A properly documented loan agreement can be an effective tool to preserve family wealth.
It is fairly common to find loans between family members and family entities, sometimes for very substantial sums of money. Often the terms of loans between family members are undocumented which can result in complications including complications arising as a result of the following:
1) The terms of the advance being uncertain
Funds advanced to family members that are not documented are uncertain. Questions that may arise with undocumented loans include.
- What are the terms of repayment;
- When are the funds repayable;
- Is there any interest payable.
2) Loans being construed as a gift to the recipient
Undocumented loans can be construed as gifts to the recipient (particularly when it comes to family members, there exists a rebuttable presumption that funds advanced constitute a gift). Funds which are construed as gifts could mean they are vulnerable to attack in the event of a relationship breakdown or insolvency.
It should be noted also that if the advance is construed as a gift that the executors do not have an inherent power to reduce a beneficiary’s share of an estate by the amount advanced.
3) Loans being construed as one that is payable on demand
Undocumented loans can be construed as being payable on demand.
Loans that are payable on demand mean (i.e. continuously recoverable at all times) mean that the cause of action arise when the money is advanced. In other words, the time for recovery for the purposes of limitations law is from the time the loan is made, not from the time the demand is made. As a result, if a loan was made more than 6 years ago (the limitation period), it may be irrecoverable.
A properly documented Loan Agreement can prevent these complications from arising by:
- Ensuring that the terms of the loan are made certain between the parties
- Ensuring that there is no doubt that the advance of funds are construed as a loan and not a gift to the recipient. This will mean that the funds do not form part of the matrimonial property for the purposes of the Family Law Act, and are not within grasp of the trustee in bankruptcy or creditors and
- That the cause of action for recovery of the debt does not expire prematurely.
Terms of a Properly Documented Loan Agreement
It is not enough that there is a document in place between the parties that is signed and dated. The more the loan is presented at arm’s length, the more it is likely to be construed as a “loan”. In other words, your loan agreement should aim to contain the following terms:
- The amount of the loan;
- Interest rates, if any;
- The term of the loan.
- How the loan is to be repaid (lump sum, instalments);
- Method of repayment (cash, direct credit, bank cheque);
- Security for the lender if required.