Kentucky Supreme Court Joins Other State Appeals Courts In Enforcing Contractual Anti-Assignment Provisions In Structured Settlements

Kentucky Supreme Court Joins Other State Appeals Courts In Enforcing Contractual Anti-Assignment Provisions In Structured Settlements

As discussed here, the Kentucky Supreme Court recently held that that state’s structured settlement protection act does not apply to workers’ compensation settlements.

In reversing an opinion of an intermediate appellate court, the Kentucky Supreme Court in American Gen. Life Ins. Co. v. DRB Capital, LLC, 2017-SC-000329-DG, 2018 Ky. LEXIS 535 (Ky. Dec. 13, 2018), also extensively discussed anti-assignment provisions in structured settlements.  In concluding that the anti-assignment clauses in the structured settlement agreement, qualified assignment agreement, and annuity contract were valid and enforceable, the Kentucky Supreme Court joined appellate courts of other states – including California, Florida, and Illinois – that, in cases involving structured settlement protection acts, upheld the contractual rights of annuity issuers and structured settlement obligors to preclude a transfer based on such contract rights.

The DRB matter involved a structured settlement of a workers’ compensation matter.  DRB, a factoring company and proposed transferee, filed a petition invoking the Kentucky Structured Settlement Protection Act, Kentucky Revised Statutes §§ 454.430 through 454.435 (Kentucky SSPA), seeking judicial approval of a transfer of the future payment rights from the worker who settled via the structured settlement, Ray Thomas, to DRB, in exchange for an immediate lump sum.  The Kentucky SSPA provides that such transactions can only become legally effective if they receive judicial approval pursuant to the SSPA, and meet other requirements.  The trial court granted such approval of the proposed transfer, and the annuity issuer and structured settlement obligor appealed to the Kentucky intermediate appellate court.  After the Kentucky Court of Appeals affirmed the trial court’s decision, the issuer and appealed to Kentucky’s high court, which held that the Kentucky SSPA did not apply to a workers’ compensation settlement, such as the one involving Thomas.

In its opinion, the Kentucky Supreme Court included some extensive analysis of the contractual anti-assignment provisions.

