233 Case Note Lewis v. Alexander Vindicates Primacy of Federal Law of Special Needs Trusts By Ron M. Landsman, Esq., CAP In Lewis v. Alexander, 1 the U.S. Court of Appeals for the Third Circuit affirmed a district court decision 2 striking down a Pennsylvania statute that severely restricted the use of pooled special needs trust (PSNT) accounts and limited trust retention of postmortem account balances to 50 percent. In doing so, it held that state Medicaid programs are required to treat as exempt the assets and income in pooled trusts meeting the requirements of 42 U.S.C. 1396p(d)(4)(C) (referred to hereinafter as d-4-c ) and only those requirements for Medicaid eligibility purposes, rejecting the contrary view of the Second and Tenth Circuits. 3 In the parlance now used, the federal special needs trust provisions of d-4-c are mandatory for the states. The Pennsylvania statute at issue, codified at 62 Pa. Stat. Ann. 1414, was enacted in 2005 to regulate special needs trusts and, as put rather generously by the Third Circuit, to ensure that these trusts were not abused. 4 The Act: required that all special needs trusts be for the sole benefit of a disabled individual. Section 1414(b)(3)(i). limited what a pooled trust could retain of a deceased beneficiary s account to 50 percent prior to Medicaid payback. Section 1414(b)(3)(iii). required that any expenditure from the trust... have a reasonable relationship to the [beneficiary s] needs, which the state agency indicated meant special needs arising from the individual s disability. Section 1414(b)(3)(ii). limited the right to establish a PSNT account to those whose special needs... will not be met without the trust. Section 1414(b)(2). Again, the needs had to be related to the treatment of the beneficiary s disability. Section 1414(f). barred people age 65 and above from establishing pooled SNT accounts. Section 1414(b)(1). authorized enforcement by Medicaid or other public agency [by] petition[ing] the court for an order terminating the trust. Section 1414(c). A complaint for declaratory and injunctive relief in the form of a putative class ac- Ron Landsman is the principal of Ron M. Landsman, P.A., an Elder Law firm in Rockville, Md. He coauthored an amicus curiae brief in Lewis v. Alexander for NAELA, the Pennsylvania chapter of NAELA, and the Special Needs Alliance (SNA), as well as an amicus curiae brief in Hobbs v. Zenderman, 579 F.3rd 1171 (10 th Cir. 2009), for the SNA. 1 Lewis v. Alexander, No. 11-3439 (3d Cir. June 20, 2012); also in 2012 WL 2334322. 2 Lewis v. Alexander, No. 2:06-cv-03963-JD, Doc. 73 (E.D. Pa. filed Aug. 23, 2011), also in 2011 WL 3678721. 3 Wong v. Doar, 571 F.3d 247, 256 257 (2d Cir. 2009); Keith v. Rizzuto, 212 F.3d 1190, 1193 (10 th Cir. 2000); cf. Norwest Bank of N.D., N.A., v. Doth, 159 F.3d 328, 330 (8th Cir. 1998). 4 Lewis, No. 11-3439, slip op. at 3.
234 NAELA Journal [Volume VIII, Number 2 tion was filed by two pooled trusts and 12 individuals, eight who had prestatute accounts and four who established their accounts after the statute was enacted. Lead counsel for the plaintiffs was Steven Feldman, a long-time Elder Law attorney and NAELA member. Of the six contested requirements, the trial court invalidated all but the first, which it held permissible since it tracked federal law, 5 and plaintiffs did not challenge that decision. On appeal by the Pennsylvania Medicaid agency, the Third Circuit affirmed the decision that states are required to honor special needs trusts and treat them and their funding as exempt, confirming the invalidity of all but the enforcement provision. In getting to that result, the court also had to address the status of federally authorized special needs trusts (SNTs), the nature of the right that arose from the statutory provisions, whether an injured party had standing under 42 U.S.C. 1983 and under the Supremacy Clause, whether these plaintiffs had sufficient present injury to have standing, and whether the case was ripe. It answered all of those questions in plaintiffs favor. 6 The parties and the court all recognized that the central issue in the case was whether the special needs trust exclusions are mandatory. If not, then plaintiffs had no substantive right to enforce and they would lose the unambiguous imposition of a duty on the state that is a linchpin for Section 1983 relief under Blessing v. Freestone. 7 Pennsylvania relied on the argument, which had prevailed in the Second and Tenth Circuits, 8 that while the inclusion of most self-settled trusts as available 9 is mandatory, the exclusion of special needs trusts in d-4-c did not, by itself, address how to treat them. Pennsylvania asserted that this created a gap in which the states could legislate; they were not required to count special needs trusts assets, but neither were they required not to count them. Under that reading, states were permitted, but not required, to treat SNTs as unavailable, and if they were not required to treat them as unavailable, they were perforce permitted to attach restrictions or conditions on their use. As the court noted, and all agreed, d-4-c plainly says the States do not have to apply the trust-counting provisions to qualifying special needs trusts, 10 but it does not go further and expressly state that they shall not be counted as available assets.... 