Fresno Lawyer – Randolf Krbechek

The fees in a probate case trigger a reaction that sometimes borders on panic.  Part of the reasoning behind the use of an estate planning trust (sometimes referred to as an inter vivos trust) is that the trust will save on attorney’s fees.

However, as I tell clients, it only works if the beneficiaries get along.  If not, the attorney’s fees in a trust dispute will greatly exceed the regular probate fees.  A case in point is the recent decision in Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530.  The estate was in the range of $65,000.  Under California law, the probate fees would have been around $2,600 (four percent of the estate).  Yet the trust litigation has triggered attorneys fees in excess of $20,000, which surely was not the intended result.

The case also stands for the proposition that a trustee cannot demand a release as a condition to making a distribution as required under the trust agreement.  (Again, such a release comes part and parcel with a probate, as the court approves all distributions by the executor.)

Here are the facts.  “In 2003, Beverly Bellows established the Beverly Bellows trust, naming her and Frederick as cotrustees. As restated in 2005, the trust provided that on her death, the trust assets would be divided equally between Frederick and Donald. Following Beverly’s death in 2008, Donald requested distribution of his share of the trust.”

Watch as the wheels start to slip – the two brothers did not get along. “In September 2009, when the distribution had not been made, Donald filed a petition in the probate court pursuant to section 17200 seeking an accounting and distribution of the trust assets. On November 13, the court ordered Frederick to provide an accounting of the trust assets and to distribute one-half of the assets to Donald within 10 days. The order awarded Donald attorney fees in the amount of $9,800.”

Ouch.  That fee award – long before the fees on appeal – was four times the total probate fees, had the estate been subject to probate.  But it only gets worse, as Donald also claimed that “Frederick had improperly deducted from the remaining corpus of the trust approximately $13,000 of his own attorney fees prior to dividing the trust assets in half.”

Never forget Molly Ivins’ first rule of holes – When you find yourself in one, stop digging.  These two brothers amassed more than $25,000 in collective attorney’s fees, before they ever took the matter up on appeal.

“On February 23, 2010, Donald filed a motion to compel compliance with the court’s November 2009 order.  Frederick opposed the motion and filed a cross-motion for abatement and for attorney fees and sanctions.”

Here’s the holding on appeal. “There is no dispute that under the terms of the trust as interpreted by the court in its November 2009 order, Frederick was required to distribute to Donald one-half of the trust assets. Under the plain language of [Probate Code] section 16004.5, subdivision (a), Frederick could not condition the payment on a release of liability . . .

“There was no dispute that Donald was entitled to receive from the trust at least $30,376.80, based on Frederick’s own accounting. Frederick, as trustee, was required to make this distribution to Donald without any strings attached. He was not entitled to condition the payment on the release of other claims or demands of the trust beneficiary.

Added the court, “[the statute] permits a trustee to seek a voluntary release or discharge.  A release obtained as a condition of accepting payment to which the beneficiary is entitled is in no sense voluntary . . . Frederick could not condition such an agreement on Donald releasing his right to an accounting or of other claims he might have against the trustee. Again, such an interpretation would render subdivision (a) nugatory.”

Finally, the court added that, “subdivision (b)(4) confirms the right of the trustee to withhold any distribution that is reasonably in dispute. In such a case, as subdivision (b)(5) confirms, the trustee may seek instructions from the court, the well-established method of resolving controversies that may arise between trustee and beneficiary . . . What the trustee may not do is extract from the beneficiary an agreement to accept a compromise concerning a disputed issue as a condition of receiving a distribution to which the beneficiary is unquestionably entitled. A trustee may not under any circumstances condition a required distribution on an involuntary release of liability.”

As it looks to this writer, the two brothers spent all of the money on attorney’s fees. That’s a bad result under any standard.

Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530

The Delaware Supreme Court recently decided William Penn Partnership v. Saliba, a case in which there are no winners.  In the case, one of the members breached his fiduciary obligations, but his conduct caused no damage.  Nonetheless, the court awarded attorneys’ fees as an “equitable remedy.”  In this author’s view, the award distorts the law of equitable remedies, creates uncertainty in the law, and rewards fruitless litigation.

The facts were as follows.  The parties were members of a limited liability company called Del Bay Associates, LLC.  Del Bay built the Beacon Motel in Lewes, Delaware in 1987, with 66 guest units.  Later, some of the members (the Lingos) wanted to “end their business relationship” with the other members.

The Lingos concocted a story about their need to dissolve the limited liability company and sell the motel to fulfill obligations under a section 1031 tax-deferred exchange.  Explained the court, “On June 10, 2003, the Lingos convinced Hoyt to sign the contract immediately so they could present it to the JGT board. The Lingos told Hoyt that if he did not sign the contract, JGT might back off.”

The court found that the representations were not true.  Instead, the Lingos controlled both sides of the transaction – seller and buyer.  For example, “The Lingos manipulated the sales process through misrepresentations and repeated material omissions such as (1) imposing an artificial deadline justified by ‘tax purposes;’ (2) failing to inform Saliba and Ksebe that they were matching their offer by assuming the existing mortgage; [and] (3) failing to inform Saliba and Ksebe that they had already committed to selling the property to JGT, an entity the Lingos controlled.”

