Blue Flower

By James Maxon, Esq. Culhane Meadows PLLC

Anyone familiar with life settlements transactions, the sale of a life insurance policy that is no longer wanted or needed into the secondary market for life insurance, knows that policy sellers are required to make a representation and warranty to the effect they are neither currently in bankruptcy nor contemplating bankruptcy. In fact, it would be fair to say this language has become boilerplate and little if any attention is paid to it.  And, in cases where a policy owner has previously declared bankruptcy while best practices dictate that the filing and discharge order be reviewed, this step is sometimes skipped due to the perception that there is little or no risk associated with a past bankruptcy. A recent case, however, underscores the importance of including this language in purchase agreements and making sure that any previous bankruptcy filings are carefully scrutinized.  In the opinion, Gladstone v. U.S. Bancorp and Coventry First, No. 13-55773 (9th Cir. 2016), the U.S. Court of Appeals for the Ninth Circuit concluded that the debtor’s interests in life insurance policies, including the secondary market value of the policies and resulting life settlements, constituted a recoverable “interest of the debtor in property” pursuant to 11 U.S.C. §548(a)(1).

The debtor, David Green, filed a Chapter 7 bankruptcy petition in 2007. In that petition, he failed to disclose several assets, including three insurance policies that were purchased in life settlements transactions by U.S. Bank and Coventry First for a total of $507,000. Five months after filing bankruptcy, Mr. Green died and the purchasers collected $9,000,000 in death benefits.

Over a year after the Chapter 7 trustee learned of Mr. Green’s death, she was informed of the existence of the policies sold in life settlements.  When Mr. Green’s wife and the agent involved in the life settlements refused to cooperate with her investigation, the Chapter 7 trustee instigated an adversary proceeding to avoid the transfers of the policies and to recover the life settlements as fraudulent transfers. The bankruptcy court granted the purchasers’ motion for summary judgment and the trustee appealed. A district court reversed the bankruptcy court’s judgment, and the matter was appealed to the Ninth Circuit, which upheld the district court.

The question presented to the court in the appeal was whether “the debtor’s interests in the term life insurance policies, including the secondary market value of the policies and resulting life settlements, constitute a recoverable “interest of the debtor in property’” under the law.  In upholding the district court’s reversal of the bankruptcy court’s decision to dismiss the adversary proceeding, the Ninth Circuit concluded that because the debtor held ownership of the policies prior to their transfer and the “property of the estate” includes all property to which debtor has legal title, that the policies were in fact included within the debtor’s bankruptcy estate. The court also noted that “as indicated by the life settlements in this case, the term life insurance policies owned by the debtor had market value to the debtor independent of the death benefit.  Therefore, the term life insurance policies and the life settlements would have been part of the bankruptcy estate if he had not transferred them.”

Thus, the Ninth Circuit held that the life settlements, because they were not disclosed in the bankruptcy proceeding, were “fraudulent transfers” and should be voided and recovered by the debtor’s estate. Practically speaking, in addition to being an important reminder to participants in the life settlements market that a seller’s past bankruptcy can come back to haunt them, the Ninth Circuit’s decision also serves as an important confirmation of the value life insurance policies can have to sellers who choose to sell them into the secondary market rather than lapsing or surrendering them.