January/February 2009

Assessing Legal Capacity
By John Gosselin
Aging Well
Vol. 2 No. 1

For any contract to be valid, the contracting person must have the legal capacity to enter into the contract—whether it is an older adult, the attorney-in-fact, or the guardian.

In general, the law presumes that all adults have legal capacity until proven otherwise. When someone has legal capacity, it means that he or she is able to enter into contractual arrangements, can choose whether to enter into an attorney-client relationship, and is capable of making decisions on his or her own.

The most important thing to remember is that legal capacity is situational and depends on the proposed act. A client who is signing a loan application or closing documents can be lucid and have legal capacity at that moment but may not five minutes later.

Here’s an example of how the required legal capacity can differ, depending on the proposed act. A relatively low level of capacity is required for an individual to create a valid will, whereas a higher capacity is required to give informed consent for medical treatment. The level of legal capacity needed to execute loan documents falls somewhere between the two.

Elusive Standard Measure of Legal Capacity
I’ve found that in my line of work as an elder law attorney, the law’s general presumption that a client has legal capacity is often inaccurate. Usually, when family members bring in an older adult client, it’s because they’ve noticed some behavior that suggests that the individual’s mental faculties are declining. Such nonclinical observations, while nondeterminative, do raise the question of whether the prospective elder client has the legal capacity to sign documents or enter into an attorney-client relationship. This situation begs the question: How does an elder law attorney determine a prospective client’s legal capacity?

Strangely, there is no standardized procedure or even a universally accepted legal definition. Some attorneys rely on their personal observations of the older adult, as well as comments from those who spend a lot of time with the individual. Other attorneys will ask the elder a series of questions, such as “What is your name? Where do you live? How many children do you have?”, and then carefully gauge the responses. Attorneys must keep at bay their own opinions of what is rational when making this determination; what may seem to be wild and inexplicable behavior may simply be eccentricity, which is not the same as incapacity.

If you are still trying to figure out where the line falls, refer to the Model Rules of Professional Conduct, which govern lawyers’ ethics nationwide. In addition, states often have rules of ethics on what constitutes legal capacity in the context of representing older adult clients. Massachusetts Rules of Professional Conduct rule 1.14 lays out what a lawyer must do if he or she suspects that a prospective client lacks legal capacity. Comment 1 to the rule states in part that “it is recognized that some persons of advanced age can be quite capable of handling routine financial matters, while needing special legal protection concerning major transactions.” What is a major transaction? A reverse mortgage would be a major transaction. This comment recognizes that there will be times when a lawyer will conclude that a client seeking to obtain legal representation in procuring a reverse mortgage loan lacks legal capacity but has the legal capacity for other contractual matters.

Reverse Mortgages and Legal Capacity
Under the federal home mortgage program, administered by the U.S. Department of Housing and Urban Development (HUD), legal representatives (guardians and attorneys-in-fact) may execute the legal documents needed for a reverse mortgage transaction, provided that the authority to do so was granted to them by the court or the power of attorney. The law requires that seniors receive counseling before they obtain a loan. Legal representatives must request counseling. Whether counseling sessions are between counselors and legal representatives or directly between counselors and elders, the reverse mortgage counseling code of ethics requires that all counseling sessions be conducted by HUD-approved home equity conversion mortgage counseling agencies. Counselors are trained to identify potential competency issues.

Lawyers and medical professionals can help reverse mortgage originators assist older adults and their families in deciding which options are best for them when facing incapacity.

Powers of Attorney
If you believe an elder’s legal capacity may decline, a power of attorney should be created and executed immediately. Powers of attorney essentially enable the named attorney-in-fact to step into the shoes of the principal, authorizing the attorney-in-fact to make financial decisions on the principal’s behalf. A family member or a trusted friend would be appropriate attorneys-in-fact, but a loan officer isn’t a good choice. A power of attorney needs to be executed while the older adult has the legal capacity to understand what he or she is signing and its consequences. There are three types of powers of attorney: durable, nondurable, and springing.

Durable powers of attorney survive incapacitation, meaning that they are still good even after the older person becomes incapacitated. Nondurable powers of attorney are the exact opposite—they terminate the moment the principal becomes incapacitated. On the other hand, springing powers of attorney become effective only when a particular event occurs that is specified in the document, such as becoming incapacitated.

In the context of reverse mortgage lending, a durable power of attorney will always be helpful if capacity is questionable, preferably with a provision specific to the transaction or, in the least, to mortgaging property.

Guardianships
A more formal option of appointing an alternate decision maker is to file for guardianship. Obtaining a guardianship involves going through the probate courts. There are generally three types of guardianships: guardianships of the estate, guardianships of the person, and plenary guardianships. Guardianships of the estate, sometimes called conservatorships, limit the appointed guardian’s authority to dealing with the incapacitated elder’s assets. Guardianships of the person give the guardian control over the ward’s person, meaning the authority to make decisions such as where the ward should live and whether to consent to medical treatment. Plenary guardianships grant the guardian the power to make decisions over both the ward’s person and estate.

Most states also permit temporary or limited guardianships. Mortgage originators need to keep in mind that the appointed guardian will need to obtain a license to mortgage from the probate, family, or surrogate court in order to obtain a reverse mortgage.

Critical Importance
Two words can sum up the reason legal capacity is of the utmost importance to the reverse mortgage industry: void and voidable. Should an elder enter into a contract for a reverse mortgage and be incapacitated at the time, then that contract becomes voidable, which means that he or she may disaffirm the terms of the contract. In other words, the contract becomes invalid. However, if an older adult is under guardianship when he or she signs a contract, that contract is void from the outset. A void contract means that it is unenforceable by either of the contracting parties.

Failure to recognize that an older adult lacks legal capacity can result in a variety of consequences for mortgage originators, including loss of the loan, loss of any advanced funds, and a negative impact on the reputation of all reverse mortgage originators. For those reasons, it is imperative that mortgage originators remember that for a reverse mortgage or any contract to be valid, the contracting person must have the legal capacity to enter into the contract, whether it’s the elder, the attorney-in-fact, or the guardian.

— John Gosselin is the founder of Law for Life, a Boston elder law firm. He is a recognized expert and frequent lecturer on reverse mortgages and their impact on government entitlement programs.