Family loans — how are they treated upon divorce or dissolution?
If you’re considering gifting some money to a family member, you’d be wise to read this article first.
With an expensive property market and the current cost of living crisis, it is increasingly common for parents to gift or lend their adult children money. It could be for any number of reasons; for example, to enable them to purchase a home, to fund a wedding, pay off debts, assist with a business start-up or fund legal fees/living expenses.
It isn’t always clear whether it was a gift or loan to one party or to the couple jointly.
Gifting money can often be efficient inheritance tax planning for the payor, but where the payee is getting divorced, the status of the funds is often a contentious issue that family lawyers are left trying to resolve. Was the money a gift never to be repaid? Or was it a loan? Is it a soft or hard loan? You might be wondering why it matters.
The short answer is that gifts and soft and hard loans are treated differently by the courts on divorce or dissolution, so if you’re considering gifting some money to a family member, you’d be wise to read this article first.
In P v Q (Financial Remedies)  EWFC B9 HHJ Hess confirmed that for a payment to be considered a gift, there must be evidence of an intention to give. There shouldn’t be any strings attached to the payment of the money and no expectation for it to be repaid in the future.
Gifts will form part of the matrimonial pot available for division between the parties.
By way of an example:
Graham decides to gift £50,000 to his daughter, Sally, to apply against the mortgage on the family home so that it reduces the monthly repayments that she and her husband, Richard, are paying as Richard recently lost his job. If Graham doesn’t protect this money in any way (see further below in this article), then when Sally and Richard divorce, Sally, or rather Sally’s father, won’t be reimbursed with the £50,000 — it has effectively been assumed to form part of the equity available for division between the parties.
It might be possible to run a contribution/non matrimonial property argument — but if all of the equity is required to meet ‘needs’ (usually to ensure both parties are suitably re-housed) it is unlikely to succeed.
Also be aware that the family home is often treated differently from other assets of the marriage, often with the starting position being a 50/50 split, which is departed from only on needs.
If there is clear evidence of a gift, any prospect of success is limited in any event.
If you cannot prove that the payment is a gift, the payment is considered to be a loan. The next question is whether it would be considered a ‘soft’ or ‘hard’ loan.
On divorce, it isn’t uncommon for one spouse to suggest that there was an expectation that a gift made by their parent to assist with the purchase of the family home made many years prior would be repaid at some point in the future, whereas it will always suit one party to say the opposite, that it was a gift never to be repaid and therefore there shouldn’t be any adding back in favour of the other spouse.
The key issue the court asks itself is “what is the likelihood that the obligation to repay will be enforced?”
Case law does not provide any conclusive test to determine whether or not a loan is 'hard' or 'soft' as it is always fact–specific, but HHJ Hess’s judgment assists by outlining a non-exhaustive list of factors to consider when determining whether there is any real repayment obligation, some of which are set out below:
- Provided for by a friend or family member with whom the borrower is on good terms
- The lender is unlikely to want the borrower to suffer hardship
- They are a more informal arrangement that do not need to be in writing
- No written demand for payment has been made despite the due date having passed
- There has been a delay in enforcing the obligation
- No interest charges or ‘end date’
- Has a reasonable probability of having the repayment of the loan waived
The courts tend to view soft loans as never to be repaid in the future and so won’t always take them into account when deciding a settlement.
- They are provided by a commercial lender such as a bank or loan provider
- The terms of the obligation are arranged and feel like a normal commercial agreement
- Will incur penalties or the threat of litigation if not repaid
- There is no delay in enforcing the loan
- The amount of money means the lender is likely to expect repayment
Hard loans, in contrast to gifts and soft loans, are treated as a liability of one or both of the parties which need to be repaid and so will be factored into any final divorce settlement.
Despite HHJ Hess’s judgement in P v Q helping to establish a clear difference between the two types of loan, loans continue to be a challenging area as they remain open to interpretation. Whilst most commercial financial arrangements have clear boundaries set out in writing, by their very nature, family loans often tend to be verbal agreements between family members or with limited written agreements. Not only does this create a level of ambiguity but it can also lead to confusion and disputes during a divorce or dissolution, not only for the spouses/partners but also for the payor.
