George F. Bearup, J.D. Senior Legal Trust Advisor

Mental Capacity

Take-Away: There are varying degrees of mental capacity for various actions or documents signed by individuals. Often those different ‘tests’ of mental capacity appear in the same legal document which might raise questions as to the validity of actions taken by third parties under those documents.

Background: The capacity of an individual differs depending upon the transaction involved.

Contract: Entering into a contract, e.g. hiring a trustee or attorney, requires contractual capacity. Contractual capacity is usually defined as: “The ability to understand the nature and effect of the act and business being transacted.”
Testamentary: Testamentary capacity usually requires that the testator know: (i) has the ability to understand that he/she is providing for the disposition of his/her property after death; (ii) the ability to know the nature and extent of their assets; and (iii) knows the natural objects of his/her bounty; and (iv) has the ability to understand in a reasonable manner the general nature and effect of his/her act in signing the Will. [MCL 700.2501]
Capacity: In Michigan testamentary capacity does not require a testator must be able to manage his/her own affairs; a lesser standard is applied for testamentary capacity. In addition, even if a conservator or guardian is appointed for the testator, he/she may still possess sufficient testamentary capacity to execute a Will. Mills v. Spears-Everett, No 291796, 2010 Mich App LEXIS 1500 (July 31, 2012)
Wills and Trusts: In Michigan the same testamentary capacity is required to execute a revocable trust as it is to sign a Will. [MCL 700.7601.]
Irrevocable Trusts: The Michigan Trust Code is silent, however, on the requisite mental capacity required to sign an irrevocable trust, or by implication to make a lifetime gift.
Lifetime Gifts: At common law the mental capacity required to make a lifetime gift is that the donor must: (i) understand the nature and purpose of the gift; (ii) the extent of the assets given; and (iii) the natural objects of the donor’s bounty. Some states add a fourth requirement which is that the donor understands that the gift will diminish the donor’s assets.
Powers of Attorney and Beneficiary Designations: According to the Reporter’s Comments to MCL 700.7601, “The standard of capacity to sign a Will or revocable trust is also applied to durable powers of attorney and beneficiary designations.”
I am not sure if that is a completely accurate conclusion, although the addition of (iv) above seems to embrace the contractual capacity element to understand the effect of the action. In Persinger v Holst, 248 Mich App 499 (2001) the Court said that the principal who signs a durable power of attorney must possess the “ability to consent to, render a degree or control over, and appreciate the significance and consequences of the resulting agency relationship.” With regard to a patient advocate designation, the Michigan statute only requires that the individual be “of sound mind at the time a patient advocate designation is made.”

Dual Documents: In many states, the mental capacity of the principal to sign a durable power of attorney for financial affairs, or a medical durable power of attorney for health-care decision making, is the capacity to contract, not testamentary capacity. As a gross generalization, contractual capacity is often viewed by courts as requiring a higher level of cognitive ability than that which is required for testamentary capacity. What happens, then, when testamentary documents like a revocable trust also includes lifetime powers that fall more into contractual capacity situation?

Consider a revocable trust where the successor trustee is authorized under the trust instrument to make gifts using trust assets when the settlor becomes mentally incapacitated. Or a durable power of attorney includes the authority granted to the agent to make gifts on behalf of the principal. The standard used to create that governing document is described above at MCL 700.2501. But the required mental capacity to make a gift is that the donor must understand the nature and purpose of the gift, and the extent of assets given, and the objects of the donor’s bounty. Some states go even further and require that the donor must also understand that the gift will diminish the donor’s assets.
Does that lifetime mental capacity standard where the power to make gifts is granted, equate to the mental capacity standard required to execute a revocable trust or durable power of attorney, where the power to make gifts is conferred on fiduciaries?
The Reporter’s Comment to MCL 700.7601 ( which describes the mental capacity to execute a revocable trust) notes: “This section does not address or alter the capacity required to make an irrevocable trust, and this question is left to the common law. UTC Section 601 comment (“To create an irrevocable trust, the settlor must have the capacity that would be needed to transfer property free of trust.’) see also Restatement (Third) of Trusts, section 11.” If funding an irrevocable trust is akin to making a lifetime gift, which then requires the common law to ascertain the required mental capacity to make a gift (contractual capacity), that mental capacity standard may not be the same to sign a revocable trust or a durable power of attorney where the gift-giving power is located.
In sum, if the power to make gifts is included in a trust or durable power of attorney, must the instrument meet the arguably higher standard of mental capacity used at common law? I confess I don’t have the answer to this question, since an agent, not the donor, is making the gift, but did the donor have the arguably higher mental capacity at the time the durable power of attorney or revocable trust was signed?

Conclusion: If a revocable trust gives to the successor trustee the ability to make gifts using trust assets, or a durable power of attorney grants to the agent the ability to make gifts using the principal’s assets, it makes sense to add some self-serving language to that delegated power where the settlor/principal acknowledges all the conditions imposed by the common law to make gifts to satisfy its mental capacity standard. For example, the instrument, whether a revocable trust or durable power of attorney, might carry the following self-serving declaration:

“I acknowledge that I have granted to the fiduciary the ability to make gifts on my behalf. I understand the nature of these possible gifts, the purpose of which will be to benefit other members of my family while reducing my estate which may be subject to estate taxation, that the gifts authorized under this instrument are restricted to my descendants who are the natural objects of my bounty of my bounty. I also understand that any such gifts made by the fiduciary will diminish my assets while I am alive.” Whether this acknowledgement satisfies the common law mental capacity standard to make gifts is unknown, but it cannot hurt if later questions arise with regard to the validity of gifts made by successor trustees or agents acting under a durable power of attorney.

It is something to think about when an instrument, like a revocable trust, has more than one function.