When will the doctrine of equity of exoneration arise? (Cadlock (the Trustee in Bankruptcy of Anthony Ivor Dunn) v Dunn and another)

When will the doctrine of equity of exoneration arise? (Cadlock (the Trustee in Bankruptcy of Anthony Ivor Dunn) v Dunn and another)

Stephen Leslie, of the LexisPSL Restructuring & Insolvency team, considers the case of Cadlock v Dunn, in which the Chancery Division was asked to consider whether a wife was entitled to rely on the doctrine of equity of exoneration in circumstances where monies borrowed were used by her husband to re-acquire an interest in the matrimonial home from the husband’s trustee in bankruptcy.

Original news

Cadlock (the Trustee in Bankruptcy of Anthony Ivor Dunn) v Dunn and another [2015] EWHC 1318 (Ch), [2015] All ER (D) 115 (May)

Mrs Dunn made a successful application under section 375 of the Insolvency Act 1986 (IA 1986) to set aside a possession and sale order and vacate the warrant for possession obtained by her husband’s trustee in bankruptcy over the matrimonial home, arguing that her interest in the property should be exonerated from the second charge registered against it with the result that the trustee had no interest in the property of realisable value.

The trustee appealed. Having considered the slightly unusual facts of the case—the second charge related to a loan obtained by Mr and Mrs Dunn to re-acquire Mr Dunn’s interest in the property in connection with his previous (first) bankruptcy—the Chancery Division dismissed the appeal holding that the second charge was to secure Mr Dunn’s debt and that Mrs Dunn did not benefit from it. Mrs Dunn was therefore entitled to an equity of exoneration.

What were the facts of the case?

In 1985, Mr and Mrs Dunn purchased the property in joint names in equal shares. There was a mortgage registered against the property. Mr Dunn was first adjudged bankrupt in 1998, and his beneficial interest in the property accordingly vested in his trustee (who incidentally was the trustee in both of Mr Dunn’s bankruptcies) pursuant to IA 1986, s 306.

In 2009, the trustee agreed to release his interest in the property for £150,000, and over the next six months or so, that sum (together with an additional sum in respect of late payment) was paid to the trustee. No document was executed by the trustee to transfer his interest, although he did remove the bankruptcy notice registered against the property at the Land Registry.

The funds used to purchase the trustee’s interest were loaned to Mr and Mrs Dunn from four individuals (the lenders), although there was no contemporaneous agreement recording the loans.

A second bankruptcy petition was presented against Mr Dunn in November 2010, and in January 2011 Mr and Mrs Dunn executed a legal charge over the property in favour of the lenders securing the sum of £196,500. In March 2011, Mr and Mrs Dunn entered into a loan agreement with the lenders which stated that the sum loaned was £196,500 plus accruing interest at 10% per annum, but did not record how that principal sum was comprised. It did, however, contain a statement that the parties wished to record in writing the terms of the loans previously made.

The legal charge was registered in April 2011 on the same day that the second bankruptcy order was made against Mr Dunn.

One issue the judge raised by way of his own analysis of the facts was whether Mr Dunn’s half share in the property realised in his first bankruptcy was in fact transferred to both Mr and Mrs Dunn—with the resultant effect that the beneficial interest in the property was split 75/25 in Mrs Dunn’s favour—and not just to Mr Dunn. Neither counsel wished to adopt that analysis at that stage as it had not previously been raised or argued. Notwithstanding the judge’s doubts on that point, the case proceeded on the basis that, as at the date of the second bankruptcy order, the property was beneficially owned by Mr and Mrs Dunn in equal shares.

What were the legal issues that the judge had to decide?

The central question arising in the appeal was whether there was an equity of exoneration in favour of Mrs Dunn in respect of the second legal charge.

Briefly, an equity of exoneration applies where a spouse or civil partner mortgages their property to secure the debt of the other spouse or civil partner—including (and most commonly) where jointly-owned property is charged to secure the indebtedness of one of them—and the person who effectively becomes a guarantor for the debt derives no benefit from the debt. Where an equity of exoneration applies, the guarantor is entitled to throw the burden of that charge on the beneficial interest of the other, thereby allowing the guarantor to claim an enhanced beneficial interest, and it is a requirement of an equity of exoneration that the parties intended that to be the effect—such intention is presumed but can be rebutted on the facts of the particular case.

What were the main legal arguments put forward?

