"It Depends" - The Answer to All Simple Yes or No Questions

Authors: Jerome C. Wegley and Neal R. Devlin

Originally published in October 2016

Copyright © 2016 Knox McLaughlin Gornall & Sennett, P.C.

This article has not been updated for current law since the date of its posting on the website. This article is not intended to provide any legal advice. Please seek advice of your professional council.

Any U.S. federal and state tax advice contained in this communication is not intended or written by the Knox Law Firm to be used, and cannot be used by you, for the purpose of: (i) avoiding penalties under the Internal Revenue Code that may be imposed upon you, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Are Incomplete Beneficiary Designations Effective? It Depends...

Most insurance policies contain language similar to the following: “Every change of beneficiary must be made in writing and filed with the Company at its Home Office, accompanied by this policy, and the Company shall be charged with notice of such change only when endorsed on this policy by the Company . . .” Annuity contracts and retirement accounts contain similar language requiring strict compliance and acceptance by the company or custodian.

Change in Circumstances – Divorce: Effect of divorce or pending divorce on designation of beneficiaries. 20 Pa. C.S.A. Section 6111.2.

Applicability: This section is applicable if an individual:

• is domiciled in this Commonwealth;
• designates the individual's spouse as beneficiary of the individual's life insurance policy, annuity contract, pension or profit-sharing plan or other contractual arrangement providing for payments to the spouse; and
• either: at the time of the individual's death is divorced from the spouse; or dies during the course of divorce proceedings, no decree of divorce has been entered pursuant to 23 Pa.C.S.§3323 (relating to decree of court) and grounds have been established as provided in 23 Pa.C.S.§3323 (g).

General rule: Any designation described in subsection (a)(ii) in favor of the individual's spouse or former spouse that was revocable by the individual at the individual's death shall become ineffective for all purposes and shall be construed as if the spouse or former spouse had predeceased the individual, unless it appears the designation was intended to survive the divorce based on:

• the wording of the designation;
• a court order;
• a written contract between the individual and the spouse or former spouse; or
• a designation of a former spouse as a beneficiary after the divorce decree has been issued.

Liability: Unless restrained by court order, no insurance company, pension or profit-sharing plan trustee or other obligor shall be liable for making payments to a spouse or former spouse which would have been proper in the absence of this section. Any spouse or former spouse to whom payment is made shall be answerable to anyone prejudiced by the payment.

Parsonese Ruling:

Decedent purchased an insurance policy June 12, 1998 and named his spouse as primary beneficiary on August 27, 1992. Decedent and spouse divorced on September 27, 1993. Decedent died on May 4, 1994. At the time of his death, the beneficiary had the power to revoke or change the beneficiary designation.

Pa. Supreme Court held that decedent’s ex-spouse was the proper beneficiary because the beneficiary designation was a contract between the decedent and the insurance company and the retroactive application of section 6111.2 (effective December 16, 1992 - four [4] months after the decedent last modified his beneficiary designation but two [2] years before he died) was unconstitutional.

Hoffman Ruling:

Decedent purchased a life insurance policy on August 12, 1992 and named his current spouse. Descendent subsequently divorced and remarried, and on February 14, 2003 named his new spouse as beneficiary. In 2008, decedent divorced again and entered a property settlement agreement with his second ex-spouse. Decedent died on November 15, 2008.

The Superior Court agreed that: (i) Section 6111.2 applies to the date of the last beneficiary designation, not the date the policy was initially issued and therefore is not being retroactively applied, and (ii) Absence of specific language in the beneficiary designation and in the property settlement agreement was not evidence that the parties agreed to keep intact the contractual rights of the beneficiary designation.

Sauers Ruling

Ex-spouse entitled to insurance proceeds of an ERISA-governed life insurance policy despite Section 6111.2 of Pennsylvania’s Probate Estate and Fiduciary Code. Section 1104(a)(1)(D) of ERISA requires plan administrators and fiduciaries “to discharge [their] duties with respect to a plan… in accordance with the documents and instruments governing the plan…”

ERISA "shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan" covered by ERISA. A state law relates to an ERISA plan "if it has a connection with or reference to such a plan."

