IN THE UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
March 20, 2006
PAUL M. PRUSKY, INDIVIDUALLY AND AS TRUSTEE, WINDSOR SECURITIES, INC. PROFIT SHARING PLAN; STEVEN G. PRUSKY, AS TRUSTEE, WINDSOR SECURITIES, INC. PROFIT SHARING PLAN, APPELLANTS
RELIASTAR LIFE INSURANCE COMPANY
Appeal from the United States District Court for the Eastern District of Pennsylvania District Court Civil No. 03-cv-06196 District Judge: The Honorable Herbert J. Hutton.
The opinion of the court was delivered by: Irenas, Senior District Judge.
Argued January 27, 2006
Before: RENDELL and SMITH, Circuit Judges, and IRENAS, District Judge.*fn1
OPINION OF THE COURT
Paul and Steven Prusky (collectively the "Pruskys") appeal from an order of the United States District Court for the Eastern District of Pennsylvania denying partial summary judgment on their breach of contract claims and entering summary judgment sua sponte in favor of ReliaStar Life Insurance Company ("ReliaStar"). The District Court had jurisdiction under 28 U.S.C. § 1332. We exercise appellate jurisdiction pursuant to 28 U.S.C. § 1291. For the reasons set forth below, we will reverse the grant of summary judgment to ReliaStar and remand the case to the District Court.
Between February 1998 and March 1999, the Windsor Securities, Inc. Profit Sharing Plan (the "Plan"), through its trustees, the Pruskys, purchased seven flexible premium variable universal life insurance policies from ReliaStar. The policies, which are identical for all purposes relevant to this appeal, each named the Plan as the policies' owner and was payable on the last to die of Paul Prusky*fn2 and his wife, Susan. As of August 2, 1999, the Plan had paid almost $2.5 million in premiums for various death benefits amounting to more than $42 million. However, it is the use of the policies as an investment vehicle that is at the root of the dispute in this case.
Many traditional life insurance policies provided that a portion of the premium be set aside in a policy reserve which accrued interest at a predetermined rate, set by the terms of the policy, which is unrelated to the return on the investments made by the insurance company. This reserve is, in effect, paid out to the beneficiary as part of the face value of the policy when the insured dies, and, as the basis of the policy's cash value, can be used for borrowing or returned to the policy's owner should a decision be made to terminate the policy. See Joseph E. Irenas, Life Insurance Income Under the Federal Income Tax, 21 Tax L. Rev. 297, 297-301 (1966). "[M]ost insurance policies are not only contracts covering the risk of death, . . . but also vehicles of saving by which money is deposited with the insurance company to accumulate at interest for the benefit of the policy holder." Id. at 297.
At some point certain segments of the life insurance industry recognized that a life insurance policy which, like traditional whole life insurance, offered a fixed death benefit and a substantial savings component and, unlike a traditional policy, offered the policyholder a right to control in some fashion the investment of accumulated reserves, might be attractive to individuals who believed they had superior investment skills. The seven flexible premium variable universal life policies purchased by the Plan from Reliastar contained this investment control feature.
Pursuant to the policies' terms, ReliaStar maintained a unit investment trust, the "Variable Account." The Variable Account, in turn, was divided into various mutual fund sub-accounts, in which the Plan was entitled to invest a portion of the net premiums paid.*fn3 Thus, the cash values of the policies were tied to the market value of the assets held in the sub-accounts. The Plan's trustees often communicated daily with ReliaStar, directing the allocation of its assets among the sub-accounts in an effort to increase the cash value of the policies.*fn4
ReliaStar's standard policies provided that (1) "written" transfer requests could be made only four times in a policy year and (2) transfers would be made on the first valuation date after the request was received. The policies also provided that Reliastar could charge a fee for each transfer up to a maximum of $25.00. However, the Pruskys specifically negotiated alternate terms. The amendments to each of the seven policies were embodied in seven practically identical memoranda drafted by ReliaStar's Second Vice President, M.C. Peg Sierk (the "Sierk Memos").
First, the Sierk Memos gave the Plan the right to make daily transfers by telephone, facsimile, or other electronic means in unlimited amounts without any transfer fee. Thus the provisions facilitated the Pruskys' preferred investment strategy of making frequent trades to take advantage of short-term variations in mutual fund pricing, a practice commonly known as "market timing."*fn5
Second, the Sierk Memos allowed the Plan to execute trades until 4:00 p.m. Central Standard Time (CST) -- one hour after the New York Stock Exchange (NYSE) closes at 4:00 p.m. Eastern Standard Time (EST) -- and mandated that those after-closing transfers receive unit values calculated for that day.
