Ch. 7 Trustee Can Recover Value of Life Settlements

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By Diane Davis

Jan. 15 — A Chapter 7 debtor's life insurance policies are “an interest of the debtor” in property and aren't excluded from the bankruptcy estate, the Ninth Circuit held Jan. 8.

Affirming the district court, Chief Judge Sidney R. Thomas of the U.S. Court of Appeals for the Ninth Circuit concluded that the Chapter 7 trustee can recover in an avoidance action the market value of the life settlements. The debtor's unmatured term life insurance policies were sold to the defendant banks prior to his death and the debtor failed to disclose the transactions when filing for bankruptcy.

The life settlements weren't excluded from the bankruptcy estate under Bankruptcy Code Section 541(b) based on the plain language of the statute, the court said. Section 541 describes what is property of the estate. According to the appeals court, neither life insurance policies, nor viatical settlements are listed among the Section 541(b) exclusions.

‘Life Settlement' Transactions

A substantial market has developed for the purchase of unmatured term life insurance policies, called “viatical settlements” or “life settlement” transactions, according to the court, in which the policy holder receives a lump-sum settlement greater than the cash surrender value of the policy but less than the policy's death benefit.

The purchaser continues to pay the policy premiums and collects the death benefit when the policyholder dies. The purchaser typically offers the life insurance benefit of the policy to potential investors, according to the court.

These type of settlements frequently occur when the policyholder is terminally ill and needs funds to pay for “end-of-life” care or needs “present cash more than the security of a death benefit,” the court said.

The purchasers/defendants U.S. Bancorp, U.S. Bank, N.A., and Coventry First LLC paid approximately $507,000 for life settlements with debtor David Green and received $9 million in death benefits when he died shortly thereafter.

Prior to his death, the debtor filed for Chapter 7 bankruptcy protection in which a debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors.

The debtor, however, failed to disclose three life settlement transactions executed between himself and Coventry First, U.S. Bancorp, and U.S. Bank National Association.

Chapter 7 trustee Leslie T. Gladstone's avoidance action wasn't time-barred, the court said, because the debtor's fraudulent concealment of the life insurance transactions equitably tolled the statute of limitations under Section 546(a)(1).

The court also agreed with the district court that the trustee should have been granted leave to amend the complaint after the discovery of new evidence, and remanded the case for further proceedings.

Failure to Disclose Transactions

The first set of the debtor's transactions involved two Transamerica policies, one with a face value of $2 million and the other with a face value of $4 million. The debtor transferred the beneficial interest in the policies to his wife, Eileen, who then signed a life settlement agreement to sell the policies to the defendants for $188,000 and $193,000, respectively. After his death five months later, the defendants received $6 million, the face value death benefits for the policies.

A month before filing Chapter 7, the debtor and his wife signed a life settlement agreement to convert a term life insurance policy and sell it to the defendants for $280,000, plus $34,776 in premium reimbursements. Eileen transferred the beneficial interest of the policy to the defendants shortly before the bankruptcy, but the policy wasn't transferred until after the bankruptcy was filed.

Eileen was paid $314,776 under the agreement, and after the debtor's death, the defendants received $3 million from the policy.

More than a year later, the trustee discovered these undisclosed assets and filed a complaint to avoid these transactions as fraudulent transfers under Section 548.

The bankruptcy court granted the defendant banks' motion for summary judgment, and the trustee appealed to the district court.

The district court reversed the judgment of the bankruptcy court and the defendants appealed to the Ninth Circuit.

Excluded From Estate?

The defendant banks argued that the life insurance policies and life settlements were excluded from the bankruptcy estate by a judicially created exclusion.

According to the defendants, the estate's interest is limited to the cash surrender value of the life insurance policies, of which there was none.

The defendants relied on Burlingham v. Crouse, 228 U.S. 459 (1913), and its progeny to argue that it is implied that life settlements are excluded from a bankruptcy estate.

The Ninth Circuit noted, however, that the defendants' argument is based on a provision of the Bankruptcy Act of 1898, which was abrogated by the adoption of the Bankruptcy Code in 1978.

According to the court, Burlingham and its progeny aren't on point with the facts of this case and aren't controlling.

The appeals court concluded that the debtor's interests in life insurance policies and life settlements weren't excluded from the property of the bankruptcy estate under Section 541(b).

The court also found that the property wasn't exempt under Section 522, which addresses exemptions. The debtor didn't claim the property as exempt and the defendants lacked standing to raise that argument. The court also noted that the defendants failed to present that argument to the district court.

Active Concealment by Debtor

The Ninth Circuit determined that the trustee's avoidance action wasn't time-barred under the two-year statute of limitations under Section 546(a)(1)(A).

The record is clear, the court said, that the debtor and his agents took steps to conceal the life settlement transactions with the defendants by transferring the beneficial interest in the policies to his wife before the sale to defendants was completed.

The defendants also knew that the debtor had transferred the beneficial interests in the life insurance policies to his wife, the court said.

According to the court, equitable tolling was appropriate due to the debtor's concealment.

Finally, the court found that the trustee should have been granted permission to amend the complaint after newly discovered evidence showed a post-petition transfer.

Judge Consuelo M. Callahan, and Senior Judge James K. Singleton of the U.S. District Court for the District of Alaska, sitting by designation, joined the opinion.

Susan C. Stevenson and Jennifer E. Duty, Pyle Sims Duncan & Stevenson, San Diego, Calif., represented defendants/appellants U.S. Bancorp, U.S. Bank N.A., and Coventry First LLC; Sean C. Coughlin, Financial Law Group, La Jolla, Calif., represented plaintiff/appellee Leslie T. Gladstone; Roland R. Peterson and Angela M. Allen, Jenner & Block, LLP, Chicago; Carl N. Wedoff, Jenner & Block, LLP, New York, N.Y., represented amicus curiae National Association of Bankruptcy Trustees.

To contact the reporter on this story: Diane Davis in Washington at

To contact the editor responsible for this story: Jay Horowitz at