Court Emphasizes Unlawful Transaction’s Substance over Form
The parties filed cross-motions for summary judgment and the U.S. District Court for the Northern District of Illinois granted the insurance company’s motion. The district court concluded that the intricate web of transactions was designed to appear as an insurable interest to hide that it was a “complicated wager on a stranger’s life.” The court also held that the bank was not entitled to any of its payments paid on behalf of the various interest holders in the original scheme. The court did grant summary judgment in favor of the bank for reimbursement of the $13,000 in premium payments it made on behalf of the last beneficial owner of the policy, a hedge fund, on the theory that the hedge fund was an innocent buyer. The bank appealed the portions of the district court’s decision adverse to it, and the insurance company appealed the reimbursement of the $13,000 in premium payments to the bank.
The U.S. Court of Appeals for the Seventh Circuit upheld the district court’s decision that the policy was void as an unlawful wager on a stranger’s life. The appellate court stated that “Illinois law prohibits the initial sale of a life insurance policy to someone who has no insurable interest in the life of the insured.” An insurable interest exists when the policyholder has an interest in the life of the insured continuing, such as when a person takes out a policy on his or her own life or the life of a close family member. A pure wager exists when a policy is initially purchased or controlled by a party that has no insurable interest. The court explained that such a policy “gives the policyholder a sinister counter interest in having the life of the insured come to an end.”
The court explained that Illinois courts look at the substance of these types of transactions to determine if the policy was initially purchased in good faith. Here, the appellate court concluded that although the policy appeared to satisfy the insurable interest requirement, the policy was nevertheless an unlawful wager for several reasons: (1) The insured took out the policy as part of a broader scheme for the secondary market company; (2) the insured did not need nor could he afford the policy himself; (3) the financing for the policy was concealed from the life insurance company; and (4) there was no serious risk the insured would retain the policy.
As to the $13,000 refund to the bank for payments made on behalf of the hedge fund, the court reversed the lower court’s decision, concluding that the bank had not offered any evidence or argument to establish its right to the refund. The court also explained that the hedge fund was not an innocent party in the scheme and conducted an in-depth review of the policy before purchasing it.
Practitioners Should Be Mindful of Policy Considerations
Litigation Section leaders observe that this case continues to clarify the tension between recognizing that life insurance policies are contracts that can be assigned and not enforcing insurance policies for uninsurable interests. “This decision reaffirms the public health policy not to have a market in the lives of people. We do not allow unlimited freedom of contract,” explains Stephen L. Brodsky, New York, NY, Web and Practice Point Editor for the Section’s Commercial & Business Litigation Committee. “As examples, for good reasons, contracts to sell body parts or to put a ‘hit’ on another are not enforceable contracts. The same rationale applies here,” illustrates Brodsky.
This decision could impact the structure of secondary market arrangements to purchase life insurance policies. “The decision is not going to dramatically change the course of the life settlement market, but it could lead to a course correction for companies pushing the boundaries of a sufficient insurable interest in the life of the insured,” reasons John C. Bonnie, Atlanta, GA, cochair for the Section’s Insurance Coverage Litigation Committee.
Section leaders advise practitioners to be mindful of the serious risk of stranger-originated policy arrangements. “In jurisdictions with similar policies against stranger-originated life insurance, there seems to be a serious risk that the transaction could be determined to be invalid. In this case, the ultimate result was very sympathetic to the life insurer and extremely harsh for the final purchaser of the policy,” comments Jared M. Katz, Santa Barbara, CA, Web and Practice Point Editor for the Section’s Commercial & Business Litigation Committee.
“The transactions leading to legal challenges and judicial scrutiny involve policies that were not organically sought out,” agrees Bonnie. “They are policies that are created in the first place by speculators who combine them with other life policies to create an investment platform. In other words, they are policies that are created specifically to feed investment opportunities in the life settlement market,” he warns.