When a loan is not a loan: Family Loans on Divorce in a COVID-19 climate

We continue our series of hot topics in family law in a COVID-19 climate. Manders Law Managing Partner, Mary-Ann Wright speaks to Barrister Charlotte Jewell from The 36 Group, on the treatment of family loans on divorce, an issue that family law clients are concerned about in the current crisis. If you are currently engaged in proceedings or are contemplating proceedings at this challenging time and a family loan is involved, the information and practical guidance below will be of relevance to you.

About the Interviewee

Charlotte has been practising in family law since 1999. She specialises solely in financial remedy matters and has significant experience at first and appellate court level. She is thoroughly adept at cases involving complexities such as foreign elements, seemingly intractable disputes, third party interests, asset tracing, forensic accountancy and interlinked company structures. Charlotte is a member of both the Family Law Bar Association and Resolution.

Question

We have all seen cases where one party to the divorce claims that a family member is calling in a significant liability, having made either a financial contribution or a “loan”. They may also be saying that they are owed money as they have a “beneficial interest” in a property or an asset (i.e. the monetary value in the asset, despite it being in held in the legal name of the other spouse). This often arouses suspicion and concern. Within the context of the economic challenges presented by the pandemic, this is likely to be a regular feature in many cases. What are the court’s powers in this regard?

It is important for clients to understand that under the Matrimonial Causes Act 1973, which guides the court when determining most financial claims in divorce cases, the court has no power to adjust the amount owed, or to assign the burden of the debt. There is every likelihood that the court will make no provision for the repayment of “soft” loans, within any settlement or order. The consequence is that such “soft” loans may then be difficult to pay back, which thereby adds to the stress that a client, who naturally feels a moral duty to repay, goes through. Stating that money is owed to you in a property or an asset means that you would then have to prove that the money loaned was meant to give you an interest in the asset. The process of proving this can often be complex and expensive.

Question

Clients often believe that all “loans” are treated the same on divorce. We know that they are not. Can you explain the difference between “hard” loans and “soft” loans for our readers?

They certainly are not treated in the same way by the court. Case law has helped clarify the position and “soft” loans are not likely to be taken into consideration unless they are backed up by a legal intention to have the loan paid back. A good example of a “hard” loan/debt is a debt to the bank, or a credit card, where the lender will take legal action in the civil court if repayments are not kept up. By contrast, a “soft” loan/debt is, for example, borrowings from a close family member or friend, where it is unlikely that the borrower will fall out with the lender, who will likely wait for the money to be repaid.

Question

So, what should clients do where a family member or friend wants to loan money to one/both spouses during the marriage, but are concerned about what would happen on any breakdown of the marriage?

  • Make it contractual: this means that there should be a document between the spouse and the proposed lender which should demonstrate all the elements of a valid contract namely, offer/ acceptance/ “consideration” (see below for explanation) and intention to create legal relations
  • To be a valid contract in these cases there must be consideration (something for something in return) moving from the borrower to the lender in return for the loan. A payment on the promise of the loan being repaid is arguably valid “consideration”.  However, it could be argued that if there is no interest due on the loan then in some way that negates the element of true consideration as the lender will not get any return on his/her loan.
  • To make it “bite” the loan should be executed as a deed. If it relates to a property it should be registered at the Land Registry. If the loan agreement is executed as a deed it is a ‘speciality’ contract, which does not require consideration, and different limitation periods also apply (12 years under s. 8 of the Limitation Act 1980). In this context, limitation periods are the time within which the lender is entitled to bring an action for breach of contract to the civil court.
  • Ensure that the loan is drawn up as proper registrable debt and encourage the borrower to enter into a prenuptial or postnuptial agreement, or a declaration of trust, which refers to it.
  • Make the loan agreement ‘repayable upon divorce proceedings’ or ‘settlement of financial remedy proceedings’
  • Detail a monthly repayment schedule in the loan document
  • Detail the final repayment date in the loan document
  • Detail interest payable in the loan document (see above in relation to the element of “consideration”)

Question

What can clients do if they did not take the steps above before accepting a “soft” loan but wish to assert that a “soft” loan should be repaid and taken into account on divorce?

  • Obtain a statement from the lender, which explains the reason and expectation they had when they loaned the money to the spouse. The statement should also explain the financial effect on the lender in event that the money is not repaid (often, for example, parental loans are made from savings intended for retirement). The statement should also attach evidence which clearly shows the money leaving their account and detail any repayments made by the spouse – repayments made before the parties separated shows a genuine intention that the loan was to be repaid.
  • If the parties are engaged in court proceedings, they should obtain the court’s permission for a statement from the lender to be introduced as part of the evidence in the case. This would also mean that the lender must be prepared to be cross examined.
  • If the Court finds the debt is (a) genuine, (b) the effect of not paying it would be damaging to the lender and (c) that both spouses’ needs can still be met if the debt is paid back, then it is likely that the money will be awarded to the spouse who says that they need to repay the loan. They will often be required to give an undertaking (a binding promise to the court) that the money will be used to pay back the loan.

Question

In some cases clients may suspect that the loan document produced in the proceedings to evidence a debt to be taken into consideration, is not in fact a loan, but merely a sham to convince the court that one party owes money, that in reality will not have to be repaid. What are your top tips on what to look out for?

