Articles – Page 10 – Law Offices of Randolf Krbechek

Court Permits 35 Year Delay in Filing Claim for Breach of Trust

Here’s an awkward fact pattern Grandfather establishes a testamentary trust, which trust was confirmed in 1971 court order. The trust provides for distributions to the “grandchildren.” A decade later, an individual (Mr. Quick) learns that he is a grandchild, and strikes up a friendship with his father, who is also a trustee of the trustee.

Another 20 years pass and Mr. Quick learns of the trust. His father having passed away, he sues the successor trustee, claiming he was deprived of the benefits of the trust. Despite the extremely long passage of time, the court allowed the case to go forward in the recent decision in In re Blowitz (June 14, 2010) 186 Cal.App.4th 371.

In its opinion, the court found that “Samuel D. Blowitz died testate in 1971. Pursuant to the terms of a testamentary trust, he left the remainder of the trust estate in equal shares to his grandchildren.”

The will was submitted to probate, and “An Order Settling First and Final Account and Report of Executor filed January 2, 1974, recounts that the trust provides: ‘Each grandchild living at the time of decedent’s death shall hold undivided equal interests in the trust estate. When a grandchild attains age twenty-five (25), the Co-trustees shall distribute to such grandchild the entire principal of such grandchild’s interest in the trust.’”

That sentence triggered the litigation. The Order did not name the grandchildren, but merely referred to “each grandchild living at the time of the decedent’s death.”

Now comes the fact that should have triggered a duty of inquiry. “In 1989, Quick learned J. Michael Blowitz was his natural father. Mr. Quick thereafter met J. Michael Blowitz, attended a Clippers game with him and built a close relationship over the next few years.”

Quick’s father was a trustee of the trust. If Quick wanted to sue someone, it should have been his father. He did not do so, instead waiting years before suing the successor trustee. In his complaint, “Quick alleged Pearson [the successor trustee] knew Quick was Samuel D. Blowitz’s grandchild and therefore a member of the class of remaindermen identified in the trust.”

The lawsuit further alleged that “Pearson willfully and unlawfully refused to give Quick notice he was a beneficiary of the trust and willfully failed to distribute Quick’s share of the trust remainder to Quick.”

By way of defense, Pearson contended Quick “played the proverbial Ostrich, stuck his head in the sand and refused to investigate. Pearson repeatedly notes Quick had an obvious source of information available to him, namely, his natural father with whom he had a good relationship and who was a co-trustee of the trust . . . Pearson asserts Quick had a duty to inquire and investigate when he became aware of facts which would put a reasonable person on notice.”

The court rejected this argument, holding that “Nothing in the second amended petition suggests Quick became aware of facts that would have put a reasonable person on notice of the existence of the trust earlier than 2007 when Quick was advised of the trust’s existence by Mickey J. Blowitz.”

The court concluded that “The second amended petition asserts Quick was unaware of the existence of the trust. It further alleges Pearson knew, at all relevant times, that Quick was a grandson of the testator and that Pearson failed to notify Quick of his interest in the trust and instructed the other trust beneficiaries not to inform Quick of the existence of the trust. Accepting the allegations of the second amended petition as true, as we must on review of an order sustaining a demurrer, we conclude Quick adequately has stated a cause of action for breach of trust by a trustee.”

This seems like a wrong decision, morally if not legally. More than 35 years elapsed before Mr. Quick filed his lawsuit. His dispute was with his real father, not the successor trustee. Under these facts, the court should not have permitted the litigation to proceed.

In re Blowitz (June 14, 2010) 186 Cal.App.4th 371

Stiff Penalty for Looting Assets From Decedent’s Estate

A recent case emphasizes that the probate court has broad powers to prevent the looting of a decedent’s estate, and can award penalty damages, as well.

In Estate of Kraus (April 27, 2010) 184 Cal.App.4th 103, the decedent’s brother used an invalid power of attorney to clean out her bank accounts in the hours before his sister’s death. As stated in the decision, “On October 22, 2006, David’s sister, Janice Helene Kraus, was dying of cancer. Janice was unmarried, did not have any children and she was in hospice care.”

Bad fact coming up. “On October 22, 2006, David had Janice execute a durable power of attorney in his favor. At the time, Janice was semi-comatose. At trial, David “could [not] remember speaking with Janice’s physicians as to whether she had the capacity to sign the power of attorney.”

More bad facts for David. “On October 22, 2006, Janice was semi-conscious and undergoing hospice care when an ‘X’ was placed on the signature line of the power of attorney. Joe Damco, her boyfriend, held Janice’s hand when the ‘X’ was placed on the signature line of the power of attorney . . . At the time of her death, Janice’s doctors assumed the cancer had spread to her brain.”

“On the morning of October 23, 2006, David closed several of Janice’s bank accounts and appropriated the funds [totaling $197,402] for himself. The money in those accounts belonged to the trust. Janice died on October 24, 2006 at 7:50 a.m.”

