Michael J. Higdon, Parens Patriae and the Disinherited Child
(July 2, 2019), available at SSRN
In the United States, parents can disinherit their dependent children. This rule, which I’ll call the “disinheritance power,” is one of the most blazingly idiosyncratic strands of American law. Indeed, no other legal system gives decedents this cruel freedom. And although scholars have criticized the disinheritance power for decades, it remains firmly on the books.
Michael Higdon’s engaging new article attacks this problem from a new angle. Higdon proposes that states use the venerable doctrine of parens patriae as a safety valve against egregious exercises of the disinheritance power.
As Higdon explains, the disinheritance power is anomalous for several reasons. First, it’s a relic. American colonies imported the disinheritance power from England. But because England abandoned the disinheritance power in 1938, the U.S. has fallen far out of step.
Second, other countries do things very differently. In China, Nordic nations, and many civil law regimes, forced heirship gives all children a set percentage of a decedent’s property. Similarly, common law countries such as Australia, Canada, and England boast family maintenance statutes, which empower judges to override a testator’s wishes in the interests of fairness. Thus, by clinging to the disinheritance power, the U.S. “stand[s] alone.”
Third, even within American law, the disinheritance power is a paradox. For one, a living parent must support his or her minor children. It is not clear why this duty ends with the parent’s death. Moreover, although domestic courts and legislators often cite the primacy of testamentary autonomy, they also recognize common-sense limits to this principle. For instance, testators and settlors can’t insulate their assets from spouses or creditors. Likewise, judges invalidate bequests that violate public policy by causing negative externalities. Indeed, a court will refuse to enforce a provision in a will that instructs the executor to tear down the testator’s house because honoring such a provision would “harm the neighbors[ and] detrimentally affect the community.” Bizarrely, though, the disinheritance power invites decedents to saddle the government with the spillover cost of caring for their kids.
In a creative maneuver, Higdon suggests that states curb the disinheritance power through their parens patriae authority. Parens patriae is the government’s prerogative to “act as guardian for those who are unable to care for themselves, such as children or disabled individuals.” It surfaced in seventeenth century Britain, where it initially “only encompassed the Crown’s ability to protect lunatics (the temporarily insane) and idiots (the permanently insane).” (Pp. 26-27.) But due to a typographical error in a 1603 opinion—in which the publisher of Coke’s Reports accidentally substituted the word “infant” for “idiot”—judges soon extended parens patriae to children. Today, courts use the doctrine to override a variety of parental decisions that aren’t in a child’s best interests, including those relating to adoption, liability waivers, and divorce settlements.
Higdon urges courts to apply the doctrine of parens patriae to disinherited children in certain contexts. His thesis is persuasive and nuanced. Rather than aiming for the sky and advocating the abolition of the disinheritance power, he argues that judges should invoke parens patriae to protect “vulnerable child heirs”: “minor children, disabled adult children whose disabilities are such that they remain dependent upon their parents, and adult children who were abused at the hands of the testator parent during their minority.” (P.9.) Yet even when a child falls into one of these camps, Higdon would require the child to demonstrate additional harm, such as a lack of funds from other sources. In this way, Higdon would rein in the disinheritance power without significantly undercutting testamentary freedom.
To borrow a quote from Deborah Batts cited at the beginning of Higdon’s piece, “when it comes to inheritance, American children are in need of a champion.” (P. 3.)
Alberto B. Lopez & Fredrick E. Vars, Wrongful Living
, 104 Iowa L. Rev.
Advance directives are often recommended, but rarely used. The latter fact is an alarming one, and Professors Alberto Lopez and Fredrick Vars tackle this problem in their Article Wrongful Living. After identifying the root causes of this state of affairs, they provide innovative practical and conceptual proposals for implementing the wishes of those who have taken the time to exercise their prospective autonomy. They argue for a tripartite solution to the persistent problem of advance directive underutilization. First, they recommend creating a nationwide registry of advance directives. Second, they suggest that attorneys be exposed to professional discipline and malpractice liability for failing to enter advance directives into said registry. Third, they reconceptualize the nature of the damages that flow from medical interventions that lead to undesired continued life, making wrongful living claims potentially more cognizable to courts. This holistic analysis of advance directives is admirable for providing a realistic blueprint for law reform, and the Article is a must-read for those scholars working in the areas of incapacity planning, health law, and torts.
Lopez and Vars first perform some necessary brush clearing by discussing the historical and philosophical background of advance directives. They detail the legal history of the device, including its origins in informed consent doctrine, the flurry of state and federal legislative activity that allowed and promoted its use, and the high-profile cases of Karen Ann Quinlan and Nancy Cruzan. They then turn to the thornier philosophical issues around advance directives, focusing on the Ronald Dworkin-Rebecca Dresser debates on their utility or normative desirability. They conclude, unsurprisingly, that advance directives do protect important autonomy or dignity interests, creating a need to analyze how best to legally implement them.
With this conceptual foundation, they turn to examining why advance directives fail to influence medical treatment decisions. One culprit is the current law, which places the onus on the declarant (their term for the person who filled out the advance directive) to notify medical institutions of the existence of the directive. Even when this is done, however, advance directives are often not placed in the medical record in a way that will make them operative in a medical setting. States and the private market have attempted to ameliorate this situation by offering advance directive registries, but these face several practical problems. First, the placement in a registry does not necessarily make the advance directive easily accessible to medical personnel at the moment of decision, as it might require passwords that only the declarant has. Second, there are significant costs to starting up such registries, explaining why many states have not endeavored to create them. Finally, the proliferation of private registries to make up for the lack of public ones actually further complicates the efforts of medical personnel, as it increases search costs to find the registry that houses a particular patient’s legal documents.
This leads to their first proposal: a national centralized registry for advance directives. There are two features that Lopez and Vars identify as must-haves for this registry. First, it must be searchable without needing information from the declarant, as she might not be in a condition to communicate or may have forgotten a login password. Second, the registry must be completely online, which allows for immediate viewing of the relevant documents. This is important as often medical decisions are made in emergency situations, and there is not time for the directive to be mailed or faxed. Lopez and Vars justify such a registry primarily on the basis that it reduces the costs of finding and using advance directives as well as saving on costs due to economies of scale. In response to critics who say that they are merely proposing another government bureaucracy, they point to the relatively successful Organ Procurement and Transplantation Network, a similar database used in emergency situations by medical professionals that is maintained by the Department of Health and Human Services.
But having a registry is only part of the solution. It must be populated with advance directives in order to be effective. To illustrate this point, Lopez and Vars draw an interesting analogy between advance directives and wills, noting that the former is only useful if they are accessible quickly and during the life of the declarant, whereas the latter are only operative and needed some time after death. Thus, their second proposal: Attorneys who safeguard advance directives for their clients must adequately preserve them as they would other client property. The simplest and best way to do this would be to enter the advance directive into the national registry. Failure to do so could (and should, they argue) subject an attorney to both professional discipline and a legal malpractice action, thus creating an incentive for attorneys to comply. Here, the authors analogize registration to the attorney recordation of deeds after a real estate transaction, both of which put third parties on notice of the client’s interests.
