Key Man Life Insurance and Corporate Knowledge: A Lesson for All to Remember

hagenow2 What a corporation’s officers and shareholders know concerning the business of the corporation, the corporation knows.  This knowledge that is imputed to a corporation remains with the corporation throughout its life, and a recent case involving “key man life insurance” highlights this important lesson for all business owners that a corporation is not allowed to suffer from “amnesia” and to otherwise ignore information that its officers have been told or that is in the corporate files.

Key man life insurance is an important tool for all small business owners, as it allows the company or the other shareholders to purchase the shares from a family of another shareholder who may have deceased.  The proceeds of that life insurance policy are used to purchase those shares, thereby allowing continuity of ownership but also providing some value for those shares to the decedent’s estate.

In a recent case decided by the 7th Circuit, a corporation had purchased key man life insurance, insuring the life of the majority shareholder.  The beneficiary originally was the other shareholder, but that was then changed so that the beneficiary was the corporation itself.  There was evidence that the intent did not change, i.e., it was the intent to have the shares of the “key man” purchased with the proceeds of the life insurance.

The key man eventually retired, and sold his shares to a new owner, who became the president of the corporation.  The insurance policy remained in place.  When the retired “key man” died, the insurance company paid the $1,000,000 of proceeds to the original beneficiary (by mistake).  That beneficiary was still the minority owner/shareholder of the company.

That person then attempted to do what had been intended all along, i.e., to use the insurance proceeds to purchase the remaining shares of the company.  The new owner, however, did not go along with the plan (and there was no written contract requiring him to do so), and eventually had the minority owner removed as an officer and board member of the corporation.

The corporation, which everyone agreed was supposed to receive the insurance proceeds, then sued the insurance company, which understandably did not want to pay another $1,000,000.  The insurance company admitted its mistake, but said that the corporation should not be allowed to collect because it knew what was going on, and allowed the insurance proceeds to be paid to the minority shareholder.

The new owner/president claimed to have been misled by the insurance company, saying “he did not know” who was supposed to get the money.  Therefore, he and the corporation argued that the insurance company must make sure that it pays the correct beneficiary, which in this case was the corporation.  During the course of the case, it was revealed that at a board meeting after the key man’s death, the corporation’s board was told and shown that the corporation was the beneficiary.  In fact, it was told this information by the minority shareholder, who ultimately received the insurance proceeds.  The corporation’s records were changed to try to conceal this fact.  There also were several copies of the correct beneficiary form in both the corporation’s files and the personal files of the new president.

Armed with this information, the court granted judgment in favor of the insurance company, finding that the company knew what was going on and chose to ignore it.  The 7th Circuit affirmed the judgment in favor of the insurance company, and found that it was not required to make another $1,000,000 payment.

The practical lesson here is summarized in a few of the comments from the 7th Circuit:

The corporation knew the truth, because its principal officers in 2003 had negotiated the policy and were well aware of its contents.  What the President and COO knew, [the corporation] knew.  There is no such thing as corporate amnesia.

* * *

Turnover in a corporation’s management does not wipe out the corporation’s fund of knowledge.  That [the new president] did not know something does not mean that [the corporation] was ignorant.

* * *

From beginning to end, [the corporation’s argument] rests on the assertion that [the president] was misled by [the insurance company] and did not know that [the corporation] was the policy’s beneficiary.  That approach commits the legal error of confusing [the president] with [the corporation]; the corporation’s knowledge, not [the president’s] is what matters.

Lesson:  What the officers of the corporation know, the corporation knows.  That knowledge does not go away throughout the life of the corporation, even as the officers change.  There is no such thing as “corporate amnesia”, even if the ownership and management of that corporation changes completely from the time that corporation gained that knowledge.

It should also be noted that the new president’s behavior in changing the corporation’s records and otherwise claiming ignorance of the situation likely played a role in the outcome.  We always advise clients that they want to be the “ones wearing the white hat” in the courtroom.  In this situation, thanks to the actions of its president, the corporation seeking the $1,000,000 clearly was not.