1. Negotiation, Holder in Due Course, and Defenses
Chapter 27
Negotiation, Holder in Due Course, and Defenses

2. Hypothetical
Nora 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?

3. “Negotiable Instrument” Terminology
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
Negotiation: Transfer of possession to third party, who becomes holder of negotiable instrument
Holder: Party who possesses negotiable instrument payable to the party, or to bearer
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
A “negotiable instrument” is a written document signed by the maker or drawer with an unconditional promise or order to pay a certain sum of money on demand or at a definite time, to order or to bearer. “Negotiation” represents the transfer of possession to a third party, who becomes the holder of the negotiable instrument. A “holder” is a party who possesses the negotiable instrument payable to the party, or to bearer. A “holder in due course” 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 the enforceability of the instrument.

4. Negotiation Requirements
Bearer Paper: Merely requires payee’s delivery of instrument to holder (Physical transfer of negotiable instrument)
Order Paper: Requires endorsement and delivery
Negotiation of bearer paper merely requires the payee’s physical delivery of the instrument to the holder. Negotiation of order paper requires endorsement and delivery.

5. Types of Endorsements “Blank”: Payee’s (or last endorsee’s) signature
Turns order paper into bearer paper
“Special”: Endorser’s signature plus named endorsee
“Pay to John Smith”
“Qualified”: Endorser’s signature plus use of language “without recourse” (limits endorser liability)
“Restrictive”: Endorser’s signature plus restrictions on future negotiation of instrument
“For deposit only”
There are four types of commercial paper endorsements. A “blank” endorsement is simply the payee’s (or last endorsee’s) signature. A “special” endorsement represents the endorser’s signature, plus a named endorsee. A “qualified” endorsement includes the endorser’s signature, plus use of the language “without recourse,” which serves to limit endorser liability. A “restrictive” endorsement contains the endorser’s signature, plus restrictions on future negotiation of the instrument. Examples of a restrictive endorsement include endorsement for deposit or collection only, an endorsement to prohibit further endorsement, a conditional endorsement, and a trust endorsement.

6. Non-criminal Endorsement Problems
Misspelled Name: Holder may endorse document with misspelled name, holder’s actual name, or both
Payable to Legal Entity:
Examples of “legal entity”--Estate, organization, partnership
Instrument may be endorsed by any authorized representative of entity
Alternative/Joint Payees
Alternative payees (“Pay to order of John Smith or Jane Smith)—
Endorsement by any one of listed payees sufficient
Joint payees (“Pay to order of John Smith and Jane Smith)—
Endorsement by all listed payees required
If a payee’s name is misspelled, the payee may endorse the document with the misspelled name, the payee’s actual name, or both. If an instrument is payable to a legal entity (such as an estate, an organization, or a partnership,) the instrument may be endorsed by any authorized representative of the entity. If alternative payees are named in the instrument (for example, “Pay to the order of John Smith or Jane Smith,”) endorsement by any one of the listed payees is sufficient. If joint payees are named in the instrument (for example, “Pay to order of John Smith and Jane Smith,”) endorsement by all listed payees is required.

7. Holder in Due Course Doctrine
Provides incentive for financial intermediaries to engage in transactions, because they receive greater legal protection by virtue of “holder in due course” status

8. Requirements for “Holder In Due Course” Status
Be holder of complete and authentic negotiable instrument
Take instrument for value
Party must take the instrument in exchange for a promise that has already been performed.
Take instrument in good faith
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
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?”
In order to achieve “holder in due course” status, an individual in possession of a negotiable instrument must be the holder of a complete and authentic negotiable instrument, take the instrument for value, take the instrument in good faith, and take the 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 the enforceability of the instrument.

9. Exceptions 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 process
Acquiring it through taking over an estate
Purchasing it as part of “bulk” transaction, not in regular course of transferor’s business
A holder is not a holder in due course if he or she takes the instrument by purchasing it at a judicial sale or taking it under legal process, acquiring it through taking over an estate, or purchasing it as part of “bulk” transaction, not in the regular course of the transferor’s business.

10. Advantage of Holder In Due Course Status
Holder in due course is generally free from following “personal” defenses:
Lack or failure of consideration
Breach of contract
Fraud in the inducement (in underlying contract)
Incapacity
Illegality
Duress
Unauthorized completion or material alteration of instrument
Unauthorized acquisition of instrument
A clear advantage of achieving holder in due course status is that the holder in due course is generally free from “personal” defenses, including lack or failure of consideration, breach of contract, fraud in the inducement (in the underlying contract,) incapacity, illegality, duress, unauthorized completion or material alteration of an instrument, and unauthorized acquisition of an instrument.

11. Holder In Due Course Is Subject to Following “Real” Defenses:
Fraud in the Essence
Discharge of the Party Liable Through Bankruptcy
Forgery
Material Alteration of Completed Instrument
Infancy (When party below legal age of consent)
A holder in due course is subject to the “real” defenses of fraud in the essence, discharge of a party liable through bankruptcy, forgery, material alteration of a completed instrument, and infancy (when a party is below the legal age of consent.)

12. “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 course
According to the “shelter” principle, if a holder cannot attain holder in due course status, the holder can acquire the rights and privileges of a holder in due course, if the item is transferred from a holder in due course.