Impact of Bankruptcy on An Insurance Policy

In understanding the consequences of bankruptcy affecting life insurance policies, we must first know and get familiar with the legal processes and terminology involved. When an individual is insolvent and therefore unable to pay his debts, legal proceedings may be instituted against him. If the debt is not settled, the final step in this process is for the creditors to petition for a bankruptcy order against him. This order is issued by the courts and is the most effective way to enforce a judgment order against a debtor for the purposes of recovery of moneys owing to the creditor. The effect of a bankruptcy (receiving and adjudication) order is to freeze the assets of the debtor and subsequently to distribute them amongst his creditors. The various stages, rules and procedure of these steps are governed by the Bankruptcy Act 1967 of  which the amendments passed in 2003 are significant.

Notable amongst these amendments is that debts owing to creditors must be a minimum sum of RM 30 000.00 for a bankruptcy petition to be initiated. Another important change is that duties of the Official Assignee are now placed in the hands of the Director General of Insolvency (DGI). The person holding this office (or his representative) is effectively responsible for the management of the affairs of the debtor and has wide discretionary powers as provided in the Bankruptcy Act.

Once a person has been declared a bankrupt, it is his responsibility to declare to the DGI all his assets and income as well as to cooperate with him in carrying out his duties. These duties include the gathering of the assets of the debtor, managing and eventually distributing them amongst the creditors. The bankrupt can no longer enter into any contracts or financial dealings without the consent of the DGI. Any moneys or assets received by the bankrupt must be declared to the DGI who will allow him to use those for the necessary expenses of maintenance of himself and his family. In this aspect, the DGI has a discretion including whether to allow for the payment of life insurance premiums by the policy owner if he is declared a bankrupt. It must be noted that he is under no obligation to make any such allowances.

 

 Trust Policies Under Section 166 of the Insurance Act 1996. 

Section 166 of this Act provides for the  creation of trusts of insurance policies for the benefit of spouse, children and (in some cases) parents, if they are named as nominees of a non-muslim policy owner. It further states that proceeds of death claims of such policies “shall not form part of the estate of the deceased policy owner or be subject to his debts”. This trust, which is a unique “statutory gift”, is a benefit not available to any other assets of a policy owner. This is because other subsections in Section 166 allow the policyowner to deal with the trust policy (under certain conditions) during his lifetime but nevertheless provides this ‘creditor protection’ benefit to his family members. Thus, it can be stated that although the trust is created during the lifetime of the policyowner, the benefit only crystallises upon his death. It is therefore clear that creditors, through the office of the DGI in bankruptcy proceedings, cannot lay a claim on these moneys. They can however, lay a claim of the cash values of the policyowner because this is deemed to be part of his assets during his life-time. The DGI in these circumstances may write to the insurance company to provide for details of the policy especially the cash (or surrender) value and has a discretion to further direct it to terminate the policy contract and forward all available moneys to him.

Although death claim proceeds are “credit protected” as stated above, this benefit can be revoked if creditors successfully obtain such an order from the court on the grounds that premiums under the policy were paid to defraud them (Section 166(5) Insurance Act 1996).


Absolute Assignment of a Life Insurance Policy. 

The effect of Section 52 of the Bankruptcy Act is that an Absolute Assignment of a life insurance policy, unless made to a purchaser (or for valuable consideration) in good faith, is deemed void against the DGI if such an assignment was effected within 2 years of the bankruptcy. This means the DGI can direct such policies to be surrendered and realize the cash value, as he would in dealing with the other assets of a bankrupt. If death occurs to the bankrupt / assignor, the death claim proceeds of the policy may therefore be used to distribute amongst the creditors. The provisions of this section further state that in certain circumstances the assignment may also be deemed void, if it was created within 5 years of the bankruptcy.

This article attempts to convey a simple overview of the law in relation to bankruptcy and its effect on life insurance policies. It is written with the intention to minimise legal language as far as possible which always runs the risk of incompleteness. Furthermore, these is very little case law (or recorded cases) in this subject which may help one to understand the practical issues better. However, it must be noted that the Director General of Insolvency (previously the Official Assignee) has wide discretionary powers in dealing with the assets of the bankrupt.   

When A Shareholder or Director Passes Away

This article highlights the issues that arise when a shareholder, who is also an active director of a private limited company (Sdn. Bhd.), passes away, and how life insurance can help to avoid or minimize the problems of such a consequence. To best understand this subject, an example is illustrated of an established and successful company with 3 shareholders who are also executive directors involved in the management and operations of the company. If one of these shareholders who owns, (for example) 30% of the shares of the company passes away, how would this affect his family, the other shareholders and the company? 

