Massachusetts Estate Planning, Probate & Elder Law

In drafting irrevocable trusts, much concern has to be given to the attitude of the MassHealth agency against irrevocable trusts, especially where the agency ends up having the weight of the Office of the Attorney General of the Commonwealth of Massachusetts on its side against any trusts that end up in Massachusetts courts. Unfortunately, many of the concerns raised at fair hearings by MassHealth agency lawyers lack serious legal research and call upon hearing officers to focus on phrases instead of reading the trust as a whole as the agency had urged the courts to do in the Doherty case.

Many of the arguments made by the MassHealth agency in claiming that powers of appointment make irrevocable trusts countable almost seem to assume an elaborate scheme whereby the holder of the power initially reserved the power with the intention of later acting in a self-serving manner.[1]  One such example is a power to appoint assets to family members, especially where the language in the power of appointment allows the appointment to be made subject to conditions; the agency often claims that the conditions could be to give the appointed assets to the power holder. Another such example often raised by the MassHealth agency in claiming that powers of appointment make irrevocable trusts countable is that a power of appointment exercisable to make donations to charitable or nonprofit organizations can be utilized to have the appointed assets pay for the power holder’s services.[2] Under Massachusetts statutory and case law and the Restatements of Property and Trusts, however, the power holder of a limited power of appointment is prohibited from exercising the power of appointment in favor of the power holder.[3]

A limited power of appointment is not an interest in property.[4]  There is nothing in federal Medicaid trust law that prohibits limited powers of appointment in irrevocable trusts; neither is there any such prohibition in the State Medicaid Manual, which is issued by the MassHealth agency’s federal oversight organization and is binding on the agency.[5]  If in the Medicaid context Congress had wanted state Medicaid agencies to consider the impact of limited powers of appointment in irrevocable trusts, Congress could have incorporated some of the so-called grantor trust rules, Internal Revenue Code sections 671-679, whereby the reservation of certain powers result in the settlor being treated as the owner of a trust for tax purposes.  These Internal Revenue Code provisions were passed by Congress long before it passed Medicaid trust laws, are very detailed, and indicate that Congress is aware that there are many varieties of trust provisions where settlors can reserve varying degrees of control over irrevocable trusts, yet Congress did not opt to subject irrevocable trusts to such scrutiny in the Medicaid context.

A settlor cannot exercise a limited power of appointment collusively with an appointee to utilize it to pay the settlor’s personal expenses, as a limited power of appointment is exercisable only in favor of permissible appointees, and any attempt to exercise a limited power in favor of an impermissible appointee is legally ineffective.  Restatement 3rd Property (Wills and Donative Transfers) § 19.15.[6]  Where an appointment is made with the purpose and expectation that some or all of the appointed property or some collateral benefit will pass to an impermissible appointee, the appointment is ineffective:

An appointment to a permissible appointee is legally ineffective to the extent that it was (i) conditioned on the appointee conferring a benefit on an impermissible appointee, (ii) subject to a charge in favor of an impermissible appointee, (iii) upon a trust for the benefit of an impermissible appointee, (iv) in consideration of a benefit conferred upon or promised to an impermissible appointee, (v) primarily for the benefit of the appointee’s creditor, if that creditor is an impermissible appointee, or (vi) motivated in any other way to be for the benefit of an impermissible appointee.” Restatement 3rd Property (Wills and Donative Transfers) §19.16.[7]

Such an attempt to benefit personally from a limited power of appointment is “frequently referred to as a ‘fraud on the power.’” Restatement 3rd Property (Wills and Donative Transfers) Chapter 19 Part D Introduction and § 19.15.[8] 

Looking at a limited power of appointment from the standpoint of the power holder’s creditor reaches the same conclusion, that it cannot benefit the power holder. If a limited power of appointment could be used (or abused) for personal benefit, it would seem that this issue would have come up in the bankruptcy context, where a court-appointed bankruptcy Trustee would have looked to expand the bankruptcy estate by pulling in assets that are subject to the power. Yet, no such case exists. The settlor’s creditors cannot reach the assets subject to such a power:

“[T]he creditors of the donee[9] of a nongeneral power of appointment (one that cannot be exercised for the economic benefit of the power holder), whether or not presently exercisable, cannot reach the property subject to the power for the satisfaction of their claims[].”  …  “The rights of creditors with respect to trust property over which the debtor has a power of appointment depend on the nature of the power. For example, the creditors of the donee of a nongeneral power of appointment (one that cannot be exercised for the economic benefit of the power holder), whether or not presently exercisable, cannot reach the property subject to the power for the satisfaction of their claims; nor is the property subject to the expenses of administering the donee’s estate.”  Restatement (Third) of Trusts, § 56, comment b (2003)  “Property subject to a nongeneral power of appointment is exempt from claims of the donee’s creditors and from liability for expenses of administering the donee’s estate.” Restatement 3rd Property (Wills and Donative Transfers) §22.1. “Because a nongeneral power of appointment is not an ownership-equivalent power, the donee’s creditors have no claim to the appointive assets, irrespective of whether or not the donee exercises the power. Restatement (Third) of Property § 22.1, comment a. 