According to his trial testimony, “David prepared the power of attorney to reclaim money in Janice’s accounts he thought belonged to Irene. Also, David wanted to secure jewelry that Janice wanted placed in her coffin.”

The trial court “found the power of attorney drafted by David on October 22, 2006, was void and David wrongfully and in bad faith converted property belonging to the trust. According to the court, “The funds secured under the power of attorney were placed in accounts in the name of David and his wife. No funds taken by David on October 23, 2006, under the power of attorney were ever placed in Irene’s accounts.” The probate court made no final determination as to the beneficiaries’ right to the funds.

The decision was affirmed in its entirety on appeal. Explained the court, “the probate court is a court of general jurisdiction (Probate Code § 800) with broad equitable powers. The probate court has jurisdiction to determine whether property is part of the decedent’s estate or living trust.”

“The probate court has general subject matter jurisdiction over the decedent’s property and as such, it is empowered to resolve competing claims over the title to and distribution of the decedent’s property. The probate court may apply general equitable principles in fashioning remedies and granting relief . . . The ultimate aim and purpose of administrative proceedings, including any special proceeding or contest to determine heirship, is to ascertain the persons entitled to share in the estate of the decedent and to decree distribution accordingly.”

Thus,“Probate Code section 850 et seq. provides a mechanism for court determination of rights in property claimed to belong to a decedent or another person. The statutory scheme’s ‘evident purpose’ is to carry out the decedent’s intent and to prevent looting of estates.”

Further, “Probate Code section 859 provides for recovery of twice the value of property taken in bad faith. The section 859 penalty is imposed when an interested party establishes both that the property in question is recoverable under section 850 and that there was a bad faith taking of the property.”

On appeal, “David conceded that the power of attorney was invalid . . . David argued the probate court should have denied the petition because the beneficiaries did not prove they had any right to the funds.”

The court summarily rejected this argument. “Section 850, by its clear and plain terms, does not require the probate court to find that the property in question belongs to the interested petitioning party. Here, the trust beneficiaries sought an order requiring David to relinquish misappropriated property. That it is unclear who is entitled to the property does not deny the beneficiaries of their interest in its rightful disposition – even if, ultimately, it does not go to the trust.”

“Under the language and purpose of the statutory scheme, and given the probate court’s broad powers, it was not required to allow the wrongdoer to retain the property misappropriated in bad faith until someone else proved a ‘better’ right to it. Under the plain terms of the statutory scheme, the probate court was not required to determine who was entitled to the funds before it could take them away from a person who was not entitled to them.”

“What was clear, as the probate court found, was that David was not entitled to take the money out of Janice’s bank accounts and put it in his own name. Given these circumstances, the probate court could reasonably, in the exercise of its statutory and equitable powers, place the funds, together with the statutory penalty imposed on David, in Janice’s estate for a future determination of their proper disposition.”

The court also affirmed the statutory penalty in the amount of $394,804. “Here, the probate court found David in bad faith wrongfully took money that was recoverable under section 850. At the time it was misappropriated, the money belonged to Janice. Now that Janice is deceased, the money belongs to her estate, her trust, or, potentially, some party claiming against her estate. But it is in David’s possession. Because the probate court found David in bad faith wrongfully took Janice’s money, he could properly be found liable for twice the value of that property.”

Finally, the court held that David had the burden to prove his financial inability to pay the penalty. “The ability to pay argument was not raised in the probate court. Even if the issue were properly raised, we would conclude David’s financial condition under these circumstances was not a relevant consideration. The Courts of Appeal have held evidence of a defendant’s financial status is not essential to the imposition of statutory penalties, and financial inability to pay is a matter to be raised in mitigation. The trust beneficiaries had no obligation to present evidence of David’s financial condition or his ability to pay the mandatory statutory penalty.”

Estate of Kraus (April 27, 2010) 184 Cal.App.4th 103

Transfer of Property Deemed Invalid Years After Deed Was Recorded

In the recent decision in Estate of Hastie, the court invalidated a transfer of real property made several years before Mr. Hastie’s death. In a matter of first impression under Probate Code section 21350, the court held that the gift to a caretaker was could be challenged years after the deed was recorded. This, surely, was not the result that Mr. Hastie wanted, as the property instead passed to relatives who had no dealings with Mr. Hastie in the years before his death.

According to the decision, “For decades there was a close relationship between [Mr. Hastie] and defendant Bingham Liverman. Liverman had a real estate background including some probate matters. A fiduciary relationship developed when Hastie granted Liverman power of attorney in October 1999 and existed continuously at all times relevant to this action, up to and including the date of Hastie’s death.”

Here’s the first bad fact for Mr. Liverman. The court finds that he was tainted because of his undefined “real estate background.”

