Winter 2010 Newsletter
Smith v. Mountjoy: Confusing Power and Duty
By: F. Philip Manns Jr. ©2010
Author’s Note: The Va. Supreme Court in Mountjoy improvidently analyzed an agent’s transaction with her principal as a matter of “consideration” (and hence a question about the agent’s power), rather than as a matter of self-dealing (and hence a question about the agent’s duty). That line of reasoning impairs the ability of counsel to divide assets among affluent couples when one of the spouses is incapacitated, and thereby markedly increases the probability that some of the incapacitated spouse’s unified credit will be wasted.
In Smith v. Mountjoy, 1 the Virginia Supreme Court upended the rule of contract consideration, finding that a restricted half-interest in a tenancy in common in six parcels of real estate constituted zero consideration. The decision perhaps had the salutary result of denying the benefit of self-dealing by an agent acting under a durable power of attorney, but came at the expense of significant damage to the law of contract consideration and to the law of agency.
The facts were remarkably simple. Husband and Wife owned six parcels of real estate as tenants by the entirety.2 Acting under a durable power of attorney, Wife executed a deed, both in her individual capacity and as agent for Husband, that transferred all the real estate ½ to Wife’s revocable trust and ½ to Husband’s revocable trust.3 Husband’s revocable trust had been created for Husband by Wife pursuant to the same power of attorney.4 Husband’s revocable trust was more favorable to Wife than Wife’s revocable trust was to Husband;5 hence the possibility of self-dealing.
Before the transaction, Husband owned a half-interest in a tenancy by the entirety; after the transaction Husband owned a half-interest in a tenancy in common, and that half-interest was held in a revocable trust. Husband’s revocable trust allowed him as settlor to revoke the trust, and if he did not, then upon his death, his half of the tenancy in common passed under the trust to Wife, or if Wife predeceased him, then to Wife’s heirs.6 Wife’s half-interest in the tenancy in common was held in Wife’s revocable trust. Similarly, but not identically,7 Wife’s revocable trust allowed her as settlor to revoke the trust, and if she did not, then upon her death, her half of the tenancy in common did not pass directly to Husband, but would be held in further trust for him, by which Husband was entitled to all income for life and principal as the trustee found necessary for Husband’s support.8
Valuing Husband’s before-transaction interest (half an entireties interest) against Husband’s after-transaction interest (half a common interest held in a revocable trust) is not easy. What is easily discernable is that Husband’s after-transaction interest had some value. Incredibly, the Supreme Court said Husband’s after-transaction interest had no value: zero, zilch, nothing, nada. “[W]e hold that no consideration passed to [Husband] in exchange for severing the tenancy by the entirety interests and conveying a one-half interest in each of the Properties to the trustee of [Wife’s] Trust.”9
Surely, that is counterfactual. First, it is manifest that in exchange for severing the entireties interests and conveying a one-half interest in each of the properties to the trustee of Wife’s trust, Husband received a half-interest in a tenancy in common held in a revocable trust. Second, it is manifest that a half-interest in a tenancy in common held in a revocable trust is not valueless; its value may be difficult to determine; its value may be less than half the value of the real estate; its value may be less than the value of half an entireties’ interest; but its value surely is not zero.
Consequently, through Wife’s agency, Husband engaged in a transaction with Wife in which Husband received some value (rather than no value). Thus, the transaction was not a gift. It was a fallacious method of reasoning for the court (1) to decide that Husband received no value, (2) to use that finding to conclude that the transaction was a gift, and (3) to decide that making the gift was beyond the scope of the agency because the power of attorney contained no express authority to make gifts.
The issue in Mountjoy should be whether the agent engaged in impermissible self-dealing by entering into a transaction with her principal in which the principal received inadequate consideration, not one in which the principal received no consideration.
The only support the court offers for its no-consideration conclusion is to assert that in the transaction, because of the non-mirrored provisions of Husband’s and Wife’s trusts, Husband lost his survivorship right in Wife’s half, while Wife kept her survivorship right in Husband’s half. Here’s the entire analysis.
[T]he disparate provisions of the two trusts allowed [Wife], along with the trustee of [Wife]’s Trust, or her heirs, eventually to obtain fee simple ownership of the Properties, irrespective of whether she or [Husband] died first. That scenario–in which [Wife] and the trustee of her trust, or her heirs, would obtain ownership of the Properties–could not have occurred when the Properties were held as tenants by the entirety, unless [Husband] predeceased [Wife].10
Even if that factually is correct,11 it does not mean that Husband received no consideration “in exchange for severing the tenancy by the entirety interests and conveying a one-half-interest in each of the Properties to the trustee of [Wife’s] Trust.”12 Even if Husband lost a survivorship right that Wife effectively retained, Husband still received consideration in the overall transaction. There can be no doubt that even if Wife had been successful in the self-interested strategy discerned by the court, Husband at an absolute minimum after the transaction had a life interest in half a tenancy in common. Again, that may have been inadequate consideration for his surrendering half an entireties interest, but it was consideration. The issue is adequacy of consideration, not its existence.
