Bankr. E.D.N.C.: In re Hutsell- Life Insurance Proceeds not Exempt

Summary:

The debtor, who tragically lost her husband just days after filing her Chapter 13 petition, sought to exempt life insurance proceeds payable to her as beneficiary under a personal policy. Her argument relied on § 1C-1601(a)(8), which protects "compensation for the death of a person upon whom the debtor was dependent for support." But the bankruptcy court, following In re Ragan, 64 B.R. 384 (Bankr. E.D.N.C. 1986), ruled that this “compensation” means wrongful death recoveries, not contractual insurance payouts, reasoning that:

The term “compensation” in (a)(8) has historically been interpreted narrowly, aimed at tort recoveries rather than contractual entitlements.

If the North Carolina legislature had intended to include life insurance proceeds under (a)(8), it would have said so — especially given its post-Ragan amendment of that very statute in 2005, which left the relevant language untouched.  Meanwhile, life insurance is already separately addressed in § 1C-1601(a)(6) (which mirrors the NC Constitution) and § 58-58-165 (for group policies).  In short: while North Carolina exemptions protect both Tort-based wrongful death proceeds from a personal injury lawsuit and  Group life insurance proceeds under § 58-58-165,   a debtor cannot  claim an exemption for life insurance proceeds from the death of a spouse — even if the debtor was financially dependent on that spouse. 

Commentary:

Judge McAfee acknowledged the emotional and financial hardship this outcome imposes and that it  exposes a glaring gap in North Carolina’s exemption framework. The state permits creditors of the beneficiary — in this case, a grieving widow — to reach life insurance proceeds that are otherwise protected from the insured’s creditors. As Judge McAfee noted, “it is difficult to articulate a rationale” for allowing tort proceeds but not insurance proceeds to be exempted in these tragic circumstances.

It is time for the North Carolina General Assembly to revisit § 1C-1601(a)(8) and clarify or expand the scope of "compensation for death" to include life insurance proceeds when the debtor was financially dependent on the decedent.  The best action that members of the North Carolina Bar Association can take is to complete its survey regarding exemption updates.  There have already been comments regarding the need for the statute to be amended in response to Hutsell. 

That survey can be completed at this link:

Complete the survey via this link.

Practice Tips & Takeaways

• Post-petition windfalls within 180 days — including life insurance — are property of the estate under § 541(a)(5). Absent a clear exemption, these funds can require 100% plans or force debtors into conversion or dismissal.
• Group policy proceeds are exempt under N.C.G.S. § 58-58-165 — don’t forget to distinguish personal from group coverage.
• Prepetition planning is key: 
  • If life insurance is a likely asset, Chapter 7 may be a more protective structure (particularly if the policy is owned by the deceased, not the debtor).
  • Additionally,  family members can remove the debtor as a beneficiary (naming the beneficiaries children or even a spendthrift trust) at any time before death,  protecting those proceeds from creditors.

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