7th Circuit Affirms, Puts Quick End To Life Insurance Investment Scheme

By Don R. Sampen, published, Chicago Daily Law Bulletin [December 3, 2015]

The 7th U.S. Circuit Court of Appeals recently held illegal under Illinois law the purchase of life insurance for investment purposes and awarded the plaintiff insurer its litigation expenses incurred in the voiding of the policies.

The case is Ohio National Life Assurance Corp. v. Davis, 803 F.3d 904 (Oct. 20, 2015). The insurer, Ohio Life, was represented by Smith, Von Schleicher & Associates. Richard C. Leng of Barrington represented the proponents of the plan. Green & Hall of Santa Ana, Calif., represented Steven Egbert, one of the investors.

The defendants participated in the purchase of what is called “stranger-originated life insurance.” Such insurance currently is prohibited at least in part by recent legislation (found at 215 ILCS 159/50(a), 159/5), but the provision was not in effect at the time of the events of which complaint was made here.

Essentially, one of the defendants, Douglas Davis, an attorney, would approach elderly persons who, in return for a small payment, would assist in the preparation of applications for life insurance policies brokered through another defendant, Movash Morady.

Once issued, the policies would be placed in irrevocable trusts controlled by Davis. While family members of the insured were initially listed as beneficiaries of the trusts, the beneficial interests were soon transferred to Morady’s husband and then sold to investors. The total death benefits of the Ohio National policies involved amounted to $2.8 million.

The premium-financing arrangements were forbidden by Morady’s contracts with Ohio National. Some of the policy applications also contained misrepresentations about the insureds. Although Morady denied responsibility for the misrepresentations, her signature appeared on the forms attesting to the fact that that she knew the insureds, but she did not.

Upon learning of the scheme, Ohio National brought suit to void the policies and thwart efforts by the investors to collect policy proceeds. It claimed that it would never have sold the policies at normal premiums had it known that the benefit proceeds would go to investors. Its claim against Morady was based on fraud and against Davis, Morady’s husband and others on civil conspiracy.

The U.S. District Court granted summary judgment in favor of Ohio National and against all defendants except one and awarded Ohio National $726,000, which appears to have included both litigation costs and brokerage commissions.

The court also permitted Ohio National to keep most of the premiums collected on the policies. As to one defendant, Egbert, the court awarded him $91,000 in premiums he had paid on the theory that he was not a participant in the conspiracy.

The defendants appealed, and Ohio National cross-appealed the ruling as to Egbert.

Insurable Interest

In an opinion by Judge Richard A. Posner, the 7th Circuit affirmed. He initially observed that insurance trusts for purposes of receiving life insurance proceeds are nothing new. The wrinkle here, though, was that the trusts were created for purposes of concealing the fact that the insured did not control the policy and that the trusts were being used for investment purposes.

He also noted the permissible practice of an insured purchasing a policy on his own life and subsequently assigning it to someone who, though chosen by the insured, lacked an insurable interest on the insured’s life. According to Posner, such transactions may have a social benefit under some circumstances. That situation, however, is different from someone purchasing the policy and lacking an insurable interest from the inception.

Here, Posner said, the defendants conspired to violate Illinois’ common-law prohibition against insurance contracts procured by persons who do not have an insurable interest. The fact that the defendants may not have known that what they were doing was illegal, moreover, made no difference because their ignorance of the law was no defense.

Litigation Expenses

As for Ohio National’s recovery of litigation expenses, which amounted to more than $605,000 of its recovery, Posner acknowledged that such expenses normally cannot be charged to the loser of the litigation. Here, however, Ohio National was entitled to obtain reimbursement of the expenses to avoid future litigation over the death benefits in the policies that it was fraudulently induced to issue.

He relied on Ritter v. Ritter, 381 Ill. 549 (1943), for the proposition that, where the wrongful acts result in the plaintiff becoming involved in litigation with third parties, the plaintiff can recover damages against the wrongdoer, measured by the reasonable expenses of the litigation. That proposition applied here because the present suit to void the policies was in lieu of future litigation with the purchasers of the policies on the death of the insureds.

In addition, Posner found that Ohio National was entitled to keep most of the premiums on the voided policies, on the theory that allowing the defendants to recoup the premiums on policies that they wrongfully caused to be issued, would increase the likelihood of unlawful activity.

Finally, with respect to Egbert, Posner agreed with the district court that no evidence existed that he knew the policy with which he was involved was void, so he was not to blame for the illegality.

Rather, the policy was void through no fault of his, the premiums were not an offset against the proceeds because there would be no proceeds and retention of the premiums would have been a windfall for Ohio National. Egbert, therefore, was entitle to recover the $91,000 he paid in premiums.

Key Points

• Life insurance policies issued to one without a proper insurable interest in the life of the insured are illegal under Illinois common law.
• A plaintiff forced into litigation with third parties by the wrongful act of a defendant is entitled to recover litigation costs from the defendant, even if the lawsuit against the defendant is in lieu of the future litigation against the third parties.
• Defendants causing the issuance of illegal policies, the potential benefits of which they sell to others, are not entitled to recoup the premiums paid on the policies when voided.