Wal-Mart Coli Suit Reinstated

The Delaware Supreme Court has reinstated an action – dismissed by the trial court based on the statute of limitations – brought by Wal-Mart Stores, Inc. against life insurance companies and brokers in connection with Wal-Mart's purchase of, and the subsequent commercial failure of, Corporate Owned Life Insurance ("COLI") policies. Wal-Mart Stores Inc. v. AIG Life Ins. Co., 860 A.2d 312 (Del. 2004). The ruling stands for two propositions beyond its immediate impact on a major litigation. First, as a procedural matter, statute of limitations defenses will be evaluated like any other issue on a motion to dismiss under Rule 12(b)(6), i.e., on the face of the complaint, without reference to extrinsic evidence. Second, the ruling makes clear that legal surprises, like factual ones, can toll a statute of limitations where, as in this case, unanticipated legal rulings cause the commercial frustration of a transaction.

Wal-Mart's Purchase Of COLI Policies In 1993-1995 And Their Subsequent Failure

Beginning in December 1993 and continuing through June 1995, Wal-Mart purchased a series of COLI programs from defendants AIG Life Insurance Company and Hartford Life Insurance Company. At the time, the use of COLI to obtain tax benefits and offset rising employee benefit costs was well established and widely utilized by many, if not most, Fortune 500 companies. The Wal-Mart COLI plans covered large groups of hourly and salaried employees, approximately 350,000 in all. The premiums were largely funded through loans provided by the insurers. The interest on those loans was intended to provide tax deductions to Wal-Mart that were essential to the economic viability of the COLI plans.

In 1996, Congress, as part of the Health Insurance Portability and Accountability Act ("HIPAA"), prospectively disallowed interest deductions for loans used to fund COLI plans. The parties had considered the possibility of such prospective changes and had structured the programs to minimize the potential adverse impact. Pursuant to those provisions, Wal-Mart began "unwinding" the COLI policies, a process that culminated with their surrender and cancellation in 2000.

HIPAA disallowed COLI interest deductions only prospectively. A more fundamental frustration of the parties' contractual purpose occurred when successful court challenges by the Internal Revenue Service resulted in the retrospective disallowance of deductions already taken in prior years. The first court decision to disallow tax deductions on COLI plans, such as Wal-Mart's, was issued in November 1999. Winn-Dixie Stores, Inc. v. C.I.R., 113 T.C. 254 (1999), aff'd, 254 F.3d 1313 (11th Cir. 2001) ("Winn-Dixie"). Two additional decisions disallowing COLI tax benefits followed. See Internal Revenue Serv. v. CM Holdings, Inc., 254 B.R. 578 (Bankr. D. Del. 2000), aff'd, 301 F.3d 96 (3d Cir. 2002); American Elec. Power, Inc. v. United States, 136 F. Supp. 2d 762 (S.D. Ohio 2001), aff'd, 326 F.3d 737 (6th Cir. 2003). Wal-Mart, under threat of litigation, eventually entered into a settlement with the IRS in the summer of 2002.

In 2001 Wal-Mart's COLI programs came under another line of attack in the form of lawsuits brought by heirs of its employees, asserting that the company lacked an insurable interest in the lives of its employees. In August 2002, one court held that Texas law, rather than the favorable Georgia law relied upon by the parties, governed the insurable interest question. The court further held that, under Texas law, Wal-Mart did not have an insurable interest in the lives of its employees, another unanticipated ruling with potentially serious tax and liability ramifications for Wal-Mart. Mayo v. Hartford Life Ins. Co., 220 F. Supp. 2d 714 and 220 F. Supp. 2d 794 (S.D. Tex. 2002), aff'd, 354 F.3d 400 (5th Cir. 2004).

Wal-Mart's Complaint

On September 3, 2002, weeks after resolving its COLI-related dispute with the IRS and shortly after the Mayo decision was handed down, Wal-Mart initiated this action in the Court of Chancery against the insurers that recommended, sold and administered the COLI plans (AIG and its COLI administrator, Westport Management Services, Inc., and Hartford and its affiliate, International Corporate Marketing Group, LLC), and the insurance specialists that advised Wal-Mart in its COLI programs and subsequently served as the administrators of the programs until surrender of the policies in early 2000 (Seabury & Smith, Inc., Marsh, Inc., Marsh & McLennan National Marketing Corporation, and National Benefits Group, Inc.).

In detailed allegations, the complaint recounted that:

1. Wal-Mart purchased established COLI programs, which provided life insurance covering Wal-Mart's employees and named Wal­Mart as beneficiary,
2. these COLI programs were created, marketed, sold and administered by the defendants, who fully understood that the financial viability of the plans was dependent on tax driven benefits,
3. the COLI plans utterly failed in their intended purposes in 2002 when Wal-­Mart, under threat of litigation, reached a settlement with the Internal Revenue Service ("IRS") that disallowed Wal-Mart's expected tax benefits from such plans, and
4. the defects in the COLI plans that caused their failure were known, or should have been known, to defendants but were never disclosed to Wal-Mart.

Based on those factual allegations, Wal-Mart asserted several causes of action, including claims based on unjust enrichment/restitution and nondisclosure. Wal-Mart did not seek the benefit of lost tax deductions, but only its "out-of-pocket" losses, in excess of $100,000,000. Wal-Mart further sought declaratory relief with respect to the insurable interest litigation against it.

