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Life Insurance Exemptions from Creditor Claims

Financial abuse | Elder Law AttorneysLife insurance proceeds is one of the most common assets left to an estate or trust by a person who dies.  But, what happens when the proceeds are received? Can they be attached by creditors of the person who died?

Fortunately for beneficiaries, certain life insurance proceeds receive special protection under Arizona law.  Arizona has an “exemption statute” that in certain circumstances protects the proceeds of life insurance from claims of creditors of the person who died.  In other words, creditors may not go after certain life insurance proceeds to pay the debt and the beneficiaries of the life insurance are entitled to keep the money.

The Life Insurance Exemption

Specifically, A.R.S. § 20-1131(A) provides that proceeds of life insurance paid to the beneficiary of the person who died are exempt from claims of creditors of the person who died.  The beneficiary of the person who died must be a third-party, meaning someone other than the person who died or that person’s legal representative.  Thus, as long as the proceeds are payable to the heirs of the person who died, they are exempt.  That so-called exemption statute was enacted because the Arizona legislature wanted to encourage people to provide for their heirs and, in turn, protect the heirs from the deceased’s creditors.

So, what happens if the life insurance proceeds are payable to a trust?  That issue was addressed in our article on the Estate of King.

And, what happens if the insurance policy was payable to a third-party beneficiary, such as the person’s surviving spouse, but the policy premiums were paid with funds that were allegedly stolen?  That was the issue in the Arizona Court of Appeals’ recent decision in ML Servicing Co., Inc. v. Coles.

The Mortgages Ltd. Case

ML Servicing was formed after the catastrophic failure and bankruptcy of the now infamous company, Mortgages Ltd.  “Mortgages, Ltd. was one of Arizona’s largest and oldest private mortgage lenders,” according to the Court’s decision.  But, in 2008, its business fell apart and a group of creditors initiated an involuntary bankruptcy of the company.  Around the same time, Scott Coles, the flamboyant millionaire CEO of Mortgages Ltd., committed suicide.  According to a Phoenix New Times article, the day before his suicide, Coles signed a last will and testament leaving his entire estate to his three children and first wife, and a note stating that his second wife, Ashley, said she no longer wanted to be married to him.  However, Coles had purchased various life insurance policies, totaling more than $60 million in benefits.  Coles had named Ashley as the beneficiary of those policies, and apparently did not make any change in the beneficiary designations before his suicide.  Those life insurance proceeds were at issue in the ML Servicing Co., Inc. v. Coles case.

Mortgages Ltd. was funded by a variety of investors, whose funds were then lent out to borrowers.  Following the collapse and bankruptcy of Mortgages Ltd., many investors were left unpaid and loans to borrowers were left unfunded.  Not surprisingly, they searched for any available source from which to recover their losses, including the $60 million in life insurance proceeds left to Ashley.

So, ML Servicing (the entity formed to represent the creditors of Mortgages Ltd.) filed a lawsuit against Ashley claiming that it was entitled to all of the life insurance proceeds because the life insurance policies were purchased with funds from Mortgages Ltd. that Coles improperly used to pay the premiums.  In other words, among other things, ML Servicing claimed that Coles misappropriated or fraudulently transferred funds from Mortgages Ltd. to pay the insurance premiums.  And, as a result, ML claimed that the creditors of Mortgages Ltd., not Ashley, were entitled to all of the insurance benefits.

Ashley moved to dismiss the lawsuit, arguing that the exemption statute clearly applied and barred the claims.  The trial court agreed and dismissed the lawsuit.  So, ML Servicing appealed.  In its September 16, 2014 opinion, Division 1 of the Arizona Court of Appeals affirmed the trial court, dismissed ML’s claims and awarded Ashley all of the life insurance proceeds.

The Court analyzed the exemption statute and confirmed Arizona’s public policy, as reflected in the statute, to protect heirs from creditors.  Because ML Servicing was a creditor and the life insurance proceeds were payable to Ashley, not Coles or his legal representative, the Court held that the exemption statute unmistakably applied, such that ML Servicing was not entitled to any of the proceeds, notwithstanding the allegation that Coles misappropriated the funds from Mortgages Ltd. to pay for the insurance policies.

The Court further explained that ML Servicing had an adequate remedy under the exemption statute.  It could have sued to recover any premium payments that were made with funds that rightfully belonged to Mortgages Ltd.  The exemption statute includes a partial exception to protecting life insurance proceeds from creditor claims.  Specifically, A.R.S. 20-1131(B) provides that “the amount of any premiums for insurance paid in fraud of creditors, with interest, shall inure to their benefit from the proceeds of the policy.”  Based upon this exception, the Court held that ML Servicing could have made a claim to recover the amount of any premium payments made on the life insurance policies with funds that it could prove were fraudulently taken from Mortgages Ltd.  The Court stated that provided an adequate remedy for any such misappropriation and that it would destroy the intent of the statute to allow ML Servicing to recover all of the insurance benefits even if the premium payments were made with misappropriated funds.  However, ML Servicing had put all its eggs in one basket.  It did not bring a claim against Ashley to recover the amount of any such premiums, estimated to be about $130,000 per year (and far short of the $60 million in insurance benefits).  As a result, the entire lawsuit was dismissed.

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Pursuing and recovering life insurance benefits for an estate or trust in Arizona can be complicated and involved.  Once the proceeds are recovered, keeping them and protecting them from improper creditor claims is also crucial.  If you have any questions or need the help of an Arizona attorney to assist in recovering, protecting or pursuing life insurance benefits, please do not hesitate to contact Berk Law Group, P.C.