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What Happened To The Freedom Of Contract?

By Tim Berry, JD - Email Editor

Date : June 25, 2009

Dear Valued Reader,

Iranian election results, Astronaut water, and efficient markets . . . what do they have in common?

Things aren’t always what they appear to be, even if spelled out in black and white.

In the case, a subsidiary of J.G. Wentworth, (the guys who advertise on late night TV about purchasing your annuity for pennies on the dollar) was trying to purchase a structured settlement (fancy name for an annuity issued to pay for a court claim) from a beneficiary of a settlement.

Why was there a court case to determine if someone could purchase an annuity from a private owner?

Back in 2002, that great moral body known as Congress decided such purchases had a nasty smell about them, that the purchasers were probably taking advantage of the sellers. Thus Congress created section 5891 of the tax code which levied a 40% penalty tax on these types of purchases, unless there was a court order proclaiming such purchase was “in the best interest of the payee”.

This law turned into just another confirmation of the law of unintended consequences, as well as another full employment act for attorneys. JG and friends merely hired attorneys to get a court order declaring the purchase as in the best interest of the payees. It doesn’t appear these court cases were met with much opposition as over 2,000 court orders were granted to JG and associates since 2002.

2,000!

Unfortunately, a judge from my hometown of Fresno didn’t get the memo that the court was supposed to automatically approve the motions. In fact, after reviewing the docs, he blindsided the industry and issued an order that would effectively void the transactions. That would mean that all of the previous 2,000 cases would be overturned.

What was the reason the judge said the sales should be “void”? Amongst other issues, the annuity contracts had anti-alienation clauses, that is to say the language on the annuity contract specifically stated the annuity contracts could not be sold to a third party. The language on some of the contracts was pretty clear. Here is a sample:

“No Payee or Beneficiary of this policy has the power to assign any payments or benefits of this annuity policy. Any attempt to make an assignment is void.”

Not much wiggle room there.

However, just try to imagine the implications if thousands of transactions that had already taken place being rendered void. What a financial and logistics nightmare. Not to mention JG and associates would lose a lot of money.

It goes without saying that the order was appealed immediately.

The appellate court came out with an absolutely fascinating and mind bending ruling. The appellate court said the structured settlements fell under California’s Uniform Commercial Code. The significance of this is that the Commercial Code says that, “assignment provisions are generally ineffective in barring transfers of structured settlement payment rights”.

Wow again. Who says the law isn’t exciting? This stuff is amazing.

Get ready for another Wow moment. The bottom line ruling by the appellate court on this issue was:

Therefore, we conclude that, where no interested parties object to the transfer of structured settlement payment rights, the anti-assignment provisions in the annuity contract, settlement agreement or other related contracts do not bar the factoring transaction at issue in this appeal.

Ok, let’s pull a “Clinton” and parse this to understand what the meaning of is, is. …

“Where no interested parties object” --- Does that mean what I think it does? We get the best of both worlds? The anti-assignment clause is valid if one of the parties objects? I still have Asset Protection with the annuity if I want it, but at the same time, I can sell it if I want to?

Quite honestly my head is spinning with the possible ramifications of this ruling.

Can I draft a promissory note with an anti-assignment clause? This could be great for both Asset Protection and estate planning purposes, especially in the current interest rate environment. For example, let’s say I loan a trust money at a current interest rate of about 4%, 15 year term, interest only with a balloon at the end of the 15 year term.

What is the fair market value of that note? What if interest rates increase, as they must, what will happen to the value of the note? If the note can’t be assigned to someone else - good luck marketing it! Same goes for any bankruptcy trustee who might take it away from you.

One of the reasons why estate planners say assets receive valuation discounts is a lack of marketability. We have now just created an asset that can’t be “marketed”, unless you want it to be. That should save some wealthy people a few hundred thousand in estate taxes.

Alternatively, let’s say you are annuity rich but cash poor. You or your client shelled out a couple hundred grand for a deferred annuity, but if they start taking withdrawals they get hit with stiff penalties. Even if the annuity has anti-assignment language it now appears that you could sell your annuity to someone else, let’s say your IRA. If your IRA has cash, you just accessed that cash in a tax free transaction, and yet don’t have to pay any early surrender fees on your annuity.

In closing, my brethren attorneys would tar and feather me if I didn’t include a big CAVEAT; this ruling was based upon California law. It goes without saying that California is special and that this ruling may or may not apply to your particular state’s laws. Check with local counsel before you do anything stupid.

To get a copy of the decision, or if you just want to bend our ear about your situation, send us an email. We look forward to discussing this with you.

Until next time,

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