Again, case law assists us here. Essentially the definition of a sham loan document is a document where the parties to the sham intend to give the court (or third parties) the appearance that they have entered into a document that intended to create legal rights and obligations that are different from the actual legal rights and obligations (if any) which the parties intended to create, if in fact they intended to create any at all!

For the court to find that the loan document is a sham, it will need to be satisfied that all the parties to that sham had a common intention that the document or acts were not in fact intended to create legal rights and obligations. It should also be noted that “reckless indifference” would be taken to constitute intention. Circumstances may even include a trust that was set up as a sham. Such a trust could in principle lose its character as a trust.

Clients need to be aware that if they wish to assert that a loan document is a sham the evidential test is high and such assertions should not be made lightly. Every case is fact specific.

Question

We often see cases where one party says that the other has been supported by a series of loans or support from family and they believe that this financial support will continue, or is likely to continue post-divorce, despite the other party’s protestations to the contrary. How does the court deal with this?

At the beginning of the proceedings, where one party may be saying,  “I don’t need to pay you money to live on each month because your family gives you so much money”, it may well be that the court accepts that view, at least until a final hearing when difficult questions will have to be answered! If a spouse has historically been supported on a continual basis in that way but is suddenly saying that their family assistance will stop or reduce, then a high level of evidence will be required to support that assertion. The court would be justified in assuming that the supply of money will continue.

However, it will take a lot to convince the court to come to a safe conclusion that the support previously given by a third party will continue infinitely beyond a final hearing, to the extent that it can be relied upon in the court’s decision making process. The economically stronger spouse is expected to support the weaker spouse and would normally be ordered to do so, rather than be able to argue that the other spouse should be supported by family. The court would have to be satisfied that the loan assistance/ monetary gifts will continue.

On the other side of the coin, where the weaker economic spouse needs an award to meet needs that can only be funded by the other spouse’s family, then the court could, if it was fair to do so, make that award. If, however, it is clear that a family member(s) would not come to the aid of the spouse then there is little a court can do.

There is a difference between a spouse receiving money under a trust, which is a legal obligation, and receiving money every now and then at the discretion of a family member. It would not be appropriate to place improper pressure on a third party.

Question

What about cases where one party says that a family loan was used to purchase, enhance or improve a matrimonial asset like a property and now seeks to have this loan repaid on divorce?

There is a fundamental difference in family law between a “gift” given to a spouse by a third party, with no strings attached or expectation of payment, and a “loan”, where the strict expectation from the outset is that the money will be paid back. The court will decide whether the money was a loan or a gift (in the absence of clear documents) on the basis of the narrative evidence- i.e. the version of the facts given by one party compared to the version of the facts given by the other party. The history of monies given to the spouse by that person would also be looked at.

The court has to decide on the ‘balance of probabilities’ – i.e. which party does the court believe more. This is not an exact science, and the cost of statements and the additional time needed at a court hearing to air the issues can sometimes outweigh the monies owed!

If the money was a loan, not a gift, and it went into a property, for example money for a new kitchen, then the crucial question will be – was the intention behind that loan to, “just get the money back at some point”, or to have a share in the house and therefore an investment? Depending on what the intention was, there are very different legal principles to be applied. If the intention of the loan was to create a share in the property, then the lender will need to be joined to the proceedings. Again, this results in higher legal fees all round. It is important to be mindful of proportionality as to legal fees which may need to be spent, versus the amount in issue.

If the third party is joined, then the Court can order that money from the marital pot be paid directly to them.

Question

Given all you say above this is a complex area and careful consideration is required before arguments regarding loans should be pursued. In conclusion are there any other important considerations that clients should be aware of?

Yes, indeed there are! It is vital that early consideration be given as to how the case should be put. Will a witness statement suffice? Or should joinder proceedings be issued to join a third party who is said to have loaned the money or granted an interest to the proceedings, as an “intervenor”? There are serious costs implications if a third party is joined, they win and successfully defend their position.

As with issues of beneficial interest, when determining the existence and “hardness” of a debt owed to a joined third party, the court applies the general common law and does not perform a discretionary exercise.

Client should also note that where a creditor appears as a witness and the court is satisfied that a debt is repayable, the court has no power to make an order in the creditor’s favour unless he/she is joined as a party to the proceedings. This means that specialist legal advice should be taken early on as the decision of whether or not to join a third party is a delicate balancing exercise. It should however be noted that where the court does find a debt repayable to the creditor, the court can, in most cases, deal with the issue indirectly by, for example, making a lump sum order in one party’s favour upon an undertaking that he or she will  repay the amount due to the creditor.

Where the decision is taken to join a creditor as an intervenor, and the court is satisfied on the balance of probabilities that a debt should be repaid, the court can enter judgment. It can proceed to order how the debt is to be repaid and consider what (if any) interest is owing.

For an initial FREE consultation on any aspect of family law, call Manders Law on 01245 895 105 or email us here.

Note: this blog is intended to give an overview (rather than comprehensive guidance and advice) on your legal or financial position and is provided for information only. It is not an endorsement of any product or service provider.