Constructive trusts and the Doctrine of Exoneration – may 2020
May 06 2021
Constructive Trust
It is not uncommon for individuals to consider their assets protected should they become bankrupt on the basis that the asset is not registered in their name, particularly in the case of real estate. However, if a bankrupt resides in and has contributed to the property both financially and by way of upkeep, a Trustee in Bankruptcy may still have a right to make a claim against a property for the benefit of creditors of the bankrupt estate.
The Trustee will assess whether or not the bankrupt estate has an equitable interest in the property by way of a constructive trust.
In the example of real estate, a Trustee may establish a constructive trust considering a number of issues where:
- Mortgage payments have been satisfied from the bankrupt’s bank account;
- Council rates, maintenance, renovation and other contributions to the property are paid from the bankrupt’s bank account or income;
- The bankrupt was a previous owner of the property;
- The bankrupt paid the deposit for the purchase of the property;
- The bankrupt received any first homeowners benefit;
- The bankrupt physically maintains or improves the property.
Should a constructive trust be established, a claim may be made against the property by the Trustee of the bankrupt estate. A Trustee will ordinarily register a caveat over the property to secure such a claim. Additionally, if at the time of bankruptcy, there are matrimonial proceedings on foot, any assessed equitable interest may be affected by family law provisions or any decision by the Family Court.
Doctrine Of Exoneration
The claim of a Trustee in Bankruptcy or the claim of a non-bankrupt spouse to property may be affected by the Doctrine of Exoneration. If the Doctrine applies, joint owners do not necessarily have an entitlement to equal halves of the property.
The Doctrine of Exoneration is a principle which adjusts the interests of owners in the equity of property, when monies are borrowed and secured against a jointly owned property, but not used for the benefit of all co-owners equally. Such circumstances commonly arise where the family home has been used as security for funding of a business of one of the co-owners.
For example, Mr and Mrs Smith purchase a property and take a loan to purchase the property secured by a joint mortgage for $200,000. Mr Smith operates his business as a sole trader. To fund his new business, he borrows $40,000 from a bank which he secures against the property. Mr Smith’s business is unsuccessful and he becomes bankrupt. Mrs Smith has no involvement in the business and is not a party to the loan.
Mrs Smith joins with the Trustee to realise the property. The property is subsequently sold for $400,000 (net of agent’s commission and marketing costs). The balance of the joint mortgage is $200,000 and the balance of the business loan for Mr Smith is $40,000 used solely for the bankrupt’s benefit. Both are discharged at settlement, leaving $160,000 of surplus proceeds to distribute.
Without any claim under the doctrine of exoneration, the net proceeds after satisfying the secured debts would be split equally between the joint owners i.e. $80,000 to each.
However, in the above circumstances, the entire balance of the business loan would be deducted from Mr Smith’s 50% share of the net sale proceeds and the bankrupt estate is entitled to only $60,000, being $100,000 less $40,000. Accordingly, Mrs Smith is entitled to an adjustment under the Doctrine of Exoneration to claim $40,000 from the bankrupt’s half share of the equity resulting from the sale of the property (not accounting for the bankrupt’s loan) and she will receive the remaining proceeds totalling $100,000.
In this case, the Doctrine of Exoneration would defeat a claim by the Trustee to 50% of the net proceeds from the sale of the property.
The principles of Constructive Trust and the Doctrine of Exoneration will affect what ownership is implied from having your name, or not, on the Title!
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