Wednesday, March 16, 2022
A family settlement agreement is a way for heirs to agree to a distribution of the decedent’s estate that is different from how the decedent desired. While most estates are handled and the decedent’s property is distributed in the manner the decedent wanted, sometimes there might be a mistake in the will or some other unanticipated result as a consequence of poor drafting of an estate plan. In those instances, a family settlement agreement may be appropriate.
When will a family settlement agreement be effective to resolve a decedent’s estate and distribute estate property – it’s the topic of today’s post.
Contract. A family settlement agreement is a contract. Thus, if it meets the requirements for a valid contract, it is a binding agreement that the probate court must respect. It’s not up to the probate judge to approve or disapprove the document. About the only issue a probate judge would deal with concerning a family settlement agreement is if there are creditors of the decedent’s estate and the funds available to pay estate debts.
As a contract, a family settlement agreement must be agreed to by all of the heirs and beneficiaries, provide that the decedent’s will is not to be probated, and provide a plan for the distribution of the decedent’s assets that replaces the disposition of assets set forth in the decedent’s will. In addition, it is critical that the terms of the agreement be negotiated as part of a transaction entered into at arm’s-length. That means that the terms of the agreement shouldn’t simply be standard “boilerplate” terms that aren’t discussed by the family. Also, it is important that the family members be represented by legal counsel, and it’s helpful that they have some understanding of business matters. Legal representation s particularly important for a family member that is complaining about the disposition of assets under the terms of the decedent’s will. It’s also important that the release language in the agreement be clear, and the agreement must evidence that the parties (heirs) were working to achieve final settlement of all claims. If these factors are satisfied, the agreement is binding on the parties and will provide protection against future liability and claims.
Appropriate use. A family settlement agreement can be appropriate when surviving family members agree as to the disposition of a deceased family member’s estate that is different from how the decedent had specified in a testamentary instrument. Often, they arise when a deceased parent has not devised property equally to all of the decedent’s children, but the children (and, perhaps a surviving spouse) agree that an equal division should be made. In addition, a family settlement agreement might lead to a better tax result for the estate over what would have occurred based on how the decedent’s estate plan was drafted. Or, perhaps the decedent’s will made a simple mistake – such as a specific devise of a tract of farmland to the wrong child as the farming heir. A family settlement agreement can be an efficient way to “clean up” the error.
Another common situation for the use of a family settlement agreement can occur with second (or subsequent) marriages and each spouse has their own child or children. Consider the following example:
Example: Sam and Lisa are married. It is the second marriage for each of them, and they each have adult children from a prior marriage, but none from their marriage. Sam farmed during his life and dies with a will that leaves all of his property to his children. Under state law, Lisa is entitled to a “family allowance” and the use of their home that she can claim as her homestead. But, Lisa would rather live near her children in a different state. The problem is that if she moves from the homestead, she loses it along with her family allowance. Sam’s children would like to have the homestead – 160 acres of irrigated farmland. Via a family settlement agreement, Sam’s children and Lisa might be able to agree that instead of Lisa receiving a family allowance, she could receive annual payments for a number of years with which she could buy a home near her children. Sam’s children could use the rental income from the farmland to fund the payments to Lisa, or sell the home and the farmland and use a part of the sale proceeds to fund the annual payments to Lisa.
A family settlement agreement may also be used to prevent a will challenge by a disaffected heir that might result in a drawn-out probate proceeding, as well as a spendthrift heir likely to squander their inheritance and seek more from the estate.
A recent case from Texas illustrates the use and enforceability of a family settlement agreement. In Austin Trust Co. v. Houren, No. 14-19-00387-CV, 2021 Tex. App. 1955 (Tex. Ct. App. Mar. 16, 2021), the decedent (former Mayor of Houston, Texas, and real estate developer) died in 2014, having outlived his wife by 30 years. The couple had five children. The pre-deceased spouse’s will created a marital trust upon her death for the decedent, naming him the sole trustee and beneficiary for life. The trust was funded with about $54 million, which represented her half of the couple’s community property. Under the trust’s terms, he could also pay himself any amounts he deemed necessary for his “health, support, or maintenance in his accustomed standard of living.” He could also utilize trust principal for this purpose, and he was also given a testamentary power of appointment over the balance of principal in the marital trust in favor of their children, their spouses, or unspecified charities. In his will, he exercised the power and directed that the balance of trust assets passed to a trust for the benefit of the children. The decedent’s other asset passed to his second wife and her two children.
