A blank promissory note with a pen.

Court Required To Allocate Debts As Part Of Marital Estate

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

Promissory Note vs Red Flags with Family Member Loans

The attorneys at Graham.Law have litigated several 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, 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 that previously flowed was no longer considered 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 the wife with a future repayment that we all knew would never be repaid.

I had a conflicting outcome in a different case, where a wife and her brother testified that the $40K the brother transferred to the parties 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 that when the wife ultimately repaid the funds to her brother, she would have to do it from her share of the marital estate instead of the loan being treated as a marital debt and the repayment 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 indicates it was a legitimate loan, not a gift. The other important 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 members to be a loan? No, but it’s a good idea to have one, as the court will require some proof of the loan, and a contemporaneous promissory note is often sufficient evidence. Conversely, mere testimony that the funds were a loan is often insufficient.

The Colorado Court of Appeals recently denied a spouse’s request to treat funds transferred to her grandmother as a loan repayment because of a lack of evidence that the funds from the grandmother were a loan, as opposed to a gift. Wood (Unpublished decision). 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 it 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 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, ¶ 32 (Unpublished decision) (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) ensure 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 promissory notes, which are long and complicated. Promissory notes can be much simpler for a “friendly” loan between family members – just state who borrowed what from whom and how it will be paid back. There is no requirement 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 a licensed attorney in any other state, so I 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 promissory note is stripped of all except the basics – good enough to use for family members, but I would never suggest using it in a commercial setting.

Note that unless you start to pay the loan back immediately, you should pick a date when payments start, no earlier than the date of your final orders hearing, and maybe even a few months after that, to allow leeway in case the hearing is continued.

The Wood decision had another notable angle to it that we wrote about in a separate post, as it is unrelated to the promissory note/loan issue. But it similarly highlights the importance of putting on evidence of value by holding that a FERS pension cannot be divided without at least some evidence that it has value.

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promissory note

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