A comparison of Mountjoy and an earlier case with similar facts makes clear that the appropriate issue in controversies of this sort is self-dealing, not consideration. In Ott v. L&J Holdings, LLC,13 Mrs. Monroe, acting under a durable power of attorney from Mr. Monroe, executed a deed transferring real estate owned solely by Mr. Monroe to a limited liability company in which Mrs. Monroe had a 20% interest.14 Mrs. Monroe “paid” for her 20% interest by executing a deed, both in her individual capacity and as agent for Mr. Mon-roe, that transferred other real estate owned by Mr. and Mrs. Monroe as tenants by the entireties to the LLC.15 Thus in the exchange, Mr. Monroe lost his survivorship right in Mrs. Monroe’s half of the entireties property in exchange for an LLC interest. Mr. Monroe also lost his outright ownership interest in the other real estate in exchange for an LLC interest. The court held that the transfer was supported by consideration.16
Mountjoy distinguishes Ott as follows:
The [Ott] trial court reached that conclusion [that the transfer was not a gift] based on its factual findings that “the transfer of the property was undertaken for legitimate business reasons and that [the husband and wife] each received benefits, including possible future tax benefits, commensurate with their respective percentage interests, without any self-dealing on [the wife’s] part.” We affirmed the trial court’s judgment, holding that the transaction at issue was within the powers granted to the wife under her husband’s power of attorney.17
Neither the Virginia Supreme Court in Mountjoy, nor the Virginia Supreme Court in Ott told us anything about the facts underlying the Ott trial court’s conclusion that self-dealing had not occurred. For instance, the LLC’s operating agreement, which Mrs. Monroe had caused to be prepared,18 could have favored Mrs. Monroe as much as the disparate trusts had favored Wife in Mountjoy. Indeed, the operating agreement could have named Mrs. Monroe as nonprobate donee of Mr. Monroe’s entire LLC interest at his death.19
The Virginia Supreme Court in Ott simply stated, without any discussion for its basis, the factual conclusion that Mr. Monroe “received benefits . . . without any self-dealing on [Mrs. Monroe’s] part,” yet the court describes the benefits only as “legitimate business reasons” and “possible future tax benefits.” In Mountjoy, there could have been similar “possible-future-tax-benefits” consideration. The exchange of Husband’s survivorship right in Wife’s half of the entireties property for a restricted survivorship right in Wife’s trust could have been for estate planning purposes. The transaction designed by Wife permitted sophisticated decisions to be made if Wife died first. Wife’s executor would be able to decide whether (1) to deduct Husband’s interest in Wife’s trust as marital QTIP property, thereby causing estate taxation in Husband’s estate which could be paid by Husband’s unified credit, or (2) not to elect QTIP, thereby causing estate taxation in Wife’s estate which could be paid by Wife’s unified credit. By leaving the real estate as entireties property, Wife’s executor would have no ability to choose which of the two estates ultimately would be liable for the estate tax on Wife’s half; instead, the first alternative noted above would be automatic and thereby potentially wasteful of Wife’s unified credit.
Realizing that there could have been an estate planning strategy for Wife’s actions in Mountjoy, causes us to consider how Mountjoy has damaged the law of agency. In Mountjoy, it appears that Wife’s actions were not part of a sophisticated estate planning strategy, for the simple reason that Husband moved to disavow the transactions as soon as he learned about them.20 Consequently, the facts appeared quite bad for Wife, and the finding of no consideration permitted the court to deny her the benefit of her apparent self-dealing.
However, in another case, the strategy might be employed fairly, wisely, and strategically to maximize the use of wife’s unified credit by her estate. Does Mountjoy mean that severing tenancies by the entireties with resulting “unequal” ownership never has consideration, so that such severing never can be done by an agent who lacks authority to make gifts?
By default, agents in Virginia lack authority to make gifts, except “in accordance with the principal’s personal history of making or joining in the making of lifetime gifts.”21 Estate planning, like other tasks, often is avoided until the need is imminent, so severing tenancies by the entireties sometimes is not pursued until one of the spouses has lost capacity, and with the matter now pressing, the other spouse engages in estate planning transactions for the couple. Suppose an existing power of attorney lacks express authority to make gifts to the agent. It’s too late for the incapacitated spouse to execute another document. Does Mountjoy mean ten-ancies by the entireties cannot be severed by an agent unless (1) the agent has power to make gifts or (2) the resulting property interests are mirror images?
