How secure is a secured loan from family and friends?

So, you have borrowed money from a family member or friend, and you have done everything correctly: you have executed a loan agreement, and the loan has been secured, maybe by a caveat over your property, or maybe by a registered mortgage on the title. You might have even read one of our other articles to help you do it.

From a family law perspective, is that enough?

Maybe not.

In the recent family law appeal of Han & Han, the Court approved a trial judge's decision to disregard a $4.66 million debt the husband contended he owed to his parents, even where there was a loan agreement and registered security.

The appeal

The appeal arose after the husband in the proceedings appealed a final property decision of the Federal Circuit and Family Court of Australia (Division 2). The husband appealed, in part, because of the primary judge's disregard of the contended debt.

The debt

Long before the parties' marriage the husband purchased a parcel of land for $1.15 million using a loan of $1.179 million from his parents and five corporations they controlled (creditors). He later borrowed a further $634,072 to fund the construction of a home on the property. After those funds were advanced, the husband entered into a loan agreement with the creditors. The creditors later registered a caveat over the real property the husband purchased with the loan.

Despite the loan agreement and the caveat, no repayments were ever made on the loan. The first time the creditors requested any repayment was after the parties were married, and they only sought interest payments at that time. The loan was only called in by the creditors after the parties' separation and the commencement of family law proceedings. Despite ongoing default, the creditors did nothing more to recover the loan.

The husband's argument

While the husband received funds of approximately $1.8 million, he contended the actual debt was $4.66 million, as a result of accrued interest.

In the appeal, the husband argued the debt should not have been disregarded by the trial judge, as it was an existing liability and secured by a caveat.

The decision

The Court rejected the husband's argument and dismissed the appeal.

With reference to case law, it determined that a strict interpretation of the property alteration provisions of the Act and the Court's requirement to identify existing liabilities does not displace the additional requirements for the Court to take into account the nature and circumstances of liabilities incurred by the parties. The Court also has a discretion to choose to separate a liability from the joint property of parties to a relationship.

Similarly, the Court is not compelled to take a secured liability into account at full value when dividing property interests; judges have wide discretion to disregard or discount liabilities whether they are secured or unsecured.

The Court explained that it will assess how to treat liabilities on a case-by-case basis by determining the likelihood of enforcement. To do this, it will consider factors such as the closeness of the connection between the debtor spouse and creditor, and the type of security for the loan. Other case law suggests the existence of documentation and past action to enforce the loan are also important.

In dismissing the appeal, the Court was persuaded by the following:

• The husband failed to prove the actual amount of the debt, so the quantum remained uncertain; and
• It was unlikely the debt would be enforced against the husband, due to:
  • legal issues with the caveat that was registered to secure the loan;
  • the creditors were the husband's parents and entities controlled by them;
  • the creditors let the loan remain dormant for 12 years, despite the loan agreement and security; and
  • even when the creditors sought to call in the debt, they took no actual steps to recover it, despite the continuing default.

What does this mean for you?

Having a loan agreement and some form of security for a loan does not necessarily mean the Court will consider and enforce a liability from a related party, such as a family member or friend. As the Court will look to determine the likelihood of enforcement, it is very important to make sure your loan is structured, secured, documented, and maintained in the most effective way for your circumstances. The risks of a loan being disregarded in a family law setting are real and tangible.

How can we assist?

While this decision provides some guidance on the Court's treatment of related party loans, it is also a recent example of just how many things in the family law jurisdiction come down to discretion. It highlights the importance of strategic and early legal advice when lending to or borrowing from someone you have a personal relationship with.

To determine the best way to structure your lending arrangement, or for assistance conducting your family law matter and evidencing a liability before the Court, our experienced Family & Relationship Law team is well-equipped to assist you.