Merrill Lynch, Pierce, Fenner & Smith, Inc. v. First Nat. Bank of Little Rock, Ark.

Decision Date10 October 1985
Docket NumberNos. 84-2107,84-2156,s. 84-2107
PartiesMERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellee, v. FIRST NATIONAL BANK OF LITTLE ROCK, ARKANSAS, Appellant. Comex, Inc.; Comex Charge Systems, Inc.; Comex Livestock Investment Systems, Inc.; Consolidated Holding Co.; Consolidated Collection Management, Inc.; Consolidated Charge System, Inc., d/b/a Comex, Inc.; and Bridgeport Company. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellee, Worthen Bank & Trust Co., Appellant, FIRST NATIONAL BANK OF LITTLE ROCK, ARKANSAS, Comex, Inc., Comex Charge Systems, Comex Livestock Investment Systems, Inc., Consolidated Holding Co., Consolidated Collection Management, Inc., Consolidated Charge System, Inc., d/b/a Comex, Inc., Bridgeport Company and Dwight L. Pierce, Appellees.
CourtU.S. Court of Appeals — Eighth Circuit

Herschel H. Friday and V. Markham Lester, Little Rock, Ark., for appellant.

Priscilla Karen Pope, Fayetteville, Ark., for appellee.

Before BRIGHT, Senior Circuit Judge, ARNOLD and FAGG, Circuit Judges.

ARNOLD, Circuit Judge.

This case arises out of a check-kiting scheme perpetrated by a group of businesses known collectively as Comex, Inc., which operated a collection service for doctors' accounts receivable. Comex had accounts with Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch), First National Bank of Little Rock B, Worthen Bank and Trust Co., N.A. (Worthen), and Bank of New York (BONY). Merrill Lynch acted in a dual capacity. It had an account as a customer with FNB. It also behaved substantially as a bank in that it maintained for Comex, among many other customers, an account known as the Ready Assets Trust, through which customers could earn interest through the purchase of Ready Assets Shares. The customer could redeem these shares for cash through a "share redemption request," which for most practical purposes had the same characteristics as an ordinary bank check. Share redemption requests were presented for payment at BONY from the Merrill Lynch account maintained there. A major advantage of the Ready Assets Trust was that it allowed customers to earn money on "float." Float refers to the period (usually two to seven days) between the drawing of a check and its ultimate collection by presentment to the drawee bank. Merrill Lynch facilitated exploitation of the float by giving immediate credit on deposits by customers such as Comex of uncollected items into its Merrill Lynch account.

The kiting scheme involved Comex's artificially inflating its balance in the Merrill Lynch Ready Assets Trust. For example, Comex would deposit with Merrill Lynch checks drawn on its account with FNB even though at that time Comex might not have had sufficient funds in that bank to cover its checks. Since Merrill Lynch chose to give immediate credit on deposits, Comex would earn money through the Ready Assets Trust on money which did not exist. Eventually, of course, Comex would have to cover its withdrawal from its account at FNB and would deposit with FNB checks drawn on another bank, for instance Worthen. Then Comex would cover its deficit at Worthen with checks drawn on other accounts including, perhaps, the interest-bearing account at Merrill Lynch. Comex was able to keep this scheme in motion for approximately one year before the kite was discovered and collapsed through the actions of FNB. The resulting loss to all financial institutions involved totalled in excess of two million dollars.

Specifically, this case involves banking transactions among Merrill Lynch, FNB, Worthen, and Comex that occurred on April 11 and 12, 1983. At some point during the course of these dealings, FNB became aware that certain checks drawn on Worthen by Comex, and deposited by Comex in Merrill Lynch's account at FNB, were being dishonored by Worthen and returned to FNB. The result of the return of these items, of course, had to be that FNB would charge them back against Merrill Lynch's account with it. But FNB (contrary, Merrill Lynch says, to its customary practice) did not promptly inform Merrill Lynch, its depositor, that this charge-back was occurring. If it had been promptly informed, Merrill Lynch says, it would have known of Comex's kiting scheme and could have protected itself against loss by not paying FNB for certain other checks drawn by Comex. FNB's major objection to this theory of recovery, as we shall see, is that the evidence before the jury was not sufficient to support it.

Merrill Lynch brought this suit in the District Court 1 for the Eastern District of Arkansas against Comex; various directors of Comex; the chief executive officer of Comex, Dwight Pierce; and the First National Bank. In an action transferred from bankruptcy court, Worthen Bank asserted claims against FNB and Comex. After a jury trial, Merrill Lynch received judgment for $1,207,580 against FNB, Dwight Pierce, and Comex, jointly and severally. The actions against the directors were voluntarily dismissed. Worthen received judgment against FNB for $394,220 and against Comex for $827,948.73. FNB was awarded indemnity against Comex for the full amount of the judgment in favor of Merrill Lynch.

