Draper v. Colvin: Recent Eighth Circuit Court Decision Affects Special Needs Planning

Published in the Oregon State Bar Elder Law Section Newsletter, April 2015.

By Geoff Bernhardt, Attorney at Law
Portland, Oregon

The Eighth Circuit Court of Appeals recently issued a decision that will require attorneys who prepare a certain type of special needs trust authorized by 42 USC 1396p(d)(4)(A) ("first-party" or "payback" special needs trusts) to reassess how they create and fund such trusts. The case is Draper v. Colvin, No. 12-2757 (March 3, 2015).

Stephany Draper was 18 years old when she suffered a traumatic brain injury in a car accident in June 2006. After the accident, she signed a power of attorney for financial decisions authorizing her parents to "fund, transfer assets to, and to instruct and advise the trustee of any trust wherein Draper is or may be the trustor or the beneficiary." Draper began to receive Supplemental Security Income (SSI) payments in July 2007. In February 2008, her father entered into a settlement of Draper's claims for personal injuries in exchange for payment of $429,259.41.

Since the SSI resource limit is $2,000, receipt of this settlement would ordinarily have made Draper ineligible for continuing SSI benefits. To avoid this result, on the same day they settled her personal injury claim, Draper's parents created the Stephany Ann Draper Special Needs Trust. This trust was intended to qualify as an exempt special needs trust pursuant to the terms of 42 USC 1396p(d)(4)(A). That federal statute authorizes the creation of an exempt special needs trust, defined as:

  • A trust containing the assets of an individual under age 65 who is disabled (as defined in section 1382c(A)(3) of this title) and which is established for the benefit of such individual by a parent, grandparent, legal guardian, or court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a state plan under this subchapter.

Note that a disabled person cannot establish a trust for him/herself under d(4)(A). The trust must be established by a parent, grandparent, legal guardian, or court.

In September 2008, Draper received a notice from the Social Security Administration, indicating that her trust was not exempt from being counted as a resource, and that she was no longer eligible for SSI benefits. SSA took the position that the trust was not exempt because it had been created by her parents acting in their capacity as agents under her power of attorney ("agents"), rather than in their capacity as her parents. This was so even though the parents had signed the trust as individuals and had not made any reference to the power of attorney within the trust document.

Draper appealed to an administrative law judge. The judge upheld the agency's decision, finding that Draper's parents had acted as Draper's agent when they established her trust. Draper appealed to the Social Security Appeals Council, and simultaneously applied for and received a state court order, retroactively modifying the trust to list the court, rather than Draper's parents, as settlor. The Appeals Council denied this request. Draper appealed to the federal district court, which affirmed the judgment of the SSA. Draper appealed that decision to the Eighth Circuit Court of Appeals.

The court began its review by noting that it would only reverse the SSA's decision if it was not supported by substantial evidence, defined as "less than a preponderance, but enough that a reasonable mind would find it adequate to support the SSA's conclusions." The court recited that "if substantial evidence supports the SSA's decision, the court does not reverse even if it would reach a different conclusion."

Draper advanced two primary arguments on appeal. First, she argued that her parents had acted "as parents" when they established her trust, and not as agents under her power of attorney. Second, she argued that the subsequent retroactive state court order remedied any initial non-compliance with 42 USC 1396p(d)(4)(A).

The court began its analysis by examining the text of (d)(4)(A). The court focused on the requirement that the trust be established by a "parent, grandparent, legal guardian, or court," and found the terms "parent" and "establish" to be ambiguous. The court concluded that the SSA had authority to interpret the statute, and had done so in POMS SI 01120.203B(1)(f) and (g). It further concluded the SSA's interpretation of the federal statute as set forth in the POMS was entitled to Skidmore level deference, and that Draper was required to comply with the POMS provisions cited above. Since the federal statute does not permit the disabled individual to create his or her own special needs trust, the POMS cautions that "a trust established under a power of attorney will result in a trust we consider to be established through the actions of the disabled individual him/herself." The parent must act as a parent, and not as agent for the disabled child.

The court interpreted the POMS section as requiring a two-part process. First, a parent, grandparent, guardian, or court must establish the trust. The POMS states that the parent can "seed" the trust with a nominal amount of the parent's own money, or the parent can create an unfunded or "dry" trust, if allowed by State law. Second, after the "seed" trust or "dry" trust has been established, assets of the disabled person may be transferred to the trust, either by a legally competent disabled person, or by another person with legal authority to transfer the disabled person's assets, such as an agent under a power of attorney.

