Probate Court Properly Changed Trust To Direct That Proceeds Go To Estate

In this dispute over trust proceeds, the probate court correctly altered the decedent’s “special needs trust” to direct that the proceeds go to the decedent’s estate rather than to the trust’s residuary beneficiary, the Michigan Court of Appeals has ruled.

In In re Hernandez Supplemental Needs Trust (Docket No. 366172), Hector Hernandez left about $2 million in settlement funds from a medical-malpractice lawsuit in a special needs trust. The trust was designed to supplement Hector’s governmental assistance benefits. The parties in the case disputed who was entitled to the trust proceeds after Hector’s death. Luisa Martinez, Hector’s sister and guardian, claimed she was entitled to the funds under the trust’s residuary clause, while Hector’s adult children (the decedent’s estate) asserted they were entitled to the proceeds. The Wayne County Probate Court granted summary disposition to the decedent’s estate and altered the trust to direct that the proceeds go to the estate.

The Court of Appeals affirmed in a published opinion.

“This case requires us to interpret the relationship between the notice provisions of the Estates and Protected Individuals Code (EPIC), MCL 700.1101 et seq., and the Michigan Court Rules governing settlement, probate, and trust proceedings,” Judge Kristina Robinson Garrett wrote for the court. In particular, she pointed out the issue was whether EPIC or the court rules required notice to Hector’s adult children when the trustee petitioned to fund the trust, before the probate court’s authorization.

“We agree that the probate court’s authorization of the trust was a protective order under EPIC,” Judge Garrett wrote. “It is undisputed that [the trustee] did not provide notice to Hector’s adult children. Therefore, the probate court did not err by concluding that the proceeding to authorize the trust was improper.”

Further, when Hector died, the trust’s purpose “became impossible to achieve,” the Court of Appeals said. As a result, the probate court properly changed “the void residuary clause” to reflect that Hector died without a will.

Judge Anica Letica and Judge Kathleen A. Feeney joined the decision.

Background

Hector and Lilia Hernandez had three children together: appellees Hector Hernandez, Jr., Bryan Hernandez and Brandon Hernandez. Hector and Lilia divorced in 2012.

Hector suffered a major stroke in 2014 and became quadriplegic. A medical-malpractice suit was filed and Hector received a settlement of about $2 million. The circuit court ordered the settlement funds be placed in a “special needs trust” for Hector’s benefit. Under 42 USC 1396p(d)(4)(A), a special needs trust benefits a disabled individual and requires the state to receive benefits upon the beneficiary’s death up to the amount paid by the state for the individual’s medical care. The trust is “established solely for the benefit of an individual under 65 years of age” and allows the individual to continue to qualify for medical assistance.

Afterward, Hector’s sister and guardian, Luisa, hired attorney Darren Findling to assist with the trust formation and to become the eventual trustee. The trust documents drafted by Findling’s law firm included a residuary clause that said:

“In the event that any Trust assets remain after payment for reimbursement to any state for medical assistance provided on the beneficiary’s behalf as set forth above, the remainder, after reasonable expenses and costs for maintaining the Trust, shall be distributed to Luisa Martinez, unless Hector M. Hernandez leaves a valid Last Will and Testament or other estate plan which recites the power granted herein, directing the funds be distributed otherwise. [Emphasis added.]”

Findling filed a petition for funding and supervision of the trust in September 2020. The probate court authorized the trust. Luisa, as grantor, and Findling, as trustee, signed the trust document. The probate court approved distribution of the trust funds in December 2020. Hector’s children were not notified of these proceedings.

Hector died in June 2021. Findling then petitioned for a final account of the trust funds. In December 2021, the probate court approved the petition and ordered distribution of the trust’s remaining balance to Luisa. The following parties subsequently filed motions in the probate court: 1) Hector’s sibling, Yolanda Lopez, petitioned the court to reform the trust; 2) Findling filed a motion for rehearing on the final account; and 3) Luisa challenged Findling’s failure to distribute the trust proceeds to her as required by the court’s final account order.

