McCONNELL v. MERRILL LYNCH PIERCE FENNER SMITH INC

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Court of Appeal, Second District, Division 5, California.

John A. McCONNELL, et al., Plaintiffs and Appellants, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant and Respondent.

Civ. 63867.

Decided: September 14, 1982

Marcus Crahan, Jr., and Jack D. Scott, Los Angeles, for plaintiffs and appellants. Macdonald, Halsted & Laybourne, Orville A. Armstrong, and Joel Mark, Los Angeles, for defendant and respondent.

Appellants had “margin accounts” for the purchase of securities on credit with respondent broker Merrill Lynch, Pierce, Fenner & Smith, Inc. (hereinafter ocassionally “Merrill Lynch”), which, they alleged charged compound interest pursuant to a written agreement which violated Section 2 of the Usury Law,1 providing that “․ interest shall not be compounded, nor ․ interest ․ construed to bear interest unless an agreement to that effect is clearly expressed in writing and signed by the party to be charged therewith․”

Appellants sought to serve as class action plaintiffs, on behalf of 52,000 similarly situated customers, and sued to recover the compound interest.   The trial court, however, reversed its earlier certification of the class and dismissed the case as a class action.   This appeal attacks those orders.

PROCEDURAL BACKGROUND

A considerable portion of the trial and appellate court history of this litigation, beginning in 1973, deals with California's traditional constitutional 10 percent usury rule (formerly article XX, § 22), which was superceded by the present article XV, section 1.   While the Supreme Court's detailed analysis of this “excess interest” issue and its ramifications on proper class composition (McConnell v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1978) 21 Cal.3d (hereinafter simply “the Supreme Court Opinion”) 365, 375, 378, 146 Cal.Rptr. 371, 578 P.2d 1375) have continuing importance in an era of a wide variety of variable-term interest arrangements, it has little bearing on the final resolution of the instant case because the aforementioned constitutional change brought an end to the “excess interest” cause of action.  (2d Civ.No. 58664.)

In January 1979,2 the trial court conditionally certified the case as a class action and, in July of 1980, entered an order that certain issues were without substantial controversy.   Among the points resolved in that “partial summary judgment,” which was binding on the trial court (Code Civ.Proc., § 437c;  Conway v. Bughouse (1980) 105 Cal.App.3d 194, 202, 164 Cal.Rptr. 585) were the following:

1. Merrill Lynch charged members of the class represented by appellants compound interest on margin accounts during the time period involved.

2. All class members had executed printed form margin agreements 3 with Merrill Lynch containing the following language:

“ ‘․ and it being further understood that I shall at all times be liable for the payment of any debit balance owing in any of my accounts with you upon demand, and that I shall be liable for any deficiency remaining in any such account(s) in the event of the liquidation thereof in whole or in part by you or by me.

“The monthly debit balance in my account(s) shall be charged, in accordance with your usual custom with interest at a rate which shall include the average rate paid by you on your general loans during the period covered by such balances respectively, and any extra rates caused by market stringency, together with a charge to cover your credit service and facilities.' ”  (Emphasis added.)

3. In accordance with the law of the case in the Supreme Court Opinion, 21 Cal.3d at 372, 146 Cal.Rptr. 371, 578 P.2d 1375, the aforementioned contractual language was not on its face sufficiently clear to comply with Section 2 of the Usury Law (dealing with compound interest).

TRIAL OF CLASS ACTION ISSUES

The then eight-year-old case was assigned to Judge Peter S. Smith for trial in early 1981.   Judge Smith elected to redetermine the conditional certification of the case as a class action at the beginning of the trial as the parties had been advised in 1979 that the ultimate trial judge would do (p. 569, infra ).

At the conclusion of the taking of testimony on the class action issues, the trial judge decertified and dismissed the action as a class action because (i) substantial individual questions of law and fact predominated over common questions, and (ii) the class action device was not a superior method for the resolution of issues presented by the pleadings.

Findings of fact and conclusions of law (Code Civ.Proc., § 632) were neither requested nor made, and trials of the individual plaintiffs' cases were continued indefinitely.

APPELLANTS' CONTENTIONS OF ERROR

In addition to arguing that the trial court failed to follow the “law of the case” of the Supreme Court Opinion, appellants contend that it erred in three respects.

Touching on each, we disagree, and affirm the orders of which appellants complain.

1. Reconsideration of the Earlier Certification of the Class

Appellants suggest that one trial judge (Smith) simply changed the prior decision of another (Lucas) on the class status at the beginning of the trial.   Their argument goes on to condemn “judge shopping” and the impropriety of “one judge of a trial court ․ retry[ing] de novo issues previously tried and determined by another judge of the same court.”

