr Shaw's share in the property would have exceeded £22,600, which would have been available to satisfy the debt to Mr Day.

Whether or not Mr Shaw's wife or daughter also held any shares in the debtor company was, on the evidence provided, unresolved.  Also, it not argued that Mr and Mrs Shaw should be equally liable on the basis that what they were effectively doing was helping their daughter in her business affairs. 

Comment

The decision applies a number of old authorities to a set of facts that may  be encountered today, and illustrates how the potentially conflicting rights and cross-rights were resolved.  There is helpful analysis in the judgment of where the ultimate liability may lie when a husband and wife mortgage their home to secure debts they owe jointly, or for a business or company owned by one of them, or by their child, or by a third party.  And although the facts involved a small business and a charge over a residential property, the principles are capable of wider application where there are "layers" of sureties and sub-sureties, with potentially significant practical and commercial results.

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