Mutual mistake helps dissolving LLC retain member’s life insurance proceeds to pay debts 

By Joe Forward, Legal Writer, State Bar of Wisconsin

Jan. 20, 2011 – The U.S. Court of Appeals for the Seventh Circuit recently concluded that Richard McDonald’s former girlfriend could not claim the proceeds of a $1 million life insurance policy on McDonald’s life because McDonald was not the owner of the policy.

That conclusion may have been different had the life insurance policy contract correctly listed B&K Enterprizes LLC (B&K) as an LLC, and not a corporation.

McDonald was the founding member of B&K – which built and operated a convenience store in Manitowoc – and also managed the day-to-day operations of the store. B&K financed the business by purchasing a $1 million life insurance policy on McDonald’s life and assigning interest in the insurance proceeds as security for business loans.

But in 2007, things went sour for McDonald. Recently divorced, McDonald was living in a motel while dating Megan Hansen, a friend of his ex-wife’s daughter. In addition, other B&K members learned that McDonald misappropriated nearly $50,000 from the company’s funds.

Facing substantial debt, the members removed McDonald as manager and hired Michael Culligan to wind up B&K’s business affairs. B&K, which had paid the life insurance premiums up through the time of liquidation, decided to let the life insurance policy lapse.

However, Culligan had previously submitted a transfer of ownership form to the policy-holder, Protective Life Insurance Co. (Protective), asking Protective to transfer ownership to McDonald. McDonald then submitted a change of beneficiary form, naming Hansen as beneficiary.

Shortly after, McDonald committed suicide. Protective filed an interpleader action, naming Hansen and B&K as defendants.

Fight for proceeds 

In Protective Life Insurance Co. v. Hansen, No. 10-2085 (Jan. 19, 2010), a three-judge panel for the Seventh Circuit Court of Appeals applied Wisconsin law to conclude that B&K, not Hansen, was entitled to the insurance policy proceeds.

When B&K obtained the policy, the policy named “B&K Inc.” as the policy owner, which was a mutual mistake on the part of B&K and Protective. B&K was an LLC, not a corporation.

This distinction is important, Judge William Bauer explained in his opinion, because under Protective’s policy terms, LLCs can submit a transfer of ownership form with the signature of one LLC officer, but corporations must submit the signature of at least two officers.

Because the policy listed B&K as a corporation, Protective sent the transfer of ownership form back to Culligan for another signature when he submitted it. He never sent it back. If the policy correctly noted B&K as an LLC, it may have accepted the form and transferred ownership.

Thus, Hansen asked the court to correct the mutual mistake. Once corrected, Hansen asked the court to find that ownership transferred because Protective would have transferred ownership based on Culligan’s signature alone, which was all that was required for LLCs.

Finally, Hansen asked the court to conclude that she was the rightful beneficiary because McDonald, as policy owner, named her the beneficiary. The panel disagreed.

Even if Wisconsin law allowed the court to reform the contract to read “B&K LLC,” the panel explained, “we cannot presume to know what Protective would have done if B&K had been listed as an LLC.”

Kathleen Britton, vice president of life insurance policies for Protective, testified that Culligan’s signature alone would have satisfied Protective’s requirements to transfer ownership, but did not testify that Protective would have actually transferred ownership based on the signature.

The panel noted that Protective could have investigated before transferring ownership or could have refused to transfer it, and Judge Bauer explained that “the proper focus here is not on what should have happened but rather on what actually happened.”

“Absent some viable legal theory, we cannot simply unwind this series of events and declare Hansen the beneficiary of the policy,” Judge Bauer wrote.

Because ownership never actually transferred, the panel concluded that B&K was the owner of the policy when McDonald committed suicide. Thus, B&K was entitled to the proceeds.

Given the holding, the panel did not decide whether McDonald gave adequate consideration to obtain ownership of the policy, or whether Culligan had authority to transfer ownership.

Equity 

The panel also explained that equitable principles favored the conclusion that B&K was entitled to the proceeds, even if Hansen had satisfied all elements of reformation, “because the equities do not lie in Hansen’s favor.”

The panel explained that McDonald was a dishonest employee, attempted to swindle B&K by transferring ownership of the policy to Hansen, and Hansen sought a windfall even though neither she nor McDonald ever paid any insurance premiums.

Meanwhile, the liquidation of assets did not provide B&K with enough money to pay its debts. It owed non-member creditors $83,000, and members had claims of approximately $400,000.