11 Plaintiffs made two arguments in response. First, relying on d-4-c and the correlative obligation to establish in its State Plan compliance with respect to... treatment of trusts, 12 the plaintiffs made a subtle argument drawn from the Medicaid statute on the nature of jural duties, following Hohfeld. 13 Perhaps putting it far too simply, the key to 5 Lewis, No. 2:06-cv-03963-JD, slip op. at 34 43, 44. 6 Although Pennsylvania challenged justifiability, its argument was largely based on the claim that d-4-c was not mandatory; it did not separately challenge, for example, whether the pooled trusts had standing in their own right, which is key to the holding with respect to retention. 7 Blessing v. Freestone, 520 U.S. 329 (1997). Blessing is one of a line of Supreme Court cases tightening the requirements for standing to obtain relief for a violation of federal law under 42 U.S.C. 1983 (2012). 8 Wong, 571 F.3d 247 and Keith, 212 F.3d 1190. 9 To call a trust available is shorthand for saying that the assets that it holds or the income that those assets generate is available for Medicaid purposes. 10 Lewis, No. 11-3439, slip op. at 31. 11 Id. at 31 32. 12 42 U.S.C. 1396a(a)(18) (2012). 13 Citing and relying on Wesley Newcomb Hohfeld, Some Fundamental Legal Conceptions as Applied in Judicial Reasoning, 23 Yale L.J. 16 (1913); Brief for Appellee at 23, Lewis v. Alexander, No. 11-3439.
Fall 2012] Case Note: Lewis v. Alexander 235 the argument is that d-4-a and -C affirmatively prohibit use of the mandatory availability rules of 42 U.S.C. 1396p(d), analogous to the Supreme Court s reasoning in Arkansas Department of Health and Human Services v. Ahlborn, 14 which held that the parallel antilien provisions in 42 U.S.C. 1396p(a) and (b) created express limits on state power. Second, they argued artfully that all of the trust provisions must be viewed in the context of Medicaid and Supplemental Security Income (SSI) as a whole, where the basic law of Medicaid is the SSI income and resource standards. State Medicaid rules either are those for SSI beneficiaries, for those who are categorically eligible, or they must be comparable, and no more restrictive, for the medically needy. 15 In that context, the mandatory inclusion of all trust assets and income as countable resources or income modifies that rule, to the extent it applies, and the exclusion of special needs trusts from the broad anti-trust provisions of d(1)-(3) leaves SNTs where they were beforehand as measured under the SSI resource and income rules. The District Court agreed with that analysis and examined each of the specific provisions of Section 1414 to see which ones violated comparability. The Third Circuit did not so much reject the comparability argument as decline to go through the analysis, saying its reliance on the Medicaid statute, alone, was adequate and more direct, and given the complexity of Medicaid, we seek to simplify the analysis in any way we can. 16 The Court s approach not necessarily inconsistent with comparability was to view the Medicaid provisions as a coherent whole to determine, through statutory analysis, whether Congress intended to require states to treat SNTs as detailed in the statute. The court said the focus on [t]his subsection, the opening clause of 42 U.S.C. 1396p(d) (4)(C), misses the forest for the trees. 17 OBRA 1993, the bill that implemented the new trust and anti-transfer provisions, provided a comprehensive system for dealing with the relationship between trusts and Medicaid eligibility. For the first time, it required compliance with Section 1396p... with respect to... treatment of certain trusts... 18 No doubt, the court said, Congress primary object was to prevent wealthy people from using trusts to shelter their assets while getting means-tested public health care benefits, but its secondary purpose was to shield special needs trusts from impacting Medicaid eligibility. 19 Congress was not sheltering SNTs from the broad anti-trust rule, but rather shelter[ing] special needs trusts from having any impact on Medicaid eligibility. It rigorously dictates what assets shall count and what assets shall not count toward Medicaid eligibility... provid[ing] a comprehensive system of asset-counting rules [where] it has actually legislated on this precise class of asset. 20 (Emphasis in original.) The Court s discussion of this holding is curiously devoid of further legal author- 14 Ark. Dept. of Health and Human Servs. v. Ahlborn, 547 U.S. 268, 164 L. Ed. 2d 459, 126 S. Ct. 1752 (2006). 15 42 U.S.C. 1396a(a)(10)(C)(i)(III), 1396a(r)(2). 16 Lewis, No. 11-3439, slip op. at 43, note 21. 17 Id. at 32. 18 Id. at 33. 19 Id. 20 Id. at 34.
