Debt and divorce

This article helps clarify when a debt going to be considered a divorce.

When family and friends lend money during a divorce, what happens to the debt?

Many people receive financial help from family or friends.  Commonly this is seen in the provision of loans to buy a house, investments, or simply to help with their legal costs.  During a divorce disputes frequently then arise about whether this money is a loan that needs to be paid back or whether it has in fact been gifted.

When is a loan or a debt considered?

Often in families and between friends people are reluctant to put documentation in place to clearly set out the position of the funds. This can lead to different people taking different views. The receiving person will often say that it is a loan, while their partner is more likely to say that it was a gift and therefore it is not expected to be repaid.  

To prove funds received are in the form of a repayable loan, you will have to show that there’s a debt that can be enforced.  Writing down a contemporaneous note at the time the loan is made is hugely beneficial.  Even more so if the document is signed by each party to the loan, and sets out the terms for repayment, including timing and whether any interest is to be attached. However, it still does not guarantee that a court will acknowledge the existence of the funds provided as a loan that is repayable.

‘Hard’ Debt & ‘Soft’ Debt

In divorce, there are two classes of debt:

A ‘Hard’ debt is one that the court views similar to a commercial debt arrangement this includes a loan from a bank, an outstanding credit card, or a finance agreement often for the purchase of a car/large furniture item.  A ‘Hard’ debt will be included in the assessment of the value of assets and factored into the division and settlement reached. 

A ‘Soft’ debt, on the other hand, is considered by the court to be one where the lender is willing to wait for the money to be repaid or might not expect to receive it paid back at all – often, the loan is made by a family member, usually a parent, ‘in advance of an inheritance at a future date’.  These debts are unlikely to be considered as liabilities having to be repaid unless there is a surplus of funds available after each party’s respective needs have been met.

Important characteristics of ‘Hard’ debt vs ‘Soft’ debt in divorce

There are no hard and fast rules governing what makes a debt ‘hard’ or ‘soft’. The Court will usually make this decision on the circumstance of each particular case and the decision can really affect how the financial settlement will be affected:

For a ‘hard’ debt:

1. The money will often have been borrowed from and repayable to a bank or a financial company.
2. The debt will be enforced if it is not repaid on the terms it was provided.
3. The debt will have terms similar to a commercial arrangement.
4. There is a written agreement covering the lending and repayment.
5. There is, or will be, a written demand for payment, a threat of litigation, or actual court action.
6. Once it is due for repayment, there has been no delay in enforcement of the payment.
7. The amount borrowed is a significant amount to the lender and is not one they would readily write off.

For a ‘soft’ debt:

1. The debt is to a family member or friend with whom good terms are kept.
2. The debt is provided informally and without commercial terms for repayment of the borrowed funds.
3. No written demand has been made for repayment, even if the due date for the repayment has passed.
4. The lender has delayed in taking any enforcement steps for non-payment.
5. The lender is likely to write off the debt.

The practical reality is that most debts will be a mix of these different factors, and will not fall easily into the explicit characteristics above.  A Judge must determine which characteristics of the debt are the most important. The classification of the debt will impact the financial settlement.

Where the debt is determined to be ‘hard’ this can create further problems. Within divorce proceedings, the court does not have the power to readjust the debt which is owed.  Nor do they have the power to shift the debt from one spouse to the other and so the Judge will need to decide how that debt will be repaid from the available assets.

Lender involvement in the divorce:

We are, more than ever, increasingly advising parties who have made loans – usually parents – as potential intervenors in other people’s divorces. This often results in them needing to be ‘joined’ to the divorce proceedings between the married couple to give evidence on the debt they have provided and can even result in separate proceedings to enforce the payment of the debt.

What can be done now?

Even if you or your family have provided funds to each other previously without any documentation in place, that doesn’t stop you from being able to address that now to ensure that the funds are protected and everyone is clear on the position.

To speak to one of our Family lawyers, contact us today.