Sunday, September 27, 2009

Religious Preference Clause: Illinois Supreme Court Rules In Favor Of Couple's Trust That Disinherits Grandchildren Who Marry Non-Jews

Chicago dentist Max Feinberg died in 1986. Prior to his death, he had a standard pourover will and revocable living trust. The trust had an unusual catch: His grandchildren wouldn't inherit a penny if they married someone who wasn't Jewish or whose non-Jewish spouse did not convert within one year. We could call this a "religious preference clause."

More specifically, the trust provided that upon his death, his assets would be split into a standard credit shelter trust and a marital deduction trust. Max's widow, Erla, was the lifetime income beneficiary of both trusts, and had a limited right to withdraw principal.

Upon Erla's death, the property would be distributed to Max's descendants. Fifty percent of the trust estate was to be held in further, separate trusts for Max's grandchildren during their lifetime on a per stirpital basis. The trust provided that any descendant who married outside the Jewish faith or whose non-Jewish spouse did not convert to Judaism within one year would be disinherited.

Feinberg's will gave control of the trusts to his wife, Erla. When she died and the grandchildren were to inherit $250,000 each, she followed her husband's wishes and imposed the same restrictions. By that time, four of the five grandchildren had married gentiles. Erla Feinberg's death triggered a series of disputes. One disinherited granddaughter had argued it was improper for a will to set up conditions that promote religious intolerance in people's marriage decisions or even encouraged couples to divorce.

On September 24, 2009, the Illinois Supreme Court unanimously ruled that Feinberg and his wife were within their rights to disinherit any grandchildren who married outside the faith as long as the method of doing so did not encourage divorce. The court's ruling was based partly on technicalities in the way this estate was arranged. The court did not provide a broad ruling on whether similar religious restrictions would be valid under other circumstances.

The state Supreme Court based much of its decision on the fact that Erla Feinberg's will awarded set amounts of money based on the marriage status of the grandchildren at the time of her 2003 death — either they qualified for the money or they didn't. The court said that meant the will didn't try to control what the grandchildren would do in the future and didn't offer any incentive for a particular couple to divorce.

A will that provided money year after year if the heir did not marry a gentile might not pass muster, the court suggested. That's because it would amount to a dead man trying to control actions for years to come and would encourage divorces so that people could claim an inheritance.

"Equal protection does not require that all children be treated equally . . . and the free exercise clause does not require a grandparent to treat grandchildren who reject his religious beliefs and customs in the same manner as he treats those who conform to his traditions," Justice Rita Garman wrote in a ruling that overturned decisions by two lower courts.

A copy of this interesting decision, In Re Estate of Max Feinberg, can be found at: http://www.state.il.us/court/OPINIONS/SupremeCourt/2009/September/106982.pdf

Posted by Henry Moravec, III. Any questions or comments should be directed to: hm@moravecslaw.com or (626) 793-3210. The firm website is http://www.moravecslaw.com/

Friday, September 25, 2009

California Attorney General Sues To Stop Los Angeles Nonprofit From Diverting Donations And To Dissolve The Charity

A recent case in California is illustrative of the worst nightmare for any nonprofit or charitable organization. On September 9, 2009, the California State Attorney General's Office filed a civil lawsuit to permanently stop UCLA Professor Gerald D. Buckberg, M.D., and five officers of the nonprofit L.B. Research Foundation from allegedly "diverting donations" from the charity to their own personal business ventures and medical research activities.

Under California law, "no part of a charitable organization's income or assets may inure to the benefit of any director, officer, member or private person." However, the State's lawsuit alleges that since 1997, L.B. Research Foundation's officers have used its funds to finance their own medical research, the research activities of companies in which they had a financial interest and the development of medical devices that they sold.

The State's lawsuit was filed in Los Angeles Superior Court. This lawsuit by the State only sets forth allegations, and L.B. Research Foundation and its officers are entitled to a full defense of these allegations. Simply because these allegations are set forth in a lawsuit, they cannot be presumed to be true. The lawsuit sets forth the following allegations against the charity and its officers:

- Failed to maintain adequate books and records in violation of Corporations Code section 6320;

- Breached their fiduciary duties in violation of Corporations Code sections 5233, 5260 and U.S. Code section 4945;

- Failed to maintain an independently elected board of directors in violation of Corporations Code sections 5210 and 5213;

- Filed and distributed false and incomplete reports in violation of Corporations Code sections 6215 and 6812; and

- Engaged in unfair competition in violation of Business and Professions Code section 17200. This allegation is designed to allow the State to recover attorney's fees and obtain injunctive relief.

The State is seeking to recover over $500,000 in misappropriated funds, permanently dissolve the charity, assess civil penalties of over $100,000 and prohibit the defendants from running a charity until they provide accounting statements to his office.

The alleged facts as set forth in the lawsuit are that Dr. Buckberg founded L.B. Research Foundation in 1997. The purpose, as stated in the articles of incorporation, was to assist people suffering from physical and mental disabilities. The Foundation was funded primarily by Dr. Buckberg, although it also received some donations from several other individuals and businesses.

