The equity of exoneration - is it still applicable?

The recent case of Day v Shaw [2014] EWHC 36 (Ch), [2014] All ER (D) 120 (Jan) looked at the court's approach when applying the equity of exoneration. We spoke to Graham McPhie, partner at Moon Beever, to look at the implications of the case.

Day v Shaw - what happened?

The defendants owned a house jointly. The first defendant was the director of a company, which took a loan from Barclays Bank that the company guaranteed. That loan was also secured by way of a second charge over the defendants’ house, and they were both mortgagors. The claimant issued proceedings against the first defendant, seeking to recover sums owed to him, which was granted and secured by way of a charging order against the first defendant’s share of the property. The claimant applied to the county court for an order that the charging order come out of the first defendant’s share of the sale proceeds after Barclays had been paid from both defendants’ share. The application was dismissed. The Chancery Division, in dismissing the appeal, held that the second defendant was entitled to indemnification from the first defendant against her liability to Barclays. The second defendant, as sub-surety, was entitled to the right of exoneration by the first defendant, as surety.

What is the equity of exoneration?

The classic definition is:

‘A person who has mortgaged his property to secure the debt of another is presumed in the absence of other evidence to be only a surety and is entitled to be exonerated by the principal debtor. The same is true where jointly-owned property is mortgaged to secure money raised for the benefit of one joint owner.’ (Fisher and Lightwood, Law of Mortgage 13th ed)

Until recently the only modern day decision on this issue was that of Re Pittortou [1985] 1 ALL ER 285. In that case, Mrs Pittortou had entered into a charge with her husband over their jointly owned property to secure his business overdraft. When dealing with the exoneration issue, practitioners can have a tendency to focus upon the part of the judgment which dealt with the fact that the exoneration is a presumption which can be rebutted if the person in whose favour it operates received direct benefits from the lending. In the case of Mrs Pittortou, the presumption was rebutted for payments the business made for household expenses such as the mortgage, food and utilities but not for any other items such as business expenses or monies used by Mr Pittortou to fund his extra-marital affair.

What issues need to be determined?

The problem with Pittortou, is that the facts of the case are very specific and the secured borrowing was an overdraft. The case could be said to be of little assistance in the more usual modern example of the monies being raised by one party’s business by a loan with that party’s spouse entering into a joint charge over their home to secure that borrowing. Often the entity which directly benefitted from the loan has been a limited company. In this instance, do the indirect benefits the family may have received from the income from the company funding normal living expenses rebut the presumption? It has widely been assumed that such indirect benefits would rebut the presumption but there has been no authority to that effect.

There has been a further issue widely ignored in that the judgment in Pittortou goes on to say:

‘The equity of exoneration is a principle of equity which depends on the presumed intention of the parties. If the circumstances of a particular case do not justify the inference, or indeed if the circumstances negate the inference, that it was the joint intention of the joint mortgagors that the burden of the secured indebtedness should fall primarily on the share of that of them who was the debtor, then that consequence will not follow.'

In modern times, can it not be said that a spouse would support the other such that they jointly contribute what they can to the family finances but share the benefits and the risks jointly? If that were so, can it not be said that there is no such presumed intention in modern day times so that the exoneration does not arise at all rendering the necessity to prove direct or indirect benefits irrelevant?

With decisions on the split of spouse’s shares in property from decisions such as Stack v Dowden [2007] UKHL 17, [2007] 2 All ER 929 and the equitable accounting decision in Clarke v Harlowe [2005] EWHC 3062 (Ch) (the equitable accounting argument being spouses or co-habitees relying upon an implied agreement that the non-paying party would reimburse the paying party—invariably not the case) the exoneration argument was beginning to appear to be an anachronism out of touch with modern cases on ascertaining equity or dividing net sale proceeds in the domestic context. Time was ripe for an examination.

What have more recent cases decided?

With apologies to bus companies everywhere, you wait nearly 30 years for a decision and two come along at once. In October 2013, Chief Registrar Baister delivered the judgment in Lemon v Chawdha and on 14 January 2014, Mr Justice Morgan delivered the judgment in Day v Shaw.

Lemon v Chawdha followed the common scenario of the monies being secured against the couple’s jointly owned property to enable Mr Chawdha’s business to purchase a property. There were issues as to whether the monies raised had been used for the business acquisition but it was found that they had been put to that use. However, the Chief Registrar went on to conclude that this was a case in which it was correct to say that the circumstances negated the inference of exoneration. This was a couple who had operated as a family unit taking the benefit of the ups and downs jointly. They operated joint bank accounts, had joint credit cards, jointly received property rent, and the totality of their income went into joint accounts over which they both had control. Any presumption of equity of exoneration was negated in this instance.

