The Application of a

No-Contest Clause

in a Trust

If you think that you have been improperly excluded from an inheritance or did not receive a fair distribution under a trust, you may wonder if there is any recourse to challenge the instrument. An individual who can demonstrate valid grounds to challenge a trust may be successful in overturning the trust. The typical grounds for contesting a trust include lack of mental capacity, mistake, undue influence, and duress. But challenging a trust is difficult and can unnecessarily delay the distributions to be made in accordance with the instrument.

A no-contest clause can be inserted into a trust to deter challenges to the validity of the trust. This clause affects only those whom the trust names as a beneficiary in the first place. The clause provides that any person who has a beneficial interest in the trust will forfeit such interest if he asserts a challenge to the trust. If the challenger was not named as a beneficiary, then the no-contest clause would not impede a challenge. Such an individual would not lose anything by contesting the trust.

In California, no-contest clauses have been historically disfavored, but several courts still allowed them in some circumstances. In 2008, California passed Senate Bill No. 1264 which repealed the prior law and proclaimed that no-contest clauses are invalid. The law provides that in California, a no-contest clause is enforceable only in the following specific circumstances: (i) a “direct” contest brought without probable cause, (ii) a challenge to the actual transfer of assets, or (iii) the filing of a creditor’s claim. A “direct contest” brought without probable cause includes those based on forgery, lack of proper execution, diminished capacity, menace, duress, fraud, undue influence, revocation, or disqualification of a beneficiary. The new law allows very few exceptions to the general prohibition on no-contest clauses.

The goal in restricting the enforceability of no-contest clauses, as indicated by the Supreme Court, is to prevent abusive fiduciary conduct by providing an outlet for disclosing such actions. No-contest clauses would otherwise have a chilling effect on beneficiaries who fear relinquishing their inheritance if they assert that the trust is invalid.   

Should You Choose a Partnership Structure for Your Business?

Once you have identified a business to purchase, there are a number of legal and practical actions to take to ensure that the transaction proceeds successfully and seamlessly. At each stage of the purchasing process, buyers should be confident that the target business is legally sound, that the transaction can proceed without legal and financial obstacles, and that the proper documents and records are prepared and executed.

Step one: Before entering into agreements related to the purchase. Prior to drafting and executing the necessary legal agreements, prospective purchasers should investigate the viability of the transaction. The due diligence process enables the purchaser to review recent financial statements, tax records and liabilities, outstanding contracts, and business debts.  In addition to assessing the financial state of the target business, the prospective buyer should ensure that the business is in compliance with applicable laws. Licenses and permits that are necessary for that particular establishment to operate should be timely obtained.  Purchasers should also check that zoning laws permit that business to be conducted in a specific area and that any environmental regulations have been addressed. Purchasers should obtain professional assistance to accurately determine the value of the business in order to establish a purchase price. There are a number of valuation methods that can be used, and some may be more appropriate based on the nature and financial profile of the business.

Step two: Preparing legal and financial documents. Once the groundwork for the transaction has been established and the prospective purchaser continues to research the health of the business, the parties can draft the necessary agreements. This includes a letter of intent that specifies the terms of the purchase of the business, including the purchase price and the conditions for the sale. The sales agreement – the pivotal document that finalizes the transaction and addresses every aspect of the purchase- must be negotiated and agreed upon by the parties. Other ancillary agreements, such as confidentiality or nondisclosure agreements to protect the seller’s proprietary information, or real property leases to handle any outstanding leases on the existing site of the business, may also need to be executed.

Step three: Closing the transaction. After the purchase agreement has been signed, the final step entails preparing documentation evidencing and completing the sale. Security agreements, UCC financing statements, a bill of sale, employee contracts, and IRS acquisition forms, among others, must be produced at the conclusion of the transaction.          

Undertaking the above steps in purchasing a business provides protections for both the purchaser and seller and helps facilitate a smooth transition from one business owner to another.