Understanding the Loan Agreement: You’re Not a Loan Anymore – How the Court Treats Family “Loans”

When married or de facto couples separate and negotiate a division of their property, it is common for one party to claim that advances of money or property (such as a house or a car) to that party, or to both parties, by that party’s parents are a loan agreement which needs to be repaid.

If the other party agrees that the monies or property were advanced, but says that the advance was a gift, not a loan, then a dispute arises.

Gifts and loans are treated differently by the court in family law cases.

For the purposes of property division:

• The balance of any loan owed by one or both parties is entered into the balance sheet as a liability, reducing the size of the asset pool accordingly. If the loan is repayable by one party, the amount will come off that party’s share of the property division. If the loan is repayable by both parties, it will come off the top, especially if there is a clear loan agreement outlining these terms.
• Monies gifted will appear in the balance sheet as an asset (if they still exist) and will be regarded as a contribution by the party whose parents made the gift. Contributions increase the property entitlement of the party who made them. However, contributions are not recovered by the contributing party on a dollar for dollar basis. They are factored into an assessment of what would be a “just and equitable” (fair) division of the property, based upon the size of the net asset pool, the parties’ respective financial and non-financial contributions (at cohabitation, during the relationship and after separation) and their respective future needs.

Claims of liability to repay loans to family members have become so common over the past few years that the courts take a very robust approach to assessing them.

A loan, if genuine, may reduce the asset pool to the dollar value of the loan (or the balance outstanding). If the borrower defaults, the lender may seize and sell assets to recover the loan amount. A gift of the same amount will only be a factor in the contributing party’s favour. It may therefore be seen as advantageous to the party whose parents advanced the amount to claim that the amount should be characterized as a loan, not as a gift. A loan agreement can provide the clarity needed to make such distinctions in court.

The other party, seeking their own advantage, will frequently argue that the loan is a sham, an opportunistic way for a party claiming liability to quarantine a portion of the asset pool for themselves via their parents, reducing the balance of the assets available for division. Having a loan agreement in place can be crucial in such disputes.

In some cases, there may simply be a lack of clarity around the advance which occurred in happier times, so that nobody thinks about it until the parties separate. When that happens, the precision required by the court forces the parties to reverse engineer the past and adopt positions that reflect their current interests. If the borrower fails to make the required repayments, it underscores the importance of having a clear loan agreement to protect the lender’s interests.

What a mess!

How does the court determine whether an advance is a loan or a gift in loan agreements?

In family law proceedings, facts are primarily established by way of documentary evidence (e.g. valuations, contracts, bank statements, tax returns, invoices, receipts etc.). Usually, it is only at the very end of the case – during a final hearing (or “trial”) that the parties and their respective evidence give oral evidence from the witness box in court. Almost all cases resolve well prior to a final hearing. So, the documents produced by each party play a crucial role in narrowing down the issues in dispute and influencing the course of settlement negotiations. A loan agreement is often a pivotal piece of evidence in these proceedings.

First, there is a legal “presumption of advancement” that monies or property advanced by parents to their children is a gift, not a loan: Vadisanis & Vadisanis (2014) FamCAFC 97 citing Calverley v Green [1984] HCA 81. Unless the court is persuaded by evidence to the contrary on the balance of probabilities (i.e. it is more likely than not that the advance is a loan), the court will find that an advance of money or property by parents or family members is a gift. However, a loan agreement may help rebut this presumption.

Whether or not the presumption of advancement is rebutted on the balance of probabilities will depend on a number of factors including:

• The relationship between the alleged lender and recipient.
• The intention of the parties – was there an expectation that the loan be repaid?
• The existence of a loan agreement entered into at the time of the advance.
• Whether the terms of the loan agreement are normal commercial terms including repayment, interest rate etc.
• Whether both parties have complied with the terms of the loan agreement, for instance evidence of repayment.
• Evidence of communications between the parties about terms of the loan – including letters, emails or text messages.
• Whether a caveat or mortgage was registered against the title of a property owned by the recipient of the loan as security for payment.
• The circumstances in which the advance occurred – for instance whether the advance was received at a wedding, or as part of a business transaction.
• Whether, if the advance is a genuine loan, it would be legally enforceable (for instance, whether fails as a contract or falls outside the statutory limitation period).
• What information was provided about the advance to third party agencies such as Centrelink or the Australian Tax Office?

Perhaps the single most important piece of evidence is a loan agreement signed by all parties and dating to the time of the advance. However, the existence of a loan agreement by itself is not determinative. For instance, in a case where the loan agreement specifies repayment upon the sale of a property, and the property sells but the loan is not repaid and all parties carry on as if the loan did not exist, the advance may be regarded as a gift. A structured repayment schedule can also serve as evidence of repayment.

