Commercial and consumer credit law - First Circuit properly construes holder in due course doctrine under Massachusetts Law.

• Author: Lee, Hayden O.

Commercial and Consumer Credit Law--First Circuit Properly Construes Holder in Due Course Doctrine Under Massachusetts Law--Jelmoli Holding, Inc. v. Raymond James Financial Services, Inc., 470 F.3d 14 (1st Cir. 2006)

Under Massachusetts law, a holder in due course takes a negotiable instrument free from the claims of others; however, when the taker obtains the instrument with notice of another's claim to the instrument, notice will negate the taker's holder in due course defense. (1) Notice of a fiduciary breach concerning the instrument is notice of a claim, so that a person who takes the instrument from a payor with notice of the payor's fiduciary breach to another is not a holder in due course. (2) In Jelmoli Holding, Inc. v. Raymond James Financial Services, Inc., (3) the First Circuit Court of Appeals considered whether, under Massachusetts law, a plaintiff may negate a holder in due course defense when the defendant had no actual knowledge that the person presenting the instrument was a fiduciary. (4) The First Circuit held, pursuant to the General Laws of Massachusetts, that a plaintiff must demonstrate that a defendant had actual knowledge of a fiduciary's status, in addition to notice of the fiduciary's underlying breach of duty. (5)

Since 1990, William Potts worked for Jelmoli Holding, Inc. (Jelmoli), a Massachusetts company with a parent corporation headquartered overseas. (6) Jelmoli permitted Potts to conduct a significant portion of its United States business, which included endorsing checks and verifying the proper maintenance of Jelmoli's United States accounts. (7) In addition to working for Jelmoli, Potts operated an individual brokerage account with the defendant, the Raymond James brokerage firm. (8)

In the stock market collapse of 2000, the value of Potts's personal account declined significantly. (9) Raymond James permitted Potts to trade on the margin, paying only a percentage of the stock price and borrowing the balance from Raymond James; accordingly, following the market collapse, Potts was unable to cover the necessary margin between stock value and balance owed. (10) In April 2000, to maintain his margin account, Potts drew checks from a Jelmoli bank account and transferred the proceeds to Raymond James. (11) In response to Raymond James's inquiry regarding the Jelmoli checks, Potts stated that he owned Jelmoli and could use the checks as he desired. (12) Between April and December 2000, Potts provided Raymond James with Jelmoli checks totaling $1.5 million to maintain his personal brokerage account. (13)

In December 2000, Potts revealed to Jelmoli that he had embezzled funds from its United States bank account to pay for his failing brokerage account with Raymond James. (14) In response, Jelmoli sued Raymond James in the federal district court in Massachusetts to recover $1.3 million of the funds Potts fraudulently transferred to Raymond James. (15) At trial, Raymond James argued that it was a statutory holder in due course and, therefore, immune from liability to Jelmoli. (16) The district court judge instructed the jury that Jelmoli could defeat Raymond James's holder in due course defense by showing that Raymond James had known of the facts and circumstances that gave it reason to know a claim existed. (17) Following the instructions, the jury determined that Raymond James was a valid holder in due course for only some of the checks but was still liable to Jelmoli for $1.1 million. (18) On appeal, the First Circuit agreed with Raymond James's position that the district court erred by failing to instruct the jury that Raymond James could have notice of Jelmoli's claim to the embezzled funds, thereby negating Raymond James's holder in due course defense, only if Raymond James had actual knowledge of Potts's fiduciary status. (19)

In 1951, the American Law Institute (ALI) and the National Conference of Commissioners on Uniform State Laws (NCCUSL) composed the original draft of the Uniform Commercial Code (UCC), making it available for the states to ratify. (20) Within this first draft, Article 3 governed the law of drafts, checks, and promissory notes. (21) In 1985, in an age where people began to conduct fewer face-to-face transactions, the ALI and NCCUSL responded to the need to modernize Article 3's governance of negotiable instruments by considering broad changes to Article 3. (22) In particular, the ALI and NCCUSL sought to "replace archaic terminology, make Article 3 more relevant to today's business transactions, and to recognize that notes and drafts have different functions so as to merit different treatments." (23) On January 24, 1991, the revised version of Article 3 (revised UCC) became available for ratification. (24)

Under the original UCC, the rules governing notice of fiduciary breach were difficult to interpret and scattered among various code sections. (25) A new provision within section 3-307 of the revised UCC consolidated these various sections and clarified that a taker's notice of a fiduciary's breach of duty, concerning the fiduciary's transfer of a negotiable instrument to the taker, vitiates the defendant-taker's status as a holder in due course. (26) Under revised UCC section 3-307, "[n]otice of breach of fiduciary duty by the fiduciary is notice of the claim of the represented person." (27) Within this framework, subsection 3-307(b)(4) outlines three specific instances in which a defendant obtains notice of a fiduciary's breach, thereby negating a defendant's holder in due course defense under revised UCC section 3-302. (28) To defeat a holder in due course defense, therefore, a plaintiff must satisfy one of the three subsection 3-307(b)(4) prongs, in addition to showing that the defendant had knowledge of the fiduciary's relationship to the plaintiff. (29)

In 1998, Massachusetts adopted an identical version of revised UCC section 3-307. (30) Until recently, Massachusetts courts had not addressed the significance of this revision. (31) Several state and federal courts, however, determined that revised UCC section 3-307 requires plaintiffs to prove that a defendant had knowledge of a fiduciary's relationship to the plaintiff, as well as notice of the fiduciary's breach in tendering a negotiable instrument to the defendant. (32)

In Jelmoli Holding, Inc., the First Circuit decided that Massachusetts law requires a plaintiff to show that a defendant had both notice of the fiduciary's breach of duty to the plaintiff, as well as knowledge of the fiduciary's relationship to the plaintiff, to defeat a holder in due course defense. (33) The court rejected the plaintiff's argument to negate the defendant's holder in due course status by showing that the defendant had notice of a fiduciary breach without also proving that...