Don’t Skimp on The Facts – Failure of Fiduciaries to Make Full Disclosure of Matters Set Forth in an Accounting May be Considered Fraud

by Carlena L. Tapella

In the recently published case of Hudson v. Foster, 2021 Cal.App. LEXIS 737, the Court of Appeal for the Second Appellate District, Division Five, determined that a former conservatee who discovered that certain transactions in his conservator’s previously approved accounting were falsely reported, was under no obligation to comb through records to verify the truth of the representations made by the conservator in the accounting.  The case is detailed with respect to the facts, but it puts fiduciaries on notice that full disclosure of material facts is required, and even slightly skewing the reporting of a transaction can be considered fraud.

Nigel Hudson was severely injured in an automobile accident.  He received a settlement of $13,863,000, and a qualified settlement fund was established to receive the settlement proceeds.  A voluntary conservatorship was established and Lucas Foster, a friend of Nigel, was appointed as the conservator of the estate.  Lucas is a film producer, notable for films such as Mr. and Mrs. Smith, Crimson Tide, and Ford v. Ferrari.  Because the settlement funds had not yet been received, Lucas agreed to advance funds for Nigel’s benefit, to be reimbursed when the settlement funds were received.  Nigel had the ability to review the conservatorship bank account records online.

When the settlement proceeds were received, the civil court ordered Lucas to pay a total of $1,945,412.43 to hundreds of creditors, including Miracle Mile ($11,250) and LA Litigation ($39,913.25).

In December 2013, Lucas filed a first and final account and a request to terminate the conservatorship of the estate.  It is not stated in the decision, but it appears that the conservatorship was terminated because Nigel had sufficiently recovered from his accident to take back the management of his own finances.  Lucas reported receiving property totaling $9,489,265.16 and disbursing $4,314,887.38, with more than 1,000 disbursements reported on the disbursements schedule.  Notable to the opinion, Lucas also reported in his petition that 17 checks listed on the disbursements schedule were paid to him directly or to his film production company to reimburse him for the funds he had advanced to Nigel prior to receiving the settlement funds.  Lucas also reported that there were a few additional entries in the disbursements schedule listing amounts paid directly to Lucas or one of his production companies, and stating that the amounts shown were reimbursement for a specific expenditure made on behalf of Nigel.  Lucas also reported that there were debts totaling approximately $300,000 that remained unpaid and that Nigel would take responsibility for payment of these debts upon the termination of the conservatorship.

Three disbursements among the hundreds listed in the schedule were checks issued for payments in the amount of $10,000 to “Miracle Mile Surgical Center,” $31,089.25 to LA Litigation Copy Services,” and $9,839.10 to “Dr. Sam Markzar, DDS.” Nigel and his court-appointed guardian ad litem signed a consent to the accounting and the court entered its order approving the accounting in March 2014.

One week after the accounting was approved, a representative from Miracle Mile contacted an associate of Lucas regarding payment of its bill for services rendered to Nigel.  Lucas and Nigel met at a Starbucks and Lucas informed Nigel that the amount owing to Miracle Mile was part of the $300,000 in unpaid debts that Lucas had been unable to negotiate.  Lucas informed Nigel that he would obtain a release from Miracle Mile and then the bill would be paid. Thereafter, Nigel never saw a release and Lucas never provided a supplemental accounting listing the bills that remained unpaid.

In October 2014, more than 18 months after the payment date reported in the accounting, LA Litigation signed a document acknowledging receipt of $23,500 in release of all claims against Nigel.  Nigel also had an unpaid debt to UCLA which Lucas informed Nigel he could settle for $60,000, so Nigel provided the funds to Lucas.  Nigel discovered later that the settlement with UCLA was $54,500, but the difference of $5,500 was not returned to Nigel.

In April 2018, Miracle Mile filed a motion in the civil action to enforce payment of its bill of $11,250, which had been ordered by the court.  Miracle Mile alleged that it had sent two letters to Lucas demanding payment, to which it received no response.  Four months later, Nigel filed a motion in the probate court to set aside the order approving the accounting on the grounds of fraud and misrepresentation of a material fact. Nigel claimed that he was unaware of any fraud related to the accounting until after Miracle Mile filed its motion.  At that time, he obtained copies of canceled checks and, comparing the canceled checks to the disbursements reported in the accounting, Nigel discovered that 28 checks reported as being paid to third parties were actually issued to Lucas or one of his companies. Although the bank statements listed the checks and amounts, only the canceled checks themselves revealed the payee.  The 28 checks issued to Lucas or one of his companies totaled $558,169.47.  Nigel also discovered that, after the accounting was approved, Lucas issued an additional four checks totaling more than $60,000 to himself or one of his companies.  Nigel alleged that, although Probate Code section 2103 releases a conservator from all claims when a judgment or order is approved, that release does not apply if the order is obtained by fraud as to any representation of a material fact.

