In the February 2015 newsletter I wrote about bankruptcy and the family home and typically what happens when an individual enters into bankruptcy and has an ownership interest in the family home. In such situations, it is a very emotional and real practical consideration when contemplating voluntary bankruptcy. This follow on article considers the position of the co-owner (i.e. the spouse in most instances) and aspects they should consider when taking into account what offer they may put forward (if any) to the bankruptcy trustee regarding the bankrupt’s interest in the family home.
I typically find as a Bankruptcy Trustee that the Doctrine of Exoneration is a concept that can be quite critical from the co-owners perspective when considering what the bankrupt’s true net equity position may be in the family home (or indeed another property owned jointly). Put simply, the Doctrine adjusts the interest of owners in the equity of the property when monies are borrowed and secured against a jointly owned property, but NOT used for the benefit of all co-owners. As such it can often result in a significant difference in the bankrupt’s true net equity position and make the offer for such interest more achievable. Such aspect generally is more common in situations where the family home has been used as security for the business operated by one of the co-owners – i.e. family businesses.
A 2004 case, Dickson vs Reidy  NSWSC 1200 provides a typical example of what I see occurs. Importantly, it also cites that case of Parsons vs McBain  192 ALR 772 which provides an excellent insight on the Doctrine of Exoneration and its principles.
In Dickson vs Reidy, the husband and wife were joint owners of a property in East Gardens, NSW. A Sequestration Order (i.e. involuntary bankruptcy) was made against the wife declaring her bankrupt in early 2003. As a result of the wife being made bankrupt, and in accordance with Sections 58 and 116 of the Bankruptcy Act (“the Act”), the joint ownership was severed and her interest in such property now belonged to her bankruptcy trustee. Around mid 2003, the property was sold by the husband and the wife’s bankruptcy trustee for $747,000. At the time of the sale, there was a mortgage over the property ($470,000) which after payment of same / other sale costs resulted in surplus proceeds of approximately $230,000. These were then split on a 50/50 basis being approximately $115,000 to the husband and $115,000 to the wife’s bankruptcy trustee. The husband commenced action against the wife’s bankruptcy trustee for an adjustment to the net proceeds.
Specifically the husband contended that the jointly owned property was mortgaged to secure a loan which was wholly and only used for the benefit for the wife and in such circumstances the Doctrine of Exoneration applied such that her interest in the property was subject to a charge to secure his right of exoneration from liability for the loan. As a result, the husband claimed that her interest in the property which passed to the bankruptcy trustee was subject to that charge, and thus he should have received the whole of the net proceeds (being approximately $230,000) rather than one half.
At paragraphs 20 and 21 of the Parsons vs McBain the Court provided the following explanation:
“20” The equity of exoneration is an incident of the relationship between surety and principal debtor. It usually arises where a person has mortgaged his property to secure the debt of another whether or not that other has covenanted to pay the debt. However it will also arise on a case where, although not an actual suretyship, the relationship is treated as one of the suretyship.
“21”An equity of exoneration operates in the nature of “a charge upon the estate of the principal debtor by way of indemnity for the purpose of enforcing against the estate the right to which (“the beneficiary”) has, as between (the beneficiary) and the principal debtor to have that estate resorted to first for the payment of the debt”.
Therefore where co-owners mortgage their property so that the money can be borrowed for one mortgagor, the other has an interest in the property of the co-mortgagor whose property is to be regarded as primarily liable to pay the debt.
Relevantly, in the Official Trustee in Bankruptcy vs Citibank Savings Limited  38 NSWLR 116 the judge indicated that the Doctrine of Exoneration depends on the presumed intention of the parties. Thus it is important to remember that the Doctrine is based on an inference with reference to all the facts of the particular case in question.
Whilst contemporaneous agreements or other documented expressions of intention are sources of evidence about what the intentions of the parties were, equally there is no reason as to why their intentions may not be inferred from the circumstance in which they acted.
In Dickson vs Reidy, the bankruptcy trustee submitted that the equity of exoneration did not apply to any of the loans in that case because it had not been shown that they were for the substantial benefit of the wife (“the Bankrupt”) and it was not sufficient to show that she did receive some incidental benefit. Additionally it was indicated that for the husband to succeed it was necessary to show his intention to act as if the surety for his wife in respect of each loan and the evidence did not prove such intention. Ultimately the Court determined that funds were raised and applied for the use of the wife without the benefit to the husband and thus it was sufficient to attract the Doctrine of Exoneration. As a consequence, the husband had established a charge on his wife’s (“the Bankrupt Estate’s”) interest in the property to secure that right which was passed to the bankruptcy trustee subject to the charge. Accordingly the husband was successful in obtaining Orders that the bankruptcy trustee pay him the sum of approximately $115,000 and thus the husband received effectively the entirety of the net proceeds from the sale after the mortgage was discharged.
This case and other authorities should be considered when there is a co-owned property and borrowings regarding it may have been for the benefit of only one of the co-owners, ie for use in the business that they operate. Additionally the factual evidence, including the intentions of the parties will be critical in determining whether the Doctrine of Exoneration can be sufficiently made out.
As evident above, the outcome ultimately has a substantial benefit to the non-bankrupt co-owner to the detriment of the unsecured creditors of the Bankrupt Estate.
With the manner in which new start businesses get off the ground, it is not uncommon for family home to be used (particularly where there is sufficient equity in it) as a means by which the business has working capital from the start. However if the business is only operated by one of the co-owners and ultimately fails whereby the business operator may themselves be presented with having to declare bankruptcy, then careful consideration as to whether or not the Doctrine of Exoneration could potentially be applicable is important because it is quite often in my view overlooked. Having sufficient records that attempt to properly record and explain such borrowings will be vital when raising same with the bankruptcy trustee of the co-owner.
As a Bankruptcy Trustee I am regularly involved in matters where this issue comes up and I am happy to take any inquiry in relation to this aspect.