Once the registry exists and is populated with a sufficient number of advance directives, the final part of the puzzle is getting medical professionals to use the registry and obey their patients’ memorialized commands. Their third proposal targets medical professionals, who might be subject to various claims for failing to comply with advance directives, specifically ones that require the discontinuation of life-sustaining treatment. Courts have been wary of wrongful life claims, primarily because they find it difficult to conceptualize continued life as a harm, as compared to nonexistence. In a clever move, Lopez and Vars reconceptualize the nature of the harm not as continued life but as a loss of enjoyment of life. The authors note that life-threatening medical events—if survived—are often followed by poor quality of life as compared with life before the medical event. This poor quality of life, in turn, is precipitated by a wrongful medical intervention caused by ignoring the dictates of an advance directive. Thus, the correct measure of damages is the difference between the quality of life in that previous state as compared to the diminished state that a person might find herself in after the wrongful medical intervention.
Whether courts will buy this particular conceptualization of damages is an open question. The harm of ignoring advance directives is more likely an injury to some type of dignity or prospective autonomy interest of the patient. However, as the authors note, courts are just as reluctant to expand dignity torts as they are to accept wrongful life claims. Therefore, the authors may provide a more realistic doctrinal route to recognition of the harms of not honoring advance directives. Coupled with their other proposals for a centralized registry and attorney incentives, we may have a path forward for making advance directives useful and effective.
Nothing incites more dread in law students and professors than the words “Rules Against Perpetuities” (RAP). As states continue to pass laws abolishing or effectively nullifying the doctrine, professors celebrate deleting this topic from their syllabi. Professor Kades demonstrates why, from a social policy perspective, society at large should dread the death of the RAP. In this article, he challenges this trend and demonstrates the negative consequences resulting from dynasty trusts, following the demise of the RAP.
Prof. Kades starts with a brief discussion of wealth and income inequality. Relying, in part, on Thomas Piketty’s research, Prof. Kades discusses how wealth inequality has a greater impact on wealth concentration than income inequality. His research supports the notion that wealth inequality has outpaced income inequity amongst the top wealth holders. He attributes this phenomenon, in part, to a mixture of wealthier individuals earning a higher rate of return on investments and their ability to save a larger part of their income. As inequality grows, individuals have more property to transfer via inheritance.
Prof. Kades argues how growing wealth precipitates increased wealth transfers which in turn contributes to further wealth and inheritance inequality. Prof. Kades provides historical data illustrating periods in which inequality was tempered and when it rose. Tying wealth to property ownership, the research demonstrates that periods of wealth decrease coincide with periods when capital property prices decrease. This history also tends to show that the rate of return on capital assets significantly exceeds the growth rate for world output. He argues this phenomenon further increases wealth and inheritance inequality. As a result, each generation has more capital, which in turn increases their capacity to accumulate yet more capital.
The RAP comes out of a particular historical context. The English Judiciary, through judicial decisions, converted fee tails to fee simple estate to make land alienable. Alienability remains a primary concern for property owners, but it is not the only justification for the RAP. For example, some scholars justify the RAP as a balance between present and future generations of property owners, although others question the claim that the RAP promotes greater utility than permitting perpetual restrictions. Professor Kades’s view is that property owners seek to avoid restrictions on their control over their devises. The RAP exists to make property more alienable and to limit “dead-hand” control in order to maximize the efficient use of property. Now, however, more than half of the states have abolished or diluted their RAP laws, and the tax laws have not made adjustments to address the consequence of allowing property ownership in perpetuity. Consequently, wealthy donors may place property in trust for descendants multiple generations down and this property may never be taxed if the donor allocates his generation-skipping transfer tax exclusion to the trust and the property remains in trust. Prof. Kades argues the estate tax has the capacity to be one of the most effective weapons against dynastic wealth, but it has been used ineffectively.
Holding accumulated capital in dynasty trusts, combined with the abolition of the RAP, exacerbates wealth and inheritance inequality. Prof. Kades argues that in addition to the negative effects of dynastic wealth, that wealth hoarding itself creates economic harms. He points out the economic health of the United States (U.S) relies on consumption and spending by the government and the private sector. The multiplier effect of government spending increases national income by encouraging consumer spending. However, dynastic trusts are not designed for spending. Instead, dynastic trusts are designed for maximum saving—for generations. As a result, government dollars used to purchase goods and services from businesses owned by dynasty trusts will reduce the multiplier, which negatively impacts the national income and inhibits the government’s ability to stimulate the economy.
Next, Prof. Kades introduces the concept of the “paradox of thrift,” which occurs when too much income is saved. When a large amount of wealth is held in dynastic trusts, it limits the government’s ability to respond to recessions, which has the greatest impact on individuals in the lowest wealth brackets. He argues that a savings rate that maximizes consumption—the “golden rule”—is equal to the sum of the depreciation rate for capital and the rate of growth of the population; he asserts that the U.S. rate has averaged substantially below this rate. In turn, this makes the economy ripe for economic decline.
Capital locked in dynasty trusts has another negative impact. The beneficiaries of dynasty trusts have major restrictions on their access to their property. In contrast, beneficiaries of non-dynastic trusts and estates have the ability to exercise control of their property, such that they may consume or dispose of it at will. They have the freedom to liquidate their property, spend assets, and leave nothing for the next generation. While this wasteful spending may be the type of behavior that estate planning professionals are hired to guard against, he argues donors should not have the power to lock up wealth to prevent future generations from spending it.
As a solution for these problems, Prof. Kades proposes tax-based solutions to curtail the negative effects of dynasty trusts. He highlights how the RAP and estate tax were designed to work together to curtail wealth concentration. Dynastic wealth benefits a few of the wealthiest families but has the potential to harm the majority of society by the negative impact it has on the economy. Even so, Prof. Kades does not advocate for reinstating the RAP. He points out that economists suggest that an effective way to curtail undesirable behavior is to institute a tax at a rate that reflects the external costs imposed on society by the undesirable activity. This solution would allow the government to raise revenue without deadweight loss.
To that end, Prof. Kades proposes taxing perpetuities at the federal level because of the systematic way states have passed laws with “race-to-the bottom” legislation to gain trust business. Further, dynastic wealth has a national impact on the economy, therefore, he argues the solution must be imposed on a national level. He identifies three specific harms associated with dynastic wealth: the paradox of thrift, the failure to save consistently with the golden rule, and the absence of wealth dissipation. In response to these harms, he offers a multilevel approach.
