Ninth Circuit Rules Chapter 7 Bankruptcy Trustee Can Recover Market Value of Debtor’s Life SettlementsThe U.S. Court of Appeals for the Ninth Circuit has ruled that a Chapter 7 debtor’s life insurance policies are “an interest of the debtor” in property and cannot be excluded from the bankruptcy estate.

In a decision that affirmed a district court ruling, the Ninth Circuit agreed that the bankruptcy trustee could recover the market value of the life settlements from the banks that purchased them — assets that the debtor failed to report in his bankruptcy filing.

The case — Gladstone v. U.S. Bancorp — involved a Chapter 7 debtor, David Green, who filed his bankruptcy petition in 2007. In that petition, he failed to disclose several assets, including three life settlements that were purchased by U.S. Bank and Coventry First for $507,000. Five months after filing bankruptcy, Green died and the banks collected $9 million in death benefits.

The Chapter 7 trustee instigated an adversary proceeding against the banks to recover the life settlements as fraudulent transfers. The bankruptcy court granted the banks’ motion for summary judgment and the trustee appealed. A district court reversed the bankruptcy court’s judgment. The banks appealed to the Ninth Circuit, which upheld the district court.

The question before the Ninth Circuit was whether “the debtor’s interests in the term life insurance policies, including the secondary market value of the policies and resulting life settlements, constitute a recoverable ‘interest of the debtor in property’” under the law. The district court had ruled properly that they are, the Ninth Circuit said:

“In short, all equitable and legal interests that the debtor has when the bankruptcy petition is filed become property of the estate, unless excluded by statute or properly exempted by the debtor. If no exclusion or exemption applies, or if the debtor has failed to claim qualifying property as exempt, then the debtor’s interest in the property remains property of the bankruptcy estate.”

The banks had argued that the life settlements were exempt because California has opted out of the federal exemption schedule — an argument that the Ninth Circuit said was “dubious, at best” since Green did not claim them as exempt in his bankruptcy petition and the banks lack standing to raise the issue.

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