Tennessee Court Upholds Public Policy Against Wagering in STOLI Context

Litigation concerning stranger-originated life insurance (“STOLI”) continues to unfold in state and federal courts across the country. Among other issues, STOLI-related lawsuits often involve disputes concerning the applicability of the contestability clause as a time-bar to a challenge to the validity of the subject policy. The latest court to confront this issue agreed with the insurer and held that the contestability clause did not bar such a challenge, relying in large part on case law and public policy against wagering contracts.

Last month, the United States District Court for the Eastern District of Tennessee issued a memorandum and order denying a defendant trustee’s motion for judgment on the pleadings in a lawsuit alleging, among other things, that the subject life insurance policy was an illegal wagering contract. The Eastern District of Tennessee premised its decision on a finding that Tennessee’s prohibition on wagering contracts extends to STOLI. Although the court indicated that the record would need to be more fully developed to determine whether the subject life insurance policy in fact constituted an illegal wagering contract, the court’s application of Tennessee’s anti-wagering law in the life insurance context is encouraging.

On November 14, 2014, plaintiff Sun Life Assurance Company of Canada filed suit in federal court against Conestoga Trust Services, LLC (“Conestoga”), as trustee of the Conestoga Settlement Trust, seeking a declaratory judgment based on an alleged STOLI scheme in connection with a two million dollar life insurance policy issued in 2008 on the life of Erwin Collins. Conestoga, on behalf of the sixth assignee of the ownership rights in the policy, moved for judgment on the pleadings, seeking to dismiss Sun Life’s complaint. Conestoga also sought judgment that it was entitled to the proceeds of the policy as a matter of law.

On September 29, 2015, the district court denied Conestoga’s motion. The court rendered several key findings, setting favorable precedent for insurers confronting STOLI-related issues. At the time the application for the policy was submitted, Mr. Collins, the insured, was 74 years old. The application identified the Erwin Collins Irrevocable Life Insurance Trust as the owner and sole beneficiary of the policy. Just over two years after issuance, Sun Life received the first of six ownership and beneficiary change requests. The last of these requests occurred on April 30, 2013, when the Conestoga Settlement Trust was designated as the owner of the policy. Mr. Collins passed away in June 2014, and Conestoga submitted a claim for benefits shortly thereafter.

In its opinion, following a fairly detailed description of STOLI schemes, the court plainly stated that “Tennessee tries to prevent STOLI schemes by requiring that purchasers of insurance policies have an insurable interest in the lives of insureds and by outlawing wagering contracts” (emphasis added). The court rejected Conestoga’s attempt to use the contestability clause as a defense. The court explained that Tennessee law is clear that contestability clauses do not bar “challenges that a policy is void as an illegal wagering contract, void for lack of an insurable interest, or void due to the invalidity of a trust.” The court further declared that “[i]f a life insurance policy is void for any of these reasons, the [contestability] clause is similarly void and without effect.” The court relied on an 1898 Tennessee Supreme Court opinion, which concluded that a wagering contract on the life of an insured was contrary to public policy. See Clement v. New York Life Ins. Co., 46 S.W. 561 (Tenn. 1898). The court also reaffirmed the Clement court’s finding that the contestability provision “relates only to matters arising between the insurer and the insured, and not to matters in which third persons are concerned.”

The court also foreshadowed an uphill battle for Conestoga’s next argument – that it was an innocent bona fide assignee under the policy. Although concluding that it could not yet determine whether Conestoga was an innocent bona fide assignee, the court reaffirmed the finding in Clement that “such assignment must be in good faith, and not as a mere colorable evasion of the provision in regard to wagering contracts, [] in order to validate or legalize the same for the proceeds of the policy.” Importantly, the court concluded that Tennessee law holds that a “transferee’s innocence or good faith would not revive a contract void from the inception as an illegal wagering contract.”

The court’s admonition against illegal wagering contracts is yet another win for insurers seeking to combat STOLI practices. On the heels of this decision, the United States Court of Appeals for the Seventh Circuit affirmed a decision in favor of Ohio National Life Assurance Corporation in a STOLI-related case. As reported in a previous Life Insurance Alert, the Seventh Circuit held that the subject policies were illegal and permitted Ohio National to retain premium and recover its attorneys’ fees.