High-profile trusts and estates lawyer Jonathan Blattmachr is famous for his clever use of trusts, family limited partnerships and sophisticated insurance plans to reduce inheritance and gift taxes. But last summer a particular insurance tactic that he had employed caught the attention of the U.S. Treasury and Internal Revenue Service after it was detailed in a front-page article in The New York Times decrying the lucrative loophole for the ultra-rich.
Now, a family that bought the same type of policy made notorious by the Times -- and the subject of an official notice from the Service -- is suing Blattmachr and his law firm, Milbank, Tweed, Hadley & McCloy LLP. The family, Charles B. Benenson, of Benenson Realty Company, his wife Jane and his son (Jane's stepson) William, claims that the plan they bought is not the one his family expected. In Los Angeles this June, the Benensons filed suit for breach of contract, malpractice and other charges.
Specifically, the Benensons claim that the insurance policy, which is supposed to pay $48.5 million in death benefits, is underfunded by about $1.5 million and might lapse within the next decade. The family blames Blattmachr, a New York-based partner at Milbank, as well as husband-and-wife insurance agents Louis and Amie Kreisberg; insurance agent Michael Brown; and the insurance companies that sold the policy. These firms include: Spectrum Consulting L.P. (also called Spectrum Financial Network Insurance and Investments, L.L.C.), where Brown is a managing partner and member; Executive Compensation Group, where Louis Kreisberg is an officer; CM Life Insurance Company, a subsidiary of Massachusetts Mutual Financial Group; and Massachusetts Mutual Financial Group.
The Benensons also allege that Blattmachr, who introduced them to the Kreisbergs and the other players in the deal, did not "fully disclose" that he also represented the other parties at the time of the introduction. (Louis Kreisberg is on the editorial board of Trusts & Estates magazine; Blattmachr is a contributor to the magazine.)
A spokesman for Milbank, who asked not to be identified, says: "Milbank's only client in the matter… was the Benensons, and they were faithfully served." Calling the suit "baseless" and "meritless," the firm spokesman said that the lawyers "intend to defend ourselves vigorously and we fully expect to prevail."
"Milbank and Mr. Blattmachr practice law," added the spokesman. "The Benensons are complaining about the insurance product that they acquired. Neither Milbank nor Mr. Blattmachr had anything to do with the client's choice of insurance products."
Kreisberg says that the lawsuit is frivolous and he fully intends to defend against it.
Brown and Mass Mutual declined to comment.
The Benensons are asking for the approximately $1.5 million they say it will take to fund the plan, a refund of the fees and commissions they paid to Blattmachr and the insurance agents, and punitive damages. Milbank Tweed's fee, according to the complaint, was $970,000; that included the work done on the deal and a tax opinion letter. Commissions to the insurance agents and broker, according to the suit, ran to more than $4.4 million. The Benensons also agreed to keep the details of the deal confidential, says one of their current lawyers, Virginia Miller of Anderson Kill & Olick, the law firm where former New York City mayor Rudolph Giuliani once worked.
The Benensons' policy, a family reverse split dollar arrangement, became a popular estate planning strategy among the very wealthy from 2000 to 2002. Armed with a 1996 IRS ruling, Blattmachr and others presented such plans as a way of passing family wealth to heirs without estate tax and with greatly reduced gift taxes on the premiums.
"I'm not saying this is the best thing since sliced bread, but it's really good for pushing wealth forward tax-free," Blattmachr said, according to The New York Times article last July. The Times story noted that insurance companies had sold thousands of these policies, adding up to billions of dollars of insurance, the bulk of it issued since early 2001.
Shortly after publication of the newspaper article, the Treasury Department and IRS issued a notice refuting Blattmachr's interpretation of the gift tax required on premium payments. Before that notice, purchasers of these plans believed that they did not have to pay gift taxes on the entire amount of the premium price, but instead could value the premiums based either on government tables or the insurance company's published rates (usually lower than the amount actually paid.) The August Notice, 2002-59, changed that. It said that the donor could no longer use the government's premium rates or lower insurance company rates if the donor, or donor's estate, has the right to the insurance.
The August notice was accompanied by a press release stating that the IRS would not respect reverse split dollar arrangements "where the parties attempt to avoid taxes by using inappropriately high current term insurance rates, prepayment of premiums or other techniques to understate the value of taxable policy benefits."
The warning was loud and clear. Soon afterward, wealthy families stopped purchasing these types of plans, say insurance lawyers. But what about those families like the Benensons that already had such plans in their estates? Estate planning experts note that it is too soon for such plans to have been audited by the IRS.
For now, the Benensons are not complaining in their lawsuit about the tax consequences of the plan. But the suit, filed just before the statute of limitations for a possible complaint ran out, could be amended later. The family's lawyers say that the Times article helped spur the lawsuit in that it contributed to their disillusionment with Blattmachr and the insurance agents.
"The itch that they had was scratched by The New York Times and then drew blood," says their attorney Eugene Anderson, name partner of Anderson Kill.
The Benenson family alleges that Blattmachr approached them in early 2000 with a life insurance plan that he proposed would be a perfect fit for the family. Blattmachr, who had represented the family for several years, according to the Benensons' current lawyers, allegedly presented the policy as an estate-planning tool that would result in lower taxes while taking account of the Benensons cash flow needs.
In 1986, New York real estate magnate Charles B. Benenson was listed in the Forbes 400 with a net worth estimated at more than $200 million. Benenson, a Yale grad, had built his father's Bronx apartment house business into a realty empire, investing with several other New York City builders, including Lawrence Tisch and Harry Helmsley.
