Life Partners, Inc. v. Arnold
No. 14-0122
Case Summary written by Ross Smith, Articles Editor.
JUSTICE BOYD delivered the opinion of the Court
This case was two consolidated cases, one class action lawsuit wherein Michael and Janet Arnold along with others brought claims against Life Partners, Inc. for violating the Texas Securities Act “by selling unregistered securities and materially misrepresenting to purchasers that they were not, in fact securities” and one from the State of Texas claiming that Life Partners, Inc., with other defendants, had committed fraud through the sale of the securities. Both cases required the courts to determine if the interests in “life settlement agreements” sold by Life Partners, Inc. were in fact securities under the Texas Securities Act.
The trial courts held that Life Partner’s had not sold any type of security, and therefore was not liable under the Texas Securities Act. The cases were reversed in part, and affirmed in part, by the Dallas Court of Appeals, which held that life settlement agreements were securities under the Texas Securities Act.
Life Partners, Inc. operates by purchasing life insurance policies from those willing to sell them, and then offering its own investors a chance to purchase an interest in the specific person’s life insurance. Life Partners offers a person a cash amount that is less than the policy pays out, but that the person can then use immediately, and Life Partners assumes the monthly payments of the life insurance policy. In return, the person will appoint Life Partners as the beneficiary under the policy. Life Partners calculates how much the cash payment will be based on when Life Partners believes the person will die. If Life Partners accurately guess’s that the person will die before the calculated date, then Life Partners and in turn its investors will make a profit on the deal. If the person lives longer than Life Partners has calculated for the cash payment, then Life Partners and its investors will lose money.
Issue (1): Are the life settlement agreements offered by Life Partners investment contracts under the Texas Security Act?
Under the Texas Security Act, “securities” are broadly defined “to include such things as ‘any limited partner interest in a limited partnership, share stock, treasury stock, . . . investment contract, or any other instrument commonly known as a security, whether similar to those herein referred to or not.’” The Texas Supreme Court only considered whether the life settlement agreements would be considered investment contracts under the statute. The court had noted in a previous case that the Texas Security Act was almost an exact copy of the definition from the Federal Securities Act of 1933. The court stated its intention to look to other state courts and federal courts which had sought to determine the meaning of investment contracts, along with its own precedent. In doing so, the Texas Supreme Court defined an investment contract as “(1) a contract, transaction, or scheme through which a person pays money (2) to participate in a common venture or enterprise (3) with the expectation of receiving profits (4) under circumstances in which the failure or success of the enterprise, and thus the person’s realization of the expected profits, is at least predominately due to the entrepreneurial or managerial, rather than merely ministerial or clerical, efforts of others, regardless of whether those efforts are made before or after the transaction.”
After defining an investment contract, the Texas Supreme Court analyzed the Supreme Court’s test, also known as the Howey/Forman test, to determine if an item claimed to be a security would fit the definition of an investment contract. From analyzing the relevant Supreme Court case law, the Texas Supreme Court found three important factors for applying the test: (1) a court should protect the public as the securities acts intended by broadly construing the definition of investment contract; (2) a court should “focus on the ‘economic realities’ of the transaction”; and (3) if the economic realities meet the requirements of the test, a court should find the transaction to be an investment contract, “regardless of the labels or terminology the parties used to describe it.”
After giving investment contracts a definition and determining the factors behind the Howey/Forman test, the Texas Supreme Court expanded on its reasons for using the definition and the factors, providing a very thorough review of relevant federal jurisprudence regarding what constitutes an investment contract. Following the review of authority, the court began to determine if the life settlement agreements offered by Life Partners, Inc. were investment contracts.
The court found that Life Partner’s, Inc. retains at least entrepreneurial or managerial efforts throughout the transaction. Life Partner’s is the sole party to determine the value of potential persons life insurance policies, and how large a cash payment should be made to them. After the purchase of the life insurance policy, Life Partners must make payments on the policy, or it will lapse, and Life Partners is the only party that can continue to tract the insured so as to know when they die and the life insurance policy becomes payable. Since investors enter into the contracts with Life Partners to purchase interests in the life insurance policies with the expectation of making a profit, during which time Life Partners retains the required degree of control over the venture, the transaction is an investment contract and therefore a security under the Texas Securities Act. Finally, the Texas Supreme Court had to determine if its holding would only apply prospectively, or retroactively to Life Partners activities.
Issue (2): Will this holding apply retroactively or only prospectively?
The Texas Supreme Court had previously adopted the Chevron standard issued by the Supreme Court for determining if a case would have only prospective relief. The Chevron standard has three factors that a court must analyze: (1) does the decision address a question of first impression or overrule precedent; (2) after looking to the merits of the specific situation, will retroactive application further or limit the operation of the rule; (3) how inequitable would a retroactive application be? In this case, the court decided that because it had previously broadly construed investment contract under the Texas Securities Act and the decision only interpreted an old law instead of creating a new one, the decision should be applied retroactively. That decision would not work inequity upon Life Partners, Inc.