What To Do When the Will is Ignored and the Estate Given to the Surviving Spouse, etc.

 In Probate, Tax

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Many, if not most, of us will have been involved in the estate of the survivor of a couple (the Survivor), where the assets of the first to die (the Deceased) have been absorbed into the estate of “our” deceased (i.e. the Survivor) even though on the face of the Will they were not necessarily entitled to them. The couple could have been married, in civil partnership, or merely partners in life.

In some cases, probate will have been obtained by the Survivor or a third party whereas in others no grant will have been obtained.

(N.B. This article considers where estate assets appear to have been wrongly administered and not where an estate is unadministered. For a discussion on unadministered estates see: Unadministered Estates – Trusts and Wills Article on LawSkills)

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There are various forms that the Will of the Deceased may take, although often the Will includes a nil rate band discretionary trust (NRBDT). Where there is an NRBDT the issues may have existed for some time, and have been exacerbated since the introduction of the transferable nil rate band (TNRB) in 2007. At that time, headlines about the TNRB suggested one could just ignore an NRBDT when administering an estate. Unfortunately, this encouraged some families and their lawyers to simply ignore an NRBDT when administering an estate and rely upon the TNRB on the death of the survivor.

So, where does this take us?

The first question is: how did the Survivor end up with the first estate if the Will did not give it to them? Maybe there was a variation (under s.142 Inheritance Tax Act 1984 – IHTA 1984) or, if there was an NRBDT, was it validly appointed to them?

Where a variation is alleged, the original beneficiaries entitled would have needed to be party to it and so should be able to verify the position (and provide a copy of the variation?). Alternatively, if the variation altered the inheritance tax (IHT) position, a copy should have been submitted to HM Revenue and Customs (HMRC), who might be able to confirm the position and, perhaps, even provide a copy. If the variation did not give rise to any additional IHT, or a repayment of IHT, since August 2002 HMRC would not have needed to see it.

If there was an NRBDT, the executors or trustees would normally need to exercise their power of appointment to release assets from the trust. The Will might provide a specific mechanism for the valid exercise of the power of appointment. Such an appointment may need to be made by deed, or must be made by at least 2 executors/trustees or a trust corporation. If any such requirement is not complied with, the appointment is void and the assets still belong to the estate or trust.

If there is no requirement for an appointment to be made by deed, a simple resolution signed by the executor(s)/trustee(s) may be a valid appointment. There is no specific format to evidence an appointment – a letter to the intended beneficiary signed by the executor(s)/trustee(s) may suffice.

Where the Will requires no particular form of appointment, a verbal appointment may be valid, although this raises the question of how such an appointment might be evidenced. However, if land is involved, it is understood that s.53(1)(c) Law of Property Act 1925 applies to the effect that for the valid appointment of an interest in land writing is required.

As mentioned above, the executors or trustees would normally need to exercise their power of appointment to release assets from an NRBDT. However, where the trust period is limited to, say, 2 years less a day from the date of death (so that s.144 IHTA 1984 might apply to avoid any IHT charge), at the end of that period, and to the extent that no valid appointment has been made, the trust fund passes under the default provisions – generally to the survivor of the couple. In such cases, it would be unlikely for the executor(s)/trustee(s) to have made an appointment to another beneficiary without giving effect to such appointment.

Does it matter whether or not Probate has been obtained?

On the basis that an executor/trustee derives their authority from the Will, and that such authority arises immediately upon the testator’s death, the power of appointment may be validly exercised independently of whether probate has been obtained. The lack of probate may impact the ability to vest legal title following the exercise of the power of appointment, but that should not undermine the situation where the power of appointment has been validly exercised.

However, if the Survivor has acquired the assets when they have no entitlement to them, the position may differ depending upon whether Probate was obtained and, if it was, to whom it was issued. Some of the implications are discussed below.

So, where does that leave us?

If the investigations reveal that the survivor of the couple had no entitlement to some or all of the assets they received from the estate of the deceased, the next question is: who was entitled to them?
In some instances, the rightful beneficiaries happen to be the same persons now entitled to the estate of the Survivor.

Whilst that is undoubtedly a relief, as it may not be necessary to unscramble all that has happened to the assets of the first estate that have been absorbed into the Survivor’s estate, are there still aspects that need to be reported to HMRC – the tax consequences may be more complicated and, therefore difficult to resolve.

If, say, the Will of the first to die included a nil rate band discretionary trust the objects of which include, amongst their number, those now entitled to the estate of the Survivor, it cannot be “assumed” that the same people are entitled to both estates. It would be open to the disappointed beneficiaries of the NRBDT to challenge ay such decision.

