The New Hampshire Supreme Court recently held that a futures commission merchant ("FCM") had no duty to liquidate a position in a customer's non-discretionary account when the customer was unable to meet margin calls, but did not order liquidation of his position. In so holding, the Court rejected the notion that the FCM had a "paternalistic" duty to protect its customer "from his own greed."
Defendant David Sands had established a losing short position in lumber futures in his non-discretionary commodity futures account with Merrill Lynch Futures, Inc., ("Merrill Lynch"). As the losses on the position mounted, Sands informed his broker that he could not satisfy further margin calls. The broker did not liquidate the account at that time. On March 5, 1993, another margin call was issued after the position sustained additional losses. Sands immediately informed his broker that he could not meet that margin call. The broker again did not liquidate the position, and further losses mounted. On March 8, 1993, Sands instructed the broker to liquidate the position, which the broker began to do on March 9, 1993. By March 11, 1993, Merrill Lynch had liquidated Sands' account, resulting in a debit balance of more than $500,000. Merrill Lynch then sued to recover the losses, and over Sands' counterclaims for, inter alia, negligence, obtained an arbitration award in excess of $600,000 in its favor, which was confirmed by the New Hampshire Superior Court.
On appeal to the New Hampshire Supreme Court, Sands maintained that Merrill Lynch's customer agreement and various provisions of its internal policy manuals established a duty to liquidate his account as soon as he indicated that he could not meet further margin calls, and that Merrill Lynch was negligent in not doing so and allowing him to incur additional losses. The Court disagreed. As the Court found, the customer agreement and the internal policy manuals did not establish any duty to liquidate on the FCM's part to protect Sands from further losses, but are designed to protect Merrill Lynch when customers cannot meet the required margin.
Specifically, the Court noted that the customer agreement at issue provided that "Merrill Lynch shall have the right . . . whenever in [its] discretion [it] consider[s] it necessary for [its] protection . . . to liquidate any or all . . . commodity futures contracts." Similarly, the Court observed that Merrill Lynch's internal liquidation rule, which stated that "[a]s soon as a customer indicates that he is unable or unwilling . . . to meet a call . . . the office must liquidate or cover," and that "'[p]laying the market' under these conditions generally leads to a greater loss, so [managers] must make certain that liquidations are not delayed," was contained in the "Control of Unsecured Debit Balances" section of Merrill Lynch's internal policy manual, which has as its stated purpose the protection of Merrill Lynch from losses. Thus, the Court concluded that Sands "c[ould] not establish negligence liability based on Merrill Lynch's failure to follow in-house rules or policies that were not designed to protect him."
Moreover, the Court noted that Sand's customer account was non-discretionary and, as such, Merrill Lynch had no authority to make investment decisions on his behalf. Having waited three days before ordering liquidation of his account, and hence continuing to "play the market" and incur additional losses, the Court stated that Sands "c[ould] not now be heard to complain that he should not have been allowed to stay in the market." "Merrill Lynch was not obligated to liquidate the account to protect the defendant from further imprudent investment activity," the Court stated.
The Court also rejected Sands' claim that Merrill Lynch breached its common law duty to mitigate damages by failing to liquidate when it learned that Sands could not meet the margin calls. According to the Court, Merrill Lynch liquidated the account within three days of receiving Sands' instruction to do so, and thus acted in a commercially reasonable fashion. *
Merrill Lynch Futures, Inc. v. Sands, 727 A.2d 1009 (N.H. 1999).