Thomas A Napolitano and Mary Napolitano

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NEW YORK
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In re:
Case No.: 07-73361-478
Thomas A. Napolitano and
Mary Napolitano,
Chapter 7
Debtors.
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MEMORANDUM DECISION AND ORDER
Appearances:
Gladstein & Messinger
By: Jack Gladstein, Esq.
Attorneys for the Debtors
118-21 Queens Boulevard
Suite 614
Forest Hills, New York 11375
Meltzer, Lippe, Goldstein & Breitstone, LLP
By: Kamini Fox, Esq.
Attorneys for the Chapter 7 Trustee
190 Willis Avenue
Mineola, New York 11501
Honorable Dorothy Eisenberg, United States Bankruptcy Judge
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The issue before the Court is whether the Court should approve a signed stipulation
between the Debtors and Neil H. Ackerman, Esq., the Chapter 7 Trustee, under which the
Trustee agrees to accept 88% of the cash surrender value of the Debtors’ life insurance policies
for the benefit of the bankruptcy estate when subsequent to the signing but prior to the hearing
on the Trustee’s application to approve the stipulation, there was a change in law regarding
whether such insurance policies are property of the debtors’ bankruptcy estate.
The Court has jurisdiction of this matter pursuant to 28 U.S.C. § 1334. This contested
matter is a core proceeding under 28 U.S.C. § 157(b)(2)(A), § 157(b)(2)(B), § 157(b)(2)(E), and
§ 157(b)(2)(O) and 11 U.S.C. § 541 and § 542. Based upon the facts and law in this case, the
Trustee’s application is granted and the Debtors’ objection is overruled. The following
constitutes the Court’s finding of fact and conclusions of law as mandated by Rule 7052 of the
Federal Rules of Bankruptcy Procedure.
FACTS
The Debtors filed for Chapter 7 relief on August 28, 2007. The Debtors listed in their
originally filed Chapter 7 schedules that Mr. Napolitano owns 3 life insurance policies and Mrs.
Napolitano owns one life insurance policy (the "Insurance Policies") as to which the total cash
surrender value was approximately $119,000. The Debtors claimed the cash surrender value as
exempt in their original Schedule C. Each spouse is the beneficiary of the other spouse's policy.
The Trustee demanded the turnover of the cash surrender value of the Insurance Policies on the
basis that the cash surrender value was not exempt in a joint case where one of the debtors is the
beneficiary. In re Ventimiglia, 362 B.R. 71, 87 (Bankr. E.D.N.Y. 2007); In re Teufel, No.
02-CV-81S, slip op. (W.D.N.Y. Sept. 24, 2002); In re Jacobs, 264 B.R. 274 (Bankr. W.D.N.Y.
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2001); cf., In re McWhorter, 312 B.R. 695 (Bankr. N.D. Ala. 2004)(relying on New York law to
interpret Alabama statute with similar language).
In order to avoid time-consuming, expensive and unnecessary litigation, the Debtors and
the Trustee entered into a stipulation on September 28, 2007 whereby the Debtors agreed to
abandon and waive their claimed exemption in the Insurance Policies (the “First Stipulation”).
The Court so ordered the First Stipulation on October 3, 2007.
Subsequent to the entry of the First Stipulation, the Debtors notified the Trustee that
Prudential Insurance Company of America (the "Insurance Company"), the company which
issued the Insurance Policies, has advised them that if the Debtors cancel the Insurance Policies,
they will have to pay capital gains taxes on the sum of $82,914.70 in the form of surrender
charges such that the actual amount that they will be able to turn over to the Trustee of the cash
surrender value shall be significantly less. In addition, if the Debtors take the entire cash
surrender value of the Insurance Policies, they will lose the Insurance Policies and it will
probably be far more costly for them to purchase similar life insurance at this time, given that the
Debtors are older and have different health conditions than when they first applied for the
Insurance Policies. Alternatively, the Debtors may borrow up to $60,843.38 (approximately 88%
of the cash surrender value) and maintain the Insurance Policies in effect.