So, we have a transaction in which one member abused his fiduciary duties to the other members.  More bluntly, “The Lingos here acted in their own self interest by orchestrating the sale of Del Bay’s sole asset, the Beacon Motel, on terms that were favorable to them.  By standing on both sides of the transaction – as the seller, through their interest in and status as managers of Del Bay, and the buyer, through their interest in JGT– they bear the burden of demonstrating the entire fairness of the transaction.”

Such proof of “entire fairness” was a burden the Lingos could not meet.  “The concept of entire fairness consists of two blended elements: fair dealing and fair price.  Fair dealing involves analyzing how the transaction was structured, the timing, disclosures, and approvals.  Fair price relates to the economic and financial considerations of the transaction.  We examine the transaction as a whole and both aspects of the test must be satisfied; a party does not meet the entire fairness standard simply by showing that the price fell within a reasonable range that would be considered fair.”

In fact, the price did fall with “a reasonable range.”  The buyer paid $6,625,000 for the Beacon Motel, while the trial court found that the “retained appraisal valued the property at $5,480,000.”  Thus, the price paid by the buyer was greater than the fair market value for the motel, meaning that the non-controlling members suffered no compensable injury.

The court found that this result was not satisfactory.  “Merely showing that the sale price was in the range of fairness, however, does not necessarily satisfy the entire fairness burden when fiduciaries stand on both sides of a transaction and manipulate the sales process.”

OK, but we have no basis on which to award damages.  “Saliba and Ksebe were left without a typical damage award because the Court’s appraisal of the property came in at a value lower than the sale price.”

What to do?  This court decided to award attorneys’ fees to the non-controlling members.  “The Chancellor concluded it would be unfair and inequitable for Saliba and Ksebe to shoulder the costs of litigation arising out of improper prelitigation conduct attributable to the Lingos that amounted to a violation of their fiduciary duties.”

Although there was no statutory or contractual basis for an award of attorneys’ fees, the Delaware Supreme Court held that “The Chancellor’s decision to award attorneys’ fees and costs was well within his discretion and is supported by Delaware law in order to discourage outright acts of disloyalty by fiduciaries.  Absent this award, Saliba and Ksebe would have been penalized for bringing a successful claim against the Lingos for breach of their fiduciary duty of loyalty.”

Which perhaps would have been the better result.  This litigation was surely driven by the attorneys, not by the injured parties, with substantial attorneys’ fees.  The court’s award of attorneys’ fees on equitable grounds will only foster litigation in the future, which is hardly an optimal result.

William Penn Partnership v. Saliba (Del. Supreme Court Feb. 9, 2011) 2011 Del. LEXIS 91

The courts are increasingly faced with the cases involving the interpretation and enforcement of estate planning trusts.  In Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, the court concisely framed the dispute:

“The beneficiary of a trust petitions to remove her sister as trustee of their parents’ trust.  The trustee responds by seeking to compel arbitration of their dispute as provided by the trust documents.

“Though the sisters are beneficiaries of the trust, neither was party to any agreement that such disputes would be resolved by arbitration.

“Here we hold that the beneficiary of a trust who did not agree to arbitrate disputes arising under the trust may not be compelled to do so.”

It seems that the trust was a standardized form.  It included the following provision:

“Any dispute arising in connection with this Trust, including disputes between Trustee and any beneficiary or among Co–Trustees, shall be settled by the negotiation, mediation and arbitration provisions of that certain LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ) entered into by the parties prior to, concurrently with or subsequent to the execution of this Trust.   In the event that the parties have not entered into a LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ), then disputes in connection with this Trust shall be settled by arbitration in accordance with the rules of the American Arbitration Association.”

(Of course, someone needs to produce the “integrity agreement.”)

On appeal, “Bukey contends that Diaz is a third party beneficiary of the Trust and she is equitably estopped from denying her obligation to arbitrate.”  Further, “Bukey relies on a trio of cases in which appellate courts have characterized a trust as a contract between a trustor and trustee.”

Explained the court of appeal, “We do not find these cases persuasive for several reasons.  First, they are factually inapposite.  The controversy here involves a dispute between the trustee and a beneficiary over the internal affairs of the Trust.”

Also,  “In Saks v. Damon Raike & Co. (1992) 7 Cal.App.4th 419, the court rejected the argument that a trust was a third party beneficiary contract. The court said: ‘The rules governing the respective rights of action of trustees and beneficiaries of express trusts are not the same as those generally applicable to promisees and third party beneficiaries’ . . .

“The general right of a third party beneficiary to sue on a contract made expressly for his or her benefit has no application where a trust has been created in favor of that party, and the contract in question is between the trustee and an agent of the trustee.”

The court concluded that the arbitration provision was not enforceable because the trust was a relationship, not a contract (which is the correct result).  “As a matter of law, the trusts at issue here were not contracts.”

