'When friendly family loans go bad...' on demand loans
Loans between family members and family entities, sometimes for very substantial amounts, are common. Often their terms are undocumented and there is no specific repayment agreement. But what might happen if you really needed to force the borrower to repay?
At law, such loans are repayable on demand – nothing surprising about that. You may therefore think that if something happens and Dad wants his money back, all he has to do is to demand it. However, in NSW the time for recovery runs for the purposes of limitations law from the time the loan is made – not from the time the demand is made. So, if such a loan was made more than six years ago, it may well be irrecoverable.
This can result in dramatic changes in the balance of assets within a family – eg the assets of one family member against another, and as between family members and family trusts and companies.
The loans of most concern in practice are what might be called ‘friendly family’ loans. Loans made by professional lenders, such as banks or other financiers, are well documented and usually have carefully stated repayment terms.
Avoiding future problems
If you have made a loan to a family member that has not been documented, there may still be some steps you can take to avoid adverse consequences, especially if the loan was made less than six years ago. We can discuss the options, but a couple of them are below:
- Add a provision for demand
Such loans should be documented without further delay, preferably by deed, so as to make them repayable at some date after a demand is made – e.g. one month, six months. This will make it clear that no time is to run until demand is made.
- Obtain a confirmation, or part payment
Alternatively, a ‘confirmation’ of the loan that complies with section 54 should be made - see above. This might be by way of a document, or part payment.
Where do problems arise with “on demand” loans?
Problems can arise in numerous areas. Some examples are given below, and assume that recovery of the relevant loan has been barred by statute after six years.
Family law - Example I: In a family law property settlement negotiation, the parties disclose all of their assets to each other. The husband contends that his gross assets of $1m are depleted by his obligation to repay his father a loan of $400,000 that the father made more than 6 years ago to enable the son to start up a business.
Problem: The loan ends up as part of the matrimonial property – being irrecoverable by the father. The wife contends either that the moneys provided were really a gift and not a loan at all, or, alternatively, if a loan, it was never intended by the father that it would be repayable - and the Family Court should take that factor into account in assessing the husband’s “financial resources”. But, as the loan was undocumented and made more than six years ago, it does not much matter - as the loan is irrecoverable in NSW anyway. The result is that the total marital assets and the husband’s share of them are rather greater than they would otherwise have been, and the husband – who had expected that at some time in the future he would receive the benefit of the loan of $400,000 from his father – ends up less well off than he had expected, having in effect to share the loan amount with the wife. And the father ends up with nothing.
Estate planning – Example II: The family assets include a family trust, the beneficiaries of which are the children and their lineal descendants (and not the parents). The gross assets of the trust are $600,000 and the net assets are apparently a modest $200,000 because the trust’s investments were funded by a loan made by the father of $400,000 shortly after the trust was established. The father’s personal assets are apparently $1,200,000 made up of $800,000 plus the $400,000 loan. He wants his wife to have all of his personal assets and intends to leave nothing at all in his will to his children. The trust was set up 10 years ago.
Problem: The assets end up in the wrong place. The loan by the father to the trust is irrecoverable. Therefore the assets of the estate left to the wife are only $800,000, not $1,200,000. The net assets of the trust have become $600,000 – all of which is to go to the benefit of the children - and not to the mother.
Estate administration – Example III: An elderly widow has $1,500,000 in assets. She gives an Enduring Power of Attorney to her eldest daughter whom she trusts implicitly. There are three other children. During her lifetime, when the widow has little interest in managing her own financial affairs, the eldest daughter helps herself to $500,000 out of her mother’s assets in order to finance some home renovations for herself. At the time, she tells her siblings that the money is a gift to her from her mother, but when the mother is confronted with this by the siblings, she says that the money provided was only a loan. There was no documentation. Eight years later, the mother dies, leaving her estate equally to her four children by her will. The other three children want the loan accounted for to the Estate as an asset, so that they will share in it. But the eldest daughter still says that the moneys provided by the mother were a gift, not a loan.
Problem: The money was provided more than six years ago and even if it was a loan rather than a gift, it is prima facie irrecoverable. That is, whether the moneys provided were a gift or a loan does not matter any more for this purpose.
Further issues: Of course, the eldest daughter as attorney may also have breached her duty to act in the best interests of the widow and may be liable accordingly. In addition, the executors may want to consider whether the principles of ademption (including ademption of a legacy by a portion) may apply to deem the moneys provided to the trusted eldest daughter to be in satisfaction of her legacy of one quarter of the estate.
Insolvency – Example IV: A father lends his son $400,000 to assist his son’s business. After eight years of business struggle, however, the son goes bankrupt as his business fails and he has personally guaranteed a very substantial debt owed to the bank. The son’s gross assets are $200,000, and he owes the bank $300,000.
Problem: The father ends up with no share of the bankrupt son’s assets. The loan was made by the father more than six years ago and was undocumented, and is therefore irrecoverable. That means that the father cannot effectively prove in the bankruptcy for his debt, and the bank (and any other creditors) will take all of the assets available for distribution.
How does the Limitation Act 1969 work in NSW in these circumstances?
Under section 14, a legal action under contract cannot be maintained after 6 years But it is section 63 that is critical: it says plainly that the effect of the Act is that a right to recover a debt is “extinguished”. The Courts on many occasions have upheld those plain words as meaning what they say. In other words, the debt is not only irrecoverable as a matter of legal procedure, it actually ceases to exist for all purposes.
Can you get around this?
If your loan was made more than six years ago, we would usually consider the fine detail of the facts to see if a problem might be avoided.
One very important factor to consider is whether there has there been a ‘confirmation’ of the debt, within the requirements of section 54. If the debt is the subject of an adequate ‘confirmation’ within the six year period (any later will be too late), time will start running again from the time of that confirmation. Some matters for consideration include:
Is a reference to a debt in a company’s books or other documents enough to be a ‘conformation’??
Has there been a part payment of the debt within the 6 year period?
Has there been a payment of interest?
Sometimes it will suit the family arrangements to repay the debt, notwithstanding that it may have been extinguished. But can that be done without adverse consequences? Consideration will need to be given to all the facts, including as to whether a deceased estate is involved and in a special position at law, or whether trustees or directors are entitled to agree to repay a loan they are no longer legally obliged to repay.
Is any change to the NSW legislation likely?
In 2004 the NSW Law Reform Commission reviewed the position in relation to on demand loans, found it unsatisfactory, recommended that the law be changed, and drafted a bill to achieve that. It provided for time not to run until a formal demand had been made, and for a 3 year limitation period. However, for reasons unknown, it was never placed before Parliament. In 2014 I wrote to the Attorney General requesting that the matter be dealt with as recommended 10 years ago. The response so far has been that the Government has referred the matter to various stakeholders (such as the Law Society of NSW and the Bar Association).
Author: John Elmgreen