On November 16, 2021, the Supreme Court of Delaware issued an opinion in Lavastone Capital LLC v. Estate of Beverly E. Berland (“Berland”) answering three certified questions under Delaware law. All three questions concerned claims brought by estates of insureds under 18 Del. C. § 2704 seeking to recover the death benefits paid to policyholders under life insurance policies issued with nonrecourse premium financing.
The policy in Berland was a $5 million policy issued by Lincoln Financial (“Lincoln”). The initial premiums were financed with a nonrecourse loan made by LaSalle Bank, with Coventry Capital I LLC as the lending-program administrator. On the application, the insured falsely stated that she had $10 million in assets and $180,000 in annual income. The policy was issued to the insured’s trust, which held it for more than two years, past the contestability period. The insured sold the policy to Coventry First LLC, as life settlement provider for Lavastone Capital LLC (“Lavastone”), for $453,822.88. The insured received $73,594.05. The insured passed away seven years later and Lincoln paid Lavastone the death benefit. The estate sued to recover the death benefit under 18 Del. C. § 2704(b).
The first and third certified questions concern the right of insured estates to bring a claim under 18 Del. C. § 2704(b). In response to the first question, the Court held that insured estates may bring claims under § 2704(b) where an insurance contract is void ab initio under § 2704(a). In answer to the third question, the Court held that insured estates could recover death benefits on life insurance policies procured without an insurable interest even if the insured committed fraud in the application, so long as the recipient of the death benefit (the current policyholder) was not a victim of the fraud.
The second certified question concerns insurable interest. It asked whether Delaware’s insurable interest statute, 18 Del. C. § 2704, “forbid[s] an insured or his or her trust to procure or effect a policy on his or her own life using a nonrecourse loan and, after the contestability period has passed, transfer the policy, or a beneficial interest in the trust that owns the policy, to a person without an insurable interest in the insured's life, if the insured did not ever intend to provide insurance protection beyond the contestability period.” The Court answered: “No, so long as the use of nonrecourse funding did not allow the insured or his or her trust to obtain the policy ‘without actually paying the premiums’ and the insured or his or her trust procured or effected the policy in good faith, for a lawful insurance purpose, and not as a cover for a wagering contract.”
The Court held that nonrecourse premium financing alone does not render a policy invalid under Delaware law. Rather, to determine whether a policy is valid, a court must look at (1) who paid the premiums; and (2) whether the insured obtained the policy in good faith—i.e., for a lawful purpose like estate planning and not as a cover for a wager. Furthermore, with respect to the first factor, the central question is whether nonrecourse funding allowed the insured to obtain the policy without paying the premiums.
The Delaware Supreme Court’s opinion on nonrecourse premium financing is no model of clarity, and lower courts interpreting it are likely to reach different conclusions about the validity of policies issued with such financing. Hence, carriers and estates will continue to challenge such policies and argue that the premium financing allowed the original owner to obtain the policy without paying the premiums, thereby rendering the policy invalid. But the Delaware Supreme Court stated clearly that nonrecourse premium financing alone does not render a policy invalid, which also means nonrecourse premium financing does not always lead to the conclusion that the original owner obtained the policy without having paid the premiums.
So the question remains: When, or under what circumstances, according to the Delaware Supreme Court, does the use of nonrecourse premium financing lead to a conclusion that the original owner obtained the policy without having paid the premiums? In many cases, the borrower pays off the loan with the proceeds from a subsequent sale of the policy. Does such repayment of the loan constitute paying the premiums? One would think so. In other cases, the borrower defaults on the loan but surrenders the policy in satisfaction of the loan. Because the borrower “repaid” the loan by surrendering the collateral, does this mean the borrower paid the premiums? Unfortunately, the Delaware Supreme Court did not answer these questions. Consequently, the meaning of the Berland decision may ultimately be determined by the trial courts who must interpret it.
Policyholders, of course, would argue quite reasonably that the answer lies in the Court’s direction to consider the context of the entire transaction and whether the insured intended to purchase the policy for lawful purposes. A lawful purpose might be any reasonable purpose for obtaining life insurance but does not include using a nonrecourse loan to fund the premiums in a hollow transaction that was intended only to put the policies into the hands of a stranger. Indeed, this interpretation would be consistent with the Court’s view that a policy is not invalid even if the original owner obtained the policy with the intent to sell it after the contestability period—so long as the original owner had a legitimate reason for obtaining the insurance.
Thus, the upshot of the Berland decision is that trial courts will now need to wrestle with how to implement the Delaware Supreme Court’s guidance on nonrecourse premium financing. But in determining whether a policy is void for lack of insurable interest, trial courts will almost certainly have to consider why the original owner purchased life insurance and used nonrecourse premium financing to do so. And that type of information will be difficult to ascertain when the person with such knowledge may no longer be alive.
Given that insurers and insured estates will continue to challenge policies obtained with nonrecourse premium financing, policyholders should prepare for such litigation and consider strategies to mitigate their risks. To the extent policyholders are interested in exploring such strategies, we are happy to (and ready to) assist.