Federal bankruptcy law has long reached the same conclusion, that limited powers of appointment do not represent assets available to the power holder:

Section 541(b)(1) of the federal Bankruptcy Code of 1978 (11 U.S.C. § 541(b)(1)) provides that ‘Property of the estate does not include any power that the debtor may only exercise solely for the benefit of an entity other than the debtor.’ This provision excludes from the federal bankruptcy estate property subject to a nongeneral power of the donee-bankrupt.  Restatement 3rd Property (Wills and Donative Transfers) §22.1 cmt d.

The simple reason that there are no bankruptcy cases holding that limited powers of appointment are problematic is that the power to appoint principal is not a power to make payment of the power holder’s personal expenses unless the power is so broad that it is a general power of appointment. Further, of practical significance is that the power holder does not have actual control over the assets, and cannot exercise any such power without going through the Trustee, who controls the assets. The Trustee then has to determine whether the attempted exercise of the power is legally effective, given that both the Trustee and the power holder have fiduciary duties under the Massachusetts Uniform Trust Code.

2. Discussion. The interpretation of a written trust is a matter of law to be resolved by the court. See Mazzola v. Myers, 363 Mass. 625, 633 (1973). The rules of construction of a contract apply similarly to trusts; where the language of a trust is clear, we look only to that plain language. See Harrison v. Marcus, 396 Mass. 424, 429 (1985). … When interpreting trust language, . . . we do not read words in isolation and out of context. Rather we strive to discern the settlor’s intent from the trust instrument as a whole and from the circumstances known to the settlor at the time the instrument was executed.” Hillman v. Hillman, 433 Mass. 590, 593 (2001), citing Pond v. Pond, 424 Mass. 894, 897 (1997).

M.G.L. c. 203E § 105 establishes “the duty of a Trustee to act in good faith and in accordance with the terms and purposes of the trust and the interests of the beneficiaries.” The Massachusetts Uniform Trust Code requires in general that fiduciary duties apply to all trusts, and is more specific about those duties in Article 8, including s. 802 (duty of loyalty), s. 803 (duty of impartiality) and s. 808 (powers to direct). For a Trustee to exercise any power, M.G.L. c. 203E § 815(b) requires that fiduciary duties must apply: “The exercise of a power shall be subject to the fiduciary duties prescribed by this article.”  To determine those fiduciary duties, the Trustee is required to read the trust as a whole.[10]  In Ferri v. Powell-Ferri, 476 Mass. 651 (2017), the SJC recently summarized how to interpret a trust properly under Massachusetts law:

“It is fundamental that a trust instrument must be construed to give effect to the intention of the donor as ascertained from the language of the whole instrument considered in the light of circumstances known to the donor at the time of its execution.” Watson v. Baker, 444 Mass. 487, 491 (2005), quoting Powers v. Wilkson, 399 Mass. 650, 653 (1987). … “In determining the meaning of a contractual provision, the court will prefer an interpretation ‘which gives a reasonable, lawful and effective meaning to all manifestations of intention, rather than one which leaves a part of those manifestations unreasonable, unlawful or [of] no effect'” (citation omitted) Siebe, Inc. v. Louis M. Gerson Co., 74 Mass. App. Ct. 544, 550 n.13 (2009). 

Ferri at 654-655.  (emphasis added)

If the Trustee determines that the self-serving exercise of a power of appointment is inconsistent with the trust, read as a whole, then the Trustee cannot take action based on the power holder’s direction, especially where the power holder also has fiduciary duties to the beneficiaries. These points are codified in M. G. L. c. 203E § 808, which states:

(b)  If the terms of a trust confer upon a person, other than the settlor of a revocable trust, power to direct certain actions of the Trustee, the Trustee shall act in accordance with an exercise of the power, unless the attempted exercise is manifestly contrary to the terms of the trust or the Trustee knows the attempted exercise would constitute a serious breach of a fiduciary duty that the person holding the power owed to the beneficiaries of the trust.

