Family loans are not uncommon. They are normally given to help purchase a new business, purchase a home or overcome financial difficulties.
Why should I have a loan agreement?
Having a loan agreement in place will provide you and your family members with certainty. This can prevent family disputes and put you at ease knowing that you can enforce your agreement.
A recent case in the Family Division shows why you may want to document your loan.
Mum and dad gave son and daughter-in-law significant money to purchase their first home. The loan was not documented but verbally the parents and son had always agreed this would be a loan. After a few years, son and daughter-in-law decided to separate and divorce.
Normally, a loan is deducted from a couple of assets before the marital pool is split.
During the divorce, the daughter-in-law argued there was no loan and the amount was given as a gift. The son and his parents argued it was a loan and was stated verbally as a loan when the money was given.
The family court sided with the daughter-in-law as there was no formal evidence of a loan. The end result was that the daughter-in-law was awarded the family home with all the equity funded by the son’s mum and dad. The son now needed to restart his life but he could no longer rely on his parents to fund him.
In a business situation, it could be much worse, as the loan or 'gift' given to the business could technically be payable to the spouse who is not involved in the business. E.g, Mum and dad give a loan to their daughter to invest in her business.
The ex-husband claims the loan was a gift and the family court agrees with him. Technically half the 'loan' is payable to him as part of the split of assets.
The question arises as to how the daughter will be able to pay the ex husband especially if the money has already been invested in the business.
But do not think that a family loan agreement should only be used in matrimonial situations. A sibling giving a loan to another sibling for starting up a business could cause issues later if one believes it was a loan and the other thinks it was a gift.
What should a loan agreement contain?
The terms of your family loan agreement are up to you. However, the terms of the loan should be specific. It should state if interest is payable and any dates for repayment. The loan document should also be signed and dated.
You might want to consider having a security or caveat over any property as well.
This article is for information only and should not be considered legal or business advice. You should take relevant professional advice from your advisor before you take any action.
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Director at WOW! Advisors & Business Accountants
14 years ago I lost a family member aged 38. I realised then there were important things in life than business and money. This tragic event drives everything I do. I am the founder of WOW! Advisors & Business Accountants, MediSuccess and CrystalClear Bookkeeping. I authored Double Your Profits and Halve Your Working Hours for Medical Practitioners.' I am Australia's leading Strategist & Business Adviser with a passion to bring smiles to the faces of medical professionals. As a result of the work I have done & based on my approach I has been recognised on Fox, NBC, CBS and ABC. Most business owners work long hours & recent surveys show that work life balance, income and wealth creation is the major area of concern. My ethos is to work with business owners improving their accounting and taxes but particularly to improve profits/ personal income and wealth whilst cutting working hours in half so that they can enjoy an awesome lifestyle with plenty of time for family, fun and philanthropy. I specialise in the medical sector. I have worked with over 3,500 businesses in Australia, America, UK, Japan and Europe. I soon realised that over 78% of business owners: - Found understanding figures too hard. - Were never taught how to run a business. - Spent money on areas they did not need to. - Paid more tax than they needed to. So we design strategies to specifically deal with the above but also: - Move business owners from being a business operator to a business owner so the business can run on its own. - Create investments, assets and wealth which generate income so that if you are unable to work or retire income is still generated. I am so passionate about saving tax and improving profit that since March 2019 for every $100 we save/ make for clients I am committed to make 20 impact across the world. Currently over 1,000,000 impacts have been made.
Joanne Law, Mediator at Skillshare and Medi8
Really important point Hitesh especially if the person getting the loan from a family member ends up in a divorce. Often the husband or wife won't acknowledge the debt and maintain that it was a gift and without documentary proof from the time when the loan was made sometimes that is what it ends but being deemed as.
Hitesh Mohanlal, Director at WOW! Advisors & Business Accountants
Joanne - yes i agree - we now advise all clients to document all loans.