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Things to keep in mind while drafting a family loan agreement

June 19, 2021
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This article is written by Srijita Adak pursuing Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

It’s regular for individuals to lend money to family or relatives. In spite of the fact that they never truly take thought of the security of these loans. Recording family loans by entering into a family loan agreement and taking security is significant. Security can be given as a mortgage of land or property. The family loan agreement gives the bank the choice to recover commitment from those assets deprived to various creditors. In the event that we don’t take security and our borrower fails, we may find that our borrower has numerous different lenders with whom we need to share their resources, achieving the awful loss of family cash. The current condition can be avoided by documenting appropriate family loan agreements. 

Many times, being unaware of the things related to family loan agreements we give money to our family members or relatives without guarantee but we often face financial loss. So, everyone should have the knowledge related to the family loan agreement to avoid any complicated situations where we cannot get the money back in life. Because if there is proper documentation of the loan with the interest percentage, the date of returning money, guarantee product, and what action could be taken if the person fails to return the money, the chances of getting the money back will be high and you will have the right to file a legal case.

What is a family loan agreement?

A loan agreement is a contract for lending/extension of money from one party to another party with the guarantee to repay the money. The party that lends/extends the money is known as the lender and the party that receives the money is known as the borrower. Examples of loans are home loan, education loan, car loan, marriage expenses, etc.

A family loan agreement is a document that allows the lending of money between individuals with relations by blood or marriage. Instead of simply lending money to a family member, with an official documentation this legally binding contract provides a blanket of trust for both the lending and the borrowing party. This is also called a promissory note which is a negotiable instrument that contains a promise to pay a certain amount of money on demand in the future. The parties in a promissory note are known as the payer/borrower who promises to pay and the payee/lender who is to receive the payment. Section 4 of the Negotiable Instruments Act,1881 defines promissory note. In spite of the fact that it is not obligatory, it’s better to draw the promissory note on stamp paper and get it notarised. Any legal official will verify it for a little expense.

Both loan agreements and promissory notes are lawfully binding and enforceable records that set out terms for the repayment of debts. But loan agreements are usually more detailed and complex and promissory notes are much simpler and easier to understand than a loan agreement. Normally, if there is a small sum of money involved and there is a lot of trust between the lender and borrower, a promissory note will be enough but if there is a huge amount of money involved and the parties are not excessively known to each other then a loan agreement is more legitimate.

Case laws

1. Chandabolu Bhaskara Rao’s case

In Chandabolu Bhaskara Rao’s case, the Hon’ble High Court of A.P held that since the promissory note is certifiably not an obligatorily attestable file, regardless of whether the marks of the attestors are taken, after its execution it doesn’t sum the material adjustment, thus it doesn’t get defiled. Hence, if there were attestors at the hour of its execution is insignificant, all the more so when its execution is conceded. 

2. Harihar v. I.T. Commissioner

In Harihar v. I.T. Commissioner case, the Madras High Court held that the document being referred to is certainly not a promissory note, on the grounds that there is no unconditional undertaking to pay a specific amount of cash.

3. Venkatasubbaiah v. Bhushayya

In Venkatasubbaiah v. Bhushayya case, by considering Section 35 of the Stamp Act, the Hon’ble High Court of A.P held that the promissory note executed in other State was responsible for stamp duty in the State where it was created, and for not paying important stamp obligation, the record would be forbidden.

Things to keep in mind while taking a family loan agreement

This loan is unconventional but still, we need to explain what it is for. The same way we would do if we were lending from a standard lender. When we reach out to our family member or friend, we need to ask them in person, if possible, otherwise, we should make a personal call to give them a thorough explanation by telling them what we need and why we need it.

We should consider the individual we are asking and his circumstance before we start inquiring. In the event that the relative or friend has faced some type of emotional harm or monetary unsteadiness, we ought not to connect with them for a loan as of now regardless of how close our relationship might be. We should ask the individual who has customary solid employment and who is monetarily steady throughout everyday life.

At the point when we conclude that we will ask either a relative or a friend for cash, we should think of this loan as professional as we would with an expert bank. When we request the cash and the friend or relative consents to the loan, we should look at when they might want to have the cash repaid. We should likewise inquire as to whether they might want interest on the credit or not.

Essential clauses of a family loan agreement

Family Loan Agreement follows the same principle as the other lending contracts and can be created with merely any terms that are agreed upon by both parties included- 

The effective date is the date when the agreement becomes binding on the parties. The date of the execution of the agreement may or may not be the effective date of the agreement. The effective date is the point at which the obligations the agreement starts. 

In the event that you neglect to meet your obligations to the agreement after this date, different parties included would now be able to sue you for breaking the agreement. So, it’s important to include the effective date of the agreement as that will determine when the obligations of the parties will start as per the terms and conditions of the agreement.

Every agreement has a section that contains the basic information to identify the parties to the agreement. This section mentions the details of the borrower and the lender. Details such as their full name, address, Company Identification Number (CIN) in case of a company, should be clearly stated. If there is more than one borrower, then the information of all the borrowers should be included in the agreement.

