DALLAS COURT DISAGREES WITH WACO: VIATICAL SETTLEMENTS ARE “INVESTMENT CONTRACTS” SUBJECT TO THE TEXAS SECURITIES ACT

Arnold v. Life Partners, Inc.
Dallas Court of Appeals, No. 05-12-00092-CV (August 28, 2013)
Justices Moseley, O’Neill (Opinion), and Lewis

Ken Carroll

Setting up a showdown in the Texas Supreme Court or the Texas Legislature, the Dallas Court of Appeals held that interests in “life settlements” or “viatical settlements”—investments in the life insurance policies of others—are “investment contracts” subject to registration and regulation under the Texas Securities Act (“TSA”). The court reversed summary judgment for Life Partners and a viatical broker, rejecting decisions of the Waco Court of Appeals and of the D.C. Circuit that had found such products not to be securities subject to the TSA and federal securities laws, respectively.

Life Partners buys life insurance policies from insured individuals for less than face value and then sells interests in those policies to investors. Such transactions are known as “life settlements” or “viatical settlements.” The profitability of such investments depends on the discount at which such policies are purchased and the time to maturity—i.e., how long a “viator” lives after selling his or her insurance policy. Investors do not become owners or beneficiaries of the individual policies; instead, Life Partners holds the policies as agent for the investors and disburses the proceeds to investors when policies mature. Sometimes investors may be required to invest additional amounts to cover added premium payments if the insured outlives the life expectancy anticipated by Life Partners.

Plaintiffs here are investors in such products, sold by Life Partners. They argued that such interests in life settlements are “investment contracts” and therefore “securities” subject to registration and regulation under the TSA. Defendants disagreed, relying on a provision of the TSA that expressly excludes from the definition of “securities” certain contracts in relation to insurance policies, and on prior decisions from the Waco Court of Appeals and the D.C. Circuit expressly finding Life Partners’ products not to be subject to the Texas and federal securities laws. Griffitts v. Life Partners, Inc., No. 10-01-00271-CV, 2004 Tex. App. LEXIS 4844 (Tex. App.—Waco May 26, 2004, no pet.); SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996).

Adopting a test articulated by the United States Supreme Court, the Texas Supreme Court has held the requirements for an “investment contract” under the TSA are (1) an investment of money; (2) in a common enterprise; (3) with an expectation of profit; (4) in reliance solely on the efforts of others. Searsy v. Comm. Trading Corp., 560 S.W.2d 637, 640 (Tex. 1977). Finding there to be no dispute about elements (1) and (3), and no meaningful dispute about element (2), the Dallas court focused on factor (4).

At the outset, it observed that the Texas Supreme Court in Searsy had explained the fourth factor should not be applied rigidly or literally, but “realistically”—i.e., success of the investment need not rely “solely” on the efforts of others, but the efforts made by those other than the investor must be “undeniably significant, . . . [in] affect[ing] the failure or success of the enterprise.” Both the D.C. Circuit and the Waco court applied a more rigid analytical approach. In particular, both held that nothing Life Partners did after sale of the viatical interests to investors had a significant effect on profitability; that was determined by “the inexorable passage of time and the inevitable death of the insured,” combined with Life Partners’ effort before the purchase in identifying viators, calculating life expectancies, and negotiating discounts and purchase prices with the insureds. Such pre-purchase efforts, those courts held, cannot satisfy factor (4). The Dallas court disagreed, expressly rejected the notion that decisions of either the Waco Court of Appeals or the D.C. Circuit were “controlling,” and held that Life Partners’ pre-purchase activities do count in determining if factor (4) is met. The court noted that such efforts are in fact largely determinative of profitability, such that this final factor clearly is satisfied. The court also rejected Life Partners’ argument that the “insurance exclusion” took life settlement interests out of the TSA. That exclusion applies only to agreements by companies “subject to the supervision or control of the Board of Insurance Commissioners.” Life Partners is not subject to such supervision.

In finding interests in life settlements to be “securities” under the TSA, the Dallas Court of Appeals followed and relied on the trend of recent decisions in the Eleventh Circuit and state appellate courts in Arizona, Colorado, Indiana, and Georgia, which have all found such investment vehicles to be subject to state and federal securities laws.