Nancy A. McLaughlin, Conservation Easements and the Valuation Conundrum
, 19 Fla. Tax Rev.
225 (forthcoming 2016), available at SSRN
In this practical and timely article, Nancy McLaughlin undertakes a comprehensive analysis of the case law addressing valuation disputes of conservation and façade easements (conservation easements that are designed to maintain the historic character of a building’s façade). She reveals a number of ways in which taxpayers overvalue their easements, and uses what she finds to propose common-sense reforms.
Valuing property for purposes of determining a tax base is usually subjective and often contentious, so valuation-based taxes like the federal transfer taxes are vulnerable to valuation abuse. But property valuation also forms the basis for certain income tax deductions. Section 170(h) of the Internal Revenue Code, enacted in 1980, permits a deduction against the income tax for taxpayers who permanently contribute certain conservation or façade easements to governmental entities or charities. This provision is famously subject to abuse, and McLaughlin points out that valuation abuses have likely worsened over time, while the IRS has also become more adept at identifying abuses. According to McLaughlin’s calculations drawn from the case law, façade easement overvaluation by taxpayers in reported cases has increased from an average of about twice the court-determined value in the early cases to more than four times the court-determined value in the more recent cases. In the conservation easement category, overvaluation as determined from the case law has jumped from an average of about twice the court-determined amount to a whopping ten times over that amount in the more recent cases.
McLaughlin first describes the rules governing valuation and the penalties that can be imposed on taxpayers and their appraisers for overstating value. As in the case of the transfer taxes, the value of the charitable contribution of a conservation easement is “fair market value,” defined as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.” The Treasury Regulations acknowledge that the best way to value a conservation easement is by reference to records of sales of comparable easements. Unfortunately, such a record is rarely, if ever, available. For this reason, most taxpayers use an alternative method approved by the regulations: the “before and after method.” This method values the easement as the difference between the value of the underlying property immediately before the donation and that of the property after its encumbrance by the donated easement. Each valuation is done at the property’s “highest and best use.”
After carefully and clearly explaining the before and after methodology, McLaughlin launches into the various approaches used in determining fair market value. Here she consults not only the case law and regulations but also the professional valuation literature produced by the appraisal industry, and explains the pros and cons of the various approaches. She then looks at common errors made by appraisers, such as assuming that a property could be rezoned, which she asserts can dramatically increase the value of an appraisal of property before the easement is attached. She also explains certain rules contained in the Treasury Regulations, including those that require the tax deduction to be reduced by benefits that inure to the donor as a result of the easement. McLaughlin then reviews the various overvaluation penalties, including both those that apply to taxpayers and those that apply to appraisers.
McLaughlin then delves into the case law, separately reviewing cases dealing with façade easements and those concerning conservation easements. She concludes, in part, that appraisers often overvalue façade easements by paying too little heed to the mitigating impact of extant historic preservation laws, by using nonlocal comparables in the “sales comparison approach,” and generally misapplying certain methods of valuation. Penalties fail to deter overvaluation, as they are rarely imposed unless they are strict liability penalties. Problems McLaughlin uncovers in the conservation easement area lead her to conclude that appraisers often assert unrealistic highest and best uses, make unrealistic assumptions regarding rezoning possibilities, misapply certain valuation analyses, and fail to consider whether the easement increases the value of other properties owned by the taxpayer. As in the case of façade easements, valuation misstatement penalties are rarely applied unless they are strict liability penalties.
McLaughlin notes that Congress recently made enhanced taxpayer incentives for façade and conservation donations a permanent part of the law, while at the same time failing to pass legislation targeting valuation abuses in the face of the Treasury’s calls for reform. McLaughlin agrees with the Treasury that reform is needed, but dismisses its specific proposals as off the mark. One Treasury proposal calls for donee organizations to be subject to penalties and loss of donee status for accepting overvalued easements where these organizations had actual or constructive knowledge that they were overvalued. McLaughlin concludes that such reforms would have little effect for at least three reasons: high values are good for donees, as they increase the likelihood of donations; valuation is necessarily subjective, and therefore knowledge of overvaluation cannot be asserted except in the most egregious cases; and such a rule would incentivize donees to obtain their own valuations, doubling the IRS’s opponents in any litigation. McLaughlin also criticizes a Treasury proposal for electronic reporting as unlikely to have an effect in most cases. Finally, she asserts that the Treasury’s proposal for creation of a tax credit program as an alternative might actually increase abuse.
McLaughlin offers eight specific proposals for reform. She proposes an increase to the statute of limitations period during which the IRS could challenge the deductions to six years from the current three. She calls for increased and more detailed reporting requirements, and renews her call for the creation of an “Easement Advisory Panel” similar to the Art Advisory Panel that assists the IRS in curbing valuation abuses. She suggests that the Treasury create a comprehensive outline with instructions for a section 170(h) appraisal, similar to the Uniform Appraisal Standard for Federal Land Acquisitions. Appraisals meeting certain criteria that indicate possible abuse should be subject to automatic IRS review, and pre-trial processes for resolving disputes should be improved. Finally, McLaughlin offers concrete proposals for changes to the appraiser penalty provisions and suggests “safe harbor provisions” for certain easement terms so that easements that are valued as though they satisfy legal requirements actually satisfy those requirements.
McLaughlin has apparently been studying and writing about façade and conservation easements for many years. In this comprehensively researched article, she puts her considerable knowledge to use in an effort to suggest reforms designed to make deductions for charitable contributions of certain property interests reflect their actual value. Although experts in the area of conservation easements might have differences with some of McLaughlin’s analyses and prescriptions for reform, this paper stands as an example of how a careful legal scholar can produce work that will lead to better laws.
Cite as: Kent D. Schenkel, Reducing Valuation Error
(October 3, 2016) (reviewing Nancy A. McLaughlin, Conservation Easements and the Valuation Conundrum
, 19 Fla. Tax Rev.
