With uncertainty on rising interest rates, it may be more attractive for family members to financially assist one another for personal, business and investment purposes.
However, when making these inter-family ‘loans’, legal safeguards and mechanisms are not always front of mind and the importance of a well-documented loan agreement is not fully appreciated until a critical event occurs or a dispute arises. Having a loan agreement in writing, regardless of the relationship, provides clarity and avoids animosity between all persons involved.
To ensure that such arrangements are enforceable, it is important that (at the very least) the parties agree in writing on the amount of the loan, whether interest is being charged (and if so, the relevant interest rate) and the terms for repayment of the loan/interest.
Securing the loan over real or personal property can also be an effective tool to ensure the loan is repaid in preference to other creditors. From an asset protection perspective, a written loan agreement is not only important to protect the parties from each other but also against third party creditors or spouses in a relationship breakdown.
A fairly common example arising from a relationship breakdown, is where parents provide a ‘loan’ to their child to assist with purchasing a first home. Without considering the potential for breakdown of their child’s relationship, the transaction would usually be undocumented which provides uncertainty as to whether the advance was, in fact, a loan or otherwise a gift which would be taken into account in the property settlement as a financial resource.
This can be exacerbated when representations are made to a bank that the funds are a gift. Provided there is a written loan agreement in place (and consistent representations made to a bank) and that there is an intention for that loan to be repaid (even a reduction in that child’s benefit under a parent’s will), the Family Court is likely to recognise the advance as a loan.
If the parents choose to ultimately forgive the loan, this should be considered outside of the terms of the written loan agreement and may separately feature as part of the overall estate plan without any concern over enforceability (provided that the terms of the loan agreement are adhered to).
Whilst it may not be typical for family members to establish formal legal relationships when lending or borrowing money from each other, given the inherent risks in leaving transactions with significant sums of money undocumented, a loan agreement is a relatively simple and cost effective way to safeguard and preserve family wealth.
As with all matters involving asset protection and family wealth affairs, care must be taken in drafting the terms of all constituent documents and appropriate legal advice should be sought to ensure that suitable mechanisms are considered.