With the current economic realities, trustees and debtors-in-possession (“DIP”), typically with oversight by both secured and unsecured creditors, are proactively managing the assets in the bankruptcy estates they are administering to maximize values in order to provide a meaningful distribution to creditors. To further this goal, practitioners are discovering new and creative ways to monetize “nontraditional” estate assets. One historically overlooked class of estate assets—life insurance policies—can yield significant returns to creditors if properly managed, and bankruptcy professionals are just beginning to understand how to unlock the policy’s value by marketing and selling such policies through life settlements. Recent trends demonstrate that, where trustees and DIPs successfully monetize a debtor’s interest in life insurance policies owned by the debtor—regardless of whether the insured is (i) the debtor, (ii) the debtor’s employee or (iii) an individual wholly unrelated to the bankruptcy case—the potential market values can dwarf the policy’s then-existing cash surrender value (“CSV”). Consequently, practitioners should ensure that the necessary focus is applied to unlock the potential value of these all too often neglected assets. Corporate–owned life insurance policies, also known as “key person” policies, have traditionally been viewed as a contingent asset, i.e., the policy has no value until the key person dies. Typically, the corporation (as owner) pays the insurance premiums on a key person and designates itself as the beneficiary of the policy. This practice effectively mitigates the financial impact associated with the sudden passing of a key executive. However, when the corporation is in bankruptcy, the key person policy often has negligible value and is frequently categorized as a liability (especially given the premium payment obligations), rather than an asset. The same is often the case for other types of life insurance policies, including policies used to insure buy-sell agreements, split-dollar funded policies and personally–owned policies assigned to lenders. As explained below, 11 U.S.C. § 363 allows the trustee or DIP to sell estate assets outside of the ordinary course of business. If the sale of policies is not possible, the trustee or DIP has three options to evaluate when administering a life insurance policy: (i) allow the policy to lapse, (ii) continue to pay the premiums to maintain the policy (assuming, of course, sufficient funds exist and the lender has consented to the use of its cash-collateral), or (iii) surrender the policy for its CSV. Unless the insured died during the bankruptcy case, a distasteful and speculative prospect for any creditor, the foregoing alternatives would never permit the estate to realize a value in excess of CSV. With Section 363, however, a trustee or DIP can expose the policies to the secondary market through court-approved auction procedures. Case studies suggest that well-structured 363 sales may permit the estate to realize as much as three to five hundred percent (300% to 500%) over the policy’s CSV.
Legal Justification for Life Settlements
Mechanics of a Life Settlement
A Buyer's Prospective
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