A Frequantly Overlooked Key Issue in Estate Planning

Celebrities and the wealthy often provide important financial lessons for the rest of us. Often, the lessons are more important for the rest of us, because the wealthy usually have enough assets to over-come the losses from their mistakes. For others, one or two critical mistakes can severely reduce financial security and impact their Estate Planning.

The latest important lesson is from the billionaire former owner of the Los Angeles Clippers NBA basketball team, Donald Sterling. You might recall that the previously low-profile Sterling received a lot of attention after recordings of him making racist comments were publicized. The comments were made to a girlfriend; Sterling was married.

NBA owners quickly moved to declare that Sterling no longer could own a team. Sterling just as quickly said he wouldn’t sell the team and began to take legal action against the league. In the midst of this standoff Sterling’s wife, Shelly, asserted herself. Most of Sterling’s assets, including the Clippers, were owned by a revocable living trust of which the Sterlings were co-trustees.

Shelly Sterling, who was estranged from Donald, declared that he was mentally incompetent and that she had authority under the trust agreement to manage trust assets on her own. She did this after doctors examined Donald and concluded he was mentally unfit to be trustee. She put the Clippers up for sale. Donald sued to stop her. The probate court ruled against Donald, finding that the doctors and Shelly acted properly. There were other details, such as Donald’s attempt to revoke the trust, but those are the key facts.

Many of you probably have very similar trusts. Even those of you without revocable living trusts need to pay attention to this case for reasons I’ll explain.

Here we had a billionaire who put substantial assets in what appears to be a standard revocable living trust. The trust no doubt primarily was created to avoid probate on Sterling’s assets and as a will substitute. But, as in many other estates, Sterling didn’t plan much for the potential of his incapacity. In fact, he put in place a plan that left him exposed if he had minor or marginal cognitive issues.

You need a better plan for incapacity than Sterling had. That need for that plan applies whether you have a revocable living trust or a financial power of attorney. If you have a living trust, you still should have the FPOA.

The incapacity terms of the revocable living trust were inadequate for Sterling’s situation and needs and for most of you. Review your revocable trust and FPOA for these key elements.

Key Estate Planning Element #1

Clear definition. There should be a clear, precise definition of incapacity. Mental incapacity is tricky. Unlike many other medical issues, mental incapacity or cognitive problems aren’t clear cut. Mental decline tends to be gradual. A person can be highly functioning and competent one day and less so the next. Variations are likely within the course of a day. Also, a person can have symptoms or a diagnosis of Alzheimer’s, or other cognitive issues, and yet still be legally competent for many purposes.

Your estate planner should be able to offer you several definitions for your trust and POA. Select the one that makes you most comfortable.

Key Estate Planning Element #2

The trigger clause. The trigger clause defines how power actually is transferred once a person meets the definition of incapacity. In Sterling’s case it apparently was vague enough to cause litigation. His wife obtained an opinion from a doctor and declared as co-trustee she had the power to remove him as trustee.

There’s no right or wrong way to phrase the trigger clause. For example, the transfer could occur by a vote (either majority or unanimous, your choice) of three to five people you trust and name in the document. They can consider whatever evidence they want, or you could require that they hear from at least one doctor who’s examined you.

Some documents allow the determination to be made by a single medical doctor. Consider whether you want this to be any medical doctor or one with a particular specialty. Others require agreement of two or three doctors, though that can be both time-consuming and expensive. As I said, there’s no clearly preferable provision. You might be content with what happened in the Sterling case. But both the definition of incapacity and the process by which incapacity is determined should be clear and precise.

Key Estate Planning Element #3

Who receives the power? Whether you have a revocable trust or an FPOA or both, you want the right person to be managing the assets. You might trust your spouse or oldest adult child, for example, to do a lot of things but do you trust him or her to manage your business? What about other assets you have?

When you own a business or real estate or have unique assets, you might want more than one successor trustee or an agent for your FPOA. There might be a certain person or people you want managing the business while other people handle other assets. Most people don’t give this issue a lot of thought, but it can be key to determining the success of your plan and security of your loved ones.

Key Estate Planning Element #4

Returning to capacity. There’s an assumption in most plans that mental incapacity is a one-way street. A plan might state what happens if the owner becomes incapacitated or has diminished capacity. But few plan for the possibility that a person might become incapacitated and then regain capacity.

For example, a person might have a stroke and need a period of rehabilitation and recovery. After that period, full or substantial mental capacity might be restored. The estate planning documents might have provided for a smooth transfer of decision making after the stroke. But most are silent about what would happen after a recovery. A complete plan has a clear definition of a return to capacity and a triggering process for restoring the owner to power.

Key Estate Planning Element #5

Review and update. It’s easy to say now, but when Sterling became estranged from his wife, the trust should have been updated. This would be difficult, of course, since they weren’t divorced and as co-trustees probably would need to negotiate changes to the trust. Or perhaps he created the trust himself and unilaterally could have revoked it or sought return of the assets. He apparently tried that, but the court did not support him.

You also need to regularly review the other terms of the documents. Since medical knowledge changes, are your definitions of incapacity and the triggering process still optimum? Do you need to make changes in the people involved, either because of changes in relationships or because someone passed away or retired?

This is an issue no one really wants to talk about. But at almost any age you are more likely to be disabled than to pass away. An estate plan isn’t complete and ready to preserve your assets unless you have a clear plan for handling incapacity.