The Court held that section 1144(a) of ERISA preempts section 6111.2 of the Pa. PEF Code.

Substantial Compliance

In order to change the beneficiary under the terms of an insurance policy, the policyholder must strictly comply with the policy's terms. Under Pennsylvania law, the only exception to strict compliance with the policies terms arises when the policyholder had done everything possible to comply with the policy terms but has not succeeded in changing the beneficiary. For the exception to apply, "there must be shown a positive, unequivocal act toward making the change, the mere declaration of intent to change the beneficiary is not enough."

The purpose of this requirement is to protect the company from distributing funds or paying proceeds to the wrong parties or multiple parties.

Pennsylvania, as well as many other states, follows the equitable doctrine of "substantial compliance." Thus Pennsylvania courts will give effect to an insured's intention to change the beneficiary on an insurance policy where, even in the absence of strict compliance with the policy provisions, the insured has made every reasonable effort under the circumstances to comply with those provisions. "The essential inquiry is whether... [it has been]... shown that the insured intended to execute a change to such an extent that effect should be given it."

What is substantial compliance?

Substantial compliance was found where an insured twice wrote to the insurance company and once to his insurance agent notifying them of his desire to change the beneficiary of his policy. For various reasons, the insurance company refused to provide the insured with their forms.

Substantial compliance was found where insured wrote changes in a memorandum in the presence of the insurance agent and two (2) witnesses.

Substantial compliance was found where an IRA owner twice requested change of beneficiary forms and called the investment firm, but died before receiving the forms. The court noted that the principals applicable to substantial compliance regarding insurance policies were analogous to individual retirement accounts.

Must Wills Be Signed and Witnessed? It Depends…

Form and Execution of a Will. Every Will shall be in writing and shall be signed by the testator at the end thereof, subject to the following rules and exceptions:

• Words following signature. The presence of any writing after the signature to a Will, whether written before or after its execution, shall not invalidate that which precedes the signature.
• Signature by mark. If the testator is unable to sign his name for any reason, a Will to which he makes his mark and to which his name is subscribed before or after he makes his mark shall be as valid as though he had signed his name thereto: Provided, That he makes his mark in the presence of two (2) witnesses who sign their names to the Will in his presence.
• Signature by another. If the testator is unable to sign his name or to make his mark for any reason, a Will to which his name is subscribed in his presence and by his express direction shall be as valid as though he had signed his name thereto: Provided, That he declares the instrument to be his Will in the presence of two (2) witnesses who sign their names to it in his presence

"[W]here a testatrix retains the custody and possession of her Will and, after her death, the Will cannot be found, a presumption arises, in the absence of proof to the contrary, that the Will was revoked or destroyed by the testatrix."

Manner of probate. All Wills shall be proved by the oaths or affirmations of two (2) competent witnesses and…

• Will signed by testator. In the case of a Will to which the testator signed his name, proof by subscribing witnesses, if there are such, shall be preferred to the extent that they are readily available, and proof of the signature of the testator shall be preferred to proof of the signature of a subscribing witness.
• Will signed by mark or by another. In the case of a Will signed by mark or by another in behalf of the testator, the proof must be by subscribing witnesses, except to the extent that the register is satisfied that such proof cannot be adduced by the exercise of reasonable diligence. In that event other proof of the execution of the Will, including proof of the subscribers' signatures, may be accepted, and proof of the signature of a witness who has subscribed to an attestation clause shall be prima facie proof that the facts recited in the attestation clause are true.
• The Pennsylvania Supreme Court held In re Estate of Hodgson that “to establish a lost Will there must be proof by two witnesses, not only of due execution, but of the contents, substantially as set forth in the copy offered for probate.” But see In re Estate of Wilner below.

McCoy

An unsigned “draft” copy of a Will was submitted for probate and accepted by the Register of Wills. The court relied on the credibility of certain witnesses over those of others to conclude that the testatrix did not revoke her Will. The court further relied on the credibility of the drafting attorney as to the contents of the Will and the two (2) individuals who testified that they witnessed the testatrix sign the Will.