As a result, in September of 2008, the Trustee and Debtors executed a new agreement,
subject to this Court's authorization and approval, providing that (a) the Debtors’ Schedule C is
amended to delete any claim of exemption in the cash surrender value; (b) the Debtors may
preserve the Insurance Policies but shall immediately make the request for the loan against their
Insurance Policies and that they shall turn over the $60,843.38 upon their receipt of same from
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the Insurance Company; and (c) that the Debtors shall have no other or further claim to these
monies, and they shall repay the loan upon such terms and in such time as they agree to with the
Insurance Company. On September 18, 2008, the Trustee filed a motion (the “Motion”) seeking
the Court’s approval of this second stipulation (the “Second Stipulation”). As of the date of the
hearing on the Trustee’s Motion, the Debtors have already turned over the $60,843.38 to the
Trustee by checks from the Insurance Company, and these monies are being held in the Trustee's
interest bearing account for this estate.
The Debtors filed an objection to the Motion on October 6, 2008 on the basis that after
the parties entered into the Second Stipulation, the Court of Appeals for the Second Circuit held
in Wornick v. Gaffney, Slip Op. No. 07-1657-bk, 2008 WL 4349810 (2d Cir. September 24,
2008) that where a debtor purchases an insurance policy on his own life for the benefit of his
joint debtor spouse, the joint debtor spouse’s interest in the policy as a beneficiary is not only
protected from the debtor’s creditors but is also protected from her own creditors because as the
beneficiary, she only has an inchoate interest in the insurance policy. The fact that the debtors
are spouses that have insurance policies on their own lives that benefit the other spouse does not
make a difference. “A joint filing does not vest the power to reach a spouse’s assets that would
have otherwise been insulated.” Wornick v. Gaffney, Slip Op. No. 07-1657-bk, 2008 WL
4349810, *4. Accordingly, the Debtors argue that the Trustee cannot administer the insurance
policies in this case.
In his Reply, the Trustee argues that the Second Stipulation which modifies the First
Stipulation constitutes a binding contract even without the Court’s approval. Moreover, the
Court has already so ordered the First Stipulation under which the Debtors each waived any right
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to claim an exemption in the insurance policies and the First Stipulation is still enforceable by
the Court.
The Court held a hearing on the Trustee’s Motion on November 13, 2008 and requested
the parties submit post-hearing memoranda regarding whether a change in law that occurs after a
stipulation is entered into affects the validity and enforceability of that stipulation. In its post-
hearing memorandum, the Debtors argue that until the Court has so ordered the Second
Stipulation the stipulation is not fully enforceable and the Court can rescind, modify or deny so-
ordering the stipulation. Therefore, the Debtors request that the Court rescind the Second
Stipulation as the Debtors would be prejudiced by the Court’s approval. The Trustee argues that
the legal support cited by the Debtors is distinguishable and that while changes in law are
inevitable, parties who negotiate in good faith based upon the law as it existed at the time should
not be denied the benefit of their bargain. Moreover, the Trustee argues that there was no
mistake or fraud on either party’s behalf when the Second Stipulation was entered that would
warrant the rescission of the Second Stipulation.
DISCUSSION
While there was a change in the interpretation of the Bankruptcy Code as to whether an
intended beneficiary’s interest in a life insurance policy is property of such beneficiary’s
bankruptcy estate, the Court must determine whether the stipulation between such debtor-
beneficiary and a Chapter 7 Trustee entered into prior to such change in law is enforceable.
Accordingly, general principles of New York contract law apply.
‘It is well settled that stipulations between parties or their attorneys, reduced to a writing
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or to an order which has been entered becomes a binding agreement; and that the authority of the
court to relieve a party from the scope of a court-approved stipulation is an exercise of discretion
which cannot be involved without a showing of good cause therefor, “such as fraud, collusion,
mistake, accident, or some other ground of the same nature.”’ Hinds v. Gulutz, 61 Misc.2d 382,
385, 305 N.Y.S.2d 691, 692 (N.Y. Sup. Ct. 1969) (internal citations omitted)(emphasis added).
See also, N.Y. C.P.L.R. § 2104; In re Royster Company, 132 B.R. 684, 687 (Bankr. S.D.N.Y.
1991)(stating that when parties enter into a stipulation, the agreement is enforceable as a contract
and a stipulation and order is a binding agreement between parties which have been so ordered
by the presiding court). In this case, there has been no allegation of fraud or collusion by either
party in negotiating the First Stipulation or the Second Stipulation. Rather, the Debtors argue
that there was a mutual mistake of law.
