Virginia State Bar

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Trusts and Estates

A Section of the Virginia State Bar.

Spring 2011 Newsletter

Newsletter - Trusts and Estates

Volume 22, No. 4

Carson v. Wells Case Summary

By: Gregory A. Giordano

In Carson v. Wells, 281 Va. 173, 705 S.E.2d 101 (2011), the Supreme Court of Virginia, in a case of first impression, clarified several areas of law pertaining to the Virginia Uniform Transfers to Minors Act, Code §§ 331-37 to -59. For the first time, the Court defined the proper standard of care under UTMA, clarified which party has the burden of proof in tracing commingled UTMA funds, and considered whether an award of attorney’s fees is appropriate under UTMA.

Facts and Procedural History
Jon C. Carlson and Valerie Wells were married from 1984 to 2000. During their marriage, they had three children, for whom they established UTMA accounts. Jon was the custodian for the majority of the UTMA accounts. Jon’s brother, James Carlson, served as custo-dian on the remaining accounts.

In December 2003, when the eldest of the three children, Eric, was in high school and deciding where to apply to college, he was informed by Jon that the money saved in the UTMA accounts for the children’s education may not be available. Eric accessed the accounts online and discovered that the UTMA funds had been withdrawn. The Carlsons subsequently ignored the repeated requests made by Wells and Eric to examine the financial records for the UTMA accounts.

Wells, together with Eric in his own right, and as next friend of the minor children, filed a complaint in the circuit court seeking removal of the Carlsons as custodians of the accounts, a full accounting, compensatory and punitive damages, attorney’s fees, and costs. In May 2004, Jon paid Plaintiffs $190,571.40, which he contended represented the balance of the UTMA funds. The Carlsons also resigned as custodians.

In March 2005, Jon provided an accounting which revealed, among other things, that he had closed most of the children’s individual UTMA accounts and transferred the funds into a single bank account that he opened both in his name and in the names of all of the children. From the commingled bank account, Jon made various transfers to reimburse himself for alleged expenses he made on behalf of the children and to make investments purportedly for the children’s benefit. These transfers included a charitable contribution made from UTMA funds to the children’s school, for which Jon claimed a charitable deduction on his personal income tax return. Jon also used UTMA funds to reimburse himself for child support payments he made to Wells.

Additionally, Jon purchased $40,000 in US Airways stock in his own name using UTMA funds belonging to the children. At the time of the stock purchase, Jon was a US Airways pilot and knew that the company was experiencing financial difficulties, yet he was gambling on “buy low – sell high” success. However, shortly after the stock purchase, US Airways filed for bankruptcy, essentially rendering the stock worthless.

In April 2005, the circuit court referred he case to a commissioner in chancery. During the six days of testimony before the commissioner in 2006, Jon admitted that he commingled the children’s UTMA funds into a single combined account. Jon claimed that his purchase of the US Airways stock did not violate the UTMA standard of care because that standard allowed for “prudent speculation.” Jon argued that in determining whether he breached the standard of care, the court should not consider individual investments, but rather should examine the performance of the portfolio as a whole.

In April 2009, the commissioner issued his report, in which he found, among other things: that Plaintiffs received a full accounting in March 2005; that Jon only breached his custodial duties in failing to allow Wells and Eric to inspect the financial records; that James did not breach any duty; that the children were entitled to $3600 in compensatory damages; and that Plaintiffs were entitled to attorney’s fees only through the date they received the accounting in March 2005. The parties filed various exceptions to the commissioner’s report.

In considering the various exceptions, the circuit court ruled that the Carlsons breached their custodial duties. The court found that James had abdicated his custodial responsibilities, and that Jon breached the standard of care through his failure to keep proper records and by speculating in US Airways stock when he knew the com-pany was on the verge of bankruptcy. Relying on Tauber v. Commonwealth, 263 Va. 250, 562 S.E.2d 118 (2002), in which the Supreme Court held that trustees of a charitable trust who com-mingled trust funds with their own property bore the burden of proving which funds they personally owned, the court ruled that the Carlsons had the burden to prove that the funds committed to their care were properly used. The court noted the difficulty in following the children’s money created by the multiple transfers of UTMA funds into three or four accounts bearing Jon’s name, with additional transfers between those accounts. The court ruled that Jon should “bear the burden of untangling matters” because his very conduct prevented a precise accounting. The court awarded the children $31,767.36 in damages from James, $28,143.52 in damages from Jon, plus $20,000 in attorney’s fees, $10,500 in com-missioner’s fees, and $2,602.03 in costs.

On appeal to the Supreme Court, the Carlsons did not assign error to the circuit court’s finding that Jon’s investment in US Airways stock was speculative. Neither did the Carlsons assign error to the circuit court’s award of commissioner’s fees and costs.

Standard of Care
For the first time in a published opinion, the Supreme Court clarified the statutory standard of care to be observed by a UTMA custodian. During the time relevant to the events at issue in this case, former Code § 31-48(B) provided that “a custodian shall observe the standard of care that would be observed by a prudent person dealing with such person’s own property.” The Court interpreted the phrase “a prudent person dealing with such person’s own property” as “a term of art invoking the common law Prudent Person Rule and effectively imposing the common law duties of trustees on UTMA custodians.” Quoting the Restatement (Second) of Trusts § 227(a), the Court ruled that the Carlsons had a duty “to make ‘only such investments as a prudent [person] would make of his own property having in view the preservation of the estate.’” Carlson, 281 Va. at 182, 705 S.E.2d at 105. The Court explained:

[The UTMA] standard is not met whenever a fiduciary to whom the Rule applies invests his beneficiary’s money however he invests his own. Rather, the Restatement clarifies that while “a [person] of intelligence may make a disposition which is speculative in character with a view to increasing his property instead of merely preserving it[, s]uch a disposition is not a proper trust investment, because it is not a disposition which makes the preservation of the fund a primary consideration.

