Featured Posts

Difilippo vs. Reed (Re: Estate of King)

May 13, 2013

Source: Steve Leimberg Archive Message #2096

 

 

“The Court held that state law protects life insurance proceeds paid to a trust and a third-party trust beneficiary from the reach of the trustor's creditors and that King did not waive that protection by generically directing debts be paid from the Trust. So the judgment of the probate court was reversed and remanded for further proceedings consistent with this decision.

 

 

Planners should note this case reinforces the importance of two important rules of life insurance planning. First, always name not only primary, but also secondary, back-up beneficiaries to a life insurance policy. Second, never (well, almost never) name the estate as beneficiary.

 

Would the outcome of this case have been different if King had named her estate as beneficiary of the life policy?  Perhaps not – but in my opinion – why take the chance?   I’ve seldom seen a situation where naming the estate as beneficiary of life insurance was a wise choice.”

 

 

EXECUTIVE SUMMARY:

 Under Arizona law, life insurance proceeds paid to a trust were held to be beyond the reach of the grantor’s creditors. The Court held that the grantor did not waive that protection by generically directing that estate debts be paid from the trust. The statutory protections afforded to life insurance proceeds could be waived only in specific, clear, effective language.

 

 

FACTS:

King, a single mother, died in November 2008.

 

King had created the revocable Trust of which her minor son, Nicholas, was the sole beneficiary. King designated Reed, as both the personal representative of her estate and the trustee of the Trust.

 

King had also purchased a life insurance policy, which she designated an asset of the Trust, and named the Trust as the beneficiary of the policy.

 

 

At her death, King was “underwater” on various real estate and other loans and her estate didn’t have enough money to pay her debts.  When she died, the life insurance policy on her life paid $2,000,000 into the Trust. Although the Trust contained other assets, such as property, stocks, and bank accounts, those assets alone were insufficient to pay King's debts.

 

 

John DiFilippo is King's former husband and Nicholas's father. DiFilippo filed claims as a creditor against King's estate, along with several other creditors. DiFilippo filed a petition asking the probate court to allow his claim against the "Estate and/or Trust."

 

 

Reed, the trustee, opposed the claim, arguing that life insurance proceeds were exempt from claims against a decedent's estate pursuant to Arizona state law.  The creditors countered that Arizona state law did not exempt life insurance proceeds unless those proceeds were payable to a third person "other than the person effecting the insurance or [the person's] legal representatives." They asserted that Reed, as trustee, was King's legal representative and that, because King purchased the life insurance policy, the statute offered no protection for the proceeds.

 

 

The probate court held that Arizona state law does protect insurance proceeds paid to trusts - but went on to state that here - the express terms of the Trust waived the protection and directed that the insurance proceeds be used to pay debts of King's estate.

 

 

Reed filed a motion for clarification/reconsideration, which the probate court denied.

 

 

 

Reed filed a timely notice of appeal which led to this case.

 

 

ISSUES OF FIRST IMPRESSION:

The state Appeals Court here was forced to address two issues of first impression:

 

 

(1)   Does Arizona law protect life insurance proceeds from the insured's creditors when the proceeds are paid to a trust whose beneficiary is a third party?

 

(2)   If the statute does protect the proceeds, did the language of the trust document waive such protection when that language generically provides the trust should pay the unpaid debts of the estate?

 

 

In construing a trust, the Court’s goal is to determine the intent of the grantor.  To find that intent, a court will generally limit its examination to the “four corners of the document

 

 

The court here observed that under the applicable state law “Life insurance proceeds paid to a decedent's beneficiary are exempt from claims of creditors of the decedent's estate…”

 

 

It added that the language of the Arizona statute is broad enough to also protect such proceeds when they are paid to a trust created by the insured in which the beneficiary is a third party:

 

 

 

“If a policy of life insurance is effected by any person on the person's own life . . . in favor of another person having an insurable interest in the policy, or made payable by . . . other means to a third person, the lawful beneficiary or such third person, other than the person effecting the insurance or the person's legal representatives, is entitled to its proceeds against the creditors and representatives of the person effecting the insurance.”

 

 

 

Protective statutes such as Arizona’s   are generally construed liberally because legislatures wanted to encourage individuals to provide for their heirs and in doing so, protect their heirs from their creditors. 

 

The Court noted that the creditors here were unable to cite cases to the contrary or otherwise support their contention that the state’s law does not protect life insurance proceeds paid to a trust beneficiary from the settlor's creditors.

 

 

 

The Creditors had argued that the statute does not protect the life insurance proceeds because King was the trustee of the Trust at the time she effected the policy, the Trust was the owner and beneficiary of the policy, and the policy was an asset of the Trust.

 

 

 

But the Court here quoted a Louisiana Court of Appeals holding  that an insured's creditors cannot reach life insurance proceeds on the life of the insured because the proceeds "do not come into existence during his life, never belong to him, and pass by virtue of the contractual agreement between the insured and the insurer to the named beneficiary."