Day v Shaw was a very slightly more complicated case. Monies were lent to a business called ‘Avon’. Mr Shaw and another were directors of that company. Mr and Mrs Shaw charged their property for monies borrowed by Avon. Mr Shaw and his co-director had given personal guarantees to the lender. Mr Day had a judgment against Mr Shaw secured against his share of the equity in the matrimonial home. If Mrs Shaw was entitled to equity of exoneration and able to cast the burden of the bank lending onto Mr Shaw’s share, Mr Day would receive nothing. His charging order would be worthless.

Arguments were raised that the exoneration could not apply as the principle lender was Avon and not Mr Shaw. This was rejected by the court upon reasoning that, at first, looks convoluted.

The court relied upon the fact that there were two categories of sureties for the principal debtor. Mr Shaw and his co-director were co-sureties under their personal guarantees. They were entitled to look to Avon or each other for a contribution to payments made under an implied indemnity to each other. Mr and Mrs Shaw as mortgagors to the bank were sub-sureties, ie ranked below Mr Shaw and Mrs Shaw. They, therefore, were entitled to an indemnity from the co-sureties above them. It followed from this that Mrs Shaw as a sub-surety was entitled to an indemnity from Mr Shaw. That entitlement to an indemnity led the court to conclude that she was entitled to equity of exoneration. The fact of her entitlement to the indemnity, means that she was able to cast the burden of the charge onto Mr Shaw’s share of the equity in the property. The decision relied, therefore, upon the implied indemnity from the surety to a sub-surety.

There is only peripheral examination in the judgment of arguments regarding benefits from the lending rebutting any exoneration. The slight referral to the evidence says that Avon had never made a profit. While it is not referred to in the judgment in any detail, this may have been sufficient to conclude that there were no benefits to the family for the lending to Avon.

There is no examination of the point that the couple may have operated as a family unit and so taken the ups and downs jointly. The court did consider what the position would be if there had been no co-sureties so that Mrs Shaw was not relying upon an indemnity in her position as sub-surety. The court concluded that the equity of exoneration would still arise and it would make no difference if the lending was directly to the husband or to his business whether that be a limited company, sole trader or a partnership. In either case the exoneration would apply.

This left the only argument to be one of whether Mrs Shaw had benefitted from the lending, and having already concluded that Avon had made no profit, it was easy to find that the exoneration was not rebutted on that ground.

Where does this leave us?

It is submitted that Lemon v Chawdha is more in tune with the current trend in decisions such as Stack v Dowden and Clarke v Harlowe to treat families as units who share the ups and downs jointly. If that is followed, effectively this is likely to mean that the exoneration will be difficult to apply in most cases where it is claimed by a spouse or co-habitee.

The decision in Day v Shaw, arguably continues the anachronism and is unsatisfactory to some extent in that it does not deal with the issue of the presumed intention of this married couple. It is useful to have some clarification that exoneration can apply no matter what the trading entity might be or the lender if, in effect, the loan was for the purposes of one party’s business. Although it is not specifically said, the implication that the any benefit Mrs Shaw might have received from Avon would have had an impact on the exoneration point, can be said to be some authority that such indirect benefits can rebut the presumption of exoneration.

In summary, Lemon v Chawdha, could be considered as being the death knell for exoneration but Day v Shawis its resurrection although regrettably on incomplete grounds and a less than thorough analysis of all the reasons. There should be more.

What can practitioners do?

Nothing changes the need to investigate the exoneration argument thoroughly. In particular, full documentation consisting of the charge, facility or offer letter, loan application forms should be obtained. Does the documentation show any misleading of the lender such that the equitable remedy of exoneration is not available?

Investigate the family finances in order to see how it was operated to show that the presumed intention that the exoneration would apply does not arise in the first instance. In particular, it is suggested that reliance is placed if at all possible on the family unit taking the ups and downs together.

Consider the benefits taken by the family from the business entity that received the financing in order to rebut the exoneration if it arises in the first place. Day v Shaw is at least an authority for such benefits impliedly being relevant to rebut the presumption.

What can spouses or cohabitees do?

The best advice is not to rely upon any presumption at the lending stage but to seek independent advice about how to protect their interest and value in the property. That may be by a declaration of trust but some documentation will need to be produced at the time of the lending which show what the parties’ actual intentions were. If the court accepts on the evidence that the parties had an actual intention that exoneration would apply, this gives a spouse more certainty than relying on presumptions which may be difficult to apply in the modern, family context.

For further reading on this, see our note on the equity of exoneration.

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