Chapter 27Negotiation, Holder in Due Course, and Defenses

HypotheticalNora Abbey, eighteen years old, is overjoyed to have received her first paycheck from her first employer, Nightingale Fashions, Inc. The check is in the amount of $542.00, and is drawn on the Bank of the Homeland. Eager to document her entitlement to the paycheck, Abbey turns the check over, and signs her name in the “endorsement” section. She gets into her car, and heads to the Bank of the Homeland, where she has a checking account, to make a deposit. Unbeknownst to Nora, the check has slipped out of her pocketbook, and onto Main Street.

A cross-wind blows the check onto a street corner. An unidentified woman picks up the check, and later that day, at another Bank of the Homeland branch, she cashes the check. Four weeks later, Nora notices that the check has been processed, and she immediately calls the vice-president of the Bank of the Homeland branch she frequents, requesting that the $542 be credited to her account. The bank vice-president assures Nora that she will “look into it,” but offers no assurances.

Must the bank credit Nora’s account?

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“Negotiable Instrument” Terminology

o Negotiable 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/bearer

o Negotiation: Transfer of possession to third party, who becomes holder of negotiable instrument

o Holder: Party who possesses negotiable instrument payable to the party, or to bearer

o Holder 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 instrument

Negotiation Requirements

o Bearer Paper: Merely requires payee’s delivery of instrument to holder (Physical transfer of negotiable instrument)

o Order Paper: Requires endorsement and delivery

Types of Endorsements

o “Blank”: Payee’s (or last endorsee’s) signature

o Turns order paper into bearer paper

o “Special”: Endorser’s signature plus named endorsee

o “Pay to John Smith”

o “Qualified”: Endorser’s signature plus use of language “without recourse” (limits endorser liability)

o “Restrictive”: Endorser’s signature plus restrictions on future negotiation of instrument

o “For deposit only”

Non-criminal Endorsement Problemso Misspelled Name: Holder may endorse document with

misspelled name, holder’s actual name, or both

o Payable to Legal Entity:

o Examples of “legal entity”--Estate, organization, partnership

o Instrument may be endorsed by any authorized

representative of entity

o Alternative/Joint Payees

o Alternative payees (“Pay to order of John Smith or Jane Smith)—

Endorsement by any one of listed payees sufficient

o Joint payees (“Pay to order of John Smith and Jane Smith)—

Endorsement by all listed payees required

Holder in Due Course Doctrine

o Provides incentive for financial intermediaries to engage in transactions, because they receive greater legal protection by virtue of “holder in due course” status

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Requirements for “Holder In Due Course” Status

o Be holder of complete and authentic negotiable instrument

o Take instrument for valueo Party must take the instrument in exchange

for a promise that has already been performed.

o Take instrument in good faitho Take 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 instrument

o Example: John uses employer’s checks to pay American Express for personal debt. Employer sues American Express. Is American Express a “holder in due course?”

Exceptions To Value Requirement

Holder is not a holder in due course if he/she takes instrument by:

o Purchasing it at a judicial sale, or by taking it under legal process

o Acquiring it through taking over an estate

o Purchasing it as part of “bulk” transaction, not in regular course of transferor’s business

Advantage of Holder In Due Course Status

Holder in due course is generally free from following “personal” defenses:

o Lack or failure of consideration

o Breach of contract

o Fraud in the inducement (in underlying contract)

o Incapacity

o Illegality

o Duress

o Unauthorized completion or material alteration of instrument

o Unauthorized acquisition of instrument

Holder In Due Course Is Subject to Following “Real” Defenses:

o Fraud in the Essence

o Discharge of the Party Liable Through Bankruptcy

o Forgery

o Material Alteration of Completed Instrument

o Infancy (When party below legal age of consent)

“Shelter” Principle

o 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 course