Wilner - New Rule of Law

Pennsylvania Supreme Court upheld the Register of Wills’ acceptance of a conformed copy of a Will despite the fact that (i) no written document signed at the end by the testator could be found, and (ii) only one (1) witness could verify the contents of the Will. New Rule of Law is that proof by two (2) witnesses of a lost Will does not require proof by two (2) witnesses of the contents of the Will.

Do Joint Bank Accounts Transfer to Surviving Joint Owner Upon Death? It Depends…

The Pennsylvania Multiple Party Account Act provides that, “[a]ny sum remaining on deposit at the death of a party to a joint account belongs to the surviving party or parties as against the estate of the decedent unless there is clear and convincing evidence of a different intent at the time the account is created. If there are two or more surviving parties, their respective ownerships during lifetime shall be in proportion to their previous ownership interests under section 6303 (relating to ownership during lifetime) augmented by an equal per capita share for each survivor of any interest the decedent may have owned in the account immediately before his death; and the right of survivorship continues between the surviving parties.”

A line of cases looked at the timing of the account’s joint tenancy and the decedent’s Will or codicil to determine the intent of the decedent making the account joint. While yet another case found that because no intent could be found that the decedent intended the account to pass to the joint survivor, it was returned to the estate. These cases seem to contradict the express language of the statute that clear and convincing evidence that no survivorship was intended, must be shown that at the time the account became joint.

This confusion was resolved in 2010 when Pennsylvania’s Supreme Court held in In re Novosielski, that the intent of the joint account was separate and apart from provisions in a Will and that prior Superior Court and orphans’ court rulings followed erroneous paths to conclude an intent other than survivorship. This ruling meant that the intent of the deceased joint owner to not create a right of survivorship must be proven by clear and convincing evidence at the time the joint tenancy is created. This presumption places the burden on the party seeking to prove the account balance is to revert to the estate.

A confidential relationship with a weakened intellect has shifted the burden to the surviving joint owner to prove the right of survivorship. In several cases that predate Novosielski, the joint owner was required to provide proof of intent to create a right of survivorship in a joint account where the surviving joint owner was found to be in a confidential relationship, and the deceased joint owner was found to have some diminished capacity. In each case (In re Dzierski Estate, Piontek Estate, Sheagan’s Estate, Downie Estate), the surviving joint owner was required to return the funds to the estate.

A confidential relationship “is one wherein a party is bound to act for the benefit of another, and can take no advantage to himself. It appears when the circumstances make it certain the parties do not deal on equal terms, but, on the one side there is an overmastering influence, or, on the other, weakness, dependence or trust, justifiably reposed; in both an unfair advantage is possible.”

Thus, the treatment of a joint account will depend upon the facts and circumstances at the time the account became joint; just like the statute says. However, where the decedent suffers from diminished intellect and the surviving joint owner was in a confidential relationship with the decedent, the presumption becomes that the balance of the joint account is an estate asset.

Does a Limited Liability Company Protect Your Assets from a Judgment Creditor? It Depends…

If the judgment creditor is trying to foreclose on the LLC interest itself, states differ on what the judgment creditor is able to get. Some states’ statutes provide that charging orders are the sole remedy of the judgment creditor

In Pennsylvania, the rule of law is found in common law and states that “Pennsylvania Limited Liability Company Law prohibits transferring or assigning a member's interest without the unanimous approval of other members of the company. However, it continues on to say “When such approval is not forthcoming, a judgment creditor is still entitled to the debtor-member's economic rights (which are transferable) to satisfy the member's indebtedness by seeking an order of court for the distributions and the return of contributions.”

We are all now familiar with the ruling In re Albright. In Albright, a bankruptcy court determined that the debtor transferred her interests in a single member limited liability company to the bankruptcy estate when she filed for Chapter 7 relief. This caused the trustee to become the sole member of the LLC. Whereupon, the trustee had the authority and power to sell the LLC’s assets, distribute the proceeds to the estate, and ultimately use them to pay the debtor’s obligations. Because Albright was decided in a bankruptcy, it was unclear how much precedent this ruling had outside of bankruptcy.

