Delaware court upholds protection for life insurance investors

On May 26, 2022, the Delaware State Supreme Court released its decision in Wells Fargo Bank, NA and Berkshire Hathaway Life Insurance Company of Nebraska v. Estate of Phyllis M. Malkin (19-14689, 17-cv-23136, 172, 2021) (“Malkin”). The Malkin decision is particularly significant for life insurance investors because it flatly rejects the proposition that Section 2704(b) (Delaware’s so-called “estate law”) excludes all defenses and does not allow the party being sued to recover the premium under any circumstances. Instead, the Court clarified that common law defenses and counterclaims are available in response to a claim under section 2704(b) and that an investor can recover the premium paid on a canceled policy by depending on the facts of each case.

In Malkin, the Delaware Supreme Court decided two certified important questions regarding the application of the Delaware Uniform Commercial Code to transactions involving so-called “stranger origin life insurance” (STOLI) policies. First, Malkin held that, in the face of an action brought by an estate under 18 Del. C. § 2704(b) (Delaware Insurable Interest Act), an innocent downstream investor who owns a STOLI policy, or the investor’s securities intermediary, can not assert the bona fide buyer and securities intermediary defenses codified in Delaware Uniform Commercial Code (UCC) Sections 8-502 and 8-115, respectively. Second, an investor may assert common law defenses to a claim under Section 2704(b) and may recover the premium he paid to the insurer to prevent the lapse of the policy even if the policy is declared void ab-initiowhether the investor can justify a right to the bonus on the basis of a viable theory such as unjust enrichment.

In Malkin, insured Phyllis Malkin, was issued a life insurance policy by insurer American General Life Insurance Company (AIG) in 2005. To pay the premiums for the policy, Mrs. Malkin used a finance loan premiums without recourse. The only collateral for the loan was the life insurance policy itself, which had a face value of $4 million. When the loan matured in 2008, Ms. Malkin elected to waive the policy in settlement of the loan instead of paying the amount owed on the loan.

Between 2008 and 2012, Ms. Malkin’s policy was transferred several times and was eventually acquired by the appellant Wells Fargo Bank, NA (Wells Fargo), as a securities intermediary for its client, Berkshire Hathaway Life Insurance Company of Nebraska (Berkshire Hathaway). Berkshire Hathaway paid all policy premiums to prevent the policy from expiring.

Ms Malkin died in 2014 and AIG paid the death benefit to Wells Fargo as a securities intermediary for Berkshire Hathaway. In 2014, Berkshire Hathaway paid around $137,000 in bonuses to AIG. In 2017, Ms. Malkin’s estate sued Wells Fargo in the United States District Court for the Southern District of Florida to recover the full death benefit under 18 Del. C.§ 2704(b). The estate claimed, among other things, that the policy was governed by Delaware law and was void because it was issued in violation of Delaware insurable interest law.

The district court ruled that Delaware law applied to the Malkin policy and that the policy lacked insurable interest and was therefore void ab-initio. The Eleventh Circuit Court of Appeals upheld the district court’s decision that the policy was void ab-initio under section 2704(b) and certified two questions to the Supreme Court of Delaware in Malkin: (1) Can an innocent downstream investor, or its securities intermediary, assert bona fide buyer and securities intermediary defenses under Delaware Sections 8-502 and 8-115 UCC, respectively, to an estate’s section 2704(b) claim and (2) can a party against whom a claim under section 2704(b) is asserted recover the premium from an estate even if the font sucks ab-initio?

On issue 1, the Court held that the UCC defenses are not available at law. The Court held that the UCC’s defense under Rule 8-502 applies only to “adverse claims”, which the UCC of Delaware defines as “a claim that a plaintiff has a ownership interest in a financial asset and that it is a violation of plaintiff’s rights for another person to hold, transfer or process the financial asset”. According to the Supreme Court, policyholders of a STOLI policy never acquire the right to the death benefit. Instead, they only acquire a void ab-initio policy which, under established law, does not exist and does not entitle its holder to receive any product. The Court therefore held that because “[n]No one can have a “property interest” in a STOLI policy or its proceeds,” Section 8-502 does not apply to a claim by an estate under Section 2704(b).

The Court came to a similar conclusion regarding Delaware UCC Section 8-115, which provides that a securities intermediary “shall not be liable to a person having a claim adverse to [a] financial asset”, unless certain circumstances are met. The Court found that a claim under Section 2704(b) is not an adverse claim and, therefore, the defense was not available against such a claim by an estate.

Importantly, the Court also held that Section 2704 does not bar a defendant from asserting common law defenses and counterclaims such as unjust enrichment in response to a claim under section 2704(b). The Court held that in determining the availability of such defences, “courts must consider the elements of the common law defenses or counterclaims asserted – and, if applicable, the public policy underlying the defenses. betting on human life ban – to decide the viability of such defenses or counterclaims to an estate’s action under section 2704(b).”

The Court then addressed the second certified question and held that a party who is sued under Section 2704(b) can recover the premiums it paid on a voided policy as long as it proves its right to these bonuses under a “viable legal theory”. The court explained that recovery is possible on the basis of common law defenses and counterclaims such as unjust enrichment, as such counterclaims do not “violate on their face the Constitution’s general prohibition against betting.” of Delaware or the state’s longstanding policy of preventing STOLI policies from paying investors. The court held that “defendants under section 2704(b) can recover the premiums they paid on a policy subsequently determined as STOLI if they can establish the elements of a viable legal theory, such as unjust enrichment”.

Malkin is a significant development in the field of STOLI litigation as it provides investors with counterclaims and potential defenses to claims brought by estates under 18 Del. C. § 2704(b), including for recovery of premiums where a policy is deemed STOLI. In addition to unjust enrichment, other common law defenses that can be pursued include ratification and cowards, which were invoked in the 2019 United States Court of Appeals, Second Circuit decision. John Hancock Life Ins. Co. of New York v. Solomon Baum Fam irrevocable. Life Ins. Tr., or other common law defenses that are regularly invoked, including promissory estoppel, forfeiture, and unclean hands. As many Section 2704(b) cases often involve knowing and willful participation by the deceased insured in the STOLI conduct, Malkin offers several fronts to attack these so-called succession cases based on the knowledge and participation of the insured in the purchase, sale or transfer of a policy. Although investors and securities intermediaries defending against estate claims under Delaware law after Malkin cannot assert Delaware UCC’s defenses to Section 2704(b) claims, they can assert common law counterclaims such as unjust enrichment to recover damages for the participation of the insured to STOLI driving and recover the premium paid to the insurer to prevent a STOLI policy from expiring.

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