 Certification of a class is subject to continual scrutiny, the reason being, simply enough, that the receipt of evidence by the court can very well change its opinion on the correctness of its earlier and expressly conditional decision on that issue.  (Grogan-Beall v. Ferdinand Roten Galleries, Inc. (1982) 133 Cal.App.3d 969, 975, 184 Cal.Rptr. 411;  Richmond v. Dart Industries (1981) 29 Cal.3d 462, 174 Cal.Rptr. 515, 629 P.2d 23;  Vasquez v. Superior Court (1971) 4 Cal.3d 800, 821, 94 Cal.Rptr. 796, 484 P.2d 964;  Beckstead v. Superior Court (1971) 21 Cal.App.3d 780, 98 Cal.Rptr. 779.)   The Los Angeles Superior Court's own Manual for the Conduct of Pre-Trial Proceedings in Class Actions (§ 422 et seq.) makes a number of provisions for the redetermination of class issues.

 But deciding whether the cited authorities would permit the trial court to simply change its mind for no particular reason (as appellants suggest Judge Smith did in the instant case) or require some sort of “changed circumstances or new evidence” (Super.Ct.Manual, supra, at § 422.5) isn't required here, as the judge plainly was presented with changed circumstances in the form of two very significant legal events.

The first of those was the Supreme Court's decision in Fletcher v. Security Pacific Nat. Bank (1979) 23 Cal.3d 442, 153 Cal.Rptr. 28, 591 P.2d 51, upholding a trial court's refusal to certify a class where individual questions of contract formation (including knowledge by the parties of banking terminology) predominated over a number of common issues of law and fact.   This decision was notwithstanding the dominant contractual position of a bank in determining the format of high-volume boiler-plate provisions and the presence of over 50,000 potential class members, factors which had to look strikingly familiar to the trial court as it embarked on the reanalysis of class issues here.

The second of those events, already alluded to above, was the passage by the voters of article XV, section 1 of the Constitution and the resulting determination in this court (April 7, 1980, 2d Civ. 58664) removing the “excess interest” issue from the lawsuit.

One may reasonably wonder, at first blush, why the removal of that issue from the case would have a major bearing on class action certification, but a reading of the Supreme Court Opinion makes it clear that its determination of class issues (favorable to appellants as representatives) earlier in this litigation was predicated on the presence of the “excess interest” issues.   In fact, class formation with respect to the “compound interest” issues was not touched on by the Supreme Court, as no such class certification had even been previously sought (much less denied or appealed) by the appellants.

Quite apart from the trial court's legal discretion in reconsidering the class issues, appellants' argument that it somehow acted unfairly in “changing its mind” does the court less than justice:  Judge Lucas expressly warned appellants that “the certification this court has made is subject to review by the trial court.” 4

2. Dismissal of the Case as a Class Action

 Fletcher v. Security Pacific Nat. Bank (1979) 23 Cal.3d 442, 153 Cal.Rptr. 28, 591 P.2d 51 is strikingly similar in some important respects to the instant case, and makes it clear that traditional contract law principles are not casually to be swept aside for the presumed efficiency of the class action process.

Appellants correctly contend that the Supreme Court held that the margin account contract language, (“․ charged, in accordance with your usual custom ․”), does not on its face or as a matter of law comply with the requirements of section 2 of the Usury law.   Where appellants, however, err, is in their assumption that this holding precludes the introduction of extrinsic evidence to show what the intention of the parties was.

If, as appellants contend, the language was not only defective on its face but could not be amplified or clarified by extrinsic evidence, the trial court would have had little function at all, save for granting a summary judgment in appellants' favor (leaving only damage calculation issues).   But the Supreme Court Opinion simply did not do that.   It did, rather permit the showing “․ that the language used clearly expressed the parties' intention to permit the compounding of interest.”  (21 Cal.3d at p. 374, fn. 5, 146 Cal.Rptr. 371, 578 P.2d 1375.)

There is nothing new in holding that extrinsic evidence can be used to clarify ambiguities and the intentions of the parties.   While the lives of judges would perhaps be easier if parties didn't use language in contracts such as “our usual custom,” the parties here manifestly did use it, in fact some 52,000 times!

In the trial court's view, which was certainly not inconsistent with the Supreme Court's, that language had to be interpreted with the aid of extrinsic evidence.

Once it became apparent extrinsic evidence would have to be used, the collapse of the matter as a class action was preordained, for the simple reason that there were vast differences in the understanding of the criticized terminology, flowing logically from the equally vast differences in the investment expertise of the members of the purported class.

The evidence established that margin account customers included people such as lawyers, accountants, investment advisers, doctors, deputy sheriffs, computer programmers, internal revenue agents, homemakers, real estate salespersons and owners of small businesses.   The debit balances in the accounts which were reviewed at the trial varied downward from $905,000.