236 NAELA Journal [Volume VIII, Number 2 ity. It relies on the exclusive nature of the trust rules in 42 U.S.C. 1396p(d)(4) almost alone, adding only the provision that requires State Plans to incorporate those rules. 21 It could have cited, but did not, the provisions in the same section that affirmatively require states to permit funding of d-4 special needs trusts by excluding them from the antitransfer rules of 42 U.S.C. 1396p(c). To be sure, transfer and resource exemptions are not entirely or necessarily coterminous, yet it would be strange indeed for Congress to say Medicaid agencies must allow individuals to fund d-4 special needs trusts without also requiring that such trusts be exempt. The court s choice of analysis is not without great significance, however. A decision based on comparability would have placed the locus of the federal standard in the SSI statute, further decision-making in the agency that determines SSI policy, and would have left the states free to be less restrictive under the comparability rule. The federal standard approach means that there is a statutory basis for mandatory rules limiting what states can do both in expanding as well as limiting the use of trusts with decision-making in the Center for Medicare & Medicaid Services rather than the unit that manages SSI. As important as this holding was, the Court sliced a fine distinction in saying that this did not resolve whether there was necessarily the kind of conflict between federal law and Section 1414 that would entitle plaintiffs to judicial protection. The question that remained, in the Court s view, was whether the federal special needs trust rules preempted state law and regulation in the area. In addition to requiring that states honor special needs trusts, this also required findings that Congress intended to displace state law, pro tanto, and that the states were not permitted to impose any additional burdens on SNTs. 22 Having found d-4 mandatory and that the federal statute occupied the field of special needs trusts, the court could give short shrift to whether any of the specific requirements of Section 1414 could stand: Section 1414(b)(3)(iii) limiting retention prior to Medicaid payback to 50 per cent of the balance of the account at death was struck down because it denied exempt status to trusts that might retain more and the individual s right to use the trust of their choice that met federal requirements. The court relied in part on the trust s standing, 23 and dismissed out of hand the individual s property interest in disposition of property after their death. 24 Section 1414(b)(3)(ii) requiring that trust expenditure[s]... have a reasonable relationship to the [beneficiary s] needs was struck down because the federal statute had no such limitation. 25 Section 1414(f) limiting the right to establish a pooled SNT account to those whose special needs... will not be met without the trust, meaning needs related 21 42 U.S.C. 1396a(a)(18). 22 Lewis, No. 11-3439, slip op. at 41 43. 23 Id. at 46, note 22. 24 Id. The court apparently was not persuaded by the amicus argument that the state failed to explain why the post-mortem disposition of one s assets is not a morally and emotionally significant right that has real legal significance. It is not irrelevant to note that there is a whole financial-legal industry devoted to that concern only. 25 Id. at 49.