“A beneficiary of a trust receives a beneficial interest in trust property while the beneficiary of a contract gains a personal claim against the promissor. Moreover, a fiduciary relationship exists between a trustee and a trust beneficiary while no such relationship generally exists between parties to a contract.”

“The legal distinctions between a trust and a contract are at the heart of why the beneficiaries cannot be required to arbitrate their claims against the defendants. Arbitration rests on an exchange of promises.  Parties to a contract may decide to exchange promises to substitute an arbitral for a judicial forum. Their agreement to do so may end up binding (or benefitting) nonsignatories.

“In contrast, a trust does not rest on an exchange of promises.  A trust merely requires a trustor to transfer a beneficial interest in property to a trustee who, under the trust instrument, relevant statutes and common law, holds that interest for the beneficiary.”

So, we have the correct result for the correct reasons.

Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, 2011 WL 1759798

In McMackin v. Ehrheart (April 8, 2011) 2011 DJDAR 5122, the court of appeal held that a Marvin-based palimony claim under California law could be asserted against an estate more than three years after the decedent’s death.  We remark on the extent to which the law is willing to allow a person to make a claim to real property when that claim is not evidenced by a writing, and, even when title was held 100% in the decedent’s name, as in McMackin.

Before reviewing the decision, let’s cut to the chase.  Hugh McCrackin lived with Patricia McGinness for 17 years, from 1987 until 2004.  He helped her in her declining health.  Patricia told people that she wanted Hugh to live in her house for the rest of her life.  The couple never married.

Let’s accept all of the foregoing as true.  On the other hand, Patricia did not make a will manifesting her intentions.  Nor did she undertake the simple expediency of executing a deed with a life estate in favor of Hugh.  Now, after Patricia’s death, Hugh petitions the court to enforce Patricia’s oral intentions.

These facts do not strike this writer as commanding judicial intervention.  The ability to execute a will or a deed with a life estate is known to all.  The notion that courts should be quick to enforce oral agreements in derogation of the statute of frauds is discomforting, and bears greater scrutiny.

To return to the case.  “Plaintiff Hugh J. McMackin lived with Patricia Lyn McGinness in her home from approximately 1987 until [Patricia] died intestate on October 1, 2004. [Hugh] was never on title to the home but continued to occupy it after [Patricia]’s death.

“Defendants Kimberly Frost and Kellian Ehrheart are [Patricia]’s daughters and are the heirs of [Patricia]’s estate. On February 25, 2008, more than three years after [Patricia]’s death, [her daughter] opened a probate . . .

“On November 23, 2009, Ehrheart served [Hugh] with a 60-day notice to quit. On January 13, 2010, [Hugh] filed a complaint, the gravamen of which was that [Patricia] promised him a life estate in the home upon her death in consideration for 17 years of his ‘love, affection, care and companionship.’”

That’s the stage for this action.  “On January 21, 2010, [Hugh] filed an ex parte application for a temporary restraining order and for an order to show cause why an injunction should not issue to enjoin [the daughters] from evicting him from the home.”

The injunction was entered in favor of Hugh, and was affirmed on appeal.  According to Hugh, Patricia “agreed that he could live in the home for the rest of his life after her death and that she made this promise in consideration of the love, affection, care and companionship we shared over those 17 years.”  The housekeeper “declared that on approximately twenty (20) different occasions [Patricia] told her that she wanted [Hugh] to live in the home for the rest of his life.”

This is a classic case of an promise that lies outside the statute of frauds, and would normally be unenforceable.  Even more, California Probate Code section 366.3 provides that an action to enforce a claim arising from an agreement with a decedent for distribution from an estate must be filed within one year after the decedent’s death.  This statute applies to “a promise to transfer property upon death [that] could be performed only after death, by the decedent’s personal representative, by conveying property that otherwise belonged to the estate.”

The court of appeal noted that “The limitations period provided in this section for commencement of an action shall not be tolled or extended for any reason except as provided in Sections 12, 12a, and 12b of this code, and [certain provisions] of the Probate Code [not applicable to this action].”

Hugh would appear to be out of luck.  However, the court of appeal rescued Hugh by allowing him to apply the doctrine of “equitable estoppel.”  “The court held that there is a distinction between the doctrine of equitable estoppel, on the one hand, and the tolling or extension of the statute of limitations, on the other hand.”

In other words, “there is a distinction between tolling and equitable estoppel. Tolling concerns the suspension of the statute of limitations. The doctrine of equitable estoppel applies only after the limitations period has run to preclude a party from asserting the statute of limitations as a defense to an untimely action where the party’s conduct has induced another into forbearing to file suit.”

The court of appeal ruled that “depending on the circumstances of each case, the doctrine of equitable estoppel may preclude a party from asserting section 366.3 as a defense to an untimely action where the party’s wrongdoing has induced another to forbear filing suit.”

Unfortunately, the opinion does not address whether there was any factual basis for Hugh’s assertion of equitable estoppel against the daughters.  We do not know that the daughters did after the death of their mother that stopped the statute of limitations from running.

