Treatment of Family Loans in Divorce and Financial Proceedings

If a member of the extended family gives money to a husband or wife during their relationship, the money is undoubtedly very welcome at the time of the gift or loan. When a couple splits up, family gifts or loans can complicate things. There may be a dispute over whether the money was a gift or a loan and how the gift or loan should be treated in the divorce and financial proceedings.

Our North West divorce solicitors provide specialist advice on the treatment of loans in divorce and financial proceedings.

Contact our specialist family lawyers for a consultation on your divorce and financial settlement.

What is a family loan in divorce financial proceedings?

A family loan is typically an informal loan between a family member and one of the divorcing spouses. It could be verbal or written, but if it is written, it could have been prepared without the benefit of legal advice, and the terms of the agreement may not be clearly defined.

Often, the spouse who received money from their side of the family will say it was a loan, while the other spouse will say it was a gift.

If agreement cannot be reached on whether the money received was a loan or a gift, the family court can be asked to decide the issue in financial proceedings brought by either the husband or the wife. The person who lent the money can also apply to intervene in the financial proceedings so they can make their case and have legal representation.

If the court says the money is a hard loan, it will affect the asset pot available to be distributed between the husband and wife. The size of a loan and its classification could substantially impact the financial court order.

In this sequence, the court must decide:

1. Was the family money a gift or a loan?
2. If it was a loan, was it a hard loan or a soft loan?
3. In light of the court’s finding on the loan status, what is the extent of the family assets available for distribution by the judge?
4. What is a fair financial settlement for the husband and wife?

Family loans and reaching a financial settlement in mediation

If you are trying to reach a financial agreement in mediation, you may need specialist legal advice on complex points, such as:

1. Whether the court would be likely to say a loan was hard or soft, and the impact on the financial settlement.
2. The value of complicated assets, such as pensions or shares in a family business.
3. The relevance of specific factors, such as pre-marriage owned property, gifts or inheritances.

Family law solicitors can advise you on specific queries to help you reach an agreement in mediation and can provide mediation support to help you convert your mediated agreement into a binding financial court order.

Family loans in financial proceedings

In divorce financial proceedings, there can be disputes about:

1. Whether money from friends or family members was a gift or a loan.
2. Whether the gift was to the husband or wife or the couple jointly.
3. If the money was a loan, the repayment terms.
4. If the money was a loan, whether the debt should be included as a debt in the asset schedule.
5. If the money has been repaid to the extended family member because of the divorce, whether the funds transferred to the relative should be added back into the asset schedule.
6. Whether the extended family member should intervene in the financial court proceedings.

Things can get very acrimonious when family money is in issue, with one party saying the money was a gift and the other a loan.

Treatment of family loans in divorce and financial proceedings

The case of P v Q (Financial Remedies) [2022] EWFC B9 (10 February 2022) clarified how the court should treat family loans in financial proceedings after a divorce.

The case emphasises the importance of extended family members taking legal advice before making a payment to a married family member to ensure it is clear if the money is a loan, a joint gift, or a gift to one spouse, with the money ring-fenced in the case of separation or divorce.

The case of P v Q (Financial Remedies) [2022] EWFC B9

The case of P v Q involved an international family based in the UK and Germany. The wife was German, living in England, and the husband was English, living in Germany with the couple’s two children. The case had many unusual points, including the value and liquidity of company shares, as the case was heard when Russian forces were massing at the Ukraine border and there were expectations of share price volatility.

Divorce and financial proceedings were started in the UK. The wife said the husband had given his mother £150,000 to reduce the family assets and to reduce the amount the husband would be ordered to pay her as a financial settlement. The husband said he had repaid his mother the £150,000 loan, and the money should not be added to the asset schedule.

The husband’s mother had given each of her three children £150,000 to help them with housing. No loan documentation was drawn up, and there was no evidence that the mother had gifted the money as part of an estate planning strategy.

No demand was ever made for repayment of the £150,000, and there was no discussion about the circumstances when repayment was required. In evidence, the mother said she hoped the family would repay the money to her if she needed it.

The husband repaid the £150,000 to his mother without his mother asking her son for the money. The wife argued the transfer was a device to remove £150,000 from the asset schedule, so she lost £75,000, using the sharing principle of a 50:50 split if £150,000 was added back into the asset schedule.