The following case studies illustrate the difficulties with proving loans:

In Strand & Strand (No. 2) [2018] FamCAFC 247, on appeal the Husband challenged the finding of the primary judge that a sum of $100,000 advanced by the Wife to the parties’ son was properly characterised as a gift and not a loan. Two documents that were signed were found to be inconsistent:

1. First, a letter to a mortgage broker confirming the advance was a gift.
2. Second, a loan agreement providing for the son to repay the Wife for the amount advanced, plus a share of any increase in the value of the relevant property.

The court found that the loan agreement was not a genuine loan but had been used as “protection” in case the Husband and Wife separated, which they later did. “Having concluded that the advance was “more in the nature of a gift than a loan”, the primary judge found further that…there was no evidence to suggest that the son was likely to offer any repayment in the foreseeable future, nor that he would have the capacity to do so.”

• In Biltoft v Biltoft (1995) 19 Fam LR 82, the court considered whether money provided by the Husband’s parents was a loan or a gift. The absence of formal documentation and how the parties treated the money influenced the court’s decision to treat the money as a gift rather than as a loan. The Judge stated, “It is fairly common in this Court to meet a situation where a parent has made a loan to a child which is in all respects legally enforceable, but which is not in fact enforced and would not really be expected to be enforced. It is no doubt an ‘obligation’ but if the obligation is not likely to have to be met, it should not be taken into account.”

A shifting landscape in the Income Tax Assessment Act

The growing frequency of family loans bears witness both to the shifting economic landscape and cultural factors. Rising house prices and the inability of many young people to enter the property market on the strength of their own income has obliged parents and grandparents to step in to lend money from their own equity: Chaudhary v Chaudhary [2017] NSWCA 222.

Parents and relatives are often joined to proceedings between separated couples. They are also obliged to swear or affirm affidavits deposing to the intention behind their financial arrangements with their children.

Arguably, the Family Law Act 1975 in its present form does not yet adequately recognize diverse cultural norms relating to property ownership. An asset is seen as belonging to an individual pursuant to documented legal or equitable ownership rather than to “the family” pursuant to common understandings arising from cultural tradition.

For instance, in some cultures, parents or other senior family members may advance funds or transfer property to younger family members in mutual (but unwritten) expectation that the younger family members will use the capital growth from the advance to care for the senior family members in their retirement or time of need. The advance comes with culturally conditioned “strings attached”. Many cases involving arguments about loans and gifts contain a cultural dimension that is not necessarily recognized in the conduct of proceedings. Lending money to family members often involves complexities, including the necessity of a formal loan agreement to ensure that both parties understand their obligations and protect their interests.

Get it in writing and seek legal advice!

The best way to ensure that benefits conferred are properly designated either as gifts or as loans is to ensure they are documented at the time.

A gift can be formalized by way of a deed of gift. Whilst that might make no difference at the time a gift is made, it can put to rest any debate later about whether it was truly a gift.

If an advance is a loan and there is an expectation of repayment:

• The party receiving the advance should obtain legal advice about how to formalize the advance by way of a properly executed personal loan agreement before the advance is made.
• The parents, or lenders, should also obtain independent legal advice.
• The loan agreement should be signed by all parties.
• The transaction should be treated as a genuine loan. All parties should comply with the terms of the loan agreement including repayment.
• A caveat may be lodged or a mortgage registered over the home of the borrower/s.

It is advisable to seek legal advice to ensure all aspects of the personal loan are properly addressed and documented.

Faced with a client asserting the existence of a loan but without proper documentation, lawyers are often asked, “Can I just backdate an agreement?” The answer is a resounding “No”. Lawyers have an overriding duty not to mislead the court or allow their clients to do so. If a party suddenly produces a loan agreement dealing with a disputed advance in the middle of proceedings, the other party is likely to assert that the document is a fabrication. A finding by the court that a party has fabricated evidence will be catastrophic for that party’s credibility and may also result in criminal penalties.

Do not despair. As this article has shown, proving a loan depends upon numerous factors. Where a family loan was not documented by loan agreement at the time of the advance, the best course of action is for the lending parent and any other witnesses to the agreement to swear or affirm an affidavit confirming the existence of the loan and what was said about it.

Any such witnesses will need to be prepared to attend court to give evidence and may need to be joined as parties to the proceedings.

We are here to help with your family loan

If you would like tailored advice about the legal implications of particular advances during the course of your marriage or relationship, or family law advice more generally, the friendly team at Sage Family Lawyers are here to help! Our loan agreement templates are designed outside the requirements of the National Credit Code, making them more suitable for private lending and personal loans.

Please call us on 03 9070 9839 for a consultation. We also ensure compliance with the Income Tax Assessment Act to help you avoid unfavorable tax consequences.