An eight-page opinion out of Atlantic County imploring courts to carefully vet the sale of structured settlements has caught the attention of industry players nationwide—and highlighted a dearth of useful guidance for judges even 15 years after model legislation was crafted to tame a Wild West marketplace.
In it, Superior Court Judge Nelson Johnson said the determination of whether selling an annuity for immediate lump-sum payment is in an applicant’s “best interest” involves “much more than merely inquiring into whether the payee is competent and has voluntarily entered into the agreement with knowledge of its consequences.”
Johnson—”absent criteria from the Legislature, and with only one published judicial decision on this issue by a New Jersey trial court”—saw fit to compose a list of considerations, such as the payee’s age, education level and living situation, as well as the proposed use of the funds.
The opinion, approved for publication Sept. 29 after being issued months earlier, is “probably the single best explication of what structured settlement statutes are supposed to do,” said Craig Ulman, the principal drafter of the 2000 model legislation, which subsequently was adopted in the vast majority of states.
Johnson “concludes correctly that the best interest test is indeed intended to be paternalistic,” added Ulman, a partner at Hogan Lovells in Washington, D.C., who represented annuity-issuing life insurers in their negotiations with the factoring companies that pay cash to the beneficiaries for the payment rights.
“It would be a good thing if courts had issued and published more rulings like Judge Johnson’s early on,” Ulman said.
Andrew Hillman, an attorney and consultant who advises factoring companies, said he found Johnson’s opinion “very much welcome, as did all of my clients.”
“This is going to be widely distributed” among factoring companies and the law firms representing them, Hillman added. “Judges don’t write opinions on these.”
Earl Nesbitt, general counsel to the National Association of Settlement Purchasers, which represents factoring companies, said, “Anytime there’s a significant opinion in this business, our members take notice of it.”
As Johnson observed, even the very basic inquiries his opinion encourages bear pointing out because New Jersey’s Structured Settlement Act, despite requiring judges to make “express findings” as to the applicant’s “best interest,” does not define the term—and neither does the model statute on which it is very closely based.
It raises a question: Why was the legislation, meant to shed light on an entire industry, so vaguely written?
The makings of the standard, and of judicial involvement in the transactions in the first place, date back to the 1970s. Structured settlements became popular then, thanks to tax code changes by the Internal Revenue Service that made them generally free from state or federal income tax if documented correctly.
As a matter of public policy, structured settlements were meant to serve as a negotiation tool for parties to personal injury and workers’ compensation cases, as well as a financial safety net for the injured.
They were used to resolve litigation alleging birth defects resulting from ingestion of Thalidomide, a drug prescribed to treat morning sickness in pregnant women.
Structured settlements, as financial instruments, take the form of annuities issued by life insurers—the benefits of which must be paid out by the insurers on certain dates, and are nonassignable.
Despite the nonassignable nature of structured settlements, the factoring industry, or “secondary market,” was born of a simple transaction: selling the rights to receive those annuity payments for a lesser lump sum, payable immediately for the ostensibly cash-needy ex-litigant.
Usually, it’s only a portion of the annuity that is sold, so the ex-litigant retains rights to at least some of his or her future payments.
To work around nonassignability provisions, early on, a crude system was developed in which beneficiaries redirected their annuity payments to lock boxes, from which they were collected by the factoring companies—all of which typically was arranged without the knowledge of the life insurers.
These structured settlement sales, as they came to light, drew the ire of plaintiffs attorneys who helped foster the settlements. Even more incensed were the insurers who wrote the annuities, because factoring agreements in some cases landed them in court, insiders said: Insurers were drawn into payment disputes between the factoring companies and their customers.
For example, there were hundreds of garnishment cases against insurers in Philadelphia courts in the 1990s stemming from these disputes, Ulman said.
The annuity sellers were not universally blameless. In some cases, they succeeded in redirecting annuity payments back to themselves once they had received their lump-sum payments from the factoring companies.
Add to the mix consumer class actions and involvement by state attorneys general, and the situation came to a head.
In the late 1990s, states took up legislation, which the factoring industry opposed, according to Ulman.
Meanwhile, there was a move afoot to amend the Internal Revenue Code to impose a 40 percent excise tax on any factoring agreement that didn’t follow a standardized procedure.
The pending amendment, ultimately enacted, along with the costly state-by-state legislative battles, motivated insurers and factoring companies to put their heads together. The former were represented by the National Structured Settlements Trade Association (NSSTA); the latter, by NASP. In September 2000, they struck an accord on the model statute, which required judicial review of structured settlement sales, to be approved if in the applicant’s “best interest.”