Courts may decline to enforce a contract predicated on a mutual mistake of law. Anita
Foundations, Inc. et al. v. ILGWU National Retirement Fund, 902 F.2d 185, 189 (2d Cir. 1990);
Board of Trustees of the Sheet Metal Workers Local Union no. 137 Insurance Annuity and
Apprenticeship Training Funds et. al v. Vic Construction Corporation, 825 F. Supp. 463, 467
(E.D.N.Y. 1993). A mutual mistake of the law requires both parties to be mistaken as to the law
and must be viewed in accordance with the law and the circumstances which existed at the time
the contract is entered into by the parties. Hinds v. Gulutz, 61 Misc.2d at 385, 305 N.Y.S.2d at
693. In this case, there was no mutual mistake of the law at the time the Second Stipulation was
entered into by the parties. At the time the stipulation was entered into, several courts had held
that the cash surrender value was not exempt in a joint bankruptcy case where one of the debtors
is the beneficiary. In re Ventimiglia, 362 B.R. 71 (Bankr. E.D.N.Y. 2007); In re Teufel, No.
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02-CV-81S, slip op. (W.D.N.Y. Sept. 24, 2002); In re Jacobs, 264 B.R. 274 (Bankr. W.D.N.Y.
2001); cf., In re McWhorter, 312 B.R. 695 (Bankr. N.D. Ala. 2004). It was on this basis and a
desire to avoid the expenses of litigation that the Debtors agreed to waive their exemption in
their insurance policies under the First Stipulation and the Second Stipulation, which was
executed almost a year after the First Stipulation, and they turned over a percentage of the cash
surrender value of the Insurance Policies to the Trustee. Accordingly, there was no mutual
mistake of law at the time the Second Stipulation was entered.
Rather, the Debtors’ basis for rescission is that there was a change in law that occurred
after the Second Stipulation was entered. Under Wornick v. Gaffney, the Court of Appeals for
the Second Circuit held, contrary to prior lower court decisions, that any leverable interest in the
cash surrender value of an insurance policy belongs to the owner/insured and not to the
beneficiary because N.Y. Insurance Law § 3212 protects the cash surrender value from the
creditors of the owner/insured. Therefore, the cash surrender value is not subject to
administration by a bankruptcy trustee. 	Wornick v. Gaffney, Slip Op. No. 07-1657-bk, 2008 WL
4349810. Accordingly, the Debtors argue that the Trustee cannot administer the cash surrender
values of the Insurance Policies for the benefit of the creditors of either Debtor.
While the turnover of the cash surrender value would significantly impact the Debtors
financially given the Second Circuit’s ruling in Wornick v. Gaffney, it is well settled that a
subsequent change in law cannot be used to set aside a written agreement. Anita Foundations,
Inc. et al. v. ILGWU National Retirement Fund, 902 F.2d 185; Board of Trustees of the Sheet
Metal Workers Local Union no. 137 Insurance Annuity and Apprenticeship Training Funds et. al
v. Vic Construction Corporation, 825 F. Supp. 463,467; Wilson v. New York City Transit
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Authority, 115 Misc.2d 1017, 545 N.Y.S.2d 962 (N.Y. City Civ. Ct. 1982), aff’d, 124 Misc.2d
839, 480 N.Y.S.2d 298 (N.Y. Sup. Ct. 1984). See also, Hinds v. Gulutz, 61 Misc.2d at 385, 305
N.Y.S.2d at 692-93; Krantz v. University of Kansas, 271 Kan. 234, 21 P.3d 561 (2001)
(discussing cases under New York law holding that a subsequent change in law will not justify
rescission of a settlement agreement or contract on the basis of mistake of law). “The uncertainty
of a legal position and the desire to avoid the risk of a lawsuit are the impetus for many out-of-
court settlements. It is simply inappropriate to equate these settlement agreements with
agreements premised upon the misapplication of settled legal principles.” Anita Foundations,
Inc. et al. v. ILGWU National Retirement Fund, 902 F.2d at 190.
In entering into a settlement agreement, parties need to consider the risks and costs of
litigation and part of this risk analysis includes the possibility that laws, including the judicial
construction of laws, may change. Board of Trustees of the Sheet Metal Workers Local Union
no. 137 Insurance Annuity and Apprenticeship Training Funds et. al v. Vic Construction
Corporation, 825 F. Supp. at 467.
“If parties can avoid contracts whenever courts clarify or change their interpretation of
statutes, thereby altering material assumptions of the parties when accepting a settlement
offer, every settlement would be susceptible to rescission due to facts entirely beyond the
control of the settling parties. A central purpose of a settlement agreement - to eliminate
all such risks while bringing finality to a dispute - would be undermined were courts to
rescind agreements under such circumstances.”
