Hotchpot Clause: Unpaid Loans Causing Estate Disputes

It’s not uncommon for people to make loans to their family or close friends. Common reasons include helping with a down payment on a house or to kickstart a new business venture. However, many people don’t consider what would happen if the lender dies before the borrower repays the loan. To avoid uncertainty, will-writers who are owed a debt from a beneficiary of their estate can include a hotchpot clause in their will.

What is a ‘Hotchpot’ Clause?

A hotchpot clause requires the executor to consider any debts or advances owed by a beneficiary when administering the estate. Essentially, the clause ensures that any assets lent to a beneficiary before the testator died do not have an unfair effect on the other beneficiaries of the will. Typically, the beneficiary who had the loan will have their inheritance reduced by the value of the balance when the testator died. This helps to ensure fairness for beneficiaries who have an equal share in the estate, but did not receive equal assistance from the will writer during their lifetime.

How Unpaid Loans Can Create Estate Disputes

To fully understand this problem, let’s consider the following example:

Imagine a father has three children and wants to divide his $900,000 estate equally among them. One of his children borrowed $100,000 from him before he passed away. The father’s will includes a hotchpot clause that requires the loan to be factored into the distribution. Without the hotchpot clause, each child would receive $300,000.

With the clause in place, the value of the estate would be considered $1,000,000 after the child ‘repaid’ the loan. Each child’s share would be valued at approximately $333,333. However, the child that borrowed money would have their inheritance reduced by the balance of the loan. In this example, they would receive a smaller sum of $233,333. This ensures fairness amongst the siblings by accounting for the money already received by the child who had the loan.

Many people in a similar scenario might assume this common-sense approach would be taken. However, without documentation in the estate plan, it’s unclear which solution the father had intended in his will. If it is not clear how the will writer intended the debt to impact a beneficiary’s inheritance, disputes can arise. It’s important that testators who have lent money to a beneficiary make their plans for the debt clear in their will.

Using a Hotchpot Clause to Prevent Disputes

A hotchpot clause ensures the executor accounts for any amounts a beneficiary received from the will-writer before their death when determining their inheritance. Usually, the clause will accumulate the value of all of the estate’s assets, including any debts owed to the estate. The goal of a hotchpot clause is to equalize the overall benefit that each beneficiary receives from the estate.

Loan vs. Gift

In general, if you’re going to issue a loan, whether it’s to your own children or to a third party, you should always create a written agreement. Without a contract, the debtor could argue that the loan was intended as a gift. In this case, the hotchpot clause would likely not be relevant, as the gift would have no impact on the estate as an inter vivos gift and the debtor would have no obligation to repay the gift. A written contract specifying that the money transfer was a loan, not a gift, reduces litigation risk during estate administration. With a written agreement and a hotchpot clause, will-writers can ensure no one unfairly benefits from the loan at the expense of other beneficiaries’ inheritance.

If you’re unsure how to include a hotchpot clause in your will, contact an experienced estate lawyer today.

Have a question about this topic or a different legal topic? Contact us for a free consultation. Reach us via phone at 250-888-0002, or via email at info@leaguelaw.com.