Lucas responded stating that there was no fraud, given that Nigel had online access to the conservatorship bank account and was aware of the discrepancy regarding the Miracle Mile debt; that Lucas had arranged for a third party to prepare the accounting; that Nigel, his guardian ad litem, and the probate court investigator had all reviewed the accounting; and, when the conservatorship was terminated in 2014, Lucas had delivered to Nigel, in multiple storage boxes, every document relating to the accounting, including the canceled checks.  Lucas also argued that the fact that the disbursements schedule showed the service providers as payees, rather than showing that one of Lucas’ production companies paid the provider and was reimbursed was “perhaps unclear, but certainly not a fraud.”  Lucas also argued that the motion to set aside the order approving the accounting was untimely, citing the case of Knox v. Dean (2012) 205 Cal.App.4th 417, and arguing that, in order to set aside the order based on misrepresentations of fact, Nigel had to show that the facts could not have been reasonably discovered prior to entry of the judgment.

Lucas also stated that he had advanced hundreds of thousands of dollars for Nigel’s benefit and reimbursed himself from the conservatorship bank account.  Lucas stated that he discussed with Nigel each payment and reimbursement as they occurred.  Further, Lucas stated he did not receive any compensation for the time he spent as Nigel’s conservator.

Nigel responded stating that Lucas admitted that the checks were not issued to the payees as represented in the accounting, and there was nothing that would have put him, the guardian ad litem, or court staff on notice of any irregularities in the accounting.  Nigel also disputed Lucas’ claim that Lucas had provided every document relating to the accounting.  When Nigel requested his records, Lucas informed Nigel that the records were “swept away and destroyed” in the mudslides that occurred in Montecito, where Lucas had a home.

At the hearing on the motion, Lucas argued that, even if he had taken the funds as alleged in the motion, Nigel was put on notice when Miracle Mile requested payment in 2014, of which Lucas informed Nigel during their meeting at Starbucks.  Nigel argued that his own access to the financial records did not absolve Lucas of providing correct information or require Nigel to verify that the payees listed in the schedules were paid.  Nigel also argued that a conservator has a duty to accurately disclose all disbursements and that Lucas had, in his accounting, clearly identified which transactions were reimbursements and that the 28 checks discovered by Nigel were not reported in the accounting as reimbursements.  Nigel also argued that he was put on notice of the of the misrepresentation of facts when Miracle Mile filed its motion in April 2018.  Further, Nigel argued that deliberately misidentifying the payee on the checks demonstrated an intent to conceal information.  He also argued that parties who reviewed the accounting were under no obligation to confirm that the checks had been listed accurately.  Indeed, he argued that, as a fiduciary, it was the obligation of the conservator to be truthful and not misrepresent material facts.  The check reported as being issued to Nigel’s dentist was, in fact, issued to Lucas’ production company.  The dentist’s custodian of records submitted a declaration that the dentist had received no payments from the conservator and that Nigel, personally, had paid for all of his own dental care.  In addition, LA Litigation submitted a declaration stating that it had not received $31,089.25 on Nigel’s account.

The probate court determined that the information Nigel had provided was insufficient and directed him to file a declaration regarding his personal knowledge of the accounting to determine whether he acted with diligence in seeking to vacate the order.  The court directed Nigel to detail the circumstances surrounding the discovery of the disputed issues in the accounting, his relevant prior communications with Lucas, and his understanding of the advances made by Lucas on Nigel’s behalf.  Specifically addressing the Miracle Mile debt, Nigel stated that Lucas had told him that the debt was part of the $300,000 in unpaid debts that he owed and he, therefore, had no reason to question it.  Nigel also stated that he understood that Lucas would reimburse himself for expenses he paid on Nigel’s behalf, but the 28 checks were reported in the accounting as direct payments to third parties, not as reimbursements to Lucas.  Further, Nigel was not aware of the $60,000 in payments Lucas made to himself or one of his companies after the accounting was approved.

Lucas filed his response to Nigel’s declaration stating, in essence, that Nigel had sufficient information in 2014 when he was informed of the unpaid debt to Miracle Mile from which he knew, or should have known, of any potential error in the accounting.  Lucas also argued that Nigel was kept informed of conservatorship finances, had access to view canceled checks, disbursements, and bank statements at any time and that Lucas did not make any false representations on which Nigel relied.  Lucas also argued that Nigel suffered no damages and that there was no showing of any fraud sufficient to set aside the order.

After the hearing on the motion, during which both sides argued what they had essentially provided in writing to the court, the court took the matter under submission and issued a minute order stating that Nigel had not provided sufficient information regarding his personal knowledge of the circumstances of the accounting, and only described his knowledge of the reimbursement process in general terms.  Further, the court found that Nigel had not acted with reasonable diligence based on the information that he should have known.  The court denied the motion to set aside the order approving the accounting.  Nigel appealed.

