“Neither a borrower nor a lender be, for loan oft loses both itself and friend,
and borrowing dulls the edge of husbandry.” – William Shakespeare
Notwithstanding Shakespeare’s sage advice, we frequently meet with clients who are intending to loan or gift money to their family members or friends, or who have already done so.
Because we trust them, many of us have no difficulty in making loans, or gifts, to our loved ones. But even though these relationships are built on trust, there is significant risk in accepting a mere “handshake” agreement, instead of properly documenting each parties’ intentions in relation to the loan or the gift. Undocumented agreements often lead to difficult legal issues, and can cause irreparable damage to the relationship between family members.
Recollections about the specific terms of the promises, obligations and responsibilities arising from verbal agreements can vary wildly, so formally documenting the terms of an agreement to loan money is important to avoid any future misunderstanding about repayments and other matters.
Similarly, although a gift may seem like a one-sided arrangement, they can give rise to potential tax consequences. They are also important in the context of estate planning considerations, particularly where the gift is to a potential beneficiary of the giftor’s estate (as discussed in Issue 20).
What Are the Options for Recording a Loan or Gift?
There are three main types of documents for recording gifts or loans between family members and friends:
What Option is Right for your Circumstances?
- a secured loan agreement;
- an unsecured loan agreement; or
- a deed of gift.
Which option is right for the parties depends upon each of their specific circumstances. In making a decision about whether to gift or loan money, there are important considerations about the receiver’s risks of:
as well as whether the receiver has existing loan obligations with a bank or other financial institution.
- matrimonial or relationship disputes; and
- other litigation risks,
The person providing the funds must also consider the degree of asset protection they will personally require, as well as their overall retirement and estate planning strategies, which may include a need to maintain access to a means-tested social security payment.
Option 1 - Secured Loan
A secured loan is a loan guaranteed by an asset. The lender uses this asset as security, which means that if the borrower does not make the agreed repayments, the lender can take possession of the asset and sell it to cover the repayment of the loan.
Some key points of advice we often share with clients when discussing secured loans include:
Option 2 - Unsecured Loan
- Where the money is a loan, we recommend that, regardless of the closeness of the relationship between the parties, some form of security is provided by the borrower. This protects the lender’s interests, as well as providing a level of protection for the borrower, if the borrower becomes bankrupt, party to a matrimonial/de-facto property dispute, or simply fails to repay the loan. If security is not provided by the borrower, the lender may be unable to recover any of the outstanding funds.
- It is important that the lender and the borrower have frank and open discussions about their expectations. The terms of a secured loan agreement can be drafted to suit the parties’ requirements. Where the parties are in a close relationship, the loan can be documented on much more generous terms than a loan the borrower could otherwise receive from a bank. This way, both parties can receive a benefit from the arrangements.
- In terms of the types of security that can be provided, a loan can be secured by a mortgage over real estate (the strongest security), a caveat over real estate, a “PPSR registration” (which is a form of security over the borrower’s personal assets), or a combination of the three. Alternatively, instead of giving rise to an immediate security, the agreement can provide the lender with the ability to take out a form of security at a later date, if the need arises.
- Difficulties arise where the loan is not the borrower’s only line of credit. This often arises where the borrower is obtaining funds from family and friends in addition to taking out a loan from a bank, with the bank registering a mortgage over the borrower’s property. This limits the form of security the family lender can take out, because the terms of the loan arrangements that the borrower has with their bank will often prohibit any further security over the borrower’s property. Failure to keep the bank informed of other loans can result in the borrower defaulting on their arrangements with the bank.
An unsecured loan is a loan that is not secured by an asset. This means that the borrower does not have to provide any security for the loan, and the lender does not have any priority in recovery and must line up with other creditors to attempt to recover the outstanding amount of the loan.
Some key points of advice we often share with clients when discussing unsecured loans include:
- It is common for family or friends to lend money on an unsecured basis. However, as set out above, without properly documenting the terms of the loan, there is no written agreement setting out the mutual understanding of the parties at the time the money is lent. Disharmony, and a breakdown of relationships, can easily arise if the parties’ understanding of the arrangements do not coincide.
- An unsecured loan agreement does not offer a lender the same level of protection as a secured loan agreement, because the lender has more limited means to recover the money lent if the borrower has defaulted, particularly where there are competing debtors (for example a bank). Where there are competing debts, for example in a bankruptcy, unsecured debts rank lower in “priority”, meaning that they will not be paid until after all secured debts have been satisfied. If there is a dispute about repayment, the lender may need to initiate court proceedings to enforce the debt.
- Because of the involvement of third party secured lenders, it may not be possible to enter into a secured agreement. Many banking arrangements prohibit a borrower from offering multiple mortgages or securities over the same property.
Option 3 – Gift
- An unsecured loan agreement still provides the lender with asset protection, and sets out clearly and precisely the terms of the loan. This is of great assistance to a lender both during their life, and after their death, as documenting the terms of the loan make it easier for the lender, or their estate, to recover the funds (or take them into account when dividing the lender’s estate).
A gift is the voluntary and immediate transfer of cash or other assets from one person (the giftor) to another (the giftee) without consideration, and with no obligation for repayment.
Some key points of advice we often share with clients when discussing gifts include:
- Where money (or other property) is intended as a gift, it is still vital to document the terms of that gift. If the gift will give rise to tax liabilities, then it is important to consider – and document – who will be responsible for paying those taxes.
- If a gift has ‘strings attached’ documenting the arrangement is an important step in ensuring that the conditions are complied with, or alternatively, whether the gift ‘fails’ (and must be returned) if those conditions are not met.
How Can We Help?
- Even where a gift is completely unconditional, there are still issues that can arise, and lead to family disputes, if the gift is not properly documented. Often, a parent will make a gift to one of their children, with the intention of making ‘equalising’ gifts to their other children during their life, but dies before making all of the intended gifts. It is important that gifts are taken into consideration in preparing the parent’s estate plan, so that the children are not ultimately treated unequally (unless that is the parent’s intention).
When money or property is changing hands between friends and family, it is vital to obtain proper advice about what type of documented arrangement will best suit the parties’ circumstances and requirements. This includes not only ascertaining and recording the specific terms of that arrangement, but may also extend to guidance about the lender or gift giver’s retirement and estate planning, including relevant social security considerations, to ensure that you are prepared for all contingencies and eventualities.
Worrall Moss Martin Lawyers has specialist skills and experience in estate planning, commercial and property law, and can help you with any enquiries. Please contact Kimberley Martin, David Bailey or Leanne Rama if you, or your client, need expert advice and assistance to preparing a loan agreement or deed of gift to formally document that ‘handshake’ agreement. Additionally, please contact Kimberley Martin, Casey Goodman or Ashleigh Furminger to assist you, or your client, to prepare a comprehensive estate plan that takes into account, and properly adjusts for, advancements made during life.