The dispute concerned the real property located at 3712 Anza Way, San Leandro. The trial court found that “in 2001, Liverman suggested that Hastie transfer an interest in the Anza Property to Liverman’s granddaughter by executing a joint tenancy grant deed in her favor. Hastie executed the deed on June 13, 2001. It was recorded on March 29, 2002.”

Here’s the second bad fact. The property was deeded to Mr. Liverman’s granddaughter.

The court continued. “In 2006, Liverman suggested that Hastie, while in the hospital a few weeks prior to his death, transfer his remaining interest in the Anza Property to Liverman’s grandson. Liverman drafted a quit claim deed from Hastie in favor of Timothy. Hastie executed the deed in June 2006. Appellant did not pay anything to Hastie in exchange for the interest in the Anza Property.”

That’s the third bad fact. A conveyance made while in the hospital, again to a grandchild. Mr. Liverman should have left well enough alone and stood on the deed recorded in 2002.

At trial, Mr. Liverman’s sole defense was his assertion that the administrator’s action was barred by the statute of limitations. Explained the court, Probate Code section 21350 lists “seven categories of persons who cannot validly be recipients of such donative transfers, including, inter alia, any person who has a fiduciary relationship with the transferor who transcribes the instrument or causes it to be transcribed; a care custodian of a dependent adult who is the transferor; and a relative of such fiduciary/transcriber or care custodian.”

This statute opened the door for the relatives to challenge the deed. “Once it is determined that a person is prohibited under section 21350 from receiving a transfer, section 21351 creates a rebuttable presumption that the transfer was the product of fraud, duress, menace, or undue influence. . . In order to rebut the presumption, the transferee must present clear and convincing evidence, which does not include his or her own testimony, that the transfer was not the product of fraud, duress, menace, or undue influence.”

That’s double handicap for the recipient, who must meet this heightened standard based on the testimony of other persons, only.

Now the court turned to the heart of the matter. “An action to establish the invalidity of any transfer described in Section 21350 can only be commenced within the periods prescribed in this section as follows:

“(a) In case of a transfer by will, at any time after letters are first issued to a general representative and before an order for final distribution is made.

“(b) In case of any transfer other than by will, within the later of three years after the transfer becomes irrevocable or three years from the date the person bringing the action discovers, or reasonably should have discovered, the facts material to the transfer.”

Stated the court, “We are called upon to interpret section 21356 to determine whether the administrator’s action was timely filed. The parties have not cited, nor have we found, any cases considering this statute.

In the court’s analysis, “The three-year period starts to run either from the date the transfer becomes irrevocable or from the date ‘the person bringing the action’ learns, or should have learned, of the material facts. Importantly, the section provides that the three-year period runs from the later of these two dates.”

According to the court, “Since the transfer became irrevocable while Hastie was still alive, the later date is three years from when the person bringing the action (the administrator) became apprised of the facts.”

In opposition, “Appellant emphasizes the fact that Steven never had any relationship with Hastie, his family or friends, and asserts that he is the respondent in this matter only because the McCartys hired his brother, George, to represent their interests.”

That strikes me as a solid argument. The court allowed strangers to interfere with the transfer, when Mr. Hastie was looking out for the persons who cared for him for years.

Even more, the court ignored the rule that the recording of a deed creates constructive notice to the whole world of the transfer. This long-standing principle was not considered by the court.

Thus, the court concluded that “it is abundantly clear that ‘the person bringing the action’ pursuant to section 21356, subdivision (b), can be the administrator of the estate following the death of the transferor and that this person might well be a stranger to the decedent. The McCartys, as children of Hastie’s predeceased spouse, were entitled to be appointed administrator and were also free to nominate another person, whether known to Hastie or not, to serve in that capacity.”

This is a difficult decision to reconcile, as strangers to the decedent were permitted to overturn a conveyance that had been made years before decedent’s death.

Estate of Hastie (First Appellate District) July 22, 2010

Judgment in Unlawful Detainer Validates Foreclosure Sale

The overlap between real property law and trust law reaches back centuries, as early trust law was concerned with the conveyancing of real property. Similarly, Prof. Maitland in his famous (and tremendously readable) “The Forms of Action at Common Law” (1909) teaches that eviction law, known as “unlawful detainer,” also reaches back hundreds of years.

Here is an important rule, arising from the wave of foreclosures which we are now witnessing – a judgment in a simple unlawful detainer lawsuit has the effect of validating, and thereby eliminating any objections to, a prior foreclosure by a lender.

To start, an unlawful detainer action is concerned with the narrow question of the right to “possession” of real property. The law holds that almost all other issues cannot be raised in the summary proceeding known as unlawful detainer.