First, he proposes instating a mandatory minimum spending amount for trusts to encourage consumption, and a special income tax on dynasty trusts that have excess savings amounts that pull the national savings rate above the golden rule. Prof. Kades asserts these measures help to avoid the negative externalities associated with depressed consumption. In order for the special tax to be effective, he suggests a tax rate that would equal the amount of excess savings on all dynasty trusts with a savings rate above the golden rule rate based on the trust’s end of year value. The tax would automatically trigger only during times when the national saving rate rises above the golden rule level.
To address the paradox of thrift, Prof. Kades proposes a different short-term tax, since this phenomenon occurs during a recession. He does not propose a specific method, fraction, or amount but suggests the tax should automatically trigger during a recession. The amount should be determined based on the amount needed for employment restoration. Implemented correctly, he argues this tax will operate as an automatic stabilizer to counteract recessions because it will free funds destined for excess savings and redirect them to consumption or production of goods for consumption. Alternatively, he suggests that these funds could be used to cut taxes for low-income households.Together these taxes would discourage the type of excess saving that pose a threat to consumption-based economies.
Overall, Prof. Kades presents compelling proposals to curtail the negative effects of wealth concentration currently exacerbated by dynasty trusts. Relying on Piketty’s work, he outlines the drawbacks of dynasty trusts when combined with the abolition of the RAP in a majority of American jurisdictions. This article methodically outlines the harmful consequences of allowing dynasty trusts to continue without effective measures to combat wealth and inheritance inequality. I recommend this article to professors teaching Property, Trusts and Estates, Taxation, and tax policy courses. I also recommend this article to scholars interested in normative solutions to wealth, income, and inheritance inequality.
Last year I reviewed Adam J. Hirsch, Inheritance on the Fringes of Marriage, which explored whether donors would want their fiancé, ex-fiancé, separated spouse, or divorcing spouse to take a share of their estate. Following this theme of donor intent vis-à-vis a current or former intimate partner, I was particularly interested in Naomi Cahn’s article, Revisiting Revocation Upon Divorce, in which she challenges lawmakers’ assumptions about decedents’ relationships with their former spouses and their former spouses’ relatives after divorce or annulment. Under the 1990 Uniform Probate Code, divorce or annulment revokes any provisions in a will or nonprobate instrument concerning the former spouse. It also revokes bequests to the former spouse’s relatives, including her children from another relationship, parents, siblings, nieces and nephews—the testator’s former stepchildren and in-laws. Although the presumption of revocation may be rebutted in limited circumstances, this is both difficult and rare. Many states follow the 1990 UPC’s approach.
I must admit that the application of the doctrine of revocation upon divorce to a former spouse’s relatives has never seemed quite right to me. Maybe it is because I share close relationships with my spouse’s relatives and would continue to want them to benefit from my estate if my marriage were to end in divorce. My expectations are also based on my parents’ own experience with divorced relatives. My mother was very close to her sister’s ex-husband until his death and my father is very close to his brother’s ex-wife. Of course, my own personal experience is not evidence of what most donors would want, but Professor Cahn identifies several developments that demonstrate that the donor’s relationship with the former spouse and the former spouse’s relatives may not necessarily end when the legal relationship is terminated.
Professor Cahn observes that the divorce process has changed since the 1970s from the acrimonious battles often found in family law casebooks in which the petitioner had to prove fault to a kinder and gentler no-fault divorce. She explains that while some divorces are still acrimonious, lawyers now encourage clients to engage in mediation and other collaborative approaches that allow former spouses to co-parent and maintain amicable relationships after divorce. Of course, an amicable relationship and effective co-parenting does not mean that a donor’s testamentary preferences vis-à-vis a former spouse will remain the same after divorce. Nonetheless, I was reminded of Professor Hirsch’s study finding that more than more than 60% of divorcing spouses (those who were in the process of divorcing but do not have a final divorce decree) wished to leave part of their estate to the divorcing spouse. While a donor’s preference vis-à-vis a divorcing spouse might not be the same as her preferences vis-à-vis a former spouse, it suggests that Professor Cahn is wise to question whether revocation upon divorce actually reflects the intent of most donors.
I appreciated Professor Cahn’s policy arguments for revisiting the presumption of revocation upon divorce. She observes that revocation may have disparate effects on women, racial and ethnic minorities, and less wealthy individuals. She explains that as a result of women’s lower earnings, fewer years in the paid workforce, and longer life expectancy, surviving former spouses are likely to be older women with fewer assets for retirement when compared with divorced men. Consequently, revocation of a designation to a former spouse has a disproportionately negative impact on divorced women. She further observes that individuals who do not update their will and nonprobate beneficiary designations after divorce may be less educated and have fewer resources than wealthier individuals who have access to lawyers who will remind them to update their estate plan after divorce and do it for them. Although the effect of revocation on racial and ethnic minorities, who are more likely to divorce but less likely to have a will or assets at death, is much less clear, Professor Cahn wisely cautions that given these gender, racial, and class differences, lawmakers should examine the consequences of the presumption of revocation on different groups.
Professor Cahn’s discussion of several empirical studies involving relationships between former family members further demonstrates that revocation upon divorce may not reflect the donor’s intent, especially when there are children of the marriage. Her own study of adult children caring for a dying parent found that one-fifth of former spouses provided some level of caregiving to the former spouse. As I read this article, I thought about divorced friends and family members and how they might act in similar circumstances. It is not surprising that a mother would help her adult son care for his dying father, even if the mother and father are divorced. It would also not be surprising if the father wanted the mother to continue to benefit from his estate, especially if they maintained a cooperative, and possibly even friendly, relationship. Professor Cahn’s discussion of another study finding that one-quarter of individuals believe that a former daughter-in-law should be included in a will after a divorce similarly demonstrates that revocation upon divorce statutes do not always reflect a donor’s intent.
Despite these changes in the divorce process and post-divorce relationships, Professor Cahn acknowledges that the presumption of revocation upon divorce may serve to effectuate decedent’s intent in some, if not many, cases. The presumption benefits donors who intended to update their estate plan after divorce but never got around to it or assumed that the designation to a former spouse and her family members would automatically be revoked after divorce. Other donors, however, may have expected that the designations they made while married would remain in effect until they affirmatively changed them. Professor Cahn examines other countries’ approaches to designations benefitting a former spouse—some countries have no presumption of revocation upon divorce while others do—to demonstrate that the UPC approach is not necessarily the best approach.
Given the lack of empirical evidence on divorced donors’ intent and the low probability that lawmakers will abolish the presumption of revocation upon divorce any time soon, Professor Cahn proposes practical solutions that would increase the likelihood of effectuating decedent’s intent without unduly burdening the courts. Her stated “goals in exploring these reforms are, first, to develop a more functional approach that would acknowledge caregiving and functional familial relationships, and second, to respect donative intent.” (P. 1907.) I was particularly persuaded by her recommendation that lawmakers retain the presumption of revocation but place a time limit on its application. This proposal, modeled on South Africa’s approach, would provide a divorced donor with some time to change the beneficiary designations but if they are not changed within that time period, the law would presume that the divorced donor intended to keep the designations made before the divorce.
