Utah Bar Journal

A critical issue is when that insurable interest must exist. In Parduhn v. Bennett, 61 P.3d 982 (Utah 2002) ("Parduhn I") and Parduhn v. Bennett, 112 P.3d 495 (Utah 2005) ("Parduhn II"), I believe the Utah Supreme Court erred in determining when an insurable interest must exist.

A detailed description of Parduhn I and the background of the insurable interest requirement is contained in Beard, Recent Case Law Developments, 2004 Utah Law Review 211 ("Recent Developments").

I. The General Rule, both Common Law and Statutory.
"[T]he almost universal rule of law in this country is that if the insurable interest requirement is satisfied at the time the policy is issued, the proceeds of the policy must be paid upon the death of the life insured without regard to whether the beneficiary has an insurable interest at the time of death." Secor v. Pioneer Foundry Company, Inc., 173 N.W.2d 780, 782 (Mich. App. 1969). See also McKee v. Penick (In re Al Zuni Trading, Inc.), 947 F.2d 1403, 1405 (9th Cir. 1991) (quoting Secor and affirming summary judgment directing policy proceeds to be paid to decedent's former employer rather than decedent's estate).

Thus, in Herman v. Provident Mutual Life Ins. Co., 886 F.2d 529 (2nd Cir. 1989), the trial court, finding that the decedent's law partners no longer had an insurable interest in the deceden's life at the time of his death because the law firm had dissolved, refused to order the distribution of life insurance proceeds to the remaining former partners, and instead directed an award to the decedent's family.

The Second Circuit reversed, as follows:

The [district] court. . . incorrectly assumed that the cessation of an insurable interest prior to the insured's death - as occurs upon the dissolution of a law firm - defeats any claim of right to the proceeds of policies that were valid at their inception. In holding that "it is only if one assumes the firm's continuing practice of law that surviving partners have an insurable interest in the continuing life of a partner," the district court adopted a view that is contrary to the common law development of rules pertaining to the requirements of an insurable interest and to the effect of its termination. More particularly, the district court's ruling contradicted the law of New York. . .

Id. at 533.

The "law of New York," N.Y.Ins. Law. ¤ 3205(b)(2), "Insurable interest in the person, consent required, exceptions," in part provides:

No person shall procureÉany contract of insurance upon the person of another unless the benefits under such contract are payable to the person insured or his personal representatives, or to a person having, at the time when such contract is made, an insurable interest in the person insured.

According to the Second Circuit, "th[is] statute clearly states that when a policy is valid at its inception, it remains so even after the purchaser's insurable interest in the life of the insured has ended." Id. at 534. The court, citing a plethora of cases from across the county in support of the majority view, rebuffed the district court's reliance on "a minority rule followed in only a handful of jurisdictions," id. at 535, and reversed.

Similarly, in In re Al Zuni, supra, the Ninth Circuit Court of Appeals construed an Arizona statute, Ariz. Rev. Stat. Ann. ¤ 20-1104(A) (1990), which provided as follows:

No person shall procure or cause to be procured any insurance contract upon the life or body of another individual unless the benefits under such contract are payable . . .to a person having, at the time when the contract was made, an insurable interest in the individual insured.

947 F.2d at 1405. The Ninth Circuit took this statute to mean that "where a valid insurable interest exists when the Policies are issued, subsequent cessation of that insurable interest does not void the Policies." Id.

II. Parduhn and Utah Law.
The Utah Insurance Code ("Code") provides in part as follows:

31A-21-104. Insurable interest and consent.
(1) (a) An insurer may not knowingly provide insurance to a person who does not have or expect to have an insurable interest in the subject of the insurance.

(b) A person may not knowingly procure, directly, by assignment, or otherwise, an interest in the proceeds of an insurance policy unless that person has or expects to have an insurable interest in the subject of the insurance.

