This month’s blog post was written by Jessica Feldman Chittley, Partner at Bales Beall LLP.
Given the cost of real estate in Canada, parents often advance funds to their married children to assist them with purchasing their first home. Frequently, those parents want to protect the funds if their child subsequently separates from his or her spouse. There are many misconceptions about how to protect these funds. Ultimately, to have these funds returned to the parents or the child upon separation, parents must undertake certain actions at the time of the advance.
Before we get into the specifics, it is helpful to summarize a few basic family law concepts to discuss meaningfully the characterization of a gift versus a loan.
Equalization
In Ontario, the legislation that governs the division of property at separation seeks to equalize the two spouses’ increase in net worth throughout the marriage. Both spouses calculate their respective net worth at the date of marriage and the date of separation. The difference between those values is referred to as the net family property. The spouse with the higher net family property pays the spouse with the lower net family property an amount to equalize their net family property values. This equalization payment has the effect of equalizing the growth of each spouse’s net worth during the marriage.
Exclusions for gifts
While a gift or inheritance received during a marriage is excluded from the net family property calculation, where that gift/inheritance is put into the matrimonial home, through the downpayment, mortgage payments, or renovation, the exclusion is lost. A matrimonial home is any property the married couple ordinarily occupies. This means what would have been excluded from sharing with a spouse upon a separation, is now subject to the equalization calculation.
Protecting the advance
The only way for a parent to protect the funds they are advancing to their child to buy a house is either for the child and their spouse to enter into a validly executed marriage contract that details how the advanced funds will be dealt with in the case of a separation or for the parent(s) to enter into a real loan arrangement with their child. Far too often, well-meaning parents enter into “loan agreements”, which are not actually loan agreements. It is these questionable loans which are usually the focus of a matrimonial dispute.
In determining how to characterize the advance of funds in a family law dispute, the Ontario Court of Appeal has confirmed that several factors are to be considered. They include:
(1) Whether there were any contemporaneous documents evidencing a loan. This includes a written loan agreement or a promissory note. You would be surprised how many parents intend to gift their children funds to buy a house but then treat that gift as a loan upon separation.
(2) Whether any repayment terms are specified. Is the loan only to be repaid on demand? If not, is interest accruing? Is there a repayment schedule? The latter two assist a court in finding that the funds were actually a loan.
(3) Whether there is security held for the loan. It is not always possible for the parents to register the loan on title if there is a large first mortgage or a first mortgage with a floating line of credit. However, note that registering the loan as a charge on title will not be enough evidence on its own.
(4) Whether there are advances to one child and not others or advances of unequal amounts to various children. If parents have advanced $500,000 to each of three children, this looks more akin to a gift.
(5) Whether there has been any demand for repayment before the parties’ separation. A demand for repayment only because of separation makes it harder to prove the advance was a loan.
(6) Whether there has been a partial repayment. If there have been repayments by the child to the parent, this helps to advance the case the funds were a loan.
(7) Whether there was any expectation or likelihood of repayment. Parents should be cautious about what they say about the funds in front of their children and their spouses.
The funds must always be treated like a loan if they are to be treated like a loan upon separation. Judges have opined in cases on the subject that given loans are commercial transactions, it would not be unusual to have the lender (the parents) and borrower (the child) each obtain independent legal advice. Further, the child’s spouse should be made aware of the loan and its terms.
Parents also need to be careful about limitation issues. If the loan agreement includes repayment terms or interest, but the parents never insist on such payments, the loan could be statute-barred at the time of separation.
Further, the additional hurdle is that even if a Court determines that the funds were in fact a loan, the full face value of the loan may not be included in the calculation of the child’s net family property for the purposes of equalization. This can occur if a Court finds that the expectancy of repayment is low. The more unlikely the debt would remain unpaid if not for a separation, the higher the discount that will be applied. The age of the parents and whether they need the funds to support their lifestyle are factors considered in this analysis.
So what is a well-meaning parent to do? A properly drafted marriage contract is the gold standard if parents want to protect the funds. If that is not possible, parents can enter into a loan agreement with their child (and ideally, the spouse as well). The loan would bear interest or have a fixed repayment schedule (or both) and the parents would collect on these amounts. A promissory note only payable on demand carries the risk that a Court will find the likelihood of repayment was low and the original amount will be largely discounted. Ultimately, it is best practice for parents to speak with a lawyer before they advance funds to their child. The cost of the advice will be far less than the legal fees spent in fighting over the characterization of the advance if the child later separates.
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