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Phil Smith
Phil Smith,
Two common questions
23 April 2014

As the trustee in bankruptcy of a debtor who secured her business obligations by granting a charge over the jointly owned matrimonial home, I am seeking possession and sale of the matrimonial home. The husband is claiming the equity of the exoneration- is he entitled to do so?

Where a charge has been granted by the joint proprietors of a property to secure the debt of only one of those joint proprietors, the other proprietor stands in the position of a surety. Once the chargeholder has been paid, the surety will be entitled to an indemnity from the debtor, but this indemnity is of little value when the debtor becomes bankrupt. The equity of exoneration was therefore developed so that the debtor's indebtedness is discharged from the debtor's interest in the property before the chargeholder can look to the other proprietor's interest for payment. This goes further as the equity of exoneration gives the innocent party a proprietary interest in the debtor's share of the property, making the innocent party a secured creditor of the debtor.

However, much will depend on the intentions of the parties at the time the charge was created and whether the circumstances justify the inference that the parties intended the debt to be paid solely by the debtor.

If the indebtedness has been incurred so that a certain standard of living can be maintained for the benefit of both proprietors, it is unlikely that the equity of exoneration will be applied.

Do check to see if the sum borrowed was paid into a joint account, whether it was used for household expenses, holidays or to purchase other assets of which the husband had the benefit. If the husband has no independent means of his own, it is likely that he was reliant on the bankrupt's income so that the equity of exoneration cannot be applied.

These principles have recently been reinforced by Chief Registrar Baister in the case of Lemon & Wood –v- Chawda and Chawda (2013) Nexis Lexis 88 and Mr Justice Morgan in Day v Shaw [2014] EWHC 36 (Ch). The cases of Bagot v Oughton (1717) 1 P Wms 347 and Gray v Dowman (1858) LJ Ch 702 confirm that the equity of exoneration can be applied in favour of a husband as well as a wife.

I am acting as the liquidator of a group of companies, X Limited, Y Limited and Z Limited. All three owe significant sums to bank "A" and there is also secondary lending to all three companies by bank "B". Only X LImited has granted any security. X owns four properties, all of which are charged to bank "A" but only two of which are charged to bank "B". Who gets what?

Having obtained all of the documents from A and B, firstly confirm that there are no deeds of priorities or guarantees. If this is the case, as separate legal entities, all of the assets and liabilities of each company will be dealt with separately, notwithstanding the fact they form part of a group of companies.

X has four properties, all of which are charged to A ("the A properties") and two of which are subject to charges in favour of A and B ("the common properties"). Subject to valuations, it is likely that A can be paid in full from the A properties, leaving B to be repaid from the common properties. However, if A enforces its security against the common properties, it is likely that B will not get anything. In this situation, the equitable doctrine of marshalling comes into play.

A creditor can take advantage of marshalling where:-

  • Its debt is secured by a second mortgage over a property.
  • That property is also subject to a first mortgage in favour of a mortgagee that is also a creditor of the debtor.
  • The first mortgagee also has security for that debt in the form of another property.
  • The first mortgagee is paid from the proceeds of the sale of the common property.
  • The second mortgagee remains unpaid
  • The proceeds of the sale of the other property are not required to pay the first mortgagee

The aim of marshalling is to ensure that the second mortgagee is not prejudiced by the arbitrary decision of the first mortgagee to enforce its security against the common property and it is particularly useful in insolvency situations, where it will maintain the position of the second mortgagee against unsecured creditors. However, it cannot be used to cause injustice to the debtor by increasing the amount owed, so that, in your case, there must be a valid debt owed by X to B for marshalling to take effect.

Once you have realised the properties, A can be paid from the A properties and B can be paid from the common properties. A and B will then be unsecured creditors of Y and Z.

However, if there is a contractual obligation on A to enforce its security against the common properties (e.g. because the other property is trading premises rather than investment premises) marshalling will not be available. Therefore the terms of the security and any deeds of priority should be checked carefully.

If there is a cross guarantee between the three companies in favour of A (or indeed B), which is secured by the charges in favour of A, then as long as those obligations have become a debt owed by X to A, A will be entitled to payment of those sums as well from the proceeds of the sale of the A properties, and vice versa if the cross guarantee is given to B.

For further information, please contact our Corporate Recovery team on 0118 952 7205 or submit an enquiry.

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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