The marital trust terminated upon the decedent’s death and a bank became the trustee for purposes of administration and making final distributions. The decedent’s attorney served as the executor of the estate. Because the marital trust was a qualified terminable interest property (QTIP) trust, the decedent’s estate was entitled to recover from the marital trust and the trust for the children any federal estate tax that the decedent’s estate owed. Thus, the bank (as trustee of the marital trust) would not make distributions until a federal estate tax return was filed and an estate tax closing letter was received from the IRS. Because of this anticipated delay in distributions from the trust, the children expressed their desire for the marital trust to distribute its assets to their trust before the estate tax return was filed and a closing letter received. To accommodate this desire without fear of any future claims, the decedent’s attorney set up a meeting with the couple’s children, bank and the children of the surviving wife. The couple’s children and the bank were represented by their own legal counsel. At the meeting the attorney proposed a family settlement agreement. Various disclosures were made, including one that the plaintiff relied upon to claim that the decedent either owed the marital trust $37 million or breach a fiduciary duty by taking excessive distributions of principal totaling $37 million.
The family settlement agreement released, “any and all liability arising from any and all Claims,” including “claims of any form of sole contributory concurrent, gross, or other negligence, undue influence, duress, breach of fiduciary duty, or other misconduct” and defined “covered activities” to include “(1) the formation, operation, management, or administration of the Estate,…or the Trusts, (2) the distribution of any property or asset of or by…the Estate,…or the Trusts, (3) any actions taken (or not taken) in reliance upon this Agreement or the facts listed in Article I,” (4) “any Claims related to, based upon, or made evident in the Disclosures,” and (5) “any Claims related to, based upon, or made evident in the facts set forth in Article I.”
Ultimately, after review by the attorneys involved and disclosure and review by the parties, all of the parties signed the family settlement agreement agreeing to all of the release and indemnity language that it contained. Funds then began to be distributed in mid-2015 and the federal estate tax return was filed in early 2016. After the IRS closing letter was received in mid-2016, the balance of the estate’s assets were distributed except for a small amount to cover administration costs. The alleged debt was not listed as part of the estate.
The plaintiff sought repayment of the alleged debt that the estate owed. The plaintiff based its claim on accounting entries in the marital trust’s general ledger. The claim was denied on the basis that the entries represented distributions from the trust rather than receivables. The plaintiff then changed amended its claim as one for breach of fiduciary duty against the estate on the basis of excessive distributions by the decedent from the marital trust. The trial court disagreed.
On appeal, the plaintiff claimed that the trial court incorrectly determined that the heir’s had “released their right to collect any debt from the Executor or the Estate…by executing the … Family Settlement Agreement” and that the breach of fiduciary duty claim had also been released. The attorney for the estate replied that the trial court had correctly determined that the family settlement agreement had “unambiguously and specifically released all clams” the plaintiff may have had against the parties to the family settlement agreement, including a breach of fiduciary claim. The appellate court affirmed the trial court, upholding the family settlement agreement.
The appellate court noted that public policy in Texas favored freedom to contract, and that the parties freely entered into the agreement with the full opportunity to be represented by legal counsel in furtherance of their own respective interests. The court noted six factors used by Texas court to consider when determining the validity of a family settlement agreement:
- Whether the terms of the agreement were negotiated rather than being boilerplate terms that were not specifically discussed by the parties;
- Whether the complaining party was represented by counsel;
- Whether negotiations occurred as part of an arms-length transaction;
- Whether the parties were knowledgeable in business matters;
- Whether the release language was clear; and
- Whether the parties were working to achieve a final settlement of all claims to enable them to part ways.
The appellate court determined that all six factors were satisfied. Accordingly, the appellate court did not have the determine whether a fiduciary duty had been breached because the parties had waived the claim.
While a family settlement agreement can be an efficient way to resolve family disputes, it must be carefully entered into and drafted properly. The agreement in the Texas case was done properly.