Opinion ID: 1425637
Heading Depth: 4
Heading Rank: 1

Heading: Reasonableness of the Pruskys' mitigation efforts

Text: Mitigation is an affirmative defense, for which the breaching party bears the burden of proof. Koppers Co., Inc. v. Aetna Cas. & Sur. Co., 98 F.3d 1440, 1448 (3d Cir.1996); Williams v. Masters, Mates & Pilots of Am., 384 Pa. 413, 120 A.2d 896, 901 (1956). To prove a failure to mitigate, one must show: (1) what reasonable actions the plaintiff ought to have taken, (2) that those actions would have reduced the damages, and (3) the amount by which the damages would have been reduced. Koppers, 98 F.3d at 1448. Damages that could have been avoided with reasonable effort without undue risk, expense, burden, or humiliation will be considered ... as not being chargeable against the defendant. WILLISTON ON CONTRACTS § 64:27, at 195. Reasonableness is to be determined from all the facts and circumstances of each case, and must be judged in the light of one viewing the situation at the time the problem was presented. In re Kellett Aircraft Corp., 186 F.2d 197, 198 (3d Cir. 1950). When a party breaches a contract by failing to perform, the injured party should make reasonable efforts to avoid loss by arranging a substitute transaction. RESTATEMENT (SECOND) OF CONTRACTS § 350 cmt. b, at 127 (1981). Where no well-established market for the particular type of performance is available, the breaching party generally bears the burden to show that a substitute transaction was available. Id. § 350 cmt. c, at 128. Whether an available alternative transaction is a suitable substitute depends on all the circumstances, including the similarity of the performance. Id. § 350 cmt. e, at 130. The issue here is whether the Pruskys, when they became unable to trade via fax on a daily basis, were required to do more than simply placing their $7 million balance in a money market fund for the three-year pendency of the litigation. Plaintiffs argue that because their only area of niche expertise is market-timing, forcing them to engage in any sort of a buy-and-hold strategy in the alternative would have required them to undertake undue risk. ReliaStar responds that keeping the entire balance idle in a low-yield, no-risk vehicle was not a reasonable substitute for the risky market-timing strategy in which the Pruskys were engaged prior to the breach. ReliaStar cites to Teachers Insurance and Annuity Association of America v. Ormesa Geothermal, 791 F.Supp. 401 (S.D.N.Y.1991) for the proposition that a reasonable substitute must be one with a similar risk-reward profile to that of the opportunity lost as a result of the breach. In Ormesa Geothermal, a lender sued a prospective borrower who reneged on a commitment to borrow $25 million. There, the court held that the injured lender was entitled to damages as measured between the interest income it would have earned under the breached agreement and that it would be deemed to have earned by timely mitigating its damages  i.e., by making an investment with similar characteristics at the time of the breach. Id. at 416. The court emphasized that in the mitigation context, an alternate investment should have investment characteristics as close as possible to the original investment in terms of principal, interest rate, borrower credit rating, and intended duration. Id. at 416; see also Teachers Ins. & Annuity Ass'n of Am. v. Coaxial Communications of Cent. Ohio, Inc., 799 F.Supp. 16, 18-19 (S.D.N.Y.1992) (following Ormesa Geothermal ). What constitutes a reasonable substitute for mitigation purposes in the context of the breach of an investment contract is largely an issue of first impression for us. However, careful study of analogous authorities leads us to conclude that the view espoused by the Ormesa Geothermal court  that courts should consider the specific nature and characteristics of the performance lost as a result of the breach in determining whether a proposed substitute was in fact reasonable  is a well-reasoned one. While there is admittedly a dearth of authorities on the precise issue at hand, we find the Seventh Circuit's decision in Fishman v. Estate of Wirtz, 807 F.2d 520 (7th Cir.1986) to be particularly helpful. In Fishman, an unsuccessful bidder for the Chicago Bulls claimed that the actual purchaser violated antitrust laws in acquiring the franchise. Finding liability, the district court calculated damages by subtracting from the undisputed antitrust damages a figure representing plaintiff's opportunity cost, an amount which the court equated to what plaintiff would have earned had he placed the idle capital in three-month treasury bills during the ten-year pendency of the dispute. Id. at 556. The Seventh Circuit upheld this methodology in principle; but, defining opportunity cost as the return on the most lucrative alternative investment, that is, the return on the `next-best' investment, id. at 556, the panel reversed on the grounds that a three-month treasury rate of return was not the next-best alternative to the particular equity investment at issue, id. at 558-59. Applying opportunity cost principles to the mitigation context, the Fishman court held that the proper alternative investment would be one yielding a similar return as might be expected for equity investments, albeit not necessarily the highest and riskiest one available. Id. at 559. [8] In particular, the court reasoned: On the one hand, we agree with the district court that while a plaintiff has a duty to mitigate damages, he should not