 

 

Likewise, in this case, the proceeds of the life insurance proceeds were never King's or Reed's. Although King bought the life insurance policy and named the Trust as beneficiary when she was the trustee, only her death triggered payment of the proceeds and a change in the trustee to Reed, her personal representative. However, Reed personally was not the beneficiary of the life insurance proceeds. The Trust was the beneficiary. So neither Reed nor King was the beneficiary of the Trust; the sole beneficiary was King's minor son. Although the policy may have been an asset of the Trust, that does not affect the applicability of the protective statute.  Therefore, neither King (who purchased the policy) nor her personal representative (Reed) was the beneficiary of the policy proceeds. So the court concluded that the state law protects the policy proceeds.

 

 

 

The creditors argued that, because King’s trust was revocable, it was liable to her personal creditors because the property of a revocable trust is subject to the claims of the settlor's creditors to the extent that the settlor's probate estate is insufficient to meet the claims.

 

 

The Court disagreed with that argument.  It noted that state law provides that the trust is liable for such debts "subject to the settlor's right to direct the source from which liabilities will be paid" and such liability is precluded "to the extent that state or federal law exempts any property of the trust from these claims . . . ."  Since King did not direct that the proceeds be used to pay the estate debts or effectively waive the protection under the protective statute, the exemption remains. 

 

 

As in many other states, here, the Arizona legislature broadly protected beneficiaries of life insurance policies from the insured's creditors.  Its legislature enacted the trust code in question to signal to potential trust settlors that "Arizona is a 'trust friendly' jurisdiction" by making clear that life insurance proceeds paid to individual and trust beneficiaries are protected from creditors of both the settlor and beneficiaries.  Therefore, the Court concluded that the statute protects life insurance policy proceeds paid to a trust beneficiary from the insured/settlor's creditors.

 

 

CAN YOU WAIVE STATUTORY PROTECTION?

 

 

 

Of course, persons protected by a statutory provision can waive that protection, unless "waiver is expressly or impliedly prohibited by the plain language of the statute.  But the Court here noted that the King’s trust did not use clear, effective language to waive the protections of Arizona’s protective statute.  When a statutory protection can be waived, the waiver must be clearly intended. A waiver is sufficiently express if "the language of waiver clearly conflicts with the right and thereby demonstrates the beneficiary's intent to waive."

 

 

 

 

Like many states, Arizona law does not expressly or impliedly prohibit a waiver of its protections.  In fact, every court that has considered whether a person can waive the statutory protections afforded to life insurance proceeds has held that the protections can be waived. But, to do so, “clear, effective language” must be used.   Courts "will not presume, from general terms employed in a will, that the testator intended to deprive his widow and children of a fund secured to their exclusive benefit by the statute."

 

 

 

When a probate estate includes funds from a life insurance policy, various courts have considered whether a generic statement in the estate documents that the estate shall pay the estate's debts is sufficient to waive statutory protection of the insurance proceeds from the deceased's creditors. In cases, where there were potentially valuable assets in the estate other than a life insurance policy, the courts have held that a directive to pay the testator's debts must explicitly include the life insurance proceeds in that directive; a general directive to pay the debts from the estate, without mention of the life insurance proceeds, does not waive the statutory exemption. 

 

 

 

These holdings are consistent with the view of one of the leading commentators on insurance law:

 

 

“For the exemption of the statute to be deemed waived it is necessary that the insured include in his or her will a clear direction that the insurance should be used for the payment of his or her debts. The mere inclusion in the will of a provision directing the payment of debts is not deemed a sufficient manifestation of an intent that the proceeds of insurance should be used for the payment of creditors. Likewise, the inclusion in the husband's will of a provision directing payment of all his debts and the distribution of the residue to his wife does not deprive her of her right to the proceeds under the statutory exemption as against his creditors, where he did not specifically refer to the policy in his will."

 

Here, King's will and the Trust do not specifically state that the debts should be paid from the life insurance proceeds. Therefore, the Court ruled that the statutory protection of King's life insurance proceeds was not waived and King's creditors cannot reach the life insurance policies.

 

 

 

As a last gasp,  DiFilippo argued that Reed, as the trustee, waived the protection of the statute by paying his attorneys' fees as personal representative of the estate from the Trust, presumably from the insurance proceeds.  But the Court pointed out that only King could have waived the statutory protection.  Reed, as trustee, could not – especially since the legal fees were incurred after King's death to protect the estate and Trust. Thus, they were not the debts of King, the person who purchased the insurance.

 

 

 

CONCLUSION:

 

The Court held that state law protects life insurance proceeds paid to a trust and a third-party trust beneficiary from the reach of the trustor's creditors and that King did not waive that protection by generically directing debts be paid from the Trust. So the judgment of the probate court was reversed and remanded for further proceedings consistent with this decision.

 

 

 

PLANNING LESSONS:

 

 

Planners should note this case reinforces the importance of two important rules of life insurance planning:

 

 

 

ALWAYS NAME NOT ONLY PRIMARY BUT ALSO SECONDARY BACK-UP BENEFICIARIES TO A LIFE INSURANCE POLICY.

 

 

 

NEVER (WELL, ALMOST NEVER) NAME THE ESTATE AS BENEFICIARY 

 

Would the outcome of this case have been different if King had named her estate as beneficiary of the life policy?  Perhaps not – but in my opinion – why take the chance?   I’ve seldom seen a situation where naming the estate as beneficiary of life insurance was a wise choice.

 

 

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

 

 

Please reload

© 2014 James R. Modrall, III

FOLLOW US:

  • w-facebook