Fall 2012] Case Note: Lewis v. Alexander 237 to the treatment of the beneficiary s disability was struck down because federal law required only that the person be disabled. Section 1414(b)(1) barring anyone age 65 or older from establishing pooled SNT accounts was also struck down as being more restrictive than federal law, which of course limits individual but not pooled accounts to individuals under age 65. 26 The court reversed the district court and upheld Section 1414(c), the enforcement provision authorizing Medicaid or other public agency [to] petition the court for an order terminating the trust. The district court held it unenforceable because it would subject Medicaid beneficiaries to loss of the use of their pooled trust account not for anything they did, but because a problem existed with some other beneficiary. 27 The court of appeals reversed, holding that this enforcement authority was a necessary element of Pennsylvania s retained general authority to regulate trusts, like other provisions permitting termination of trusts whose trustees breach their duties. 28 Throughout this discussion, the Court carefully noted, as all parties necessarily acknowledged or urged, as the case may be, that Congress did not abrogate state trust law generally or create its own general federal law of trusts. 29 Congress did not intend to interfere with application of such traditional rules. After all, Congress did not pass a federal body of trust law, estate law, or property law when enacting Medicaid. It relied and continues to rely on state laws governing such issues. 30 Rather, taking state trust law as a given, it established specific and precise rules for how trusts created under state law are to be treated. 31 There is necessarily some tension between this conclusion and the bar on states adding requirements, the court noted. For example, even application of the trustee s traditional duty of loyalty to administer the trust solely in the interests of the beneficiaries could be considered an extra requirement. 32 Not having enacted a general federal law of trusts, Congress must of course intend its provisions to fit within that framework. This interplay became especially important in the court s treatment of, for example, the requirement that expenditures have a reasonable relationship to the needs of the beneficiary. In rejecting the imposition of this specific requirement on SNTs, and in the particular way the State did, the court responded to its justifiable concern with the potential for fraud and abuse. Putting aside that there is no history of particular problems with SNTs, the court said: States are not without tools to prevent abuse. The trust-counting rules are built atop the States legal framework for trusts. Special needs trusts are therefore subject to supervision by the courts and legal actions to enforce trustees fiduciary duties. 33 26 Cf. 42 U.S.C. 1396p(d)(4)(A), 1396p(d)(4)(C). 27 Lewis, No. 2:06-cv-03963-JD, slip op. at 34 35. 28 Lewis, No. 11-3439, slip op. at 54 55, citing, among others, 20 Pa. Consol. Stat. Ann. 7740.2. 29 Cf. Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938). 30 Lewis, No. 11-3439, slip op. at 43. 31 Id. at 34, 43. 32 Id. at 43. 33 Id. at 49. See also slip op. at 52, dismissing the reasonable relationship provision purportedly designed to prevent fraud and abuse, given the availability of the state s full complement of general trust and non-profit laws to combat waste, fraud, and abuse.
238 NAELA Journal [Volume VIII, Number 2 The fly in the ointment for PSNTs and their advocates is that in holding that denying over-65-year-olds access to pooled SNTs was not permissible, the Court assumed that the over-65 transfer penalty applied in funding such a trust is permissible. 34 Whether the transfer penalty applied to pooled trust accounts was not an issue before the court and was not briefed by either party. Since the statute under attack broadly prohibited any use of pooled trusts by the elderly, the Plaintiffs logically focused on the lack of an age limitation in d-4-c, as compared to d-4-a. On the other hand, plaintiffs failed even to note the issue in relying on the district court s favorable decision on this point, 35 which also found logic in Congress choice to permit anyone to establish pooled trust accounts while limiting their use for older people, the ones more likely to seek long term care benefits, the kind subject to transfer penalties. The Lewis court would almost certainly come to a different result than that in Hobbs v. Zenderman, 36 the Tenth Circuit decision following Keith v. Rizzuto, 37 which held that states were not required to permit the use of special needs trusts. To be sure, the lower court in Lewis allowed Pennsylvania to retain a sole benefit standard in its state law, like the one purportedly enforced in Hobbs, and the court of appeals recognized that conventional state trust law would always be available to police breaches of fiduciary duty. But the Third Circuit could hardly go so far afield as the Tenth did in allowing the state to put its financial interests ahead of beneficiaries based on, of all things, the sole benefit requirement. And the Third Circuit s reasoning would have required the New Mexico Medicaid agency to return to the probate court, which had already approved most of the actions later attacked in a denial of Medicaid benefits. It is of course not possible to know definitively what most moved the judges to decide as they did. But one of many wise choices made by Steve Feldman was to choose Zackery Lewis as lead plaintiff. It was Zackery s parents wish to put his $1.8 million settlement into The Family Trust, one of the two pooled trust plaintiffs, that led to a probate court decision approving it to be in Zackery s best interests to do so. 38 By highlighting that Pennsylvania would require by legislation a result a court had already found not in the best interests of an individual beneficiary, Feldman framed the debate in a way that helped, if it did not assure, his ultimate victory. 34 Id. at 52 53. 35 Lewis, No. 2:06-cv-03963-JD, slip op. at 36 37. 36 Hobbs v. Zenderman, 579 F.3d 1171 (10th Cir. 2009). 37 Keith, 212 F.3d 1190. 38 Lewis v. Magee Women s Hosp., 67 Pa. D. & C.4th 362 (Pa. Ct. Com. Pleas 2004), also in 2004 WL 2526187.