Parental loans to children – what could possibly go wrong?

A recent NSW Court of Appeal case highlights the need to carefully document parental funding arrangements. The case involved a father funding his son’s and daughter-in-law’s house purchase. The issue, whether the funding provided was a gift or a loan, arose after the couple separated.

Background to the loan

Adrian and his wife Justine signed a contract to buy a home in Sydney. They signed a pre-nuptial Financial Agreement which provided that Adrian would keep any property given to him by his parents. Adrian was to be the 87.5 % tenant in common owner and Justine the 12.5 % owner of the property because of the money the father was providing.

Statutory declaration of gift

Adrian’s father paid the deposit to the agent by a personal cheque and paid the stamp duty. After the auction, he asked his bank to arrange a bank loan for the couple for part of the purchase price. He told the bank he would gift $1,200,000 to Adrian and Justine, making a statutory declaration to that effect. Lending banks often insist on this to improve their lending position.

Letter to lawyer describing loan

Adrian and Justine made a formal loan application, attaching the father’s statutory declaration. The couple later wrote to their lawyer (also the father’s lawyer) instructing him that the father was lending $1.2 million towards the purchase and showing that Adrian’s large 87.5% share in the property was based upon that loan to him. The father instructed the same lawyer to prepare a second mortgage for his loan.

2nd Mortgage to the Father

Adrian and Justine signed the second mortgage in favour of the father. The second mortgage showed Adrian was being loaned the money by his father. Justine signed an acknowledgement of the loan, witnessed by the same lawyer.

At the settlement, the bank provided $400,000 secured by a registered first mortgage and the father paid the balance of $977,714, secured by the second mortgage.

Marriage breakdown

After the marriage breakdown, the father demanded repayment of the money he had provided and commenced Supreme Court proceedings for possession of the home. Justine claimed the funds were a gift to Adrian, not a loan. She succeeded at first instance and the second mortgage was ordered to be discharged. The father appealed.

Family Law proceedings – wife claims money was a gift

In the meantime, there were Family Law proceedings between Justine and Adrian. If the father’s money was a gift, Justine could claim it was part of the matrimonial asset pool. The Family Court ordered the home to be sold, the bank was paid out and the balance (the father’s share) held in trust, pending the outcome of the Court of Appeal proceedings.

Court of Appeal declares money from father to be a loan

The Court of Appeal allowed the father’s appeal. The deposit payment was held to be a gift by the father, but was conditional on completion of the purchase contract. The Court found it to be “unequivocally” clear that the payments were a loan to Adrian, payable on demand, secured by a second mortgage over the property. The Court of Appeal said Justine suffered no injustice, as she obtained an opportunity to acquire a share in a property, with no personal exposure under the second mortgage and that she understood the second mortgage obligations.

The importance of planning and documenting loans

Anyone planning to assist their children to buy a property should consider the risk that a future partner or a creditor might make a claim on the asset funded by the parent. If the arrangement is not properly documented, it is likely that the contribution will be deemed to be a gift and, if the worst happens, the money could be lost to both the parent and the child.

 

Disclaimer

This article was written by Margaret Miller, partner at Bell Legal Group. It is general in nature, is not legal advice and must not be relied on as such. If you need assistance relating to the topics discussed, please contact Margaret to obtain advice specific to your circumstances. Call 07 5597 3366 or send an email to mmiller@belllegal.com.au