SUCCESSION PLANNING
Don't Let HIPAA Paralyze Your Succession Planning

New health-care private laws can stymie decision making

In the mid-1990s, Black Manufacturing’s succession plan included recapitalization of its stock into voting and non-voting shares. Howard Black, the 75-year-old patriarch, wanted to transfer business ownership to his children and step back from the day-to-day operations.

Because he was not ready to completely give up control, he retained the majority of the voting stock, but transferred all non-voting and the remaining voting stock to his children in trust. He retired, but remained Chairman of the Board. Howard, a widower, created a Revocable Living Trust (RLT) that would distribute his voting shares to his active children when he died.

The succession plan worked well. Howard was free to focus on business strategy and was an insightful board Chairman and a good mentor. His daughter Elizabeth had become an effective president. Together, they created a 10-year growth plan for increased profitability and market share, and the company enjoyed good relationships with its employees, customers and vendors.

In 2004, Howard, who was now in his mid-80s, was incapacitated by a stroke. To make matters worse, the company was negotiating a merger with a competitor. Assuming the business issues could be worked out, state law required a majority of holders of all classes of stock to approve the transaction.

As merger discussions proceeded, Elizabeth reviewed Howard’s RLT to find out the identity of the successor trustee. She wanted to make sure that the successor trustee had time to review the proposed merger before the closing date.

The RLT review brought good and bad news. The good news was that Howard’s brother Norman was the successor trustee. As a board member, he was intimately involved in the merger transaction. The horrible news was that Norman could not be appointed successor trustee as intended.

HIPAA Gets in the Way
According to the privacy provisions of the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which took effect in April 2003, health-care providers cannot disclose protected health information to anyone other than the patient, someone authorized by state law to act on the patient’s behalf (for example, a parent for a minor child) or another person when the patient has given their consent to have protected health information disclosed to that person. Even worse, providers face sanctions under HIPAA for unauthorized disclosure of private health information. HIPAA affects virtually all doctors, dentists, pharmacists, hospitals and health-care providers. Its privacy provisions greatly restrict to whom providers can provide medical information. People who can view a patient’s medical records are those appointed as the patient’s agent under a “health-care power of attorney.” This document, which must comply with applicable state laws, identifies who can make certain health-related decisions on a patient’s behalf.

So what did HIPAA have to do with Black Manufacturing’s pending merger? A lot, it turns out. Under Howard’s RLT, Norman was to become the successor trustee upon a medical determination of Howard’s incapacity . Under HIPAA, however, medical providers could not share information about Howard’s medical condition with Norman , creating a classic Catch-22: Norman could not trigger his appointment as trustee of the RLT, which defeated its purpose.

Other Implications
The HIPAA privacy provisions also affect these two areas:

Springing Powers of Attorney for Health Care or Financial Decisions. Whether for healthcare or financial decisions, springing powers take effect when a person shows incapacity. Therefore, the agent does not become the agent until incapacity occurs. As in the example above, the prospective agent is not entitled to receive medical information to determine if the power has in fact “sprung” to life.

Replacing Trustees/Agents. For any trust or active power of attorney, what happens if the trustee or agent becomes incapacitated? If a medical showing of incapacity is necessary to replace the trustee or agent, what happens if you do not have access to their medical records?

For Black Manufacturing, the story eventually ended well. Norman was appointed successor trustee of Howard’s RLT and the merger was approved. Unfortunately, Norman had to go to state court to obtain a legal ruling of incapacity, which was costly and time-consuming. The lesson to be learned is simple: Update your planning documents before medical incapacity leads to legal paralysis.

A 68-year-old sister/aunt owns 35% of the company but never worked in the business. While she counts on her quarterly dividend distributions, her family’s next generation wants to reduce dividends to grow the business. A 75-year-old uncle comes in to work once a week, but still demands the full compensation and benefits he earned in his prime. His nieces and nephews acquiesce because, “We want to still be friends with Uncle Bill when this is over.”