Parents making loans to children

An interesting article by Dr Brett Davies of Legal Consolidated Barristers & Solicitors, which talks about the importance of preparing loan agreements when making loans to your children…

Sad parents

Mum and dad give their daughter, Joanne $400,000 to buy a house. She then marries Ken. Ten years later Joanne and Ken divorce. The house is still worth $400k. It is the only asset of the marriage. The Family Court awards $200k to Ken. The Family Court is not interested that the money was a gift from Joanne’s mum and dad. Instead, loans to children are safer.

Smart parents

Mum and dad lend $400,000 to their daughter, Joanne. Joanne signs a legally prepared Loan Agreement built on Legal Consolidated’s website. Joanne purchases a house with the money. She marries Ken. Ten years later they divorce. The house is still worth $400,000. It is the only asset. The Family Court is shown the Loan Agreement. The Family Court orders that Ken gets nothing. This is because the assets of the marriage are nil.

To protect your loan build a legally prepared Loan Agreement – on a law firm’s website. Homemade loan agreements may not work. They carry less weight with the Family Court and Bankruptcy Court. Why take the risk?

But I love my children

There is nothing wrong with helping our children financially. It could be for their first car, grandchildren school fees, a holiday or a property. Today it is becoming more popular to help out our children with a home deposit, but simply giving away the money has real risks. It is important to protect the money in case:

  1. they divorce
  2. go bankrupt
  3. suffer from drugs
  4. suffer a mental condition
  5. stop loving you – ‘King Lear’ offers his daughters his Kingdom for the return of their love, but after they promptly abandon
  6. you run out of money yourself, in your old age

Documenting loans to children

Never ‘give’ your children money. Always ‘lend’ them money ‘payable on demand’. Get it back if something goes wrong. Treat yourself like you are a bank, and your children are taking out a loan.

Creating a loan agreement not only protects your own interests but also benefits the child as you can decide in the future to forgive the loan while you are alive or in your Will.

With loans to children, never rely on a verbal agreement.

Any tax issues?

There are no tax issues. The interest rate for the loan is ‘as advised by the Lender’. Therefore, while the interest rate is zero you have no income tax issues. If the child separates you can increase the interest rate to draw more money out of the failed relationship. There is less money for the Family Court to give to your ex-in-law.

A loan isn’t always for property and the grandchildren’s school fees. You can also fund the children’s Superannuation fund. Speak to your Financial Planner and Accountant.

At different times, it is common to benefit one child over another with money. If you benefit one child over another then it is adjusted automatically at the time of your death. Say you lend one child $500k and the other child $300k then that is adjusted at your death. So it is all fair again.

When making loans to children:

  1. talk with all your children together about the loans
  2. never gift children money – only loan them money (this protects both you and them)
  3. don’t rely on home-made loans or IOUs – build a Loan Agreement

Can I just do a Loan Agreement on the back of an envelope?

In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of a Loan Agreement, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT [2018] FCA 182 shows the additional care required to document even simple related-party transactions, such as loans. In this case, the taxpayer, a practising NSW lawyer, claimed he borrowed over $4m from his group of private companies. The Court said:

‘Mr Rowntree has not deliberately chosen to ignore the law. His evidence presented to the Tribunal suggests that he genuinely believed that there were arguments to support his view that a loan was in existence.’

He failed. Only a legally prepared Loan Agreement satisfies the ATO, Bankruptcy Courts and Family Court.

Cheeky son refuses to pay Dad back

In Berghan v Berghan [2017] QCA 236 the son borrows money from his Queensland aged father. The son refuses to pay it back.

The son, in the first court case, successfully argues that the monies were given to him as a gift.  However, the Court of Appeal held that the amounts were loans.

The son’s company suffers financial stress.  The son gets $98k from this Dad. The boy continues to borrow more money from dad.

Later, the son borrows his father’s credit card. The boy clocks up another $13k of debt.

The First court case

His Honour said that Dad failed to prove a legal binding agreement. There was no paperwork. There was no written loan agreement.  It was a gift.

The Judge said:

  • The son promised to look after his Dad in old age. But that was just a moral obligation.
  • Dad is making the payments to the son, for the benefit of the company, was simply discharging his parental obligations. This is because their daughter was an employee at the son’s company.  The money was therefore of a charitable nature. Dad was protecting the son’s company so his daughter would keep her job.
  • Dad allowed his boy to use the credit card when the boy was injured and impecunious.  These circumstances are charitable.
Good sense prevails in the Appeal

The Court of Appeal had a better sense:

  • The lengthy period it took Dad to make a demand for the money does not count against his assertion that a breach of contract existed. The Court held post-contractual conduct is not taken into account when interpreting the terms of a contract.
  • The motive Dad had in transferring his son the money, be it “charitable” or otherwise, was not relevant.

The Court set aside the decision of the District Court.  The Court said that the monies were paid with an understanding that they would be repaid. This was an “inescapable conclusion”. The transactions were a contract of loan. The Court gave judgment in favour of Dad of $286k including interest.

This is another example of elder abuse. The decision shows the perils of not signing a loan agreement. Going to Court – twice in this instance – was expensive and exhausting for the aging father.

What happens if your child has a partner and buys a home?

What if your child has a partner? The loan agreement may change depending on whose name the home is purchased under. Best that your child signs the Loan Agreement and buys the home just in their name. This binds your child alone, and the partner has no say in the matter. What if the partner objects? It is important to stay firm and explain it is ‘to protect your interests, it is nothing personal’. This protects yourself and your child, if the relationship with the partner does not end up ‘happily ever after’.

What happens if the home is purchased in both your child and their partner’s name? Then both your child and their partner sign the Loan Agreement. Our Loan Agreements allows the loan to be lodged as a caveat. Or our Loan Agreement can be registered as a second mortgage – but the bank is notified. So caveats are more common.