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What You Should Know about Small Claims Disputes Over Loans to Friends or Relatives

People often find themselves seeking repayment of a loan to a friend in small claims court. When a friend or relative asks for a loan, ask yourself, “Why me and not a bank?” The reason the person isn’t going to a lending institution is probably because she has bad credit or doesn’t make timely payments. So she turns to the Bank of Mom or Good Friend Financial Service.

The first question to ask the potential borrower is, “How and when will I get paid back?” Because the person is either a relative or a close, personal friend, you may be embarrassed to ask this question. Stick to your guns and get a commitment in writing.

Obviously, when these types of money transactions occur between parents and kids, it may be years before you ever see your money. Most parents forget about loans made to kids, rather than hauling them into court. But if a friend or more distant relative — who actually can afford to pay you back — defaults on the loan, then you have issues.

One reason to get your kid to acknowledge a loan in writing is to forestall issues with your other children. If you intend your children to share equally in your estate, giving one some bucks puts your other children at a disadvantage if you don’t get the money back before it’s time to settle your estate. The favored child may come in for a little — or a lot of —resentment.

Proving your case in court isn’t easy unless you take steps to actually treat your loan like a loan — writing up a legal document or promissory note and having it signed and witnessed. Without anything in writing, the issue becomes one of credibility.

The judge has to decide which story sounds more plausible — yours or the defendant’s. If you did do things properly, good for you — this will be much easier to prove in court and may actually inspire your friend or relative to pay you back sometime so you don’t have to go to court.

But alas, because the money is usually loaned to a family member or friend, people are reluctant to ask for a written document acknowledging the debt — after all, you wouldn’t want to reduce your personal relationship to some sort of business transaction, right? If she doesn’t pay you back, however, and you have no paperwork stating the amount or the terms, you’re in trouble, for a number of reasons:

  • You may have waited a long time to sue, in the vain hope that your friend would pay you back. If you wait too long, the defendant can claim that the statute of limitations has run, making the debt uncollectible in the court system.

  • If the defendant doesn’t admit the loan, proving the terms becomes difficult. Because you have the burden of proof, you have to prove your case. It’s amazing how many defendants get amnesia about the transaction or claim the money was a gift.

  • If you gave someone cash, you have to establish where you got the cash. Preferably, you took it from a bank account and not from under the mattress, so you can show the withdrawal of funds. If the money was given by check, then the issue is, why was it given?

  • You claim the money was a loan, but the defendant alleges it was a gift, presumably tied to the fact that both of you celebrate National Cupcake Week or the anniversary of the laying of the first transatlantic cable.

  • The defendant alleges she is being paid back for moneys she previously lent you, which of course there is an equal lack of documentation to prove. Or she uses the old reliable excuse that she’s being paid for odd jobs she did for you.

Don’t expect interest on the loan unless those terms are included in the written agreement. If you didn’t specify interest in your documents, the court may not grant you any or grant statutory interest. If you win and the judge awards interest back to the time of the loan, rather than the date of the judgment, you may actually get more than you would have designated in a promissory note.

If you’re loaning money by check, making a notation on the check such as “loan” is helpful. This also prevents your warm, close, personal friend from filling in the blank notation line with “gift,” or “repayment of loan.”

If you gave the defendant the money by check, make sure you have a copy of the check before filing your case. You don’t want to show up in court and have to ask for an adjournment to get the evidence you need. The judge doesn’t have to grant an adjournment and then you have to try your case without the necessary documents. This often results in a “loss.”

Because most banks don’t return the actual checks anymore, and some don’t even produce copies, getting a copy of the check is something to address early on. The best time to do this is when you first make the loan — request the check from the bank in anticipation that in a year or so you’ll be in court and need proof.

And remember that if the bank isn’t cooperative, you may need to get a subpoena from the court to have the bank records produced, causing further delay in your quest for justice.

Get a copy of the front and the back of the check. This helps prove the borrower received the money and cashed the check. This is especially true if you stupidly made the check out to “cash.”

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