Stated the court, “We are not asked, nor do we decide, whether this implied ruling was supported by substantial evidence because [the daughters] made it clear at oral argument on appeal that they challenge the application of equitable estoppel as a matter of law, not whether the evidence supported its application for the purposes of the issuance of a preliminary injunction.“

That’s the easy way out.  The court does not tell us what the daughters said or did that gave Hugh the right claim they were estopped (i.e., prevented by their conduct) from asserting the one-year statute of limitations as a defense.  For the time being, Hugh has deftly stepped over both the statute of frauds and the statute of limitations.

McMackin v. Ehrheart (April 8, 2011) 2011 DJDAR 5122

Scholars trace the creation of the English common law to the second half of the 12th century, at the time of Henry II.  Explains Belgian scholar Raoul Van Caenegem in The Birth of the English Common Law (Cambridge Univ. Press 1973), “the Common Law of England – so different from the jus commune or common learned law of the European universities – is the oldest national law in Europe.  It is the oldest body of law that was common to a whole kingdom and administered by central court with the nation-wide competence in first instance.  In the rest of Europe, law was either European or local, not national.”

Prof. Van Caenegem continues.  “The breakthrough of a centralized and modernized legal system took place exceptionally early in England (and Normandy), before Roman law was in a position to exert any profound influence . . .

“If the modernization of law came exceptionally early in England, it was also remarkably systematic.  The activity of the justices at Westminster and in eyre and the various actions with which they dealt formed a coherent whole and were grasped and described as such.  This new law and its judicial apparatus were national and royal.  Not local magnates, but the king and his central justices were the bearers of the whole system and application was nation-wide.  This was very unlike the Continent, were local and regional custom reigned supreme . . .

“The breach came during the momentous modernization of European society in general, and the law in particular, that took place in the 12th and 13th centuries, a watershed of the greatest importance . . .

The professor traces these developments to William the Conqueror’s invasion of England in 1066.  After losing control over Normandy at the beginning of the 12th century, the English rulers (of Norman descent) began to centralize the legal system in England.

“English law prefers precedent as a basis for judgments, and moves empirically from case to case, from one reality to another.  Continental law tends to move more theoretically by deductive reasoning, basing judgments on abstract principles; it is more conceptual, more scholastic and works with more definitions and distinctions.”

Twenty years of chaos during the first half of the 12th century gave Henry II a footing on which to establish binding legal precedent in a society that had been sorely lacking therein.  “It was a coincidence again that Henry II ruled after Stephen and Matilda had created such chaos that the country was ripe for the stern, nation-wide clean-up of the Assizes and the liquidation of judicial contradictions and uncertainties through centralization in the royal courts.”

“This Anglo-Norman law only became English after the loss of Normandy, nurtured (while it withered away in Normandy) by a state that had turned from the Anglo-Norman into an English state, with English instead of French kings, justices of English descent on the benches, and with an aristocracy that had in the end become so English that the conquest was viewed with distaste by men who were French in speech and habits, and who owned their whole family fortune to William I and his successors.  It was in the 13th century the diffusion of Norman and English into one nation took place in that, and Common Law, which bound together for freemen of every descent, became truly English.”

Who created the English Common Law?  Not surprisingly, it was initially established to protect the upper class.  “The Common Law took no interest in the unfree peasants who were harshly excluded and amerced if they tried to use its benefits.  The man who created it were members of a small aristocracy and it was accessible to them and the free minority of the natives [ ] and they created it in order to preserve harmony among the free, landowning top class.”

(The professor notes that French was the language of the English legal system from the late 13th century until 1731, when English was established as the official language of the law in England by an act of Parliament of George II.)

The law of eviction, or unlawful detainer, has roots that extend back hundreds of years.  Here in California, where everyone has the opportunity to make a fresh start, we sometimes forget the past and how it affects our laws.

Yet in eviction, which is properly referred to as “unlawful detainer,” the historical underpinnings are quite plain.  Unlawful detainer is concerned with the possession of real property and is described as a “summary remedy.”  In contrast, an action to determine title to real estate is known as a “quiet title” proceeding, and involves the full trial process.

This distinction between an action for possession and an action for title existed in feudal England.  Legal historian R.C. Van Caenegem, in a series of lectures compiled in The Birth of the English Common Law (Cambridge Univ. Press 1973), explained how these two legal actions were established under King Henry II (1133–89), who reigned from 1154.

It is astonishing to note how closely the forms of action that existed almost 900 years ago parallel those that we use today in California.  Prof. Van Caenegem begins by noting that, “The assize and the action based on it offered protection of tenure, i.e. the peaceful possession and exploitation of free land, at a time when land was the essential form of wealth, the basis of almost everyone’s livelihood and the great source of power and prestige.”

Let’s pause.  It was important for the King to maintain peace in his kingdom.  Acts of self-help to regain possession of real property were likely to lead to violent responses.  The use of the courts, and a ban on self-help, helped preserve peace.  We continue to follow this rule to this day.

Prof. Van Caenegem continues.  “The classic action of novel disseisin, a fruit of Henry II’s reign, was the culmination of a very long royal preoccupation with seisin, witnessed by numerous orders to restore possession, with or without certain forms of judicial enquiry.”

