November 20, 2018

New York Law Journal / Written by: Harvey M. Stone, Richard H. Dolan

This column reports on several significant, representative decisions handed down recently in the U.S. District Court for the Eastern District of New York. Judge Jack B. Weinstein enforced the incontestability provision of a life insurance policy though the policy was procured by fraud. In separate cases, Judge Denis R. Hurley, relying on the preemption doctrine, denied a motion to remand to state Supreme Court; and Judge Eric N. Vitaliano, finding no diversity jurisdiction, granted a motion to remand. And Judge William F. Kuntz II set forth reasons for sentencing defendant to a four-year jail term with a large restitution payment.

Incontestability Enforced

In  AEI Life v. Lincoln Benefit Life, 14 CV 6449 (EDNY, Dec. 22, 2016), Judge Weinstein rejected an insurer's effort to get around a life insurance policy's incontestability provision by arguing that the policy was procured by fraud. The result turned on the court's decision to apply New York rather than New Jersey law as specified in the insurance contract. New York law, unlike New Jersey law, bars an insurer from challenging the validity of a life insurance policy on grounds of fraud in the inducement after expiration of the two-year period specified in the incontestability clause.

In 2008, defendant Lincoln Benefit Life (LBL) issued an insurance policy for over $6 million on the life of one Gabriela Fischer. The initial owner and beneficiary of the policy was the "Gabriela Fisher Trust," whose beneficiary was Ms. Fischer's son, Irving Fischer. Shortly before the trust bought the policy, $1 million was wired into the trust's account by another individual. In 2011, the trust sold the policy to a third party, which a few days later sold the policy to plaintiff AEI Life (AEI). Since then, AEI continuously paid the premiums. The insurance contract contained a choice of law provision specifying New Jersey law.

LBL brought a declaratory judgment action in the District of New Jersey seeking to declare the policy invalid. That action was stayed after AEI brought this action seeking to bar LBL from contesting the validity of the policy, based on the policy's incontestability clause. New York law requires all life insurance policies to contain a two-year incontestability clause barring the insurer from challenging the validity of the policy after expiration of the two-year period. There is no exception for fraud in the making of the insurance contract or for lack of an insurable interest. The New York Court of Appeals explained the underlying rationale as seeking to prevent "'a forfeiture to [the policy owner] ... and an unnecessary advantage to [the insurer] by enabling it to avoid a claim it previously accepted.'" Slip op. 10 (quoting  New England Mut. Life Ins. v. Caruso, 535 N.E.2d 270, 274-75 (N.Y. 1989)). New Jersey law also requires that all life insurance policies contain a two-year incontestability clause, but in contrast to New York law, allows an insurer to deny a claim after expiration of the two-year period if the insured committed fraud on the policy application.

Because jurisdiction was based on diversity, the court had to apply New York conflict of law rules. Under those rules, the parties' choice of New Jersey law was entitled to a presumption of validity, but that presumption is rebutted when, among other things, "the contract as a whole is procured through fraud." Slip op. 7. If the parties' choice of law is disregarded on account of fraud, the court must determine which state's law to apply by, first, determining whether there is an "actual conflict" between the two states' laws, and if there is such a conflict, by applying a "center of gravity" analysis to determine which state's interest predominates. Slip op. 8.

The court had no difficulty concluding, after a hearing, that the policy was fraudulently procured. The original insured, Ms. Fischer, testified that she did not recall signing the policy or meeting the insurance agent who sold the policy; did not know there was a $6 million policy on her life; and did not have sufficient funds to pay the premiums or meet the financial qualifications certified in the accompanying financial statement. Her son did not recall signing the policy application or being present when his mother signed, did not know who paid the premiums, and did not authorize anyone else to pay them, though he admitted that he may have signed checks presented to him by the insurance agent. Mr. Fischer claimed not to care about the million dollars wired to the trust's account to pay the premiums, and admitted that the insurance agent paid him $50,000 for acting as a middleman in the sale of the policy, which he did not share with his mother. The insurance agent admitted to splitting his $100,000 commission with Mr. Fischer though he knew that was not permitted, and claimed not to know who wired the million dollars to cover the premiums. Slip op. 13-14.

The court found that all three witnesses lied, choosing to deny their knowledge "because they feared they might have to pay a penalty, or, in the case of the son and the agent, disgorge a large profit." Slip op. 15. Although the facts surrounding the policy's creation "remain shrouded in mystery," id. at 20, the fraud in the inducement was undeniable. Thus, the policy's New Jersey choice of law provision was unenforceable.

