Bagby v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 15 January 1974
• Docket Number: No. 72-1511,73-1191.,72-1511
• Parties: Anna C. BAGBY, Individually and as Guardian of Kenneth Bagby and Dixie Bagby, Minors, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellant, v. COMMERCE BANK OF KANSAS CITY, Appellee, v. TRADERS NATIONAL BANK and City National Bank and Trust Co., Fourth-Party Defendants. Anna C. BAGBY, Individually and as Guardian of Kenneth Bagby and Dixie Bagby, Minors, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant, v. COMMERCE BANK OF KANSAS CITY, Appellee, v. TRADERS NATIONAL BANK and City National Bank & Trust Company, Appellants.
• Court: U.S. Court of Appeals — Eighth Circuit

491 F.2d 192 (1974)

Anna C. BAGBY, Individually and as Guardian of Kenneth Bagby and Dixie Bagby, Minors, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Appellant, v. COMMERCE BANK OF KANSAS CITY, Appellee, v. TRADERS NATIONAL BANK and City National Bank and Trust Co., Fourth-Party Defendants.

Anna C. BAGBY, Individually and as Guardian of Kenneth Bagby and Dixie Bagby, Minors, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant, v. COMMERCE BANK OF KANSAS CITY, Appellee, v. TRADERS NATIONAL BANK and City National Bank & Trust Company, Appellants.

Nos. 72-1511, 73-1191.

United States Court of Appeals, Eighth Circuit.

Submitted November 16, 1973.

Decided January 15, 1974.

Rehearing and Rehearings Denied February 6, 1974.

COPYRIGHT MATERIAL OMITTED

F. Philip Kirwan, Kansas City, Mo., for Merrill Lynch.

John C. Thurlo and Richard K. Andrews, Kansas City, Mo., for Commerce Bank.

Robert K. Ball, II, Kansas City, Mo., for Traders National Bank.

Before HEANEY, ROSS and STEPHENSON, Circuit Judges.

Rehearing and Rehearings En Banc Denied February 6, 1974.

STEPHENSON, Circuit Judge.

This appeal involves an interpretation of § 3-406 of the Uniform Commercial Code, as adopted in Missouri, which specifies that negligence which "substantially contributes to * * * the making of an unauthorized signature * * *" will preclude the drawer from asserting a forgery.

The appeal is a consolidation of two diversity actions originally brought in the United States District Court for the Western District of Missouri. Initially, plaintiff Anna C. Bagby sought damages from defendant Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) for the conversion and sale of certain shares of common stock. Merrill Lynch in turn brought a third-party action against its drawee-bank, Commerce Bank of Kansas City (Commerce Bank), for conversion of funds by paying certain checks over unauthorized or forged indorsements. Commerce Bank then brought a fourth-party action against two collecting banks, Traders National Bank (Traders Bank) and City National Bank (City Bank) seeking indemnification based upon indorsement guarantees. Mrs. Bagby's original claim against Merrill Lynch was subsequently settled, and her complaint was dismissed upon her motion. The remaining claims of Merrill Lynch were tried to the court sitting without a jury, and resulted in a judgment in favor of Commerce Bank. The district court's memorandum and order, filed July 11, 1972, is reported at 348 F.Supp. 969 (W.D.Mo.1972). The facts are fully set forth in Judge Hunter's excellent opinion and will be reported only to the extent necessary for disposition of the issues presented.

Later, the fourth-party complaint was tried to the court with judgment being rendered in favor of Commerce Bank against Traders Bank and City Bank for attorney fees and litigation expenses incurred by Commerce in defending the claim against Merrill Lynch. This opinion was not published.

Both the third and fourth party actions presented questions of first impression in Missouri. Although under such circumstances we give "great weight" to the determination of local law by a district court, we are not bound by that determination. Luke v. American Family Mutual Insurance Company, 476 F.2d 1015, 1019 & n. 6 (CA 8, 1972), aff'd, en banc, 475 F.2d 1023.

I. Merrill Lynch v. Commerce Bank¹

Following the death of her husband, Mrs. Bagby contacted attorney Marshall Lyons for the primary purpose of obtaining an appointment of guardianship for her two minor children so that certain shares of Sears, Roebuck stock could be issued to them. She and her children were beneficiaries of the Savings and Profitsharing Pension Fund of the Sears Company. She was so appointed.

In December of 1967, several shares of Sears stock were issued to Mrs. Bagby, both as an individual and in her capacity as guardian. They were sent to her in care of attorney Lyons. Lyons thereafter contacted a Merrill Lynch account executive through whom an account was opened in the name of Mrs. Bagby individually and another opened in her name as guardian. No Merrill Lynch representative ever met Mrs. Bagby personally, nor confirmed Lyons' authority to open the accounts. No contact whatsoever was made with Mrs. Bagby. All information received by Merrill Lynch was obtained through Lyons. Merrill Lynch dealt solely with Lyons and it did not at any time give Mrs. Bagby personal confirmation that the accounts had been opened.

