Appeals Court Declines Reformation Of Policy
February 16, 2011
The 7th U.S. Circuit Court of Appeals, construing Wisconsin law, recently declined to allow a two-pronged reformation of a life insurance policy, which might have resulted in the policy proceeds being paid to a changed beneficiary, especially under circumstances suggesting that the person whose life was insured had engaged in a swindle. Protective Life Insurance Co. v. Hansen, No. 10-2085, 2011 WL 148812 (7th Cir. Jan. 19, 2011).
The insurer, Protective, was represented by Sean D. Lanphier of Mallery & Zimmerman, Milwaukee. Ross Anderson of Whyte Hirschboeck & Dudek, Milwaukee, and Brian Maloney of Hanaway Ross, S.C., Green Bay, represented the proposed beneficiary, Megan Hansen.
Background
B&K was a Wisconsin limited liability company that owned and operated a gas station. McDonald was a founding member of the LLC and manager of day-to-day operations. B&K purchased a "key man" million-dollar life insurance policy on McDonald's life, issued by Protective, and then assigned its interest in the proceeds as security for various loans.
In 2007, McDonald's life was in disarray. He was in the midst of a divorce while living in a motel and dating Hansen, a friend of his wife's daughter. In addition, B&K was operating at a loss and its other members suspected that McDonald was mismanaging the company. An audit of B&K's books revealed that McDonald appropriated some $48,000 of B&K's funds and used a portion to purchase items for Hansen.
At that point, the other LLC members hired Michael Culligan to wind up B&K's affairs and liquidate its assets, including the Protective life insurance policy. The policy then had a cash surrender value of $217 and the B&K members decided to let it lapse. Prior to the lapse, however, and unbeknownst to the B&K members, Culligan signed a submitted change-of-ownership from to Protective, asking it to transfer ownership from B&K to McDonald.
Subsequently, believing himself to be the new owner, McDonald submitted a change-of-beneficiary form designating Hansen as the new beneficiary. McDonald then committed suicide.
The Protective policy
Under the terms of the Protective policy, an owner could transfer ownership by signing and submitting the necessary form. Although the form needed to bear only one signature for an LLC, Protective required two signatures for a corporation. B&K was an LLC, but it was recorded on the Protective policy as a corporation.
Thus, when Protective received the change-of-ownership form signed only by Culligan, it sent the form back and requested another signature. Culligan never provided another signature and Protective never changed the owner of the policy.
Protective's policy also provided that only the owner could change the beneficiary of the policy. Thus, McDonald's attempt to change the beneficiary from B&K to Hansen was only effective if McDonald was the owner of the policy when he submitted the form.
The lawsuit
The liquidation of B&K's assets did not generate enough proceeds to pay its secured debt and all its members, therefore, were compelled to contribute. McDonald, however, owned the largest portion of B&K and made no contributions, thus forcing other members to cover his share. At the time of the lawsuit, creditors of B&K still had claims totaling $83,000 and members had claims totaling $400,000.
Protective filed this action as an interpleader to determine who was entitled to the policy proceeds. Hansen and B&K were named defendants; they filed cross motions for summary judgment. The district court granted judgment in favor of B&K; Hansen appealed.
Double reformation rejected
In a decision by Judge William J. Bauer, the 7th Circuit affirmed. He first addressed Hansen's "series of interlocking arguments" that (a) B&K and Protective made a mutual mistake in identifying B&K as a corporation rather than an LLC and the policy should be appropriately reformed, (b) upon reformation the court should recognize the validity of Culligan's form transferring ownership to McDonald, and (c) upon recognizing McDonald as the owner, the court should further recognize his transfer of the policy to Hansen.
Bauer acknowledged that a policy could be reformed under Wisconsin law upon mutual mistake and, he assumed, without deciding that the policy should be reformed to reflect that B&K was an LLC. With respect to recognizing the transfer of ownership, he noted that Hansen's argument was based on testimony from a Protective vice president that, had B&K been listed as an LLC, Culligan's sole signature would have been sufficient.
Bauer questioned the sufficiency of the evidence, however, to establish that, even though the sole signature would have been adequate, Protective actually would have transferred ownership to McDonald. He suggested that Protective might instead have started an investigation or otherwise refused the transfer.
But even if Protective would have transferred the policy to McDonald, Bauer said, that is not what happened. Rather, Protective sent the form back to Culligan, Culligan never resubmitted it and the court could not unwind the series of events to declare Hansen the beneficiary.
He noted that Hansen was seeking a double reformation: First to make B&K an LLC and then to make McDonald the owner. While B&K and Protective may have made a mistake in not naming B&K an LLC, Hansen did not allege that the contracting parties - B&K and Protective - made any additional mistakes. Thus, after reforming the contract once, no legal theory existed under which the court could reform it further.
Third-party beneficiary rejected
As an alternative theory, Hansen argued that the court should recognize that B&K and McDonald formed a binding contract to transfer ownership of the policy, which Hansen could enforce as an intended third-party beneficiary. Bauer rejected this argument on two grounds. First, even if the change-of-ownership form could be construed as a contract, it was a contract between B&K and Protective, to which McDonald was not a party. Because he was not, Hansen had no authority to enforce it. Second, even if the change-of-ownership form could be construed as a contract between McDonald and Protective, it made no mention of Hansen or any other beneficiary and she could not enforce it for that additional reason.
Equitable considerations
Finally, even if Hansen had satisfied all the elements for reformation, Bauer said that reformation still would be improper. He said McDonald was a dishonest employee who exploited his position in the company and misappropriated funds and that evidence in the record suggested that Hansen knew of his planned suicide. She now was seeking a windfall and the equities favored B&K.
The court, therefore, affirmed summary judgment in favor of B&K.
Key point
Contract reformation is available only to correct contract terms, not to establish what might have occurred had terms earlier been corrected.