  • A contract, the court said, “will be enforced according to its terms.”
  • Further, the court said that “Kentucky law has long held that anti-assignment clauses in contracts are enforceable.”
  • Such “black-letter law principles” are “consistent with general contract principles” that a contract right can be assigned unless “(a) the substitution of a right of the assignee for the right of the assignor would materially change the duty of the obligor, or materially increase the burden or risk imposed on him by his contract, or materially impair his chance of obtaining return performance, or materially reduce its value to him, or (b) the assignment is forbidden by statute or is otherwise inoperative on grounds of public policy, or (c) assignment is validly precluded by contract.”
  • The court further said that the language of the anti-assignment provisions was “clear” and “unambiguous”.  “In the Settlement Agreement that Thomas signed, he expressly agreed that he had no ‘power to sell, mortgage, encumber, or anticipate the Periodic Payments, or any part thereof, by assignment or otherwise.'”  The court added that the anti-assignment provisions in the qualified assignment agreement and annuity contract “are similarly clear and unambiguous, leaving little doubt about the correct outcome of this dispute unless the anti-assignment language is deemed void as against public policy.”
  • The Kentucky Supreme Court rejected the argument that the anti-assignment provisions in the structured settlement agreement, qualified assignment agreement, and annuity contract “are void as a matter of public policy”.  Much of the Court’s opinion on this point focused on Thomas’s argument that the anti-assignment provision is void as a matter of public policy centers on this Court’s decision in Wehr Constructors, Inc. v. Assurance Co. of America, 384 S.W.3d 680 (Ky. 2012).  The Court described how, in Wehr, a hospital – that had contracted with Wehr Constructors to perform floor installation – purchased a builder’s risk insurance policy that said its rights under the policy “may not be transferred” without the insurer’s consent.  “After installation, a portion of the floor was damaged,” and the hospital and Wehr settled a payment dispute whereby the hospital assigned its insurance claim to Wehr.  Wehr sued the insurer to recover payment under the insurance policy for the damaged floors.  The insurer argued that, since it did not consent to the assignment to Wehr, the assignment was unenforceable.  The Kentucky Supreme Court in Wehr stated that “a non-assignment clause in an insurance policy, while certainly enforceable prior to an occurrence of a covered loss, is not enforceable for assignments made after the occurrence” based on public policy grounds relating to the disfavoring of restraints on the alienability of choses in action.  In the DRB litigation, the intermediate appellate court “relied heavily on Wehr in deciding that the structured settlement payments had “the hallmark of a personal property interest under Wehr” and “cannot be restrained from alienability.”  The Kentucky Supreme Court said it was “compelled to hold otherwise because insurance policies and workers’ compensation settlement agreements (and their accompanying assignment and annuity contracts) are different both in substance and treatment.”  In particular, in an insurance context, “[a]ssignment before a loss occurs would require the insurer to deal with someone other than the insured, essentially to contract with a party other than the one upon whom the underwriting decision was made” and so “[p]ublic policy supports contractual provisions prohibiting the insured from foisting a stranger on the insurer.”  This contrasts, said the Court, with the situation “when the loss has already occurred” and “the claim is a chose in action and the insurer is essentially a debtor whose liability is fixed” so that “[a]llowing assignment is consistent with fundamental principles of debtor-creditor law and facilitates settlement of disputes, such as the one between the hospital and contractor in Wehr.”  In DRB, when Thomas entered into the structured settlement agreement, containing an anti-assignability clause, it was “after he prevailed on his workers’ compensation claim and after his damages were assessed” and so “Thomas’s chose in action was fully resolved.”   In other words, “Thomas voluntarily entered into the Settlement Agreement after his workers’ compensation loss occurred and specifically to resolve his chose in action (his workers’ compensation claim)” and “[h]e expressly accepted the restraint on alienation of any and all periodic payments due to him as a result of his workers’ compensation settlement.”  Public policy, then, “fully supports enforcement”of the clear, unambiguous provisions.
  • In addition, the Kentucky Supreme Court said that the anti-assignment provisions served public policy, in that they were consistent with the tax treatment of structured settlements.
  • For one, the Court went into some detail about the provisions of the Internal Revenue Code.  “The Settlement Agreement, [qualified assignment agreement], and Annuity . . . are of unique character, carefully drafted in contemplation of the tax benefits provided by 26 U.S.C. §§ 104(a) and 130,” said the Court.  “Section 104(a) states, in relevant part, that gross income does not include ‘(1) amounts received under workmen’s compensation acts as compensation for personal injuries or sickness; (2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.'”  Workers’ compensation payees, such as Thomas, “generally are entitled to receive their payments tax-free” but “if the payee is deemed to have constructive receipt or the present economic benefit of the structured future payments, then the exclusion under § 104 does not apply and the payee is taxed on the income,” wrote the Court.  In addition, 26 U.S.C. § 130 states that “[a]ny amount received for agreeing to a qualified assignment shall not be included in gross income to the extent that such amount does not exceed the aggregate cost of any qualified funding assets.”  The Court described how Section 130 “allows an entity who undertakes the obligation of making periodic payments . . . to exclude from its gross income the amount received for undertaking the payment obligation, to the extent that the amount does not exceed the cost of the funding asset (here, the annuity contract).”  To exclude, from the annuity issuer’s gross income, the amount received to fund the annuity contract, the structured settlement payments “cannot be “accelerated, deferred, increased, or decreased” as per 26 U.S.C. § 130(c)(2)(B).
  • The Kentucky Supreme Court also went into the public policy underlying these Internal Revenue Code provisions.  “The periodic payment structure embodied in structured settlements serves a public policy purpose by providing income over the long-term for injured parties,” said the Court.  “As opposed to their receiving an immediate one-time payment, they are compensated for the injury and loss of earning capacity over a period of years”.  Further, in cases involving injured workers, “[p]reventing immediate access to a large settlement sum is especially important in the realm of workers’ compensation, where injured workers may have no prospect of ever returning to work.”  Thus, “structured settlements not only benefit the injured worker but help ensure that his or her family is provided for as well.”
  • The Kentucky Supreme Court indicated that these policies may be undermined by structured settlement factoring.  “Once structured settlement agreements are in effect, many personal injury plaintiffs seek to undo the deferred payment aspect of their settlements and instead access an immediate lump sum,” wrote the Court.  “Factoring companies are ready to accommodate these plaintiffs by offering immediate, but substantially discounted, lump sum payments in exchange for the face value of the future payment rights” but “such factoring agreements undermine one of the main purposes behind structured settlements for personal injury victims or injured workers — ensuring their long-term welfare.”  As a result, “most states have enacted some form of limitations or requirements for these structured settlement transfer agreements” – namely, the 49 state structured settlement protection acts, like the Kentucky SSPA.
  • “To receive favorable tax treatment, a structured settlement agreement must be drafted properly,” said the Court.  In the DRB matter, the Court said that the settlement agreement contemplated a “qualified assignment” within the definition of “qualified assignment” in 26 U.S.C. § 130, meaning that the structured settlement payments cannot be “accelerated, deferred, increased, or decreased by the recipient of such payments.” 26 U.S.C. § 130(c)(2)(B).  “This requirement,” noted the Court, “ensures that the payee will not be in constructive receipt or have the present economic benefit of the payments” because “[i]f a payee is deemed to have actual or constructive receipt, or present economic benefit, then the party that accepted the qualified assignment and purchased an annuity to fund the payment obligations can be taxed on the amount it received and used to purchase the annuity.”  In addition, said the Court, “the tax benefits afforded the injured worker under § 104(a) are denied if the payee has actual or constructive receipt of the money”, adding that it is notable that “income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.”  Thus, to avoid “present economic benefit” concerns, “the payee must have no ownership or control of the annuity.”  In the DRB matter, “the anti-assignment and anti-acceleration provisions that were included in the Settlement Agreement, [qualified assignment agreement], and Annuity . . . impose substantial limitations and restrictions on Thomas by not allowing assignment or transfer of the Periodic Payments.”  Further, he “has no ownership interest in the Annuity . . . .”  Such terms “are in place precisely to avoid constructive receipt and present economic benefit thereby protecting him, the payee, and obligated parties from unfavorable tax treatment.”

