How is debt dealt with on divorce? Are all loans taken into account by a judge when it comes to financial settlements? Claire Porter explains that it may depend on the type and terms of the loan.
Personal debt is rising
The UK Debt Statistics Report undertaken by Aryza in October 2021 reported that the UK saw average personal debt rise by 11.93% between May 2021 – October 2021, with men having an average debt of £19,650.37, making up 43.48% of the total and women having an average personal debt of £16,287.37, making up 54.15% of the total. This increase in average debt level has been felt hardest in the younger age brackets with those aged 30-39 experiencing the highest increase in average debt level. It is therefore unsurprising that the issue of debt and how this ought to be dealt with by the parties on divorce is a common issue that needs to be resolved.
Will all loans be taken into account?
Within financial remedy proceedings, lawyers often describe loans as being “soft” or “hard”. The distinction between both can be determined by considering whether there is a contractual obligation to repay. A hard debt will be regarded by the court as due and payable however a debt where there is only a moral obligation to repay, are known as soft debts.
If a judge considers the debt to be a soft debt, the judge may exercise his or her discretion to leave it out of the schedule of assets and liabilities for division between the parties as he or she does not consider the soft debt a liability that needs to be repaid. This is often the case in circumstances where the lender is a friend or family member who remains on good terms and who is unlikely to want the debtor to suffer financial hardship. If the terms of the lending are informal or if repayment of monies due has not been enforced (i.e., there has been no written demand for payment despite the due date having passed), the court would be more inclined to treat it as a soft loan.
A recent case study
In the recent case of P v Q (Financial Remedies)  (10 February 2022) HHJ Hess helpfully summarised the principled application to loans from family members.
The court determined at final hearing whether monies advanced to the husband and wife by their respective parents were gifts or loans.
HHJ Hess derived the following principles:
- There is not any hard or fast test as to when an obligation or loan will fall into one category or another, and the cases reveal a wide variety of circumstances which cause a particular obligation or loan to fall on one side or other of the line.
- Analysis will usually target whether or not it is likely in reality that the obligation will be enforced.
- Factors which on their own or in combination point the judge towards the conclusion that an obligation is a hard obligation include (1) the fact that it is an obligation to a finance company; (2) that the terms of the obligation have the feel of a normal commercial arrangement; (3) that the obligation arises out of a written agreement; (4) that there is a written demand for payment, a threat of litigation or actual litigation or actual or consequent intervention in the financial remedies proceedings; (5) that there has not been a delay in enforcing the obligation; and (6) that the amount of money is such that it would be less likely for a creditor to be likely to waive the obligation either wholly or partly.
- Factors which may on their own or in combination point the judge towards the conclusion that an obligation is in the category of soft include: (1) it is an obligation to a friend or family member with whom the debtor remains on good terms and who is unlikely to want the debtor to suffer hardship; (2) the obligation arose informally and the terms of the obligation do not have the feel of a normal commercial arrangement; (3) there has been no written demand for payment despite the due date having passed; (4) there has been a delay in enforcing the obligation; or (5) the amount of money is such that it would be more likely for the creditor to be likely to waive the obligation either wholly or partly, albeit that the amount of money involved is not necessarily decisive, and there are examples in the authorities of large amounts of money being treated as being soft obligations.
- It is for the judge to determine, looking at all of these factors, and maybe other matters, what the appropriate determinations to make in a particular case in the promotion of a fair outcome.
What to take from the outcome
If a family member or friend loans you money, for example, to help meet payment of your legal fees as is often the case, it would be wise to enter into a formal loan agreement which creates a contractual relationship and ensures there is documentary evidence reflecting the intention behind the loan and the terms of repayment.
It should be made clear within the formal loan agreement whether interest is payable, whether security is to be provided and when repayment is due.
At a recent final hearing, we successfully persuaded the judge to award our client (the husband) a larger division of the net proceeds of sale of the family home due to the high level of debt he was obligated to pay to both commercial lenders and monies owed to his father for reimbursement of legal fees incurred in funding the case. The District Judge made a final order that the net proceeds of sale of the family home should be divided 74% to the husband and 26% to the wife.