In Olmstead (a non-bankruptcy case), Florida’s Supreme Court discussed whether the charging order provisions of the LLC act provided the sole remedy for judgment creditors against a member’s single member LLC interest. In ruling that it was not, the court pointed to the language of the transfer provisions of the statute. Like Pennsylvania, Florida restricts transfers of LLC interests without the consent of the other members. Absent from the Florida statute (and Pennsylvania’s) is the express provision that a charging order is a creditor’s sole remedy.

Olmstead essentially confirmed what everyone believed. That is, creditors can foreclose on a single member LLC interest.

The unanswered issue is whether a 1% interest owned by a related party (family member or a trust) is sufficient to invoke the statutory protection. Will courts challenge the relationship of the owners or the business purpose of the LLC to find ways to reach the debtor’s LLC interest?

Are Real Property Transfers to Trusts Subject to Transfer Tax? It Depends…

All transfers of real property are subject to Pennsylvania’s realty transfer tax unless the transfer is excluded or the parties are exempt.

Excluded transfers – trusts:

“A transfer for no or nominal actual consideration to a trustee of a living trust from the settlor of the living trust. No such exemption shall be granted unless the recorder of deeds is presented with a copy of the living trust instrument.”

“A transfer for no or nominal actual consideration to a trustee of an ordinary trust where the transfer of the same property would be exempt if the transfer was made directly from the grantor to all of the possible beneficiaries that are entitled to receive the property or proceeds from the sale of the property under the trust, whether or not such beneficiaries are contingent or specifically named. A trust clause which identifies the contingent beneficiaries by reference to the heirs of the trust settlor as determined by the laws of the intestate succession shall not disqualify a transfer from the exclusion provided by this clause. No such exemption shall be granted unless the recorder of deeds is presented with a copy of the trust instrument that clearly identifies the grantor and all possible beneficiaries.”

"Ordinary trust." Any trust, other than a business trust or a living trust, which takes effect during the lifetime of the settlor and for which the trustees of the trust take title to property primarily for the purpose of protecting, managing or conserving it until distribution to the named beneficiaries of the trust. An ordinary trust does not include a trust that has an objective to carry on business and divide gains, nor does it either expressly or impliedly have any of the following features: the treatment of beneficiaries as associates, the treatment of the interests in the trust as personal property, the free transferability of beneficial interests in the trust, centralized management by the trustee or the beneficiaries, or continuity of life.

Kosco – Mr. and Mrs. Kosco built a retirement home designed to accommodate visits from their four (4) children and their families. In February 2006, Taxpayers executed the Trust, making Taxpayers both trustees and beneficiaries and making their four (4) children secondary beneficiaries. In May 2006, Taxpayers transferred the home to the Trust for no actual consideration. The Department of Revenue assessed transfer tax of $6,244.

The court agreed with Pennsylvania that “the business character of a trust controls over the settlors' purported intent to create an ordinary trust."

The court also agreed with Pennsylvania that the trust expressly contained all of the features of a business trust and that the Trust's objective was not just to protect, manage and conserve Taxpayer's realty.

• Business Objective – “The Trust contains numerous paragraphs authorizing the trustees to carry on business, including renting, mortgaging, selling or disposing of real property, and earning investment income for Trust beneficiaries.
• Beneficiaries as Associates – “Trust's beneficiaries are entitled to the Trust's earnings, avails and proceeds derived from the sale, rental or other disposition of the Trust corpus.”
• Interests Considered Personal Property – “That the interest of any beneficiary hereunder shall consist solely of a power of direction to deal with the title to said property and to manage and control said property as hereinafter provided, and the right to receive the proceeds from rentals and from mortgages, sales or other dispositions of said premises, and that such right in the avails of said property shall be deemed to be personal property, and may be assigned and transferred…”
• Free Transferability of Beneficial Interest – “beneficiaries' rights to the proceeds and avails from the rental, sale or other disposition of trust property, are freely transferable.”
• Centralized Management – “provisions authorizing the trustees to carry on business, including renting, mortgaging, selling or disposing of the Trust property, and earning investment income for Trust beneficiaries.”
• Continuity of Life – Trust was to continue for a specific period of time and not in perpetuity, but the court focused on provisions that facilitated administration. The first provision provided that the death of a beneficiary did not terminate the trust or affect the trustee’s powers; the second provision dealt with the appointment of successor trustees.