be required to take undue risks. On the other hand, we cannot adopt a measure of opportunity cost which would reward a plaintiff for letting his capital lie fallow while he waited passively for many years to collect his [] damage[s] award. While, as we have noted, an investor of risk capital may have no duty of cover in the same sense as a commodity trader's duty, the loss of one investment opportunity does not negate the assumption that the capital will seek out some comparable opportunity. Id. at 558 (internal citation omitted). The Seventh Circuit remanded for the district court to reconsider the question of the appropriate opportunity cost. Id. at 559. In doing so, however, the court did not preclude the use of the treasury rate altogether; it merely opined that it was unreasonable to use the T-bills rate for the entire ten-year damages period. Id. at 559-60 (while undue risk may not be forced on a victim of wrongdoing, leaving equity funds indefinitely in treasury bills could discourage enterprise and would not be a proper assumption for the computation of the opportunity cost of equity in the long run) (emphasis added). Indeed, the court expressly acknowledged that given the nature and complexity of the particular lost investment opportunity at issue, it may have been entirely reasonable to place the unused funds in treasuries for some initial period of time while plaintiffs sought out and structured alternative investments. Id. at 559. Similarly, the Court of Federal Claims' mitigation decision in Koby v. United States, 53 Fed.Cl. 493 (2002), a breach of contract case, also lends support to the Ormesa Geothermal view. In Koby, plaintiff purchased an apartment building at an Internal Revenue Service (IRS) auction, but the IRS unilaterally rescinded the sales agreement and subsequently put the property up for auction again. There, the court rejected the IRS's argument that plaintiff's failure to participate in the second auction constituted a failure to mitigate because [t]he latter transaction [] did not involve remotely the same type of performance owed under the prior contract. Id. at 498. In particular, the court found: the second auction was merely an open-ended offer of sale to the public, whereas plaintiff previously had a contract to buy at a fixed price; the second auction's minimum sales price was nearly four times the original minimum; and the second auction's owner redemption period would have occurred at a time when real estate prices were increasing, thereby increasing the likelihood of redemption. Id. at 498 n. 4. These cases are persuasive support for the District Court's conclusion that the Pruskys did not adequately and reasonably mitigate their damages. [9] In particular, the District Court found as follows: The Pruskys had previously invested [the insurance policy] funds in vehicles with substantial exposure to the equity markets and had produced double-digit returns, whereas money market funds have often underperformed inflation. Prusky II, 474 F.Supp.2d at 709. These findings are supported by the record. See JA I at 283a-284a (Steven Prusky's testimony that market-timing is not without risk). Thus, prior to ReliaStar's breach, the Pruskys were clearly engaged in an active investment strategy that entailed a degree of risk, but one which commensurately had historically yielded handsome returns. As such, the passive, post-breach allocation of Plaintiffs' funds to a risk-free, low-return money market fund is decidedly not a comparable alternative investment opportunity. The District Court's finding on this point is not clearly erroneous. The Pruskys implicitly contend that because their market-timing strategy is so unique, no comparable investment opportunities exist for them. While this argument admittedly has some intuitive appeal, we nevertheless fear that its wholesale adoption would leave us teetering on the edge of the proverbial slippery slope. Our concern with the Pruskys' position is that under it, few, if any, injured investors will have to mitigate damages because nearly all investment opportunities are unique in some aspects. Not surprisingly, we are not alone in our concern, as other courts have also declined such arguments and require mitigation regardless of the particular lost opportunity at issue. See, e.g., Fishman, 807 F.2d at 559 (unsuccessful purchaser of Chicago Bulls was expected to seek out alternative equity investment); McGrath v. McGrath, No. 0202753H, 2007 WL 738697, - (Mass.Super.Ct. Feb. 12, 2007) (rejecting argument that no substitute existed when defendants were forced out of an ownership stake in an apartment complex; acknowledging that investment in real estate mutual funds or REITs could have been reasonable alternatives). We see no reason to depart from this well-trodden path. Certainly, investing in mutual funds entails a degree of risk, and it would likely be improper to force such investments upon laypersons if their prior investments were exclusively in low- to no-risk vehicles like certificates of deposits or treasuries. But that was not the case with the Pruskys. Paul and Steven Prusky had a long track record  indeed, over three decades worth, combined  as successful money managers. See Ormesa Geothermal, 791 F.Supp. at 417 (although it may not be appropriate to force unsophisticated individuals to assume risks in investing monetary rewards, those same concerns do not apply to sophisticated investors). Thus, their portrayal of themselves as entirely clueless about general equity and