Bowling Green, Inc. v. State Street Bank and Trust Co.

• Citation: 425 F.2d 81
• Decision Date: 06 May 1970
• Docket Number: No. 7475.,7475.
• Parties: BOWLING GREEN, INC., Plaintiff, Appellant, v. STATE STREET BANK AND TRUST COMPANY, Defendant, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

425 F.2d 81 (1970)

BOWLING GREEN, INC., Plaintiff, Appellant, v. STATE STREET BANK AND TRUST COMPANY, Defendant, Appellee.

No. 7475.

United States Court of Appeals, First Circuit.

May 6, 1970.

Marcus E. Cohn, Boston, Mass., with whom Bernard P. Rome and Wasserman & Salter, Boston, Mass., were on brief, for appellant.

Charles C. Craig, Boston, Mass., with whom Craig & Craig, Boston, Mass., was on brief, for appellee.

Before ALDRICH, Chief Judge, McENTEE and COFFIN, Circuit Judges.

COFFIN, Circuit Judge.

On September 26, 1966, plaintiff Bowling Green, Inc., the operator of a bowling alley, negotiated a United States government check for $15,306 to Bowl-Mor, Inc., a manufacturer of bowling alley equipment. The check, which plaintiff had acquired through a Small Business Administration loan, represented the first installment on a conditional sales contract for the purchase of candlepin setting machines. On the following day, September 27, a representative of Bowl-Mor deposited the check in defendant State Street Bank and Trust Co. The Bank immediately credited $5,024.85 of the check against an overdraft in Bowl-Mor's account. Later that day, when the Bank learned that Bowl-Mor had filed a petition for reorganization under Chapter X of the Bankruptcy Act, it transferred $233.61 of Bowl-Mor's funds to another account and applied the remaining $10,047.54 against debts which Bowl-Mor owed the Bank. Shortly thereafter, Bowl-Mor's petition for reorganization was dismissed and the firm was adjudicated a bankrupt. Plaintiff has never received the pin-setting machines for which it contracted. Its part payment remains in the hands of defendant Bank.

Plaintiff brought this diversity action to recover its payment from defendant Bank on the grounds that the Bank is constructive trustee of the funds deposited by Bowl-Mor. In the court below, plaintiff argued that Bowl-Mor knew it could not perform at the time it accepted payment, that the Bank was aware of this fraudulent conduct, and that the Bank therefore received Bowl-Mor's deposit impressed with a constructive trust in plaintiff's favor. The district court rejected plaintiff's view of the evidence, concluding instead that the Bank was a holder in due course within the meaning of Mass.Gen.Laws Ann. c. 106 §§ 4-209 and 3-302, and was therefore entitled to take the item in question free of all personal defenses. Bowling Green, Inc., etc. v. State Street Bank and Trust Co., 307 F.Supp. 648 (D.Mass.1969).

Plaintiff's appeal challenges the conclusion of the district court in three respects. First, plaintiff maintains that the Bank has not met its burden of establishing that it was a "holder" of the item within the meaning of Mass.Gen. Laws Ann. c. 106 § 1-201(20), and thus cannot be a "holder in due course" within the meaning of § 4-209 and § 3-302.¹ Second, plaintiff argues that the Bank's close working relation with Bowl-Mor prevented it from becoming a holder in good faith. Finally, plaintiff denies that defendant gave value within the meaning of § 4-209 for the $10,047.54 which it set off against Bowl-Mor's loan account.

Plaintiff's first objection arises from a technical failure of proof. The district court found that plaintiff had endorsed the item in question to Bowl-Mor, but there was no evidence that Bowl-Mor supplied its own endorsement before depositing the item in the Bank. Thus we cannot tell whether the Bank is a holder within the meaning of § 1-201(20), which defines holder as one who takes an instrument endorsed to him, or to bearer, or in blank. But, argues plaintiff, once it is shown that a defense to an instrument exists, the Bank has the burden of showing that it is in all respects a holder in due course. This failure of proof, in plaintiff's eyes, is fatal to the Bank's case.

We readily agree with plaintiff that the Bank has the burden of establishing its status in all respects. Mass.Gen.Laws Ann. c. 106 § 3-307(3),² on which plaintiff relies to establish the defendant's burden, seems addressed primarily to cases in which a holder seeks to enforce an instrument, but Massachusetts courts have indicated that the policy of § 3-307(3) applies whenever a party invokes the rights of a holder in due course either offensively or defensively. Cf. Elbar Realty Inc. v. City Bank & Trust Co., 342 Mass. 262, 267-268, 173 N.E.2d 256 (1961). The issue, however, is not whether the Bank bears the burden of proof, but whether it must establish that it took the item in question by endorsement in order to meet its burden. We think not. The evidence in this case indicates that the Bank's transferor, Bowl-Mor, was a holder. Under Mass.Gen.Laws Ann. c. 106, § 3-201(a), transfer of an instrument vests in the transferee all the rights of the transferor. As the Official Comment to § 3-201 indicates, one who is not a holder must first establish the transaction by which he acquired the instrument before enforcing it, but the Bank has met this burden here.