This practice is known as "late trading."*fn6
Beginning in March 1998, Paul Prusky placed sub-account transfer requests, by telephone or other electronic means, often on a daily basis, and ReliaStar made the transfers. Many of the transfer requests were made between 3:00 p.m. and 3:30 p.m. CST (after the NYSE had closed for the day) but were valued at the current day's price.
In November, 2002, ReliaStar informed the Plan that it would no longer implement transfer instructions as of the date received unless the requests were received by the close of the NYSE (3:00 p.m. CST). ReliaStar's stated reason for the change was to comply with applicable law and regulations requiring transfer requests made after the close of NYSE to be valued at the next day's price. The Pruskys objected to this unilateral change of the agreement, but nonetheless continued dealing with ReliaStar, and ReliaStar continued to honor all trades made by electronic means (so long as they were placed before 3:00 p.m. CST) until October 8, 2003, when it notified the Plan that, after receiving a complaint from the Pioneer funds, it would no longer accept trades "via facsimile, phone or internet" in those funds. Effective November 7, 2003, that restriction was applied to trades in all funds, thereby effectively eliminating the Pruskys' ability to execute daily transfers in accordance with their market timing strategy.
This diversity suit followed, seeking damages for breach of contract and specific performance of only the market timing provisions. Neither damages nor specific performance was sought for the elimination of the late trading provisions of the Sierk memos. The Pruskys moved for partial summary judgment on liability only. ReliaStar opposed the motion asserting, among other things, that because the late trading provisions were both illegal and an integral part of the contract between the parties, the policies were void in their entirety. The District Court accepted this argument, denied the Plan's motion for partial summary judgment, and, sua sponte, entered summary judgment in favor of ReliaStar. Because of this ruling the trial judge did not consider other defenses raised by ReliaStar in opposition to the partial summary judgment motion. The Pruskys filed this timely appeal.
Because we are reviewing a grant of summary judgment, our review is plenary. Am. Flint Glass Workers Union v. Beaumont Glass Co., 62 F.3d 574, 578 (3d Cir. 1995). Drawing all reasonable inferences in favor of the party against whom judgment is sought, judgment pursuant to Federal Rule of Civil Procedure 56 should be granted only when no issues of material fact exist and the party for whom judgment is entered is entitled to judgment as a matter of law. Id.
The Pruskys assert that the District Court procedurally erred by sua sponte enteringsummary judgment in favor of ReliaStar without adequate notice, and substantively erred by concluding that the late trading provision voided the life insurance contracts in their entirety, thereby precluding the Pruskys from enforcing the market timing provisions. We hold that the District Court erred on the merits*fn7 and will reverse and remand.
The District Court held that the undisputed evidence demonstrated that the illegal late trading provisions were "an essential and non-severable part of the [life insurance] contracts." We disagree.
Under Pennsylvania contract law, a party my enforce legal provisions of a contract containing an illegal provision provided that the primary purpose of the contract or an essential part of the agreed exchange is not affected by disregarding the illegal provision. Spinetti v. Service Corp. Int'l, 324 F.3d 212, 219-20 (3d Cir. 2003) (quoting Restatements (First) and (Second) of Contracts, §§ 603 and 184 respectively); see also Huber v. Huber, 323 Pa. Super. 530, 538 (1984) (holding the child support provisions under post-nuptial agreement were enforceable although the other terms of the contract may have been illegal); Forbes v. Forbes, 159 Pa. Super. 243, 249 (1946) (upholding validity of contract when disregarding the illegal provision "would not defeat the primary purpose of the contract").
