Feature

posted 14 Jun 2004 in Volume 9 Issue 4

The wisdom test

‘Knowledge dwells in heads replete with thoughts of other men; wisdom in minds attentive to their own’ (William Cowper 1731-1800). Caroline Bielanska addresses the relationship between mental capacity and wisdom. Does the client really know their own mind? Professional awareness and applied professional ethics loom large in her advice to practitioners.

An instruction from the client?

Mrs King’s husband died a year ago. She was heavily reliant on him to manage the finances and since his death has lent on her son Thomas to assist with all her paperwork. Mrs King has booked an appointment to see you as her solicitor about transferring her home to Thomas. She is concerned about care fees. She asks that Thomas sit in on the meeting as she finds it useful to have him there. You have ascertained that she has capacity, have gone through all the pros and cons and asked her to think about what she would like to do next. Two days later you receive a phone call from Mrs King to say she did not really understand everything you said, but her son (who understands these things better than she) has told her to get the ball rolling for the house to be transferred.

The purpose of this article is to consider whether you should draft the paperwork and your duty towards clients like Mrs King and whether you need to be satisfied that they have passed the ‘wisdom test’, that is, they fully understand and have they balanced the implications to arrive at a considered conclusion? The wisdom test is different to the test of capacity and needs to be clearly distinguished.

The capacity test

The requisite capacity to make a gift was set out in Re Beaney [1978] 2 All ER 595, where the judge said: “The degree or extent of understanding required in respect of any instrument is relative to the transaction which it is to effect… Thus, at one extreme, if the subject matter and value of the gift are trivial in relation to the donor’s other assets, a low degree of understanding will suffice. But, at the other (extreme), if its effect is to dispose of the donor’s only asset of value and thus, for practical purposes, to pre-empt the devolution of his estate under (the donor’s) will or… Intestacy, then the degree of understanding required is as high as that required for (making) a will, and the donor must understand the claims of all potential donees and the extent of the property disposed of.”

The capacity test does not require that the donor understands the effect on his future financial position. The Beaney test depends on understanding the act itself rather than the possible long-term implications of the decision.

Undue influence and the wisdom test

Although satisfied that the client has capacity to make the gift, the wisdom test applies to ensure the gift is safe from claims of undue influence.

In the Court of Appeal case of Hammond v Osbourne [2002] EWCA Civ 885, the court held that where the donor had made an intended substantial gift (91.6 per cent of the donor’s liquid assets), he should have been told of the magnitude of the gifts both in absolute and comparative terms, and advised in relation to the wisdom of such gifts. Without this, it was impossible to say that the gifts were made by him after full, free and informed thought. As a consequence, the gifts were set aside on the grounds of undue influence.

The wisdom test and the duty of care

The extent of the professional’s duty to apply the wisdom test was considered in the case of Finsbury Park Mortgage Funding Limited v Ronald Burrows (LTL 3/5/02- Unreported). The court held that solicitors owed a duty of care to ensure that clients understood the implications of their action.

The facts of the Burrows case: A vulnerable person in dangerous company

Mr Burrows, aged 73, owned his house, free of debt. He lived on his state pension and income from two investment funds;
His wife had died in 1997 and she had managed the domestic finances as Mr Burrows had a limited grasp of financial affairs. He was, however, at the time thought by witnesses to be in command of his faculties;
In the early part of 2000, Mr Burrows was befriended by an unidentified person and cashed his investment funds. Shortly after, the funds were paid out of his bank, leaving him with only his state pension to live on;
In October 2000, Mr Burrows took a mortgage of £55,000 on his home, which at the time was worth £70,000. It appeared from the evidence that Mr Burrows was being assisted by an unidentified person. The loan was an interest only mortgage and Mr Burrows was committed to pay £500 per month back to the lenders. On his income, Mr Burrows could not meet the repayment sum. During the following two months, the total advance was paid out of his account in tranches, to unidentified persons. These people had clearly identified Mr Burrows as someone they could financially abuse;
The solicitor acted for both Mr Burrows and the mortgage company, but did not feel it was his duty to go through the mortgage application to check the details on it, ascertain that Mr Burrows knew of the size of the repayments or ask whether he could meet them.

The court’s attitude to professionals indicated in the Burrows case

The court held that common sense requires any professional to make sure that the person they are dealing with understands what they are doing. In this case, it should have been obvious that they were dealing with an elderly gentleman who might need treating with a little care.

In the circumstances, it was just, fair and reasonable to expect the solicitor to check with the borrower that he understood what he was doing. It was not enough just to be satisfied that he knew it was a mortgage and what would happen if he did not pay.

The solicitor should have made sufficient enquiries to assure the lenders that the borrower realised the nature and extent of the liability, the effect of non-payment, but also an idea of the sums involved.

The lenders expected a completed certificate from the solicitor confirming that the borrower knew the obligation and plans for repayment. If the solicitor had fulfilled his duty to Mr Burrows he would have also satisfied the duty he owed to the lenders and they would not have advanced the funds to Mr Burrows. If the solicitors had asked the right questions they would have seen that Mr Burrows did not want or need the mortgage and could not repay it. The solicitors were ordered to put Mr Burrows back into the pre-mortgage position.

The requirement to apply the wisdom test to gifts

The Law Society in their Guidance to Solicitors On The Making Gifts Of Property (March 2000) specifically states that the role of the solicitor is more than just drawing up and registering the necessary deeds and documents. There is a duty to ensure that the client fully understands the nature, effect, benefits, risks and foreseeable consequences of making of the gift. There is no expectation, however, to advise on the wisdom or morality of making the gift; that is, should or should not the client make the gift?

