How is debt dealt with in divorce? The difference between “soft” and “hard” loans

March 24, 2022

A recent case before the Family Court provided some helpful guidance on how debt should be dealt with in financial settlements following divorce together with the difference in the treatment between “soft” loans and “hard” loans.

It is quite common that in a marriage either one or both spouses will have incurred debt of some kind, whether formally through a commercial arrangement with the likes of a bank or more informally by borrowing money from family members.

Upon divorce and separation, it is not unusual for spouses to laden themselves with more debt as their financial circumstances have to adjust and outgoings increase.

When considering what a fair financial settlement looks like, there can be the question of what to do with the debt and whether or not allowance should be made for certain debts to be repaid from the assets available.

In P v Q [2022] EWFC B9 both spouses had incurred debts.  The husband alleged that during the course of the marriage, his mother had lent him £150,000 to help with purchasing a home.  He alleged that there was an expectation that when his mother was no longer able to look after herself into her old age, the money would be re-paid to her.  There were no document to record the loan.

After the husband and wife separated and during the course of negotiations, the husband, without any demand from his mother, repaid the sum of £150,000 to her and asserted that it represented the repayment of the loan.

The Judge did not accept that the £150,000 was a “hard” loan from the husband’s mother which required repayment.  The husband’s mother gave evidence during the Court Hearing and when pressed, explained that she could not envisage any circumstance in which she would pursue the loan as a debt by way of litigation.

The Judge therefore decided to ‘add back’ the sum of £150,000 onto the Schedule of Assets (as if the husband had not made the payment back to his mother).

What is the difference between a ‘soft loan’ and a ‘hard loan’?

Within his Judgment, the Judge set out a number of points which can be considered to help determine whether or not a debt can be included or excluded from the Schedule of Assets:

1. Once a Judge has decided that a contractually binding obligation to a third party exists, the Court may consider whether the obligation is hard or soft. If it is a soft obligation, the Judge may decide, as an exercise of discretion, to leave it out of the Schedule of Assets and Liabilities.
2. There is no hard or fast test as to whether or not a loan will fall into one category or another and each case will be facts specific.
3. A common feature of cases comes down to the question of whether or not it is likely, in reality, that a debt obligation will be enforced.

Other factors to consider (though not an exhaustive list) include:

1. Is it an obligation to a finance company?
2. Do the terms of the obligation have the feel of a normal commercial arrangement?
3. Does the obligation arise out of a written agreement?
4. Is there a written demand for payment or threat of litigation and/or actual litigation?
5. Has there been a delay in enforcing the repayment of the debt?
6. Is the amount of money such that it would be less likely for a creditor to be likely to waive the obligation either wholly or partly?

The Judge went on to consider features which could lead a Judge to conclude that a debt obligation is in the category of “soft” loan:

1. It is an obligation to a friend or family member with whom the debtor remains on good terms and who is likely to want the debtor not 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. Is the amount of money such that it would be likely for the creditor to waive the obligation either wholly or partly? However, the amount of the debt, is not necessarily decisive.

Careful consideration will be needed in each case as to how particular debts should be treated. Attention should be given to how loans are structured and formalised, particularly if the spouse has borrowed money from family or friends.

Dominic Lee

John Hooper & Co

22.03.22