225 (forthcoming 2016), available at SSRN), http://trustest.jotwell.com/reducing-valuation-error/
Adam J. Hirsch, Airbrushed Heirs: The Problem of Children Omitted from Wills,
50 Real Property, Trust and Estate L.J.
175 (2015), available at SSRN
One of the most frustrating aspects of the practice of estate planning and probate law is dealing with outdated plans. Specifically, when a testator has a change in circumstances and does not update his will or trust, we are left to speculate what the testator would have wanted.
Many jurisdictions provide statutory protections for children who were born or adopted by the testator after the will was created based on the presumption that these children were unintentionally disinherited. Professor Hirsch challenges this presumption by exploring the policy and the shortcomings of the various pretermission (“unintentional omission”) rules. He focuses on two policy perspectives: the concern that testators pretermitted children because of forgetfulness, and the concern that testators failed to update their wills to account for changed circumstances. He raises questions about whether a testator’s unambiguous plan should be disrupted and how long a will should remain obsolescent (i.e., may no longer reflect the desires of the testator), after a change in circumstance.
While Professor Hirsch concedes that an existing child left out of a will is likely excluded intentionally, he challenges the presumption of inclusion by suggesting that pretermitted children may also be intentionally omitted if a testator does not update his plans after a certain period of time. Hirsch supports his premise by outlining why a testator might fail to update a will. The reasons include incapacitation, waiting for the right time, and just not getting around to it for a while (“lag time”). He then surmises that the longer the delay, the more likely it is that the testator did not want to update his plan. If that is the case, Professor Hirsch questions whether the implied pretermission rules should take effect.
Specifically, Professor Hirsch proposes that legislators balance the risk of unintentional/intentional disinheritance by setting a time for the presumption to expire. Additionally, he proposes a preferential share concept, based on the size of the estate, similar to intestacy statutes. In other words, if the estate is small, then the surviving spouse would receive all, or the bulk of the estate, but if the estate is sufficiently larger, then the pretermitted children would receive a direct share.
Professor Hirsch also identifies several shortcomings in the pretermission statutes, but I will address only three of them. The pretermission provisions under the Uniform Probate Code (UPC) apply only to children, and only seven jurisdictions expressly include their descendants. In addition, the UPC pretermission provisions do not cover embryonic children, and only eleven states expressly cover embryonic children. Furthermore, under the UPC the inheritance rights of posthumously conceived children will be evaluated on a case-by-case basis. According to the UPC, posthumously conceived children born to a surviving spouse are presumed to have intestacy rights, while children born to anyone else are not presumed to have intestacy rights. He questions why the intestacy rights of these children should differ from intestacy rights of any other children.
Another issue Professor Hirsch addresses is the rights of unknown children of the testator. A father of a child may be unaware that his past relationship resulted in the birth of a child, especially if he does not maintain contact with the mother of the child. In the case where a testator is unaware of a child at the time he created his will, Professor Hirsch proposes that a will should be considered obsolescent only after the testator becomes aware of the child, rather than basing it on the birthdate of the child. Currently only two jurisdictions make such a provision. Contrary to the view that pretermission statutes should not apply to these children because the testator did not have an opportunity to clarify his intent, Hirsch finds – based on a poll that he commissioned for the paper – that by large margins both men and women would prefer to have unknown children inherit equally with the known ones.
Next, Professor Hirsch addresses the fact that pretermission statutes under the UPC, and in most states, apply only to wills. Nonprobate assets and will substitutes that might comprise a majority of the value of an estate are not subject to the pretermission statutes. While the Restatement of Property indicates pretermission provisions should apply to comprehensive will substitutes such as revocable trusts, it excludes pay-on-death designations for bank accounts. Professor Hirsch asserts there should be no distinction because a pay-on-death account is the functional equivalent of a specific bequest.
Professor Hirsch also describes the advantages and disadvantages to permitting extrinsic evidence to determine testamentary intent and overcome the pretermission presumptions. An obvious disadvantage is the cost of adjudicating on a case-by-case basis. Other disadvantages include unreliable testimony, ambiguous testimony regarding the relationship with the omitted child, and misconstruing statements made by the testator. On the other hand, allowing extrinsic evidence would permit the drafting attorney to report any missing information and clarify issues to effectuate the testator’s intent about the omitted child. Another advantage to permitting extrinsic evidence is that it would make up for shortcomings in the statutes. Professor Hirsch suggests extrinsic evidence should be permitted to determine testamentary intent just as the UPC permits extrinsic evidence to override other default rules dealing with changed circumstances.
In short, Professor Hirsch concludes that existing rules regarding omitted children are inadequate. He suggests the rules should be more flexible; to wit, the presumption should be temporary and expire after a passage of time and should be decided on a case-by-case basis. Professor Hirsch’s article provides great topics of discussion for Trusts and Estates courses. His article also provides something to think about for drafters of future UPC and state statute revisions regarding omitted children.
In The One-Hundredth Anniversary of the Federal Estate Tax: It’s Time to Renew Our Vows, Paul L. Caron tracks how the modern estate tax has evolved since its 1916 inception and contends the tax should be modified to serve its original purposes. Caron analogizes the nation’s relationship to the estate tax as that of an aging marriage, arguing that our passion for the tax has cooled with the passage of time. He urges us to find that lost passion and renew our vows to the estate tax we once so adored. To do so, we must reinvigorate the estate tax and restore it to its historical position as an important, robust component of our federal tax system.
Caron contends that Congress enacted the federal estate tax in 1916 to serve three policy ends. First, the act was enacted as a revenue measure, conceived in part to meet the increasing fiscal obligations in the era of World War I. Second, the tax was designed to increase the progressivity of the tax system as a whole, counterbalancing a growing inequality of income in the early twentieth century. Third, the tax was structured to help curb rising concentrations of American wealth. Caron contends that these three goals are as relevant, and important, today as they were a century ago. To meet them, he urges, the federal estate tax should be reinvigorated by reversing the recent trend toward higher exemption levels and lower rates. Paraphrasing Proverbs 5:18, Caron urges us to restore “the estate tax of our youth.”