Throughout these various filings, Hector’s adult children received notice of the court proceedings for the first time. As a result, they petitioned to vacate the probate’s court order allowing the final account that distributed the trust’s remainder to Luisa. The children ultimately filed a motion for summary disposition, claiming there was no question of material fact that Luisa and the probate court unlawfully created the residuary clause. The children argued the trust was not properly formed because, as Hector’s presumptive heirs, they were entitled to notice of the proceedings. The children also argued the trust could not constitute Hector’s will.

The probate court granted the children’s motion and held that the court improperly authorized the trust because neither Findling nor Luisa notified Hector’s adult children of the proceedings. According to the probate court, the residuary clause could not be deemed as Hector’s will because 1) the trust did not include his signature and 2) Luisa did not produce clear and convincing evidence of Hector’s intent to leave her the remaining balance and, therefore, failed to create a material question of fact. 

Thereafter, the probate court altered the trust’s residuary clause and replaced Luisa with Hector’s estate as the remainder beneficiary. The probate court also modified its order allowing a final account and directed all remaining assets to “the personal representative of the estate of Hector M. Hernandez.”

Luisa appealed.

Necessary Notice

On appeal, Luisa contended the probate court wrongly held that Hector’s children were entitled to notice of the petition for funding the special needs trust. She argued that only “the presumptive heirs of the protected individual” are entitled to notice and, because Hector was not a “protected individual” at the time of the proceedings, notice was not required in this case.

In its analysis, the Court of Appeals first noted it was “undisputed” that Hector was legally incapacitated before his death. “Claims settled on behalf of persons who are legally incapacitated are governed by EPIC and the applicable court rules,” the appeals court said, citing MCR 2.420(A). “After the circuit court approved Hector’s settlement and ordered the creation of the special needs trust, Findling petitioned for funding under MCR 2.420(B)(5): If a settlement or judgment provides for the creation of a trust for the minor or legally incapacitated individual, the circuit court shall determine the amount to be paid to the trust, but the trust shall not be funded without prior approval of the trust by the probate court pursuant to notice to all interested persons and a hearing. [Emphasis added.]”

The primary issue was whether EPIC or the court rules required notice to Hector’s children when Findling petitioned to fund the special needs trust, the Court of Appeals explained. “In arguing that the adult children were not entitled to notice, Luisa focuses her analysis entirely on MCR 2.420, MCR 5.125(C)(29)(b), and the definition of a protected individual in EPIC. According to Luisa, because the court had not yet entered a protective order or appointed a conservator for Hector when Findling first petitioned for funding, the children were not the presumptive heirs of a ‘protected individual’ entitled to notice of the proceedings.”

However, Luisa’s argument “fails to address the probate court’s ruling that Hector’s adult children were entitled to notice not because he was a protected individual, but because Findling’s petition for funding and approval of the trust was a ‘protective proceeding’ under MCL 700.5401 and MCL 700.5408,” the Court of Appeals said. “This is significant because EPIC mandates further notice requirements for petitions for ‘protective proceeding[s],’ or those proceedings requesting a protective order to protect the property of disabled persons. … EPIC defines a proceeding as ‘an application and a petition, and may be an action at law or a suit in equity.’ … These notice provisions apply before a probate court enters a protective order. … MCL 700.5405(1)- (2). MCL 700.5311(1)(a) … requires that notice of a hearing be provided to ‘[t]he ward or the individual alleged to be incapacitated and that individual’s spouse, parents, and adult children.’ (Emphasis added).”

Moreover, neither party in this case “contest[ed] the probate court’s conclusion that Findling’s petition for authorization and approval of the trust was a protected proceeding or that the probate court’s authorization of the trust was a protective order under EPIC,” the Court of Appeals observed. “When MCL 700.5405 and MCL 700.5311(1)(a) are read together, it is plain that notice of a proceeding for a protective order must be given to the incapacitated individual’s ‘spouse, parents, and adult children.’”

The Court of Appeals concluded the probate court’s authorization of the trust was a protective order under EPIC and that Findling did not provide notice to Hector’s children. As a result, the probate court properly held that “the proceeding to authorize the trust was improper.”