Comex, which is now in bankruptcy, did not appeal the judgment of the District Court. Dwight Pierce gave notice of an appeal but failed to prosecute his appeal, which is dismissed. 8th Cir.R. 13. First National Bank appeals the denial of its motions for directed verdict and for judgment notwithstanding the verdict. Worthen appeals only from that part of the judgment and order which held FNB to be jointly and severally liable to Merrill Lynch. We modify the portion of the District Court judgment awarding FNB complete indemnity against Comex, and affirm in all other respects.

I.

FNB raises two points in its appeal. 2 First, it asserts that the verdict was contrary to prevailing law. Second, it argues that there was insufficient evidence to support the verdict of the jury.

A. The Bank's Duty to its Customer

Merrill Lynch's theory of recovery is based on the common-law tort of deceit. It alleged and sought to prove that FNB deliberately failed to inform Merrill Lynch that over one million dollars in bad checks had been returned from Worthen and were to be charged to Merrill Lynch's account. It sought to prove that a previous, established course of dealing existed between Merrill Lynch and FNB by which FNB consistently informed Merrill Lynch of large-item returns when they were received, and that Merrill Lynch justifiably relied on the bank's so informing it. Merrill Lynch alleged that FNB deliberately chose to delay informing it of these large return items so that the bank could protect its own assets by collecting on other checks which had been drawn on Merrill Lynch by its customer, Comex.

At trial FNB relied mainly on the theory that FNB had no duty to Merrill Lynch or other financial institutions to discover the existence of a check-kiting scheme and then surrender the benefit of its diligence by disclosing the kite before acting to protect itself.

FNB also sought to prove that Merrill Lynch was negligent in allowing its customer Comex to inflate the value of its Ready Assets Trust balance by giving immediate credit on Comex deposits, and that Merrill Lynch was in an equal or better position to discover the scheme but had exempted Comex from its in-house kite-detection routines. FNB's reliance on what is essentially a contributory-negligence defense is misplaced, for the central question in this case is not whether FNB or Merrill Lynch had a duty to the other to discover and disclose the check-kiting scheme as such. Rather, Merrill Lynch alleged, and FNB failed to refute, that FNB departed from its established course of dealing with Merrill Lynch in order to shift the ultimate loss to Merrill Lynch. Since FNB did not attempt to prove that Merrill Lynch was negligent in relying on FNB's policy of prompt notification when large charge-back items came in, the question of contributory negligence is irrelevant to the outcome of this case. 3

First National Bank does not object to the District Court's instructions on the elements of deceit, 4 which essentially follow Arkansas law. The Arkansas Supreme Court in Beam v. Monsanto Co., 259 Ark. 253, 264, 532 S.W.2d 175, 180-81 (1976), adopted Dean Prosser's five-element definition of the tort of deceit, as follows:

1. A false representation made by the defendant. In the ordinary case this representation must be one of fact.

2. Knowledge or belief on the part of the defendant that the representation is false--or, what is regarded as equivalent, that he has not a sufficient basis of information to make it. This element is often given the technical name of 'scienter.'

3. An intention to induce the plaintiff to act or refrain from action in reliance upon the misrepresentation.

4. Justifiable reliance upon the misrepresentation on the part of the plaintiff, in taking action or refraining from it.

5. Damage to the plaintiff, resulting from such reliance.

W. Prosser, Law of Torts 685-86 (4th ed. 1971). See also MFA Mut. Ins. Co. v. Keller, 274 Ark. 281, 623 S.W.2d 841 (1981); Storthz v. Commercial Nat. Bank, 276 Ark. 10, 631 S.W.2d 613 (1982). Neither does the bank challenge the instruction on misrepresentation by failure to act. 5 When a fact is peculiarly within the knowledge of one party and of such a nature that the other party is justified in assuming the existence of that fact, then there is a duty to disclose the fact. Bridges v. United Savings Association, 246 Ark. 221, 228, 438 S.W.2d 303, 306 (1969). Justifiable reliance of this sort may arise through the course of dealing between the bank and its customer. See City National Bank v. McCann, 193 Ark. 967, 972-73, 106 S.W.2d 195, 199 (1937). The duty to speak may be based on special circumstances, such as a confidential relationship, in which one party knows that another is relying...

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