Loans and Capital Distributions to Beneficiaries
Care is required in funding arrangements. In the last issue of Trust eSpeaking (September 2008), we discussed the scenario that often occurs when trustees provide funds to beneficiaries, for example, to help in the purchase of a house. This article further develops that theme, and considers how the funds made available to a beneficiary should be treated and, in particular, whether they should be provided by either a capital distribution or a loan.
A capital distribution, by its very nature, represents the absolute transfer of capital from the trust to the beneficiary with the trust losing control of the funds once they have been distributed. As the ownership of the funds has changed the capital is at risk of being treated as relationship property (and ultimately lost).
We recommend that, in most instances, the trust should lend funds to a beneficiary and ensure appropriate documentation is completed. If the beneficiary and their partner do separate, then the trust can demand repayment of the loan. When the loan is repaid, the funds would be held once again by the trust and could be dealt with at that stage in any way that the trustees thought appropriate, including re-advancing the funds to the beneficiary.
If trust funds are lent to a beneficiary, trustees must decide on how the trust should document the loan. The most likely methods are either to obtain a mortgage which would normally be registered against the title to the property being purchased, or to execute a deed of acknowledgement of debt.
If the funds are secured by a mortgage, then there is more security provided to the trust, subject of course to the value of the property. If the funds are secured by a deed of acknowledgement of debt (which is frequently the option chosen), then there is very little or no security provided. It is important that trustees discuss with their lawyer the type of loan documentation and security required.
If funds are lent, rather than the trustees agreeing to a capital distribution, there is an additional factor that may complicate matters. When a lender (most likely a bank) considers a loan application, it assesses the purchaser’s equity being contributed to the purchase. Many lenders will not treat trust loans as comprising part of a purchaser’s cash contribution, or equity, towards a purchase. In other words the lender will frequently treat trust advances as being further advances even if no interest is to be charged, and the lender may decline the loan application as the purchaser has contributed insufficient cash. In order to agree to the loan, a lender may require that the trust’s transfer of funds to a beneficiary be an absolute transfer, that is a capital distribution rather than a loan. However, as stated above, a capital distribution has property relationship division consequences.
It is strongly recommended that any sale and purchase agreement for a property be conditional on finance, and the financial condition in the agreement not be confirmed as having been satisfied until the lender’s loan offer has been carefully read and approved.
In summary, there are various options available for trustees to help beneficiaries purchase property. If you as a trustee want to help a beneficiary, then please consult us before doing anything.