State repayment clearly when borrowing
Published 10/14/05

Borrowing from your boss may cause you problems if you are not clear on repayment terms or fail to pay the loan back. There are several issues that both parties should consider regarding such loans.

First, they should decide if it is to be an advance on wages, salary, commissions, or bonus. If so, there should be a specific written agreement between the parties memorializing this fact and authorizing specific credits or deductions from the employee's compensation to pay back the advance.

If the loan is not in the form of an advance against the employee's future compensation, then it is advisable to have the employee sign a promissory note in favor of the employer setting forth the specific repayment terms, stating whether interest is to be charged, and whether the loan can be prepaid without accruing interest for the remainder of the repayment period set forth in the promissory note.

A promissory note may provide either for payment on demand by the employer, or may provide for payments over a period of time, much like an automobile loan. However, a promissory note payable on the demand of the employer may be argued by the employee to have been intended as compensation rather than a loan.

If this is true, such a mischaracterization in the financial records of the employer could amount to fraud to creditors, and/or investors as well as tax fraud if the income is not reported on the employee's tax return.

While a true demand loan evidenced by a promissory note may be a perfectly legitimate transaction between the parties, given the unique relationship between employer and employee not shared by other creditors and debtors, the employer should be careful about the appearance of impropriety and may be better served by using a term loan rather than a demand loan.

If the parties do not agree to loan repayment through deductions from the employee's employment compensation under specific terms, then the employer may not offset the employee's compensation against missed loan payments and must resort to traditional creditor remedies to collect the loan.

Employers should also be careful about inconsistent characterizations of a loan. For example, if an employee is using the employer loan as a down payment for a house and the employee fails to disclose the transaction as a loan to the bank or mortgage company, an employer who assists in the mischaracterization may be subject to liability for the misrepresentation and may possibly provide a dishonest employer a facially valid defense to his repayment obligation by virtue of the employer's characterization of the payment as a gift or earned compensation rather than a loan.

Employees who do enter into such loans should also remember that unless they have a contract to the contrary, they are generally employed at the will of the employer. If in the future they are having difficulty in making loan repayments, they may be jeopardizing their relationship with their employer, on whose good graces the employee relies for the retention of his employment.

Federal bankruptcy law, 11USC§524(b) states that no private employer may fire or otherwise discriminate against its employee solely because the employer filed for bankruptcy and wiped out the debt owed to the employer. Yet this law does not prevent an employer from firing an employee for other reasons and the employee may find it difficult to prove his firing was solely because he failed to pay back the loan from his employer which was discharged through his bankruptcy.

J. Daniel Marr is a director and shareholder at Hamblett & Kerrigan, P.A. His legal practice includes counseling businesses and business persons on a variety of legal issues, including employment, and advocating on their behalf. You can reach Attorney Marr by e-mail at: dmarr@hamker.com

This information is general information and may not reflect the most current legal developments, verdicts or settlements. The information provided should not be relied upon as an indication of the actual state of the law or of future developments. The information contained on the Hamblett & Kerrigan website is for informational purposes only and does not constitute legal advice. If the information referenced may be of legal importance to you, you should consult with an attorney to provide you with legal guidance and opinion as the the effect of the current law upon your situation.