It is quite common for many of us to make loans to family members and friends, or for loans to exist between us and our family company or family trust.
For many of these loans, it is also quite common that the terms of these loans are not documented, that they are interest free and that there is no specific arrangements reached regarding repayment so that a loan is repayable when the lender wants it back. In other words, the loan is repayable on demand.
How does the law apply to loans repayable on demand?
The making of a loan between the lender and the borrower creates a contract between them. A loan which is repayable on demand (i.e. one where no time for repayment is specified, or expressed to be “payable on demand”) creates an immediate debt so that the lender can commence legal action for its recovery at any time after the loan was made. This means that the lender’s right to recover the loan commences as soon as the borrower receives the money. Section 14 of the Limitation Act states that a legal action under a contract cannot be started after six years from when the right to take the legal action arose. Section 63 of the Limitation Act states that a right to recover a debt is extinguished at the end of that six-year period. In other words, after six years from the making of the “payable on demand” loan it is not only not recoverable by legal proceedings, it actually ceases to exist for all legal purposes.
What are some unintended consequences of this law regarding loans repayable on demand?
The following are some examples:
- Family Law – a father lends his married son $200,000 to buy a house. The understanding is that the money is repayable on demand and the loan is not documented. Eight years later the son’s marriage breaks down and the wife contends that the money was a gift and not a loan. Because of the effect of the Limitation Act the loan is not recoverable by the father with the result that the father potentially ends up with nothing, the son’s property pool is not decreased by the loan and the wife is able to make a claim on the asset pool without considering the reduction to it by the repayment of the loan.”
- Wills and Estates – an elderly mother with three daughters, lends one daughter $300,000 to buy a house. Because of the trust between the parties the loan is not documented. Eight years later the mother dies and the daughter who received the loan disputes the validity of the loan with the result that the mother’s estate was diminished by the $300,000, which the borrower daughter should have repaid. The defaulting sister received her one third share in the estate, plus the benefit of the $300,000 loan she was not obliged to repay.
The moral of the story is, when lending money, particularly to family members or friends, get legal advice and get the loan documented in an enforceable way. If a loan has already been made, repayable on demand, we would recommend that you obtain a “confirmation” of the loan as soon as possible. Section 54 of the Limitation Act states that if a confirmation is made, the time that has elapsed between the making of the loan and the confirmation does not count in the six-year limitation period and the six-year period starts on the date of the confirmation.
The confirmation can be obtained by the borrower making a payment of interest, the borrower making a part repayment of the loan or the borrower providing a written acknowledgement that the loan was made to him or her and the written acknowledgement is dated. The limitation period would start from the date of the written acknowledgement. Also, if a loan repayable on demand is made by way of deed, there is a twelve-year limitation period, rather than a six-year limitation period.
It pays to get good legal advice! If you need advice about any kind of loan prior to or after the loan is entered into, call Paul Pritchard on 9543 1444.