In his exploration of these three policy ends, Caron first addresses the federal estate tax’s role as a revenue measure. His detailed historical and policy analysis traces the history of the estate tax as a war tax from the 1797 stamp tax used to build up American armed forces for a potential war with France through the taxes that funded the Civil War and Spanish-American War. As the nation considered entry into World War I, Congress again turned to estate taxation and enacted the modern estate tax in 1916. However, as Caron illustrates with a series of graphs and charts, recent Congresses have largely eviscerated that tax as a source of revenue. Currently, the tax impacts just 0.2% of decedents and raises just 0.6% of federal revenue, a fraction of what the estate tax generated at its more youthful prime. Caron urges Congress to reverse this modern trend by lowering the tax exemption and raising the rate, changes that could double, or quadruple, the revenue-raising potential of the tax. He contends that this increase in estate tax revenue is vital in an era in which government expenditures and the national debt both continue to grow (due in part to the “wartime” demands of battling terrorism).
Caron next turns to the second historical justification for the estate tax: its ability to enhance the overall progressivity of the U.S. tax system. Caron’s work in this section utilizes economic data spanning back over a century to illustrate trends in income across socioeconomic groups. From this historical perspective, Caron illustrates a growing imbalance in income between the nation’s highest wage earners and the rest of the labor force, a phenomenon fueled in part by declining progressivity in the tax system over time. He argues that the trend must be reversed and offers the estate tax as a crucial tool in that effort.
In the final section of his paper, Caron pivots to his third major point: that the concentration of wealth is growing as imbalanced as is concentration of income. As he did with the issue of income inequality, he contends that the estate tax is uniquely suited to address this policy concern.
In sum, Caron contends, the America of 2016 looks similar to that of 1916 in numerous key ways. We are a nation at war in need of revenue, and inequalities of growth and income have risen to alarming levels. In 2016 as in 1916, the estate tax offers at least a partial solution to all of these ills. Although the estate tax seemingly has gone out of vogue with many politicians and policymakers, Caron urges us to rediscover the love we once felt for her.
Caron’s work is a pithy tour through of a century’s worth of economic history and estate tax policy. I recommend it highly.
Language matters. In her recent article, Not Your Mother’s Will: Gender, Language, and Wills, Karen Sneddon details just how much language matters in the context of wills and trusts. In a comprehensive review of linguistic theory and its intersection with inheritance law, Sneddon illuminates how will clauses and trust structures reflect gender schemas about men and women.
Sneddon first lays a foundation for her hypothesis that will drafting reflects masculine and feminine roles and norms by acquainting the reader with basic linguistic theory. She notes that wills are one of the most personal and oldest forms of legal writing. Sneddon goes on to introduce the concept of androcentrism as a driver of language-based gender norms. Phrases that focus on men as the typical and women as the atypical mirror what Sneddon describes as the remnants of patrimony. Cultures perform and reproduce gender through language. Using terms like “executor” and “executrix” implies that the latter is the less important variation on the central role. Interestingly, Sneddon asserts that prior to the nineteenth century there were fewer gender distinctions in language and actually more female executors. She suggests that the rise of Victorian ideals relating to the delicate nature of womanhood may have contributed to this shift away from women performing such public duties and that the increase in the gendered form “executrix” reflects those societal changes.
Sneddon proceeds to give the reader several striking examples of form book instructions and sample clauses that clearly reflect gendered views of women. For example: “As one author generalized in 1970, ‘Many older women with no family (and usually with estates that do not exceed $2,000) want to leave each memento they own to a different person.’”
These gender schemas are reified when included in form books in ways that are subtle but powerful. Sneddon highlights this entrenching effect when she writes, “Some modern form books continue to endorse gendered recommendations, such as a form that limits a daughter’s ability to appoint property to her husband. The form book does not present a similar sample provision to limit a son’s ability to appoint property to his wife.”
In addition to specific language in the text of instruments, Sneddon points out the gendered nature of estate planning structures like qualified terminable interest property trusts (QTIPs). For example: “Due to life expectancies, QTIPs are more frequently created for female spouses with the ultimate disposition of the trust property then being directed by the deceased male spouse.”
Sneddon goes on to note additional examples of gendered terms, like “testator” and “testatrix,” that imply the norm is male and the feminine version is the “other.” She gives examples of cases, form books and even a fairly recent ABA Probate & Property article that use gendered terms like “testatrix.” Sneddon argues that the continued use of these gendered labels, despite attempts to gender-neutralize the language of inheritance law, reinforces the idea that men and women can be expected to behave differently in bequeathing property and making dispositive decisions that reallocate their property after death. The use of such terms also diminishes women and tends to make them less visible in discourse within the field. Positing women as the “other” and the persistence of androcentrism in language slows our progress toward gender equality.
While I highly recommend this article to all those interested in both inheritance law and gender equality, it could be more succinct. That said, one reason it is fairly long is that the footnotes contain such a rich array of sources, some of which are tangential to the main point about gendered language, but all of which are fascinating to read.
In conclusion, Sneddon’s readers will be exposed to intellectual disciplines, like linguistic theory, that give new depth to the words in testamentary instruments as one reads them in the future. Readers will also think more carefully about the choice of words as they draft instruments for their clients. And since being thoughtful wordsmiths is one of our primary roles as estate planners, that’s a very good thing.
Ante-mortem probate addresses a glaring deficiency with the post-mortem probate model prevalently used in the United States. In post-mortem probate contests the key witness—the testator—is deceased, leaving the courts with only indirect evidence of the testator’s capacity and freedom from undue influence. The relative ease with which individuals dissatisfied with the testator’s choice of beneficiaries may manipulate this indirect evidence encourages spurious will contests. In ante-mortem probate the testator executes a will and then asks for a declaratory judgment ruling that the will is valid, that all technical formalities were satisfied, that the testator had the required testamentary capacity to execute a will, and was not under undue influence. The beneficiaries of the will and the heirs apparent are given notice so they may contest the probate of the will. In addition to providing greater certainty to the testator of the will’s validity, the procedure makes will contests less likely. But ante-mortem probate is not without its price: The ante-mortem process may be extremely disruptive to the testator and the testator’s family. The testator may not wish to disclose the contents of the will nor to face the potential embarrassment that may occur if testamentary capacity is litigated. It involves additional costs and may raise due process and conflict of laws problems.