“It was not the preoccupation with seisin that was new, but its systematic judicial form in the hands of the royal justices and the fact that it was now at the disposal of all free men.  Seisin and the protection of seisin – as opposed to right and the lawsuits connected with it – were very old notions, with roots in Germanic gewere, feudal vestitura and ecclesiastical ideas . . . of the early Middle Ages.”

Listen carefully to the following words, for they remain valid today.  “People had known for centuries that seisin and right – possessio and proprietas being the corresponding Roman notions – were two different things and that measures concerning seisin could be followed by litigation on right, but could just as well be taken for their own sake and without further litigation.  So it had been in the past and so it remained after novel disseisin had taken shape.”

Here he is explaining that distinct legal procedures existed for actions based on possession, as opposed to actions based on title, during the time of Henry II.  Were we to meet a lawyer from that time, we would speak the same language when it came to a lawsuit for eviction, in which the sole legal issue is the right to possession of the property.  That is a remarkable notion.

Prof. Van Caenegem continues. “Of course, people who lost their case on seisin could try an action on right, but this was an exceedingly rare phenomenon and the reason is not far to seek.  Seisin was not merely a question of material but of lawful detention: ‘seisin must include some modicum of right, and it is hardly possible to say where seisin ends and right begins.’”

“The question put to the jury was not only whether A had been disseised without judgment, but whether he had been disseised unjustly and without judgment: the jury had to go into the legal situation and if a jury of twelve lawful freemen had found that a man had not been disseised unjustly the chances that a subsequent jury of twelve knights in a process on right would find that he had, after all, the greater right were very small.  It is not because a negative judgment on seisin leaves the loser the theoretical liberty to start a plea on right that his real chances are good.”

So remains the law today.  Which is remarkable to this author; an everyday lawsuit in California is the same lawsuit that would have been filed in feudal England in 1150.

R.C. Van Caenegem, The Birth of the English Common Law (Cambridge Univ. Press 1973)

Another in a recent wave of California cases has hit the nail on the head, holding that the trustee can be held liable for debts, but not the trust itself.  The reason is elementary – a trust is a relationship, not an entity.  This rule has roots that run back hundreds of years.  It explains a number of the seeming paradoxes in trust law.

The second published appellate decision in Greenspan v. LADT, LLC (Dec. 30, 2010) 191 Cal.App.4th 486 concerned efforts to enforce an $8.45 million judgment.  It seems that $47 million in assets that should have been available to satisfy a judgment had dwindled to $13,000.  The judgment creditor looked to other assets to satisfy the judgment.

This is one of the inflection points at which our legal system buckles.  It can be inordinately difficult to enforce a judgment.  Here, the court held that it was proper to amend the judgment to add the trustee as a judgment debtor.  With a twist, because the trustee was the manager of the limited liability companies against which the judgment was entered, such that the liability was based on an alter ego theory.

Let’s consider the court’s analysis.  The court held that Barry Shy could be added as judgment debtor based on “his control of the Shy Trust and its companies to such an extent that his failure to satisfy the judgment would promote injustice.”

The court employed a well-known procedure, stating that “Amendment of a judgment to add an alter ego is an equitable procedure based on the theory that the court is not amending the judgment to add a new defendant but is merely inserting the correct name of the real defendant.”

Now, I have trouble understanding why equity should intervene, because the claim seeks substantive legal relief.  The cavalier use of this procedure does not promote justice, especially when the defendants were known to the plaintiff during the trial on the merits.  Still, court held that “such a procedure is an appropriate and complete method by which to bind new defendants where it can be demonstrated that in their capacity as alter ego of the corporation they in fact had control of the previous litigation, and thus were virtually represented in the lawsuit.”

The trustee was the manager of the limited liability companies against which judgment was entered.  His liability arose, as a factual matter, from his management of the limited liability companies, not from his acts as trustee (manager) of the trusts.  This then is a leap, albeit a small one.  With our modern statutory schemes for limited liability companies, we have made it difficult to enforce judgments placed against an LLC.

Stated the court, “we conclude the alter ego doctrine may apply to a trustee but not a trust . . . Courts often speak of the alter ego doctrine as if it applied to a trust as an entity.  But a distinction must be made between a trust and a trustee. The general rule that a trust is a relationship is universally recognized by U.S. cases and statutes, and is consistent with the prevailing norms of the entire common-law world. The fundamental nature of this relationship is that one person holds legal title for the benefit of another person.  Thus, in actuality, a trust is not a legal person which can own property or enter into contracts.”

That is a rock-solid statement of the law, correct on all points.  “Because a trust is not an entity, it’s impossible for a trust to be anybody’s alter ego. That’s because alter ego theory, which is simply one of the grounds to ‘pierce the corporate veil,’ is inescapably linked to the notion that one person or entity exercises undue control over another person or entity.  However, a trust’s status as a non-entity logically precludes a trust from being an alter ego.”

