Informal Family Business Arrangments Can Unintentionally Expose Assets To Creditors

Jon Alper Business Asset Protection

Business arrangements among family members are usually informal without full legal documentation. Casual business dealings among family members work fine between the family members themselves as long as the family relationships are on good terms. But, when the same family members have creditor problems an informal family business dealing can lead to problems when proper documentation is lacking. Consider a caller who described a property he purchased with his parents. The deed showed the parents and a child each had an undivided 50% interest in the property as tenants in common. This means that each 50% interest is separate from the other 50% interest. The parents paid cash for their interest. The child borrowed 50% of the purchase price to pay his part of the purchase. The child made all the mortgage payments by himself. The bank demanded a mortgage on the entire property, not just the child’s half, to secure the loan. The property has not changed value since the purchase.

Now, the child has a potential creditor. The child wants to know if his half interest is fully protected by the mortgage and whether; the creditor can reach any part of his parents’ share of the equity. There is no written agreement among the family members expressing who is liable to pay the mortgage.

The family intended that the child would be fully responsible for the mortgage and that the mortgage would be paid first from the child’s share of the property before the debt would affect the parents’ interest. It would help if the family reduced the agreement to writing. Even with a written agreement, once the bank insisted on a mortgage of the entire property (as most banks would do) then the mortgage security applies equally to the parents and the child’s 50% interest. Each partner, the child and the parents, have an equal amount of equity in the property equal to about half the fair market value. I think the child’s creditor could levy upon the equity in the child’s undivided interest. The creditor could probably force a sale of the property and take half the net proceeds after payment of the mortgage.

The strict legal interpretation of this arrangement is that the parents gifted 50% of their contribution and 50% of the equity to the child. Once the bank demanded a mortgage on the entire property the parents should have recorded a second mortgage and note due from the child to repay the parents’ contribution to the child’s 50% undivided interest. If the parents were to record their mortgage after the child had a creditor problem the mortgage could be undone as a fraudulent transfer.

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