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Cinderella’s Revenge in Heller and The Timing Stinks in Klehm

Heirs retroactively cut stepmother's allowance using New York's new total return law. An appellate court gives its blessing

Cinderella's Revenge

Heirs retroactively cut stepmother's allowance using New York's new total return law. An appellate court gives its blessing

Most states have enacted some form of a total return statute in the last five years that authorizes trustees either to convert old income-only trusts to unitrusts, or to treat a portion of the trust's principle as income -- or both. We are just beginning to see some litigation surface related to these issues. In the Matter of Heller, 800 N.Y.S.2d 207 (2005), wrestled with two issues of first impression regarding the new unitrust provisions of the New York statute: Can a trustee who's also a remainderman elect unitrust status even though he stands to benefit from his choice to pay a fixed percentage to the income beneficiary? And can this election be made retroactive?

Unfortunately for one stepmother, the answer is "yes" to both questions, according to New York's Supreme Court, appellate division, second department.

Stepmother Bertha Heller initiated proceedings to annul and set aside a unitrust election made by her stepsons, the trustees of a trust her deceased husband Jacob had set up in 1984. These stepsons, Herbert M. and Alan J. Heller, also are the remainder beneficiaries of this trust. Because Herbert and Alan made a unitrust election, Bertha's income dropped from $190,000 to $70,000 a year. Worse for Bertha, her stepsons made this election retroactive to 2002, meaning she actually owed the trust $120,000 a year for the past three years. The sweeping changes to New York's trust law went into effect Jan. 1, 2002.

After looking at the relevant statute and legislative history, appellate court judges Thomas A. Adams, Fred T. Santucci, William F. Mastro and Robert A. Spolzino found that trustees are not prohibited from making a unitrust election even when they also are remainder beneficiaries that may benefit from such election. The court held that even though trustees have a fiduciary duty to both income and remainder beneficiaries, it's common for the trustees to be interested parties. The court found there was no reason why a trustee as a remainderman would be per se prohibited from making a unitrust election.

The court also found that, because the language of the governing statute authorizes the trustees who've made the election to specify its effective date, retroactive application of the election is allowed.

This would seem to be an aberrant decision, given the trustee's conflict of interest. But clearly these are issues that other courts will likely have to grapple with. Perhaps total return statutes need to provide for the problem of interested trustees that Heller highlights. They could require court approval in such cases and more clearly articulate the standard to be considered when a conversion is sought.

The Timing Stinks

When a motion to disqualify the opposing party's attorney fails to pass the smell test -- according to the Illinois Court of Appeals

To maintain public confidence in the legal profession and ensure the integrity of judicial proceedings, courts have the authority to disqualify an attorney from representing a particular client. However, because disqualification serves to destroy the attorney-client relationship by preventing a party from freely retaining counsel of his choice, it is regarded as a drastic measure that courts should apply only when absolutely necessary. Motions to disqualify attorneys are generally viewed with caution because they can be used as a tool to harass opposing counsel. To discourage tactical gamesmanship, courts require motions to disqualify attorneys to be made with reasonable promptness after a party discovers facts that lead to the motion. Promptness is the lesson learned the hard way by the sons of Lois E. Klehm in the Illinois appeals case, In re Estate of Klehm, 842 N.E.2d 1177

Lois E. Klehm died on Dec. 8, 1998. She was survived by her three adult children: Roy, Arnold, and Kathleen. Another child, Carl, had pre-deceased her, but his widow, Susan, was party to the proceedings.

In January 1999, Kathleen filed a petition to probate her mother's will. She was represented by the law firm of Cappetta & Shadle Ltd. in Oakbrook, Ill. Shortly thereafter, the probate court admitted the will to probate and appointed Kathleen as executor of her mother's estate. The will had nominated all three living children as co-executors, but the sons declined to act. In August of 1999, the sons filed suit contesting the will, citing undue influence.

From January 1999 through 2003, Cappetta & Shadle represented Kathleen in the will contest and certain negotiations concerning the estate's claims against the sons and their business entities. In August 2003, discussions broke down; Kathleen filed a citation petition against her two brothers, her sister-in-law Susan and their businesses for the purpose of discovering and recovering assets allegedly belonging to the estate.

The defendants filed a motion to disqualify Cappetta & Shadle from representing Kathleen in the citation proceeding. They claimed the firm had represented them previously in various transactions at issue in the pending citation proceeding. Their representation of Kathleen in this matter therefore allegedly violated Rule 1.9 of the Illinois Rules of Professional Conduct because it involved litigation adverse to a former client's interest in a matter "substantially related" to the former representation.

After a week of hearings, the probate court entered an order disqualifying the law firm from representing Kathleen in the citation proceedings.

The appeals court reversed, agreeing with Kathleen that the probate court abused its discretion by failing to find that the defendants waived their right to seek disqualification of the law firm because the defendants waited almost four years before raising the issue.

The appellate court noted that in determining whether a moving party has waived its right to object to an attorney's representation of an adverse party on conflict of interest grounds, courts consider such factors as:

  • the length of the delay in bringing the motion to disqualify;
  • when the movant learned of the conflict;
  • whether the movant was represented by counsel during the delay:
  • why the delay occurred; and
  • whether disqualification would result in prejudice to the non-moving party

The record showed that the defendants in the citation proceeding and their attorney knew or should have known of a potential conflict since August 1999, when they declined to act as co-executors and filed a will contest. "Nonetheless, they permitted the probate case to proceed for approximately four years before filing their motion to disqualify Cappetta & Shadle on September 30, 2003," the court said.

In what is then basically dicta, the appeals court held that even if the defendants had not waived their right to seek disqualification, the record showed that the movants failed to meet their burden of establishing a "substantial relationship" between the attorneys' earlier representation of the movants and their subsequent representation of Kathleen. As stated by the court, the primary concern under the substantial relationship test for disqualifying an attorney based on a prior representation is whether confidential information that might have been gained in the first representation may be used to the detriment of the former client in the subsequent action.

To apply the test, the court:

  • first makes a factual reconstruction of the scope of the prior legal representation;
  • second, determines whether it is reasonable to infer that the confidential information allegedly given would have been given to a lawyer representing a client in those matters; and
  • third, determines whether the information is relevant to issues raised in the pending litigation against the former client.

According to the appellate court, even absent the waiver, the defendants would not have met their burden.

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