Purchase v Gift: Inter-generational Wealth Transfer Is Cautionary Tale For Lawyers
A recent Ontario Court of Appeal decision provides a cautionary tale for lawyers who provide estate planning and tax restructuring advice to both parties involved in inter-generational wealth transfers.
The story itself is fairly simple. Mr. and Mrs. Roth purchased a grocery store together with their daughter and son-in-law back in the mid-1980s. After a brief period of running the business as a partnership, they incorporated the business along the same ownership split with the parents receiving 51% of the profits, while the children received 49% of the profits. The relationship worked until the father developed health issues and realized that he would not be able to work in the store much longer. A deal was negotiated between parents and children whereby the parents would give ownership of their share to the children in return for 51% of the profits while one or both of them was alive. After death, all profits as well as the store itself would belong to the children.
To ensure enforcement of this arrangement, the parties agreed that a demand promissory note, in the amount of $408,000.00 would be executed. If any income payments were missed, the note would be called. The note could also be called if the store was sold to a third party or if the daughter became less than a 50% owner in the business. The parents stated that if the promissory note was used, it would be forgiven in their wills. That condition, however, was not documented as part of the deal.
As is often the case, both the parents and the children used the same lawyer. He or she did not insist that either party receive independent legal advice. Rather, s/he documented the transaction as the parties had agreed.
For approximately ten years, the children dutifully paid the parents 51% of the profits. Then, however, the situation changed. The store had expanded with the expansion being funded by the franchisor's head office. The children were not meeting their obligations and under pressure from head office, considered their options of declaring bankruptcy or giving the store back to the franchisor. In exchange for the latter option, both the daughter and her husband would become employees. Importantly, the parents would no longer receive their 51% share of the income.
This news did not go over well and the promissory note was called by the father. Since payment was not forthcoming, he sued. Before the matter could get to trial, however, he died, leaving the action to be continued by his wife and his estate. The children, in turn sued the lawyer for not having provided adequate advice and for breaching the fiduciary duty owed to them. The action against the lawyer failed at trial but was overturned upon appeal.
The heart of the issue against the lawyer was whether there was a conflict of interest in acting for both the parents and the children. Specifically, had the lawyer breached the duty he owed to the children by not insisting that they receiving independent legal advice about the transaction. Underlying this issue was the issue of whether the agreement between the parents and the children was a gift of a significant asset or a significant liability. The trial judge had, accepted the lawyer's premise that the children were receiving a "huge benefit." In other words, the deal was a gift from the parents.
The Court of Appeal disagreed and ruled that this finding was a palpable and overriding error. Rather, the children were committing to a significant obligation in promising to pay 51% of the store's income for the lifespan of the longest surviving parent. Failure to pay would trigger the demand of the full amount of the promissory note. There was no documented agreement that income payments would be subtracted from the amount of the promissory note. Nor was their any documentation that the promissory note would be forgiven at death. The failure to document these two conditions or to explain them to the children constituted a breach of fiduciary duty.
The lawyer's characterization of the agreement; being that the deal was a "huge benefit" to the children suggests that she or he did not fully look at the potential consequences of the transfer. The Court of Appeal stated as much in its finding that the lawyer did not understand the implications for the children.
The Lesson: When acting on both sides of the transaction it is prudent to think about the consequences of the worst situation happening. Had this lawyer considered the obligations owed by the children, s/he likely would have documented provisions to deal with the potential vulnerability. Alternatively, s/he could have insisted that independent legal advice be obtained. Either way, the likelihood of liability would have been reduced.
Roth Estate v. Juschka, 2016 ONCA 92 https://www.canlii.org/en/on/onca/doc/2016/2016onca92/2016onca92.html?resultIndex=1
The content and the opinions expressed here is informational purposes only and does not constitute legal or professional advice. Nor does reading or commenting on it create a lawyer/client relationship with the author. I encourage you to contact me directly at adrianlawoffice@gmail.com if you have specific legal questions or concerns.
The author encourages you to share this article on social media.
Follow me on Twitter @gwendolynadrian