Professor Cahn also proposes amending revocation upon divorce statutes to allow rebuttal of the presumption by extrinsic (but clear and convincing) evidence of donor’s intent. Such evidence might include the relationship between the donor and the former spouse (or the former spouse’s relatives if they are designated beneficiaries) after the divorce, the length of time between the divorce and donor’s death, and any oral statements that indicate intent.
My favorite solutions were those that courts and lawyers could adopt rather easily. Professor Cahn proposes that family courts include advice on divorce filing forms explaining the revocation upon divorce rule (or whatever default rule the state has adopted) and allowing divorcing spouses to make an alternative designation on the form itself. She also reminds family law practitioners to advise their divorcing clients to update their beneficiary designations to reflect their intent, and trust and estate lawyers to draft documents that clarify the status of a designation to a spouse and the spouse’s relatives in the event of divorce. She observes that trusts and estates lawyers routinely draft provisions designating who should take a bequest if “my spouse does not survive me” and can easily add language designating who should take if “my spouse and I divorce.”
Professor Cahn’s article is a must read for anyone interested in recognizing the post-divorce collaborative and caregiving relationships that family law encourages and respecting divorced donors’ intent vis-à-vis a former spouse and the former spouse’s relatives.
Note About the Title: The term “renegotiated families” is taken from Robert E. Emery, Renegotiating Family Relationships: Divorce, Child Custody, and Mediation (1994).
For decades, state and federal governments have increased their watch on fringe lending practices such as payday loans, title loans, tax refund anticipation loans, and pension loans. The main reason for this increased regulation is that these loans often have astronomical interest rates which may force borrowers to come back for renewal loans. Probate loans are a lesser known form of fringe lending that have managed to slip below the radar of nearly all regulatory bodies in the United States.
Professor David Horton identifies the issues and discusses the alarming consequences of probate loans in his article entitled Borrowing in the Shadow of Death: Another Look at Probate Lending. His article examines three common methods of fringe finance, tax refund anticipation loans (RALs), payday loans, and pension loans, and then focuses on probate loans by drawing comparisons between the methods and identifying similarities.
Professor Horton explains the background for short-term lending practices and the current regulatory scheme for each method. In 1968, Congress passed the Truth in Lending Act (TILA) mandating the disclosure of information by lenders to prospective borrowers in an effort to protect consumers. This Act prevents lenders from keeping borrowers in the dark about the terms of the loans into which they enter. Many state legislatures have enacted their own laws to further protect consumer by regulating loans. A key development occurred in 2010 when the IRS announced it would no longer provide RAL issuers with the “debt indicator” used to estimate a prospective borrower’s anticipated tax return. Following this announcement, the Federal Deposit Insurance Commission warned all RAL lenders of the riskiness of RALs, resulting in a reduction of total RAL sales per year.
Probate loans are similar to other methods of fringe lending in many respects, but starkly different is the circumstance in which probate loans arise and the average loan amount. Professor Horton explains that probate loans are different as the practice tends to target people who are in the process of grieving. This makes probate loans especially predatory especially when there are few if any laws in place to regulate them. The average probate loan is more than $10,000; a sum much larger than the average payday loan. Most alarming is the reality that probate loans tend to have interest rates over 50%.
Professor Horton explains his groundbreaking empirical study of probate loans, starting with the identification of each estate administration involved in probate lending over a period of time in Alameda County, California. He devised a formula to calculate annual parentage rate of interest on the loans. Professor Horton determines that over a period of a few years in Alameda County, lending companies made nearly $5,000,000 on a total investment of just over $3,000,000. Most borrowers repaid within a year or two after the assignment of the loan. This results in an average APR on probate loans of around 50%.
Probate loans raise special concerns as California is the only state with a specialized probate lending statute on the books. Professor Horton explains that the current handling of these loans by using traditional legal theories such as usury and unconscionable is inadequate. An heir or beneficiary can assign an entire inheritance for instant cash, only to end up owing anywhere from 150% to more than 900% of the total loan amount upon conclusion of the estate administration.
Professor Horton is to be highly commended for addressing an issue that continues to fly below the radar of nearly every state and federal regulatory body. His extensive research to analyze the prevalence of probate lending and to calculate the expected cost of the loan uncovered an alarming trend that calls for rapid change in the legal system to protect consumers who elect to cash in early on their inheritances. I echo Professor Horton’s plea that legislatures and courts take prompt action so that consumers who elect to seek a probate loan can do so in “a transparent and fair fashion.”
[Special thanks for the outstanding assistance of Katherine Peters, J.D. Candidate May 2019, Texas Tech University School of Law, in preparing this review.]
In 2002, Professor Spitko published An Accrual/Multi-Factor Approach to Intestate Inheritance Rights for Unmarried Committed Partners in the Oregon Law Review. Since then, in 2006, Scotland statutorily began to provide intestate inheritance rights to unmarried cohabitants. Three years later, the Scottish Law Commission recommended reforming and replacing the 2006 law with rights for unmarried cohabitants that would apply to intestate and testate estates. Several years later, in March of 2016, the Justice Committee of the Scottish Parliament published Post-Legislative Scrutiny of the Family Law (Scotland) Act 2006. Professor Spitko analyzed these developments in Scotland and used them as a basis for reexamining his 2002 proposal.
I must admit that I am a huge fan of looking to other countries’ experiences for insight into our own legal system. I also think our intestacy laws need to be updated to reflect societal changes that have happened in recent years. As a result, I found Professor Spitko’s article to be fascinating.
Part I of the article starts by noting that no state in the U.S. grants inheritance rights to unmarried, unregistered cohabitants. It then explains why it makes sense to look at the Scottish experience. Significantly, it notes that the norms of Scottish and U.S. succession law are very similar in that they both prefer limited judicial discretion and fixed entitlements and they both value certainty. Given that the 2006 Scottish law has been extensively critiqued by practitioners, academics, and courts, it’s worth examining it. Part I then notes that its examination focuses on three “issues of principle” and two “issues of execution.” The issues of principle are (1) does the law fulfill its purpose?; (2) what is the impact of the law on certainty and administrative convenience?; and (3) what are the implications of the law on marriage? The issues of execution are (1) what is the impact of the duration of the cohabitation?; and (2) what is the impact of will substitutes?
In Part II of his article, Professor Spitko analyzes the 2006 Scottish law and focuses on the three issues of principle mentioned above. The law defines a “cohabitant” as “a man and a woman who are (or were) living together as if they were husband and wife; or…to persons of the same sex who are (or were) living together as if they were civil partners.” The law says that a court must consider three factors in determining whether somebody is a cohabitant: (1) length of time living together, (2) nature of their relationship, and (3) extent and nature of financial arrangements during their time living together. The law does not provide a fixed intestate share to the surviving cohabitant. Instead, it gives the court near unlimited discretion to determine if people qualify as cohabitants and to decide the share, with one key limitation: the intestate share cannot exceed the amount the person would have received had he or she been a spouse or civil partner of the deceased. In determining the size of the intestate share, the court is to consider will substitutes.