Id. at 183, 705 S.E.2d at 105-06. (emphasis in original).

Accordingly, Jon violated the UTMA standard of care when he speculated in US Airways stock. Jon could not escape that standard merely because his prior investments in US Airways stock were profitable or because he invested his own funds with the children’s funds. He knew when he used the UTMA funds to purchase the stock that US Airways was on the brink of bankruptcy. Jon thus violated the standard of care through his “prudent speculation” in the stock.

The Court further ruled that unlike under the Prudent Investor Rule, the custodian’s conduct under the Prudent Person Rule is evaluated with respect to each individual investment rather than the performance of the investment portfolio as a whole. However, the Court noted that application of the Prudent Person Rule “admittedly is anachronistic” given the “divergence between outdated capital-preservation investment strategies and modern portfolio management.” Id. at 184, 705 S.E.2d at 106. Yet the Prudent Investor Rule did not apply to this case. It was not until 2007, well after the relevant time periods at issue in Carlson, that the General Assembly amended UTMA to include the standard of care embodied in the Prudent Investor Rule under the Uniform Prudent Investor Act.

Burden of Tracing Commingled Funds
The Supreme Court, again, for the first time in a published opinion, ruled that the UTMA custodian has the burden of tracing commingled UTMA funds. The Court explained:

The custodian of a UTMA account has a statutory duty to keep records of the custodial funds. When the custodian commingles his own funds with the custodial funds, he does so at his peril. Any failure to maintain clear and accurate records distinguishing his funds from the custodial funds places the custodian’s funds in jeopardy. This approach is pragmatic and sensible, for it is the custodian who chooses to commingle the funds and it is the custodian who knows to what purpose he has used them. It is far simpler for him to record his transactions as he makes them than for the beneficiary to attempt to reconstruct the transactions after the fact.

Id. at 186, 705 S.E.2d at 107-08. Because Jon admitted that he commingled all the children’s UTMA funds into a single bank account, he bore the burden of establishing that each transfer from that account was for a proper purpose under UTMA.

Attorney’s Fees
The Supreme Court flatly rejected the Carlsons’ claim that they should have been awarded their attorney’s fees as the substantially prevailing party. All those contemplating to serve as UTMA custodians should heed the Court’s admonition of the Carlsons for taking their custodial responsibilities lightly. The Court noted that the Carlsons appeared to “shrug off” condemnation for breaches of their statutory duties as custodians. The Court admonished the Carlsons:

Their position reflects disrespect for the gravity of the responsibili-ties assumed by one who agrees to serve as a custodian under the UTMA. We believe the General Assembly acted purposefully when it imposed the obligations found in the statutes. Those obligations may not be treated casually or with cavalier disregard.

Id. at 187, 705 S.E.2d at 108. The Court further explained that the Carlsons “appear never to have grasped the import of their roles as custodians.” Id. “This was a grave misunderstanding on their part as it led them to breach their statutory obligations to the detriment of the Children and the diminution of the funds entrusted to the Carlsons’ care.” Id. The Court ruled that given the circuit court’s findings, “there can be no plausible contention that the Carlsons substantially prevailed below.” Id.

The Court also affirmed the award of attorney’s fees to Plaintiffs. The Court ruled that Plaintiffs were the substantially prevailing party because they obtained much of the relief sought in their complaint, including an accounting, removal of the Carlsons as custodians, and compensatory damages.

Additionally, although UTMA does not expressly provide for attorney’s fees, the Court held that an award of fees was appropriate given the Carlsons’ “pattern of misconduct.” The Court explained its ruling:

The Carlsons callously disregarded their custodial obligations under the UTMA. They deliberately withheld the records of the UTMA accounts from the Plaintiffs for more than a year. Those records, once produced and examined by the commissioner and the circuit court, revealed that Jon had commingled the UTMA funds from the Children’s various individual accounts into a single account, in violation of Code § 31-48(E). Thereafter, he used a charitable contribution made from UTMA funds to the Children’s school as a charitable deduction on his personal income tax return and used UTMA funds to reimburse himself for a child support payment he made to Wells, in violation of Code § 31-50. In this case, these facts are sufficient to establish a “pattern of misconduct,” . . . specifically a pervasive, wanton dereliction of the duties imposed by the General Assembly on UTMA custodians.

Id. at 189-90, 705 S.E.2d at 109-10.

The Supreme Court’s opinion in Carlson is thus an important guide for UTMA custodians and legal practitioners alike as to the appropriate standard of care to be applied to everyday custodial duties. Custodians should take heed that they administer their responsibilities with the appropriate reverence and seriousness. Should custodians breach their duties by commingling custodial assets with their own, they will bear the burden of separating the custodial funds from their own assets, or otherwise risk losing their personal portion of the commingled funds to the beneficiaries. They will also likely have to pay attorney’s fees to UTMA beneficiaries who successfully challenge the custodians’ conduct in the courts.

Greg A. Giordano is Of Counsel at Troutman Sanders. He is a former lecturer in labor law at Old Dominion University, a former adjunct Professor of Law at Regent University, the author of numerous articles and a frequent lecturer at various seminars. He served as Vice Chairman of the Second District Ethics Committee and is a past Chairman of the Labor Law Section of the Eastern District of Virginia Federal Bar Association. He is a former President of the Virginia Beach Bar Association and the Tidewater Federal Bar Association. He is currently a member of the Virginia State Bar, the Virginia State Bar Bench/Bar Committee and the Virginia Beach Bar Association. Greg is listed in The Best Lawyers in America, the Virginia Business Legal Elite, and Virginia Super Lawyers.