Nearly every state, including New Jersey in 2001, has adopted it, a process that has taken years.
In that time, however, the question of what aligns a factoring transaction with that standard has not been thoroughly answered.
In 2002, Mercer County Superior Court Judge Jack Sabatino issued In re Transfer of Structured Settlement Rights by Spinelli. In the decision, Sabatino expressed concern over the sale of $120,000 in future payments for an immediate $31,000 lump sum, but ultimately signed off because of the applicant’s cash needs and sophistication as a former employee of Morgan Stanley and Paine Webber. Johnson consulted Spinelli in his own ruling.
But few courts have broached the subject in a written ruling.
According to Hillman, president of Specialty Asset Advisors Inc. of West Palm Beach, Florida, the model statute was “vague to begin with because we couldn’t come up with any kind of objective standards.”
“What we didn’t want to do was to pigeonhole anybody’s right to get these funds,” he said. “They wanted flexibility.”
Peter Arnold, who spent 19 years with the NSSTA and was privy to the negotiations of the model legislation, cited “inherent difficulty in writing legally defensible rules” to govern “something as difficult as financial planning for accident victims who had fundamentally different demands on their money.”
“There’s general recognition that the law is a blunt instrument,” Arnold said. “And, as such, it’s not very good at providing special financial guidelines for judges in incredibly complex financial matters.”
Nesbitt said: “At the time that a lot of interested parties were talking about legislation, there was a lot of discussion … including a discussion of what should be the standard of review.”
Options ranging from no standard at all to the more restrictive “imminent financial hardship” standard—which at least a couple states eventually adopted—were discussed but rejected in favor of the best interest standard, Nesbitt said.
According to Ulman, longtime counsel to the NSSTA, drafters intended for judges to seize on the best interest standard and run with it—at least that was the hope.
“‘Best interest’ was a standard that we thought judges could figure out, considering the public policy objectives,” he said.
Ulman said vagueness didn’t amount to a concession. But he did emphasize that the battles over regulating the industry from 1998 to 2000, leading up to the model legislation in September 2000, were hard-fought.
“The factoring companies fought these [earlier state] statutes tooth and nail,” Ulman said. “They wanted to assure that there would be no effective regulation.”
But Hillman—noting that his former employer, J.G. Wentworth, voluntarily met with about two dozen state attorneys general in the late 1990s—contended that, “really, there was no pushback by the factoring companies.”
“There were skirmishes,” he acknowledged. “The factoring companies were feeling their way through an unregulated market. Many of them wanted to do the right thing.”
According to Arnold, “some of the larger players are not as averse to judicial oversight as they were, because it keeps out some of the bad players.”
“Regulation begets legitimacy,” he said. “It also weeds out bad actors.”
The industry indeed has come under fire over the years, including recently. The Washington Post reported in August that black residents in Baltimore who had received structured settlements to resolve lead paint poisoning litigation have been selling future payments for a fraction of their worth. One woman featured in the report sold decades’ worth of payments totalling $547,000 for a lump sum of $63,000. The factoring company involved in that transaction, Access Funding, through its CEO defended its practices, citing customers’ need for quick cash for housing needs, and denied knowledge of the seller’s cognitive impairments resulting from the lead poisoning, according to the Post.
Also the business of structured settlements appears to be not what it once was.
According to an industry report by Atlanta-based Structured Financial Associates Inc. obtained by the Law Journal, $5.25 billion worth of annuities were issued last year, with an average value of $197,586. So far in 2015, the industry is on pace to issue a total of $5.36 billion in annuities.
The 2014 total represented a second-straight year of increase from the 2012 total of $4.82 billion, but was still significantly less than the high of $6.23 billion in 2008—a drop-off that also doesn’t account for inflation.
There also has been a noticeable decrease in the number of life insurers involved with structured settlements over the past decade and a half, according to the report. So far in 2015, eight carriers have written annuities, compared with 22 in 2002, 21 in 2003, 16 in 2004, and 15 in 2005.
Hillman, noting that “there are always rogue players in every industry,” nonetheless said the factoring industry provided “a very-much-needed service to people who had no other means of obtaining cash.”
“These clients are in need,” Hillman said. “That sounds Pollyannaish, but it’s true.”
“I looked at this opinion and said, these 15 factors are no different from what my clients are doing,” in evaluating factoring agreements, he added.
Ulman said Johnson’s opinion “will have more influence in more places” because the New Jersey statute is very close to the model statute.
“There very definitely continue to be abuses,” he added. “The best cure for abuses is decisions like this.”
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