Lending to Friends or Family is Tricky
Friends and family want to help each other out, but if they are not careful, they could end up with financial disaster when the borrower-friend gets into financial trouble or files bankruptcy. Lending to friends or family is a tricky situation.
A recent bankruptcy case from Texas, In re Dahlin, illustrates this very well. Husband and Wife were divorced and under the divorce decree, wife got the marital residence but had to stay current on the Wells Fargo mortgage, for which husband remained liable. She fell behind and Husband exercised his right under the divorce decree to file for foreclosure. Wife decided to put an end to this by borrowing money from her friends, Mr. and Mrs. Dale, to pay off Wells Fargo. The Dales did this right away by a wire transfer. However, unlike a bank, they did not insist on getting a Promissory Note and Mortgage on the property at the same time. Wells Fargo recorded a Release of Lien. The property was now free and clear. The Dales pressured Wife to sign a new Note and Mortgage to them but she stalled. Then the house was destroyed by fire and Wife filed an insurance claim. Two days later, Wife finally went to an attorney to prepare a Note and Mortgage for the Dales. Unbeknownst to them, she was also finalizing a bankruptcy with the same attorney. Wife then sent the Dales their executed Note and Mortgage, which they recorded one day after Wife filed for bankruptcy. Wife got over $333,000 in insurance proceeds and claimed them as exempt so she would not have to turn the money over to her trustee.
The trustee laid claim to the money, and by agreement the money was deposited with the court until the issues could be resolved. The Dales and the Trustee each claimed a superior right to the insurance proceeds. The Dales lost. The reason is that the bankruptcy trustee had certain “strong arm” powers including all the rights of a good faith real estate buyer of the property on the date the bankruptcy was filed. Since on that date the Dales had not recorded their mortgage, the Trustee won. The Dales assertion of various equitable remedies including constructive trust could not override the Trustee’s powers.
The moral of this story is to “think like a bank” when lending to friends or family. Had the Dales done this, they would have made sure they had a mortgage ready to record at the same time they paid out money. Just like a bank, they also should have required that they be listed as co-insureds on the fire insurance policy for the home. Had they done this, they, not the Trustee, would have gotten the insurance proceeds. Instead, they can only file a claim and will have to share the money with all Wife’s other creditors.
Another moral here is to get your own legal advice in these situations. It may be the best money you ever spent. Contact a bankruptcy attorney in our office at 856-596-2828 for expert legal advice.