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Unraveling the Mysteries of the Florida Exemptions for Life Insurance and Annuity Contracts, Part Two

Real Property, Probate and Trust Law

This is the second installment of a two-part article that provides a detailed analysis of the creditor exemptions available under Florida law for life insurance policies and annuity contracts. Part one of this article, in the December 2008 issue, examined several aspects of these exemptions, including the application of the exemption to the proceeds received under a policy because of the insured’s death, structural issues regarding the ownership of life insurance, the ability of a debtor to access the cash surrender value of a policy without forfeiting the benefit of the exemption, and the meaning of the term “annuity contract.”

This final installment discusses one more structural issue related to annuity contracts, that is, does the exemption for the proceeds of an annuity contract apply to deferred annuity arrangements. This issue is important to consider in a period in which insurance companies provide a wide variety of financial products, including several variations of insurance and annuity products, in an effort to remain competitive in the market and offer flexible and attractive investment vehicles to savvy modern investors. This installment also examines the application of the exemption for annuity contracts to traditional estate planning arrangements such as charitable remainder trusts, grantor retained interest trusts and third-party, non-self-settled trusts. Finally, this installment of the article examines the application of the Florida fraudulent conversion rule to the life insurance and annuity exemption under §222.14.

Exemption for Proceeds of Annuity Contract Held to Apply to Deferred Annuities : Section 222.14 does not provide a definition of “proceeds.” However, case law has been favorable to debtors. For example, the exemption for the “proceeds” of an annuity contract was held to apply to single premium deferred annuities in the case of Goldenberg v. Sawczak, 791 So. 2d 1078 (Fla. 2001). In Goldenberg, Dr. Goldenberg (the debtor) had performed gall bladder surgery on Sawczak (the creditor). The creditor subsequently filed suit against the debtor for malpractice. The debtor filed a petition under Ch. 7 of the Bankruptcy Code on the same day that jury deliberations were scheduled in the malpractice case filed by the creditor. The creditor was granted an emergency motion for relief from the bankruptcy automatic stay so that the malpractice trial could be completed. The creditor obtained a judgment against the debtor in the amount of $4,000,629. On the schedules attached to the bankruptcy petition, the debtor listed assets totaling $3,791,119, of which the debtor claimed $3,751,678 as exempt. Included in these exempt assets were seven commercial annuity contracts with a combined value of $355,894 that the debtor had obtained well in advance of the litigation.

The commercial annuities were single premium deferred annuities. The contracts provided that the single premium of each annuity accumulated interest until the maturity date, at which time certain sums would become payable to the annuitant or his survivors under various settlement options. The annuities also allowed for the surrender of the contract in exchange for a designated lump sum payment. The surrender value was affected by the timing of when the annuity contract was surrendered. The earlier the annuity contract was surrendered, the higher the surrender penalty. The debtor was both the owner and annuitant of the annuities.

The debtor’s case worked its way through the bankruptcy system until the U.S. Court of Appeals for the 11th Circuit was faced with the question whether the cash surrender value of the annuity contracts was exempt as proceeds under §222.14. The 11th Circuit declined to express an opinion on the issue, and certified the following question to the Florida Supreme Court: “Are the cash surrender values of [debtor]’s annuity contracts exempt from legal process under Fla. Stat. Ann. § 222.14 (West 1998)?

The creditor argued that §222.14 exempts only the proceeds of annuity contracts (which the creditor took to mean only those payments made as an annuity, that is, payments made after maturity) and did not include withdrawals from the cash surrender value.1 The Florida Supreme Court rejected the creditor’s argument. According to the Supreme Court:

The terms of section 222.14 are clear….Sawczak would have us define the term “proceeds” to include only those payments that commence at the maturity date of Goldenberg’s policies. In other words, Sawczak maintains that moneys received by surrendering an annuity contract are not proceeds. We do not find a basis for such a narrow definition of “proceeds” in the statute or in the commonly accepted definition of proceeds. The dictionary definition of proceeds is “the net amount received after deduction of any discount or charges.” Merriam Webster’s Collegiate Dictionary 929 (10th ed. 1994). The only difference between receiving payment streams after maturity and a settlement payment before maturity is the surrender charge. Thus, we conclude that the “proceeds of annuity contracts” include moneys received from surrendering an annuity contract prior to maturity.2

In reaching its conclusion, the Florida Supreme Court focused on the statutory language, “upon whatever form. . . . ” Reviewing its decision in a prior case, the Supreme Court concluded that the “clarity” of quoted language appears to “indicate that the form of payment is not relevant for purposes of having the exemption apply.”3

The Florida Supreme Court also looked to In re McCollam, 612 So. 2d 572 (Fla. 1993). It reasoned that if the legislature intended to limit the exemption to particular annuity contracts, it would have included such restrictive language when the statute was amended to include annuity contracts in 1978, which it did not.