The court is still right on the money.  “Unlike a corporation, a trust is not a legal entity. Legal title to property owned by a trust is held by the trustee.  A trust is simply a collection of assets and liabilities. As such, it has no capacity to sue or be sued, or to defend an action.”

But now we enter a hazy area.  Generally, a claim against the trustee must be connected to a claim connected with the management and operation of trust assets.  Stated differently, the personal liability of a trustee for his wrongdoing does not enable a judgment creditor to reach trust assets.  Such protection of trust assets is tied to the fundamental notion that a trust is a relationship, whereby the trustee holds title to the trust assets for benefit of the cestui que trust.

The court’s next step is not on such firm grounding.  “The proper procedure for one who wishes to ensure that trust property will be available to satisfy a judgment is to sue the trustee in his or her representative capacity.”  True, but the court seeks to hold the trustee liable for debts owed by a trust asset.  How do we cross this bridge?

In a single leap.  “In the present case, Greenspan properly sought to add Moti Shai, the trustee of the Shy Trust, as a judgment debtor.  If Moti Shai is the alter ego of Barry Shy, then Barry may be considered the owner of the Shy Trust’s assets for purposes of satisfying the judgment.”

This result means that the court is disregarding two layers – the limited liability company (on alter ego grounds) and the trust.  I propose that the trust should be disregarded on a more fundamental basis – an estate planning trust has no legal effect until the death of the settlor.  If the trust is revocable by the trustor, it should always be ignored by the court.  If the trust is irrevocable, then we enter the familiar area of the fraudulent transfer.  In other words, the court reached the right result, but there’s an easier way to connect the dots.

Greenspan v. LADT, LLC (Dec. 30, 2010) 191 Cal.App.4th 486

A new decision has made an important change concerning he liability of real estate brokers in the context of a bankruptcy.  Specifically, the decision in In re Honkanen, 2011 DJDAR 3358 (9th Cir. Bankruptcy Appellate Panel March 4, 2011) holds that a real estate broker can obtain a discharge from a state court finding of breach of fiduciary duties if the finding was based on the debtor’s status as a broker.

In other words, state law holds that a broker owes fiduciary duties to his client.  Bankruptcy law holds that certain debts arising out of a breach of fiduciary duties are not dischargeable in bankruptcy.  The Honkanen court stepped into the intersection of these rules and held that the broker’s breach of fiduciary duties is a dischargeable debt because the broker was not acting as a trustee.  This represents a change in existing precedent.

Here are the facts.  “Honkanen had acted as Archer’s real estate broker[.]  After the transaction was not consummated, Archer sued Honkanen in state court accusing Honkanen of performing her real estate licensee duties negligently and of intentionally breaching her fiduciary duty to Archer.”

According to the lawsuit, “The alleged breach consisted of Honkanen making intentional misrepresentations to Archer concerning the real estate purchase agreement and the insufficiency of Archer’s performance, in addition to failing to disclose the deficiency in Archer’s performance . . . Archer also accused Honkanen of breaching her fiduciary duty of loyalty to Archer, the buyer, by acting in the interest of the seller rather than in Archer’s, interest.”

The result was in favor of the client.  “The jury awarded Archer damages in the amount of $356,000 for negligent and intentional breach of Honkanen’s fiduciary duty to Archer.”

Ms. Honkanen later filed for bankruptcy.  The client filed an adversary complaint seeking to hold that the debt was not dischargeable.  Based on prior case law (which was favorable to the creditor), “the only evidence admitted at trial was the original state court complaint, the state court judgment, and the state court jury instructions.”

Under prior law, this would have been sufficient to support a finding of non-dischargeability.  However, the appellate court made a break with published precedent, explaining that, “The broad definition of fiduciary under nonbankruptcy law – a relationship involving trust, confidence, and good faith – is inapplicable the dischargeability context.”

Instead, the Honkanen court stated that in the bankruptcy context, “the Ninth Circuit has adopted a narrow definition of ‘fiduciary.’ To fit within § 523 (a) (4), the fiduciary relationship must be one arising from an express or technical trust that was imposed before, and without reference to, the wrongdoing that caused the debt as opposed to a trust ex maleficio, constructively imposed because of the act of wrongdoing from which the debt arose.”

In other words, for the debt to be non-dischargeable, “the applicable state law must clearly define fiduciary duties and identify trust property . . . The mere fact that state law puts two parties in a fiduciary-like relationship does not necessarily mean it is a fiduciary relationship within 11 U.S.C. § 523 (a)(4).”

The Honkanen court then found a change in the law.  “In Cantrell, 329 F.3d 1119 (2003), the Ninth Circuit decided an issue of first impression and interpreted California corporate law to conclude that while officers and directors of a corporation are imbued with the fiduciary duties of an agent and certain duties of a trustee, they are not trustees with respect to corporate assets and, therefore, are not fiduciaries within the meaning of § 523(a)(4).”