The article then focuses on the three issues of principle. First, with respect to the purpose of the law, critics of Scotland’s 2006 law have focused on the law’s lack of clarity with respect to its purpose. The article notes that the law does not seek to convey marriage-like rights on unmarried, unregistered cohabitants, but there is little clarity regarding what exactly it is attempting to convey. Second, with respect to certainty and administrative convenience, the discretion of the court is so unfettered that there is virtually no certainty regarding the outcome. Interestingly, the lack of a specific time period for people to live together to qualify as cohabitants has not really created any significant administrative issues. Finally, with respect to implications for marriage, the law’s drafters focused on protecting the special status of marriage by differentiating the rights of cohabitants from those of spouses, by capping the amount that a cohabitant can receive at a spousal or civil partner’s share, and by subordinating the rights of a surviving cohabitant to those of a spouse or civil partner of the deceased cohabitant.
The article then discusses the Scottish Law Commission’s (SLC) 2009 reform proposal. The SLC urged parliament to repeal the law and replace it with rights for surviving cohabitants that would apply to both testate and intestate estates. The reform proposal would focus on the contributions of the surviving cohabitant to the partnership. It does not take into account will substitutes. The SLC proposal defines a cohabitant as somebody who was “living with the deceased in a relationship which had the characteristics of the relationship between spouses or civil partners.” The proposal urges the court to focus on five factors: (1) whether they were members of the same household, (2) stability of the relationship, (3) whether the relationship was sexual, (4) whether they had (or accepted) children together, and (5) whether they appeared to others as if they were married, in civil partnership, or cohabitants with each other. The proposal lets the court determine the appropriate percentage of the estate to be received, considering the length of the cohabitation, the interdependence of the parties, and what the survivor contributed to their life together. A surviving cohabitant can assert a claim even if there is a surviving spouse.
In Part III of his article, Professor Spitko uses the Scottish experience to analyze how a U.S. state might best craft an intestacy statute that provides for cohabitants. Here, Professor Spitko refers to his own 2002 article, which proposed an accrual/multi-factor approach to cohabitants, and uses the Scottish experience to update and improve his proposal. He appropriately notes that we cannot just do exactly what Scotland has done. We need to consider where U.S. values are different from Scottish values and adjust accordingly.
First, Professor Spitko notes that it is critically important for the statute to clearly state the purposes and values behind the law. Also, in a country that values certainty and predictability, the law cannot give the court unfettered discretion to apply the law. Finally, any law in the U.S. must be mindful of the political reality that it will be difficult to garnish sufficient support for any law that is perceived as undermining the institution of marriage.
Second, Professor Spitko revisits his 2002 accrual/multi-factor approach proposal. He notes that the 2002 proposal’s stated purpose is (1) to promote the decedent’s unexpressed donative intent, (2) to recognize the survivor’s contributions, and (3) to protect the survivor’s reliance interest. I should be revised to note that any of those three is a qualifying purpose. More specifically, the revised proposal would qualify a couple as cohabitating if (1) they lived together in a physically and emotionally intimate partnership and (2) there is evidence that either (a) the decedent intended to benefit the survivor, (b) the survivor contributed to the decedent’s well-being, or (c) the survivor relied on the relationship.
As to administrative convenience and certainty, the original proposal was clear and simple in that it provided an inheritance schedule that gave the survivor a percentage of the intestate estate based on years of living together but it required a minimum three-year period before any inheritance would happen. The revised proposal would keep the same basic schedule, but it would allow short-term cohabitants (i.e., living together less than three years) to inherit, if circumstances warrant it, up to the amount that somebody might inherit after living together three years. For longer periods together, the schedule would not be as rigid as in the 2002 proposal. Instead, there would be limited flexibility by giving the court limited discretion to deviate from a fixed percentage, up or down within a range.
As to implications for marriage, the revised proposal would do two things that were not done in the 2002 proposal so as to not discourage marriage. First, it would limit the amount that a surviving cohabitant may receive to the amount that that person would have received had the cohabitants been married. Second, it would prohibit a surviving cohabitant from making a claim on the intestate estate if there actually is a surviving spouse of the decedent.
Professor Spitko has written an excellent, thought-provoking piece. Our society is changing, and a greater number of couples are choosing to cohabitate. Because intestacy laws, in theory, reflect the presumed intentions of the decedent, intestacy laws need to change to reflect this reality. By looking at the Scottish experience, Professor Spitko is moving the conversation forward and helping states that might want to update their intestacy laws to conform with modern realities.
Can an estate or trust with charitable and non-charitable beneficiaries (1) receive income in respect of a decedent (IRD) proceeds, (2) distribute (or set aside) for a charitable purpose the IRD proceeds, and (3) perhaps not be allowed an Internal Revenue (IRC) code section 642(c) income tax charitable deduction? You may know that the answer is “yes.” In their article, Professor F. Ladson Boyle and Jonathan G. Blattmachr not only explain when and why such income tax charitable deduction is available, but also suggest planning techniques to ensure that the deduction is, indeed, available.
To start, here are the authors’ suggested solutions for ensuring that the section 642(c) income tax charitable deduction is available to the estate or trust. First, if possible, designate the charity as the direct beneficiary of the individual retirement account (IRA) or other IRD; do not have the IRD proceeds pass through the decedent’s probate estate or revocable trust. (P. 413.) Second, if the charity cannot be the direct beneficiary of the IRD and if the governing testamentary instrument can be drafted or amended, then ensure that the IRD is “specifically devised to charity as a pre-residuary devise.” (P. 413.) Third, if an estate is in administration, then the personal representative “might distribute the IRD in kind to the charity as a part of the residuary devise due to the charity” (but not to satisfy a specific pecuniary amount). (P. 414.)
Fourth, if none of the foregoing options are viable and the estate will receive the IRD proceeds, then the personal representative “might fully distribute the portion of the estate that is due non-charitable beneficiaries in a tax year before collection of the IRD.” (P. 414.) Effectively, the charity becomes the sole beneficiary of the estate, and the IRD proceeds received will be fully offset by the charitable deduction (P. 414) (because, in the tax year when the IRD proceeds are received and distributed, there effectively are no non-charitable beneficiaries). Fifth, if the decedent had a revocable trust, the personal representative and the trustee of the revocable trust “should consider making a joint election under section 645 to treat the revocable trust as a part of the estate so that the section 642(c) charitable set aside deduction is available, if that is needed or desirable.” (P. 414.)
