Wednesday, May 13, 2015

No. 101: Life Partners and the Texas Supreme Court

On May 8, 2015, in a landmark opinion delivered by Justice Jeffrey S. Boyd, the Texas Supreme Court ruled that the life settlement agreements sold by Life Partners, Inc. (Waco, TX), an operating subsidiary of Life Partners Holdings, Inc. (LPHI), "are investment contracts, and thus securities, under the Texas Securities Act." No dissent was filed.

The opinion is the culmination of a 20-year struggle by the now bankrupt company and Brian D. Pardo, former chief executive officer and majority shareholder of LPHI, to avoid having to comply with securities laws. The impact of the opinion on the bankruptcy case is not known, but the ruling clears the air on the status of life settlement agreements.

The Opinion
The Texas Supreme Court opinion grew out of rulings by two Texas appellate courts. The trial courts had found in favor of Life Partners, and both appellate courts had reversed the trial court decisions. The Texas Supreme Court affirmed the rulings of the two appellate courts. (See Life Partners v. Arnold, Court of Appeals for the Fifth District of Texas, No. 14-0122, and LPHI v. State of Texas, Court of Appeals for the Third District of Texas, No. 14-0226.)

The elaborate 40-page opinion not only says Life Partners' life settlement agreements are securities under the Texas Securities Act, but also declines to give the ruling only prospective application. Life Partners had requested only prospective application in the event of an adverse decision on the underlying issue. This is important because it means that the ruling applies retroactively to all of Life Partners' past activities. Here is the first paragraph of the opinion:
The primary issue in these two separate cases is whether a "life settlement agreement" or "viatical settlement agreement" is an "investment contract" under the Texas Securities Act. We hold that the agreements at issue are investment contracts because they constitute transactions through which a person pays money to participate in a common enterprise with the expectation of receiving profits, under circumstances in which the failure or success of the enterprise and the person's realization of the expected profits is at least predominately due to the entrepreneurial or managerial efforts of others. We decline to give today's holding only prospective application, and we decline to consider the merits of the "relief defendants'" evidentiary arguments. In short, we affirm the courts of appeals' judgments in both cases.
The Trustee's Reaction
I contacted H. Thomas Moran II, the Chapter 11 Trustee in the Life Partners bankruptcy case. In response to my invitation to comment on the opinion, he said:
I respect the ruling by the Texas Supreme Court. The ruling brings clarity to the bankruptcy and ultimately will benefit those affected most by the Life Partners business model.
The 1996 Federal Appellate Ruling
I wrote many articles in The Insurance Forum over the years and posted many blog items about Life Partners. My first mention of the company was in the March 1999 issue of the Forum, which was devoted in its entirety to a 12-page article entitled "Viatical Transactions and the Growth of the Frightening Secondary Market for Life Insurance Policies." The article included a section subtitled "The Life Partners Case." Here is a shortened version of that section:
In 1995 the Securities and Exchange Commission (SEC) alleged that Life Partners had violated federal securities laws by selling unregistered securities. A federal district court ruled in favor of the SEC. Life Partners appealed. On July 5, 1996, a panel of the U.S. Court of Appeals for the District of Columbia Circuit reversed the decision in a 2 to 1 ruling. The majority said a viatical transaction satisfied two of the three necessary elements in the definition of a security, but did not satisfy the third element. The dissenting judge said a viatical transaction satisfied all three elements. The SEC petitioned for a rehearing; the panel denied the petition in a 2 to 1 ruling.
The 1996 Dissent
The 1996 dissent was written by Patricia M. Wald, a distinguished jurist. She served on the D.C. Circuit from 1979 to 1999, and was its chief judge from 1986 to 1991. She also has had an outstanding career before and after her tenure on the D.C. Circuit. She served as an assistant attorney general in the administration of President Jimmy Carter before he appointed her to the D.C. Circuit. Later she served as a judge on the International Criminal Tribunal for the Former Yugoslavia and currently serves as a member of the Privacy and Civil Liberties Oversight Board.

Many who cite the 1996 appellate ruling, including Life Partners, rarely if ever mention that it was a split opinion. Judge Boyd, in the ruling last week, included an exhaustive discussion of the judicial history of the issue and quoted extensively from Judge Wald's superb dissenting opinion. It is a classic example of a dissenting opinion that was later adopted by a majority of the judges who have studied the issue.

LPHI's Pre-Bankruptcy Views
Prior to its January 2015 bankruptcy filing, LPHI, in filings with the SEC, often discussed the litigation that led to the Texas Supreme Court opinion. For example, the appellate court handed down its decision in the Arnold case on August 13, 2013. LPHI disclosed it in an 8-K (material event) report filed a full month later, despite the fact that an 8-K is supposed to be filed within four business days after the event. LPHI disagreed with the ruling and cited, among other things, the 1996 D.C. Circuit opinion without mentioning that it was a split opinion. LPHI said:
Should the decision ever become final, it would result in a material adverse effect on our operations and require substantial changes in our business model.
Availability of the Opinion
I am offering a complimentary 40-page PDF containing the recent opinion by the Texas Supreme Court. E-mail and ask for the May 8 Texas Supreme Court opinion in the Life Partners cases.