On two occasions in 1968, the Probate Court of Ray County, Missouri authorized the sale of Sears stock in the guardian estate. There is no evidence that Merrill Lynch ever received copies of these orders. On four occasions between January 1, 1968 and June 19, 1968, Sears stock certificates in Mrs. Bagby's name both as an individual and as guardian of the minor children were indorsed with a facsimile signature of Mrs. Bagby and delivered to Merrill Lynch, who, in turn, sold the stock through the accounts opened by Lyons. Merrill Lynch did not verify whether Mrs. Bagby had authorized anyone to indorse any of the stock certificates with a stamped facsimile signature. As payment, Merrill Lynch drew four checks against its checking account which it maintained with Commerce Bank. The initial check was made payable to "Mrs. Anna C. Bagby, c/o Marshall W. Lyons," and was indorsed "Anna C. Bagby, c/o Marshall W. Lyons, Marshall W. Lyons." The second check was made payable to "Anna C. Bagby" and indorsed "Anna C. Bagby, M. W. Lyons." Both checks were deposited by Lyons in his personal account at Traders Bank. The third check was made payable to "Anna C. Bagby, Gdn. Est., Kenneth R. and Dixie Bagby" and indorsed "Anna C. Bagby, Est. Kenneth R. and Dixie Bagby M. W. Lyons." The final check was made payable to "Anna C. Bagby, Gdn. Est. of Kenneth R. Bagby" and indorsed "Anna C. Bagby Gdn. Est. Kenneth R. Bagby M. W. Lyons." These latter two checks were deposited by Lyons in his personal account at City Bank, with the exception of $250.00 of the amount of the fourth check which was paid in cash to Lyons. Merrill Lynch never obtained authorization from Mrs. Bagby for the drawing and issuance of the checks to Lyons.

In reliance upon guarantees of prior indorsements, Commerce Bank paid the checks upon presentment by the collecting banks and charged the respective indicated sums against Merrill Lynch's account.² At the time it paid on the checks, Commerce Bank had no actual knowledge that the indorsements were forged or unauthorized.

Mrs. Bagby denied the genuineness of the indorsements as her signature and denied that she authorized anyone to indorse the checks with her signature. She further denied that Lyons had any authority to have the checks drawn or to receive them. She never received any proceeds from the checks, and denied knowing of their existence prior to their payment by Commerce Bank.

Merrill Lynch, after settling with Mrs. Bagby, pressed its third-party complaint against Commerce Bank for paying the Bagby checks over the forged indorsements. The district court, however, held that Merrill Lynch was foreclosed from recovering against Commerce Bank under V.A.M.S. § 400.3-406 (1959), (§ 3-406). It held that Merrill Lynch by its own actions (1) in failing to ascertain Lyons' authority and (2) in placing the checks in Lyons' hands on four separate occasions in violation of its own regulations, and the Rules of the New York Stock Exchange³ and sound business practices, was guilty of negligence which "substantially contributed" to the payment of the checks over unauthorized signatures.

In so holding, the district court determined that the adoption by Missouri of § 3-406 "materially altered the test of causation" previously applied in Missouri under the Uniform Negotiable Instruments Act. Under pre-code Missouri law only negligence which proximately related to a forgery or the detection thereof, and not merely to the issuance of the checks, would relieve a drawee-bank of liability for payment. American Sash & Door Co. v. Commerce Trust Co., 332 Mo. 98, 56 S.W.2d 1034, 1038 (1932); accord, Scott v. First Nat. Bank in St. Louis, 343 Mo. 77, 119 S.W. 2d 929, 936-937 (1938).

It is our view that Missouri's adoption of § 3-406 did not materially change the test of causation necessary to preclude a drawer from recovery, and that in this respect pre-code Missouri law has not been modified.

§ 3-406 reads as follows:

Any person who by his negligence substantially contributes to a material alteration of the instrument or to the making of an unauthorized signature is precluded from asserting the alteration or lack of authority against a holder in due course or against a drawee or other payor who pays the instrument in good faith and in accordance with the reasonable commercial standards of the drawee\'s or payor\'s business. (Emphasis supplied.)

Commerce Bank urges our acceptance of the district court's rationale that the use of the expression "substantially contributes" in § 3-406, rather than the wording "direct and proximate cause" (as was the sine qua non of pre-code law necessary to deny a drawer's recovery) creates a broader test which shortens the chain of causation. See, Thompson Maple Products v. Citizens National Bank, 211 Pa.Super. 42, 234 A.2d 32, 34 (1967); accord, National Bank & Trust Co. of Central Pa. v. Commonwealth, 9 Pa.Cmwlth. 358, 305 A.2d 769 (1973). We do not agree.

Although the official comment to § 3-406 expressly states that no attempt is made to define negligence,⁴ we are persuaded that the intended use of "substantially contributes" necessarily requires some showing of a causal relationship equivalent to the "substantial factor" test generally applied in the law of negligence. Gast v. American Casualty Company of Reading, Pa., 99 N.J.Super. 538, 240 A.2d 682, 685 (1968); Gresham State Bank v. O. & K. Construction Co., 231 Or. 106, 370 P.2d 726, 372 P.2d 187 (1962); National...