It is very important to give the details of each party because a mere mistake can change the whole thing. Also, in case of dispute, the relevant details of the parties are very essential.

The term of a loan is the duration of the agreement. In which the parties will decide the time till which the agreement is supposed to continue. It is very important to include the duration of the agreement i.e., how many months or years as it is closely tied with termination or renewal.

In this clause, the loan amount and the method of distribution of the amount, and the purpose of the loan have to be stated. This clause should be precise and verified properly.

We need to keep a receipt of all payments, preferably having them pay by check so a written record is established because sometimes after having a written agreement also we may find it hard to collect the loan money from the friend or family member. The good news is that if we have a written contract, we do have the ability to take this person to court. 

Whenever two friends or relatives end up acquiring or work together, there is consistently a danger for the relationship. It is justifiable that we needed to help them since we care for them exceptionally assuming it’s for something like credit for hospital expenses, our heart says normally to help. If we find that we have to track down our friends each month to get a payment, and they are not as sincere as we originally thought, the relationship may become damaged. We begin to take a different perspective of that person from a business point of view. 

When the loan was originally requested and we agreed to the terms, we knew that the situation had the potential to turn negative. Even if we have taken our friends or family members to court for their loan, we may still not receive all of what was originally loaned. If there is no written agreement on the loan, we may not be awarded any of the loans. 

It is one of the most essential clauses in a family loan agreement. This clause indicates how and when the credit is to be reimbursed by the borrower to the lender. It’s a basic condition that contains numerous information. The reimbursement can be a lump sum amount or on a periodical premise. The repayment can be made via cheque or another method as instructed by the lender or agreed by both parties mutually. Without a repayment date, any loan agreement will not be effective as it decides when the lending money will be repaid. In the absence of this clause, there will be no binding on the borrower to repay the loan. 

In casual lending, it happens many times that the borrower says they will pay on time but as years pass they don’t repay the amount. So, even in casual lending, if we lend money to friends or relatives, we should always ask for the repayment date.

Interest is the cost of borrowing money. Interest is usually expressed in annual percentage or percentage per annum, i.e., % p.a. Authorities are skeptical of interest-free loans, and if a loan is interest-free, the Internal Revenue Service will consider it a gift which means that the lender will have to pay taxes as if interest had been charged. However, whether or not you decide to charge interest can depend on a lot of variables such as the length of the loan, the amount of the loan, and much more before making your decision. Since family loan agreements are usually between individuals that know each other well they don’t always include interest as other common loan agreements. But when a family member or friend decides to charge interest, the loan cannot be viewed as a gift.  

Since we are reaching out to a family member or friend for a loan, we are seeking an option that we cannot otherwise afford. If a family member decides to charge an interest rate on a loan, they can charge at a rate of their choosing with room for negotiation. Because these are individuals that know us personally and understand our situation and the interest rate can be negotiated to a percentage that allows them to make the payments affordable. 

A family loan agreement can contain a default interest clause. This condition builds the financing cost that is payable on sums that are not paid when they fall due. The borrower is liable to pay certain changes which are decided by the lender as default interest for late payment. It is very beneficial for the borrower in case of late payment or default payment.

Other than this clause there are clauses like indemnification, governing law, dispute resolution, amendment, notification, signatories which are equally important.

Conclusion

Whether we are requesting the loan from friends and family or a direct lender, a loan agreement is a situation that should never be overlooked. Particularly in light of the fact that it can possibly cause negative strain on a relationship. In the event that an arrangement between friends or relatives can be met, supported, and paid effectively then the connection between the two parties can be effectively kept up. When an agreement is written out, it helps to safeguard the transaction, and ultimately, it can actually help preserve relations between people we have known for most of our lives. The value behind written agreements is preventing disputes from springing up in the first place.

Sample drafting of a family loan agreement

This family loan agreement (“Agreement”) is made on ___ day of ____(year) at___ (place);

BY AND BETWEEN

Mr. ___, aged ___ years, son of ___, Aadhar no. ____, resident of ___ (which expression shall unless repugnant to the context shall include his/her heir, representatives, executors, administrators, successors, assignees, etc.) hereinafter called the “Lender” of the FIRST PART.

AND

Mr. ___, aged ___ years, son of ____, Aadhar no. ____, resident of ___ (which expression unless repugnant to the context shall include his/her heir, representatives, executors, administrators, successors, assignees, etc.) hereinafter called the “Borrower” of the SECOND PART.

WHEREAS 

The Borrower being in need of money for the purpose of his family/business/personal expenses had requested the Lender to lend him a sum of Rs. 3,00,000/- (Rupees Three Lakhs) only for the period of 1 (one) month (i.e., ___ to ___). If in case the borrower fails to repay the amount within the stipulated period then the borrower has to pay 10% interest to the Lender.

Mr. ______                                                                                    Mr. ________

LENDER                                                                                       BORROWER

WITNESSES:

1.

2.

Reference


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