Promissory Note Needed for Family Loan

A blank promissory note with a pen.

Court Required To Allocate Debts As Part Of Marital Estate

Upon dissolution, the trial court is required to “equitably” allocate the marital estate, which includes not just property, but also the debts acquired during the marriage. But that does not mean the judge has to accept what one party claims at face value – evidence is still required to prove a debt exists.

Loans From Family Members Raise Red Flags

I have litigated a number of cases where one spouse had an alleged loan from family members that he/she wanted treated as a marital debt, while the other spouse argued that the funds were gifts, not to be repaid, rather than loans. Why does this matter? If a spouse is allocated a $10,000 marital loan in her column, she will receive $10,000 more in assets to offset that liability. If it’s treated as a gift, then she receives no additional funds to repay the money.

Trial court rulings are all over the place. In one case I’ll never forget, the wife’s family had oil wealth, and had gifted her tens of thousands over the years (as well as her sister). Yet upon filing for divorce, the money which flowed was no longer a gift, but a loan the daughter was expected to repay. And despite the wife not including these funds as a loan on her sworn financial statement, and the lack of a promissory note, the court accepted they were loans and credited wife with a possible future repayment that we all knew would never actually be repaid.

In another case, a wife and her brother both testified that the $40K the brother transferred to the couple to buy a house was a loan, he was not wealthy and had to take out a second mortgage to lend the funds. Yet because there was no contemporaneous promissory note, the court treated the funds as a gift, not a loan. This means when the wife did ultimately repay the funds to her brother, she would have to do it from her share of the marital estate, instead of it coming from both spouses’ shares.

And the list goes on. If the couple has been repaying the funds to the family member during the marriage, that’s a pretty good indication it was a loan, not a gift. The other important piece of evidence is a promissory note, contemporaneously executed when the funds were transferred, not concocted after-the-fact.

Importance of A Promissory Note For A Family Loan

Is a promissory note legally required before the court will find money from family to be a loan? No, but it’s a good idea to have one, as the court will require proof of the loan, and a contemporaneous promissory note is often sufficient evidence.

The Colorado Court of Appeals recently denied a spouse’s request to treat funds transferred to her grandmother were a loan repayment because of a lack of evidence the funds from the grandmother were a loan, as opposed to a gift. Wood.1In re: Marriage of Koch & Wood (Colo.App. 2019) (Unpublished decision). And the court explicitly highlighted the absence of a promissory note as a problem.

Mind you, the facts were pretty unflattering for the wife. Immediately before serving the husband with the dissolution summons, she withdrew $35,000 from marital accounts and transferred them to her mother. The wife claimed that her mother had lent her the money in the preceding years to pay for her education, and therefore she was merely paying back this marital debt.

However, the court was more than skeptical, based not only on the timing of the payment, but also the absence of any corroboration that the original funds from her mother were actually a loan instead of a gift. And, as the Court of Appeals pointed out, “Maternal grandmother did not require mother to sign a promissory note contemporaneous with the loan.” Wood.2In re: Marriage of Koch & Wood (Colo.App. 2019), ¶ 32 (Cleaned up).

Finding the wife’s testimony not credible, the trial court allocated those funds to the wife, and the husband received an offset of a comparable amount. The wife appealed, and the Court of Appeals upheld the award.

Two takeaways: (1) don’t transfer marital funds to friends or family immediately before filing for divorce, and (2) make sure all intra-family loans are evidenced with a contemporaneous promissory note!

Sample Promissory Note?

A promissory note is, essentially, a promise to pay money to a person. If you take out a car or home loan, you have variations of them, long and complicated. For a family loan, they can be much simpler – just state who borrowed what from whom, and how it will be paid back. There is not a need to charge interest either, if the purpose of the note is to memorialize the loan  to prove the debt exists.

Here is a link to a sample promissory note that works for a loan from family in a Colorado divorce. I’m not licensed anywhere else, so don’t know how well it would work in other states, but you can search for all kinds of sample promissory notes on the web. And note that this is stripped of all except the basics – good for use among family, but not in a commercial setting.

FERS Pension Not Divided Without Evidence Of Value. 

The Wood decision had another notable angle to it, unrelated to the family “loan”, but similarly highlighting the importance of putting on evidence of value.

During the marriage, the husband was a federal employee who had undeniably contributed to FERS (the Federal Employees’ Retirement System). However, the wife did not obtain a copy of the FERS packet, nor put on evidence of how much he had contributed, how much the account was worth, nor how much the husband would receive upon retirement. She merely asked the court to divide the FERS.

Note – this is not quite as crazy as it may seem – courts will typically divide a “defined benefit” retirement plan  according to a coverture formula, with the marital share calculated by dividing the months of marriage overlapping service by the total months of service at retirement. In such cases, evidence of a specific value does not really affect how the pension is divided.

But in this case, the absence of any evidence of value whatsoever was fatal to the wife’s case, and the trial court declined to divide the FERS. The Court of Appeals upheld that order:

“A district court is required to find the approximate current value of all property owned by the parties. But when no evidence of the value of a particular asset is presented, there is no error in the court’s failure to include that asset in the property division. Without any evidence to show the value of father’s FERS defined benefit retirement account, the court did not err in failing to value or divide it.”

Wood.3In re: Marriage of Koch & Wood (Colo.App. 2019), ¶ 24 (Cleaned up) (Unpublished decision).

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