Contractual loan agreements are the best way to legally bind the repayment of money. However, individuals often forgo drafting legal documents in situations when they are sourcing funding from family members, or using money from one business to supply cash to their other enterprises on commercial terms.
The costly mistake here is that skipping this important legal step can have negative ramifications in the future, and perhaps even lead to disputes in court. It is important to always have a written loan agreement, ideally signed by all relevant parties, during the exchange of significant sums of money.
Even if you trust those involved, err on the side of caution with written documents to best protect everyone. These documents should deal with: how and when repayments should be made, if any interest will be applied, what the default processes might be and which security measures are being implemented.
The following scenarios spotlight some seemingly sheltered ways to seek a loan, yet these can be problematic if not protected with written agreements.
- Relatives loaning money for launching a business.
- Borrowing funds from a spouse to pay off a debt.
- Owning multiple businesses and loaning funds from one entity to another on commercial terms.
- Selling land or a lucrative asset using the ‘vendor finance’ method.
- Parents lending money to children to buy a house.
The key thing to remember is that if one party to the loan arrangement dies, the other party will be left dealing the deceased’s estate – and the executor will not have first hand knowledge of what the agreement was or when the loan is repayable. Similarly, it is common to have a falling out between parties, which changes the relationship and can lead to a differing view on what the deal actually was. Often in family law disputes, parties will argue that a loan was actually a gift (or vice versa) if there is no contemporaneous agreement to prove otherwise.
Also, in each of the above cases there will be varying tax implications. Where money is lent between related businesses, written agreements can be crucial to show the Australian Tax Office or State Revenue offices that a deal is arms length and how it is characterised.
The best way to proceed is to discuss the implications with expert commercial lawyers, to ensure all parties are well informed about how the loan may impact them. Similarly, if security is being offered against mortgages or land charges, this can be risky and should be managed carefully.
Moreover, the language used in these documents must be clear and simple for all people to understand. Lawyers can help draft such language without compromising on legal validity by adding clauses that best protect those involved.