bond mutual fund investments once taken out of their market-timing niche strains credulity. Furthermore, it bears noting that ReliaStar's breach only prevented the Pruskys from trading by electronic means; they were expressly permitted to engage in frequent trading as long as the trades were submitted by U.S. mail. [10] Nothing in the record supports the Pruskys' implicit suggestion that they would have been required to blindly pick at various volatile equity and bond funds and sit idly by in the face of significant fund declines. On the contrary, they possessed the ability to modify their allocations as necessary, albeit with a day or more lag. [11] Considered alongside the well-known fact, which Steven Prusky himself acknowledged at trial, see JA I at 280a, that mutual fund investments by their very nature are less likely to be susceptible to dramatic changes in value on a day-to-day basis relative to direct individual equity investments, it is clear that Plaintiffs' suggested doomsday scenario  that their fund values would decline so significantly as to cause the policies to lapse  was but a remote possibility. Moreover, as the Seventh Circuit indicated, the duration of the mitigation period is also an important consideration in the reasonableness inquiry. See Fishman, 807 F.2d at 559 (unreasonable to place funds that would have been used for an equity investment in no-risk treasuries for ten years). Here, the District Court found that notwithstanding Steven Prusky's testimony that he had hoped the dispute with ReliaStar would be resolved in a matter of weeks, no reasonable person, especially not one assisted by able and seasoned counsel, could have harbored such illusions about the nature of federal litigation. Prusky II, 474 F.Supp.2d at 709 n. 14. This is a sensible conclusion, especially in light of the fact that the Pruskys are clearly no strangers to litigating in the federal courts. See, e.g., Windsor Sec., Inc. v. Hartford Life Ins. Co., 986 F.2d 655 (3d Cir.1993) (plaintiff Paul Prusky alleged insurer's transfer restrictions constituted breach of contract); Prusky v. Aetna Life Ins. & Annuity Co., 2006 WL 952320 (3d Cir. April 13, 2006) (plaintiffs Paul and Steven Prusky appealed in breach of contract action); Prusky v. Prudential Ins. Co. of Am., 44 Fed.Appx. 545 (3d Cir.2002) (Paul Prusky sued for breach of contract). Indeed, even if Steven Prusky's belief was reasonable at the outset of the litigation, it would have become decidedly unreasonable as the case progressed on with no end in sight; at that point, Plaintiffs should have adjusted their mitigation strategy accordingly. On the other hand, we acknowledge that the Pruskys' position is not without support. First, as a practical matter, had the breach period coincided with a widespread market decline, it is possible that any form of a buy-and-hold strategy would have underperformed money market returns. However, in such a case, as Defendant's counsel explicitly acknowledged during oral arguments, ReliaStar would also have been liable for the losses, so long as the investment strategy was, and continued to be, reasonable. See RESTATEMENT (SECOND) OF CONTRACTS § 350 cmt. h, at 132-33 (injured party who makes reasonable but unsuccessful efforts to avoid additional loss not precluded from recovery); id. § 347 cmt. c, at 114 (injured party may recover for incidental and consequential costs/damages incurred as a result of reasonable efforts at mitigation, even if efforts proved unsuccessful). Second, that the Pruskys did have all of their money in money market funds for periods of time prior to the breach is some support that their actual mitigation strategy  100% allocation to money market  wasn't as incomparable to their desired strategy as ReliaStar suggests. However, using the trades the Pruskys requested during the breach period as a proxy, where on average only 44% of their money was in money market, see JA I at 28a, a 100% money market allocation would appear to be the exception rather than the rule. Furthermore, it obviously would have been impossible to even come close to achieving the double-digit returns to which Plaintiffs were accustomed with a pure money market allocation. Therefore, on the whole, it is hard to conceive of the two different strategies  one active and weighted towards equity and high yield, and the other passive and without any risk exposure  as comparable. We recognize that the Pruskys were confronted with a difficult mitigation decision, and are not unsympathetic to their claim that the inability to execute immediate trades eroded much of their market expertise and advantage. Ultimately, however, the crux of this case turns on whether, putting aside any prospect of future legal recovery, an experienced investor would have been content to leave $7 million of capital entirely invested in money market for a multi-year, and potentially indefinite, period. We think the answer is a decided no. In light of all the circumstances, we do not think it unreasonable, as the District Court concluded, to expect intelligent individuals like the Pruskys, indeed, individuals who invest money for a living, to position their investments for higher returns than that which could have been expected from a certificate of deposit. On balance, the fixed money market allocation was not the next-best alternative to Plaintiffs' favored market-timing strategy. Accordingly, the District Court's conclusion that the Pruskys did not reasonably mitigate their damages was not clearly erroneous.