Susan G. Thatch’s article concisely discusses the advantages and disadvantages of implementing an ante-mortem probate statute in New Jersey and, by analogy, in any state. The article focuses on the debate of whether allowing ante-mortem probate is useful to testators or harmful to families by reviewing the ante-mortem probate model currently used by five states, as well as other models which scholars have suggested. The article takes the view that if the suggested statute is implemented, it should supplement instead of supplant traditional probate options already available to New Jersey citizens. Figuring out the best way to ensure peace of mind for the testator while fully considering the arguments for and against an ante-mortem probate statute forms the foundation of the article.
The article describes three principal models suggested for successfully structuring and implementing ante-mortem probate—the contest model, the conservatorship model, and the administrative model. Although all currently enacted state enabling statutes adopt the contest model, Ms. Thatch explains how each of the models operate and the benefits and disadvantages of each one. Overall, all of the models allow a court to determine if “the testator had adequate testamentary capacity and was free from undue influence” while the testator is still alive. The difference between the models is the extent to which beneficiaries and heirs are required to be notified and represented. By examining both the model currently used and those suggested by scholars, Ms. Thatch provides a comprehensive look at how New Jersey could structure its statute.
Ms. Thatch then analyzes the statutes in the five states where ante-mortem statutes is available—North Dakota, Ohio, Arkansas, Alaska, and New Hampshire. All of the states have statutes based on a variation of the contest model. Ms. Thatch acknowledges that North Dakota, Ohio, and Arkansas, states that have allowed ante-mortem probate since the 1970s, have reported a low usage of the ante-mortem probate procedure. However, Ms. Thatch explains that North Dakota and Ohio practitioners reported that it was valuable to have the statute available.
The article addresses how implementing an ante-mortem procedure in New Jersey would help practitioners have a valuable probate tool available to them. Although Ms. Thatch describes the current alternatives available to safeguard a testator’s intent, such as video-recording the will execution ceremony, creating an inter-vivos trust, using an inter-vivos transfer, and adding a no contest clause, the article explains why all of these options are not enough to ensure that the testator’s capacity will not be contested or that a beneficiary or heir will not claim undue influence.
In addressing the reasons for allowing ante-mortem probate, the article mentions the risk presented by the growing demographic of elderly citizens. Elderly citizens are at a greater risk of either being taken advantage of or having guardians inappropriately allocate or dispose of assets. Testators might benefit from having these pre-death probate disputes handled by ante-mortem probate. Additionally, ante-mortem probate can help ensure that the testator’s intent is not frustrated if the testator decides to depart from “deeply held societal values” when distributing assets. However, the article also mentions that the downside of allowing ante-mortem probate is that it can create family strife. The testator can determine whether the benefits of ante-mortem probate would exceed the potential difficulties. Because there are arguments for and against ante-mortem probate, the New Jersey Law Revision Committee will take into consideration the area of law and practitioners’ opinions before deciding whether the statute would be useful to testators and practitioners in New Jersey.
As a long-time advocate of ante-mortem probate, I highly recommend this article. Ms. Thatch makes well-reasoned arguments for allowing ante-mortem probate after considering both the value the statute could provide to testators and practitioners and the implications that may arise from its use.
[Special thanks to the outstanding assistance of Elizabeth Nanez, J.D. Candidate May 2016, Texas Tech University School of Law, for her assistance in preparing this review.]
Two years ago, my friend Myra died of cancer. She was survived by her husband Scott and their six-year old daughter Isla, as well as her parents, siblings, and many nieces and nephews. As Scott tried to make sense of his wife’s death, he was somewhat comforted by the knowledge that her pension and life insurance would cover the mortgage and keep their daughter in the only school she had ever known—the school where her mother had taught kindergarten.
Scott’s comfort was short-lived. Although Myra did have a pension and life insurance, neither Scott nor their daughter were the beneficiaries. When Myra began working as a school teacher many years ago, she designated her mother and only nephew at the time as the beneficiaries of her life insurance and state pension. Years later, she married Scott and had a daughter together, but never updated her beneficiary designations. She simply forgot. But she also believed that because she did not have a will, Scott would inherit everything she owned and use it to take care of their daughter. She was wrong. Although Scott inherited her very modest intestate estate, her pension and life insurance benefits went to her mother and oldest nephew instead of Scott—her intended beneficiary and intestate heir. The family was torn apart and Isla has had almost no contact with her maternal relatives since her mother’s death.
In their article, Revisiting the Revolution: Reintegrating the Wealth Transmission System, Professors Melanie B. Leslie and Stewart E. Sterk illustrate the law’s failure to address the problems created by the proliferation of non-probate instruments. This failure has deprived intended beneficiaries, like Scott, of assets that the decedent intended them to take and has also enabled wrongful takers, including former spouses, to receive assets that the decedent clearly did not want them to have.
Many individuals hold the bulk of their assets in non-probate instruments, such as retirement accounts, life insurance contracts, payable on death (POD) bank accounts, and revocable trusts. These instruments are not governed by wills law doctrines or the default rules of intestacy—rules that aim, among other goals, to honor decedent’s likely intent. Yet, the law does little to effectuate (and sometimes even frustrates) the decedent’s intent when her assets are held in non-probate instruments. As Leslie and Sterk demonstrate, these non-probate instruments have led to a fragmented and uncoordinated wealth transfer system in which donors, lawyers, and beneficiaries often lack accurate and complete information. They have also increased both the likelihood of error when creating an estate plan and the risk that wrongful takers of assets held in non-probate devices will squander them before their rightful beneficiaries have an opportunity to claim them.