To this end, non-dischargeability for breach of fiduciary obligations requires an express finding of a trust.  “In Cantrell, Cal-Micro, the plaintiff, contended that under California law a corporate officer is a statutory trustee with respect to corporate assets but the court rejected that contention because the cases relied upon by Cal-Micro merely held that officers owe fiduciary duties in their capacity as agents of a corporation – but failed to hold the officers are trustees of an express, technical, or statutory trust with respect to corporate assets.”

Here is an important point of law.  “A director of a corporation acts in a fiduciary capacity and the law does not allow him to secure any personal advantage as against the corporation or its stockholders.  However, speaking, the relationship is not one of trust, but of agency.”

Therefore, the law did not support a holding of non-dischargeability.  “Based on the requirements set forth in Cantrell, a California real estate licensee does not meet the fiduciary capacity requirement of § 523(a) (4) solely based on his or her status as a real estate licensee.  General fiduciary obligations are not sufficient to fulfill the fiduciary capacity requirement in the absence of a statutory, express, or technical trust.”

The decision affirms that fiduciary obligations – and the results arising from such a relationship – are often case-specific.

In re Honkanen, 2011 DJDAR 3358 (9th Cir. Bankruptcy Appellate Panel March 4, 2011)

The decision in Smith v. Home Loan Funding, Inc. (Feb. 25, 2011) 2011 DJDAR 2968 may have satisfied a “feel good” impulse at the Court of Appeal.  However, it seems that Justice Gilbert jumped the rails when he affirmed the award of damages.  Even more, he awarded attorney’s fees when there was no contract between the parties providing for such recovery.  The result is intellectually disappointing.

The case involved a loan that was placed by Home Loan Funding (HLF).  According to the opinion, “Anthony Baden worked for HLF as a loan officer.  He had no real estate or mortgage broker license.  In March 2006, Tonya Smith contacted Baden in response to an advertisement she received from HLF.  She sought a $40,000 home equity line of credit.  Her home had existing first and second mortgages.”

Here comes the fact that gave rise to a finding of liability.  “[Anthony] told [Tonya] he could ‘shop the loan.’  When asked whether Baden ever told her that he was a mortgage broker Smith replied, “I believe so, yes.”  Smith testified that she trusted Baden completely, and believed he would provide her with the best loan.”

In fact, “Baden provided Smith with a $700,000 first trust deed.  The loan had a term of 30 years with a variable interest rate. The loan contained a 3.85 margin over the indexed interest rate.”

In addition, “Smith did not want a prepayment penalty on the new loan. Baden represented to her that the new loan would have none.  Baden reassured Smith and her husband throughout escrow that there would be no prepayment penalty and sent an email to assure them.”  But when it came time to close, “a prepayment penalty was reinserted into the transaction by means of a rider.”

The loan was favorable to the broker.  “Smith’s expert, Luis Araya, testified that the commission available to HLF for the sale of the loan on the secondary market was greatly enhanced by the inclusion of both a prepayment penalty and a heavily marked-up margin.  Araya also testified that a 3.85 margin is ‘astronomical.’”

Now we start to wonder about the bona fides of the transaction, and whether they support the award of damages.  “Araya testified that Smith cannot refinance her loan in today’s market. She cannot provide sufficient documentation of her income.  There are no longer loans available without documentation of income.”

Duh.  Those days are gone.  But this statement suggests that the borrower (Tonya) obtained what is sometimes referred to as a “liar loan,” with no evidence of income or ability to repay the loan.  Meaning we can expect this loan to tilt into foreclosure.

The court noted that “a mortgage broker has a fiduciary duty toward the borrower.”  HLF argued that since it placed the loan in-house, it acted as the lender, not as a mortgage broker.  The court rejected this argument: “But that HLF ultimately persuaded Smith to accept one of its loans, hardly negates that HLF undertook to act as Smith’s broker.  Instead, it is evidence of HLF’s and Baden’s self-dealing at the expense of Smith.”

Now the thorny issue of damages.  On appeal, “HLF contends the trial court erred in awarding damages for the full life of the 30-year loan.  It claims there is no evidence Smith would hold the loan or the property for 30 years . . . In Stratton v. Tejani (1982) 139 Cal.App.3d 204 . . . The court stated that residential real property typically is held for only seven to ten years.”

That’s an accurate statement regarding property ownership.  Even more, what if the house goes to foreclosure (perhaps likely, given that the loan was made without proof of income)?  It seems that if the court were to award damages on a 30-year basis, it would provide a windfall to the customer.

But that argument went nowhere on appeal.  Stated Justice Gilbert, “We think Stratton is not applicable here. That the mortgage has a term of 30 years is sufficient to support the trial court’s calculation . . . The evidence is that Smith does not qualify to refinance.  She is more likely than anyone to be saddled with a 30-year mortgage.”

To rub salt in the wound, the court of appeal affirmed an award of attorney’s fees to the borrower based on a clause in “the note secured by the deed of trust.’”

Common sense tells me that the promissory note is separate from the claim against the mortgage broker, which claim was based on breach of fiduciary duties.  Remember when the court said, “You shopped the loan, you’re a mortgage broker.”  On appeal “HLF points out that under section 1717 a prevailing party cannot recover fees for actions based on tort including breach of fiduciary duty and misrepresentation.”