The judge had to consider whether the £150,000 (and other family monies) were gifts or loans. The judge held that for money to amount to a gift, there must be an intention to give away with no expectation of repayment. Accordingly, the judge held that the £150,000 payment was a loan.

The arguments didn’t stop there. Using case law, the judge had to consider whether the loan was a hard or soft loan to determine whether the £150,000 should be added back into the asset schedule.

The judge concluded the loan was a soft loan. This meant the loan monies were added back into the asset schedule, thus increasing the amount to be shared between the husband and wife by £150,000 and increasing the size of the wife’s award.

The law and the treatment of family loans in financial proceedings

The judge in the case of P v Q said he had to consider the factors set out in Section 25 of the Matrimonial Causes Act 1973, together with any relevant case law, to decide:

1. How to treat the loan and
2. How to split the assets.

Section 25 Matrimonial Causes Act 1973 broadly says it is the duty of the court when making a financial court order to have regard to all the circumstances of the case, first consideration being given to the welfare while a minor of any child of the family who has not attained the age of eighteen. Amongst other things, and of relevance to family money and loans, the court should pay particular regard to:

1. The income, earning capacity, property and other financial resources which each of the parties to the marriage has or is likely to have in the foreseeable future, including in the case of earning capacity any increase in that capacity which it would in the opinion of the court be reasonable to expect a party to the marriage to take steps to acquire, and
2. The financial needs, obligations, and responsibilities that each of the parties to the marriage has or is likely to have in the foreseeable future.

Is a family loan a soft loan?

A loan can be classed as hard or soft. The definition is important because a soft loan will not carry as much weight in divorce financial proceedings as a hard loan.

A hard loan is more like a commercial or contractual agreement, while a soft loan is an arrangement between family members without too much formality.

In P v Q, the judge said that when looking at the treatment of loans in financial proceedings, the court needs to consider:

1. If there is a contractually binding obligation by a party to the marriage towards a third party, the court should consider whether the obligation is a hard obligation debt or a soft debt.
2. There is no set test to decide if a loan amounts to a hard or soft debt.
3. A common feature of family loan analysis in financial proceedings is determining whether the obligation to repay will be enforced.
4. The court should consider common factors that point toward a hard or soft loan.

Evidence that a loan is a hard loan in financial proceedings

Factors that point to a loan being classed by a judge as a hard loan include:

1. The terms of the obligation feel like a normal commercial arrangement.
2. There is a written loan agreement and a written demand for payment.
3. There is a threat of litigation or intervention in the financial settlement proceedings.
4. There was no delay in enforcing the debt.
5. The amount of money owed is such that it would be less likely for a creditor to waive the obligation to pay.

Evidence that a loan is a soft loan in financial proceedings

Factors that point to a loan being classed by a judge as a soft loan include:

1. The debt is owed to a friend or family member who remains on good terms.
2. The loan is informal without a commercial arrangement feel to the loan.
3. There has been no written demand for payment despite the loan repayment date having passed.
4. There has been a delay in enforcing repayment.
5. The amount of the money is such that it would be more likely for the creditor to be likely to waive the obligation to repay.

Divorce and private client considerations when making or receiving family loans

If you are thinking about making a gift or loan to a family member, it is sensible to take private client advice to:

1. Understand estate planning and ensure your gift is tax-efficient for inheritance tax purposes, and
2. Ring-fenced and protected in case the family member gets divorced. This can be achieved through a formal loan document, preferably combined with a prenuptial agreement or postnuptial agreement.

Specialist divorce and financial advice on the treatment of loans in divorce proceedings

Our expert divorce solicitors can help you if you are:

1. Disputing a payment made by a family member was a loan and not a gift.
2. Arguing that the money given by your family to you individually or as a couple was a loan.
3. The loan maker who needs advice on intervening in the financial proceedings to protect your loan and financial interests.

Our divorce lawyers will:

• Give an unbiased view of whether the court will likely say the money is a gift or a loan. Whilst you may not like the opinion about the treatment of the family money, you don’t want to waste time or money on an argument that you are not likely to win.
• Look at the additional legal costs of arguing whether the family money was a gift or loan, as you don’t want to spend more on legal costs arguing the point if the costs will be more than the amount to be gained in your likely financial award.

Our family law solicitors can also help prepare prenuptial and postnuptial agreements, and our private client lawyers can advise on estate planning, gifting, and family loans.

Contact our specialist family lawyers for a consultation on your divorce and financial settlement.