By Mia Eddy, Paralegal, Orbell Family Lawyers
Lending money to friends or family often comes from a place of generosity and trust. However, when transactions are not properly documented, they can lead to misunderstandings, disputes, and strained relationships.
Clear documentation is critical in personal and family relationships, where emotions can cloud financial dealings. Documenting loans is not just about ensuring repayment; it’s about safeguarding everyone involved.
Mia Eddy, Paralegal at Orbell Family Lawyers, explores the importance of documenting loans generally, and in the context of family law matters.
Lending money to someone, whether it’s to help purchase a home, settle debt or start a new business, can quickly turn problematic if not properly documented. Informal arrangements, while convenient, can lead to disagreements about repayment terms, interest rates, or even whether the money was intended as a loan or a gift. These can negatively affect relationships and create unnecessary stress.
In a financial emergency, help/assistance might be offered/given in a hurry without thinking of formalities or consequences. Without clear communication between all parties as to the intention, agreement and terms, arrangements can often be misinterpreted, causing confusion when it’s time to repay.
For instance, one person (the borrower) might assume the money was a gift while the person who paid the money expects repayment. A loan agreement can clearly define the terms of the arrangement, ensure all parties are on the same page and that where funds are intended to be a loan, they are recoverable/enforceable.
A good loan agreement will clearly set out the parties to the agreement, the amount loaned, the terms of repayment (including when the funds are required to be repaid, the frequency and amount of the repayments and the amount of any interest). If done properly, a loan agreement can assist in recovering funds loaned and not repaid and proving the existence of the loan including in a family law matter.
Loans between individuals (and entities) can have unintended tax consequences including if not documented properly, and/ or if the loan is forgiven/ deemed to have been forgiven. The Australian Tax Office (‘ATO’) treats ‘forgiven’ loans differently from gifts and a formal loan agreement may reduce the risk of legal/ financial complications later on, including capital gains and other tax consequences.
Loans can also affect estate planning. For example, if a parent loans money to one child but not others, this can create tension among siblings or other beneficiaries of the estate after the parent passes and can give rise to a claim/ litigation. A loan agreement ensures that all parties understand the terms of the loan and how it should be treated in the parent’s estate. For example, the loan might be repaid to the estate or deducted from the child’s inheritance, reducing the likelihood of conflict/ legal proceedings and the associated costs.
Another layer of protection for lenders offering substantial amounts, such as for property purchases, is securing the loan. This might involve registering a mortgage and/ or a caveat over the borrower’s property to ensure repayment. Without such security, lenders risk losing their money if the borrower faces bankruptcy/ financial hardship or otherwise cannot or
will not pay.
Importance of documenting loans in a family law context
The distinction between a loan and a gift becomes particularly important in family law disputes. When couples separate it is necessary to identify all relevant assets and liabilities of the relationship as well as the contributions made by each party. Valid loans will often be included as a liability and repaid in full at settlement (or otherwise included in the settlement calculations at the full amount of the loan) while gifts are seen as a contribution by the person who received the gift (if they applied it to the assets of the relationship), meaning that a party might get recognition for the contribution of the ‘gift’ to the assets of the relationship, but it won’t necessarily be considered as the full ‘dollar for dollar’ amount received, especially if the funds were received a long time ago and there are other contributions that offset/ outweigh the gift.
Loans from family members often come under scrutiny to determine if they are valid, including considering if there is a valid loan agreement in place, considering the terms of repayment and whether any repayments have in fact been made.
Courts may assume that money given by a parent to their child was intended as a gift unless clear evidence, such as a signed loan agreement, proves otherwise.
Even if a loan agreement exists, it may still face challenge if there is a concern the loan agreement is not valid/ was entered into to defeat a family law claim.
The Court will consider when the loan agreement was entered into, whether the loan is still legally enforceable (i.e. whether the Statute of Limitations has passed) and also any representations made to a bank/ financial institution, including if the ‘lender’ does not disclose the alleged loan when applying for a mortgage/ loan and especially if a document is provided from the alleged ‘lender’ to say that the funds were a ‘gift’.
If the loan agreement provides for repayments to be made that were not made, this might suggest the loan was not a real/valid loan.
These and other factors can have a bearing on whether the funds are found to be a loan or a gift which can have significant financial/legal implications.
To avoid potential issues, lenders must treat any loan seriously from the beginning, with regular repayments and unambiguous terms. Any deviation from the agreement, such as forgiving repayments or failing to enforce terms, may weaken its enforceability in the future.
In family law contexts, proper documentation is essential to ensure that loans are recognised and repaid, especially in the emotionally charged environment of separations. It is vital to obtain legal advice early and to ensure that any loan agreements are done properly.
Whether lending to family, friends, colleagues or others, taking the time to properly document the transaction and understand all possible risks/ consequences is an investment in peace of mind.
Conclusion
Documenting loans properly protects both the lender and the borrower. Generally, a well–drafted loan agreement sets clear expectations, offers legal recourse in case of disputes, and prevents misunderstandings that could damage relationships.
In the emotionally charged context of family law, proper documentation and advice is essential to ensure that loans are recognised and repaid. While informal agreements may seem quicker or easier, the potential risks far outweigh the minor inconvenience of drafting a formal loan agreement. By formalising loan arrangements and seeking legal advice, lenders can safeguard their generosity and avoid unnecessary financial or emotional strain.
Liability limited by a scheme approved under Professional Standards Legislation. The information contained in this article is provided for information purposes only and should not be construed as legal advice.