What Is The Equity Of Exoneration, And When Is It Important?

The legal concept "equity of exoneration" is essentially an indemnity coupled with a proprietary interest. Although the term will not be immediately familiar to everyone, the recent decision in Day v Shaw and another [2014] EWHC 36 (Ch) shows that it is alive and well, and can make a significant difference when there is competition between secured creditors against the same asset.

The facts and decision

Mr Day made a loan to a company controlled by Mr Shaw and his daughter. He obtained judgment against the company for a sum which, with costs exceeded £22,000, and obtained a charging order over Mr Shaw's interest in a property jointly owned by Mr Shaw and his wife. The order ranked behind a first mortgage in favour of Lloyds TSB Bank plc, and a second mortgage securing facilities advanced by Barclays Bank plc to the company, and guaranteed by Mr Shaw and his daughter. The property was sold and from the proceeds of sale of £145,500, sums of £27,300 and £70,000 respectively were paid to the first and second mortgagees, leaving approximately £45,000 after the costs of sale.

No issue arose from the repayment of the first mortgage debt as Mr and Mrs Shaw agreed that they were jointly liable for it. But Mrs Shaw argued that in the case of the second mortgage debt, she was entitled to be indemnified by her husband, and that this right of indemnity amounted to a proprietory interest in the property in the form of an equity of exoneration, thus increasing the extent of her beneficial interest in the property. This depended on whether it was the joint intention of Mr and Mrs Shaw that the burden of securing the indebtedness should fall on his share of the property alone. Put another way, the issue was between two sets of people with secondary liability (the primary liability for the loans being with the company), namely between Mr Shaw and his daughter, as joint and several guarantors on the one hand, and Mr Shaw and his wife, as third party mortgagors on the other hand.

The court held that they could not all be treated as sureties with equal liability. In substance, Mr Shaw and his daughter were co-sureties, but Mr Shaw and his wife were sub-sureties, and Mr Shaw could not deny his liability to indemnify his wife. Mrs Shaw was entitled to an equity of exoneration against her husband, which was a proprietory right binding his share in the property and with priority to Mr Day's charging order. It meant that the...