The Attorney General's office launched an investigation in 2007. The investigation allegedly revealed that the foundation has been under the primary control of Dr. Buckberg and L.B. Research has been used primarily to fund Dr. Buckberg's research and development projects and the research of his colleagues and friends. The allegations include the following:

■ The lawsuit alleges that from 1997 through 2004, Dr. Buckberg used $120,000 in donations to produce an educational DVD for use by medical professionals. The rights to the DVD belong to The Helical Heart Company, a for-profit corporation which Dr. Buckberg owns.

■ The lawsuit also alleges that in 2000, $1 million of the charity's funds were donated to UCLA to establish an endowed faculty chair. Dr. Buckberg then purportedly applied for an appointment to the chair and, when that application was rejected, L.B. Research Foundation sued UCLA. Approximately $300,000 of the Foundation's assets have been allegedly used to pay legal fees related to that lawsuit.

■ The lawsuit further alleges that in 2003, Dr. Buckberg used $15,000 of the charity's funds to pay General Theming Contractors, LLC - which he owns -- to build plastic heart models, which he subsequently sold.

■ The lawsuit also alleges that from 2002 to 2006, Dr. Buckberg used over $50,000 of the charity's funds to pay the travel and hotel expenses of physicians whose research benefited a medical device licensed and patented by a for-profit corporation owned and controlled by Dr. Buckberg. The investigation further revealed that not all board members knew they were officers of L.B. Research or that they were even part of L.B. Research's board of directors.

■ Dr. Buckberg allegedly had sole custody of the charity's financial records and checkbook. The State also claims that very few of the board's grant-making decisions were documented and board members failed to understand that the charity's assets could not be used for their personal benefit.

Attorney Commentary: This lawsuit involves Gerald D. Buckberg, M.D., a world-recognized pioneer in the development of life-saving heart surgery techniques, which shows that even well-credentialed persons can be the subject of investigations by the State. The investigation went on for at least two years before the lawsuit was filed. It is during this time in which the nonprofit charity has an opportunity to present the facts and seek to prevent such a lawsuit.

Nonprofits should understand that it is not simply the IRS who regulates them. The California Attorney General's Office regulates charities and the professional fundraisers who solicit on their behalf. The purpose of this oversight is to protect charitable assets for their intended use and ensure that the charitable donations contributed by Californians are not misapplied and squandered through fraud or other means.

Nonprofits should understand that the Attorney General operates a regulatory program and encourages the reporting of "charity fraud. " This reporting can be legitimate or it can be frivolous complaints made anonymously by disgruntled ex-employees or persons who do not have all the facts.

The State Attorney General's Office has a 60-page publication entitled "Guide For Charities" which outlines that office's oversight over nonprofits and summarizes many of the laws applicable to nonprofits. It can be found at:

Nonprofits need to ensure compliance with the state law as set forth in the California Corporations Code regarding fiduciary duties, maintaining adequate records, maintaining an independently elected board of directors and other related laws. Compliance and obtaining proper legal advice regarding potential conflicts of interest can prevent or limit any issues arising later. A lawsuit such as the one filed here can often cripple a nonprofit and harm its fundraising even if the case is later dismissed or won in the nonprofit's favor.

Posted by Henry Moravec, III. Any questions or comments should be directed to: hm@moravecslaw.com or (626) 793-3210. The firm website is http://www.moravecslaw.com/

Mr. Moravec has a specialty in representing nonprofits and in nonprofit law. Mr. Moravec was a consultant and chapter editor for California Continuing Education of the Bar, Advising California Nonprofit Corporations, 2nd Edition 1998. In addition, he was the 1998-1999 chair of the Exempt Organizations Committee of the Los Angeles County Bar Association.

Saturday, September 12, 2009

Preserving Your Wealth With Family Limited Partnerships (FLP)

An FLP is an entity formed as a statutory limited liability partnership in which the only partners are family members. FLPs must have a business purpose and be of a fixed duration of years. Business owners establishing FLPs can act as general partners, hold many of the limited partner interests, and maintain control of the assets.

An FLP is a valuable estate planning tool because it allows you to give limited partnership interests to your children while still retaining control over the entity. Children, as limited partners, cannot transfer their partnership interests without your consent, as general partner and they will have no personal liability for partnership debt or obligations.

Gifts of limited partnership interests to your children can generate substantial valuation discounts because they are minority interests and lack of marketability reduces their value. Furthermore, these minority interest gifts can be made gift tax free if under the annual exclusion amount ($13,000 for single filers, $26,000 for joint filers in 2009).

Gifts that qualify for the annual exclusion will not reduce your lifetime exemption and are excluded from your estate. Furthermore, you can give away up to $1 million during your lifetime tax free ($2 million for a couple), but doing so will reduce the amount you are able to transfer estate tax free at death. FLPs also provide a measure of asset protection because once assets are transferred to an FLP, the limited partners own partnership interests rather than the specific assets themselves.

In California, the only remedy available to a creditor against a partnership interest is in the form of a charging order by a court. The charging order limits a creditor’s interest against a partner to distributions of income and principal made from the partnership. Income of the FLP “passes through” to the partners and are taxed as ordinary income, capital gains, etc.

