“Diminishing” Returns: A Pre-Petition Change of Life Insurance Beneficiary is Not Subject to Avoidance as a Fraudulent Transfer
Does a debtor’s pre-petition change of the beneficiary of a life insurance policy constitute a “transfer” of an interest of the debtor in property? Not according to the U.S. Bankruptcy Court for the Eastern District of North Carolina, which held earlier this week that such transfers do not “diminish” the estate.
In Harrison, the debtor’s schedules listed his interest in a life insurance policy with a cash value of $814,917. The debtor’s wife was the beneficiary of the policy on the petition date; so, he claimed the $814,917 as exempt under applicable NC law. However, just prior to the petition, the debtor changed the beneficiary from his former employer to his wife. The Chapter 7 Trustee instituted an adversary proceeding to avoid the change in beneficiary as an impermissible “transfer” of the beneficial interest in the life insurance policy under, inter alia, sections 544 and 548 of the Bankruptcy Code.
The court first discussed Section 548, which permits a Trustee to “avoid any transfer of an interest of the debtor in property, or any obligation . . . incurred by the debtor” that was made or incurred within two years prior to the petition date with an intent “to hinder, delay, or defraud any entity to which the debtor was or became . . . indebted”. Next, Judge Humrickhouse revisited the key definitions and applicable principles that gird this section of the Code. A “transfer” for purposes of Sections 544 and 548 is a “mode . . . of disposing or parting with . . . property or . . . an interest in property.” But, importantly, avoidance under Section 548 requires more than just a “transfer”; it requires a “transfer of an interest of the debtor in property.” And, since the “interest of the debtor in property” is generally regarded as coterminous with Section 541’s definition of “property of the estate,” a transfer made by the debtor within the two years before the petition that does not “diminish the estate” – i.e., that does not alter the scope of what would have been property of the estate but for the transfer – cannot be avoided under Section 548.
With this analytical framework established, the court turned to the parties’ arguments. Both focused on a North Carolina Supreme Court decision that held that beneficiaries of life insurance policies acquire vested interests when the insurance takes effect if the contract does not contain a “reservation of the right to change the beneficiary, assign the policy, or divert the proceeds.” If a beneficiary’s rights are subject to change, however, the interest is a “mere expectancy” and not “property” and thus cannot “ripen into a vested interest before the death of the insured.” As applied here, this would mean that for as long as the debtor is alive, the beneficiary does not have a property right, only a “mere expectancy.”
In the view of the Bankruptcy Court, however, “the parties miss[ed] the mark” in referring to Russell, because the “precise question” is whether “the debtor had an interest in property which was transferred.” The interest of the beneficiary was beside the point. The “owner of an unmatured life insurance contract acquires the rights granted in the contract”, one of which is to change beneficiaries. When the debtor exercised that right prior to the petition, “neither the ownership of the [insurance policy] nor the right under the policy to change the beneficiary designation was transferred.” Because the debtor retained ownership of the policy and the related rights – because his rights in the policy were the same both before and after the change – the estate was not “diminished” by the designation of his spouse as beneficiary. As a result, there was no transfer of an interest in property.
“But, wait a minute,” careful readers are thinking: “the estate was diminished, because the debtor was only able to claim an exemption in the life insurance policy as a result of changing the beneficiary from his former employer (no exemption allowed) to his wife (exemption possibly allowed).” Right? Wrong. As the court insightfully explained, while also gently chiding the Trustee, this argument “conflate[s] the concept of what constitutes property of the estate with what property may be exempted from the estate.”
What the trustee truly objects to is the transformation of the Life Insurance Policy from an asset which could not have been exempted to one in which the debtor could claim an exemption. While the change of the beneficiary designation may have had the effect of allowing the debtor to claim an exemption in the Life Insurance Policy, there was no transfer of an interest in property. It is premature for the court to determine the propriety of the debtor’s claim of exemption in the Life Insurance Policy. On the petition date, the Life Insurance Policy was property of the estate, subject to exemption. Once an objection to exemption is filed, the property remains subject to administration pending resolution of the exemption dispute. The exemption issue is before the court and will be determined in a later hearing. The propriety of changing the qualities and characteristics of property just prior to filing a bankruptcy petition is the subject of an objection to exemption and many reported decisions exist for guidance. The court anticipates it will be given that guidance at the hearing on the objection to exemption.
So, while there was no transfer that the trustee can avoid under Section 548, there may yet be consequences for the debtor’s pre-bankruptcy change in beneficiary, in the form of the court sustaining an objection to the claimed exemption.
 Harden v. Harrison, 2021 BL 61665 at *7 (Bankr. E.D.N.C. Feb. 22, 2021).
 N.C. Gen. State §1C-1601(a)(6) and N.C. Const. Art. X. §5. Importantly, the debtor could not have claimed this exemption if his former employee was the named beneficiary on the petition date.
 Harrison, 2021 BL 61665 at *4-5 citing 11 U.S.C. § 548(a). Section 548 also permits the trustee to avoid transfers within the two-year window if the debtor “received less than a reasonably equivalent value in exchange for such transfer or obligation” and meets the criteria in Section 548(A)(i)(I)-(IV).
 Id. at *4-5 (citing 11 U.S.C. §101(54)(D); In re Whitley, 828 F.3d 205, 208 (4th Cir. 2017)).
 Id. at 5 (emphasis added).
 Id. at 6 (citing Russell v. Owen, 165 S.E. 687 (N.C. 1932)).
 Id. (citing Russell, 165 S.E. at 689).
 Id. (emphasis added).
 Id. at 6-7 (citing cases).
 Id. at 7.
 Id. at 8.
 Id. at 8-9 (emphasis added).