Utah Code Ann. ¤ 31A-21-104(1)(a). Utah's Code is, if anything, more liberal on the insurable interest issue than the laws of New York and Arizona, for Utah's statute can be satisfied by the expectation of such an interest, although if the expectation never bears fruit, presumably the policy will not be effective.

The statute then tells us what an insurable interest is for the purposes of life insurance:

(a) (i) "Insurable interest" in a person means: (A) for persons closely related by blood or by law, a substantial interest engendered by love and affection;

or

(B) in the case of other persons, a lawful and substantial interest in having the life, health, and bodily safety of the person insured continue.

The Code then gives some examples of insurable interest, including the following:

(iv) A shareholder or partner has an insurable interest in the life of other shareholders or partners for purposes of insurance contracts that are an integral part of a legitimate buy-sell agreement respecting shares or a partnership interest in the business.

This example was the one at issue in the Parduhn cases, for therein, as explained in Recent Developments, two partners had a buy-sell agreement (a standard agreement which provides for one partner to buy out the other's interest in case of death, with the purchase price often funded by life insurance). One partner died. The other partner, Parduhn, had been named the beneficiary of the life insurance proceeds. A dispute arose between the decedent's heirs and Parduhn over whether the partnership, and thus the buy-sell agreement, had terminated prior to the death, and to whom the policy proceeds should be distributed.

The trial court held, inter alia, that the policy's designation of beneficiary was ambiguous. The Parduhn I Court reversed this finding, noting that "[t]he insurance policy unambiguously designate[d] Parduhn as the beneficiary." 61 P.3d at 984. The Court nonetheless found that the partnership, and the buy-sell agreement along with it, had terminated prior to the death, that Parduhn had lost his insurable interest in the decedentÕs life, and that the matter should be remanded for an equitable distribution of policy proceeds under Utah Code Ann. ¤ 31A-21-104(5), which permits the court to distribute policy proceeds when the beneficiary fails to meet the insurable interest test. 61 P.3d at 987.

In Parduhn II, the decedent's former partner challenged the distribution of proceeds. The Supreme Court affirmed.

III. The Parduhn Analysis.
Concerning the issue of insurable interest, Parduhn I held as follows:

Section 31A-21-104(2)(a) specifically limits partners' insurable interest, required by section 31A-21-104(1)(b) for obtaining insurance generally, to those that are "for purposes of insurance contracts that are an integral part of a legitimate buy-sell agreement." Because the buy-sell agreement was terminated, Parduhn had no insurable interest which was "for purposes of [an] insurance contract [] that [was] an integral part of a legitimate buy-sell agreement." Thus, at the time of Buchi's death, Parduhn lacked an insurable interest under section 31A-21-104(1)(b), and may "not knowingly procure. . . an interest in the proceeds of [the] insurance policy."

61 P.3d at 986. Parduhn sought re-hearing, arguing (correctly, I believe) that the Court had erred in finding that section 31A-21-104(2)(a) "limits a partner's insurable interest" to partnerships with buy-sell agreements. Parduhn further challenged (again, correctly, and this is the far more important point) the Court's holding that a beneficiary of a life insurance policy could collect only if the insurable interest existed at the time the proceeds were distributed. 112 P.2d at 499. The Court "denied Parduhn's motion for rehearing without discussion." Id.

When Parduhn came back to challenge the distribution made by the trial court after remand, the Parduhn II Court remained steadfast:

Parduhn makes two additional argument. First, he argues that we erroneously concluded in Parduhn I that a partner's insurable interest must exist at the time policy proceeds are distributed, rather than at the time the insurance policy is acquired. Second, he argues that we incorrectly concluded in Parduhn I that the only insurable interest a partner may have in a copartner's life is through a buy-sell agreement. Because those claims were squarely at issue in Parduhn's petition for rehearing, which we denied, we decline to revisit them here.

Parduhn II at 502 n.4. See also id. at 499 ("Although Parduhn was the designated policy beneficiary, we held [in Parduhn I] that he could not legally collect the proceeds because he had lost his insurable interest in Buchi's life upon the dissolution of the partnership and the termination of the buy-sell agreement.")