Draper argued that her trust, at inception, satisfied the POMS criteria. Her parents, acting as parents, established a valid unfunded or "dry" trust. Draper emphasized that her parents had not referenced her power of attorney when they created the trust. They later acted in their capacity as Draper's agent to transfer her personal injury settlement proceeds to the trust.

The court rejected Draper's contention that her parents had established a "dry" trust. The court noted that, on the same day the trust was signed, it was funded with $429,259.41 in personal injury proceeds. The trust itself made this explicit, stating that "this trust is funded with the proceeds of the settlement of a liability claim."

Draper next argued that even if her parents had not created a dry trust, it was still valid because they acted in their individual capacity as parents when creating the trust—and not as her agents under the power of attorney.

Even though Draper's parents had signed only as individuals—they did not sign "John and Krystal Draper, POA for Stephany Draper"—the court concluded that they had acted as agents for Draper when they established the trust. The court first cited "traditional trust-law principles." The court stated that creation of a funded or "non-empty" trust requires more than just execution of trust documents, and that funding plays "a key role," citing the Restatement (Third) of Trusts for this proposition. In the case of a "funded" trust, the court also interpreted POMS SI 01120.203B(1)(g) and "traditional trust law" to require that someone with a legal interest in the trust assets be involved in the trust's creation. In other words, the court considered the funding of a "funded" trust to be inextricably linked with its creation.

The court went on to find that Draper's parents had no interest in the personal injury settlement proceeds, except as Draper's agent under the power of attorney. Under the court's logic, since the settlement proceeds were the source of the initial funding, the parents could only have created the trust in their capacity as Draper's agent. The court concluded that "substantial evidence" supported the SSA's contention that Draper's parents acted as agents for Draper when they established the trust. The court affirmed the district court's holding that the trust was established by the parents as agents for their daughter; that the trust was a countable resource for SSI purposes; and that Draper was not entitled to SSI benefits.

This case is troubling for special needs planners because Draper's attorneys followed accepted practice in establishing Draper's trust. Experienced special needs planners know that 42 USC 1396p(d)(4)A) requires that an exempt trust be established by a parent, grandparent, guardian, or court, and that the disabled person may not establish his or her own special needs trust. Special needs planners are also aware that there has to be some mechanism available to fund the trust, such as a competent disabled individual, an existing power of attorney, or a legal conservator. Special needs planning attorneys did not consider that the SSA would effectively merge the establishment and initial funding of the trust into one action, but that is what the Eighth Circuit has done in Draper. As of April 14, 2015, Draper had not sought rehearing en banc by the Eighth Circuit, nor had she filed a petition for certiorari to the US Supreme Court.

While an Eighth Circuit court case is not binding precedent in Oregon, it is still the opinion of a federal circuit court of appeals, upholding a position taken by the Social Security Administration. Meanwhile, Oregon special needs planning attorneys should consider taking the following protective measures:

  1. In order to avoid having the SSA argue that the establishment of the trust is linked to the ultimate funding source (usually a personal injury settlement or an unplanned inheritance), the attorney should consider having the parent, grandparent, or legal guardian who establishes the trust "seed" the trust by putting a nominal amount (for example, $10) of the settlor's own money into the trust, as the initial trust funding.
  2. The special needs planning attorney should consider omitting reference to the ultimate source of funding of the trust. Right now, it is common for attorneys to include a provision in the trust stating that "this trust shall be funded with proceeds of a personal injury settlement." This language caused problems for Draper, and supported the court's holding that the parents acted as agents when creating the trust. Better to reference "seed" funds of $10 as the initial trust asset.
  3. Consider adding explicit language to the special needs trust, stating that the settlor is acting in settlor's capacity as an individual parent of the beneficiary, and in no other capacity.
  4. It is common to see powers of attorney prepared by experienced lawyers that give the agent authority to "establish and fund a trust with my assets pursuant to 42 USC 1396p(d)(4)(A)." Consider updating this language to eliminate the agent's authority to "establish" a (d)(4)(A) trust, while retaining authority to fund a special needs trust.
  5. Court-created trusts now appear to be a safer option than parent-created trusts.

Attorneys working in the area of special needs trusts should review the Draper case, and adjust their forms and procedures accordingly, to avoid costly and protracted litigation with the SSA.

Original article appeared in the Oregon State Bar Elder Law Section Newsletter, page 10.

DISCLAIMER – The information contained in this article should be used for general purposes and should not be construed as legal advice. Consult with your own attorney if you have specific legal questions.

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