Life Partners, et al. v. Arnold et al.; Texas Supreme Court confirms fractionalized life settlement interests sold to Texas investors are investment contract
Locke Lord LLP
USA May 27 2015
The ruling – On May 8, 2015, the Texas Supreme Court, in Life Partners, Inc., et al. v. Michael Arnold, et al., case number 14-1022, unanimously affirmed two Texas state appellate court decisions and concluded that fractionalized life settlement interests in the death benefits payable under in-force, non-variable life insurance policies were securities required to be registered under the Texas Securities Act. In so holding, the Texas Supreme Court over-turned a 2004 Texas appellate court decision, Griffitts v. Life Partners, that had arrived at a contrary result. Texas now falls in line with virtually all other state courts in the country on the issue.
Life Partners had been selling fractionalized life settlement interests since 1991. In 1996, the D.C. Circuit, in a case brought against Life Partners by the Securities and Exchange Commission, the two member majority, over a very strong dissent, ruled that the LPI life settlement interests were not securities under federal law because the profitability of the investment post–purchase depended solely on the longevity of the insured and not the significant efforts of the promoter post sale. Based on the presumed [see below on the retroactive application of the new decision] comfort of these two cases, LPI continued selling the life settlement interests around the country without registration under the Securities Act of 1933 or the state laws of any state that had not concluded, by statute or case law, that the life settlement interests were securities. In 2005, however, in a case with striking similarity to the SEC’s case against Life Partners in 1996, the Eleventh Circuit, in SEC v. Mutual Benefits, concluded that the life settlement interests were securities under federal law and disregarded any distinction between pre-and post sale efforts of the promoter. Life Partners ignored this case entirely in the conduct of its business.
The fundamental question before the Texas Supreme Court was whether life settlement interests were investment contracts under the 1946 U.S. Supreme court decision in SEC v. Howey, i.e., the investment of money in a common enterprises with the expectation of profits solely [primarily] from the efforts of others. The Texas Supreme Court had earlier adopted the Howey test in 1977 (Searsy v. Commercial Trading Corp.), so the principal issue was whether there was any justification in recognizing a distinction between pre and post sale efforts of the promoter. The Texas Supreme Court rejected the notion that there should be any distinction and furthermore concluded that there were significant post-sale services provided by Life Partners that were essential to the profitability of the investments in the life settlement interests.
Perhaps the most intriguing (and somewhat unexpected) aspect of the Texas Supreme Court ruling was that it should be afforded retroactive application. That issue is very significant because, among other things, there is a three year automatic strict liability rescission right for purchasers of a security that should have been, but were not, registered under the Texas Securities Act.
This case impacts the sale of fractionalized interests only; the parties conceded that the commonality requirement of Howey was satisfied [horizontal commonality in this case], so that it is fair to assume that this case has no adverse application to the sale of whole policies in Texas to a single investor. However, under the laws of many other states (although not federal law at this stage), the sale of a whole policy to an investor does constitute the offer and sale of a security under the state’s Blue sky laws.
Life Partners is in a bankruptcy proceeding under Chapter 11. The amount of the claims for the life settlement interest investors for rescission and securities fraud still within the statute of limitation(s) periods stand apart from the claims of the other life settlement interest holders whose claims may be time-barred.
The Trustee in the bankruptcy proceeding has seized upon the Texas Supreme Court case to take some very significant positions with respect to the life settlement investors which, using his terminology, hold “Contract Positions” with respect to the death benefits payable to the escrow agents in connection with approximately 3,600 life insurance policies with an aggregate face value in excess of $2.4 billion owned of record by Life Partners. Until the Trustee can sort through the complexities of the bankruptcy proceeding and potential claims of creditors/contract position holders, particularly in light of the Texas Supreme Court decision, he has suspended all payments of death benefit proceeds to contract position holders, advised them that they remain obligated to fund premium calls and servicing expenses for the life insurance policies with respect to which they hold contract positions and has frozen the sale and transfer of any of the contract positions on the grounds that such transfers might be in violation of applicable state security laws (presumably not limited to Texas).
On May 26, 2015, a petition for re-hearing was filed with the TX Supreme Court by the two escrow agent defendants on the grounds that although the Supreme Court correctly ruled as a matter of law that, upon the facts as stated by the Supreme Court in its opinion, the life settlement interests as described were investment contracts and therefore securities under the Texas Securities Act, those facts were not supported by the record of the case from the lower courts.
Locke Lord LLP - Brian T. Casey and Thomas D. Sherman |