Error Not ‘Harmless’

Luisa further argued that: 1) any deficient notice to Hector’s children was “harmless error” because the trust’s residuary clause was “plainly valid and enforceable,” and 2) the probate court improperly held that she failed to raise a genuine issue of material fact that Hector intended the trust to distribute the remaining balance to her upon his death.

“On its face, the trust’s residuary clause unambiguously requires that, upon Hector’s death, any remaining trust assets must be distributed to Luisa after reimbursement to the state for medical assistance,” the Court of Appeals wrote. “While this would typically end our analysis, … interpretation of the trust in this manner directly contradicts the circuit court’s order directing creation of the trust. When the circuit court approved Hector’s medical malpractice settlement, it ordered Luisa to create a special needs trust for Hector’s benefit.”

According to the circuit court’s order, Luisa, “’the person serving as the fiduciary (guardian or conservator) is receiving no funds, individually, from the settlement/judgment,’” the Court of Appeals noted. “In other words, the circuit court granted Luisa, as Hector’s guardian, the authority to create the special needs trust, but explicitly barred Luisa from receiving any funds from the settlement or judgment. Beyond this authority to create the trust, Luisa, as guardian, had no power to decide where Hector’s property went upon his death.”

When Findling drafted the trust, “the stated purpose was ‘to supplement any benefits received (or for which Hector [Sr.] … may be eligible) from various governmental assistance programs and not to supplant any such benefits,’” the Court of Appeals explained. “Because the effect of the residuary clause goes beyond the circuit court’s direction, Luisa’s authority as guardian, and the limited intent of the trust, the trust provision naming Luisa as residuary beneficiary is void and unenforceable as written.”

However, the residuary clause may have been enforceable “if Luisa could show that Hector intended for her to receive his property upon his death,” the Court of Appeals noted. “Hector had no other estate plan, so if Luisa proved this intent, the probate court could have relied on the residuary clause as Hector’s will.” Moreover, under MCL 700.2503, “any document or writing that does not comply with the requirements of MCL 700.2502 ‘can constitute a valid will provided that the proponent of the document or writing establishes by clear and convincing evidence that the decedent intended the document or writing to constitute the decedent’s will.’”

The Court of Appeals said it agreed with the probate court that Luisa did not show, by clear and convincing evidence, that Hector intended the residuary clause to allocate his property upon his death. “First, the trust was not executed as a valid will,” the appeals court said. “It is undisputed that Hector did not sign the trust, and the trust only contained the signatures of Luisa, as grantor, and Findling, as trustee. Therefore, the trust itself supports the conclusion that Hector did not review or approve of the residuary clause. And, when viewed in the light most favorable to Luisa, the extrinsic evidence does not clearly and convincingly show that Hector intended for the clause to allocate his property upon his death.”

As a result, “the fact that Findling failed to notify the children of the proceedings was not harmless error,” the Court of Appeals held. “The trust contained a large remainder balance, money that Hector’s adult children validly had an interest in under the principles of intestate succession. … Without notice of the proceedings, the children could not contest the residuary clause and its allocation of the remainder to Luisa. Therefore, the probate court did not err when it granted summary disposition in the children’s favor and vacated its order allowing a final account.”

Clause Correctly Changed

Lastly, Luisa claimed the probate court erred by directing the trust’s remainder to Hector’s estate because it “improperly held that the existence of Hector’s children was a ‘circumstance not anticipated by the settlor.’”

The Court of Appeals agreed the probate court erroneously ruled that the trust was created and authorized under the premise that Hector did not have children, mainly because Luisa knew that Hector had children. “Regardless, … the probate court properly changed the residuary clause to allocate Hector’s remaining assets to his estate, which is the correct outcome because the residuary clause was void and the trust terminated upon Hector’s death.”

The trust’s stated intent was “’to supplement any benefits received (or for which Hector M. Hernandez may be eligible) from various governmental assistance programs and not to supplant any such benefits,’” the Court of Appeals pointed out. “’All actions of the Trustee shall be directed toward carrying out this intent.’ When Hector died, the trust’s purpose became impossible to achieve. Therefore, the trial court did not err by changing the void residuary clause to reflect the fact that Hector died without a will. … We affirm.”