We doubt, moreover, whether the concept of "holder" as defined in § 1-201(20) applies with full force to Article 4. Article 4 establishes a comprehensive scheme for simplifying and expediting bank collections. Its provisions govern the more general rules of Article 3 wherever inconsistent. Mass.Gen. Laws Ann. c. 106 § 4-102(1). As part of this expediting process, Article 4 recognizes the common bank practice of accepting unendorsed checks for deposit. See Funk, Banks and the UCC 133 (1964). § 4-201(1) provides that the lack of an endorsement shall not affect the bank's status as agent for collection, and § 4-205(1) authorizes the collecting bank to supply the missing endorsements as a matter of course.³ In practice, banks comply with § 4-205 by stamping the item "deposited to the account of the named payee" or some similar formula. Funk, supra at 133. We doubt whether the bank's status should turn on proof of whether a clerk employed the appropriate stamp, and we hesitate to penalize a bank which accepted unendorsed checks for deposit in reliance on the Code, at least when, as here, the customer himself clearly satisfies the definition of "holder". Section 4-209 does provide that a bank must comply "with the requirements of section 3-302 on what constitutes a holder in due course," but we think this language refers to the enumerated requirements of good faith and lack of notice rather than to the status of holder, a status which § 3-302 assumes rather than requires. We therefore hold that a bank which takes an item for collection from a customer who was himself a holder need not establish that it took the item by negotiation in order to satisfy § 4-209.

Plaintiff's second objection arises from the intimate relationship between Bowl-Mor and the Bank, a relationship which plaintiff maintains precludes a finding of good faith. The record shows that the Bank was one of BowlMor's three major creditors, and that it regularly provided short term financing for Bowl-Mor against the security of Bowl-Mor's inventory and unperformed contracts. The loan officer in charge of Bowl-Mor's account, Francis Haydock, was also a director of Bowl-Mor until August 1966. Haydock knew of Bowl-Mor's poor financial health and of its inability to satisfy all its creditors during 1966. In the five months before the transaction in question, the Bank charged $1,000,000 of Bowl-Mor's debt to the Bank's reserve for bad debts. However, the record also shows that the Bank continued to make loans to Bowl-Mor until September 12.

The Bank was also aware of the underlying transaction between Bowl-Mor and the plaintiff which led to the deposit on September 26. During the week prior to this transaction, Bowl-Mor had overdrawn its checking account with the Bank to meet a payroll. In order to persuade the Bank to honor the overdraft, officials of Bowl-Mor contacted Haydock and informed him that a check for $15,000 would be deposited as soon as plaintiff could obtain the funds from the Small Business Administration. The district court found, however, that the Bank was not aware that the directors of Bowl-Mor had authorized a Chapter X petition or that Bowl-Mor officials planned to file the petition on September 27.

On the basis of this record, the district court found that the Bank acted in good faith and without notice of any defense to the instrument. The Code defines "good faith" as "honesty in fact", Mass.Gen.Laws Ann. c. 106 § 1-201(19), an essentially subjective test which focuses on the state of mind of the person in question. The Code's definition of "notice", Mass.Gen.Laws Ann. c. 106 § 1-201(25), while considerably more prolix, also focuses on the actual knowledge of the individuals allegedly notified. Since the application of these definitions turns so heavily on the facts of an individual case, rulings of a district court under §§ 3-302(1) (b) and 3-302(1) (c) should never be reversed unless clearly erroneous. In this case, the evidence indicated that Bowl-Mor had persevered in spite of long-term financial ill health, and that the event which precipitated its demise was the withdrawal of financial support by another major creditor, Otis Elevator Co., on the morning of September 27, after the deposit of plaintiff's check. Thus, at the time of deposit, the Bank might reasonably have expected Bowl-Mor to continue its shambling pace rather than cease business immediately. The findings of the district court are not, therefore, clearly erroneous.

Plaintiff, however, urges us to adopt the "objective" standard of good faith promulgated in Jones v. Approved Ban-credit Corp., 256 A.2d 739 (Del.Sup.Ct. 1969), which held that a finance company could not as a matter of law be a holder in due course of a consumer installment note which it discounted for a closely affiliated construction company. We doubt whether Approved Bancredit represents the law in Massachusetts. In a similar case, Universal C.I.T. Credit Corp. v. Ingel, 347 Mass. 119, 196 N.E. 2d 847 (...