Loaning money to a friend or family member? Here’s what you need to know

Many of us have helped a family member or friend before by providing an interest-free loan. Although the loan is not intended to be a gift, the details may not have been formalised and there may be no stipulation as to when and how the loan must be repaid.

A similar situation occurs where a director is loaning money to his or her company or a family member lends money to a family trust without formally documenting the transaction or specifying a repayment date.

A loan falling in these categories is considered a ‘loan payable on demand’.

Despite good intentions between the lender and borrower, these types of loans may create unintended and adverse consequences.

This article identifies some of the potential pitfalls of informal loans or loans payable on demand, particularly those made to family or friends.

The legal nature of loans payable on demand

If you have made an informal loan to a friend, relative, family company or trust, the interplay of these two legal rules must be considered:

  1. The law defines a loan made that has no specified date for repayment, or that is payable on request, as a ‘loan payable on demand’. Once the money is handed over the lender may have an immediate right to sue for recovery of the debt.
  2. Limitation legislation in each Australian jurisdiction places time restrictions on a person’s right to commence legal proceedings for various types of action. In Western Australia, the Limitation Act 2005 (WA) provides that a cause of action cannot be brought after the expiration of six years from the date that the cause of action first accrues.

The effect of these principles means that, because a loan payable on demand creates an immediate legal right for the lender to sue from the time the money is advanced, the limitation period may be triggered at this point and the lender will only have six years from the date of payment of the loan to pursue the borrower for the debt.

What to do if you are loaning money or have lent money

If you intend on loaning money, whether to a family member, a friend, or a family company, it is important to have a written deed or loan agreement in place. The agreement should specifically state that the loan will become payable at a future date. In this case, the limitation period will most likely not be triggered until the future date specified in the agreement.

Your lawyer can assist in preparing the deed or agreement to ensure that the limitation period will not be triggered as soon as the money is advanced. He or she can also flag any other potential issues and help you understand your rights and protect your interests under the agreement.

If you have already loaned money without formalising an agreement, you may still be able to extend the limitation period by obtaining an acknowledgment of the loan or requesting that the borrower enter into a loan agreement.

Legislation in each jurisdiction has provisions enabling the limitation period to ‘re-start’ upon acknowledgment or confirmation by the borrower of the debt. In Western Australia, confirmation must be received before the expiration of the six-year limitation period and is established by the borrower either confirming the debt in writing, or making a payment of principal or interest under the loan. The limitation period is reset from the time that the confirmation is received.

Timing as to when confirmation may be obtained, and the evidence required to establish acknowledgment of debt varies between States and Territories. Your lawyer can explain the applicable rules in your area.

Conclusion

Loaning money informally without a fixed date for repayment can lead to unintended consequences – if a lender decides not to request repayment of the loan within six years after it is made, it may become impossible to recover the funds.

If you are in a position to help out a friend or family member by lending them some money, that’s great news. But be aware, a loan that falls into the legal definition of a loan payable on demand, may become a loan never repayable.

All financial transactions, even the ‘friendly’ ones, should be in writing to ensure that the parties are aware of their obligations and the lender is properly protected.

If you or someone you know wants more information or needs help or advice, please contact us.

 

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