While there are many advantages to FLPs there are expenses for establishing and maintaining an FLP, retained partnership interests appreciate in your estate until transferred, and gifts do not receive a step-up in basis. As you can see, FLPs are complex and proper planning is essential.

Posted by Henry Moravec, III. Any questions or comments should be directed to: hm@moravecslaw.com or (626) 793-3210. The firm website is http://www.moravecslaw.com/

Wednesday, September 2, 2009

Six Methods To Reduce Estate And Trust Litigation During The Estate Planning Stage

In reviewing some articles regarding reducing litigation in the estate and trust context, there is an article that gives insight at the planning stage. Jonathan G. Blattmachr, a partner at a New York law firm, Milbank, Tweed, Hadley & McCoy LLP, published "Reducing Estate and Trust Litigation Through Disclosure, In Terrorem Clauses, Mediation and Arbitration" in the Cardozo Journal of Conflict Resolution 9 Cardozo J. Conflict Resol. 237 (2008).

In this article, he suggests six methods to reduce the potential for litigation. Although these are not guaranteed ways of avoiding litigation and every estate plan is different, they are useful to consider in the estate planning stage. There are other methods as well, but the methods referenced in this article are a good starting point:

1. Advise Inheritors of Inheritance Plans. Especially when children of the decedent are treated unequally, will contests and litigation arise from disappointed feelings of entitlement. Telling the children ahead of time what their shares will be may avoid a later dispute. Blattmachr even suggests that one could enter into a contract (for consideration or something of value) with such a person that he or she will not object to the validity of the document. Blattmachr notes, however, that "advising a child that he or she will not receive an equal share may have adverse effects even if it prevents litigation after death." Thus, informing inheritors of the plans could cause family problems in the present.

2. Use a Revocable Trust in Lieu of a Will. Since a revocable trust can be funded and operate during lifetime, it is difficult to contest on the grounds that the individual was unaware of its terms. When the Settlor of the trust dies, there is no need to begin a court proceeding to "prove" the validity of the trust, such as there is for a will.

3. Use an Irrevocable Trust in Lieu of a Will or Revocable Trust. An irrevocable trust is even less likely, in Blattmachr's view, to be challenged than a revocable trust. Irrevocable trusts can be drafted in such a way so that transfers of property to them are not completed gifts. Alternatively, making a transfer that is a completed gift, paying gift tax, and filing a gift tax return disclosing details may be additional evidence that the transfer was truly intended. Again, Blattmachr believes that a lifetime trust that is significantly funded is less likely to be challenged.

4. Use a Disinheritance Or No Contest Clause. If the testator lives in a state such as California that will enforce it under certain circumstances, a disinheritance clause (also called an in terrorem clause for the Latin word "in fear") could be used. The goal here is to prevent beneficiaries from causing a legal ruckus after the testator is gone. A lot of trust and estate litigation is not about the validity of the document, it is about its interpretation or about actions taken by the fiduciary. In order to reduce this type of litigation, a disinheritance clause can cause a forfeiture of a beneficiary's interest if such a challenge is made. The entire estate plan must be consistent with this clause.

With the advent of passage of Senate Bill 1264 which enacts Probate Code Sections 21310-21315 effective January 1, 2010, California's "no contest" law has been significantly weakened. This weakening affects wills and trusts that became irrevocable after January 1, 2001 and later. "No contest" clauses traditionally penalize parties who attempt to attack a will or a trust. Now, it will be significantly easier to attack a will or a trust in California.

5. Use Mediation or Arbitration Provisions. Arbitration or mediation cannot be used with respect to the challenge of a document's validity unless the parties agree to it. Using a disinheritance clause to cause forfeiture if the parties will not participate can be used. This could stop claims that are filed only to harass other beneficiaries or to delay distributions to others. Another approach would be having the parties enter into a contract agreeing to arbitration before the transfer.

6. Use a Condition Precedent to a Bequest as an Alternative Method of Causing Participation in Mediation or Arbitration. Since a person cannot be forced to participate in arbitration or mediation unless the law provides for enforcement, consideration must be given to how to get parties to use these methods. One can use the carrot instead of the stick. Parties can be given a benefit if they consent to use arbitration or mediation instead of resorting to court.

When creating estate plans or trust documents it is important to consider the potential for litigation and whether it should be addressed prior to the death or after the death of the people creating it. While much can be done prior to death to resolve potential disputes and keep communications open, often issues only arise after the death of the trustees. During the estate planning stage, this is the time for you to consider what can be done to reduce the likelihood of estate and trust litigation.

Posted by Henry Moravec, III. Any questions or comments should be directed to: hm@moravecslaw.com or (626) 793-3210. The firm is located at 2233 Huntington Drive, Suite 17, San Marino, CA 91108. The firm website is http://www.moravecslaw.com/

Moravecs has some of Los Angeles' best probate attorneys who can help you reduce the risk of trust litigation or represent you to achieve the best possible result in California trust litigation or Los Angeles trust litigation.