The practitioner’s role is to apply his knowledge, experience, understanding, common sense and insight into the client’s concerns, which enable the client to weigh up all the issues and arrive at an informed decision. It is the client who makes the decision but the practitioner who provides the advice to enable the client to do so.

The Law Society guidance sets out in general terms the implications of making the gift as follows:

Possible benefits of gifts to be understood by the client

A saving of inheritance tax, probate fees and costs on the death of the donor;
Avoiding the need to sell the home to pay for charges such as residential care or nursing-home fees, so securing the family’s inheritance;
Avoiding the value of the home being taken into account in means-testing for other benefits or services.

To this list, should be added the advantages of passing the financial responsibility of home ownership to another, avoiding complications if the donor loses capacity, minimising delays on death and satisfying legal or moral obligations.

Possible risks of gifts to be understood by the client

The value of the home may still be taken into account under the anti-avoidance measures in relation to means testing.

The advice given will need to extend to an explanation as to when and if this is likely to apply, together with details of the local authority financial assessment and enforcement proceedings.

The capital-gains-tax, owner-occupier exemption will apply to the gift, but may be lost thereafter and there will be no automatic uplift to the market value of the home on the donor’s death.

As there may be tax payable by the donee, he should be advised to obtain separate legal representation. With property prices being so high and gains increasing, this may be a risk the donee does not want to take.

The donee may fail to keep his side of the understanding, whether deliberately or through no fault of his own. For example, he may:

Fail to support the client, such as not topping up residential care fees;
Seek to move the client prematurely into residential care in order to occupy the home themselves or to sell it;
Die suddenly without making suitable provision for the client;
Run into financial difficulties because of unemployment or divorce or become bankrupt and in consequence, be unable to support the client.

The home may be lost on the bankruptcy, divorce or death of the donee, resulting in the client being made homeless if s/he is still living there;
There may be no inheritance-tax saving while the client continues to live in the home, yet there could be a liability for inheritance tax if the donee dies before the client.

Consider also the proposals of the government to create an income tax charge on the occupancy of the former home announced in the pre-budget statement in December 2003.

The donee may lose entitlement to benefits and/or services (for example, social security benefits, legal aid) due to personal means-testing, if not living in the home;
In the event of needing welfare assistance, the local authority may decide that the gift was an intentional deprivation of capital and assess the donor as having notional capital equal to the value of the home, rather than the property itself.

This may have implications both in accessing for and funding assistance and can result in substantial correspondence being entered into by the practitioner and the local authority.

The client may never need residential or nursing-home care.

Research by Laing and Buisson (2003) has shown that living in a residential care settings across all sectors affects approximately six per cent of the UK population. This equates to 501,900 people. Set this against the financial crisis that threatens the closure of many homes. There is a greater chance that the client may end up being cared for in his or her own home rather than in an institutional setting.

Over the past 15 months to April 2003, there has been a decrease in beds by 13,400 places. This is the sixth successive annual decrease and the ninth year in succession in which overall capacity has fallen short of what would be expected from an ageing population. There has been a slowing down of care-home closures, although still high, but with fewer new homes opening this has caused a shortfall in suitable available beds in parts of the country.

If the client does eventually need residential or nursing-home care, but no longer has the resources to pay the fees him/herself because of the gift, the local authority may only pay for a basic level of care (for example, a shared room ), so the client may be dependent on relatives to top up the fees if a better standard of care is desired.

Add to this the impact of the Delayed Discharge Act 2003. The local authority is fined every day that a patient remains in an acute hospital bed when they are ready to be discharged. Although there is a duty to consult with the patient and any carer about the discharge, the patient could be placed in a home, not of their choice. This could be many miles away from family and friends. Researchers at University College London, writing in the British Medical Journal this January said: “The combination of reduced NHS and social services capacity and new financial incentives could see the chronically ill and older patients being forced into accommodation, which is inappropriate and does not serve their needs.”

How can you be satisfied Mrs King has passed the wisdom test?

Assume you transfer the house and give no more thought to the wisdom test and a year later, Mrs King has a stroke. She wants to remain in her own home but she does not qualify for help from social services under their eligibility criteria and she does not have the finances to pay for home care. Had she retained her home she could have downsized or remortgage to alleviate her financial position. If she moves into a care home, the transfer may be considered by the local authority as a deliberate deprivation. If she is denied financial support by them, Mrs King may well look to the practitioner who advised her for redress. She may well say that she did not understand the implications of what she was doing.

It is vital that practitioners in this area try and standardise the way they work to prevent such claims being made. Suggestions include:

Provide a standard information sheet for clients considering transferring asset, given to them before the first appointment. This provides a foundation for your advice. The Age Concern Fact Sheet 40 is a good starting point and a name that clients recognise and trust;
Create a financial pro forma, providing details of the client’s income, expenditure, capital, savings, investments, debts as well as any interest in trusts. This can be completed by the client before the meeting to focus their minds on their financial situation and assist you in identifying their needs. If they have seen an IFA recently, their report may help and, if not, consider recommending one;
Advice given should be followed up by a report detailing the options and advice given. Much can be standardised and wherever possible, plain English should be used;
Run through the benefits, risks and implications again briefly and ask the client to confirm the rationale for their decision so this can be documented;
Ask the client if there is anything they do not understand and try to address matters specifically. Sometimes, clients may feel overwhelmed by the process, but given time, will understand the implications;
If a client is vague and cannot explain what points they do not understand it may be better not to act.

Professional ethics provide the foundation on which solicitors act for clients. The various options for asset protection build on this fundamental foundation and it is from this that we are able to advise the likes of Mrs King.

Caroline Bielanska is a solicitor, TEP, freelance consultant and lecturer. She can be contacted at: caroline.bielanska@ntlworld.com