First and foremost, the following must be noted. The shares of an individual, like all his other personal assets, are part of his estate. Upon his death, these are dealt with by the estate administration laws. The legal representatives of the estate i.e. the executor or administrator, will be the only ones allowed to deal with the shares. Furthermore, they are authorized to deal with it only after the Probate or Letters of Administration are obtained from the High Court. This is applicable whether the Shareholder is Muslim or Non-Muslim.

Secondly, it must also be noted that upon death of a shareholder the Articles of Association of the company (which is a requirement of the Companies Act 1965) further stipulate that any transfer of shares may only be done with the consent of the directors. The legal representative is authorized to instruct the directors to transfer the shares according to the Will, or the Distribution laws of the country (this will differ in the case of Muslims and Non-Muslims). The beneficiaries who are entitled to the shares may also voluntarily transfer the shares to others (again with the consent of the directors). 

Thirdly, beneficiaries are entitled to only the rights and benefits (if any) that are due to them as a consequence of their ownership of the shares (e.g. dividends). They are, of course not entitled to the salary, allowances, perks or any other benefits which were given to the deceased Shareholder in his capacity as director. It must be pointed out that in such companies (as given in this example) the directors hardly ever declare dividends. Profits of the company are usually further invested in the company or are given to the directors as bonuses or in various forms of additional benefits. The net effect of this scenario is that, the beneficiaries are entitled to the shares whose monetary value would be a very subjective matter and if they are in urgent need of funds, they would need to sell the shares at a “willing-buyer-willing-seller” basis to the other shareholders / directors or any other persons interested in the purchase. It is thus obvious, that the beneficiaries would not be in a ‘strong-bargaining-position’. Family members holding on to the shares of a minority shareholder (30%), would not be too much of an inconvenience or bother to the surviving shareholders / director’s.      

In order to avoid these difficulties and pitfalls to the beneficiaries of a deceased shareholder / director, the following is recommended. Shareholders should enter into a ‘Buy-Sell Agreement’ of the shares which is to take effect upon the death of any one of them. The key issues to be addressed in such an agreement must include.

i)    The obligation of the surviving shareholders to purchase the shares of a deceased         shareholder.

ii)   The current value of each shareholders interest and provisions to revalue them in          the future.

iii)  The distribution of the deceased’s shares amongst the surviving shareholders.

iv)  The mechanisms of the transfer and execution of the relevant documents.

v)   The duty of the legal representatives of the estate of the deceased shareholder who     is bound by the terms of the agreement.

Of course, several other terms and conditions, depending on the peculiarities of each company will be further necessary to give effect to such an agreement. Foremost amongst these would be the appropriate funding method for the purchase of the deceased’s shares. Life insurance would be the obvious choice of moneys that would available upon the death of a shareholder. Suitably arranged insurance policies would be able to provide all or a substantial part of the moneys necessary to give effect to such a ‘Buy-Sell arrangement’.

As there are several details and legal matters to be considered shareholders, need to source for suitably qualified and experienced insurance agents or financial planners to ‘put together’ such a “buyout” scheme of shares upon the death of a shareholder.

Trust Policies – A Unique Benefit for Business Owners

The objective of Trust insurance policies is to establish a fund for the benefit of immediate family members of the policyowner which is not subject to creditors. This is the only asset a policyowner can own and control and yet enjoy such creditor protection benefits.

What are the features of such a policy?

·         It must be a life insurance or personal accident contract which a Non-Muslim policyowner purchases on his own life.

·         Nominees must be named in the contract and these are confined to the spouse and children of the policyowner. If the policyowner is single, parents who are named as nominees also qualify for these benefits

·         The appointment of Trustees in the policy is optional. If appointed, their duties are as follows

i)                   during the life-time of the policyowner, the consent of the Trustees is needed to make any contractual changes in the policy contract;

ii)                 upon the death of the policyowner, the Trustees receive the claim proceeds and are responsible to pay out or manage the fund for the beneficiaries.

·         It must be noted that the unique credit protection benefits in Trust policies may not be available to a policyowner if he had purchased the contract during a period of time when he was insolvent or was subject to legal action by creditors.

·         If the policyowner is declared bankrupt during his lifetime, the policy contract may have to be surrendered for its cash value which may be utilised to satisfy the creditors. This is subject to the discretion of the Director General of Insolvency.

·      The law relating to Trust policies is found in Section 166 of the Insurance Act 1996.

Watch Your Thoughts!

"The thought manifests as the word; 

the word manifests as the deed;

 the deed develops into habit; 

and habit hardens into character. 

So watch the thought and its ways with care,

and let it spring from love born out of concern for all beings." 

                                                                                - Buddha