The court agreed that the Kosco Trust contained all six (6) features, and said that “if the trust contains any of these features, it does not qualify as an ordinary trust.”

So is the rule of law that any trust that expressly or impliedly has a trustee (centralization of management), OR provides for successor trustees (continuity of life), OR is able to dispose of or mortgage real property, or earn investment income for beneficiaries (business objective) is a business trust?

What about qualified personal residence trusts? What about Medicaid income only trusts?

Is Consideration Necessary to Create a Binding Contract? It Depends…

The general rule of law in Pennsylvania is that promises or obligations of a party to a contract must be supported by consideration in order to be binding. Contracts governed by the Uniform Commercial Code (UCC) are a notable exception.

Is the contract under Seal?

A promise under seal was a way of making a promise enforceable regardless of consideration. Over time, the seal was eroded by case law and the UCC, but it still survives in Pennsylvania. Pennsylvania will not enforce promises under seal in courts of equity. Pennsylvania will enforce promises under seal in courts of law. Erie Telecommunications, Inc. was unsuccessful in its claim to invalidate a release agreement for lack of consideration because it signed the release agreement under seal.

Did the signor intend to be legally bound?

Pennsylvania is the only state that adopted and kept the Uniform Written Obligations Act: “A written release or promise, hereafter made and signed by the person releasing or promising, shall not be invalid or unenforceable for lack of consideration, if the writing also contains an additional express statement, in any form of language, that the signer intends to be legally bound.”

Appellees (presumably Pittsburgh Steelers fans) were precluded from raising lack of consideration to void a stadium builder license agreement where licensee expressly agreed to be legally bound by the agreement. “[A] written agreement shall not be void for lack of consideration if it contains an express statement "that the signer intends to be legally bound" by it.”

What about promises not to compete? David Sacko, upon request of his employer and without any consideration, signed a “Non-Competition Agreement” that, among other things, prevented him from competing against his current employer for a certain period of time within a certain territory and included the magic language that the parties intended to be legally bound.

The Uniform Written Obligations Act is statutory law and has been enforced by courts since its inception in 1937. The requirement to provide adequate additional consideration to create an enforceable restricted covenant is equally well settled law in Pennsylvania.

The issue of “whether the enforcement of an employment agreement containing a restrictive covenant not to compete, entered into after the commencement of employment, may be challenged by an employee for a lack of consideration, where the agreement, by its express terms, states that the parties ‘intend to be legally bound,’ which language implicates the insulating effect of the Uniform Written Obligations Act (UWOA)” was never considered by Pennsylvania’s court before Sacko.

Socko first challenged the Non-Competition Agreement in 2012. Pennsylvania’s Supreme Court finally resolved the issue in November of 2015.

The court reasoned that the UWOA does preclude a party from requesting relief due to lack of consideration. However, in determining the issue before it, the court looked to the rules of statutory construction; specifically, whether the interpretation of a statute leads to an absurd or unreasonable result. The court concluded that it would be unreasonable to apply the UWOA to employment agreements containing restrictive covenants.

So, the rule is that contracts entered into under seal, or with the intent to be legally bound are enforceable without consideration unless they are governed by the UCC or would produce and absurd result?

Can a Majority Shareholder Unilaterally Control His/Her Company? It Depends…

In general, the Pennsylvania Business Corporation Law (BCL) provides that shareholders of a company have broad rights to make decisions impacting the company. 15 Pa. C.S. §§ 1755 – 1770 provide detailed rules by which shareholders can make decisions impacting nearly all aspects of a corporation. At its most basic, as long as shareholders follow the appropriate rules in providing notice of a meeting, and conducting the meeting appropriately, a majority of the shareholders of a company can largely control the actions of the company.

