Lenders Beware: Book Entries Alone May Not Be Enough to Evidence a Loan

Sometimes loans are not documented, especially when the two parties to the loan are family members or shareholders in a small business. However, the parties’ financial accounts may include a book entry relating to that undocumented loan. A recent NSW case demonstrates the importance of documenting loans properly and shows that a book entry in financial accounts that supposedly evidences a loan may not be enough. The case also reinforces the established legal position that if a loan is repayable on demand and not at the end of a fixed term, the limitation period for enforcing the loan (6 years in most Australian jurisdictions) will begin on the date on which the initial loan advance is made.

A mother took action against her son to recover $250,000. This was supposedly the principal outstanding under a loan that the mother made to her son in June 2010. The mother’s action also included a claim for interest at the rate of 8% per annum on the principal. The son denied that a loan had been made to him by his mother. Alternatively, he said that if a loan was found to exist it was time barred as the limitation period had run out. The son made cross-claims of his own against his mother, including for breach of fiduciary duty, fraud and deceit, relating to her supposed use of his cheque book to transfer sums to herself or for her benefit.

The financial statements of the son recorded the son’s loan from the mother as a liability of the son for four consecutive financial years. The tax returns of the son for those financial years claimed deductions for interest expenses, and the tax returns of the mother for the corresponding years disclosed interest income earned by the mother.

He said, she said

• The mother said that she had told her son words to the effect that “I agree to lend you the money that I have in a term deposit which is about to mature”.
• The son denied the existence of a loan agreement. The son said that, alternatively, even if there was a loan agreement, there was not an agreed repayment date. As there was no express term for repayment, the common law position was that any principal sum owing was to be repaid on demand and that any cause of action arose when the funds were advanced. As a result, the son said that the sum owing became time-barred under the Limitation Act 1969 (NSW) on 1 July 2016, before the mother’s claim was commenced. The son also said that his mother did not actually pay him the principal amount of the supposed loan. Rather, the supposed principal amount of $267,237 that was transferred to his bank account was from a bank account in the name of a family company of which his mother and father were directors.

The Court’s Findings

• Despite the accounting evidence of a loan from the mother to the son, the court was not confident that the son understood his balance sheet and tax returns. This was even though the son signed those documents and had the benefit in his taxation affairs that reflected the existence of the loan.
• Even if there was a binding loan agreement, the mother’s claim could not succeed, because the court was unable to find that the loan was repayable on a fixed date. As a result, any loan owing was to be treated as an immediate debt that was statute-barred six years from the date of initial advance.

Key Points

Where a loan is made between family members or shareholders in a small business:

• it should be contained in a written loan agreement to avoid any suggestion that the advance of money is something other than a loan (e.g. a gift); and
• that written loan agreement should ideally include an express repayment date (even if it may be extended from time to time by agreement), to minimise the risk that the agreement will not be able to be enforced because of the expiry of the applicable limitation period.

Read the case here.

Queries

For more information, contact any member of our Banking and Finance Team.

Disclaimer

This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.