The Delaware Supreme Court’s Second Major Opinion on the Secondary Life Market Offers Substantial Protections for Investors

In Malkin, the Delaware Supreme Court decided two important certified questions concerning the Delaware Uniform Commercial Code’s application to transactions involving so-called “stranger-originated life insurance” (STOLI) policies. First, Malkin held that, when faced with an action brought by an estate under 18 Del. C. § 2704(b) (Delaware’s insurable interest statute), an innocent downstream investor-owner of a STOLI policy, or the investor’s securities intermediary, cannot assert the bona fide purchaser and securities intermediatory defenses codified in Delaware Uniform Commercial Code (UCC) Sections 8-502 and 8-115, respectively. Second, an investor may assert common law defenses in response to a Section 2704(b) claim and may recover the premium it paid to the insurer to keep the policy from lapsing even if the policy is determined to be void ab initio, if the investor can show entitlement to premium based on a viable theory such as unjust enrichment.

In Malkin, the insured Phyllis Malkin, was issued a life insurance policy by insurer American General Life Insurance Company (AIG) in 2005. To pay the policy’s premiums, Mrs. Malkin used a non-recourse premium financing loan. The only collateral for the loan was the life insurance policy itself, which had a face value of $4 million. When the loan came due in 2008, Mrs. Malkin chose to relinquish the policy in satisfaction of the loan instead of paying the amount due on the loan. 

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

Mrs. Malkin passed away in 2014, and AIG paid the death benefit to Wells Fargo as a securities intermediary for Berkshire Hathaway. By 2014, Berkshire Hathaway had paid approximately $137,000 in premiums to AIG. In 2017, Mrs. Malkin’s estate sued Wells Fargo in the United States District Court for the Southern District of Florida to recover the entire 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’s insurable interest statute. 

The District Court held that Delaware law applied to the Malkin policy and that the policy lacked insurable interest and was therefore void ab initio. The Court of Appeals for the Eleventh Circuit affirmed the District Court’s determination that the policy was void ab initio under Section 2704(b) and certified two questions to the Delaware Supreme Court in Malkin: (1) can an innocent downstream investor, or its securities intermediary, assert bona fide purchaser and securities intermediatory defenses under Delaware UCC Sections 8-502 and 8-115, respectively, to an estate’s Section 2704(b) claim and (2) may a party against whom a Section 2704(b) claim is asserted recover premium from an estate even if the policy is void ab initio?

On Question 1, the Court held that the UCC defenses are not available as a matter of law. The Court held that the UCC defense under Section 8-502 applies only to “adverse claims,” which the Delaware UCC defines as “a claim that a claimant has a property interest in a financial asset and that it is a violation of the rights of the claimant for another person to hold, transfer, or deal with the financial asset.” According to the Supreme Court, purchasers of a STOLI policy never acquire the right to the death benefit. Instead, they acquire only a void ab initio policy that, under established law, does not exist and does not entitle the holder to receive any proceeds. The Court, therefore, held that because “[n]obody 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 reached a similar conclusion regarding Section 8-115 of the Delaware UCC, which provides that a securities intermediary “is not liable to a person having an adverse claim to [a] financial asset,” unless certain circumstances are met. The Court concluded 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 to determine the availability of such defenses, “courts must look to the elements of the common-law defenses or counterclaims asserted—and, where appropriate, the public policy underlying the ban on human-life wagering—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 that is being sued under Section 2704(b) may recover premiums it has paid on a void policy so long as it proves its entitlement to those premiums under a “viable legal theory.” The court explained that recovery is possible based upon common law defenses and counterclaims such as unjust enrichment since such counterclaims do not on their “face violate the Delaware Constitution’s general prohibition of wagering or the State’s longstanding policy of preventing STOLI policies from paying out to investors.” The court held that “Section 2704(b) defendants may recover the premiums they paid on a policy later determined to be 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 because it provides investors with potential counterclaims and defenses against claims asserted by estates under 18 Del. C. § 2704(b), including for the recoupment of premiums in the event a policy is deemed STOLI. In addition to unjust enrichment, other common law defenses that may be pursued include ratification and laches, which were relied upon in the 2019 United States Court of Appeals, Second Circuit decision John Hancock Life Ins. Co. of New York v. Solomon Baum Irrevocable Fam. Life Ins. Tr., or other common law defenses that are routinely raised, including promissory estoppel, forfeiture, and unclean hands. As many cases arising under Section 2704(b) often involve knowing and willful participation by the deceased insured in STOLI conduct, Malkin provides multiple fronts on which to attack these so-called estate cases based on the insured’s knowledge and participation in the procurement, sale or transfer of a policy. Although investors and securities intermediaries defending against estate claims under Delaware law after Malkin may not assert Delaware UCC defenses to Section 2704(b) claims, they may assert common law counterclaims such as unjust enrichment to recover damages from estates for the insured’s participation in STOLI conduct and recoup premium paid to the insurer to keep a STOLI policy from lapsing. 

Feel free to contact Jule Rousseau, James Westerlind, Andrew Dykens, and Anna Mandel from ArentFox Schiff LLP’s Insurance & Reinsurance Practice Group to discuss this decision or these issues further.