Survivor has no identifiable entitlement

If it transpires that the Survivor has no identifiable entitlement to the assets absorbed into their estate or, whilst they could have become entitled to them, the correct actions were not taken to validly entitle them to such assets, the estate of the Deceased will need to be restored (applying the principle from Target Holdings Limited v. Redferns [1996] 4 All E R 705 CA). This will require the various transactions benefitting the Survivor to be identified and unravelled. This may be relatively straightforward if the assets have remained in their original form. However, if they have changed in substance or form – e.g. sold or substantially altered (if a house, it could have been extended or other significant work undertaken) – careful consideration will need to be given as to how to identify what should now be in the estate of the Deceased. The normal tracing rules will apply.

Where the Survivor has taken over assets to which they have no identifiable right, it will be clear that they should be handed over to the rightful beneficiary(s). If the assets have changed in substance, it may be necessary to negotiate with the rightful beneficiary(s) as to what they are entitled to, especially if, say, the assets have been sold and the proceeds applied in the purchase of something else (to what extent are they entitled to share in any gain in value of that replacement asset, or suffer a share of any loss in value?).

Survivor has only a partial entitlement

In some cases, though, the Survivor will have an interest in the assets, albeit not an absolute (e.g. an interest in possession only) or full interest. It does not seem that such a situation has yet been addressed by the courts. Until that happens, it may well be a case of negotiation between the parties. Mediation might well be advised or, perhaps even, early neutral evaluation (ENE). Whilst ENE is usually non-binding, there is no reason why the parties cannot agree to accept the evaluator’s recommendation.

One example of this situation would be where there is an NRBDT and the Survivor is entitled to the remainder of the estate. If the estate was more than sufficient to fund the NRBDT in full, the NRBDT might reasonably be considered to be an unpaid legacy and the Survivor’s estate liable to the trustees for the amount of the legacy plus interest. However, if the estate was insufficient as at the date of death to satisfy the NRBDT in full, to what extent should the Survivor’s estate be liable to the trustees if the asset value has increased significantly? The answer may depend upon whether the Survivor was complicit in the arrangements by which assets were absorbed into their estate.

If they were complicit, then should they have been entitled to anything, or should all of the estate been applied in (partial) satisfaction of the NRB gift into trust? This would be the most straightforward solution, although may well be challenged. Mindful of the likely value involved, would it be cost-effective to litigate or would a negotiated settlement be preferable (mediation or ENE?).

In some instances, the gift to the NRBDT is a cash sum and by their will, or the letter of wishes, the testator directs that the Survivor is to be the Principal Beneficiary and/or that their interests are to be paramount.  In such cases, even where the Survivor has been complicit in the transfer of the assets into their name, it may be argued that the testator’s intentions have been satisfied.  The action may also have effectively been endorsed by HMRC confirming that s.144 IHTA 1984 applied to the transfer.  Whilst it may still be open to a disappointed member of the discretionary class to challenge the position, the personal representative(s) of the Survivor’s estate may not unreasonably decide to accept matters have been correctly dealt with notwithstanding a lack of documentary evidence.

If the Survivor was not complicit and probate was obtained shortly after the death, it may be argued that the executor(s) should have appropriated all of the estate assets to the trust in partial satisfaction of the NRB trust. However, those dealing with the Survivor’s estate may well take a different view, alleging that the trustees should only receive the value of the legacy plus interest for late payment. Alternatively, those dealing with the Survivor’s estate might assert that the Survivor was an innocent party to the arrangement and it is for the executor(s) to compensate the trust for the loss arising by the incorrect distribution of the estate.

If no probate was obtained and the above circumstances apply (i.e. that the Survivor was an innocent party to the arrangement), the probability is that the NRB trust should be treated as “unpaid” and for the Survivor to be liable only for the value of the legacy plus interest.

Costs

Arguably, the costs of identifying and unravelling the position should fall on whoever was responsible for incorrectly diverting the Deceased’s assets to the Survivor. This may be the named executor(s)/trustee(s) of the Deceased and/or the Survivor. If the person(s) believed to be responsible is a professional, consideration should be given to notifying them of the situation as soon as possible as the costs of resolving the issues might be recoverable from their professional indemnity insurers if they can be shown to have been negligent, or that they acted in breach of trust.

Tax

This article does not address any of the issues that may arise in respect of UK taxes. Tax will follow the event, so that until what has happened, and what should have happened, have been identified an attempt at analysing the tax issues would be premature. Clearly, though, if a negotiated settlement is to be achieved between the Survivor and those rightfully entitled to the assets wrongly absorbed into the Survivor’s estate, the parties should try and obtain an idea of the tax issues and potential liabilities that might arise.

As identified above, resolution of the tax consequences of the original mis-direction of the estate assets and the actions needed to correct the situation may represent a whole new ball-game.

Summary

As will be seen from the above, the steps needed to remedy the situation are likely to be fact specific and unlikely to result in a clear-cut resolution. Much will depend upon the personalities involved and what has happened to the assets that have incorrectly been passed to the Survivor. Where the parties are not likely to be able to agree how the position can be rectified, consideration should be given to the use of mediation or, perhaps, binding early neutral evaluation rather than litigation.

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