Who Do You Trust With Your Money? (Part Two – A Cautionary Tale)

The appointment of an agent under a Power of Attorney is a minefield of potential abuses.  Even a trusted person can become untrustworthy. Agents often have a great deal of discretion and the potential for conflicts of interest abound.

If a power of attorney is effective when executed, the agent can act on the principal’s behalf at any time. While the principal is healthy and active, the agent is unlikely to be deployed. However, the principal need not be utterly incapacitated for the agent to step in. The principal might be of diminished capacity, but not utterly without decision-making ability. When the principal steps aside from managing their own finances, we have the greatest risk of financial abuse by the agent, especially when the principal is elderly

By way of example, an 83-year-old widow, Enid, is grieving the loss of her husband of 55 years. She has rarely paid bills and has little knowledge of investments. Enid has executed a power of attorney naming her oldest of two sons, Max, to serve as her agent. Presumably, Max is the person whom she most trusts. Enid also has executed a will naming Max as the personal representative of her estate. Enid has empowered the oldest son, Max, with financial management, both now and upon her later death.

Max undertakes the administration and management of his widowed mother’s finances. In so doing he makes gifts from Enid’s money to his own children for their college education. Max supposes that Enid would want to help with her grandchildren’s education. Then Max is given advice by a CPA that he should undertake tax planning to reduce mom’s taxable estate by making sizeable gifts of her assets during her lifetime. Max makes gifts to himself and his family members. Max also thinks about how much time he is spending assisting Enid. Given the amount of time spent tending to mom’s finances, Max decides to pay himself substantial compensation.

If the power of attorney document is silent as to gift-giving or compensation, there will be room for discretion if not abuse. A carefully drafted power of attorney will speak to these possible disbursements of funds. The likelihood that the agent will be financially abusive is diminished with carefully drafted documents.

Maryland law tries to reign in the potential for abuse. Pursuant to Section 17-113 of the MD Code, Estates and Trusts, “an agent . . . shall . . .  (3) act only within the scope of authority granted in the power of attorney.” A well-drafted power of attorney clearly sets out the scope of authority. In particular, the power of attorney should address those areas that might be a conflict of interest for the agent. Ripe for abuse are the powers of an agent to make gifts and to pay themselves compensation.

As to the gift-giving power, many powers of attorney documents limit the power of making gifts to a set amount and to a certain category of people. The cap on gifts most often employed and suggested by the Uniform Power of Attorney Act is the Internal Revenue Code’s annual gift tax exemption. The gift tax exemption amount is an amount that passes free of gift tax annually, currently set at $15,000. Accordingly, a power of attorney can limit gifts made by the agent to the annual gift tax exemption amount. This limitation is prudent as annual exclusion gifts are not so great as to exhaust the principal’s funds.

A second limitation as to transfers refers to the potential recipients of gifts.  The principal would do well to consider permitting gifts only to immediate family members or specifically named intimates of the principal.

If the power of attorney does not limit gift-giving, Maryland’s standard power of attorney states that “an agent may only make a gift of the principal’s property as the agent determines is consistent with the principal’s objectives if actually known by the agent and, if unknown, as the agent determines is consistent with the principal’s best interest based on all relevant factors . . .”  There is a danger of abuse in the agent’s subjective understanding of gifting funds for the principal’s objectives or best interests. A clear standard as to amounts and transferees is much preferred.

As to compensation, “If the principal indicates in the power of attorney that the agent is entitled to compensation, the agent may receive compensation based on what is reasonable under the circumstances or on another basis as set forth in the power of attorney.” Section 17-114, MD Code, Estates and Trusts. A well-drafted power of attorney should clearly state the compensation permitted to the agent either as an hourly rate or as a percentage calculation based on the disbursements made or the size of the estate.

Let’s add another element to this situation. Enid’s youngest child, Jack, might know nothing of the gifts to Max’s family while Enid was alive.  Jack might know nothing of the compensation Max paid to himself. Jack might not even know about any of these transfers. But Jack is a beneficiary of Enid’s estate. The law requires that the personal representative keep the beneficiaries of an estate informed.  Jack might then notice that Enid’s assets are not as great as he anticipated. Jack might question Max, Max might be defensive, and there will likely be conflict.  Jack might react with anger and alarm upon learning that mom’s wealth had gone disproportionately to the older sibling and his family. Enter the lawyers, as Jack brings an action against Max. Be forewarned that litigation is expensive.

If Jack only learns about the purported financial abuse after Enid dies, the situation is perilous. Max was named the personal representative in Enid’s will.  Max has control of Enid’s estate.  The determination as to whether Max was abusive is left to the personal representative; that is Max! Max is unlikely to find that his distributions to family or compensation he took were unreasonable or prohibited. Now Jack must hire an attorney with his own money to have Max removed as the personal representative.

If the court agrees with Jack’s position, it is likely that a third, unrelated party will be named as a personal representative. At the very least this means more fees, more costs, and more acrimony between Enid’s children. That newly appointed personal representative will have to determine whether or not Max’s gifts and compensation were wrongfully distributed and whether they should have been part of the estate, which is quite a burden. The finding of a wrongful distribution may have consequences for the estate including the difficulty in collecting funds, the recalculation of income and estate taxes, and the additional legal expenses.

Errors and misunderstandings happen when documents are inconclusive or poorly drafted.  Enid presumed that her oldest child was someone to be trusted and perhaps he was. Perhaps Max thought that he was acting within the four corners of the power of attorney. Max may have correctly believed his mother would want to fund a college education and make gifts. But those choices were not clearly authorized by Enid’s power of attorney.

The other son, Jack, will likely have a different opinion. Whether or not Max was well-intentioned or appropriately compensated, the law limited Max’s discretion when he distributed Enid’s money.

There is no foolproof formula to avoid an unscrupulous fiduciary abusing their discretion. However, a well-considered and carefully drafted document can limit the chances of dishonesty and deception. A rainy-day legal fund to pay for the litigation is also advisable.