Two bankruptcy judges in Texas have now rejected clever arguments that would have effectively overruled the Texas legislature and terminated the state exemption for owners and beneficiaries of life insurance policies.
The facts were simple and typical for debtors with whole life insurance policies.
A couple in chapter 7 both had whole life policies. The wife was the owner of a $50,000 policy on her life. Her husband was the beneficiary. The policy had a $13,000 cash surrender value.
The husband, also in chapter 7, had a $100,000 policy on his life. His debtor/wife was the beneficiary. The husband’s policy had a $76,500 cash surrender value.
Under state law, they both claimed exemptions covering the policies and their cash surrender values.
Before 1991, there was a loophole in the Texas exemption for life insurance. Because the former statute did not exempt cash values, courts held that policies were like bank accounts that the insured could access at any time and that creditors could seize. The Fifth Circuit observed that the ability of creditors to seize the policies effectively destroyed whole life policies in Texas. Milligan v. Trautman (In re Trautman), 496 F.3d 366, 369-370 (5th Cir. 2007).
The Texas legislature amended the exemption statute in 1991. The law now exempts “any benefits, including the cash value and proceeds of an insurance policy, to be provided to an insured or beneficiary” under a life insurance policy. [Emphasis added.]
The trustee objected to the couple’s exemption claims, based on the idea that the debtors’ only rights were as owners of the policies and that those rights were not exempt.
In his fact-finding, Bankruptcy Judge Craig A. Gargotta of San Antonio said in his February 14 opinion that the debtors had exempted the policies, which had cash surrender values of $13,000 and $76,500, respectively. He said that the trustee therefore could not liquidate the policies for the benefit of creditors because the policies were exempt. There was no cash surrender value to exempt, because the debtors had not surrendered the policies.
Even if the debtors had exempted only the cash surrender values, Judge Gargotta said that the Texas statute now “explicitly allows debtors to exempt the cash value of an existing life insurance policy.”
In Trautman, the Fifth Circuit held that the amended statute did not “exempt money from a surrendered whole-life policy, money a beneficiary will certainly never see.” [Emphasis added.] On the other hand, the appeals court said in dicta that creditors “cannot now garnish, seize, or claim in bankruptcy the cash values of an existing policy — a blessing to contingent beneficiaries, who now may later receive a death-benefit.” [Emphasis in original.]
Judge Gargotta held that the debtors had properly exempted their policies. He said they had two grounds for the exemption: “as insureds of their own policies and beneficiaries of their spouses.”
Updates
The same issue, brought by the same trustee as appellant, was argued on appeal in February before District Judge Lee Yaekel of Austin. Low v. Gordon (In re Gordon), 22-00947 (W.D. Tex.).
In the lower court in Gordon, Bankruptcy Judge Tony M. Davis of Austin ruled against the same trustee on the same arguments submitted to Judge Gargotta.
If the decision on appeal comes down in favor of the trustee, the Texas legislature will need to amend the statute once again.
Two bankruptcy judges in Texas have now rejected clever arguments that would have effectively overruled the Texas legislature and terminated the state exemption for owners and beneficiaries of life insurance policies.
The facts were simple and typical for debtors with whole life insurance policies.
A couple in chapter 7 both had whole life policies. The wife was the owner of a $50,000 policy on her life. Her husband was the beneficiary. The policy had a $13,000 cash surrender value.
The husband, also in chapter 7, had a $100,000 policy on his life. His debtor/wife was the beneficiary. The husband’s policy had a $76,500 cash surrender value.
Under state law, they both claimed exemptions covering the policies and their cash surrender values.