Leslie and Sterk remind us that these problems were not unforeseen. They note that thirty years ago Professor John Langbein cautioned that non-probate transfers would create some potential challenges but he was optimistic that these would be addressed by lawmakers and financial intermediaries. Yet, they have not been. Leslie and Sterk’s examination of the beneficiary forms provided by insurance companies demonstrate that these forms are rarely designed to carry out the donor’s intent. In fact, they are often downright confusing—even to experts like Leslie and Sterk. In addition, state legislators have failed to extend wills law doctrines that are designed to effectuate the decedent’s intent (such as anti-lapse statutes, revocation-upon-divorce rules, and doctrines dealing with spouses and children omitted from a will) to non-probate assets.
In Leslie and Sterk’s view, the benefits of avoiding probate are sufficiently advantageous that we should not throw the baby out with the bath water. Consequently, they focus on reforms that would allow donors to continue to transfer wealth outside of the probate process while also ensuring that non-probate transfers accurately reflect the donor’s intent. For example, they recommend the creation of statutory forms for non-probate transfers to ensure donors understand the transfers they are making. They also recommend that states require custodians of non-probate assets to notify the decedent’s spouse and children of their existence and that they wait thirty to sixty days before distributing the assets to the designated beneficiaries to ensure that they are not dissipated before the intended takers have an opportunity claim them.
Their most important proposal, in my view, is one that some states and the UPC have adopted, but not fully. Leslie and Sterk propose extending all of the wills law doctrines designed to carry out decedent’s intent to non-probate instruments. Although some states apply certain intent-furthering doctrines (like revocation-upon-divorce) to both probate and non-probate instruments, they have not extended all of these doctrines to non-probate devices. Had the rule dealing with an omitted spouse in a will (UPC 2-301) applied to Myra’s pension and life insurance, Scott would have received Myra’s entire pension and life insurance, as she wished.
Leslie and Sterk’s most controversial reform is probably their recommendation to grant executors and administrators authority to alter the decedent’s non-probate transfers when they believe the transfers would thwart the decedent’s overall estate plan. Such power risks increased litigation from beneficiaries who receive less after the executor’s or administrator’s adjustments than under decedent’s designation (as Leslie and Sterk acknowledge). It could also take us down a dangerous road that, in my view, is best avoided. It is quite challenging for neutral factfinders in a courtroom with clear evidentiary rules to determine a decedent’s wishes. I think it would be more difficult, maybe impossible, for an executor or administrator (who is often a family member or friend) to objectively ascertain decedent’s wishes even if she lacks a financial interest in the disposition of assets.
One of Leslie and Sterk’s reforms directly addresses the problem of forgetful donors. They propose creating a nationwide voluntary registration system that would list each individual’s nonprobate transfers. Anytime a registered individual (again, registration is voluntary) attempts to make a transfer, the financial intermediary would remind her about her past designations. This reminder might be all some individuals need to help them coordinate their non-probate transfers and incorporate them into their overall estate plan. Other donors, like Myra, might benefit from an annual email reminder to check their beneficiary designations to make sure they reflect their wishes.
My initial reason for selecting this article as a Jotwell read was personal as I saw firsthand how a nonprobate transfer tore a family apart. However, the reforms Leslie and Sterk recommend are sure to help carry out the intentions of countless decedents even when they chose to avoid probate.
Over the past few decades, most states have repealed the Rule Against Perpetuities or significantly extended the time period during which trusts may continue to exist. As a result of these changes, estate planners frequently attempt to extend the terms of trusts that were originally created to comply with the Rule Against Perpetuities. They primarily do this through modification doctrines, such as equitable deviation.
In this article, Dean Reid Kress Weisbord argues against the use of modification doctrines to extend the duration of trusts beyond the Rule Against Perpetuities period that was in effect when the trust was created. In addition, he recommends that the drafters of the Uniform Trust Code (the “UTC”) modify the UTC to clarify that modification doctrines do not permit the addition of beneficiaries to the trust who were not identified in the original trust instrument.
In Part I of his article, Dean Weisbord discusses the reasons for opposition to “dead hand control” and the historic application of the Rule Against Perpetuities to minimize long-term dead hand control. In this section, he notes that there are three primary arguments against dead hand control. First, long-term dead hand control creates inflexible restrictions that fail to account for a change of circumstances. Second, the large number of beneficiaries that could exist if a trust were allowed to exist for many generations would create an unmanageable administrative task for the trustee. Third, long-term trusts contribute to the concentration of wealth in upper class families, worsening the gap between rich and poor in our society.
In Part II, Dean Weisbord explores the considerations that a trustee should weigh in deciding whether to file a petition to extend the duration of an irrevocable trust. These considerations include the settlor’s intent, whether the jurisdiction retroactively repealed or abrogated the Rule Against Perpetuities, the transfer tax consequences of extending the trust’s duration, whether there are fraudulent transfer law implications to extending the trust duration, and the trustee’s potential for a conflict of interest in seeking to extend the duration of the trust.
In Part III, Dean Weisbord examines the doctrine of equitable deviation and focuses on how it can be applied to extend the duration of an irrevocable trust. As a general matter, equitable deviation permits the modification of a trust if circumstances arise that the settlor did not anticipate and if modification will further the purpose of the trust. The rationale for this doctrine is that, based on our knowledge of the settlor’s intent, the settlor would have selected different trust terms if he or she had been aware of current circumstances.
The reasons that support using the doctrine of equitable deviation to extend the duration of a trust include the following: (1) a settlor may have intended to create a perpetual trust but failed to consider the possibility that the Rule Against Perpetuities would be repealed or abrogated, (2) there is a related doctrine that allows the modification of a trust to achieve the settlor’s tax objectives, (3) a jurisdiction that retroactively repeals the Rule Against Perpetuities has in effect nullified the requirement that a trust have an ascertainable beneficiary, (4) the law should not discriminate against a settlor who intended to create a perpetual trust but created an irrevocable trust before repeal of the jurisdiction’s Rule Against Perpetuities, and (5) the jurisdiction’s repeal of the Rule Against Perpetuities shows a public policy favoring perpetual trusts.