But Utah's insurable interest statute nowhere requires that an insurable interest exist at the time the proceeds are distributed (it is incorrect to conclude, as does Recent Developments, that "[t]he statute does not clearly address the situation. . . where an insurable interest existed at the inception of the policy but extinguished prior to death.") The holding of Parduhn I that "Parduhn lacked an insurable interest under section 31A-21-104(1)(b), and may 'not knowingly procure. . . an interest in the proceeds of [the] insurance policy'" fails to take into account that Parduhn already had such an interest when the policy was taken out (neither Parduhn decision cites any cases or statutes from other jurisdictions on the insurable interest issue).

To be sure, Utah's statute does not contain the phrase "at the time the contract was made" when referring to when the insurable interest in the beneficiary must exist, but this was done only so that the statute, without resulting in ambiguity, could make clear that the insurable interest requirement is satisfied as long as there is an expectation of such an interest when the policy is issued, thus creating an even more liberal version of the rule. Nothing in the Utah statute vitiates the rule that the insurable interest, once it attaches, suffices for payment of policy proceeds upon the insured's death. See, e.g., Herman v. Provident Mutual Life Ins. Co., supra, 886 F.2d at 535 ("'the dissolution of a partnership does not preclude recovery upon the life of one partner in favor of the other'") (citation omitted).

This conclusion I believe finds additional support in section 31A-21-104(1)(a) of the Code, the insurable interest requirement for insurers, which provides that "[a]n insurer may not knowingly provide insurance to a person who does not have or expect to have an insurable interest in the subject of the insurance." This language clearly speaks to the outset of the transaction, not the end of it, and there seems no reason to read the insurable interest requirement imposed on the beneficiary in any different light.

Concerning the court's reliance on the section of the Code covering partners and "buy-sell" agreements, the Parduhn II court read the Parduhn I holding to be that "a partner has an insurable interest in the life of a copartner only if the 'insurance contracts. . . are an integral part of a legitimate buy-sell agreement respecting. . . a partnership interest in the business.'" Parduhn II, 112 P.3d at 499 (emphasis added). Yet the word "only" nowhere appears in the statute, and in fact many partnership agreements require partners to carry life insurance payable to the partnership for a whole variety of reasons that have nothing to do with buy-sell agreements.

The Court's error here is in confusing an example of an insurable interest (that which inheres in a buy-sell arrangement) as pre-empting the general, governing rule of section 31A-21-104(2)(a)(i)(B), which provides that an insurable interest, for non-relatives, is "a lawful and substantial interest in having the life, health, and bodily safety of the person insured continue." In other words, this is a case of "ejusdem generis" in reverse: the general rule governing insurable interests is given first, followed by examples. Here, however, the specific does not control the general, but the general the specific.

IV. The Unaddressed Issue of Standing.
"The law is well established throughout the country that only the insurer can raise the objection of want of an insurable interest." Ryan v. Tickle, 316 N.W.2d 580, 582 (Neb. 1982). It does not appear from the captions or texts of the Parduhn decisions that the actual insurer participated in the case. Neither Parduhn decision addresses whether the Court was adopting a rule permitting parties other than the insurer to challenge insurable interests.

V. The Issue of Equitable Distribution, and Whether Parduhn was Narrowly Decided.
As Recent Developments explains in detail, Parduhn I did not throw Parduhn out of court, but instead remanded the case for an equitable distribution of proceeds, and clearly left Parduhn in the running for such a distribution (although we know from Parduhn II that the distribution did not turn out as Parduhn had hoped).

In addition, from the lack of case citations on the insurable interest issue in Parduhn, we perhaps can conclude that the Court did not truly intend to adopt a rule of universal applicability, and that Parduhn should be limited solely to insurance policies entered into in connection with partnership buy-sell agreements. The Court's language, however, seems broader than that. We will need to await further decisions to see how wide of a net was truly cast.