Yet, a federal case from last fall reminds us that the property owner has the right to contest the validity of a foreclosure sale in defense to an action for unlawful detainer. In Nyugen v. LaSalle Bank, C.D. Cal. Case No. 09-0881 (Order entered October 13, 2009), the court held as follows:

“Defendant LaSalle brought suit against Plaintiffs in Orange County Superior Court for unlawful detainer following the foreclosure sale. There, Nguyen (Plaintiff herein) urged that LaSalle’s foreclosure was improper and alleged multiple affirmative defenses. The state court entered judgment in favor of LaSalle, finding that LaSalle’s evidence established all elements of its claim”

“Plaintiffs urge that by alleging fraud, undue influence, and breach of covenant of good faith and fair dealing, that res judicata does not bar their claims. However, as discussed below, Plaintiffs’ allegations not only fail herein, but were also rejected in the unlawful detainer proceeding.”

Held the court, “Although most issues unrelated to possession can be raised in a subsequent action between the parties, the issue of the irregularity of the foreclosure or execution sale is barred by a judgment in an unlawful detainer action.”

That is a powerful statement of law. And correct, also. The federal court cited to Freeze v. Salot (1954) 122 Cal.App.2d 561, which held as follows:

“The municipal court had jurisdiction of the action between Aguilar and plaintiff. We must conclude from the allegations with respect to the averment of the complaint in the municipal court action that it was a proceeding in unlawful detainer.”

OK, so we know the court is reviewing the judgment in an unlawful detainer action. Note that the judgment was entered by default, which means that the defendant did not appear in the action, and did not contest the claim of unlawful detainer.

The court continued. “The facts [pled in the new lawsuit alleged] that plaintiff was not in default under the deed of trust, that the note had been fully paid on November 6, 1948, and that she had no notice that the property was to be sold, were available to her as a defense in that proceeding. The question is whether the judgment of the municipal court [in the eviction lawsuit] is res judicata in this action.”

Reviewing the decision in Seidell v. Anglo-California Trust Co., 55 Cal.App.2d 913, the court ruled in favor of the lender. Stated the court, Seidell “was a suit to set aside a trustee’s deed to realty for alleged fraud and irregularities in the foreclosure proceeding. The question on appeal was whether a judgment which was rendered in a former proceeding in unlawful detainer was res judicata. The purchaser at the trustee’s sale had conveyed the property prior to the proceeding in unlawful detainer.

“The judgment in the unlawful detainer suit bars the appellants from now contending the trustees’ deed to the real property was void on account of the alleged irregularities of procedure in the foreclosure of the deed of trust.”

“In this case the challenged unlawful detainer judgment determined issues tendered by these appellants in their answer which constituted legal defenses of alleged specific violations of the statute in failing to give the notice of sale required by section 2924 of the Civil Code, lack of consideration for the note secured by the trust deed, and other asserted defects going to the validity of the trust deed and note secured thereby, and to the proceedings on the sale of that property under the provisions of the deed.”

“All of those issues of law, as distinguished from equity, affecting the legality of the note, deed of trust and the sale were properly determined against the defendants in that unlawful detention suit.”

To drive the nail home, the court held that “Plaintiff’s failure to appear in the municipal court action was a confession that all the material facts alleged in the complaint in that action were true. A judgment by default is a complete adjudication of all the right of the parties embraced in the prayer of the complaint and stands on the same footing as a judgment after answer and trial with respect to issues tendered by the complaint.”

A powerful lesson, 50 years on. A homeowner must contest the validity of a foreclosure in a subsequent action for unlawful detainer whereby the lender seeks a judgment for possession of the real property. Failure to do so waives all defenses, both state and federal, relating to irregularities regarding the foreclosure.

Deed to Estate Planning Trust – Struggling for the Right Result

A recent decision involving a deed to an estate planning trust achieved the correct result, but with unnecessary effort.

The facts in Luna v. Brownell (June 15, 2010) 2010 DJDAR 8811 were simple.

“On August 13, 2006, Al executed a quitclaim deed transferring his interest in the Property as an individual to himself as trustee of the Trust.”

“On August 29, 2006, Al executed the declaration of trust for the Trust. The declaration of trust stated that Al was the trustee.”

“On September 8, 2006, the grant deeds transferring plaintiffs’ interest in the Property to Al as trustee of the Trust were recorded.”

“Al died on September 19, 2006.”

The hitch in the analysis arises because the court implicitly considered Al’s revocable estate planning trust to be different from Al. It is not: the trust is not different from a Will, at least during Al’s lifetime.

The court presented its discussion as follows. “A deed does not transfer title to the grantee until it has been legally delivered. Delivery is a question of intent. A valid delivery of a deed depends upon whether the grantor intended that it should be presently operative.”

The court starts pushing in the wrong direction from the beginning. This is should be treated as a wills question, not as a conveyancing question.

“In addition, acceptance by the grantee is necessary to make a delivery effective and the deed operative. Whether the deed was accepted by the grantee so as to complete a transfer of title to him is likewise a question of fact for the trial court.”

The court continued. “On August 8, 2006, after understanding that Al wanted his property in his own name for purposes of creating a trust, the plaintiffs did not dispute his ownership . . . The [real] question before this court therefore is whether the quitclaim deed executed by Al on August 13, 2006, transferring the Property from Al as an individual to Al as trustee of the Trust was void because the Trust did not exist on the date the deed was executed.”

Following decisions from other jurisdictions, the court held the conveyance was effective. For example, in John Davis & Co. v. Cedar Glen # Four, Inc. (Wash. 1969) 450 P.2d 166, the court considered the validity of a quitclaim deed transferring real property to a corporation. Held the court, “A deed to a corporation made prior to its organization, is valid between the parties. Title passes when the corporation is legally incorporated. This is particularly true as against one who does not hold superior title when the corporation goes into possession under the deed.”

Similarly, in Heartland v. McIntosh Racing Stable (W.Va. 2006) 632 S.E.2d 296 the court held that “A deed drawn and executed in anticipation of the creation of the grantee as a corporation, limited liability company, or other legal entity entitled to hold real property is not invalidated because the grantee entity had not been established as required by law at the time of such execution, if the entity is in fact created thereafter in compliance with the requirements of law and the executed deed is properly delivered to the entity, the grantee, after its creation.”

Both are solid analyses under corporate law. What the recent California court should have looked at in Al’s case was the following:

(1) Did Al want his property to be handled in a probate?

A. He did not. He wanted to provide for a non-probate transfer via an estate planning trust.

(2) Did Al intend for his trust to control the disposition of his real property?

A. Yes.

Unfortunately, current trust law invites confusion by (sometimes) treating a revocable estate planning trust as a separate entity. Having considered authorities from other states, the California court held as follows:

“A quitclaim deed transferring property to the trustee of a trust is not void as between the grantor and grantee merely because the trust had not been created at the time the deed was executed, if (1) the deed was executed in anticipation of the creation of the trust and (2) the trust is in fact created thereafter. Such a deed is valid between the grantor and grantee on the date the trust was formed.”

That’s a nice, concrete statement of law, and obviously the result intended by the decedent. But the conveyancing gloss detracts from a focus on the decedent’s intention.

Luna v. Brownell (June 15, 2010) 2010 DJDAR 8811

No Claim in California for Intentional Interference with an Inheritance Expectancy

A recent case affirms that California does not recognize a claim based on “intentional interference with an inheritance expectancy.” However, the court’s analysis leaves the door open to future litigation arising from different fact patterns.

The lawsuit in Munn v. Briggs, 2010 DJDAR 8680 (4th Dist. June 11, 2010) was based on the following claim. “James alleged Carlyn and Michael intentionally interfered with his inheritance expectancy. Before the codicil, James had an expectancy to share equally with his sister Carlyn in the balance of the survivor’s trust, each having a one-half interest.” As a result of the codicil, James took less than he expected from his parent’s estate.

James sued his sister claiming that we was deprived of his inheritance due to Carlyn’s tortious conduct. “The probate court sustained the demurrer without leave to amend. In so doing, the court ruled no California case has ever expressly held that the cause of action of intentional interference with an inheritance expectancy is recognized in California.”

On appeal, the court held that “Under American law, testators have a right to completely disinherit nearly anyone, and there is no right to inherit. Of course, tortious conduct relating to wills, such as the use of undue influence, threats, or coercion to procure a particular disposition, or destruction of a will, has long been understood as a legal wrong, but only against the testator whose right of free testation is infringed upon, not the beneficiary.”

“A purported injury to an intended recipient is not cognizable (because there is no right to inherit); instead, the probate system through the will contest proceeding aims to offer all interested parties a forum in which to litigate the testator’s true intentions.”

The court recognized that “Section 774B of the Restatement (2d) Torts provides: ‘One who by fraud, duress or other tortious means intentionally prevents another from receiving from a third person an inheritance or gift that he would otherwise have received is subject to liability to the other for loss of the inheritance or gift’.”

Let’s pause there. The predicate act must be “fraud, duress or other tortious means.” Such wrongful conduct is independently actionable. We do not need to create a new tort to cover acts that are already unlawful.

The Restatement further notes liability under section 774B is “limited to cases in which the actor has interfered with the inheritance or gift by means that are independently tortious in character,” including when a third person has been induced to make or not make a “bequest or gift by fraud, duress, defamation or tortious abuse of fiduciary duty,” or when a will or document making a gift has been “forged, altered or suppressed.”

Now we are sliding into the same morass as “tortious interference with a contract,” which also requires such “independent wrongful conduct.” Tortious inference with a contract is a murky, unclear area of the law, and should not be expanded.

Even more, we can ask, Why isn’t slander an adequate remedy? If a person was deprived of a gift because someone lied about them, then slander would be the appropriate remedy.

The court of appeal added that “our independent research also confirms that when a party has an adequate remedy in probate, the party generally will be precluded from recovering in tort for interference with an expectancy.”

For example, “if the claimed wrongdoing relates to the execution or revocation of a will, and the claimant has standing in the probate proceeding, the court should not entertain an independent action even if the jurisdiction recognizes the tort of interference with an inheritance.”

The court of appeal noted that inheritance laws are “purely a creature of statute” (see In re Darling (1916) 173 Cal. 221, 223), and cited a New Mexico case with approval. The court in New Mexico stated:

“We feel compelled to protect the jurisdictional space carved out by our legislature when it enacted the Probate Code and created remedies, such as a will contest, designed exclusively for probate. We note that a will contest in probate requires a greater burden of persuasion than an independent action in tort. A presumption of due execution normally attaches to a testamentary instrument administered in probate, but not necessarily in tort.”

“If we were to permit, much less encourage, dual litigation tracks for disgruntled heirs, we would risk destabilizing the law of probate and creating uncertainty and inconsistency in its place. We would risk undermining the legislative intent inherent in creating the Probate Code as the preferable, if not exclusive, remedy for disputes over testamentary documents.” Wilson v. Fritschy (N.M. App. 2002) 55 P.3d 997.

For now, California does not recognize the tort of “interference with an expectancy.” To this author, there is no need for such a tort. However, we would need to consider the proper factual situation, which would involve a lifetime transfer accompanied by “independent wrongful acts,” which would merit further scrutiny.

Munn v. Briggs, 2010 DJDAR 8680 (4th Dist. June 11, 2010)

Florida Court of Appeal Permits Assets to be Hidden in Trust

A recent decision from the Florida court of appeals exalts form over substance to a achieve an unjust decision. Here is the case in a nutshell. Mom set up an irrevocable trust for benefit of one of sons. The trust contained a spendthrift provision, meaning that creditors could not reach trust assets before distribution to the beneficiary.

A large judgment was entered against the beneficiary son. After mom’s death, the second son served as named trustee, with complete discretion as to when to make distributions to the debtor brother. In fact, the trustee son allowed all trust decisions to be made by the debtor brother.

The creditor argued that the debtor’s interest should be available to satisfy the judgment, because the debtor brother effectively exercised control over the trust property. Notwithstanding these facts, the court held that the creditor was not able to reach the debtor brother’s interest because of the spendthrift provision.

This is a terrible decision on policy grounds, as the court expressly permitted the two brothers to manipulate a legal entity to commit fraud on the creditor. Here are the facts in more detail.

“In April 2004, Elizabeth Miller established the James F. Miller Irrevocable Trust (the James Trust) for the benefit of her son, James. She named her other son, Jerry, sole trustee. The James Trust is a discretionary trust under which Jerry has absolute discretion to make distributions for James and James’s qualified spouse.”

“The James Trust contains a spendthrift provision and gives Jerry, as trustee, the complete discretion to terminate the trust by distributing the entire principal to the beneficiary for any reason.”

After forming the trust, Elizabeth transferred property to the trust. The principal asset of the trust was “a residence located in Islamorada, Florida” with a value greater than $1 million.

In 2007, Kresser obtained a judgment against James for $1,019,095. Elizabeth died on September 10, 2007. “When Kresser was unable to collect on his judgment from James he brought proceedings supplementary against them and impleaded Jerry, as trustee of the James Trust. Kresser asserted that he was entitled to execute on the James Trust’s assets . . . because James exercised dominion and control over all of the trust assets and over Jerry, as trustee.”

The trial court found in favor of the creditor. The trial court “set forth a detailed account of James’s significant control over the James Trust and over Jerry, as trustee. The trial court found that Jerry had almost completely turned over management of the trust’s day-to-day operations to James. James controlled all important decisions concerning the trust assets, including investment decisions. ”

“Jerry never independently investigated these decisions to determine whether they were in the best interest of the trust, and some of the decisions have turned out to be unwise. The trial court concluded that Jerry simply rubber-stamped James’s decisions and ‘served as the legal veneer to disguise James’s exclusive dominion and control of the Trust assets.’”

It’s remarkable that a court of appeal would have interest in reviewing this decision. Even more remarkable, the trial court was reversed on appeal. In ruling against the creditor, the court of appeal held that “the James Trust does not give James any express control over distributions of the assets. Jerry, as trustee, has sole discretion to distribute income or principal to James, or to terminate the trust.”

Said the court of appeal, “while we agree that the facts in this case are perhaps the most egregious example of a trustee abdicating his responsibilities to manage and distribute trust property, the law requires that the focus must be on the terms of the trust and not the actions of the trustee or beneficiary. In this case, the trust terms granted Jerry, not James, the sole and exclusive authority to make distributions to James. The trust did not give James any authority whatsoever to manage or distribute trust property.”

That’s the court of appeal saying form matters more than substance, and adding that, “We’ll ignore what’s really going on if you right it down properly.”

Stated the court, “In this case, James may ask Jerry for as many distributions as he because Jerry has sole discretion to make distributions, he may also choose to deny James’s requests at any time, and James would have no recourse against him unless he were abusing his discretion as trustee.”

“Until Jerry makes a distribution to James, Kresser and other creditors may not satisfy James’s debts through trust assets. Accordingly, the trial court erred in invalidating the James Trust’s spendthrift provision and allowing Kresser to reach trust assets before they have been distributed to James.”

To rub salt in the wound, the court of appeal stated that “to conclude otherwise would ignore the realities of the relationship between a beneficiary and trustee of a discretionary trust – the beneficiary always pining for distributions which he feels are rightfully his, and the trustee striving to allow only those distributions that coincide with the settlor’s express intent, as set forth in the trust documents . . . In the case before us, it is not the role of the courts to evaluate how well the trustee is performing his duties. We are instead limited, by statute, to evaluating the express language of the trust to determine the extent of the beneficiary’s control and the extent to which a creditor may reach trust assets.”

That is not correct. It is the court’s duty to “evaluate how well the trustee is performing his duties” when the trustee has effectively turned over control of the assets to the judgment debtor. The Florida court of appeal failed badly in reversing the trial court.

Miller v. Kresser, — So.3d —, 2010 WL1779899 (Fla. 4th DCA May 5, 2010)

Lenders Behaving Badly

Professor Brent T. White from The University of Arizona Law School has followed up his report issued last fall regarding troubled loans. Prof. White personally communicated with more than 350 individuals regarding their mortgage problems.

His new report raises a number of troubling issues, but none more so than the dissembling tactics of lenders.

Writes Prof. White, “The reason that many strategic defaulters struggle so long before deciding to default is that fear and anxiety are not typically enough in isolation to cause them to stop making payments. Rather such anxiety more frequently serves as a call to action, driving homeowners to try to do something about their situation – such as contacting their lender to try to work out a loan modification or a short sale.

“In fact, not a single strategic defaulter in the 356 accounts reviewed for this article reported having stopped paying their mortgages without first contacting their lender . . . Many underwater homeowners who seek help from their lenders, however, are turned away at the door. As one homeowner explains, ‘I called my lender and ask if I could discuss a loan modification and they said absolutely not.’ Lenders give numerous reasons for this, most commonly that homeowners are current on their mortgages.”

If you are current on your loan, regardless of the financial struggles to maintain the loan, you will never get your loan modified. “The fact being a ‘responsible’ borrower is the surest way not to get a loan modification can be a rude awakening for many homeowners.”

Prof White continues. “This is because most lenders don’t modify mortgages or agree to short sales for homeowners who might continue making their payments absent such accommodation. The best predictor that a homeowner will continue making payments is a good credit score and a past history of making their payments. Homeowners with such characteristics thus have little chance of getting help unless they first miss some payments, and they are frequently told this by the loan servicing personnel who take their calls.”

Worse yet, “The loan modification process turns out, however, to be immensely frustrating[.] Homeowners are frequently unable to reach anyone to discuss their applications’ status[.] Their paperwork is ‘lost’ repeatedly[.] They are treated rudely and lied to[.] Worse, after months of frustration, most homeowners learn that their lender is not willing to work with them after all.”

Prof. White is not exaggerating. I have yet to meet a borrower with anything positive to say about the loan modification process. As a society, we are not serious about helping borrowers with troubled home loans.

Brent T. White, Take this House and Shove it: The Emotional Drivers of Strategic Default (May 2010)

The Mortgage Crisis Continues

This is an updated report on the status the foreclosure crisis in Fresno County as of June 2010, based on anecdotal evidence. In a word, it’s brutal for troubled borrowers.

Foreclosures Are Continuing: There does not seem to be any slowdown in foreclosures. Lenders buy in for the amount of the unpaid debt, then sell at a slight markup. The buyer then markets the property for a greater profit.

Example: A house might sell at foreclosure to the lender for $120,000. The lender resells the property for $150,000. The buyer in turn markets and sell the house for $200,000. All of this takes place within six months. The original owner takes nothing on the mark up.

Cash is King: Lenders have little risk on foreclosure sales because houses re-sell quickly on all-cash offers. Evictions follow rapidly after the foreclosure sale, and are sometimes started on the day of the sale.

Securitization Creates Murky Ownership: Because of the securitization of mortgages, it is extremely difficult to determine who is calling the shots for the lender. It seems that mortgages have been sold off piecemeal, and the third-party mortgage holders are conducting the foreclosures. The owner is greatly distanced from the lender, and it is almost impossible to identify the entity that is in control of the mortgage and the foreclosure process.

The Home Affordable Modification Program is a Failure: This writer has yet to see one mortgage that was modified as a result of the federal Home Affordable Modification Program. The external evidence on the HAMP program is damning.

Professor Jean Braucher from The University of Arizona Law School explains that “HAMP provided for modification of first-lien mortgage loans originated on or before January 1, 2009, where the loan was secured by a one- to four-unit property, one unit of which was the borrower‘s principal residence.”

In order to qualify for a HAMP modification, “the debtor‘s gross monthly mortgage payment had to exceed 31 percent of gross income [and] the borrower had to document a financial hardship and be delinquent on the loan.”

That would cover a lot of troubled mortgages. Explains Prof. Braucher, “The goal of HAMP is to create a partnership between the government and private institutions in order to reduce borrowers‘ gross monthly payments to an affordable level. The level has been set at 31 percent of the borrowers‘ gross monthly income.”

However, the rules have never been explained. “The HAMP [ ] formula was not made public, in part out of concern that doing so would have allowed borrowers to game the calculation, but making it difficult for borrowers and their mortgage counselors to know whether to apply for a modification and to assess denial of an offer.”

Further, the lender bears the costs. “HAMP made investors responsible in full for the cost of bringing the debtor‘s gross monthly mortgage payment down to 38 percent of gross monthly income. HAMP also provided for the government to then share equally with investors the further cost of bringing the mortgage payment down to 31 percent of income.”

So, in order for HAMP to work, the lender has to admit it made a bad lending decision, and has to agree to eat part of the loss. Sadly, given the availability of cash in the housing market, it’s easier for the lender to precipitate a foreclosure sale, then sell the property for the full amount of the loan and all delinquency charges, meaning that the lender is made whole, and the owner absorbs the entire loss.

Notes Prof Braucher, “through September 1, 2009, the Congressional Oversight Panel reported that HAMP, with a goal of avoiding three to four million foreclosures in three years, had achieved only 362,348 three-month trial modifications. Even more disappointing, the Congressional Oversight Panel reported that the program had achieved only 1,711 permanent modifications through September 1, 2009.”

Thus, the federal loan modification program has been a profound failure. This writer’s experiences with troubled borrowers have been similar.

Jean Braucher, Humpty Dumpty and the Foreclosure Crisis: Lessons from the Lackluster First Year of the Home Affordable Modification Program (May 2010).

Private Trust Company – A Curious Hybrid

Attorneys Jim Weller and Alan Ytterberg published a recent article discussing an odd hybrid entity – the “private trust company.” As the authors explain, “Similar to a regulated trust company, an unregulated trust company is an entity formed under state law for the limited purpose of providing trust services to a single family.”

A private trust company is first an entity established under state law. “Most states that authorize private trust companies allow them to be formed as a corporation or a limited liability company.” However, “there is no information available to ascertain the number of unregulated trust companies that have been formed in the U.S.”

By way of history, “U.S. Trust Company (est. 1853), Northern Trust (est. 1889), and Bessemer Trust (est. 1907) were originally formed as private trust companies, but today they are known and respected as public trust companies that provide a wide range of fiduciary and trust services.”

A private trust company is a state-chartered institution that is formed to manage assets for wealthy families into the future. Thus, “it is a state chartered entity that is formed for the express purpose of providing trust and fiduciary services to a single family” and is tied to one or more irrevocable trusts established by the family.

State the authors, “there are a variety of states which promote private trust companies. Most of these states have favorable tax laws, and they have modernized their trust laws. In that regard, Wyoming, Nevada, South Dakota, and Texas are some of the more popular states where wealthy families are chartering private trust companies.”

States have different requirements for physical presence in the jurisdiction, but the requirements are not difficult to satisfy. For example, “Licensed family trust companies in Nevada must have at least one officer who is a Nevada resident, a physical office in Nevada, and “a bank account with a state chartered or national bank having a principal or branch offices in Nevada.”

The authors further explain that, “State banking commissioners have less incentive to subject a private trust company to the same regulatory oversight that a public trust company has because there is no public interest to protect. This distinction is formally recognized in states which permit private trust companies to seek exemption from certain regulatory provisions that apply to trust companies transacting business with the public.”

So, the state sanctions the formation of an entity, accords it the privileges of conducting business and of limited liability, but provides for little if any public or regulatory oversight. “A private trust company must meet minimum capital requirements in order to exercise the fiduciary powers granted to it by the chartering state. These capital requirements vary from state to state. South Dakota has the lowest capital requirement at $200,000.”

The authors add that, “a private trust company must apply for and obtain a charter from the state where it is to be located. Once the charter is granted, the private trust company is subject to the laws and regulations of that state. The lone exception is an unregulated trust company which can be formed in Massachusetts, Nevada, Pennsylvania, Virginia, and Wyoming.”

That’s private justice for the very wealthy in America, which is a distressing topic.