There was a conflict between New Jersey and New York law on the enforcement of incontestability clauses in life insurance policies in these circumstances, and New York conflicts of law principles applied. With virtually all the underlying events having taken place in New York and involving New York residents and businesses, New York was the "center of gravity" for the dispute. Accordingly, LBL was barred from challenging the validity of the policy, as the two-year period for doing so had long ended. The court believed this to be the equitable result, since AEI had been making premium payments for five years and LBL "was taking full economic benefit of the policy and could have made an earlier investigation into its validity." Slip op. 20.

Motions to Remand

Two Eastern District judges dealt with remand motions. In Ciampa v. Oxford Health Insurance, 15 CV 6451 ( EDNY, Dec. 21, 2016), Judge Hurley denied plaintiff's motion to remand because her state law claims were preempted by federal statute, the Employee Retirement Income Security Act of 1974 (ERISA). In  Atanasio,  individually and derivatively on behalf of  Somerset Production Company v. O'Neill, Judge Vitaliano granted plaintiff's motion to remand because there was no diversity jurisdiction.

Plaintiff Alexandria Ciampa brought an action under New York General Business Law (NYGBL) §349 alleging that defendant used deceptive business practices to market and sell its Group Medical Coverage. Plaintiff had back surgery performed by a physician out of the Plan's network and Oxford only reimbursed her $5,645.19 out of the total medical bill in the amount of $68,545. After the court dismissed plaintiff's prior ERISA action for additional benefits under the plan, plaintiff filed the present action in Nassau Supreme Court alleging violations under the NYGBL, which defendant removed to the Eastern District.

In support of removal, defendant asserted federal question jurisdiction pursuant to 28 U.S.C. §1331, contending that ERISA preempted plaintiff's New York state claims. ERISA protects the interests of participants in employee benefit plans and creates a comprehensive enforcement scheme that preempts any state law cause of action that "duplicates, supplements, or supplants an ERISA remedy." Hurley decided that plaintiff's claims implicated coverage and benefit determinations under ERISA, even though she sought damages in the form of reimbursement of premiums instead of benefits. In addition, defendant's actions implicated no independent duty under state law, apart from the determination of benefits under the plan.

In  Atanasio, filed in Kings County Supreme Court, plaintiff alleged that defendant had breached fiduciary duties by withdrawing $4.7 million from the accounts of Somerset Production Company, LLC. As a basis for removing the action to federal court, defendant O'Neill asserted federal subject matter jurisdiction based on diversity of citizenship, contending that plaintiff Atanasio was a citizen of New York, while O'Neill was a citizen of Florida. But as Vitaliano noted, in a derivative action on behalf of an LLC, the LLC is a necessary party and its citizenship should be taken into account to determine diversity. Both plaintiff and defendant were members of Somerset, and an LLC takes the citizenships of all its members. The result was that complete diversity would be impossible whether Somerset was a plaintiff or defendant, because Somerset would be a citizen of both New York and Florida.

Reasons for Sentence

In  United States v. Conway, 16 CR 52 (EDNY, Jan. 11, 2017), Judge Kuntz explained the reasons, pursuant to 18 U.S.C. §3553(c), for sentencing defendant in a fraud case to prison for 48 months and over $4,700,000 in restitution.

Defendant pled guilty to one count of wire fraud, 18 U.S.C. §1343. At the time of the offense, he was president of Choice Office Solutions LLC, which bought and leased office equipment. From March 2014 to August 2015, defendant fraudulently induced two victims-John Doe and De Lage Landen Financial Solutions Partner (DLLFSP)-to finance forged lease agreements. For example, defendant provided the victims with fabricated Lease Agreements between Choice Leasing and the New York Mets. The purported signatures on behalf of the Mets were forged. When DLLFSP requested a letter of authorization from the Mets, defendant sent an email to DLLFSP on Mets letterhead signed "Jeffrey Wilpon," chief operating officer. Wilpon's name was misspelled and his signature forged.

The court's reasons for its sentence included the following:

"Defendant knowingly promulgated a fraudulent scheme that lasted for approximately seventeen months and included two victims to finance numerous forged lease agreements[,]" resulting in a multimillion dollar loss to them. Defendant showed a "reckless disregard for the law[.]" A "significant sentence" was necessary "to afford adequate deterrence, both specific and general, to criminal conduct. See 18 U.S.C. §3553(2)(B)." Slip op. 5-6.

The maximum term of incarceration under the wire fraud statute is 20 years. Defendant's Guidelines range was 41 to 52 months. His sentence of 48 months "falls within the range of sentences set forth by Congress and the President" and avoids sentencing disparities among defendants with similar records. Slip op. 7-8.

Based on the victims' losses, Kuntz ordered $3,555,493 in restitution to John Doe and $1,203,516 to DLLFSP. Slip op. 9.

Harvey M. Stone and Richard H. Dolan are partners at Schlam Stone & Dolan.