Those are the authors’ suggested solutions to the problem of a possibly unavailable income tax charitable deduction for distributing IRD to a charitable beneficiary. So, why and when is such income tax charitable deduction available? In order to answer that question, the authors must initially cover several topics, which are briefly summarized here. First, the authors note that, if both estate and income taxes must be paid, then the distribution of IRD to a non-charitable beneficiary may, ultimately, be very small. (Pp. 373-374.) Accordingly, the authors suggest that IRD be paid directly to an individual or charity; the authors note that, however, if an IRA is ultimately payable to an estate, the Service has allowed (in private letter rulings) estates to “assign IRAs and other retirement benefits to charities” (Pp. 374-375.) I wonder if seeking a private letter ruling might be a sixth suggested solution? The authors also conclude, after an extensive discussion, that “a charity’s residuary interest in an estate or trust is not a separate share within the meaning of section 663(c).” (P. 397.)
The authors then narrow the income tax charitable deduction issue to “whether a direction in a decedent’s will that a charity’s interest in the residue of an estate or trust should be satisfied out of any IRD will be given a tax effect under the Code and Regulations.” (P. 397.) The answer lies in determining whether the direction to allocate IRD assets (or their proceeds) to charity has “economic effect independent of income tax consequences,” which is from Treas. Reg. section 1.642(c)-3(b)(2). (Pp. 397-398.) Determining whether a direction has such “economic effect” is, however, no simple task.
The authors first summarize the charitable ordering rules (P. 399) and then the general rules for allocating deductions against different classes of income (Pp. 400-401); both sets of rules apply because the allocation of the charitable deduction “occurs before the allocation of other allowable deductions.” (P. 400.) An example in the Regulations shows one governing instrument’s provision that has “economic effect independent of income tax consequences” because, under the facts of that example, “the amount to be paid to the charitable organization each year is dependent upon the amount of ordinary income the trust earns within that taxable year.” (P. 402, citing the Treasury Regulation example.)
The facts in that Treasury Regulation example are: “A trust instrument provides that 100 percent of the trust’s ordinary income must be distributed currently to an organization described in section 170(c) and that all remaining items of income must be distributed currently to B, a noncharitable beneficiary.” (P. 403.) The authors note that “the amount of cash (or other property) that is distributed to the charity is directly related to the principal that is producing the income” and that a “change in the composition of principal affects the amount the charity is to receive” (P. 404.) Accordingly, the direction in this trust to direct 100 percent of the trust’s ordinary income to a charitable organization has “economic effect independent of income tax consequences.”
But wait!—IRD is usually treated as accounting principal, not accounting income. Consequently, the authors re-examine the charitable ordering rules and the general rules for allocating deductions against different classes of income, this time focusing on accounting principal like IRD. The authors conclude that, to have economic effect, a direction to allocate payment to a charity must have “an impact on the underlying assets that produce the income, and therefore on the entitlement to the income the property generates.” (P. 407.)
But don’t forget!—at issue is the allocating of IRD to a charity, not to a non-charitable beneficiary. The authors draw and analogize from what they have already discussed (among other things, separate share regulations, and distributions of income and of principal) to conclude that “an allocation of IRD to a tax-exempt charity seems to be valid as well under the 2012 charitable ordering Regulations.” (P. 408.) The authors note, however, that their conclusion is “not free of doubt, but is a reasoned analysis of the applicable Regulations.” (P. 412.) They posit that the “economic effect” test may, perhaps, only be determined as an objective question of fact on a case-by-case basis. (P. 412.) Finally, the authors conclude that a personal representative having, under the governing instrument or local law, the discretion to allocate IRD to a charity likely “will be ineffective” (P. 415) for lacking “economic effect.”
The authors have discussed the many legal topics invoked in answering when can an estate or trust distribute IRD to a charity and receive an income tax charitable deduction: the income taxation of trusts and estates, the income taxation of IRD, the separate shares of an estate or trust, a specific gift to a charity vs. a fractional residuary gift to a charity, the “economic effect” test of the Treasury Regulations, the charitable ordering rules, the general rules for allocating deductions against different classes of income, distributions of accounting income vs. accounting principal, distributions to charitable beneficiaries vs. non-charitable beneficiaries, and distributions pursuant to the governing instrument vs. under the personal representative’s discretion—all leading to the final topic of distributions by an estate or trust of accounting principal (as part of a residuary gift) to a charitable beneficiary. The authors concluded that the availability of an income tax charitable deduction for such a distribution is not always certain. When, at the end of the article, the authors proposed their alternative actions to take in order to avoid such a distribution (and tests and rules associated thereto), I was all ears.
Susan Gary, Restricted Charitable Gifts: Public Benefit, Public Voice
, 81 Alb. L. Rev
101 (2018), available at SSRN.
Susan Gary’s Restricted Charitable Gifts: Public Benefit, Public Voice makes the case for legal reforms that reflect the public’s interest in loosening donor control of charitable gifts. Gary writes that her article is aimed at advocating for the adoption of reforms that increase “the consideration of the public benefit standard in charities law,” so I know that she didn’t set out to change the way I teach my Estates course. But that’s exactly what she did, and it’s why I like her article.
In classes on charitable trusts, my big picture questions are about the relationship between donors and charities: when should the law defer to the dead hand and when should it permit charities to modify donor-restricted gifts? Gary’s article has convinced me that the public interest—not donors or charities—should instead assume center stage. Restricted Charitable Gifts: Public Benefit, Public Voice is one of those rare articles that prompts me to re-conceptualize material I’ve taught for many years, particularly the enforcement role of the attorney general.
Gary begins with the familiar observation that while the donor and charity are the immediate parties in any charitable gift, the public is also part of the transaction. For example, whenever a charitable donor receives a tax benefit from a gift, the public has subsidized the donor’s charitable giving. Trust law is also generous with charitable donors, exempting them from the Rule Against Perpetuities and other requirements for private gifts. When a gift is large enough, the public confers prestige on the donor, which can lead to improved social standing, business gains, and a generally enhanced reputation.
Gary uses well-known examples to illustrate why the public has an interest in whether and how long donors can place restrictions on charitable gifts. I won’t belabor these examples here, but in each, the public has an obvious interest in the charitable gift: the Barnes Foundation (arguably the greatest private American art collection), the Buck Trust (hundreds of millions of dollars earmarked for “the needy” in affluent Marin County, California), and the Leona M. and Harry B. Helmsley Trust (donor desired multi-billion dollar trust to be used “for the provision of care for dogs”). As Gary explains, in order for any of these gifts to be “charitable” under trust law, they must confer a “public benefit.” (P. 593-94.) The requirement of a public benefit raises questions about whether “the public should have a voice in how charitable assets are used” or if “some limit should be imposed on the donor’s directions, even if the directions comply with a general understanding of charitable purposes.” (P. 594.)
Enter the state attorney general. Donors usually cannot sue to enforce the terms of their charitable gifts. Instead, the attorney general oversees the use of charitable assets. As an elected official, the attorney general is likely to consider the preferences of the electorate when deciding whether to pursue an enforcement action. The examples in the preceding paragraph illustrate that sometimes donor-imposed restrictions conflict with the public interest. This conflict is frequently cited as a reason to give donors standing to enforce the terms of their charitable gifts.