It was submitted on Mrs Dunn’s behalf that the facts demonstrated a classic case for an equity of exoneration to operate. The loan was obtained in order to allow Mr Dunn to re-acquire his interest in the property, and Mrs Dunn received no financial benefit at all from that transaction.

Counsel for the trustee, however, submitted that the charge was not made for the purposes of Mr Dunn, and that the monies were not loaned for his benefit. Indeed, Mrs Dunn benefitted from the transaction by virtue of the preservation of the matrimonial home, and the incidental expenses that she saved by avoiding a sale of the property.

It was common ground that the legal charge in favour of the lenders was effective to create an equitable charge of Mrs Dunn’s beneficial share of the property in respect of the whole of the outstanding debt.

What did the judge decide, and why?

The judge, in applying the approach of Scott J (as he was then) in Re Pittortou [1985] 1 All ER 285, decided that Mrs Dunn was entitled to an equity of exoneration in respect of the second charge:

  • the purpose of the loan was to enable Mr Dunn to re-acquire his interest in the property from the trustee, Mr Dunn was the person primarily responsible for repaying the lenders
  • Mrs Dunn had accordingly charged her beneficial interest in the property to secure Mr Dunn’s indebtedness
  • Mrs Dunn derived no benefit from Mr Dunn re-acquiring his interest in the property—the fact that it allowed her to remain in occupation of the property did not matter
  • there was nothing in the facts of the case to negate the inference that Mr and Mrs Dunn intended for Mr Dunn’s liability for the loans to fall on his beneficial interest in the property

However, as no explanation was provided as to how the principal loan sum of £196,500 was made up, the judge held that the equity of exoneration in this case was limited to sums loaned plus interest in respect of Mr Dunn’s re-acquisition of his interest in the property from the trustee.

To what extent is this judgment helpful in clarifying the law in this area?

This case was decided on its own, slightly unusual facts, and therefore does not add anything of particular significance to the law.

It was, however, interesting to see the judge apply a seemingly narrow interpretation as to what benefit Mrs Dunn received as a result of Mr Dunn’s re-acquisition of his interest in the property. The focus was on the fact that the loan was obtained for that purpose and that the re-acquisition in itself did not result in any change to Mrs Dunn’s share of the beneficial interest in the property—what could perhaps be described as ‘indirect’ benefits to Mrs Dunn (that it enabled her to remain in occupation of the property, and saved her the costs incidental with any sale of the property) did not matter.

It is wondered what the outcome might have been had the judge’s analysis of the beneficial interest split in the property been adopted, ie that the property would on that analysis have been held 75/25 in Mrs Dunn’s favour.

What practical lessons can those advising take away from the case?

It is not uncommon for trustees in bankruptcy to be faced with claims for an equity of exoneration when seeking to ascertain—and ultimately realise—their beneficial interest in jointly-owned properties. Some claims will be more straightforward, ie where a joint owner borrows monies secured against the property to clear their own personal debts, than others, ie where a joint owner borrows monies secured against the property to support a business, the fruits of which benefit the entire family. Some claims, if successful, will result in the trustee’s interest in the property having no or little value such that it is not in the interests of creditors to pursue, whereas others will result in a reduction in value of that interest, but will still ultimately mean that there is an asset that can be realised.

Whether the party seeking an equity of exoneration has in fact received a benefit will often fall to be the central issue to be determined in any claim. This case demonstrates that the court may look at that issue narrowly, and that other indirect benefits may not be taken into consideration. Trustees in bankruptcy and those advising them will need to be alert to this possibility.

Stephen Leslie is a solicitor in the Lexis®PSL Restructuring & Insolvency team

Further Reading

If you are a LexisPSL subscriber, you may be interested in:

Matrimonial home—overview

Family proceedings and ancillary relief—overview

The equity of exoneration and how it applies in practice

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First published on LexisPSL Restructuring and Insolvency

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About the author:

Stephen qualified as a solicitor in 2005 and joined the Restructuring and Insolvency team at Lexis®PSL in September 2014 from Shoosmiths LLP, where he was a senior associate in the restructuring and insolvency team.

Primarily focused on contentious and advisory corporate and personal insolvency work, Stephen’s experience includes acting for office-holders on a wide range of issues, including appointments, investigations and the recovery and realisation of assets (including antecedent transaction claims), and for creditors in respect of the impact on them of the insolvency of debtors and counterparties.