Some of the prospective class members maintained margin accounts with other broker/dealers before they opened their margin account with Merrill Lynch;  some, such as Mr. McConnell, previously maintained margin accounts with Merrill Lynch before signing the customers agreement which was in issue in the present case;  some maintained several margin accounts at Merrill Lynch;  and, some had learned about margin accounts by reading books on the subject.

Some of these customers received respondent's “What Is Margin?” booklet or other Merrill Lynch literature explaining margin accounts and interest calculation;  others denied that they had ever received such materials.   Most of the customers had bought and sold stock on margin and received at least one or more monthly statements of account from Merrill Lynch before signing the customers agreement.

Some of the customers knew and were aware that at their option compound interest would be charged on the debit balances they maintained and some said they were not.   Most of the customers were able to read and interpret the monthly statements of account furnished to them by Merrill Lynch and discern quite readily therefrom that interest on their debit balance was being charged monthly and, if not paid, added to the next month's statement.   Others testified that they were not able to discern that fact from the statements.   Still others simply didn't care.

But in learning about the differences in the backgrounds and investment plans of the various class members, the trial court learned something else, which was perhaps as fatal to the class action status of the case:  Some customers 5 directed the broker to apply income credits to their accounts (in those happy months when there was any income) sometimes totally “wiping out” any charges against the account from the prior month, including, but not limited to, interest charges.   In such situations (varying from person-to-person, month-to-month and depending on when, what and for how much, a customer bought or sold) there was no compounding in a given month or, if the investor was skillful, wealthy or lucky enough, ever.   The compounding occurred only in a month into which there was a “debit balance” carried forward.

Further, while the law of the case compels our acceptance of the Supreme Court Opinion's determination that the language was not sufficient “on its face” to “warn” a customer, one could, in the analysis of appellants' position, argue that the “plain meaning” of charging interest on a monthly debit balance (which might well include “old” interest) is that “interest on interest” would be included.   We have no quarrel with the Supreme Court on this issue, but mention the point only to illustrate how the broad legal theories of the parties could easily have been reversed by a difference in one clearly “close call” by the Court, with appellants insisting that a just result required a review of extrinsic evidence on the various investors' sophistication and Merrill Lynch demanding that we hold to “explicit” contractual language.

In sum, where, as here, judicial interpretation of language (such as “usual custom”) in a contract plainly calls for reference to extrinsic evidence which varies from putative member-to-member, the class cannot be maintained, regardless of the number of potential members or the presence of other common issues of law or fact.

3. Refusal, at the Time of Decertification, to Permit Appellants to Add an Additional Class Representative

 Given that the reason for the trial judge's dismissal of the matter as a class action was lack of requisite commonality of the contractual issues among members of the class already before him, adding or substituting new members would have simply compounded the problem.6  There was no error here.

The judgment of the superior court is affirmed and the claims of the individual plaintiffs remanded to that court for trial or other resolution.

FOOTNOTES

FOOTNOTE.  

1.   We speak here of the uncodified 1919 initiative provisions of California law dealing only with the concept of usury in the compounding of interest.  (Derring's Ann.Uncod.Measures 1919–1, § 2 (1973 ed.) p. 40.)   The various West's series carry this statute as Civil Code section 1916–2 for convenience.   It will simply be referred to as “Section 2 of the Usury Law” herein.

2.   Prior to the dismissal of the excess interest cause of action.

3.   There were two different agreement forms, and the differences do not affect our decisions;  each version contained the quoted language.

4.   Judge Lucas was concerned that the individual contract formation and interpretation issues discussed in the Supreme Court Opinion might render the action incapable of being maintained as a class action and certified the action only after appellants' counsel stated on the record that these individual issues would not be raised at trial:“ ‘THE COURT:  Well, you have cast some doubt on the issues when you have declarations submitted as to the individual experience of individuals within the class.“ ‘Now either you need to, on the record, tell me, “I will not introduce individuals testifying as to their individual experiences because I am relying on the overall nonexistence of actual wording in any of these documents, and I'm willing to meet Merrill Lynch's contentions as to usual custom in some common way rather than individual experience”—now are you prepared to make such a statement to the court?“MR. CRAHAN:  Yes, I am ․' ”

5.   There being no particular rhyme or reason to which ones in the record, but credit status and income tax considerations as well as simple happenstance bear on the issue.

6.   There is no inconsistency between this holding and those commending the class action's use in the enforcement of consumer rights.   The multiple plaintiffs in Vasquez v. Superior Court, supra, and Daar v. Yellow Cab Co. (1967) 67 Cal.2d 695, 63 Cal.Rptr. 724, 433 P.2d 732 had engaged in transactions identical except for damages.  (See Grogan-Beall v. Ferdinand Roten Galleries, Inc. (1982) 133 Cal.App.3d 969, 184 Cal.Rptr. 411.

ERIC E. YOUNGER, Associate Justice.* FN* Assigned by the Chairperson of the Judicial Council.

FEINERMAN, P. J., and STEPHENS, J., concur.