The undisputed record evidence demonstrates that the primary purpose of the contracts at issue was to insure the lives of Paul and Susan Prusky, while simultaneously providing the Plan with savings and investment opportunities. This goal may be accomplished without the late trading provisions.*fn8 Certainly the late trading provision did not impact the life insurance aspect of the ReliaStar policies.*fn9 Nor was the goal to use the policies as investment vehicles meaningfully impaired. Whatever value the right of late trading may have been to the Pruskys, it is small compared to the overall investment benefit of the policies which the Pruskys have striven hard to keep in effect. For more than a year after ReliaStar informed the Plan that it would no longer permit late trading on orders received after 3 p.m. CST, the Plan continued to place numerous sub-account transfer requests before the NYSE closed, which ReliaStar honored.*fn10
The Plan surely bargained for the late trading provisions, but such bargaining does not per se turn the provision into one that is the "primary purpose" of the policy. Contract therefore are not illegal, we agree with the District Court's conclusion that the late trading provisions of the contracts specifically allowed the Plan to execute transfers after the close of the NYSE, receiving the current day's NAV instead of the next day's NAV, in violation of the forward pricing rule. negotiations often involve a series of offers and counter-offers involving issues large and small. The fact that a bargained for benefit is ceded by the other party is no particular indication of the importance of the benefit to either side of the deal. Indeed, the willingness of one side to concede a benefit to another might just as well be a sign of its unimportance. Moreover, the importance of a contract right to a particular party is not necessarily an indication that it is the "primary purpose" of the contract. Potential parties to a contract may invest a great deal of importance to what others might consider a minor point.
ReliaStar argued three alternate grounds for upholding the grant of summary judgment, not relied upon by the District Court, two of which were argued on this appeal: (i) changed circumstance had rendered the performance of the market timing provisions of the Sierk memos impracticable and impossible; and (ii) the market timing provisions, although not illegal, were not enforceable because they violated public policy.*fn11
ReliaStar asserts that it should be excused from performing its obligations in the Sierk Memos because recent regulatory developments designed to deal with market timing have made performance impracticable. Under Pennsylvania law, a party's obligations may be discharged by a "supervening impracticability" "where after the contract is made, a party's performance is made impracticable without his fault by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate to the contrary." Luber v. Luber, 614 A.2d 771, 774 (Pa. Super. Ct. 1992) (quoting Restatement (Second) of Contracts § 261). "The theory of legal impossibility is objective rather than subjective; the act contemplated under the settlement must be incapable of being performed." Felix v. Giuseppe Kitchens & Baths, Inc., 848 A.2d 943, 948 (Pa. Super. Ct. 2004). On the record before us ReliaStar has not met this standard.
ReliaStar in fact allowed the Plan to execute frequent transfers via electronic means, which clearly indicates that the contract could be performed. ReliaStar honored such transfers (as long as they were executed before the close of the NYSE) until late 2003. Moreover, while regulators have focused more attention on dealing with the perceived adverse effects of market timing in recent years*fn12 no regulation prevented ReliaStar from executing frequent transfers submitted by electronic means. The regulatory focus on market timing*fn13 may have imposed difficulties on ReliaStar in conducting these transactions, but increased burden on a party does not render performance impracticable. See Luber, 614 A.2d at 774 ("a party generally assumes the risk of his own inability to perform his contractual duties").*fn14 were shared by others in the mutual fund industry and noted by the Securities and Exchange Commission. See Offers of Exchange Involving Registered Open-End Investment Companies and Unit Investment Trusts, Investment Company Act Rel. No. IC-16504, 53 Fed. Reg. 30,299, 30,301, 30,307 (1988). During [1989 and 1990], other mutual funds such as Fidelity Investments and Vanguard Group began imposing 'anti-timer' restrictions to mitigate the perceived negative effects of unrestricted timing activity.").
Similarly, we also conclude that the market timing provisions do not violate public policy. ReliaStar readily admits that market timing is not illegal and that investors are expressly permitted to engage in market timing under applicable regulations. Yet ReliaStar asserts that they are excused from performing because market timing is a "disruptive," "suspect and disfavored activity." This is not the law. "Public policy is to be ascertained by reference to the laws and legal precedents and not from general considerations of supposed public interest. As the term 'public policy' is vague, there must be found definite indications in the law of the sovereignty to justify the invalidation of a contract as contrary to that policy." Prudential Prop. & Cas. Ins. Co. v. Colbert, 813 A.2d 747, 750 (Pa. 2002). We find no basis in the laws or legal precedents to conclude that market timing is contrary to public policy. Thus we hold ReliaStar's nonperformance may not be excused on public policy grounds.*fn15
Based on the foregoing we will reverse the District Court's sua sponte grant of summary judgment to ReliaStar and remand the case to that Court for further proceedings consistent with this Opinion.