Gary argues persuasively, however, that attention to the electorate may be one of the attorney general’s greatest strengths since “the Attorney General is elected to protect the interests of the public.” (P. 598.) In other words, oversight by the attorney general ensures that the public has a seat at the table. Using the attorney general’s political status as a justification for shifting more enforcement power to donors ignores that every donation has three parties: the donor, the charity, and the public that subsidizes and supports the charitable gift.
Gary recognizes the financial constraints and other structural limitations on the attorney general’s ability to monitor “every charity and every restricted gift.” (P. 598.) This is another oft-cited rationale for proposals that would broader donor standing. My Estates class has fallen into this trap for years: if not the attorney general, then the donor. But reforms that give donors increased enforcement power do little to advance the public’s interest in the charitable gift. Gary surveys proposals that re-allocate control over the terms of charitable gifts, including rules that would relax donor restrictions after a set number of years and expand the application of cy pres. The cumulative effect of Gary’s survey, and her article overall, is to emphasize that legal reforms in charities law must make the public’s voice as loud as that of donors and charities.
James J. White, Fraudulent Conveyances Masquerading as Asset Protection Trusts
, 47 UCC L.J.
367 (2017), available at SSRN
Property rights are contingent. While property owners enjoy exclusive access to property owned, laws governing creditors’ rights moderate owners’ rights under certain conditions. Failure to satisfy a debt can trigger legal processes that may even lead to a complete stripping of ownership rights in favor of the creditor. Viewed this way, the sorting of rights to property is a zero-sum game where a creditor’s gain offsets an owner’s loss.
Trusts can reduce the vulnerability of an owner’s property rights by adding additional complexity to the ownership arrangement. The spendthrift trust is the obvious example. In such an arrangement an owner transfers the ownership bundle in manner that is said to “split” new ownership rights between a trustee and one or more beneficiaries. Afterwards, the beneficiaries enjoy the benefits of ownership, but neither a beneficiary nor most third parties are capable of diminishing beneficial ownership rights in the spendthrift trust arrangement.
Spendthrift trusts are typically explained as devices. Reference is to the law governing trusts. In these explanations informed by trust law, the fact that creditors’ property rights, including those of involuntary creditors, are diminished by spendthrift trusts is incidental to the main event—the legal operation of the trust device itself. Policy justification focuses on the freedom of the original owner to “dispose” of property as he or she pleases. And while beneficiaries gain a beneficial interest that diminishes baseline property rights of creditors, we phrase our explanations in terms of what is missing from the beneficial owner’s bundle of rights. So we point out that, in a spendthrift trust, a beneficiary has no right to grant creditors an up-front inchoate right to beneficially-owned property. And despite that involuntary creditors lose baseline rights to the beneficial owner’s property, we focus on the beneficial owner’s loss of the “involuntary” right to transfer property rights to a creditor. But in fact, spendthrift trusts are no exception to the zero-sum sorting of property rights between owners and creditors. Rights gained by beneficiaries are lost by creditors.
Crucial to creation of a spendthrift trust is a benefactor who transfers property rights to the trust arrangement. But a newer legal invention, the so-called “self-settled domestic asset protection trust” (DAPT), dispenses with the necessity of the gratuitous third-party transfer. In these devices, the settlor becomes the beneficiary; the trust is “self-settled.” The DAPT is necessarily statutorily enabled, as the common law justification for spendthrift trusts, the freedom of disposition of the original owner, is absent from the facts. The original owner retains, rather than disposes of, his or her beneficial ownership rights. Yet the nomenclature reveals the bias in favor of the trust beneficiary. Trust properties are “assets” and assets are “protected.” Of course, to “protect” an asset is to increase an owner’s rights, and to diminish the rights of creditors. Here, however, it may not be so easy to de-emphasize the zero-sum nature of property rights. A scholar viewing these devices from the creditor’s standpoint may in fact cry “foul.” Professor James J. White, in a provocatively entitled essay appearing in the Uniform Commercial Code Law Journal, concludes that these devices “are fraudulent conveyances plain and simple.” Although White considers his view both “dispassionate” and “slightly skeptical,” he seems particularly concerned about involuntary creditors; his primary examples being “ex-wives and malpractice plaintiffs.”
Professor White first briefly reviews the history of the DAPT, pointing out that while prior to 1997 the device was not available in any U.S. jurisdiction, now seventeen states enable some version of the DAPT. Before enactment of DAPT statutes, Americans wishing to curb creditors’ rights to property they owned by placing that property in trust had to do so through the laws of certain foreign jurisdictions such as the Cook Islands. In 1997, however, the states of Delaware and Alaska enacted statutes enabling domestic self-settled trusts that curbed creditors’ rights to the settlor/beneficiary’s property. Since that time, another fifteen states enacted similar statutes. According to Professor White, while the sponsors of the Delaware and Alaska legislation were entrepreneurs, lawyers, and trust companies who saw a market for these trusts, later “unsuspecting and uninformed” legislators were simply swayed by the argument that their jurisdictions needed similar statutes in order to keep assets and trust business from flowing to other states. White attempts to assure us that with these reasons for the legislation, legislators did not actually face the “reprehensible” reversal of longstanding public policy that self-settled trusts could not foil the rights of creditors and “stiff ex-wives and deprive successful malpractice plaintiffs from satisfaction out of a settlor/defendant’s trust assets.” Perhaps Professor White assumes too much naiveté on behalf of legislators here. It seems at least as likely that many of these legislators were sympathetic to the favored causes of certain constituents and campaign donors.
Regardless of the reasons for enactment in the various states, Professor White is certainly correct when he notes that the promoters of these trusts, post-adoption by the legislature, focus on the DAPT’s ability to protect assets from claims of creditors. Some promoters are very specific, listing divorce and tort actions as occasions where these trusts offer protection. As White sums it up, “the multiple pages of internet listings, some subtle, some strident, and some with false denials make plain that keeping assets out of the hands of creditors, particularly tort plaintiffs and former wives, is a principal purpose of these trusts.” But the value of White’s insights for the trusts and estates bar lies in his discussion of the changes that the statutes made to fraudulent conveyance law, and his consideration of whether those changes mean that property transfers to these trusts fall outside the rather complicated determination of a fraudulent conveyance. DAPT statutes reduce the statute of limitations for filing claims based on a fraudulent conveyance and require the claimant to prove actual intent on the part of the property owner to “hinder, delay or defraud” a creditor.
