Succession Planning for Farmers: Part Three – Your children paying the purchase price off by Vendor Financing
Earlier this year we launched our “Succession Planning” series. Our first two columns started with the basics and raised questions you should be considering when making your succession plan. You can review these here: Part One and Part Two.
In our last issue, we discussed the different ways your children could pay the purchase price to you if you needed them to pay a sum of money for the farm. One of the options we touched on was ‘Vendor Financing’.
If you are providing Vendor Finance you are essentially acting as a ‘bank’. Accordingly, you should ensure you have the same or similar rights that a bank would have if loaning money to a borrower. These rights should be clearly set out in a Loan Agreement.
The following case study illustrates what could go wrong if there is no written Loan Agreement in place to set out the terms of the Vendor Finance.
Farmer Joe wants to retire. He wants to hand down his farm to his son, Kevin. Joe has minimal non-farm assets so needs to receive money from the transfer of the farm in order to fund his retirement. Joe and Kevin agree that Kevin can take the farm now and pay Joe a sum of $500,000 for the farm over a period of 15 years. Joe doesn’t go to see his solicitor about this arrangement. They are happy to keep it as a hand-shake deal.
What could go wrong?
1. As there was no discussion about when Kevin had to make repayments, he has decided to pay Joe back by making yearly installments. This poses a problem to Joe who has no other income or assets to live off during the first year while he’s waiting for his first payment to be made. If Joe had a written Loan Agreement in place prepared by his solicitor, he would have had the opportunity to include a more regular repayment plan from Kevin.
2. If Joe had received the $500,000 up front, he would have been able to invest this and earn interest on it. Joe gets advice from his financial planner to collect interest from Kevin to compensate Joe. Kevin refuses to pay interest to Joe. Again, if Joe had a written Loan Agreement in place, he would have had the opportunity to set an interest rate payable by Kevin.
3. After some time, Kevin agrees with Joe to start making weekly repayments to him. However Kevin keeps forgetting to transfer the money on time to Joe. This often leaves Joe chasing him for payment. If Joe had a written Loan Agreement in place he could have included a clause allowing him to charge default interest if there were any late payments received to act as a deterrent for Kevin from forgetting to pay on time.
4. Kevin falls ill and is unable to work the farm. The condition of the cane drops significantly and affects his cane pays from the Mill. Kevin now has no ability to make the weekly repayments back to Joe. If Joe had a Loan Agreement in place, he could have made it a condition of the Vendor Financing for Kevin to hold Life, TPD and Income Protection Insurances to cover him in the event of him falling ill and not being able to run the farm.
5. As Kevin now owns the land, he goes to a bank and takes a loan out to fund building a new house and shed on the property. The bank takes a mortgage over the property and has no knowledge of the debt owed to Joe for the farm. Kevin fails to make the repayments to the bank on time (because of his illness) and the bank forecloses and sells the farm to recover their debt. They only recover enough money to pay the bank’s debt back. Kevin now has no farm and no income from the farm to pay back Joe his vendor finance. This could have been avoided if Joe had made it a condition of the Vendor Financing to secure a first ranking mortgage over the farm.
So as you can see, a lot can go wrong on a hand-shake deal, even when just between family members!
Next issue, we will continue to discuss Succession Planning for Farmers and explore the situation where you want to transition your children into the farming business gradually and provide some useful tips on how to go about this.
The content of this column is to provide a general guide on this topic. Professional advice should be sought about your specific circumstances.
For more information please contact our rural team.