Arizona Court of Appeals Division One Holds That Life Insurance Proceeds Paid to Lawful Beneficiary Are Exempt from Claims of Creditors of Decedent’s Estate, Including Defrauded Creditors Who Allege Premium Funds Were Misappropriated.

This case arose out of a dispute over insurance proceeds paid to Scott Coles’s widow following his death.  Mr. Coles was the former CEO of Mortgages Ltd., which was solely owned by Mr. Coles’s revocable trust.  Mortgages Ltd. became insolvent shortly before his passing.  It was reorganized and renamed ML Servicing Co., Inc, and a liquidating trust was created in a U.S. Bankruptcy Court-approved plan. 

ML Servicing Co. and ML Liquidating Trust (collectively Plaintiffs/Appellants) filed a lawsuit against Mr. Coles’s widow seeking to recover the insurance proceeds, believed to be in excess of $60 million, alleging that the insurance premiums had been paid with misappropriated funds from Mortgages Ltd.  The trial court granted a motion to dismiss, holding that Arizona’s exemption statute, A.R.S. § 20-1131, barred any creditor of a decedent from recovering life insurance proceeds from a beneficiary.  Plaintiffs/Appellants filed a timely notice of appeal. 

The Court of Appeals affirmed.  Arizona statute provides that life insurance proceeds paid to a lawful beneficiary are exempt from claims of creditors of the decedent’s estate.  A.R.S. § 20-1131(A); see also In re Estate of King (King), 228 Ariz. 565, 568 ¶ 10, 269 P.3d 1189, 1192 (App. 2012).  When insurance premiums have been paid by fraudulent means, A.R.S. § 20-1131(B) provides a means to recover the fraudulently taken premiums.  Plaintiffs/Appellants, however, chose not to pursue relief under A.R.S. § 20-1131(B) and instead brought claims as to the proceeds of the policies. 

Plaintiffs/Appellants argued that A.R.S. § 20-1131(A) did not exempt their claim because they were suing as the policies’ owner and not as a creditor.  The Court, however, found that they were creditors under the ordinary meaning of the term—entities to which a debt was owed.  Moreover, they could not be the “owner” because no person or entity owns insurance proceeds until the insureds’ death. 

The Court also rejected Plaintiffs/Appellants argument that Mr. Coles could not have named a “lawful beneficiary” because he did not lawfully own the premium money.  The “lawful beneficiary,” the Court found, “has nothing to do with procurement of a policy.”  Mr. Coles’s widow was a lawful beneficiary. 

Plaintiffs/Appellants also raised a constructive trust theory, arguing that the exemption statute was inapplicable because they possessed a constructive trust on funds used to pay the premiums and therefore owned the proceeds.  However, because A.R.S. § 20-1131(B) provides an adequate remedy at law, the Court held that the imposition of a constructive trust would not be proper. 

Lastly, the Court rejected the Plaintiffs/Appellants’ argument that the exemption statute constitutes an unconstitutional taking.  Because they never had a property interest in the proceeds, the statute was not an unconstitutional taking of their property. 

The Court affirmed the trial court’s award of attorney fees under A.R.S. § 12-341.01 but denied an award of attorney fees on appeal. 

Judge Orozco authored the opinion; Judges Winthrop and Jones joined.