Exemption for Proceeds of Annuity Contract Does Not Apply to Exempt a Donor’s Interest in Certain Self-settled Trust Arrangements: Despite McCollam’s broad definition of annuity contract, the exemption for the proceeds of an annuity contract issued to a citizen or resident of Florida should not apply to a settlor-donor’s interest in a charitable remainder trust (whether an annuity trust or a unitrust) or a grantor retained trust (whether a grantor retained annuity trust or grantor retained unitrust) (in any case, a “grantor retained interest trust”). The statute uses the term “issued.” It does not seem possible for a debtor to cause an annuity contract to be issued to himself in such a trust arrangement. As noted below, only a third party can issue an annuity to an annuitant.

Although a grantor retained interest trust can be analogized in some ways to the private annuity transaction in In re Mart, 88 B.R. 436 (Bankr. S.D. Fla. 1988)(because the trust’s grantor derives economic benefits from the assets the grantor originally transferred to trust), the two arrangements are substantially different. First, the private annuity transaction approximates a sale; however, a transfer to a grantor retained interest trust does not. Second, and perhaps most important, a grantor retained interest trust is a form of a “self-settled trust.”4 With respect to the assets of a self-settled irrevocable trust, a creditor or assignee of a settlor may reach the maximum amount that can be distributed to or for the benefit of the settlor. This common law rule is now codified in F.S. §736.0505.5 Trumping the self-settled trust doctrine through use of the annuity contract exemption in §222.14 is inconsistent with the purpose of the self-settled trust doctrine. Furthermore, the terms of §222.14 suggest that its protection should not apply to a self-settled trust like a charitable remainder trust or grantor retained annuity trust.

The terms “issue” and “issuer” are not defined in the text of the statute. Nevertheless, it is reasonable to assume that the definition of “issuer” found in F.S. §517.021(14) would apply. This provision defines an issuer as “[a]ny person who proposes to issue, has issued, or shall hereafter issue any security. Any person who acts as a promoter for and on behalf of a corporation, trust, or unincorporated association or partnership of any kind to be formed shall be deemed an issuer.” Additionally, Black’s Law Dictionary defines the term issuer as “a person or entity (such as a corporation or bank) that issues securities, negotiable instruments, or letters of credit.” In the context of self-settled trusts, there is no act whereby one party issues anything of value to another party. No case law exists on this issue.6

If protection of a retained interest in a grantor retained interest trust is desirable, one might consider establishing such a trust in (or moving an existing trust to) a jurisdiction that provides creditor protection for self-settled trusts, such as Alaska, Delaware, Rhode Island, or South Dakota.7

Exemption for Proceeds of Annuity Contract Should Not Apply to Exempt a Nonsettlor Donee’s Interest in Charitable Remainder Trust Arrangement or in Any Other Third-party Trust Arrangement Providing an Annuity Type Benefit: Based on the legislative history that the exemption for annuities is intended to apply to commercial annuity arrangements that are within the definition of life insurance, the annuity exemption should not apply to a third-party nonsettlors interest in a charitable remainder trust or any other third-party trust that grants a beneficiary an annuity interest in the trust.8

Fraudulent Conversions: Section 222.30 sets forth Florida’s fraudulent conversion rule.9 A conversion includes any method of selling or disposing an asset such that the products or proceeds of the asset become exempt from the claim of a creditor of the debtor, but remain the property of the debtor.10 If a debtor converts nonexempt property to exempt property with the intent to hinder, delay, or defraud a creditor, the conversion is a fraudulent asset conversion as to the creditor. It does not matter whether the creditor’s claim accrued prior to or after the conversion of the asset.11 If a creditor proves a debtor made a fraudulent asset conversion, the creditor may avoid the conversion to the extent necessary to satisfy its claim, attach the asset converted as provided by applicable law (or obtain such other provisional remedy against the asset), and obtain an injunction prohibiting a debtor from further converting an asset or other property or any other relief the circumstances may require.12 If a creditor has obtained a judgment against the debtor, it can levy on the converted asset or its proceeds upon an order of the court.13 Any claim that an asset was fraudulently converted must be brought within four years after the conversion was made by the debtor, otherwise the action is extinguished.14 If an asset is converted and subsequently transferred to a third party, the fraudulent transfer rules can apply to the transfer to the third party.15

