Negotiation and Holder in Due Course

Negotiation

  • Negotiation:
    • Transfer of possession of a negotiable instrument.
    • From one person to another, who becomes a holder.
  • Holder:
    • In possession of instrument.
    • Made payable to the holder or to the bearer.
    • Made payable to identified person & is that identified person.
  • Formal Requirements for Negotiation:
    • Order paper (an instrument made payable to a specific person).
    • Bearer paper (an instrument made payable to bearer or to cash).

Indorsement

  • Nature of Indorsement:
    • "signature… made on instrument for purpose of":
      • Negotiating
      • Restricting payment
      • Incurring indorser’s liability
  • Wrong/Misspelled Name:
    • Indorsement can be made either in own name or name on instrument.
  • Checks Deposited without Indorsement:
    • Bank uses stamp.
  • Transfer of Order Instrument:
    • If order instrument transferred without indorsement, not negotiated & transferee not holder.

Types of Indorsements

  • Indorsement is made by holder of the instrument signing it (alone or with words).
    • Example: Signing the back of a check.
  • The holder should sign his name as it appears on the instrument.
  • Effects:
    • Necessary for negotiation.
    • Form affects future attempts to negotiate.
    • Makes person liable.
  • Special Indorsement:
    • Contains the signature of the indorser along with words indicating to whose order the instrument is payable.
  • Blank Indorsement:
    • An indorser signs his name without specifying whom the instrument is payable to.
  • Restrictive Indorsement:
    • An endorsement that specifies the purpose of the indorsement or the use to be made of the indorsement.
      • Example: A "For Deposit Only" notation.
    • A person who takes an instrument with a restrictive endorsement must pay or apply money/value given for the instrument in a way that is consistent with the indorsement.
  • Qualified Indorsement:
    • The indorser disclaims her liability to make the instrument good if the maker or drawer defaults on it.
      • Usually contains words like "Without Recourse."

Consequences of Indorsements

  • Blank:
    • Example: Mark Smith (Assume a check is payable "To the Order of Mark Smith.")
    • Consequences:
      • 1. Satisfies the indorsement requirement for the negotiation of order paper.
      • 2. The instrument becomes bearer paper and can be negotiated by delivery alone.
      • 3. The indorser becomes obligated on the instrument.
  • Special:
    • Example: Pay to the Order of Joan Brown, Mark Smith (Assume a check is payable "To the Order of Mark Smith.")
    • Consequences:
      • 1. Satisfies the indorsement requirement for the negotiation of order paper.
      • 2. The instrument remains order paper and Joan Brown's indorsement is required for further negotiation.
      • 3. The indorser becomes obligated on the instrument.
  • Restrictive:
    • Example: For deposit only to my account in First American Bank Mark Smith (Assume a check is payable "To the Order of Mark Smith.")
    • Consequences:
      • 1. Satisfies the indorsement requirement for the negotiation of order paper.
      • 2. The person who pays value for the instrument is obligated to pay it consistent with the indorsement (i.e., to pay it into Mark Smith's account at First American Bank).
      • 3. The indorser becomes obligated on the instrument.
  • Qualified:
    • Example: Mark Smith (without recourse) (Assume a check is payable "To the Order of Mark Smith.")
    • Consequences:
      • 1. Satisfies the indorsement requirement for negotiation of order paper.
      • 2. Eliminates the indorser's obligation.

Rescission of Indorsement

  • Negotiation is effective even if negotiation is:
    • Made by minor, corporation exceeding its powers, anyone without contractual capacity.
    • Obtained by fraud/duress/mistake.
    • Made in breach of duty.
    • Part of illegal transaction.
  • However, negotiations in these cases are subject to rescission if done prior to transfer to one who qualifies as a holder in due course.

Holder in Due Course

  • Takes negotiable instrument free of all:
    • Personal defenses
    • Claims to instrument
    • Claims in recoupment
  • Does not take instrument free of real defenses.
  • General requirements—must take instrument:
    • For value
    • In good faith
    • Without notice that it is overdue/dishonored
    • Without notice contains unauthorized signature or has been altered
    • Without notice of claim or possessory interest in it
    • Without notice of defense against it or claim in recoupment to it
  • Holder:
    • “…of a negotiable instrument, must have possession of an instrument that is either payable to ‘bearer’ or that is payable to him.”

Value

  • Agreed-upon promise of performance has been performed.
  • Acquires security interest/lien on instrument.
  • Takes instrument in payment/security for antecedent claim.
  • Gives negotiable instrument for it.
  • Makes irrevocable commitment to 3rd person.

Good Faith

  • "…person claimed it honestly and in the observance of reasonable commercial standards of fair dealing."

Overdue or Dishonored Instruments

  • Instruments are Overdue:
    • The day after demand for payment has been made.
    • 90 days after its date if it is a check.
    • When outstanding for unreasonably long time in light of nature/trade practice (if it’s not a check).
  • Dishonored Instruments:
    • Occurs when holder presents for payment & payment has been refused.

Issues Disqualifying Holder in Due Course

  • Notice of Unauthorized Signature or Alteration (once notified, disqualified as holder).
  • Notice of Adverse Claim
    • Notice of breach of fiduciary duty (can’t negotiate for own behalf).
    • Notice of defenses & claims of recoupment.
  • Irregular & incomplete instruments:
    • Material term is blank.
    • Irregular paper is used.