Pennsylvania law does provide “Dissenter’s rights,” by which a shareholder who is not in the majority on certain, fundamental issues (e.g. merging with another corporation), may vote against that action and then exercise his or her dissenter’s rights. The exercise of dissenter’s rights provides the dissenting shareholder with the right to demand that the corporation redeem his or her shares at “Fair Value.” When invoked, dissenter’s rights provide the dissenting shareholder with a strong argument to obtain a value higher than fair market value for his or her shares. However, standing alone, the exercise of dissenter’s rights will not prevent the majority shareholders from taking the action they desire; it will simply require that they redeem the dissenting minority.

However, beyond dissenter’s rights, case law has developed that restricts a majority shareholder’s ability to act in ways that benefit the majority to the exclusion of the minority.

In Viener v. Jacobs, 834 A.2d 542 (Pa. Super, 2003), the Superior Court addressed a breach of fiduciary duty claim brought by a minority shareholder against the majority owner. In that case, the evidence showed that the majority owner had engaged in a number of cash transactions that harmed the overall businesses in which the minority was an owner, and benefitted the majority owners.

In analyzing this, the Court noted that “It is axiomatic that majority shareholders have a duty not to use their power in such a way to exclude minority shareholders from their proper share of benefits accruing form the enterprise.” This does not mean that majority shareholders cannot act in their own interest, but it means that when they do, it must also be in the best interest of the corporation and all shareholders.

The Court found that diverting money from the corporation to benefit just the majority was a breach of this duty and awarded the plaintiff substantial damages, including an award of punitive damages.

Take-Away in a Hypothetical

It is very common for majority shareholders in closely-held corporation to also be employed by those corporations. A recurring issue in such situations is the compensation paid by a majority shareholder. If that compensation is paid in a manner that could be viewed as exceeding reasonable compensation, it can present an issue of compliance with the majority’s duties to the minority.

The ideal situation is to have a disinterested compensation committee set the majority shareholder’s compensation. However, this often is not acceptable to the owners of small businesses.

An additional option is to engage an outside consultant to review the compensation plan to ensure that the Company has proof that the plan is reasonable.

Finally, and at a minimum, it is best for a majority shareholder to be transparent with regard to his or her compensation. By making all shareholders aware of the compensation, it helps avoid the impression that the majority shareholder is acting in a fraudulent or oppressive manner.

Additionally, if a minority shareholder decides to challenge the compensation, making him or her aware of it early starts that statute of limitations on that claim. Thus, it helps avoid a situation where a minority shareholder takes the benefit of the work of the majority shareholder for years through appreciation in value of his or her shares in the corporation, only to later challenge the compensation the majority paid to itself.

Can I Be Confident That a Choice of Forum Clause in My Agreements Means I Get to Litigate in My Home Forum? It Depends…

It is both common and advisable to include a choice of forum clause in most contracts. These clauses are designed to identify the geographic location of the courts in which a dispute under that contract must be brought.

Courts are generally inclined to enforce these clauses, with two (2) notable exceptions:

• The clause must be written to make it clear that the indentified forum is the exclusive venue. Often these clauses identify a jurisdiction in which parties agree to waive objections to personal jurisdiction, but sometimes do not identify that jurisdiction as exclusive. If the clause is written to identify where a claim may be brought, but does not make it clear that such a jurisdiction is exclusive, then courts will often allow cases to proceed in other otherwise appropriate jurisdictions.
• The identified jurisdiction must comport with constitutional requirements. While parties have broad rights to identify the jurisdiction in which a dispute must be resolved, that jurisdiction must have some connection with the parties or agreement. For instance, a party with significant bargaining power cannot choose a completely unrelated forum (e.g. a New York transaction with New York entities, identifying the Southern District of California as the exclusive form). In such a circumstance, a party may be able to file a case in another jurisdiction if they can show that the indentified forum does not comply with constitutional requirements.

Authors: Jerome C. Wegley and Neal R. Devlin

Originally published in October 2016

Copyright © 2016 Knox McLaughlin Gornall & Sennett, P.C.