The reasons against using the doctrine of equitable deviation to extend the duration of a trust include the following: (1) trust term extension hurts current beneficiaries by converting their remainder interests into lifetime interests, (2) equitable deviation exists to implement the settlor’s intent as it existed when the trust was created but it might be used in this case to reconsider the settlor’s original intent, (3) creating new future beneficiaries undermines the core trust law requirement of definite, ascertainable beneficiaries, and (4) there is too much risk of misinterpreting a deceased settlor’s intent.
After analyzing the reasons for and against utilizing the doctrine of equitable deviation to extend the terms of a trust, Dean Weisbord concludes that the arguments against extension outweigh the reasons in favor. The strongest consideration appears to be that current beneficiaries are hurt by converting their remainder interests into lifetime interests.
In Part IV, Dean Weisbord analyzes broader issues with trust term extension and its potential for misuse by corporate fiduciaries. The main issue he sees is the financial incentive of corporate trustees to lobby for trust term extension. The existence of more long-term trusts means more business for corporate trust companies, and they have a huge financial incentive to advocate for repeal of the Rule Against Perpetuities. This repeal not only extends their business interests in current trusts, but it helps their state to attract additional trust business. As mentioned, Dean Weisbord concludes that the UTC should be modified to prohibit the addition of beneficiaries who were not in the original trust instrument.
Dean Weisbord has written an interesting and thought-provoking piece. I find the argument that trust modification to extend the duration of a trust hurts current beneficiaries to be particularly compelling. At a minimum, it seems that the only time when trust modification to extend trust duration should be allowed is when all the beneficiaries provide informed consent.
Some multi-parent families are created by law and others are created by science. California and a few other states have acknowledged that a child can have more than two legal parents. Professor Daar calls these multi-legal families or families in law. In their quest to serve their patients, physicians seek ways to enable infertile couples to have healthy children. Those doctors make their “treatment” decisions without considering the legal consequences of their actions. For example, in an attempt to lessen the possibility of a child inheriting a medical ailment from his or her mother, doctors may replace unhealthy mitochondrial with material obtained from the oocyte of a healthy female. The use of this mitochondrial manipulation technology (MMT) may result in a child being conceived using an oocyte containing mitochondrial DNA from two women. Professor Daar refers to this as a multi-genetic family or a family in genetics. Numerous articles and books have been written about multi-parent families. Most of the scholarly literature discusses the family law issues that arise because of the existence of these types of families. In her article, Professor Daar goes in a different direction. She focuses upon the impact that the recognition of multi-parent families may have on the intestacy system.
Professor Daar makes the distinction between legal parents and genetic parents. She explores the steps that can be taken in order for the intestacy system to accommodate multi-legal families. In multi-legal cases, more than two persons have been adjudicated as the child’s legal parents. The article also discusses the intestacy system’s treatment of multi-genetics families. In those situations, even though the parents and the children are related by genetics, their relationships may not be legally recognized. Professor Daar examines the manner in which the children and adults in these families may be treated under the intestacy system. Professor Daar analyzes the options of including multi-parent families under existing intestacy systems, creating new intestacy schemes to accommodate them, or excluding multi-parent families from the intestacy system. Professor Daar analyzes the treatment of multi-parent families under the existing intestacy system. As a part of that analysis, she compares multi-legal families to other nontraditional families. With regards to multi-genetic families, Professor Daar evaluates the treatment of families that are connected to the decedent by blood.
American succession law has changed to accommodate the needs of children who are part of nontraditional families. Professor Daar discusses the rules that apply to stepchildren and adopted children. In most states, stepchildren are not permitted to inherit from their stepparents. However, in a few states, stepchildren may be able to inherit if there are no genetically-related heirs in order to prevent the estate from going to the state. At least one state allows stepchildren to inherit if the stepchild-stepparent relationship started when the child was a minor and clear and convincing evidence indicates that the stepparent would have adopted the child if a legal barrier had not existed. When a child is adopted, the genetic parent-child relationship is severed and the adoptive parent-child relationship is created. Therefore, adopted children can typically only inherit from and through their adoptive parents. Nonetheless, if a child is adopted by his or her stepparent, that child may be permitted to inherit from both the adoptive and genetic parents. The Uniform Probate Code and some states also permit dual inheritance if a child is adopted after the death of both genetic parents. Professor Daar concludes that in states that permit more than two legal parents, the child would be allowed to inherit from and through all of the parents. Thus, these multi-parent children would be legally better off than stepchildren and adopted children. Unlike stepparents and parents who put their children up for adoption, parents in multi-legal families would benefit from being able to inherit from the children.
The law is not likely to treat multi-genetic parents like other non-traditional families. For instance, in cases involving children conceived using assisted reproductive technology, the person donating gametes are not considered to be legal parents of the resulting children. The person donating the mitochondria in MMT will probably be treated like an egg or sperm donor. Hence, that person will probably not be given legal parent status. Since the parent-child relationship would be based on genetics and not law, Professor Daar looks at cases where the right to inherit under the intestacy system is strictly based on genetics. In the case of remote heirs, the law gives preference to distance relatives over close friends. However, non-marital children have to be acknowledged in order to obtain the right to inherit from their fathers. Genetics alone is not enough to create the father-child relationship. Professor Daar concludes that a multi-genetic parent would probably not be treated like other genetically-related persons because it would be difficult to trace the person’s relationship to the decedent to a common ancestor.
Professor Daar examines the viability of an intestacy system that creates a special category for mitochondrial heirs. Under that proposed system, persons contributing genetic material would inherit to avoid having the property escheat to the state. The benefit of this approach would be to ensure that someone genetically-related to the decedent would take the property. This is in keeping with the intestacy system’s preference for transferring property to genetically-related persons. Professor Daar identified three shortcomings of this proposed scheme. The first weakness she points out is that only persons of a female lineage would be able to inherit because the genetic link in MMT situations is based on mitochondrial DNA that only comes from females. Thus, this intestacy scheme would lead to gender discrimination and inequality among similarly situated descendants. Professor Daar’s second concern is related to the integrity of the intestacy system. It may be difficult to identify particular heirs because the parents may not tell anyone that the child was conceived using MMT. Moreover, if someone claimed to be genetically-related to the decedent, proving that fact through testing may be complicated and expensive. Lastly, Professor Daar maintains that, giving mitochondrial families inheritance rights would directly conflict with the manner in which the law treats families created using gamete donations.
