Prusky v. Reliastar Life Ins. Co.

• Decision Date: 20 March 2006
• Docket Number: No. 05-1611.,05-1611.
• Parties: 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 v. RELIASTAR LIFE INSURANCE COMPANY.
• Court: U.S. Court of Appeals — Third Circuit

Page 695

445 F.3d 695

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 v. RELIASTAR LIFE INSURANCE COMPANY.

No. 05-1611.

United States Court of Appeals, Third Circuit.

Argued January 27, 2006.

Filed March 20, 2006.

Arlin M. Adams, Bruce P. Merenstein [Argued], Schnader Harrison Segal & Lewis LLP, Philadelphia, PA, for Appellants.

Joseph P. Moodhe [Argued], Debevoise & Plimpton LLP, New York, NY, Mathieu J. Shapiro, Obermayer Rebmann Maxwell & Hippel LLP, Philadelphia, PA, for Appellee.

Before RENDELL and SMITH, Circuit Judges, and IRENAS, District Judge.^*

IRENAS, Senior District Judge.

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.

I.

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 Prusky¹ 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.² 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.³

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."⁴

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 (N.Y.SE) 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."⁵

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.

II.

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 entering summary 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 merits⁶ and will reverse and remand.

III.

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, 470 A.2d 1385 (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, 48 A.2d 153 (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.⁷ Certainly the late trading provision did not impact the life insurance aspect of the ReliaStar policies.⁸ Nor was the goal to use the policies as investment vehicles meaningfully impaired. Whatever value the...