Defendants moved to dismiss the complaint for failure to state a claim upon which relief can be granted and on the basis of the applicable statute of limitations. As to Wal-Mart's declaratory relief cause of action, defendants also asserted that that claim was unripe since Wal-Mart had yet to suffer actual injury. On March 21, 2003, Wal-Mart, joined as plaintiff by the Georgia trustee of the grantor trust holding the Wal-Mart COLI policies, Wachovia Bank of Georgia, N.A., filed an amended complaint that realleged and expanded upon the allegations of the original complaint. Defendants again filed motions to dismiss, attacking the amended complaint both on the merits and on laches/statute of limitations grounds.

Dismissal of Wal-Mart's Amended Complaint By The Court Of Chancery

On March 2, 2004, the Court of Chancery issued a Memorandum Opinion (revised March 8, 2004) granting the motions to dismiss, exclusively on the ground that the equitable, tort and contract claims asserted in the amended complaint – including the cause of action for declaratory relief – were barred as a matter of law by the statute of limitations, 10 Del. C. § 8106, applied by analogy to this proceeding in equity. Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 2004 WL 405913 (Del. Ch.). The trial court ruled first that Wal-Mart's claims all accrued at the time it purchased the COLI plans in 1993-1995, more than three years before Wal-Mart brought suit in 2002. The trial court held further that there was no basis to toll the statute of limitations, inasmuch as Wal-Mart was, as a matter of undisputed fact, on "inquiry" notice of the defendants' malfeasance no later than 1995 as a result of several newspaper articles and two internal IRS memoranda issued to unrelated parties.

Reinstatement Of The Action By The Delaware Supreme Court

On appeal, as in the trial court, Wal-Mart argued that the action was not time-barred for three reasons. First, the cause of action did not accrue until Wal-Mart settled with the IRS in 2002, because it was only then that it was established that the commercial purpose of the COLI plans would not be fulfilled. See Walker v. Continental Life & Accident Co., 445 F.2d 1072, 1074-75 (9th Cir. 1971). Second, in the alternative, Wal-Mart argued that the statute did not begin to run until the cancellation and surrender of the COLI policies in 2000 closed the mutual running accounts among the parties. See 10 Del. C. § 8108 ("[i]n the case of a mutual and running account between the parties, the limitation, specified in § 8106 of this title, shall not begin to run while such account continues open and current"). Third and finally, Wal-Mart argued that the action was tolled until 1999 at the earliest, when the Winn-Dixie decision for the first time upheld the IRS' retrospective disallowance of income tax deductions for interest payments under a COLI plan.

The Delaware Supreme Court adopted the third ground for reversal. The Court reaffirmed the traditional rule that "a cause of action ‘accrues' under Section 8106 at the time of the wrongful act, even if the plaintiff is ignorant of the cause of action." 860 A.2d at 319. The Court assumed that Wal-Mart's cause of action accrued when it purchased the COLI policies – by 1995 at the latest – but still found that the statute of limitations was tolled until October 19, 1999, less than three years before Wal-Mart filed its complaint in September 2002.

The Court stated that "[e]ven after a cause of action accrues, the ‘running' of the limitations period can be ‘tolled' in certain limited circumstances. Under the ‘discovery' rule the statute is tolled where the injury is ‘inherently unknowable and the claimant is blamelessly ignorant of the wrongful act and the injury complained of.' " Id., citing Coleman v. PriceWaterhouseCoopers, LLC, 854 A.2d 838, 842-43 (Del. 2004) (statute tolled in accountant malpractice action because lay person is unable to detect negligence in accounting practices); Layton v. Allen, 246 A.2d 794 (Del. 1968) (statute tolled in medical malpractice action; injury from foreign object left in patent was inherently unknowable until the patient first experienced pain).

Applying this standard, the Court determined that the facts as pleaded in Wal-Mart's Amended Complaint "create a reasonable inference that Wal-Mart's tax-related injuries were inherently unknowable before October 1999 [when the Winn-Dixie decision retroactively disallowed deductions for interest payments on policy loans] and that Wal-Mart's insurable interest-related injuries were inherently unknowable before 2002," when Mayo held that Wal-Mart lacked an insurable interest in the lives of its employees. 860 A.2d at 321. The Court further held that "[t]hose same pleaded facts also create a reasonable inference that Wal-Mart was blamelessly ignorant of the ‘wrongful acts.' " Id.

In reaching those conclusions, the Delaware Supreme Court disagreed with the conclusion that Wal-Mart had been placed on early "inquiry notice" of possible claims by virtue of various newspaper articles and IRS memoranda in the 1990s on the subject of COLI policies. The Delaware Supreme Court ruled that:

1. these materials were extrinsic to the complaint and not properly considered on a motion to dismiss under Rule 12(b)(6) of the Delaware Court of Chancery; The Chancery Court rule is identical to Rule 12(b)(6), Fed. R. Civ. P.
2. the newspaper articles did not discuss retrospective disallowance of deductions for interest and so did not put Wal-Mart on "inquiry notice" of that possibility; and
3. the newspaper articles did not address the insurable interest issue at all and did not put Wal-Mart on inquiry notice on this point either. Id. at 320-21.

Accordingly, the Delaware Supreme Court reversed the decision of the Court of Chancery and remanded the case for further proceedings consistent with the opinion. Id. At 321. On remand, the trial court has indicated that it will consider alternate grounds for dismissal, with oral argument to be held on February 24, 2005.

The Delaware Supreme Court decision in Wal-Mart stands for at least two propositions likely to have continuing significance. First, as a procedural matter, if a statute of limitations defense is presented on a Rule 12(b)(6) motion to dismiss, before any discovery is taken, the issue must be decided on the face of the complaint, without resort to extrinsic evidence. Second, the decision makes clear that, where a commercial transaction fails because of unanticipated legal rulings, the statute of limitations may be tolled until the time of such rulings, just as it may be tolled until discovery of facts establishing injury theretofore hidden.