For insolvency practitioners, the doctrine of equity of exoneration can severely hamper the ability to release funds, especially in regard to the sale of a bankrupt’s family home. Understanding how and when the doctrine applies and when the presumption can be rebutted is a crucial part of creating a successful strategy to pay creditors as much as possible.
What is Equity of Exoneration?
Equity of exoneration arises when one owner of joint property (for example, the marital home) takes out a loan against that house for their sole benefit (the most common example is when one spouse takes out a mortgage to acquire capital for their business). The co-owner of the property acts as a surety (a person who takes responsibility for another's performance of an undertaking, for example, a debt). Under the doctrine of equity of exoneration, the non-benefiting co-owner is presumed to be entitled to be exonerated out of the other owner's share of the property should they default on the loan payments and/or be declared bankrupt.
It is vital to note that the presumption of equity of exoneration cannot be taken for granted as it can be rebutted in certain situations.
When Does the Doctrine of Equity of Exoneration Apply?
If there is no evidence of an actual or inferred intention that the surety planned to benefit from the debt in question, there is a presumption that the parties intended for the principal debtor to bear full liability.
In Pittoriou (A Bankrupt), Re [1985] 1 W.L.R. 58, the husband took over a family restaurant and ran it independently of his wife. A legal charge was executed on the matrimonial home. In 1979 the couple jointly purchased a new home and took out another mortgage to fund the restaurant and pay household expenses. In 1981, the couple divorced and in 1982, the husband was declared bankrupt.
The trustee in bankruptcy sought a declaration that the husband and his former wife were each beneficially entitled to a one-half share in the equity of the marital home and for an order for the sale of that property.
The Court held that the application of the doctrine of equity of exoneration depended on the parties' presumed intentions. In this case, as payments from the mortgage on the property were paid household expenses, it could not be presumed that the mortgage was for the husband's sole interest. Therefore, the Court ruled that before the doctrine could be applied, the amount spent on household expenses should be deducted from the proceeds of the house sale.
Is the Presumption of Equity of Exoneration Rebuttable?
Yes, and this was illustrated in Pittoriou and the more recent case of Armstrong (As Trustee In Bankruptcy Of Onyearu) V Onyearu & Anor [2017] EWCA Civ 268, which again concerned a husband and wife and a jointly-owned family home. Case law holds that the presumption that equity of exoneration applies can be rebutted if it can be proven, on the balance of probabilities (the civil standard of proof), that the person relying on the doctrine benefited from the loan.
In Armstrong, the husband was a Solicitor with his own practice, and his wife was a lecturer. They had separate bank accounts, but each contributed to a joint account that covered living expenses. The husband met the monthly interest payments on the mortgage and the wife paid the utility bills, council tax and all other household expenses.
A mortgage was obtained using the family home as security by the husband to provide capital for his law firm. He was subsequently declared bankrupt, and the trustee in bankruptcy applied to the Court for a declaration that the home should be sold. The wife argued that equity of exoneration applied and therefore her share of the property was excluded from paying her husband's debt.
In the first instance, the Judge held that the wife was exonerated because she had a separate bank account. The trustee appealed the decision.
Dismissing the appeal, the Court of Appeal referred to the trend of financial emancipation of women that began with the passing of the Married Women's Property Act 1870. The Court declared that the law must be consistent with the principle that couples (be they married or cohabiting) are entitled to keep their finances as separate as they wish and, therefore, treat a couple as separate people when one acts as surety for another unless there is evidence to the contrary.
The trustee had argued that the wife received a benefit from the loan in question because it kept his law firm running; therefore, he could continue to pay the mortgage on the family home. The Court of Appeal stated that this was an indirect benefit and consequently did not rebut the presumption of exoneration. Any benefit derived by the wife was subject to a double contingency: namely, that the husband's firm would continue and that it would be profitable. Thus, the husband and his creditors benefited directly from the loan, and any benefit received by the wife was too remote to provide a basis for inferring or presuming that she intended to bear the burden of paying back the debt equally with her husband.
When Surety Wants to Rely on Equity of Exoneration, What Should an Insolvency Practitioner Do?
Insolvency practitioners charged with recovering as much money as possible for creditors can run into serious issues if equity of exoneration applies to property and assets that can be sold to liquidate much-needed funds. The key to rebutting the presumption is to deep-dive into the family finances to uncover whether the surety received a direct benefit from the loan or the business that received the finance.
How We Can Help
As experts in insolvency law, Witan Solicitors can assist insolvency practitioners with all aspects of their role, including rebutting the presumption of equity of exoneration. Contact us via email for more information.