White admits that since the case law is scarce or nonexistent, the effect of these legislative changes in actual cases is unknown. However, he suggests that current law as to determining actual intent “will be relatively easy to meet in view of the skepticism that many courts will have and because the advertising and sales information reveal a pervasive intent to hamper creditors.” On the other hand, he concedes that shortening the statutes of limitations for bringing such claims could be a “powerful restriction” on them. White takes the reader through an analysis of the steps for proving actual intent to hinder, delay or defraud future creditors, including involuntary creditors, which likely make up the bulk of those potential creditors with which the typical DAPT settlor/beneficiary is concerned. Although White reviews some case law helpful in this analysis, given the general paucity of cases much of White’s musings here are speculative. In an interesting observation on this subject, White notes that commentators do not even agree on the definition of “future creditor,” with some asserting that courts “are unwilling to void transfers whose purpose and effect is to shelter assets from creditors that were unknown at the time of the transfer” while others do not so conclude.
White also explores the question of which jurisdiction’s laws will apply in these cases. In federal bankruptcy cases, he points out that a ten-year statute of limitations may apply to fraudulent transfers regardless of state law. Further, since only seventeen states enacted DAPT legislation, many out-of-state settlor/beneficiaries must rely on a choice of law term in the trust instrument in order to take advantage of a DAPT. In such cases the public policy exception in the state where the settlor/beneficiary resides may negate the choice of law provision. White cites a federal bankruptcy case from a court sitting in Washington in observing that “it was no surprise that the court inferred a public policy against self-settled trusts from a Washington statute that prohibits self-settled trusts.” White also very briefly confronts the arguments that the DAPT is no different from a limited liability company (LLC), a homestead exemption, and other statutory diminishments of creditors’ rights. A more thorough comparison with these devices would give additional context.
In his concise essay, Professor White’s creditors’ rights perspective alerts us to potential legal and public policy uncertainties created by the DAPT. Regardless of whether the reader agrees with White that the DAPT is a form of fraudulent conveyance, his essay is a reminder of what I describe above as the zero-sum aspect of property rights. Strengthening the property rights of beneficial owners decreases the rights of creditors. Whether a particular increase and decrease is desirable invokes important questions of law and policy. In considering the DAPT from the standpoint of fraudulent conveyance law, Professor James J. White offers trusts and estates specialists a fresh perspective.
Susan N. Gary, Best Interests in the Long Term: Fiduciary Duties and ESG Integration
, 90 U. of Colo. L. Rev.
__ (forthcoming 2018), available at SSRN
What is the time frame of fiduciary duties? In other words, what time horizon should fiduciaries have in mind as they execute their responsibilities? This is an underexamined aspect of fiduciary law, and Professor Susan Gary’s piece, Best Interests in the Long-Term: Fiduciary Duties and ESG Integration, provides a thought-provoking entry point using the lens of socially responsible investing (SRI). Gary argues that if prudent investing evolves to encompass a longer-term understanding of value creation, then consideration of environmental, social, and governance (ESG) factors may become not only possible, but legally required. If this occurs, we may witness a tectonic shift in investor behavior similar to that produced by enshrining modern portfolio theory (MPT) in fiduciary law.
Gary starts by reviewing the different terminologies and strategies of SRI. The goal is to differentiate ESG integration—Gary’s primary object of analysis—from other types of SRI. ESG integration is a holistic investment strategy that considers traditional financial factors alongside material ESG factors, with materiality defined as the likelihood that the ESG factor has some relationship with financial outcomes. Environmental factors might include a company’s energy efficiency policies, while social factors can run the gamut from human rights to labor conditions to community relations. Governance factors, in turn, involve such issues as board diversity, executive compensation, and transparency policies. Gary contrasts ESG integration with early forms of SRI that employed negative screening mechanisms to exclude certain socially undesirable companies or classes of assets from an investment portfolio. She also distinguishes it from a more modern form of SRI called impact investing, which typically involves a sacrifice of economic return in exchange for a measurable social impact.
With those definitions in place, Gary turns to investment theory. MPT currently dominates this space, with its focus on maximizing returns by diversifying the portfolio to manage risk. Early theoretical work examining the relationship between MPT and SRI concluded that SRI was undesirable for two reasons. First, it hinders attempts at diversification by removing certain classes of assets from portfolios for non-financial reasons. Second, the screening required by SRI theoretically increases administrative costs as compared to non-SRI alternatives. Gary contends that the first objection conflates SRI with negative screens, when certain types of SRI like ESG integration do not employ such screens. As for the second objection, she believes that it carries less weight today as SRI information has become more readily available. She devotes one section of the paper to detailing the numerous governmental and non-governmental entities that now require or collect ESG information.
As SRI has matured, researchers have produced more data to help resolve this debate. Unfortunately, the empirical studies on the costs of SRI are not entirely conclusive. However, Gary highlights several studies finding that SRI has no effect or a positive effect on returns. She uses these findings to explore the financial case for ESG integration, which is tied to a critique of short-termism in current financial thinking. Specifically, some theorists posit that MPT has led to a focus on short-term risk and return as opposed to longer-term systemic risk because the former is theoretically manageable by investors while the latter is not. Thus, financial markets have become too focused on quarterly evaluations of companies as well as maximization of short-term profit. In contrast, ESG factors are by their nature more systemic and long-term. They hedge against longer-term concerns such as access to fresh water or the stability and credibility of financial markets. This helps explain why studies showing positive results from ESG integration tend to have longer time horizons.
This is all a prelude to the legal analysis in the article, which concerns how SRI interfaces with fiduciary duties. The fiduciary duty of care requires that fiduciaries manage assets with reasonable care, skill, and caution. Gary observes that this standard is malleable and has in the recent past been subject to reinterpretation with the legal adoption of the principles of MPT. She argues that a similar evolution is underway as we learn more about ESG integration, which appears to pose no threat to financial returns and may in fact enhance them. An even more radical change in mindset may be in the offing as well, with a shift from a short-term to a long-term understanding of value creation. This potential temporal shift is the most intriguing element of the piece, and it surfaces more explicitly in Gary’s consideration of the fiduciary duty of impartiality. This duty requires fiduciaries to consider adequately the interests of differently-situated beneficiaries, and it is heavily implicated when fiduciaries manage assets for beneficiaries across generations. In this case, it may be necessary to contemplate ESG factors in order to respect the interests of future sets of beneficiaries. In other words, reflexive short-termism might be prohibited. This fiduciary duty seems to the most fertile ground for Gary’s arguments.
I was curious to what degree Gary predicates her case for ESG integration on long-term financial thinking, given that longer-term studies provide her strongest evidence. To the extent that she does, it may be necessary to lay out a normative case for long-termism, which raises its own set of thorny questions. Why should we evaluate financial returns on a quarterly, yearly, or longer basis? Are there not scenarios in which a shorter time horizon might make sense? Some beneficiaries may have short-term needs, and others might not live long enough to see a longer time horizon. If different temporal scopes for fiduciary duty are desirable based on the circumstances, how should we set the default rule for the prudent investor? However one thinks fiduciary duties should be structured, Gary has made a forceful case that ESG factors can no longer be ignored. Her piece compels us to reckon with fundamental questions about the temporal scope of fiduciary duty and the relevant time frame for investor behavior. These are not small questions, and Gary provides a valuable analysis that will jumpstart a dialogue on these important issues.