But when it came to attorney’s fees, the court lumped it all together, even though no claim was stated under the promissory note or the deed of trust.

Here comes the train wreck.  “Here, not only did HLF have a fiduciary obligation, but Baden made an express oral promise to Smith that he would shop the best loan for her.  [T]he trial court treated the oral brokerage agreement and the loan documents as a single agreement. This was justified because they were all part of the same transaction.  The award of attorney fees was proper.”

That seems like piling on.  The defendant was held liable as a fiduciary because of shopped the loan.  Then the court mashed all of the documents together and said, “Hey, we found an attorney’s fees clause in one of the contracts.”  That is not a logical outcome.  But, because the California Supreme Court almost never takes up business cases for review, the decision will be binding.

Smith v. Home Loan Funding, Inc. (Feb. 25, 2011) 2011 DJDAR 2968

The decision in Bonfigli v. Strachan (Feb. 24, 2011) 2011 DJDAR 2893 is a reminder not to press for advantage when using a power of attorney.  The defendant was a developer who used a power of attorney to reconfigure two parcels so that he got to keep the land, but did not have to pay the seller.  Needless to say, the court of appeal was not amused.

As part of its analysis, the court considered the rules applicable to a “power coupled with an interest,” and based its decision on a Supreme Court case from 1823.  Let’s take a history lesson.

Plaintiff owned two parcels on Sebastopol Road in Santa Rosa.  The defendant developer needed “needed the [plaintiffs’] parcel in order to develop the overall project, and specifically, the ‘Village Square’ portion of the development.”  Defendant took an option to purchase the properties.  In a critical fact, “The option expired on July 1, 2001, without being exercised.”

Here’s where it gets interesting.  “In May 2001, respondents filed a lot line adjustment application with the City of Santa Rosa.”  Acting under a power of attorney, the developer executed the lot line adjustment on behalf of plaintiffs.  According to the court, “the reason given for the lot line adjustment was to ‘reconfigure lot line as desired by property owners.’”

However, the reality was that “the requested adjustment decreased the size of the Bonfiglis’ front parcel by approximately 60 percent,” with the acreage being transferred to a different parcel owned by the developer.  Which is to say, the defendant took land from plaintiffs “to create a buildable parcel [but] respondents did not pay the Bonfiglis for the transfer nor did they ever purchase the front parcel.”

Then, to rub salt in the wound, the developer encumbered the property with a $22.6 million loan.  “The Bonfiglis’ parcel, among others, was used as collateral for the loan, with respondents signing as attorneys-in-fact for the Bonfiglis . . . even though the option had expired.”  This was followed, not surprisingly, by a bankruptcy filing by the entity that was being used to make the development.

It seems astonishing that this case made it to a jury, and more astonishing that plaintiffs did not prevail (however, reversed on appeal).  The critical issues on appeal involved a power of attorney signed by plaintiffs in 2000.

Here the court used its wayback machine, stating that “California decisional law has consistently followed the definition of a power coupled with an interest set out by Chief Justice Marshall in Hunt v. Rousmanier (1823) 21 U.S. 174, 203: ‘A power coupled with an interest,” is a power which accompanies, or is connected with, an interest.  The power and the interest are united in the same person.’”

This isn’t a traditional power of attorney.  Its sui generis.  “The purpose of a power coupled with an interest is to protect the agent’s interest in the subject and its value, this kind of power of attorney is not an ‘agency’ as that term is commonly understood.  Rather, the creator of the power relinquishes irrevocably any authority to direct the attorney-in-fact who is permitted, under such an arrangement, to act solely in his own interests. “

This special kind of power of attorney does not create fiduciary obligations by the power holder in favor of his principal.  Citing the Restatement Third of Agency, section 3.12, the court explained that a “power given as security does not create a relationship of agency . . . The holder is not subject to the creator’s control and the holder does not owe fiduciary duties to the creator.”

However, “If the creator grants the power to protect an ownership interest of the holder, the power terminates when the holder no longer has the ownership interest.” For this reason, the developer was held liable for wrongful acts after its option had expired.  “The powers granted to [the developer gave] them the power to use the land to develop the project.  The interest being protected is the right to purchase the property at a specified price; and the value of that interest was secured by respondents’ ability to control the property for development purposes.”

Even more, the developer (Alan Strachan, who was represented by family member Gordon Strachan) was held personally liable for the injuries to plaintiffs because he directed his business entity to execute the lot line adjustment.

Explained that court, “Respondents [ ] cannot escape potential liability by using their business entity as a shield . . . Directors or officers are liable to third persons who are injured by their own tortious conduct regardless of whether they acted on behalf of the corporation and regardless of whether the corporation is also liable.”

Added the court, “This liability does not depend on the same grounds as ‘piercing the corporate veil,’ on account of inadequate capitalization for instance, but rather on the officer or director’s personal participation or specific authorization of the tortious act.”

In the end, justice was served.

Bonfigli v. Strachan (Feb. 24, 2011) 2011 DJDAR 2893