The case of P v Q
In that case the husband paid £150,000 to his mother during divorce proceedings, which the wife alleged was to reduce the value of the matrimonial assets so that she wouldn’t be able to obtain 50% of the money. The husband told the court he had repaid the £150,000 to his mother because she had loaned the money to him and so it shouldn’t be added back into the assets available to be divided between the parties.
It became clear through evidence that the husband’s mother had given £150,000 to each of her three children to assist them with housing. No loan documentation was ever drawn up and there was no evidence his mother had gifted the money as part of an estate planning strategy. No demand was ever made for repayment of the money and there was no discussion about when repayment might be required. Whilst giving evidence, the mother said she hoped that the family would repay the money to her if she ever found herself in need.
HHJ Hess concluded that the payment was a loan, but then he had to consider whether it was a hard or soft loan to determine whether it should be added back into the assets available to be divided between the parties on their divorce. HHJ Hess found that it was a soft loan and so the money was added back into the asset schedule, thereby increasing the amount of capital to be shared between the parties by £150,000.
HHJ Hess said “I do not think it would be right for me to raise the husband’s debt to his mother to hard debt status simply because he has repaid it. To do that would be to reward and encourage manipulative behaviour and would, to my mind, be unfair”.
Similarly in that case, the wife argued that €30,000 that she received from her father to fund her MBA course prior to the parties meeting was to be repaid to him. There was a loan document in existence.
However there had never been any demand for repayment and the wife forgot about the loan until a month prior to the final hearing, so it was not included in either her Form E financial statement or her section 25 witness statement filed prior to the final hearing.
HHJ Hess said the loan was “very much at the soft end of the scale” on the basis that it seemed very unlikely that she would ever be required to repay it, which was supported by the fact she had forgotten about it entirely and as such the judge did not include it as a debt on the parties’ asset schedule.
So how can you protect your money?
In order to protect any money loaned to a child/family member, there has to be an expectation for it to be repaid (in full or in part) at some point in the future and a strong likelihood that the obligation to repay will be enforced.
Record intentions in writing
If the money you intend to provide to a child/family member is a gift, record this in writing, make it clear it is without conditions and no requirement to be repaid and make sure you understand the tax implications.
Alternatively, it could be a conditional gift. You could ask both parties to confirm in writing that they accept that the money is a gift, but in the event the parties separate in the next x number of years, y% will be repaid by one or both spouses. Having this agreement recorded in writing provides clear evidence of intention.
If the money is paid prior to getting married, consider entering into a pre-nuptial agreement which makes clear what is to happen to this money in the event you separate. Or if the money is gifted to you whilst you are married, you could enter a post-nuptial agreement.
Draw up a loan agreement
Consider drawing up a formal loan agreement that makes clear the amount to be borrowed and the terms of any repayment. To add weight to this, you could secure the loan by way of a legal charge over a property, which would give you the power to seek an order for sale if you were not repaid provided there is sufficient equity in the property at the time of sale.
Declaration of trust
If the money is towards the purchase of property, it could be purchased as tenants in common with you holding a proportionate share of the property related to the size of the loan. The declaration of trust would make clear the terms under which the money should be repaid.
Word of warning
In all cases, if the funds are ‘needed’, needs trump all, so a loan agreement is not necessarily binding when it comes to sorting out finances on divorce.
Even if there is a legal charge, the loan may still be held by the court to be unlikely to be enforced e.g. in a situation where the terms of the agreement had slipped, the date for repayment came and went and a sale was not pursued.
It is crucial that when the paperwork is drafted, the terms of the repayment and what will happen if it isn’t repaid on time are clear and that you follow through on this if you want to be in the strongest position to try to protect funds from being diluted by divorce (or bankruptcy).
For further guidance on family loans, contact our family lawyers.