Michael Hawkins, an Ontario consultant and farmer who owns about 50 head of cattle, was looking for extra income when he started buying Canadian life-insurance policies a decade ago. What he got was an unexpected legal battle that could lead to huge losses for some of Canada’s largest financial institutions.

Mr. Hawkins argues the eight insurance policies, into which he has pumped 14 million Canadian dollars (US$11 million), should continue to pay above-market interest rates for as long as he likes.

Now,...