The fraudulent conversion statute has been held inapplicable under the Florida Constitution to the conversion of a nonexempt asset to homestead property.16 Nonetheless, the exemptions provided in §§222.13 and 222.14 cannot be used in the same manner as the homestead exemption because such exemptions are provided by statute and not the Constitution of Florida.17 Thus, use of the exemptions under §§222.13 and 222.14 for last minute or “panic” planning is not possible because of the application of Florida’s fraudulent conversion statute.18

Perhaps a more favorable result will occur for a judgment debtor who relocates to Florida when the debtor already owns interests in life insurance and annuity contracts. For instance, in Slatcoff v. Dezen, 76 So. 2d 792 (Fla. 1955), Lucille Slatcoff (the creditor) attempted to enforce a judgment against the cash surrender value of life insurance policies issued upon the life of Max Dezen (the debtor). When the policies were issued, the debtor was not a Florida resident; however, the debtor was a Florida resident when the creditor attempted to enforce her judgment against the debtor’s life insurance policies. The court held that residency is reviewed when the exempt property is subjected to legal process and that the debtor’s life insurance policies were exempt because the debtor was a Florida resident when the creditor attempted to subject the debtor’s life insurance policies to legal process.

On a similar note, in Marshall v. Bacon, 97 So. 2d 252 (Fla. 1957), Marshall (the creditor) obtained a judgment against her ex-husband, Bacon (the debtor) for alimony and support payments owed pursuant to a divorce decree. The debtor owned three insurance policies issued on his life while he was a Florida resident. Subsequent to the divorce, the debtor became a permanent resident of California. The court held in accordance with its decision in Slatcoff that it is the domiciliary status of the insured when the property is sought to be subjected to legal process that controls the result. As a result, the debtor had no right to claim the exemption for the cash surrender value of life insurance policies because the debtor was a resident of California when the creditor attempted to subject the life insurance policies to legal process.19

Sections 222.13 and 222.14 offer generous exemptions to protect the value of an insurance contract and an annuity contract. Nevertheless, careful planning is necessary to avoid unwittingly forfeiting the benefits of these exemptions. It is important to recognize the limitations of these exemptions, how the exemptions operate, and the types of arrangements the exemptions protect.

1 A lower federal court had held that the debtor, in essence, had an option to purchase the annuity contracts when the debtor filed for bankruptcy because annuity payments had yet to commence (and the debtor could have surrendered the contracts) to the court. Options to purchase annuity contracts are not, themselves, annuity contracts.

2 The Supreme Court made its holding contingent upon the existence of a penalty being imposed upon a surrender of the contract. Goldenberg, 791 So. 2d at 1083.

3 Goldenberg, 791 So. 2d at 1082.

4 See Restatement (Second) of Trusts §156(2) (1959), which provides in relevant part “[w]here a person creates for his own benefit, a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit.” See also Restatement (Third) of Trusts §25. Restatement (Third) of Trusts §58(2) provides “A restraint on the voluntary and involuntary alienation of a beneficial interest retained by the settlor of a trust is invalid.” See also Comment e to Restatement (Third) of Trusts Section 58(2). This black letter rule is commonly referred to as the “Self-Settled Trust Doctrine.” It is adapted from old English law. See, e.g., Stat. 3 Hen. VII, c.4. (1487), providing, “[a]ll deeds of gift of goods and chattels, made or to be made in trust to the use of that person or persons that made the same deed or gift, be void and of none effect.” See also §505 of art. 5 of the Uniform Trust Code.

5 Fla. Stat. §736.0505(1)(b).

6 The 11th Circuit avoided determining whether a charitable remainder trust was protected by §222.14 in the case of In re Brown, 303 F.3d 1261 (11th Cir. 2002). In this case, a debtor attempted to raise the argument that her income interest in a charitable remainder trust should be exempt from her bankruptcy estate because it constituted an annuity under Florida law and the annuity exemption under §222.14 should apply to protect it. The debtor had hoped to overcome a lower court’s conclusion that the charitable remainder trust was a self-settled trust. However, the debtor failed to timely assert the application of the annuity exemption; therefore, the appellate court refused to permit the debtor to argue the exemption applied on appeal. Even if the debtor were permitted to raise this issue on appeal, it seems unlikely that the court would have given her the protection of the annuity exemption. The foregoing authority seems too compelling.

7 Residency in such a state is not required to take advantage of its trust law. See, e.g., Subchapter VI of Ch. 35 of Part V of Title 12 of the Delaware Code. way of example, 12 Del Code Ann. §3570(10)b provides for the protection of a donor-settlor’s interest when a trust agreement contains a provision permitting the potential or actual receipt of income or principal from a charitable remainder unitrust or charitable remainder annuity trust (as such trusts are defined in §664 of the Internal Revenue Code).

