Avoid the risks of undocumented loan and security agreements

By Ryan Doll, Lawyer

MST Lawyers is often asked to advise in respect of loan and security agreements that were not documented at the time that money was advanced.

While unwritten arrangements are common between “friendly” parties such as family members, or a company and its directors, matters can be confused over time by factors such as:

• changes in the relationship between the lender and the borrower;
• the death of party;
• disagreement as to the terms of the loan or the security;
• the involvement of third parties, such as liquidators, administrators, bankruptcy trustees, or deceased estates;
• the borrower’s obligations to other creditors; and
• legal requirements and time limits for registering securities such as a caveat or mortgage over land, or a collateral agreement in respect of other property.

Failing to document a loan agreement can have significant consequences as a party may be unable to prove that a debt is owed, or the terms on which the debt is to be repaid.

Similarly, failing to document and register security arrangements (for example by registering a caveat over property, or by registering a security interest on the Personal Property Securities Register (PPSR)) can be disastrous, as:

• the lender may be unable to prove that security was offered by the borrower;
• the lender may become an ‘unsecured creditor’ in the liquidation or bankruptcy of the borrower, receiving cents on the dollar instead of full repayment; and
• the lender may lose priority of payment to other creditors of the borrower who properly document and register their own security arrangements.

The following circumstances may arise if loans or security agreements are not properly documented or actioned:

Example 1 – Loan to Family Member

 Parents loan $200,000 to their daughter in order to fund a property purchase with her husband.

• The loan is interest free and the parties agree that the loan shall be repaid if the daughter separates from her husband or when the property is sold.
• The loan is not documented and no security is put in place. Twelve months later the couple separates.
• In divorce proceedings, without a written loan agreement the court may hold that the $200,000 was a gift from the parents rather than a loan. Consequently, as part of the separation, the $200,000 may form part of the matrimonial estate to be divided between the daughter and her ex-husband.
• This could have been avoided if the loan was evidenced by a written agreement and/or if repayment was secured by a caveat registered against the title of the property.

Example 2 – Director Loan to Company

• A café owner wants to inject working capital into their struggling business. The business is run through a Pty Ltd company of which the owner is the sole director and sole shareholder.
• The director borrows $100,000 against their house (granting the bank a mortgage) and loans this sum to the company. The loan is recorded in the company accounts, but no security is put in place.
• The company has significant other debts, including to finance companies and trade creditors. These creditors have secured their debts against the assets of the company by PPSR registrations.
• Six months later the business fails and the company enters liquidation. The liquidator sells the company’s assets and pays the secured creditors in full. With no security in place, the director is an unsecured creditor of the company.
• Insufficient funds remain to pay the unsecured creditors of the company. The director receives only $4,000 out of the remaining funds. Despite this, the director must continue to service the $100,000 loan from the bank or risk losing their house.
• This could have been avoided if the director had been a secured creditor by way of a loan agreement with security over the company’s assets registered on the PPSR.

 HOW CAN MST LAWYERS HELP?

Documenting loan and security arrangements creates certainty as to the terms of the agreement and the rights of the parties. Best practice is to take this step at the time of making the agreement, however, if you have not done so, you may still be able to protect yourself by a Deed of Acknowledgement of Debt which confirms the terms of the existing loan and enables the lender to register any agreed security.

If you are party to an unwritten loan agreement – or if you are considering entering into a loan or security arrangement – MST Lawyers can assist by providing specialist advice in respect of your rights and by preparing simple, cost-effective documentation to evidence the terms of the loan and any security.

Please contact Ryan Doll from MST Lawyers’ commercial team on +613 8540 0214 or at ryan.doll@mst.com.au.