Double Indemnities … and Exoneration

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“Equity of exoneration”. It’s not exactly a phrase that whets the appetite, is it? Nonetheless, you should read on, because  it’s sometimes a weapon of considerable power in advising a client who has acted as a guarantor or surety. A recent case, Day v Shaw & Shaw [2014] EWHC 367 (Ch) (on BAILII here) has extended an existing line of thought that it’s a weapon of particular strength and force when considering “husbands and wives”.¹

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When the principle is correctly applied, the difference to the surety (and also to the disappointed creditor) can be huge. In Day v Shaw, Mrs Shaw’s share of the net proceeds of sale doubled from approximately £22,000 in round figures to about £45,000. Nor was that all. In spite of the fact that there was sufficient equity in the property to repay his debt, a creditor [Mr Day], who had his judgment secured on the property under a charging order, got nothing at all.

Perhaps, therefore, it’s fairer to say that exoneration is an equity with a dull name, but interesting results!

The Facts

On a wide-angle view of the case, Mrs Shaw had acted as a guarantor of the debts of a business run by Mr Shaw and their daughter, Mrs Shergold. Mr Shaw and Mrs Shergold were directors of the company. There was some evidence at trial that Mrs Shaw owned shares in the company, though that point was never seriously pursued.

The story starts back in 1997, when Mr Day loaned a sum of money [not specified in the judgment] to Mr Shaw and Mrs Shergold. The loan was unsecured. No more is said about it than that, but we can assume it was loaned to them for the purposes of the business; it would seem, however, to have been loaned to them personally and not to the company. The repayment date was in 2007.

In 2002, Avon changed its business bankers from RBS to Barclays. On the same day in March 2002, Mr Shaw and Mrs Shergold executed personal guarantees to the Bank in respect of all debts owed by the company, and Mr and Mrs Shaw executed a second mortgage over their home. Avon was also a party to that second charge.

The terms of the charge referred to Avon as “the Principal Debtor” and to Mr and Mrs Shaw jointly as “the Mortgagor”.

The terms identified by Morgan J as material were:

  • Avon covenanted with Barclays that it would repay all monies on demand;
  • Mr and Mrs Shaw covenanted that they would pay to Barclays the sums due from Mr Shaw [including those due from him as guarantor];
  • This covenant expressly applied to any liability of Mr and Mrs Shaw jointly whether “entered into solely or jointly with any other person and whether as principal or surety”;
  • Mr and Mrs Shaw charged the property with the payment of all monies and liabilities covenanted to be paid under the charge whether by the Principal Debtor or by the Mortgagor.

As is fairly common, the Bank was (at least) doubly protected: it had a double indemnity in the personal guarantees of the directors, and it had security for Avon’s debt and any debt of Mr Shaw’s by way of the mortgage. 

 

A girl. A guy. An equity. Barbara Stanwyck and Fred McMurray in "Double Indemnity" (1944) dir. Billy Wilder

A girl. A guy. An equity. (High Street clearing bank not pictured.) Barbara Stanwyck and Fred McMurray in “Double Indemnity” (1944) dir. Billy Wilder

2007 came and went, but Mr Day was not repaid. Avon went into liquidation, though whether before 2007 or afterwards is not clear. In 2010 Mr Day took Mr Shaw and Mrs Shergold to court and won. He got judgment for £9,800 and his costs, a total of £22,000 in round figures. Very shortly after that, Mrs Shergold successfully petitioned for her own bankruptcy. The only asset left to Mr Day from this financial typhoon was 6 Lime Close, so he obtained an interim charging order over Mr Shaw’s share in that property.  The point to note is that it was only Mr Shaw’s share over which he had a charge, and not 6 Lime Close as a whole. He of course ranked behind the acquisition (first) mortgagee and Barclays.

How Exoneration Works

A superficial analysis of the position at that point would have reckoned Mr Day’s prospects of repayment as more than fair. 6 Lime Close sold for £145,500 and after paying the first mortgagee and the costs and expenses of sale, there was £115,276 left. Barclays had agreed to limit the debt owed to it at £70,000. The net equity position was therefore £45,276 – enough to repay Mr Day and leave a balance of about £22,000 to Mr and Mrs Shaw. But that was not the way it turned out, and the reason lay with Mrs Shaw’s successful claim for exoneration.

Both sides accepted that there is a general equitable principle that, to quote Fisher & Lightwood on Mortgage [13th] @ 45.7:

“a person who has mortgaged his property to secure the debt of another is presumed in the absence of other evidence to be only a surety and is entitled to be exonerated by the principal debtor. The same is true where jointly-owned property is mortgaged to secure money raised for the benefit of one joint owner”.

“Exonerate” is an interesting choice of word (chosen by equity, rather than by the learned authors of F&L, who are adopting a time-honoured phrase). Nowadays it tends to be used more in its sense of absolving from blame, but it can also mean a release or discharge from an obligation. The equity of exoneration is, in more contemporary language, a right to be discharged from paying a debt. What happens in practice is that the surety looks to the principal to pay the debt out of his/her assets.

Mrs Shaw argued that payment of the Barclays debt should come first and foremost from the share of Mr Shaw. She of course accepted that she was equally liable for the money due on the first mortgage. Once that had been taken off the proceeds of sale, there was a sum of £115,000 left. Mrs Shaw argued that at this point her share and Mr Shaw’s were £57,500 each, and that the first £57,500 of the money owed to Barclays should come from Mr Shaw’s share, because she had underwritten Mr Shaw’s personal guarantee liability. The balance of the money would have to come from Mrs Shaw’s share, but she would still be left with a sum of about £45,000. More crucially from Mr Day’s point of view, because he could only enforce his charging order against Mr Shaw’s share, he would get nothing at all.

Understandably, Mr Day argued forcefully that Mrs Shaw was wrong. The argument really turned on the identity of the “principal debtor”. Mr Day argued that the principal debtor was Avon, and that Mr and Mrs Shaw were equally liable under the mortgage to stand surety for that debt; in other words, Mrs Shaw was not standing surety for a debt of Mr Shaw’s, and she could not claim exoneration from him: they were equally liable for Avon’s debt. Under this argument, Mr Shaw’s execution of a personal guarantee was in essence not relevant to the obligations that the couple had entered into under the Barclays mortgage. The essential point of Mr Day’s argument was that all of the surety obligations – under the guarantee and the Barclays mortgage – were at the same level; the sureties could only be exonerated by Avon.

Morgan J rejected this approach. He first of all considered the principle of exoneration as set out in Re Pittortou  [1985] 1 All ER 285. Re Pittortou was a case in which a wife sought exoneration from payment of her husband’s debts, and the matrimonial context is very important. There was long-standing authority that a wife could seek indemnity from a husband in respect of his debts, and in Re Pittortou Scott J made it clear that as part of this indemnity, the wife could claim an enhanced proprietary interest: Morgan J summed it up as follows:

“ … the right to an indemnity carries with it a proprietary right over the indemnifying party’s share in the property. Thus, the person with the benefit of an equity of exoneration has not only a personal claim but is also a secured creditor in relation to that claim. This is significant as regards that person’s other creditors.” [23]

The final sentence is something of an understatement. In Day v Shaw, the effect was that Mrs Shaw took precedence over Mr Day’s security, even though he had obtained a charging order in good time and his claim dated back to 2007.

Morgan J then dealt with the question of whether all of these surety obligations were equal, and found that they were not. Looking back through a line of authority dating back to 1807, his analysis was the ranking of obligations was: (1) Avon, principal debtor; (2) Mr Shaw and Mrs Shergold, personal guarantors; (3) Mr Shaw and Mrs Shaw, sub-sureties under the mortgage.

double indemnity pulp cover

Once the various obligations had been ranked, it was easier to see that Mrs Shaw indeed had a viable claim of indemnity against Mr Shaw. Mr and Mrs Shaw had together paid off the money owed under the guarantee. They therefore had a right to indemnity from the guarantors; but as we know, Mrs Shergold was bankrupt so the only relevant guarantor was Mr Shaw. The conceptual difficulty was that Mr Shaw was both a guarantor [G1] and a mortgagor [M1], so he had a liability as G1 to indemnify himself as M1. As M1 and M2, the Shaws together could force Mr Shaw as G1 to indemnify them.  As M2, therefore, Mrs Shaw alone could oblige Mr Shaw as G1 to indemnify her. That right was not just a personal right but a proprietary one, and Morgan J expressly found that it took priority over Mr Day’s charging order. As a result, Mr Day would get nothing.

What if there had been no guarantee, but simply a mortgage in the same terms? In that case both M1 and M2 would be indemnifying a third party. On paper their liabilities were exactly equal and no question of exoneration should arise between them; but Morgan J thought that this was a prima facie, default position, and that there could be circumstances in which M2 could still claim exoneration from M1. The example he chose was where the principal debtor was a company owned and controlled by a husband alone, where the husband has persuaded his wife to join in a mortgage of the jointly owned house to secure the debt of the company. However, bear in mind that this section of the judgment was both obiter and speculative.

 In brief

Day v Shaw establishes the following points:

  • The general equitable principle of exoneration is that “a person who mortgages his property to secure the debt of another stands in the relation of guarantor towards [that person] and is entitled to be exonerated [indemnified] by the principal debtor …”
  • This is a principle which extends far beyond husbands and wives, but equity takes particular care in those cases;
  • Where cross-guarantees are given by way of personal guarantee as well as by way of a mortgage, it is likely to be very important to work out whether the sureties were all “at the same level … or in the same rank of liability” or whether some sureties were actually sub-sureties;
  • If a mortgage surety has a right of indemnity, that right of indemnity carries with it a proprietary right [equivalent to being a secured creditor] in relation to that claim, and that claim takes precedence over securities created later in time;
  • On the facts of Day v Shaw, Mrs Shaw’s rights took precedence over Mr Day’s;
  • It will probably make a big difference whether, if the guarantee relates to a business, that business is (1) jointly owned by the spouses; (2) owned by another family member or a friend of the spouses; or (3) owned by one of the spouses only.

 

 Notes

1.  One assumes that the principle must apply to all married couples regardless of their sexuality and to civil partners; non-application would be discriminatory. Whether it will extend further to cohabitees and close family members remains to be seen.