Perhaps a less extreme example will make the point as well. Must drafters of powers of attorney for spouses now routinely authorize gifts to the agent, so as to permit severing entireties property? If so, that creates another conundrum. Powers of attorney often expressly deny an agent power to make gifts to the agent, because of the resultant estate tax problem created for the agent. If an agent dies while holding a power to appoint a principal’s property to the agent, then the agent’s federal gross estate can include all of the principal’s property.22 Mountjoy appears to require drafters very carefully to draft gifting powers, both to satisfy Mountjoy and to obviate the agent’s estate tax issue.
As well, the recent enactment of the Uniform Power of Attorney Act in Virginia further complicates the Mountjoy agency analysis.23 Under Virginia law, as of July 1, 2010, “if a power of attorney grants to an agent authority to do all acts that a principal could do,” the agent has the general authority described in sections 26-98 through 26-110 of the Code of Virginia.24 Section 26-105 grants the agent authority with respect to “estates, trusts, and other beneficial interests,” and specifically authorizes the agent to “transfer an interest of the principal in real property . . . to the trustee of a revocable trust created by the principal as settlor.”25
Thus, applying the new law to Mountjoy, had Husband created Husband’s trust, then Wife acting under the power of attorney could have transferred Husband’s half of the entireties property to Husband’s trust because Husband’s power of attorney to Wife authorized Wife “to do and transact all and every kind of business whatsoever in [his] name as fully as though [he] was acting[.]”26 Or maybe Wife could not. If the severance and transfer is a gift, as Mountjoy seemingly held, then we have a conflict between the rules for gifts by agents and the rules for “estates, trusts, and other beneficial interests.” And that’s how Mountjoy does significant damage to the law of agency—an unnatural, unreal, result-oriented reading of the law of consideration throws confusion into the law of agency.
Is the severance of a tenancy by the entirety into interests in which both husband and wife have rights, albeit unequal, (i) an estate-trust-and-other-beneficial-interests transaction that one spouse is authorized to enter on behalf of the other, as agent, subject of course to her fiduciary duties, or (ii) a not-permitted gift unless the power of attorney expressly grants the agent power to make gifts? After Mountjoy, we do not know.
The purpose of this paper has been to demonstrate that a better analysis in Mountjoy would have been to find that consideration existed so that agent authority existed, and analyze the case under self-dealing doctrine, rather than to further muddy the turbid waters of consideration doctrine and concomitantly stir unneces-sarily the turbid waters of agency doctrine regarding whether agents can make gifts to themselves.
Cases exactly like Mountjoy arising after July 1, 2010, can be more satisfactorily resolved under the new law. Under the Act, the power to “create, amend, revoke, or terminate an inter vivos trust” “on behalf of the principal or with the principal’s property” may be done by the agent “only if the power of attorney expressly grants the agent the authority.”27 The power of attorney in Mountjoy likely did not include such a power. Thus, Wife would not have had the power to create Husband’s trust, and her lack of authority to enter the transaction would have been clear without recourse to unreal manipulations of the law of consideration. Deciding the retroactive application of the Uniform Power of Attorney Act is not an easy matter. The Act provides that it applies to all judicial proceedings unless the court finds that application would substantially interfere with the effective conduct of the judicial proceeding or prejudice the rights of a party, but the Act also provides that “an act done before July 1, 2010, is not affected by this act.”28 Nonetheless, it is clear that for powers of attorney executed after July 1, 2010, if another situation exactly like Mountjoy arises, the agent will lack authority to create the trust.
Yet, if a Mountjoy-like situation arises under the Act, but a trust for the principal is not created by the agent, yet some other “unequal” severance of a tenancy by the entirety is made, we do not know whether the severance transaction is a permitted estate-trust-and-other-beneficial-interests transaction or a prohibited gift. Mountjoy decided that an unequal severance of a tenancy by the entirety is without consideration and thereby beyond the power of an agent not authorized to make gifts. That removes power from the agent to engage in estate planning, and sets up a conflict with the Act’s granting authority with respect to “estates, trusts, and other beneficial interests.”29
A better approach in Mountjoy would have been to analyze the question as Ott had done. In both Mountjoy and Ott, the principal did receive consideration in the transactions that the agent undertook; neither case involved gifts, so we can save ourselves from the already-difficult-enough doctrines of contract consideration and agent’s gifts to agent. Ott, Mountjoy, and similar cases are self-dealing cases. Self-dealing cases are no picnic, but at least an analysis along that line of inquiry focuses on the main rather than peripheral issues.
