20-May-21
FW: Disinheriting Heirs with Limited Powers of Attorney
Take-Away: If an individual is given a limited power of appointment over trust assets, the settlor of the trust should be expressly alerted to the fact that the exercise of that limited power of appointment could effectively disinherit the settlor’s heirs who are the trust’s remainder beneficiaries.
Background: Adding limited powers of appointment to a trust is viewed as a great way to add flexibility to the trust to promote its effective administration and to respond to the changing needs of the trust’s beneficiaries. After several years have past, the circumstances of the remainder beneficiaries might dramatically change, e.g. divorce; creditors; substance abuse; addictions, etc, which would lead the holder of the limited power of appointment to exercise it in a manner to change the ultimate distribution from the trust from as it is currently written, to a new distribution pattern, arguably to the remainder beneficiaries. Consequently, it is common to find limited powers of appointment in many current trust instruments.
Disinheritance: While the settlor understands the purpose of the limited power of appointment in their trust is to add flexibility to respond to changes in the beneficiaries’ circumstances, the settlor seldom stops to think that the exercise of the limited power of appointment by its holder can also fully disinherit their heirs (remainder beneficiaries) under their trust.
This question surfaced, albeit in unusual circumstances, in a recent Michigan Court of Appeals decision.
In re December 23, 2002 Restatement of the Vivian Stolaruk Living Trust, Michigan Court of Appeals, No. 2019-387099-TV (April 22, 2021)
Facts: Vivian created a trust in 2002 which provided for the creation of a marital trust and a credit shelter, or ‘family trust,’ on her death. Her husband, Steve, was given an identical testamentary limited power of appointment over both the ‘marital trust’ and the ‘family trust’ after Vivian’s death. Vivian’s descendants were entitled to principal and income from the ‘family trust’ subject to a HEMS standard of distribution, with outright distributions to them from the trust(s) after Steve’s death.
– Testamentary Limited Power of Appointment: The limited power of appointment provided, in part: “My spouse [Steve] shall have the limited testamentary power to appoint to or for the benefit of my descendants, persons who at any time were married to a descendant of mine, and/or to religious, scientific, charitable or educational organizations.” The testamentary limited power of appointment had to be exercised by Steve in a valid last will or trust.
– Vivian’s Trust’s Distribution: Vivian died in 2003. The trust provided that on Steve’s death the marital and family trusts would be divided: $150,000 to each grandchild, $4.0 million to their son Marc, and $1.5 million to their daughter Ann Marie, with the residue then passing to a private foundation. As noted, though, Steve held a testamentary limited power of appointment over the corpus of both trusts.
– Exercise of the Limited Power of Appointment: Steve amended and restated his own living trust several times after Vivian’s death. In the last amendment and restatement to his trust in 2017, Steve deliberately exercised the testamentary limited power of appointment over both the marital and the family trusts, appointing all property subject to that power of appointment to the St. Joseph Mercy Oakland hospital. Steve died in 2018. Accordingly, by his exercise of the testamentary limited powers of appointment over the trusts, Steve effectively disinherited his son, his daughter, and his grandchildren in favor of a charity.
Litigation: Marc and Ann Marie filed a petition to modified or reform Vivan’s trust, along with asking for the removal of the trustee of the trusts, coincidently the drafting attorney. The children claimed that their mother never intended that the trusts be drafted in a way that would give Steve the ability to disinherit her children as beneficiaries of the trusts, i.e. that Vivian’s trust was a product of mistake of fact and/or law and the court needed to reform the trust to conform with Vivian’s intention that the trust(s) “take care of her children.”
Probate Court: The trustee filed a motion for summary disposition of the children’s petition, arguing that either the statute of limitations or laches barred the children’s claim for reformation as they had not used due diligence in pursing that claim after Vivian’s trusts became irrevocable. Moreover, it would be inequitable to permit the children to reform the trust after so many years of delay (going back to 2003 when Vivian died). Permitting the remedy of a trust reformation now would create a substantial prejudice to Steve, and obviously to St. Joseph hospital.
