During the COVID-19 pandemic, friends and family members may agree to loan money to friends or relatives.
Even though the return of the money may not be the main consideration at this time, there are some key steps that should be taken to protect any funds that are loaned.
As a result of the COVID-19 pandemic, many otherwise completely viable businesses have been pushed into financial hardship. Even with the wide range of stimulus measures in place, some businesses will require additional capital to weather the storm but have a reasonable expectation of emerging on the other side. Furthermore, people with otherwise stable jobs have found themselves stood down or made redundant.
If you are considering making a loan to a friend or family member and even if you have considered their financial position and you are reasonably confident that they or their business has good prospects, you should take some form of security to better protect the funds that have been loaned.
Generally, for a lender, taking some form of security will leave them in a far better position than they would otherwise be in if the borrower becomes insolvent.
The most common forms of security a lender should consider when making a loan to a small to medium business will be one or both of:
In both instances, the value of the securities will still be limited by what secured creditors are already in place (for instance if there is already substantial bank debt). But as a general rule, being a secured creditor, even behind a bank, will generally place a lender in a much stronger position than an unsecured creditor.
Once you make the decision to take some form of security, it is vitally important that you properly document both the loan and the accompanying security documents.
A security is generally only as good as the underlying liability to pay a debt, so it is important that the loan agreement itself is enforceable in all respects.
The important thing to remember is that you are not drafting this document to put oppressive obligations on your friend or family member but, rather, to protect your interests.
In other words, you are drafting the document so that you can potentially enforce against a liquidator and also to rank ahead of ordinary unsecured creditors. It is to protect your money against claims by third parties.
This generally means properly documenting all of the key loan terms such as:
Even if you do not have particular expectations around the time for repayment, we generally recommend that you nominate a time for repayment in the loan agreement, as this gives certainty and increases the enforceability of the loan.
If you reach the stated time and your friend or family member is still running the business, you can always provide an extension if required.
By properly documenting the arrangement and any securities, you are both providing your friend or family member much needed support and by properly documenting the transaction and taking appropriate security, you are protecting yourself.
In the instance that you need to rely on that security, generally it will not be a circumstance where you are taking money from your friend or family member but instead you will be protecting it from other third party creditors that would otherwise share in it.
The information in this blog is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. It is not intended to be comprehensive nor does it constitute legal advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstances.