Powers of Appointment Gone Wrong
“Powers of Appointment Gone Wrong,” that’s the subject of today’s ACTEC Trust and Estate Talk.
Transcript/Show Notes
This is Connie Tromble Eyster, ACTEC Fellow from Boulder, Colorado. Powers of appointment are an important tool in the estate planning attorney’s toolbox box, adding flexibility to administrative and distribution of irrevocable trusts. What do trustees need to know when problems arise with the exercise of powers of appointment?
ACTEC Fellows Jared Cloud of Chicago, Illinois, and Charlie Pieterse of Greenwich, Connecticut, discuss the issues that can arise for fiduciaries administering a trust when a power of appointment has been exercised. Welcome, Jared and Charlie.
So, what do trustees do when they learn that a power holder has exercised a power of appointment?
Exercising a Power of Appointment
Charlie Pieterse: Thank you, Connie. They don’t need to run away, and we’ll talk about in a moment what they should do. But, you know, it’s been my experience in researching and commenting on powers of appointment that no discussion of powers of appointment can begin without the reading of a quote from Professor Barton Leach of Harvard Law School back in the ‘30s. And he characterized powers of appointment as “the most efficient, dispositive device that the ingenuity of Anglo-American lawyers has ever worked out.” And Professor Barton’s words are true. And as stated in a fairly recent article by Jonathan Blattmachr, Kim Kamin, and Jeffrey Bergman, “[p]erhaps no tool in estate planning is more ubiquitous, yet less understood than the power of appointment.” And that dichotomy, I think, is where the issues arise that Jared and I, as fiduciary litigators, see all the time, and with increasing frequency. But before we get into some cases that shed some light on what a fiduciary should do, I’m going to have passed the baton to Jared and he’s going to just make sure we’re operating with the same vocabulary set. Jared?
Uniform Powers of Appointment Act
Jared Cloud: Thanks, Charlie. For purposes of the discussion today, I’m going to take our definition of power of appointment from the Uniform Powers of Appointment Act, which was promulgated by the Uniform Law Commission in 2013 and has been adopted by a significant number of states, but not an overwhelming majority. It’s still a pretty good definition and based pretty solidly in the common law.
Under Section 102 of the Uniform Powers of Appointment Act, a power of appointment means “a power that enables a power holder acting in a non-fiduciary capacity to designate a recipient of an ownership interest in, or another power of appointment over, the appointive property. The term power of appointment does not include a power of attorney.”
There are different types of powers of appointment, (1) a general power of appointment, which lets the power holder appoint the property to anyone in the world, including themselves; (2) a non-general or limited power of appointment, which allows the power holder to appoint the property, as you might expect, to some smaller group of people, which may just be members of a particular family, or other well-defined groups of individuals, or it could be as broad as everybody in the world except the power holder, the power holder’s estate, the power holder’s creditors, and the creditors of the power holder’s estate.
Powers of appointment can also be presently exercisable, meaning as soon as the power is created, it can be exercised by the power holder, or they may be not presently exercisable – they’re limited to being exercised at some point in the future, or in a testamentary document, such as a will, by the power holder to take effect only at the power holder’s death.
There is also a split in the Uniform Powers of Appointment Act between exclusionary and non-exclusionary powers of appointment. For our purposes, and the defaults under the Uniform Powers of Appointment Act, powers of appointment are generally exclusionary powers. Non-exclusionary powers are specifically described, which allow others to take as well as those specifically identified. Charlie?
Examples of Power of Appointment Litigation
Charlie Pieterse: Sure. Thanks for that, Jared. So, let’s talk about the situation where a fiduciary is either acting in the capacity as an executor of an estate or trustee of a trust, and the assets in that trust or in that estate are some of those assets are subject to the exercise of a power of appointment. What should that trustee do when they get advised that the power has been exercised? So, we’ll take a look at three cases that examine that issue or give insight into what should be done in that situation and the possible consequences from acting or not acting that could flow from that.
In re Robert McDowell Revocable Trust
First, let’s take a look at a case out of the Nebraska Supreme Court – In Re Robert McDowell Revocable Trust. And in the McDowell case, the issue concerned the validity of the exercise of a limited testamentary power of appointment in favor of the powerholder’s own revocable trust. So, right away you can see an issue there, right, because we’re dealing with a limited power of appointment in which it was exercised in the powerholder’s will, but the powerholder exercised it to his own revocable trust.
So, that immediately raises the question, “Hey, is this a permissible appointee?” Now, the fiduciary never thought about that, never examined that question, and when they got notice from the trustee of the trust to transfer the assets over to that trust, they simply did that. Down the road, a taker in default- someone who would have taken but for the exercise of the power of appointment- said, “Wait a second, this was not a permissible exercise of a power of appointment,” and brought an action against the trustee and said, “You should have done an independent examination here.” And so, the issue was, was this a permissible exercise?
And the court said two things. First, it said, “No, this was an improper exercise because it was not a permissible appointee.” But more importantly, and for the fiduciary’s perspective, it said that the failure to inquire and to transfer the assets of the trust was a breach of fiduciary duty. So, they said, “Look, you as a trustee had an independent duty to see if that power of appointment had been validly exercised.” So, the Nebraska case stands for the proposition of what happens if you do nothing, but just simply act in response to the power of appointment?
Benjamin v. Corasaniti
Let’s now turn to the second case, and that is Benjamin v. Corasaniti. That’s a case out of the Connecticut Supreme Court, and that case also dealt with the exercise of a testamentary power of appointment. In that case, the exercise was to a permissible appointee, facially, but it was to a charitable trust, which was in the class of permissible appointees. But there was an issue as to whether or not the trust, the charitable trust, existed, and thus, if it didn’t exist, the exercise was invalid.
The trustee did its own independent examination in this case and determined that, yes, this exercise was appropriate, that the fact that the charitable trust had not received assets prior to the exercise of the power of appointment did not render it an impermissible appointee and was 100% sure that this was a proper exercise. Nonetheless, they did not follow in the footsteps of the trustee we just heard about in Nebraska. They brought a petition to the probate court in Connecticut and asked for the court’s instruction and essentially asked the court to pass on whether this was a proper exercise of the power of appointment. The probate court did that, reviewed it, and found that it was. An appeal was taken, it went up to the Connecticut Superior Court. Again, the court found it was permissible and then it went all the way up to the Connecticut Supreme Court, and again, they found it was a permissible appointee.
A lot of money was spent. There were underlying issues that motivated the parties to contest this issue, which we don’t need to get into here, but the real issue was that the trustee, even though it knew it was right, decided to take the time and expend trust funds to make sure that what it was doing was correct, and it all worked out well, except for the party challenging.
BMO Harris Bank N.A. v. Towers
The third case we’re going to look at, and this is probably a case that Jared knows better than I do because it comes out of the great state of Illinois, is BMO Harris Bank N.A. v. Towers. And this is from the appellate courts in Illinois. And in this case, somewhat, again, involving the validity of the exercise of a limited testamentary power of appointment, the trustee undertook its own exam and said, “Yeah, this is a proper exercise of a power of appointment.” But they said, “You know what? We want to be clear. We’re going to go ahead and file this petition with the court.” In other words, they did just what the trustee in the course of the case in Connecticut did. But the twist in this case is that the party that was seeking to take the position that it was a permissible—I’m sorry, in the BMO Harris case, the trustee determined it was an impermissible exercise, and was pretty clear on that, but asked the court to pass on that issue. The party that would have been benefited, if it was a permissible exercise, counterclaimed against the trustee and said, “Look, you breached your fiduciary duty by asking the court to pass on the validity of the exercise. You shouldn’t have done anything. And you wasted trust funds and time and effort, and therefore you breached your fiduciary duty.”
And the court, first off, found that the trustee was right. It was an impermissible exercise. But more importantly, it went on to hold the following; it said, “Look, a trustee has twin duties here, among others. It has a duty of impartiality to all the beneficiaries of the trust, but it also has a duty to administer the trust pursuant to its terms. So, if a legitimate question arises, it’s perfectly appropriate to seek a judicial ruling on the permissibility of the exercise of a power of appointment.”
Now, you might wonder, “hey, was the finding that trustee acted appropriately in some way dictated by the fact that the court found that the trustee’s conclusion was correct?” And that’s not the case. The court went out of its way to make it clear that irrespective of the outcome of its determination as the exercise, the trustee was protected by bringing this petition.
Lessons Learned from Power of Appointment Litigation
What do we learn from these three cases?
- First, never not undertake an independent review.
- Secondly, even though if you’re sure that you’ve interpreted the trust correctly or the power of appointment correctly, go to court if there’s a possibility of a dispute.
- And third, in going to court, you don’t need to worry about being hit for a breach of fiduciary duty by some disappointed party.
Jared, I’ll pass the baton back to you.
Jared Cloud: Thanks, Charlie. And I agree, the BMO Harris Bank v. Towers should be of some comfort to trustees and should be cautionary tale for drafting attorneys who are including the exercise of non-general power of appointment in their client’s wills or other testamentary documents because they can’t be corrected after the fact.
Fraud on the Power of Appointment
Jared Cloud: The one additional topic we wanted to cover today is the other place where I’ve seen powers of appointment come up in litigation. And I think Charlie has had cases like this as well, where somebody wants to exercise a power of appointment in favor of another party to litigation as a way of settling the dispute. And the concern has been in Illinois before the enactment of the Uniform Powers of Appointment Act that this would be what’s called “a fraud on the power.” If one party settles a dispute by exercising a power of appointment that they have in favor of another party to the dispute, even though they’re not the power holder party is not receiving the property, the power holder party is receiving a benefit from the exercise by getting a release or some other benefit from the settlement of the litigation itself. It’s indirect, but it’s there.
The case law was not inconsistent, but it was a little thin with the enactment of the Uniform Power of Appointment Act here, and in other states that have adopted it as well, Section 405 prescribes when a contract to exercise a power of appointment can be valid. It states that a power holder of a presently exercisable power of appointment may contract first, not to exercise the power at all. That doesn’t seem to be limited by what type of power of appointment it is. You can agree and presumably receive consideration for a contract not to exercise and just allow the property to be distributed ultimately to the people who are the takers in default by not exercising. But if you’re going to exercise a contract to exercise the power itself, that contract is only valid if the contract, when made, does not confer a benefit on an impermissible appointee.
So it’s not a question of whether the property itself is appointed to an impermissible appointee, but rather if the contract provides a benefit to any impermissible appointee, that contract is invalid and the exercise pursuant to that contract is invalid. So if the power holder party receives a benefit from the settlement of the litigation, exercising a power in favor of another party is going to be invalid and that’s not a good way to settle cases.
As note, the Uniform Act also states that a power holder simply may not contract to exercise or not exercise a power of appointment that is not presently exercisable unless the power holder is also the donor of the power of the person who established the power of appointment in the first place and specifically reserved it in a revocable trust. So very limited circumstances.
Connie Tromble Eyster: Thank you, Jared and Charlie. This has been so interesting. I really enjoyed hearing your thoughts on exercises of powers of appointment and I thank you so much for sharing your practical knowledge with us. It’s been hugely helpful.
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