(c) A person who holds a power to direct is presumptively a fiduciary who is required to act in good faith with regard to the purposes of the trust and the interests of the beneficiaries. The holder of a power to direct shall be liable for any loss that results from a breach of fiduciary duty.

Thus, if the power holder directed the Trustee to distribute trust assets to a nonprofit nursing home or to a relative in a way that may benefit the settlor, the combination of sections 105, 815(b) and 808 of M.G.L. c. 203E prevents the Trustee from taking such action if it would violate the terms of the trust which prohibit distributions of principal to or for the benefit of the settlor. 

The MassHealth agency’s argument that limited powers of appointment cause a trust to be countable is missing an important element. In the oral arguments preceding the decision in Daley, SJC Chief Justice Ralph Gants pressed the MassHealth agency’s lawyers three times to tell him how the nursing home would get paid if the trusts were found countable. Under federal Medicaid trust law, for a trust to be deemed countable, there has to be a direct mechanism within the trust so that payments could be made to or for the MassHealth applicant or his/her creditors, which would include the nursing home that is providing long-term care. A limited power of appointment does not provide such a mechanism to make the creditor whole.  If a MassHealth applicant is denied benefits due to a problematic trust yet the unpaid nursing home cannot thereafter reach that trust to be reimbursed for the nursing home resident’s unpaid debt, the nursing home would be caught in the middle, and have no source of payment. It strains credulity that Congress would have passed a federal Medicaid trust law whereby a medical provider such as a nursing home would be required to provide extensive, expensive, ongoing health care services to a person who has no potential public or private source of payment.

[1] Hearing Officer Brook Padgett, in Fair Hearing Decision 1604346, has chastised the agency on this point: “MassHealth must review the Trust instrument as a whole, and it does not have free rein to create any scenario which in theory may allow hypothetical access to principal through some convoluted scheme, without concern as to whether the action is prohibited by the Trust or regardless of the fiduciary responsibility and duties of the Trustee.”

[2] This agency argument practically presumes that the drafting attorney intentionally placed this option into the trust after having discussed how to utilize it, and also presumes that a nursing home run as a nonprofit organization would agree to accept payment in this fashion.

[3] The Restatements have detailed coverage of limited powers of appointment because such powers have been utilized for many decades in estate planning, such as in multi-generational estate tax planning and charitable trusts.

[4] Restatement 3rd Property (Wills and Donative Transfers) §22.1 Comment a (“a nongeneral power of appointment is not an ownership-equivalent power.”  Restatement 2nd (Donative Transfers) 13.6, Comment b (“Where a non-general power has been created, the donee is not in the position of an owner either as a matter of common-law doctrine or the practicalities of the situation.)

[5] When the United States Department of Health and Human Services or its Centers for Medicare and Medicaid Services issues an interpretation of federal law in the State Medicaid Manual, the state Medicaid agencies are bound by it. The Foreword to the State Medicaid Manual, at B.1., states:  “Contents.– The manual provides instructions, regulatory citations, and information for implementing provisions of Title XIX of the Social Security Act (the Act). Instructions are official interpretations of the law and regulations, and, as such, are binding on Medicaid State agencies. This authority is recognized in the introductory paragraph of State plans.”

[6] See also Pitman v. Pitman, 314 Mass. 465, 476 (1943) (“[T]here is a fraudulent exercise of a power not only where the donee acts corruptly for a pecuniary gain but where he acts primarily for his own personal advantage or that of a third person who is a non-object of the power and thereby abuses the power [].”)

[7] This issue was raised in New York two decades ago, and the United States District Court for the Northern District of New York held that although the settlor had reserved a limited power of appointment over an irrevocable trust, in the absence of bad faith or fraud, the remote possibility of collusion between the settlor and beneficiaries should not be considered in determining whether the assets of the trust are available for federal Medicaid trust purposes. Verdow v. Sutkowy, 209 F.R.D. 309, 316 (N.D.N.Y. 2002).

[8] See also Annotation, “Validity and effect of agreement by donee of power of appointment respecting its exercise or nonexercise,” 163 A.L.R. 1449 (1944).

[9] Note that the holder of a power of appointment is known here as a “donee.”

[10] “When interpreting trust language, . . . we do not read words in isolation and out of context. Rather we strive to discern the settlor’s intent from the trust instrument as a whole[].” Hillman v. Hillman, 433 Mass. 590, 593 (2001), citing Pond v. Pond, 424 Mass. 894, 897 (1997). Under proper trust interpretation, where possible inconsistencies or ambiguities should not be read in the worst possible way, the prohibition against the distribution of principal in the trust to or for the benefit of the MassHealth applicant should not be tossed aside.