8 Nonetheless, inclusion of a spendthrift clause in such a trust should provide some level of protection before the payments are received by the beneficiary. See Fla. Stat. §736.0502.

9 Although beyond the scope of this article, planners should consider the potential application of a new bankruptcy fraudulent transfer rule that was passed into law as part of the 2005 Bankruptcy Reform Act. Section 548(e)(1) of the Bankruptcy Code provides: “In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if a) such transfer was made to a self-settled trust or similar device; b) such transfer was by the debtor; c) the debtor is a beneficiary of such trust or similar device; and d) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.” (Emphasis supplied.) The issue that must be considered is whether a life insurance policy or an annuity contract would be a “similar device” to a self-settled trust.

10 Fla. Stat. §222.30(1).

11 Fla. Stat. §222.30(2).

12 Fla. Stat. §222.30(3).

13 Fla. Stat. §222.30(4).

14 Fla. Stat. §222.30(5).

15 Fla. Stat. §222.30(6).

16 Havoco of America, Ltd. v. Hill, 790 So. 2d 1018 (Fla. 2001); Conseco Servs., LLC v. Cuneo, 3 Dist. Case No.3D04-1995. LT Case No. 04-15589 (2005). Thus, the conversion of nonexempt property to exempt homestead property appears permissible at any time before such nonexempt property is seized by a creditor because homestead protection is a right granted under the state constitution. Id. But see §§522(b)(3)(A), 522(o), 522(p)(2)(B), and 522(q) of the Bankruptcy Code. Ostendorf v. Turner, 426 So. 2d 539 (Fla. 1982) (“The legislature is powerless to affect the rights provided by the homestead exemption through statutory enactments.”). See also Sparkman v. State ex rel. Scott, 58 So. 2d 431 (Fla. 1952) (providing “[e]xpress or implied provisions of the Constitution cannot be altered, contracted or enlarged by legislative enactments”).

17 See, e.g., In re Lazin, 221 B.R. 982 (M.D. Fla. 1998).

18 Perhaps this is also a circumstance where Florida is a less desirable jurisdiction to declare bankruptcy for certain debtors who want to convert nonexempt assets to exempt assets immediately prior to filing for bankruptcy. For instance, in some cases, bankruptcy courts have approved such conversions. See In re Moore, 177 B.R. 437 (Bankr. N.D.N.Y. 1994); Crews v. First Colony Life Ins. Co. (In re Barker), 168 B.R. 773 (Bankr. M.D. Fla. 1994); In re Lindberg, 735 F.2d 1087, 12 B.C.D. 81 (8 Cir. 1984), cert. denied, 469 U.S. 1073 (1984). Nonetheless, the fraudulent conversion statute in Florida seems to preclude such a prebankruptcy planning opportunity.

19 The Florida fraudulent conversion statute does not appear to apply to a change in residency from a state that provides no exemption for such assets or a less favorable exemption. Of course, this result cannot be guaranteed and such a strategy should only be employed after careful consideration analysis. While the exemption set forth in §222.14 may be available to a debtor in this instance immediately following a change in residency to Florida when the issue is presented to a state court or a federal court in a nonbankruptcy proceeding, the exemption will not be available to the debtor who files a bankruptcy petition within two years of a change in residency to Florida. Pursuant to §522(b)(3)(A) of the Bankruptcy Code, if the debtor has moved from one state to another state within the two-year period prior to filing the petition, the debtor’s domicile for purposes of available state exemptions will be based on the six-month period (or longer portion thereof) immediately preceding the two-year period.

Jonathan E. Gopman is a principal in the law office of Cummings & Lockwood, LLC, where he leads the wealth protection practice group. He has authored numerous articles and is a frequent lecturer on the topics of asset protection and estate planning. He received his juris doctorate from The Florida State University College of Law (with high honors) and an LL.M. in estate planning from the University of Miami School of Law.

Howard M. Hujsa is a principal in the private clients group of Cummings & Lockwood, LLC, in Bonita Springs. His practice involves estate and gift tax planning, tax-exempt organizations, and the administration of estates and trusts. He is certified by The Florida Bar in wills, trusts, and estates law and received his J.D., cum laude, from the University of Miami School of Law.

Matthew N. Turko is an associate in the Naples office of the law firm of Cummings & Lockwood, LLC, where he practices in the wealth protection practice group. He received his J.D., magna cum laude, from Stetson University College of Law.

This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Sandra F. Diamond, chair, and William P. Sklar and Richard R. Gans, editors.

Real Property, Probate and Trust Law