Treatment of Family Loans in Divorce and Financial Settlement Proceedings

Getting divorced and reaching a financial settlement can be hard, even where there are only two of you involved in reaching a financial settlement and securing a Financial Court Order. It can be even harder when family members have given or loaned money, with disputes over whether the money was a gift or a loan and how the loan should be treated in the divorce and financial settlement proceedings.

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The recent financial settlement Court case of P v Q (Financial Remedies) [2022] EWFC B9 (10 February 2022) has confirmed how the Courts should treat family loans in a divorce. The case emphasises the importance of extended family members taking legal advice if they intend the transfer of money to be a loan or want a gift to be ring-fenced in the case of separation or divorce.

Family loans in financial settlement proceedings

If a member of the extended family gives money to a husband or wife during their relationship then undoubtedly at the time of the gift or loan the money is very welcome. When a couple split up, family loans can complicate things where there is a dispute about:

• Whether the money was a gift or loan.
• Whether the gift was to the husband or wife or to the couple jointly.
• If the money was a loan, the repayment terms.
• If the money was a loan, whether the debt should be included as a debt in the asset schedule.
• If the money has been repaid to the extended family member because of the divorce, whether the money transferred to the relative should be added back into the asset schedule.
• Whether the extended family member should intervene in the financial settlement 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.

Expert divorce and financial settlement solicitors say it is best to:

• Get help from an experienced divorce and financial settlement solicitor. They will give you an unbiased view on whether the family Court will say the money is a gift or a loan. Whilst you may not like their 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 cost of arguing whether the family money was a gift or loan as you don’t want to spend more in legal costs arguing the point if the costs will be more than the amount to be gained in your likely financial settlement.

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. 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, particularly as the case was heard at a time when Russian forces were massing at the Ukraine border and there were expectations of share price volatility because the shares were held in an energy company.

Divorce and financial settlement proceedings were started in the UK. The wife said the husband had given his mother £150,000 to reduce the amount the wife would receive as a financial settlement. The husband said he had given his mother the £150,000 to repay a loan and that the money should not be added back into the asset schedule.

The judge acknowledged he had to consider the factors set out in Section 25 and Section 25A Matrimonial Causes Act 1973 together with any relevant case law when deciding how to split the assets and how to treat the family loan money.

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 particular relevance to family money and loans, the Court should have particular regard to:

• 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.
• The financial needs, obligations and responsibilities which each of the parties to the marriage has or is likely to have in the foreseeable future.

In the case of P and Q , the husband’s mother gave each of her three children the sum of £150,000 to help them with housing. No loan documentation was drawn up. There was no evidence that the husband’s 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 was in need.

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

The judge had to consider if 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 £150,000 was a loan.

The arguments didn’t stop there as the judge, using case law, then had to go on to consider the nature of the hard or soft loan to determine if the £150,000 should be added back into the asset schedule.

When looking at the treatment of loans in financial settlement proceedings, the judge said the family Court needs to consider:

• If a judge concludes there is a contractually binding obligation by a party to the marriage towards a third party, the Court should then consider whether the obligation is a hard obligation debt or a soft debt.
• There is no set test to decide if a loan amounts to a hard or soft debt.
• A common feature of family loan analysis in financial settlement proceedings is to consider if the obligation to repay will be enforced.
• Factors pointing to a hard loan include that the terms of the obligation feel like a normal commercial arrangement, there is a written loan agreement and a written demand for payment, a threat of litigation or intervention in the financial settlement proceedings, there hasn’t been a delay in enforcing the debt and the amount of money owed is such that it would be less likely for a creditor to waive the obligation to pay.
• Factors pointing to a soft loan include that the debt is owed to a friend or family member who remains on good terms, the loan is informal without a commercial arrangement feel to the loan, there has been no written demand for payment despite the loan repayment date having passed, there has been a delay in enforcing repayment, and 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.

Using these principles and looking at the facts of the husband’s loan from his mother, the judge concluded the loan fell into the ‘soft’ category of loan. For the financial settlement, that 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.

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 try to ensure your gift is either tax efficient for inheritance tax purposes or ring fenced and protected in case of divorce through the use of a loan document, preferably combined with a prenuptial agreement or postnuptial agreement.

For expert Divorce and Financial Settlement advice call our team of specialist divorce lawyers or complete our online enquiry form.