Bank of Mum and Dad – New Guidance on Loans and Gifts

It is not uncommon at all for couples starting out their independent lives together to receive financial help from one or more of their respective parents or families.  What a fabulous position to be in, to be able to help your children financially as they embark on their future.  Very often, this assistance is given “on trust”, with the parties believing they have a common understanding of the terms on which the assistance is offered.  However, it is also unfortunately very common that everyone’s interpretation of the terms can be slightly different, and most significantly, undocumented.

Whilst for a lot of families this will cause no issue at all, when a couple separate or divorce problems can easily arise.  Was the money made available as a gift, or as a loan?  If it was a loan, what are the terms of repayment, and are they enforceable? If there are no documented terms of repayment, then lengthy and expensive litigation can ensue in order to establish where the facts lie.  In divorce proceedings, this can involve family members facing a choice to intervene in the proceedings, i.e. become a party in their own right in order to argue their case.  Even though the family may be separating, very often grandparents don’t want to be pitching against the parent of their grandchildren, with whom they will want to retain a healthy and positive relationship for the future. Aside from the undeniable fact that this can be unpleasant and divisive, it also increases legal fees exponentially.

Even if a family law Judge determines that the offer of money from family members does indeed constitute a loan, the next issue is often whether it is a “soft” loan, or a “hard” loan, i.e. will the loan really be called in by the family members?  Often it is argued that the monies loaned will simply be made available to the party from whose family the loan originated once divorce proceedings have concluded.

There are various steps that can be taken by both the persons offering financial help, and the couple accepting it, in order to protect against this position in the future.  Those offering a loan can ensure that the loan is documented, with clear terms as to the expectation of repayment, including amounts, dates and whether or not interest is to accrue.  If the funds are being used towards the deposit of a property, a properly executed Declaration of Trust is to be advised.

A couple who intend to marry should seriously consider entering into a Pre-Nuptial Agreement as part of which any loan made by either party’s parents can be clearly dealt with as part of the terms.  A couple who are already married should take advice about entering into a Post-Nuptial Agreement to try and avoid potential protracted litigation in the future.  Whilst Pre-Nuptial and Post-Nuptial Agreements are not strictly binding under English law, they are evidence of the parties’ intention, and will be considered on divorce as one of the relevant factors to be taken into consideration.  More detailed information about Pre-Nuptial and Post-Nuptial Agreements is the subject of a separate article.

Unmarried couples should consider entering into a Cohabitation Agreement.  Like Pre-Nuptial and Post-Nuptial Agreements, a Cohabitation Agreement is not an automatically legally binding document, but it is evidence of intention.  When properly drafted and executed, this can provide a measure of protection to unmarried parties.

Another issue which can arise is where the parties themselves make loans or gifts using matrimonial funds, to third parties.  For example, one party gives, say, £10,000 to their brother.  The other party may say that is a loan that should be repaid, and is therefore effectively an asset of the first party (or in essence, that the money has been paid to the brother to keep it safe for that first party).   A properly drafted and considered Pre-Nuptial/Post-Nuptial Agreement can deal in advance with how payments of this nature are treated on divorce.

In P v Q [2022] All ER (D) 100 (Feb) His Honour Judge Hess heard a financial remedies case in which there had been several “loans” made by each party to family members.  In his judgment, HHJ Hess made the following comments inter alia:

The first question is whether these advances should be regarded (in strict legal terms) as gifts or loans. As a matter of general principle, for an advance of money to be a gift there must be evidence of an intention to give – the animus donandi. [….] On the face of it, both these transactions are loans which could, in theory, be enforced.

In the family court, however, that is not the end of the matter because the inclusion or exclusion of a technically enforceable debt in an asset schedule can depend on its softness/hardness. This is perhaps an elusive topic to nail down, but it falls for determination in the present case as in many others.

The Judge then went on to consider several prior authorities and analyses dealing with this point, and made some very helpful indications of how the court should approach these issues:

I derive the following summary of principles from this reading:-

(a) Once a judge has decided that a contractually binding obligation by a party to the marriage towards a third party exists, the court may properly wish to go on to consider whether the obligation is in the category of a hard obligation or loan, in which case it should appear on the judges’ computation table, or it is in the category of a soft obligation or loan, in which case the judge may decide as an exercise of discretion to leave it out of the computation table.

(b) There is not in the authorities any hard or fast test as to when an obligation or loan will fall into one category or another, and the cases reveal a wide variety of circumstances which cause a particular obligation or loan to fall on one side or other of the line.

(c) A common feature of these cases is that the analysis targets whether or not it is likely in reality that the obligation will be enforced [……….]

(e) Factors which on their own or in combination point the judge towards the conclusion that an obligation is in the category of a hard obligation include (1) the fact that it is an obligation to a finance company; (2) that the terms of the obligation have the feel of a normal commercial arrangement; (3) that the obligation arises out of a written agreement; (4) that there is a written demand for payment, a threat of litigation or actual litigation or actual or consequent intervention in the financial remedies proceedings; (5) that there has not been a delay in enforcing the obligation; and (6) that the amount of money is such that it would be less likely for a creditor to be likely to waive the obligation either wholly or partly.

(f) Factors which may on their own or in combination point the judge towards the conclusion that an obligation is in the category of soft include: (1) it is an obligation to a friend or family member with whom the debtor remains on good terms and who is unlikely to want the debtor to suffer hardship; (2) the obligation arose informally and the terms of the obligation do not have the feel of a normal commercial arrangement; (3) there has been no written demand for payment despite the due date having passed; (4) there has been a delay in enforcing the obligation; or (5) the amount of money is such that it would be more likely for the creditor to be likely to waive the obligation either wholly or partly, albeit that the amount of money involved is not necessarily decisive, and there are examples in the authorities of large amounts of money being treated as being soft obligations.

(g) It may be that there are some factors in a particular case which fall on one side of the line and other factors which fall on the other side of the line, and it is for the judge to determine, looking at all of these factors, and maybe other matters, what the appropriate determinations to make in a particular case in the promotion of a fair outcome.

As can be seen from the Judge’s comments above, quite a lengthy exercise has to be undertaken in order to determine how loans/gifts from family members or friends should be dealt with.  These guidelines were reiterated by the same Judge in YC v ZC when once again considering the approach to analysing ‘hard’ versus ‘soft’ debts,

One of the most common reasons for not dealing with a Declaration of Trust, Pre-Nuptial Agreement, Post Nuptial Agreement or Cohabitation Agreement is the cost.  However, it would be no exaggeration to say that the cost of litigating whether or not a family loan is a loan or a gift, soft or hard, will easily be ten times as much as the cost of having the protective document properly prepared.  Furthermore, in divorce cases, the usual family costs rules do not apply to an intervenor’s case. Therefore, if Mum and Dad do intervene in divorce proceedings, costs orders may be made against the loser which is a significant deterrent against pursuing even very valid claims. For this reason, many parents having loaned their children money at the commencement of their relationship, end up losing out unnecessarily when the relationship breaks down.

If you would like any further information or advice about the issues raised in this article, please contact a member of our Family Team.