– Flowchart: The children argued that the attorney-trustee [Julius Giarmarco] had used a flowchart when he explained the trust to their parents, and to Marc who also was present, and while the testamentary power of appointment was referenced on that flowchart with regard to both the marital and family trusts, there was never any discussion or example provided of how that limited power of appointment could be exercised by Steve to disinherit the children or grandchildren.
– Probate Judge: The judge, noting in the decision that the children’s relationship with their father had ‘soured horribly’ before Steve’s death, found that there would be irreparable prejudice to Steve [the holder of the limited power of appointment] if the Vivian’s trust were to be reformed at ten years later. Needless to say, the St. Joseph hospital also claimed prejudice, and actively supported the trustee’s position in the probate court to dismiss the claim for trust reformation. Because the children could have filed their claim for reformation of the trust shortly after their mother’s death in 2003 when her trust became irrevocable, the judge held that the statute of limitations precluded hearing their claim at this late date. Marc and Ann Marie appealed this decision.
Court of Appeals: The probate judge’s order was reversed, one a split decision, one judge dissenting, and the case was sent back to the probate court for further proceedings including the right to conduct discovery and to gather evidence. This may be one of those court decisions where two of the judges felt that if they kept the case alive a bit longer, then the parties might actually settle the dispute (or the judges may have been troubled because the exercised limited power of appointment disinherited the grandchildren, who apparently had done nothing to anger Steve, unlike Marc and Ann Marie.)
– Laches: The judges viewed the facts in a light most favorable to the children, and ‘reasonable minds could disagree regarding whether the children were dilatory by failing to scrutinize the trust, of which they had a copy, to discover the alleged ‘drafting error.’ To avoid the equitable defense of laches, the children had to show that they had acted with due diligence in pursuing their claim after it [the alleged mistake in Vivian’s trust] was discovered. The judges felt that they should have more time to conduct discovery to show that they did, in fact, act with diligence.
–No Discussion About What Would Happen if the Power of Appointment was Exercised: Key to the judges’ unwillingness to sustain the motion for summary disposition was the flowchart attorney Giamarco had prepared. It was used at the attorney conference where the documents were explained to Vivian and Steve, at which Marc was also present, where the flowchart showed the children would receive most of the trust assets upon the Steve’s death, but there was never any discussion about Steve possessing the authority to disinherit the children and grandchildren, in favor of a charity by exercising that testamentary limited power of appointment.
“Giarmarco’s repeated use of the flowchart to represent how the estate plan operated and the fact that nothing on the flowchart indicated that the surviving spouse could exercise his or her testamentary LPA’s to appoint all the principal and undistributed net income from the marital and family trusts to a charitable organization of that spouse’s choosing, such facts could reasonably support the conclusion that, at least in 2003, due diligence did it call for petitioners [the children] to scrutinize the actual terms of the [trust.]”
The judges seem to attach a lot of significance to the fact that neither the flowchart, nor any verbal explanations provided by the attorney to his clients, revealed the possibility of the exercise of the testamentary limited power of appointment that would disinherit the children or grandchildren.
Whose Intent Prevails: Additionally, the judges also raised the rhetorical question whether Steve’s intention to disinherit the children from Vivian’s assets using the testamentary limited power of appointment, should take precedence over Vivian’s intentions to the contrary, which is Vivian’s presumed intention regarding the distribution of her assets. This seems to ignore the whole purpose behind granting another individual a testamentary power of appointment- you are giving that person ultimate control over the assets subject to the power of appointment, regardless of the settlor’s initial preference for how the assets would ultimately be distributed.
Conclusion: This decision was something of a surprise. While a trust reformation, after 10 years, was not granted, it left the door open for that relief. More surprising was the judges’ inference that somehow Vivan’s testamentary wishes would ‘take precedence’ over Steve’s exercised testamentary power of appointment. That does not sound correct if Steve actually followed the conditions attached to the exercise, so that the power of appointment was done correctly. Finally, the big take-away for me was a reminder to attorneys to bring to a settlor’s attention the fact that the limited power of appointment could be exercised to disinherit the settlor’s intended beneficiaries. Probably not enough time is spent telling clients how powerful a power of attorney can be to ‘disrupt’ the settlor’s estate plan.