The plan Blattmachr allegedly approved involved purchasing a $60 million life insurance policy on his wife Jane, who was 81 years old in the summer of 2000, when the deal was signed. In a complex sequence of events, the family is said to have used the Alaska Trust Company, run by Blattmachr's brother, Douglas, to create a trust to buy the insurance policy.
Other parties Benenson claims were involved in the transaction include the Kreisbergs, Michael Brown and companies headed by them, with Massachusetts Mutual Financial Group the ultimate insurer.
According to the complaint, the Benensons were supposed to pay about $23.5 million in premiums during the first three years of the policy, but also get back about $3.7 million in a partial surrender. Meanwhile, the policy proceeds were to decrease from $60 million in the first year to $48.5 million in year four, after which the plan was to pay $48.5 million regardless of when Jane died.
To make matters even more complicated, the policy was backdated to June of 1999, when Jane was still 80 because Mass Mutual does not issue this type of policy on people older than 80.
The family's current lawyers say the backdating, while perfectly legal in itself, ended up causing the confusion that led to the problems.
The Benensons thought they were agreeing to pay about $10.96 million in premiums in the first year, $7.2 million in the second year and $5.6 million in the third year. The family also expected to withdraw approximately $3.7 million in the second year.
But what the family did not realize was that the schedule of payments and withdrawals was also backdated one year. According to the Benensons, this meant that they were supposed to pay around $18 million, then receive $3.7 million back shortly upon signing the contract. Instead, they only paid around $10.9 million and never withdrew the $3.7 million.
The Benensons claim they did not know anything was amiss until June of 2001, when the Kreisbergs allegedly asked for an additional $577,616.
Relations between the Benensons and the defendants soon unraveled.
Who Understood What?
One of the steps the Benensons took was to hire Richard Harris, a New Jersey insurance agent, as a consultant. "From a life insurance point of view, in terms of all the twists and turns, this is rocket science," says Harris of the intricate deal. He alleges that the family never received all of the materials they were entitled to. Without that paperwork, he says, there is no way the Benensons could have fully understood the policy they had purchased.
Harris also concludes that if the family now takes out the $3.7 million, the policy will be left underfunded and will lapse within the next 10 years, before Jane's 93rd birthday. These numbers are somewhat inexact, says Harris. Benenson attorney Virginia Miller calculates that the policy would lapse even earlier, before Jane's 91st birthday.
Regardless, Harris and Miller both say that it is their understanding that the family did not realize they had to pay two years' worth of premiums upon signing. Had this been clearer, the family might not have done the deal. "If they thought they had to put up $18 million up front instead of $11 million up front, they might not have gone ahead with transaction," says Harris.
This is also where Blattmachr's representation of both the insurance agents and Benensons becomes problematic, say the Benensons' lawyers. As the agents' commission was dependent on the deal going through, they had a motive to see it close. That motive, they allege, created a potential conflict of interest that was not "fully disclosed" as early as it could have been.
Miller says that Blattmachr did disclose the potential conflict of interest before the family signed the deal. But, she says, the Benensons did not agree in writing to waive the potential conflict of interest, as is required by legal ethics rules in California -- where the lawsuit was filed and where William Benenson, trustee of the insurance trust, lives. Miller also claims that the Benensons did not fully understand the ramifications of the potential conflict.
Yet another allegation in the complaint is that Blattmachr did not disclose his relationship with the Alaska Trust Company, whose president and CEO is Jonathan's brother, Douglas Blattmachr.
Even so, courts looking at the Benenson situation might not view the potential conflict as problematic, say legal ethics experts. Malpractice claims frequently contain allegations that an attorney did not disclose a conflict of interest, says legal ethics scholar John Leubsdorf, a professor at Rutgers School of Law, Newark. But, adds Leubsdorf, disgruntled clients can't prove malpractice simply because there is a conflict of interest. There also has to be a problem with the legal services received and, if the lawyer provided good representation, the conflict will not in itself be grounds for a lawsuit.
The Benensons' complaint lists a variety of other matters about which they contend they were misled. For example, the Benensons believed the agents' compensation would be about $2 million to $2.5 million, but now say that the agents and their broker together received more than $4.4 million.
The legal complaint does not provide an explanation for the Benensons' mistaken belief about the fees, but Harris claims that the amount was too deeply buried in the fine print.
Another, related allegation is that no one discussed with the Benensons the possibility of funding the deal with private placement life insurance. Harris says that commissions are usually much lower with private placement life insurance because they are separately negotiated.
"Generally, when those things become negotiated," says Harris, "the numbers are hugely different." He estimates that the commission only would have been $600,000 with private placement.
An Industry Watches
For all of the allegations in the complaint, the one claim that is missing -- an accusation that Blattmachr gave bad tax advice -- is what industry observers are most interested in seeing litigated.
Even in the pre-August 2002 heyday of the family reverse split dollar plan, tax and insurance experts were divided about whether it was a legitimate way of lessening taxes. Some think that Blattmachr might yet prevail should the IRS fight the tax breaks in court.
But others remark that these types of aggressive tax-lessening policies were always a train wreck waiting to happen.
"Highly paid people tempt clients with ways to circumvent the intent of the tax laws," says Joseph Belth, a professor emeritus of insurance at Indiana University. But, he says, purchasers of these aggressive policies frequently don't realize the ramifications of their plans. "In most policies issued for non-traditional products, there's a great deal of risk on the policy-holder," says Belth. "The whole nature of the risks assumed by a policy-holder are not made completely clear at the time of sale."