The Court’s analysis, as described above, puts considerable focus on important aspects of the tax treatment of structured settlements.  It should be noted, too, that the Court began its analysis by stating that a contract will be “enforced according to its terms” and that “black-letter” legal principles uphold anti-assignment clauses as validly precluded an assignment, with no mention of the rationale for such preclusion.

Such reasoning is consistent with the appellate courts of other states that have upheld anti-assignment provisions in structured settlement provisions.  Indeed, courts in state after state have, over the years, upheld the contract rights of annuity issuers and structured settlement obligors to choose to assert their interests and enforce contractual anti-assignment provisions to preclude transfers of structured settlement payment rights.  Such appeals court decisions include the following:

  • Rapid Settlements, Ltd. v. Dickerson, 941 So. 2d 1275 (Fla. Ct. App. 2006), which upheld, in a Florida Structured Settlement Protection Act matter, a trial court’s uphold the rights of a an annuity issuer and structured settlement obligor to preclude a transfer based on assertion of rights under a contractual anti-assignment provision in a structured settlement agreement governed by Florida law, and which was recently cited favorably in Talcott Resolution Life Ins. Co. v. Novation Capital, LLC, 2018 Fla. App. LEXIS 17998 (Fla. Ct. App. 2018).  (Reardon Scanlon Partner Pete Vodola represented the annuity issuer and structured settlement obligor in both the Dickerson and Novation Capital appeals.)
  • In re Foreman, 850 N.E.2d 387 (Ill. App. Ct. 2006), which upheld, in an Illinois Structured Settlement Protection Act matter, a structured settlement agreement’s contractual anti-assignment provision under Illinois law, and which was cited by the Kentucky Supreme Court in the DRB opinion for the proposition that Section 5891 of the Internal Revenue Code only concerns whether the factoring transaction is taxed and not whether a transfer of structured settlement payments is enforceable.  (Reardon Scanlon’s Managing Partner Kathy Scanlon represented the annuity issuer and structured settlement obligor during the Foreman litigation.)
  • Rapid Settlements, Ltd. v. Symetra Life Ins. Co., 2007 Cal. App. Unpub. LEXIS 4462 (Cal. Ct. App. June 1, 2007), which was the first appellate opinion in a California Structured Settlement Protection Act case, and upheld a contractual anti-assignment provision in a structured settlement agreement under California law.  (Reardon Scanlon’s Pete Vodola represented the annuity issuer and structured settlement obligor in this appeal.)

The full opinion in American Gen. Life Ins. Co. v. DRB Capital, LLC, 2017-SC-000329-DG, 2018 Ky. LEXIS 535 (Ky. Dec. 13, 2018), is available here.

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