Id., 825 F. Supp. at 468. Accordingly, there is no basis to rescind the Second Stipulation on the
basis of a subsequent change in law.
While the Debtors argue that the Second Stipulation is not enforceable without the
Court’s authorization, the Court notes that legal authority cited by the Debtors are
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distinguishable from the case before the Court. Those cases simply hold that the court has the
ability to enforce a stipulation that has been so ordered by the Court and those cases do not
involve a party to a stipulation seeking to rescind such agreement based upon a subsequent
change in the interpretation of the law. Even though the Court has not yet so-ordered the Second
Stipulation, it does not change the fact that both the Debtors and counsel for the Trustee
executed the Second Stipulation and such stipulation is a binding contract under N.Y. C.P.L.R. §
2104.
Moreover, the Debtors remain bound by the First Stipulation which the Court so-ordered
and has not been appealed. The Debtors have not provided any basis for the Court to rescind the
First Stipulation as there was no mutual mistake of law at the time such stipulation was entered
into and the Second Circuit’s subsequent decision in Wornick v. Gaffney does not nullify the
validity or enforceability of the First Stipulation for the same reasons it does not allow the
Debtors to rescind the Second Stipulation. After due consideration, the Court notes that if it does
not approve the Second Stipulation, the Debtors would be subject to harsh financial and tax
consequences of the First Stipulation which the court has already approved and is a final order.
The Second Stipulation lessens the consequences of the First Stipulation as the Trustee is willing
to accept less than 100% of the cash surrender value in full settlement and satisfaction of the
claims of each of the Debtors’ bankruptcy estates in and to the Insurance Policies without the
necessity of cashing out or canceling the Insurance Policies. Approval of the Second Stipulation
would not result in the creditors being unjustly enriched at the expense of the Debtors as the
Debtors had previously agreed to the turnover of a percentage of the cash surrender value of the
Insurance Proceeds without having the Insurance Policies cancelled and the Trustee should be
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entitled to the benefit of his bargain.
While the Trustee has not set forth how the proposed distribution of the proceeds from
the Insurance Policies will be distributed with respect to the creditors of each of the Debtors’
bankruptcy estate, the Debtors request that in the event the Court approves the Second
Stipulation that the proceeds from the 3 Insurance Policies held by Thomas Napolitano for the
benefit of Mary Napolitano, with the maximum loan value of $41,267.95 be available only to
Mary Napolitano’s creditors. As there is only one filed proof of claim in the amount of
$2,306.64 that is filed against Mary Napolitano’s bankruptcy estate, the Debtors argue that any
recovery by the Trustee from the Insurance Policies should be limited to $2,306.64 and any
surplus arising from the cash surrender value relating to the Insurance Policies under which she
is a beneficiary should be returned to her and not be used to satisfy the separate claims filed
against Thomas Napolitano’s bankruptcy estate.
The manner of how the cash surrender value of the Insurance Proceeds is to be
distributed is not now an issue before this Court as it does not affect the Debtors’ obligation to
turnover the agreed upon cash surrender value of the Insurance Policies pursuant to the Second
Stipulation. However, the Court does note that while 11 U.S.C. § 302 allows spouses to file a
bankruptcy petition jointly, it does not automatically consolidate their bankruptcy estates. 11
U.S.C. § 302; Wornick v. Gaffney, Slip Op. No. 07-1657-bk, 2008 WL 4349810, * 4 (stating that
“the trustee may not reach assets in a joint filing that he could not have reached had the spouses
filed separately.”) There has not been any motion filed seeking substantive consolidation of the
joint Debtors’ bankruptcy estates. If the Debtors have any objection to the manner in which the
funds from the Insurance Policies are to be distributed among the creditors of the bankruptcy
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estates, the Debtors may raise this issue at any time prior to the case being closed. The Court
declines to limit any recovery by the Trustee under the Insurance Policies other than to what was
agreed upon under the Second Stipulation at this time.
CONCLUSION
Based upon the foregoing, the Trustee’s motion seeking approval of the Second
Stipulation is granted and the Debtors’ objection is overruled.
So ordered.
Dated: December 23, 2008
Central Islip, New York
s/ Dorothy Eisenberg__________
Dorothy Eisenberg
United States Bankruptcy Judge
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