The law of self-dealing with respect to agents acting under durable powers of attorney is underdeveloped;30 and perhaps the Mountjoy court preferred the more-developed doctrine of consideration to the less-developed doctrine regarding self-dealing by agents.31 However, it would have been far better for the Virginia Supreme Court meaningfully to address the doctrine relating to self-dealing by agents acting under durable powers of attorney. Instead, we face logic-defying leaps within the law of consideration and concomitant uncertainty about the demarcation between gifts on the one hand and estate-trust-and-other-beneficial-interests transactions on the other.
Philip Manns has been Professor of Law at Liberty University School of Law since 2006; for 15 years prior to joining Liberty, he was Professor of Law at California Western School of Law in San Diego. He is a graduate of the University of Virginia (B.S. Chemical Engineering) and the University of Maryland School of Law. He is an active member of the Virginia and Maryland bars, and is an inactive member of the California and Georgia bars.
1 280 Va. 46 (2010).
2 Id. at 50.
4 Id. at 49. In Mountjoy, there was no discussion about whether the power of attorney authorized Wife to create an inter-vivos trust on Husband’s behalf. All parties and the court apparently assumed she did. Had the court waited three weeks to issue its decision, it would have had to consider the affect of the Uniform Power of Attorney Act in Virginia, which became effective July 1, 2010. Under the new law, an agent has the power to “create, amend, revoke, or terminate an inter vivos trust” “on behalf of the principal or with the principal’s property” “only if the power of attorney expressly grants the agent the authority.” Va. Code Ann. § 26-95(A)(1). See infra note 27 and accompanying text. There is no indication that the power of attorney in Mountjoy expressly included that power.
5 Id. at 49-50.
6 Id. at 49.
7 Id. (The court specifically noted that the survivorship provisions of Husband’s and Wife’s trusts were not “mirror images.”).
9 Id. at 54 (emphasis added).
10 Id. at 54.
11 The court’s analysis is contrary to the facts it stated. In fact, Husband did have a survivorship right in Wife’s half: he was entitled to all the income and discretionary distributions of principal from Wife’s half, provided he survived Wife. Id. at 50-51. Consequently, even if the consideration analysis solely is focused on the survivorship rights exchange (although such a limited focus is wrong because consideration law tells us to focus on the entire exchange), Husband received “survivorship consideration” for surrendering his “entireties survivorship right” in Wife’s half; Wife may have received more survivorship consideration, but Husband received some. The question is adequacy, not existence.
12 Id. at 54 (emphasis added).
13 275 Va. 182 (2008).
14 Id. at 185-86.
16 In Ott, a finding of consideration was necessary to validate the transaction, because the power of attorney expressly denied the agent authority to make gifts to the agent. Id. at 185.
17 Mountjoy, 280 Va. at 55 (emphasis added).
18 Ott, 275 Va. at 185.
19 Va. Code Ann. § 64.1-45.3 permits “a provision for a nonprobate transfer on death in . . . a certificated or uncertificated security . . . or other written instrument of a similar nature.”
20 Mountjoy, 275 Va. at 50.
21 Va. Code Ann. § 26-95(H), which restates a provision previously codified in § 11-9.5.
22 Under I.R.C. § 2041, agent would possess a general power of appointment.
23 In Mountjoy, the court expressly noted that the Uniform Power of Attorney Act, had not become effective prior to its decision. One wonders whether the court rushed the decision to beat effectiveness of the Act, because upon the Act’s effectiveness on July 1, 2010 (20 days after the decision was rendered), the Act expressly applies to “a judicial proceeding concerning a power of attorney commenced before July 1, 2010, unless the court finds that application of a provision of this act would substantially interfere with the effective conduct of the judicial proceeding or prejudice the rights of a party, in which case that provision does not apply and the superseded law applies.” Va. Code Ann. § 26-116(3). Note that the section numbers of the codification of the Uniform Power of Attorney Act within the Code of Virginia differ from the Acts that enacted them.
24 Va. Code Ann. § 26-95(C).
25 Va. Code Ann. § 26-105(B)(7).
26 Mountjoy, 280 Va. at 49.
27 Va. Code Ann. § 26-95(A)(1).
28 Va. Code Ann. § 26-116(4).
29 Va. Code Ann. § 26-105.
30 Unif. Power of Attorney Act § 114 cmt. (“Although well settled that an agent under a power of attorney is a fiduciary, there is little clarity in state power of attorney statutes about what that means.”).
31 Grubb v. Grubb, 272 Va. 45, 53 (2006), provides that any transaction that an agent consummates with his principal to the agent’s own benefit presumptively is fraudulent, and the burden shifts to the agent to produce clear and convincing evidence to rebut the presumption.