Professor Daar argues that, for intestacy purposes, a parent-child relationship should not exist between persons in multi-genetic families created using MMT. Professor Daar bases her argument on the fact that the law does not give other children conceived using assisted reproductive technology the right to inherit under the intestacy system. She also contends that giving intestacy rights to multi-genetic families does not make sense from a legal, practical or social sense. The ways in which families are formed will continue to evolve. Eventually, legislatures and courts will comprehend that the current law is not adequate to deal with the unique issues faced by those nontraditional families. Professor Daar’s article makes a valuable contribution to a conversation that will continue to be necessary as long as there is not a strong connection between the needs of multi-parent families and the intestacy system.
Traditionally, irrevocable trusts have been, well, irrevocable. The terms of the trust are fixed and the life of the trust cannot be cut short. Whether irrevocability emanates from the trust document itself or from circumstances such as the settlor’s death or incapacity, traditional irrevocability tied the hands of those interested in modifying the trust to accommodate changes in circumstances. Irrevocability was the doctrine through which the settlor could maintain control of the trust property throughout the life of the trust. Trust law acknowledges the tension between the original intent of the settlor’s dead-hand control and the current desires of the beneficiaries. As this tension is being resolved by greater accommodation of the current beneficiaries’ desires, has the doctrine of irrevocability lost its relevance?
In his recent article entitled Sherlock Holmes and the Problem of the Dead Hand: The Modification and Termination of “Irrevocable” Trusts, Dean Richard Ausness proposes a compromise. The first generation of trust beneficiaries would remain subject to the traditional rules disfavoring modification and early termination of trusts; subsequent generations of trust beneficiaries, however, would possess a liberating ability to modify a trust without court approval. The language of irrevocability would have renewed life, but only a short life.
Even under traditional trust practices, an irrevocable trust is somewhat of a false moniker. There are several avenues around true irrevocability, but each requires either the consent of the settlor or judicial approval. These avenues are, however, consistent with the norm of honoring the settlor’s wishes.
Under the Claflin doctrine, the beneficiaries of an irrevocable trust may petition for its termination when all material purposes of the trust have been satisfied. Having done what it was supposed to do, a trust under Claflin in effect no longer serves the settlor’s intended purpose. Claflin writes in an assumed premise, namely, that once the settlor’s objective in creating a trust has been accomplished, the trust need not continue. Irrevocability is merely a guarantee of the fulfillment of the trust’s purpose.
The Claflin doctrine, however, is inapplicable to several categories of trust such as spendthrift trusts and support trusts, as the continuance of such trusts is the material purpose thereof. The Claflin doctrine is also ill suited to modify trusts terminating at a set age of the beneficiary or upon a set occurrence. The purpose of the trust is, by definition, not fulfilled until such age or occurrence materializes. When faced with strict adherence to the irrevocability required by a settlor, courts at times embrace “partial termination” of the trust as a middle ground. The portion of the trust continuing intact preserves the original intent while distribution of some trust assets free of the trust accommodates the beneficiaries. Partial termination is a logical form of judicial relief when appreciation of trust assets has resulted in the overfunding of a trust relative to the trust’s purpose. True irrevocability in such cases would not add anything to the fulfillment of the settlor’s intent. The doctrine of equitable deviation offers some relief from strict adherence to the terms of an irrevocable trust, but only with respect to administrative (as opposed to distributive) provisions.
In a nutshell, traditional doctrines provide little support for modifying or terminating an irrevocable trust. Both the Uniform Trust Code and the Restatement (Third) of Trusts relax the stance on trust irrevocability. The Uniform Trust Code permits flexibility to accommodate circumstances not anticipated by the settlor. The restatement permits weighing the material purpose of the trust against the reasons for modifying or terminating the trust. However, both the Uniform Trust Code and the Restatement (Third) of Trusts require judicial involvement in trust modification and termination.
There are various roundabout ways of terminating or modifying a trust without involving the courts. First, the settlor may vest the trustee with the power giving to terminate or modify the trust. A trustee with this authority may act without court intervention unless the trustee abuses his discretion or acts unreasonably. Second, in the trust instrument, the settlor could authorize the trustee to “decant” the trust. This option involves transferring the trust property to a separate trust, created for the beneficiaries. And finally, the settlor could designate a trust protector who has the power to modify or terminate the trust. A trust protector is “a person, other than the settlor or a trustee, who is authorized to exercise one or more powers over the trust.” Despite the fact that trust protectors are separate and distinct from trustees, they still owe a fiduciary duty to the beneficiaries of the trust.
Dean Ausness proposes a chronological limitation on the settlor’s dead hand control by requiring adherence to the settlor’s intent with respect to first generation trust beneficiaries. This acknowledges the settlor’s “right to control the trust property during the lives of persons who are personally known to him.” However, Dean Ausness recognizes that the duration of dead hand control must be limited to protect the legitimate interests of beneficiaries. He thus suggests that members of succeeding classes of beneficiaries – i.e., the settlor’s grandchildren – should be able to freely modify or terminate the trust. Those beneficiaries who do not wish to terminate their interest in the trust may request that their share be placed in a separate sub-trust. This solution “strike[s] a reasonable balance between the rights of the deceased settlor (the dead hand) and those living beneficiaries.”
Cite as: Lynda Wray Black, How to Bolster the “Ir” in Irrevocable
(March 11, 2016) (reviewing Richard C. Ausness, Sherlock Holmes and the Problem of the Dead Hand: The Modification and Termination of “Irrevocable” Trusts
, 28 Quinnipiac Prob. L.J.
