Negotiation, Holder in Due Course, and Defenses

Chapter 27Negotiation, Holder in Due Course, and DefensesCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.27-2“Negotiable Instrument” TerminologyNegotiable Instrument: Written document signed by maker/drawer with unconditional promise/order to pay certain sum of money on demand or at definite time to order/bearerNegotiation: Transfer of possession to third party, who becomes holder of negotiable instrumentHolder: Party who possesses negotiable instrument payable to the party, or to bearerHolder in Due Course: Certain holder who has greater legal rights to the negotiable instrument (compared to mere holder), since the holder in due course is free from certain competing claims and defenses to enforceability of instrument27-3Negotiation RequirementsBearer Paper: Merely requires payee’s delivery of instrument to holder (Physical transfer of negotiable instrument)Order Paper: Requires endorsement and delivery27-4Types of Endorsements“Blank”: Payee’s (or last endorsee’s) signature“Special”: Endorser’s signature plus named endorsee“Qualified”: Endorser’s signature plus use of language “without recourse” (limits endorser liability)“Restrictive”: Endorser’s signature plus restrictions on future negotiation of instrumentEndorsement for deposit or collection onlyEndorsement to prohibit further endorsementConditional endorsementTrust endorsement27-5Non-criminal Endorsement ProblemsMisspelled Name: Holder may endorse document with misspelled name, holder’s actual name, or bothPayable to Legal Entity: Examples of “legal entity”--Estate, organization, partnership Instrument may be endorsed by any authorized representative of entityAlternative/Joint PayeesAlternative payees (“Pay to order of John Smith or Jane Smith)— Endorsement by any one of listed payees sufficientJoint payees (“Pay to order of John Smith and Jane Smith)— Endorsement by all listed payees requiredHolder in Due Course DoctrineProvides incentive for financial intermediaries to engage in transactions, because they receive greater legal protection by virtue of “holder in due course” status27-627-7Requirements for “Holder In Due Course” StatusBe holder of complete and authentic negotiable instrumentTake instrument for valueTake instrument in good faithTake instrument without notice that it is overdue or dishonored, that it has been altered or has an unauthorized signature, or that it is subject to adverse claims or defenses to enforceability of instrument27-8Holder Takes Instrument “For Value” If Holder:Performs promise for which instrument issuedAcquires security interest or other lien in instrumentTakes instrument for payment of preceding claimExchanges instrument for another negotiable instrumentExchanges instrument for an irrevocable obligation to third party27-9Exceptions To Value Requirement Holder is not a holder in due course if he/she takes instrument by:Purchasing it at a judicial sale, or by taking it under legal processAcquiring it through taking over an estatePurchasing it as part of “bulk” transaction, not in regular course of transferor’s business27-10Advantage of Holder In Due Course Status Holder in due course is generally free from following “personal” defenses:Lack or failure of considerationBreach of contractFraud in the inducement (in underlying contract)IncapacityIllegalityDuressUnauthorized completion or material alteration of instrumentUnauthorized acquisition of instrument27-11Holder In Due Course Is Subject to Following “Real” Defenses:Fraud in the EssenceDischarge of the Party Liable Through BankruptcyForgeryMaterial Alteration of Completed InstrumentInfancy (When party below legal age of consent)“Shelter” Principle:If holder cannot attain holder in due course status, holder can acquire rights and privileges of holder in due course, if item transferred from a holder in due course27-12Federal Trade Commission Rule: Negotiation of consumer notes may not be subject to holder in due course status, if consumer credit contract or purchase money loan contains following statement (in 10-point, boldface type):“ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF 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”27-13