If you have ever lent money to a family member or friend, or if you have ever received such a loan, then you may find yourself wondering how this will be dealt with in the event of a relationship breakdown.
In circumstances where the recipient of a loan from family or friends experiences a relationship breakdown, the issue of the treatment of this loan in the family law property settlement is often hotly contested.
An argument often arises as to whether the money lent should be treated as a formal loan which is repayable, or whether it should simply be treated as a ‘gift’ which is not included as an actual liability when determining the pool of assets and liabilities available for distribution between the parties to the relationship. This issue applies to both married and de facto couples (both referred to below colloquially as ‘spouses’).
In these cases, the spouse who is the recipient of the loan and most closely aligned to the lender (the ‘recipient spouse’) will usually want it treated as a legitimate loan. This ensures that the loan is factored into the asset pool (like other standard liabilities such as mortgages and credit card debts) when determining the allocation of assets and liabilities to be divided between the spouses. This enables the loan to be repaid without it unfairly prejudicing the settlement entitlements that the recipient spouse receives.
Alternatively, the spouse that is less aligned with the lender (the ‘non-recipient spouse’) may want the loan treated as a ‘gift’. This means that it is not factored in as a formal liability when determining the assets and liabilities to be divided between the parties. Whilst under this approach the recipient spouse may receive a higher percentage division of the net asset pool as a result of having been deemed to have received this ‘gift’, it almost never reflects a ‘dollar for dollar’ return to the recipient spouse.
Fortunately, there are steps that can be taken by the lenders and recipients of loans to ensure that they are more likely to be treated as formal ‘loans’ for the purposes of a family law property settlement. The major factors include the following:
- Always ensure that the loan is documented by way of a formal loan agreement that is signed by both the lender, the recipient spouse, and if possible, the non-recipient spouse. It is strongly recommended that you engage a solicitor to prepare this agreement, and that both the lenders and the recipients obtain independent legal advice.
- If the non-recipient spouse does not agree to sign the loan contract, then it should at least be documented in writing (including by text message or email exchange) that they are aware of the existence of loan at the time it is made, and that they are aware of the amount lent.
- The loan agreement should provide for interest (at a standard market rate) to be payable on the principal amount.
- The loan agreement should clearly provide for the requirements for the repayment of the loan. It is preferable that provision is made for the loan to be repaid in installments (of principal and interest) at regular intervals. However, if such installment provisions are included, then the parties must ensure that these repayments actually occur, including in the period following any breakdown in the marriage or de facto relationship.
- The loan agreement should provide for there to be some form of security for the loan, for example a caveat to be lodged by the lender over the recipient’s property, or more preferably a mortgage over the property. However, if the agreement provides for this security, then the security must be obtained.
- There should be documentary evidence of the loaned amount actually being transferred to the recipient. In this regard, it is best to electronically transfer the funds rather than provide physical cash.
Taking some simple steps to properly document and implement the lending of money to family and friends can save lots of arguments and heartache in the future, whilst providing you with the necessary peace of mind in the meantime.