237 (2015)), http://trustest.jotwell.com/how-to-bolster-the-ir-in-irrevocable/
Mary F. Radford, Predispute Arbitration Agreements Between Trustees and Financial Services Institutions: Are Beneficiaries Bound?, 40 ACTEC L. J. 273 (2014).
Disputes are a persistent reality of trust law and even the most meticulously-drafted and expertly-administered trust can be embroiled in litigation, often involving trust investments. In an effort to avoid litigation, many investment advisors and banks include in their routine account agreements, provisions requiring arbitration in the event of any dispute. When a trustee opens an account that contains a mandatory arbitration provision, are the beneficiaries also bound?
Professor Mary Radford delves deep into the practice, cases, and theory of predispute arbitration provisions. Her discerning and experienced eye expertly distills the essence of a trustee’s fiduciary responsibilities with the practical realities of investing in the 21st century. This article appealed to me because it offers a thoughtful, sophisticated, and wide-ranging look at an increasingly common provision. At a time that arbitration clauses are under review, the article connects trust law to the wider world; it is a good example of the law as “seamless web.”
Part I presents the background of predispute arbitration agreements, with a focus on those used in the securities industry. Professor Radford marshals this material in a clear and concise fashion to provide the necessary starting point for the analytical framework going forward. Noting the longstanding federal policy favoring arbitration for the resolution of disputes, it is the SEC and the Financial Industry Regulatory Authority (FINRA) that developed the rules that actually govern these account agreements. The still-controversial rules became widespread after the Supreme Court effectively upheld the enforceability of the provisions in the late 1980s. This securities industry perspective, however, must be reconciled with a trustee’s fiduciary duties. Radford concludes that a trustee does have the authority to enter into these agreements, but that does not necessarily answer the question as to the beneficiary’s rights.
Part II reviews the cases that consider whether a nonsignatory trust beneficiary can be bound by the trustee’s agreement to arbitrate. The cases are few in number and weigh in favor of upholding the arbitration provision. Because the cases tend to be in state court proceedings and some are unpublished opinions, Radford wisely uses the cases, not as precedent, but as illustrations of the range and depth of the legal theories courts use in upholding the arbitration provision.
Part III is the legal center of the article. It discerns and examines the main theories courts have used in determining whether to enforce the arbitration provision against nonsignatory beneficiaries. Estoppel theory, a common approach, simply provides that a person cannot assert a claim that is based on an agreement and then disavow another portion of that agreement. Third party beneficiary is the second theory that courts have used and its focus is on the intent of the parties. Agency theory is also applicable given the contractual nature of the transaction. Often the agreement will include a provision that extends the agreement to the signatory’s successors and assigns. Finally and returning to the basics, courts note that there is a strong federal and state policy favoring arbitration of disputes. Radford provides a useful template for evaluating the impact of predispute arbitration provisions, agreed to by a trustee, on the nonsignatory beneficiaries.
Part IV discusses the current landscape of arbitration agreements. It starts by pointing up the flaws in the cases that allow nonsignatory beneficiaries to avoid arbitration. One court premised its refusal to enforce the provision because the beneficiary had no knowledge of the agreement. Radford points out that this theory would create a “dangerous” precedent. A beneficiary would only need to deny knowledge of the contract in order to avoid the contract. She rightfully points out that it would be far better to allow a beneficiary to proceed against the trustee on grounds of failing to keep the beneficiary reasonably informed than to fail to enforce contracts properly entered into by the trustee. Another court attempted to make the financial services institution a fiduciary to the nonsignatory beneficiaries separate and apart from the account. This is “troublesome” as Radford points out because without the account agreement there is no connection to the nonsignatory beneficiaries. While there may in some circumstances be some duty, it is necessary to first find a relationship between the parties in order to define the duty. Duties do not just exist in the ether.
Taking on the big picture, Radford asks the basic question: what is it that we lose when we force a securities arbitration on a nonsignatory? Radford addresses two major issues to the beneficiary – costs and fairness, and the larger societal issue of the negative impact on the development of trust law. There are no easy answers here. The differential in costs between an arbitration and litigation will depend on a number of factors and cannot be answered definitively. Fairness is equally elusive. Investors are skeptical of the overall fairness in FINRA arbitrations. There is a sense, supported by scholarship, that arbitration favors the “big guys” over the “little guys.” There is also the perception that arbitrators have an industry bias. Interestingly and in response to this criticism, a recent change in FINRA procedures allows customers with claims of $100,000 or more to choose a panel composed entirely of public arbitrators (that is, arbitrators who are not associated with the financial services industry), rather than a mixed panel. A study in 2013 showed that customers who used an all public panel were successful 62% of the time, compared to a 44% rate when a mixed panel was used. This corresponds favorably with a 60% success rate generally for plaintiffs in trials. Finally, there is the policy concern that FINRA arbitrations are not required to give reasons for the decisions. While the result in any particular arbitration may be understandable to the participants, the lack of a reasoned decision means that the “development and the evolution of theories in this area of the law cannot occur” because the “decisions are made under a shroud of secrecy.”
In the conclusion, Radford acknowledges that she has ”grappled with the issues” and “has not been very successful in coming up” with workable solutions. This is not a failure, this is a generous recognition that as long as Congress does not prohibit the predispute arbitration provision, there is little that can be done from the trust law perspective. To prohibit trustees from signing these agreements would likely foreclose trustees from using most financial services institutions; that is simply not practical. Similarly labelling these agreements as a breach of fiduciary duty is equally impractical and runs afoul of the prudent investor standard. Most promising and original is the author’s proposal to amend FINRA rules in cases involving a trust beneficiary. If the panel of arbitrators could include arbitrators who have knowledge of trust law, the “subtleties of the trust-related claims” would not be lost in the arbitration process. This could address the bias perception and perhaps reduce the need to pursue a secondary action against the trustee in court.
Radford’s article is a reminder that in understanding trust law, it is as important to have a sense of the practical realities in which a trust operates, as it is to know the history and theory of the law.