UK: Sub-Sureties And The Equity Of Exoneration: An Equitable Division Of Liabilities

Day v. Shaw and Shaw [2014] EWHC 36 (Ch)
Last Updated: 26 January 2015
Article by Lucy Walker and Hanh Nguyen

In Day v. Shaw, the Court of Appeal considered the application of the equity of exoneration in circumstances where a wife entered into a mortgage to secure a debt guaranteed by her husband, Mr Shaw.

Mr Day obtained a charging order over Mr Shaw's share of the property. However, the mortgage took effect in priority to the charging order and liability fell first on Mr Shaw's share of the property (due to the principle of equity of exoneration). The liability under the mortgage exceeded the value of the Mr Shaw's interest, and accordingly Mr Day received nothing.

The Facts

In this case, there were various people who were liable in different ways for the debt owed to Barclays, as follows:

  1. The Loan: Barclays Bank plc ("Barclays") advanced a loan in favour of Avon Independence Limited ("Avon").
  2. The Guarantee: Under the loan agreement, the two company directors of Avon (Mr Shaw and his daughter) acted as joint and several guarantors.
  3. The Mortgage: By way of further surety, Mr Shaw and his wife granted a mortgage in favour of Barclays over their jointly owned property.

Mr Shaw and his daughter ran Avon jointly as company directors. Mrs Shaw was not a director of Avon, nor was she directly involved in the running of the company.

In light of the above, Avon was the principal debtor under the loan. Under the mortgage, Mr Shaw and his wife covenanted to pay (1) the sums due from Avon to Barclays pursuant to the loan and (2) the sums due from Mr Shaw and his daughter to Barclays under the guarantee.

Avon defaulted on the loan. Consequently, Mr Shaw and his daughter were personally liable as guarantors under the guarantee.

The Charging Order

In 1997, Mr Shaw and his daughter (acting as directors of Avon) borrowed a sum of money from Mr Day. The loan was never repaid and Mr Day obtained a County Court Judgment against Mr Shaw and his daughter for a sum in excess of £22,000. The daughter was then made bankrupt on 29 November 2010.

As Mr Shaw and his daughter were jointly liable for the loan (and the prospects of recovery from the daughter were slim) Mr Day obtained a charging order over Mr Shaw's share of his jointly owned property in respect of the unpaid judgment. The charging order only attached to Mr Shaw's beneficial interest in the property as his wife was not a party to the loan nor was she liable under the judgment for repayment.

The Issue

Mr Day argued that his charging order should take priority over the mortgage. If the mortgage were to be repaid first, this could preclude any return under the charging order.

Upon sale of the property, Mr Day claimed that he was entitled to the net proceeds of Mr Shaw's interest in the property in accordance with the charging order. However, Mrs Shaw argued that she was entitled to be indemnified by Mr Shaw in relation to her liability under the mortgage and that any indemnity should be subject to the equity of exoneration.

'The Equity of Exoneration':

"A person who mortgages his property to secure the debt of another stands in the relation of guarantor towards the person whose debt is thus secured, and is entitled to be exonerated by the principal debtor. This principle also applies where jointly owned property is charged to secure the indebtedness of one co-owner."
(Halsbury's Laws of England, 5th Ed vol. 49 para 1152)

If exoneration were to apply, the mortgage would first be repaid from the beneficial interest of Mr Shaw with any shortfall balance being paid out of his wife's share of the property. In this case, if exoneration applied, the charging order over Mr Shaw's interest in the property would have no opportunity to "bite" as the mortgage liability exceeded the value of Mr Shaw's interest in the property.

Reasoning of the Court

The Court considered that the principal debtor under the loan (and the mortgage) was Avon. The Loan was guaranteed by Mr Shaw and his daughter, who had a secondary liability as guarantors (and sureties). Mr and Mrs Shaw also had an additional secondary liability under the mortgage.

The Court held that Mr and Mrs Shaw were therefore acting as sub-sureties for the debts under both the loan and the guarantee (rather than co-sureties equally liable with Mr Shaw and his daughter for the principal debt).

The court determined that, as a result, the sub-sureties (i.e. Mr Shaw and his wife) were entitled to be indemnified by the sureties (i.e. Mr Shaw and his daughter) in the same way as a surety is entitled to be indemnified by a principal debtor.

As between the guarantors and the mortgagors, the principal debtor would be the guarantors (Mr Shaw and his daughter). Mr and Mrs Shaw as mortgagors therefore had a theoretical right of an indemnity from Avon (although Avon went into liquidation and any indemnity was worthless), in addition to a right of indemnity from the guarantors (Mr Shaw and his daughter).

In light of the fact that their daughter had been made bankrupt and was unable to provide any form of indemnity, the resulting position was that Mrs Shaw was entitled to be indemnified by Mr Shaw under the guarantee. It also followed that, in relation to the equity of exoneration, Mrs Shaw was entitled to be indemnified by Mr Shaw in respect of the charge in favour of Barclays.

Accordingly, the liability under the mortgage should fall first on Mr Shaw's share of the net proceeds of sale of the property with the shortfall balance to be taken out of Mrs Shaw's share. As the value of Barclays' charge exceeded the value of Mr Shaw's share of the net proceeds, Mr Day's charging order did not have the opportunity to take effect.

Comment

The Court stated that, had there not been a guarantee, the principal debtor would have been Avon. In that event, the default position would be that each mortgagor would be equally liable in respect of the debt.

However, there would still need to be an equitable division of the liability. In this case, as Avon was controlled by Mr Shaw alone (as between husband and wife), the debt was the responsibility of the husband alone. Mrs Shaw did not derive any benefit from the loan advanced to Avon as she had no direct interest in the running of the company.

Practice points

This case is a useful demonstration of the principle that the right of indemnity and the equity of exoneration will apply between co-sureties in a situation where the debt was incurred solely for the benefit of only one party.

It is increasingly common for parents or spouses to become a party to a loan or mortgage for the benefit of a family member who needs to raise capital for a business or for personal purposes. In situations where the parent or spouse derives no benefit from the loan, they may be entitled to an indemnity from their co-surety in accordance with the equity of exoneration. However, in the absence of evidence to the contrary, the default position will remain that co-sureties are equally liable under any loan agreement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Lucy Walker
 
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