Requirements for Holder in Due Course

  • Must be a holder.
    • A holder is a person in possession of an instrument payable to bearer or payable to him.
  • Must take for value.
    • A holder has given value:
      • a. To the extent the agreed-on consideration has been paid or performed.
      • b. To the extent a security interest or lien has been obtained.
      • c. By payment of or granting security for—an antecedent claim.
      • d. By giving a negotiable instrument for it.
      • e. By making an irrevocable commitment to a third person.
  • Must take in good faith.
    • Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing.
  • Must take without notice that the instrument is overdue.
    • An instrument payable on demand is overdue the day after demand for payment has been duly made.
    • A check is overdue 90 days after its date.
    • If it is an instrument other than a check and payable on demand, when it has been outstanding for an unreasonably long period of time in light of the nature of the instrument and trade practice, it is overdue.
    • If it is an instrument due on a certain date, then it is overdue at the beginning of the next day after the due date.
  • Must take without knowledge that the instrument has been dishonored.
    • An instrument has been dishonored when the holder has presented it for payment (or acceptance) and payment (or acceptance) has been refused.
  • Must take without notice of any uncured default with respect to payment of another instrument issued as part of the same series.
    • If there is a series of notes, holder must take without notice that there is an uncured default as to any other notes in the series.
  • Must take without notice that the instrument contains an unauthorized signature or has been altered.
    • Notice of unauthorized signature or alteration—change in a material term-prevents holder from obtaining HDC status.
  • Must take without notice of any claim of a property or possessory interest in it.
    • Claims of property or possessory interest include:
      • a. Claim by someone that she is the rightful owner of the instrument.
      • b. Person seeking to rescind a prior negotiation of the instrument.
      • c. Claim by a beneficiary that a fiduciary negotiated the instrument for his own benefit.
  • Must take without notice that any party has a defense against it.
    • Defenses include real defenses that go to the validity of the instrument and personal defenses that commonly are defenses to a simple contract.
  • Must take without notice of a claim in recoupment to it.
    • A claim in recoupment is a claim of the obligor on the instrument against the original payee that arises from the transaction that gave rise to the instrument.
  • The instrument must not bear apparent evidence of forgery or alteration or be irregular or incomplete.
    • The instrument must not contain obvious reasons to question its authenticity.

Shelter Rule

  • Transferee obtains rights the transferor had, including:
    • Right to enforce instrument.
    • Any right as holder in due course.

Rights of Holder in Due Course

  • Claims & Defenses Generally
    • UCC Article 3
    • Real defenses
    • Personal defenses
    • Claims to an instrument
    • Claims in recoupment
  • Importance of Being a Holder in Due Course
    • Person in possession must be entitled to enforce.
    • Only worry is real defenses, (those that affect validity).

Real Defenses

  • Minority/Infancy
  • Incapacity
  • Duress
  • Illegality
  • Fraud
  • Discharge in Bankruptcy
  • Other Defenses
    • Forgery
    • Alteration
    • Discharge

Personal Defenses

  • Lack/failure of consideration
  • Breach of contract/warranty
  • Fraud in inducement
  • Incapacity – voidable
  • Illegality – voidable
  • Duress – voidable
  • Unauthorized completion/alteration
  • Nonissuance, conditional issuance, special issuance
  • Failure to sign
  • Modification
  • Payment violates a restrictive indorsement
  • Breach of warranty when draft accepted

Claims

  • To Instrument
    • Claim to ownership by one who asserts ownership & wrongfully deprived of possession
    • Claim of lien
    • Claim for rescission of indorsement
  • In Recoupment
    • Not a defense but is really an offset of liability

Claims/Defenses against Payment of Negotiable Instruments

  • Real Defense
    • Valid against all holders, including holders in due course and holders who have the rights of holders in due course.
    • Examples
      • 1. Minority that under state law makes the contract void or voidable.
      • 2. Other lack of capacity that makes the contract void.
      • 3. Duress that makes the contract void.
      • 4. Illegality that makes the contract void.
      • 5. Fraud in the essence (fraud in the factum).
      • 6. Discharge in bankruptcy.
  • Personal Defense
    • Valid against plain holders of instruments—but not against holders in due course or holders who have the rights of in-due-course holders through the shelter rule.
    • Examples
      • 1. Lack or failure of consideration.
      • 2. Breach of contract (including breach of warranty).
      • 3. Fraud in the inducement.
      • 4. Lack of capacity that makes the contract voidable (except minority).
      • 5. Illegality that makes the contract voidable.
      • 6. Duress that makes the contract voidable.
      • 7. Unauthorized completion of an incomplete instrument, or material alteration of the instrument.
      • 8. Nonissuance of the instrument.
      • 9. Failure to countersign a traveler's check.
        1. Modification of the obligation by a separate agreement.
        1. Payment that violates a restrictive indorsement.
        1. Breach of warranty when a draft is accepted.
  • Claim to an Instrument
    • Examples
      • 1. Claim of ownership by someone who claims to be the owner and that he was wrongfully deprived of possession.
      • 2. Claim of a lien on the instrument.
      • 3. Claim for rescission of an indorsement.
  • Claims in Recoupment
    • Examples
      • 1. Breach of warranty in the sale of goods for which the instrument was issued.

Changes in Holder in Due Course Rule for Consumer Credit Transactions

  • Consumer Disadvantages
    • Give negotiable instrument unintentionally
    • Seller may negotiate note at discount to 3rd party, consumer must pay 3rd party in full & recover from seller (but not from the new holder in due course)
  • State Legislation
    • Some states have limited holder in due course as affects consumers, consumer paper

Federal Trade Commissions Rules

  • NOTICE: ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF THE GOODS OR SERVICES OBTAINED PURSUANT HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER.

Transfer of Commercial Paper

  • Nonconsumer Credit Transaction
    • Negotiable Commercial Paper
      • Negotiated to Holder With Due Course Status
        • Defenses: REAL DEFENSES ONLY
      • Negotiated to Holder Without Due Course Status
        • Defenses: Real and Personal Defenses
  • Assignment
    • Non-Negotiable Commercial Paper
      • Assigned to Assignee
  • Consumer Credit Transaction