Bankruptcy & Lending To Friends: Watch the Paperwork

by Wendell Sherk, Missouri Bankruptcy Attorney

It’s not unusual for folks to get loans from friends and family when they’re in financial trouble or facing bankruptcy.  But it’s good to do the paperwork right sometimes.

If mom is going to lend you money to buy a car, she should act like the Bank of Mother and take the time to do the paperwork to make it a proper car loan, for example.  Depending on your state laws, this will often mean that you have a real promissory note that includes a security agreement — a pledge — of the car as collateral for the loan.  And mom’s lien should be recorded on the car’s certificate of title, just like a bank would.  At the same time the loan is made.

These sorts of details can protect mom’s right to collect the debt — and potentially make it easier for you to keep the car if you have to file bankruptcy some day.

What happens when you don’t jump through the paperwork hoops?  Sometimes everyone loses.  (At least everyone you care about!)

Take for example the recent case where a friend had taken out a mortgage on property from a friend.  The paperwork had been done correctly originally.  But later on, the friend lent more money.  Initially to help out with the borrower’s payroll but then the borrower used the money to pay the real estate taxes on the property.

When the borrower filed bankruptcy, the trustee believed there was enough equity in the property to sell it to make money for the other creditors.  The lender-friend claimed there was no equity — and therefore the trustee shouldn’t sell — because he had paid the real estate taxes (with the new loan) and added that to the balance of the mortgage was eating up the equity.

The 8th Circuit Bankruptcy Appellate Panel allowed the trustee to sell.  It pointed out that the lender-friend had not complied with the actual loan contract — he had not paid the taxes himself and added it to the loan — but rather had made a new loan to his friend, who could have used it for other things including the original purpose (helping meet his payroll).

So the friendly lender would not have his new loan secured by the property, would not get that money back and the debtor lost the property.  All because two friends acted like friends do, helping one another out in a tight spot.

The moral to the story is that friendship is friendship.  And lending is… business — treat it like a business.  That way, no one else can step in and ruin your friendship later.

The case mentioned here is VanCura v. Hanrahan (In re Meill), #10-6019 (8th Cir. BAP 12/30/10) (slip opinion).

Wendell J. Sherk is an attorney in St. Louis, practicing primarily in consumer bankruptcy and debtor representation.  He graduated from Washington University in 1986 and Washington University School of Law in 1989.  He is a principal of the firm Sherk & Swope, LLC as well as a member of the National Association of Consumer Bankruptcy Attorneys, American Bankruptcy Institute, and The Missouri Bar.  He contributes to the blog and his e-mail is: [email protected].

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