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Apportioning the debt between joint borrowers: Indemnity and Equitable Exoneration

This section deals with a number of important principles which are frequently overlooked in the context of joint borrowing

Example 1

Mr & Mrs Smith are the joint legal and beneficial owners of their matrimonial home, valued at £150,000.00.
Mr Smith runs a business. He obtains a business loan from the bank for £75,000.00, secured by way of legal mortgage over the property.

Joint and Several Liability

As against the bank, Mr & Mrs Smith bear joint and several liability – that is the bank is entitled to claim the full amount outstanding from either or both of them.

Indemnity or Contribution

However, as between themselves, since the mortgage is for Mr Smith’s benefit, Mrs Smith stands in the position of a surety only – that is she is simply providing security for the benefit of Mr Smith as principal debtor. Accordingly she is entitled to look to Mr Smith for an indemnity in respect of her liability to the bank. Had the loan been for their joint benefit, her claim would be for a contribution only.

Equitable Exoneration

In addition, Mrs Smith is entitled to be exonerated by Mr Smith so that on a sale, the bank is required to recover its debt from Mr Smith’s half share first before claiming from Mrs Smith’s share. On the figures, subject to the costs of sale, the bank would recover its £75,000 from Mr Smith’s half share, leaving the remaining £75,000 to Mrs Smith.

If she had not raised an exoneration claim however, again subject to the costs of sale, the bank would recover its £75,000 from the proceeds of sale first, leaving £37,500 each to Mr & Mrs Smith. That would leave her £37,500 down.

The principle of equitable exoneration typically arises in the context of wives giving security for their husband’s debts, often where exoneration is sought against the husband’s trustee in bankruptcy (Re Pittortou [1985] 1 WLR 58; Re Richards [2009] EWHC 1760 (Ch) - featured in the July 09 Update). However, the principle also applies in reverse - to husbands giving security for their wives' borrowing (Bagot v Oughton (1717) 1 P Wms 347) and also in other relationships eg. a parent providing security for their children’s debts (Re A Debtor [1976] 2 All ER 1010). The principle also applies where one person mortgages his solely owned property to secure the debts of another.

In each case, equity presumes that in the absence of a contrary intention, the person providing the security does so as a surety only and is entitled to an indemnity against the principal debtor and to be exonerated first out of his property (Re Pittortou [1985] 1 WLR 58 per Scott J at p 61D).

However, it is only a principle of equity which depends upon 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 their joint intention that the secured indebtedness should fall primarily on the share of one of them as principal debtor, the the presumption will not apply and exoneration will not be allowed (Re Pittortou [1985] 1 WLR 58 per Scott J at p 62A).

Thus, the presumption has been rebutted in the following circumstances:

(1) Where the evidence shows that the wife intended to make a gift to the husband (Clinton v Hooper (1791) 3 Bro CC 201;

(2) Where the money was borrowed for the wife’s benefit – either wholly or jointly with her husband – this will include general household and family living expenses (Gray v Dowman (1858) 27 LJ Ch 702; Re Pittortou [1985] 1 WLR 58);

(3) Where the money was raised to repay monies borrowed by the husband to service their extravagant lifestyle (Paget v Paget [1898] 1 Ch 470);

(4) Where the money was raised in part to discharge the wife’s debts, albeit the husband had the benefit of the surplus (Lewis v Nangle (1752) 1 Cox Eq Cas 240).

Example 2

As in example 1 above, but this time, the £75,000 is required:

• As to £50,000 for Mr Smith’s business
• As to the remaining £25,000 for home improvements

Mrs Smith can only seek to be exonerated to the extent of £50,000 since she has received a benefit from the other £25,000. Thus on a sale, the bank would be entitled to its £25,000 first, leaving £50,000 to be recovered out of the half share in the net proceeds due to Mr Smith. Again, subject to the costs of sale, Mr Smith would receive £12,500. Mrs Smith would receive £62,500.

Inquiry

Where there is any doubt as to who benefited from the mortgage advance, the court will order an inquiry. For example in Re Pittortou it was held that prima facie the equity of exoneration applied in respect of a second charge to the bank, taken as security for the husband’s borrowings, save to the extent that it could be shown that it represented payments made by the husband for the benefit of the household, including payments made to discharge a first charge to a building society, and in this respect the court ordered an inquiry to be made so as to identify the apportionments to be made out of the proceeds of sale.

The relationship between Equitable Exoneration and Undue Influence

It will immediately be seen that a claim for an indemnity and equitable exoneration is to a large extent a hostile act, and one that normally only arises following a breakdown in the relationship between the parties or upon one of them being adjudged bankrupt. Thus in the examples given above, whereas the wife was at one point prepared to give security for her husband's borrowings by entering into a joint mortgage with him, she is now effectively seeking to apportion the debt to her husband (or his trustee in bankruptcy) by way of indemnity claim, and ringfence her beneficial interest by way of equitable exoneration.

The very fact that the wife is claiming an indemnity, and/or equitable exoneration, means that she accepts the validity of the mortgage. However, the fact that she has given security for her husband's borrowings will frequently raise the possibility that her signature to the mortgage has been procured by undue influence in which case it may be open to the wife to challenge the validity of the mortgage and seek to set it aside, certainly as against her. If she is successful, then she will avoid liability under the mortgage and preserve her beneficial interest free of charge, meaning that she will probably not need to claim an indemnity and/or equitable exoneration. However, the possibility of seeking an indemnity and/or contribution should not be overlooked, and ought to be pleaded in any Defence and/or Part 20 Claim.