November 10, 2010

Estate Planning Mistakes

The following are some common estate planning problems I have seen over the years.

1. Adding a child's name to the title of the family home

Parents often wish to leave their entire estate to their children. One imprudent method of doing this is to add a child's name to the title of the home by partially transferring the parents' interest in the home to include the child as well. For example, Hal and Wendy have two children, Samuel and Donna. They decide that both should inherit the home once both of them have passed away. They execute a deed transferring their interest in a home to include their children as well. Thus, the deed to the home now reads that it is owned by Hal, Wendy, Samuel and Donna.

There are two reasons why this procedure is not recommended at all. 

First, since Samuel and Donna are owners of the home, they can force what is known as a "partition action." In a partition action, the property is either physically divided up and distributed to the owners in proportional to their interest, sold and the proceeds distributed in accordance with the ownership interests or one party buys out the interest of the other party. CCP §§873.210-873.290; CCP §§873.510-873.850; CCP §§873.910-873.980. Each owner has a right to seek a partition action subject to waiver. CCP § 872.710(b). Essentially, if one owner seeks a partition action, there is nothing a co-owner can do to stop it. From our example, if Samuel and Donna become fed up with their parents for whatever reason, say they failed to let them stay out late one evening when they can back from college, they can petition a local court to partition the family home, regardless of any objections by Hal and Wendy.

Second, adding a child's name to the family home is foolish because of liability reasons. Most assets are subject to recovery if a creditor obtains a court judgment against the debtor. For example, if Samuel ran over an unsuspecting bicyclist with his car and the injured bicyclist won a judgment against Samuel in civil court, Samuel would be personally liable for this judgment. This means that most of his assets would be subject to attachment by the bicyclist. Consequently, the bicyclist would be very pleased to see that he could attach a judgment lien to the property that Samuel owned with his parents. By placing a judgment lien on the property, this would prevent the sale of the home until the judgment lien was paid off. So if Hal and Wendy ever decided to sell the home, they would have to either pay off the judgment lien in full or negotiate a reduced price. 

2. Failure to observe formalities

The legal system is very much interested in formalities. Certain formalities must be met in order for a document or legal action to be considered valid. For example, typewritten wills in California require that 2 witnesses sign the will. Prob C § 6110(c). This means that a notarized signature will not suffice because a notary is only 1 person. Thus, the fact that you had your will notarized is a clear indication that it is probably not valid. For whatever reason, many people believe that 1 notary equals 2 witnesses for executing a will, which is clearly not true.

3. Selecting the wrong trustee of a living trust

Besides the beneficiary designation, the biggest question a person confronts when writing a trust is who will be the successor trustee. The choices include family members, friends, professional trustees, trust companies and attorneys. Often times a family member is selected and major problems ensue because the family member is ill-prepared to handle such a responsibility.

4. Oral estate planning   

It is not uncommon to hear a disgruntled heir state "Aunt Gertrude told me when I was young that I would inherit her antique brooch when she passed away." Yes we all have been the recipients of a statement by a relative promising us something when they pass on. 

The good news is that these statements make us feel happy because it shows that our relatives care enough about us to see us inherit a prized possession of theirs. The bad news is that these statement have speculative legal value at best and thereby most likely not to persuade a court as to its veracity. Prob C § 15207. In particular, most attorneys cringe when they hear about oral agreements pertaining to an inheritance because if the matter was so important it would have been written down. As the saying goes, "talk is cheap" and most people will casually throw around all sorts of ideas. Yet when given the opportunity to express their thoughts on paper, people often have a change of heart and refuse to spell out their testamentary intentions.

5. Avoidance of creditors by transferring property pre-death

People regularly incur a large amount of debt in the latter stages of their life due to costly life-prolonging medical care. Cognizant of this debt, people mistakenly assume that if they transfer their assets to the beneficiaries of their will or trust before they pass away, their creditors (medical insurance company, credit cards, etc.) will have no recourse against them because the property is not in their control. 

For instance, Dan had health problems and owed Chase Bank roughly $50,000 in credit card debt due to medical charges. Dan had written in his will that his friend Ezekiel would inherit his home upon his death. Rather than have Chase Bank place a judgment lien on the property, Dan transferred his interest in the home to Ezekiel one month before he passed away, assuming that the transfer would allow Ezekiel to inherit the home free and clear of any claim by Chase Bank.

However, California law provides creditors many legal remedies if the transfer was done to defraud a creditor's attempt to recover a lawful debt owed. Uniform Fraudulent Transfer Act CC §§3439-3439.12. In this case, Chase Bank could see that Dan transferred the home to Ezekiel even though Dan surely had to know that he owed Chase Bank $50,000. Thus, Chase Bank could successfully pursue a lawsuit against Dan's estate for fraudulently conveying the property to Ezekiel. Chase Bank could then either nullify the transaction, attach their claim to the home via a judgment lien, or prevent a future transfer of the home by Ezekiel. CC § 3439.07.