Law on giving safe friendly loan in India

What is a friendly loan?

A friendly loan is basically lending money to your friends or relatives for a personal reason like to help them in the time of financial difficulties. They are considered a loan between individuals and are not typically classified as a commercial transaction.  A loan to a family member or a friend is usually an unsecured loan and the terms and conditions are basically undefined or indeterminate and demanding payback is often difficult. And if the loan goes bad, the relationship also sours. Moreover, such a loan is usually interest-free. This means you lose money.

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What Are the Types of Friendly Loans?

There are two types of friendly loan, unsecured friendly loan and secured friendly loan. As the name explains, if the borrower fails to repay the loan as agreed, legal action can be pursued only if the debt is secured. Unsecured loans can never be successfully enforced. Let's take a deeper look at the key differences between them:

Unsecured friendly loan

There are no written documents to back up this form of loan. It is solely discussed verbally, and there is no legal recourse against verbal proceedings. This form of financing is solely based on friendship and trust.

Secured friendly loan

A secured loan is one in which the borrower puts up an asset as collateral. If the borrower is unable to repay the loan, the lender may repossess the asset, whether it be a car or a piece of jewellery. This approach is similar to the long-gone practice of barter loans. It is best to include a contract in writing known as a 'promissory note' for secure transactions. It isn't an official contract, but it does provide legal support. A promissory note is non-negotiable to ensure that all parties comprehend the favourable loan terms. This notice should include the loan amount, interest rate (if applicable), repayment schedule, and deadline and repercussions to be taken in case of non payment of the loan

Is there any legal document so that you can clearly define the terms and conditions of a friendly loan?

There are two ways of doing this:

• PROMISSORY NOTE (or)

• LOAN AGREEMENT

A Promissory note is a written promise to pay a debt. It is a financial instrument, in which one party promises in writing to pay a determinate sum of money to the other, either at a fixed, determinable future time or on demand of the payee subject to specific terms and conditions. If you wish to keep it simple and only for the record, go for a promissory note. This instrument comes under Section 4 of the Negotiable Instruments Act, 1881, and has to be signed by the borrower. A Loan Agreement (Loan Contract) acknowledges that there is a loan, a specific promise to pay, and also states that the lender has a right to recourse. An example can be a FORECLOSURE. If you want to have a right to recourse, then go for a Loan Agreement instead of a Promissory Note.

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What is the tax implication on loans between friends/family?

A friendly loan is generally without any interest and there is no provision to charge any notional interest on the same. But if you charge an interest rate then the interest earned on a loan has to be treated as “ Income from other sources.” This income should be shown in your (lender) Income Tax Return. If you borrow money from your friend/relative to construct a house, the repayments are not eligible for tax deductions. Tax deduction under Section 80c with respect to principal repayment is not allowed. But Tax benefit under Section 24 of the Income Tax Act can be claimed as a Tax deduction with respect to Interest paid on a loan. The main criteria is & lsquo the loan should not be for personal use. Gifts from family members are not taxable, and neither are the loans. But any gift above Rs 50,000 from a friend during a financial year is taxable. However, if it's a loan (with or without interest), it becomes tax-free.

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What precautions should be taken while lending/accepting friendly loans?

• All loan transactions should be by account payee cheque or bank draft

• If you are giving a loan that is interest-free ensure that the loan is out of your own savings and not from interest-bearing borrowed funds.

• Be cautious regarding the creditworthiness of your lender.

How to Take Legal Action for the Recovery of a Friendly Loan?

In order to recover a friendly loan, the lender may send legal notice to the borrower. Before initiating any formal legal action, this notice will be given. It is not difficult to file a lawsuit using a promissory note, despite what many people think. According to law, any written agreement is proof. Usually, it is not required to file a lawsuit in recovery cases because most of them are settled after a legal notification is sent. To do this, a professionally written and legally sound notice must be sent. You will have the best chance of getting your money back and a timely response if you do this.

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Documents Required to Send a Legal Notice

A legal notice is basically asking the borrower to give your money back or else legal action will be taken against them. A legal notice must have-

• A legal notice is insufficient if it doesn't contain the necessary paperwork:

• Affidavit or evidence of money lent to or due from you

• The amount that the other party agrees to give you has to be specified in the agreement.

• Any evidence that you are due money

• A practising advocate must review and sign the legal notification. The notice should also be carefully reviewed by the lender when it is drafted.

What Details Should a Legal Notice Cover?

A legal notice must-

• The legal notice must be drafted by an advocate in order to hold any importance.

• It must also provide the advocate's address and phone number.

• The notice's issue date, the borrower's name, address, and contact information, all need to be made very clear.

• It is also necessary to include the lender's name and details.

• The notice must specify how the other party's action or inaction violated your rights and that is the amount they need to return.

• The opposing party should be given a deadline to comply with, and if they don't, the matter may be brought before the judge.

• The notice must be signed by the lender and the advocate writing it.

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The Basic Format for Legal Notice

Ref no. Dated ________ REGD.A.D. LEGAL NOTICE To, __________ Dear Sir/Ma'am On behalf of my client __________, I do hereby serve you with the following Legal Notice:-

1. My client is a __________ firm/individual under the name of M/s __________.

2. My client is engaged in __________ business of the __________ etc.

3. My client did __________ and helped you in __________ way.

4. My client raised bills for each and every work performed for payment.

5. You have miserably failed to pay the liability of the principal amount of Rs. __________/- Hence, you are liable to pay Rs. __________/- alongwith interest @__% p.a.

6. My client is entitled to ? __________/- as a recovery from you.

7. My client has given you a chance upon chance to make timely payments, but your failure to do so lands you in this position.

I, therefore, through this notice call upon you to pay my client ?__________/- , along with future interest @__% p.a. A copy of this notice is saved in my office for record and to take future course of action. (__________) ADVOCATE

How can a Lawyer help you to recover a Friendly Loan?

A lawyer can help recover a friendly loan by drafting a legal notice demanding the money back, discussing and mediating with the borrower, bringing legal action where required, and, in the event that the case is successful, making sure the court's payback requirements are carried out. A lawyer ensures that all the legal requirements are completed and is able to understand the legal language better than a common man hence ensuring their client is not deprived of their rights.

Advocate Chikirsha Mohanty

Greater Kailash - 1, Delhi
5 years

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