The Court of Appeal discussed the fiduciary obligation of a conservator, including the affirmative obligation to provide full disclosure of all material facts, stating that the “lack of full disclosure will amount to fraud.”  The Court discussed the “critical wrinkle” in the extrinsic fraud rule as applied to fiduciaries.  As an example, the Court cited the case of Conservatorship of Coffey (1986) 186 Cal.App.3d 1431, which determined that “a life insurance beneficiary was not required to oversee the activities of the conservator, scrutinize accountings and detect omissions, warn the conservator or take other action, to receive a benefit that the conservator had a statutory duty to conserve.  Sound policy considerations require that we reject the imposition of such a duty, for otherwise, we would encourage the conservator who acted with less than ordinary care and diligence to hide his failings by nondisclosure, hoping to eliminate or lessen his liability by the beneficiary’s failure to detect the omission.”

The Court further stated that the fiduciary relationship comes with a fiduciary obligation. Citing the case of Estate of Sanders (1985) 40 Cal.3d 607, the Court stated that “When there exists a relationship of trust and confidence it is the duty of one in whom the confidence is reposed to make full disclosure of all material facts within his knowledge relating to the transaction in question and any concealment of material facts is a fraud.”  “Where there is [such] a duty to disclose, the disclosure must be full and complete, and any material concealment or misrepresentation will amount to fraud sufficient to entitle the party injured thereby to an action.”

Turning to the question of the duty of diligence to discover misrepresentations of a material fact, the Court distinguished civil proceedings and the duty of a party to take advantage of discovery procedures, with a conservator’s presentation of an accounting to the court for approval, which is not an adversarial proceeding.  However, “Once a party actually becomes aware of facts which would make a reasonably prudent person suspicious of wrongdoing by a fiduciary, the party is put on inquiry notice and has a duty to investigate,” citing Bennett v. Hibernia Bank (1956) 47 Cal.2d 540.  When there is a fiduciary relationship, “facts which would ordinarily require investigation may not excite suspicion and less diligence is required. “ Id. at pp. 559-560.

The Court then discussed the Knox case as argued by Lucas for the proposition that a party seeking to set aside a judgment for extrinsic fraud based on misrepresentation of facts “must show the party could not reasonably have discovered the misrepresentations prior to entry of judgment.”  The Court rejected any interpretation of Knox which would require a conservatee with no actual notice of facts that suggest wrongdoing to conduct an investigation to verify the facts in a conservator’s account prior to entry of judgment.  When considering intrinsic fraud as opposed to extrinsic fraud, the Court concluded that Probate Code section 2103 clearly states that the conservator is not released from any claims when the order is obtained by “misrepresentation of material fact in the petition or account.”  If a conservator misrepresents a material fact in an accounting that has been approved by the court, a party bringing a subsequent action on behalf of the conservatee does not need to show that the misrepresentation could not have been discovered prior to entry of the order approving the account.  Probate Code section 2103 does not impose on fiduciary relationships the discovery obligation that applies in non-fiduciary relationships.

Applying its analysis to the motion filed by Nigel, the Court of Appeal stated that the probate court improperly placed the burden on Nigel to show that he could not have discovered the misrepresentations of material fact in the final account prior to the entry of the order.  The probate court focused on Nigel’s knowledge of the reimbursement process, but the transactions at issue did not involve reimbursements. Rather, the focus of the motion was on the 28 checks which were reported as being paid to third-party providers when, in fact, they were paid to Lucas or one of his companies.  While Lucas argued that what he claimed to be reimbursements were “poorly presented,” two of the checks were identified as being issued to creditors who had not been paid by Lucas, so there was no reimbursement.

The Court of Appeal rejected the proposition that Nigel’s “mere access to information [triggered] an obligation to comb through the records to verify the truth” of Lucas’ representations.  Rather, the inquiry into whether Nigel acted diligently required the court first to determine when Nigel actually discovered formerly unknown information “sufficient to put a reasonable person on notice for fraud.”  The Court of Appeal then remanded the case to the probate court to determine whether Nigel met the requirements for relief based on the law discussed in the opinion.

What this case makes clear is that a fiduciary should never skew information.  It appears that the conservator was taking the position that his reporting in the accounting of transactions as being paid to third parties for services, when he claims they actually were reimbursements to one of his companies for payment for such services, were simply “poorly presented.”  However, the conservator never stated that fact in the schedules or in the petition.  What his schedules claimed were that checks were issued to specifically identified third parties, and they were not.  Never fudge.  Always make full disclosure.  In this case, the conservator even had a third party prepare his accounting.  If a fiduciary uses the services of a third party to prepare the account schedules, the fiduciary must ensure that the individual is aware that every single transaction is to be reported exactly as disclosed in the financial statements, canceled checks, and any receipts or invoices.  Failure to do so could give rise to possible liability years later.