Chapter 27Chapter 27Negotiation, Negotiation,

Holder in Due Holder in Due Course, and Course, and

DefensesDefenses

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““Negotiable Instrument” Negotiable Instrument” TerminologyTerminology

Negotiable Instrument: Written document signed by Negotiable Instrument: Written document signed by maker/drawer with unconditional promise/order to pay maker/drawer with unconditional promise/order to pay certain sum of money on demand or at definite time to certain sum of money on demand or at definite time to order/bearerorder/bearer

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

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

Holder in Due Course: Certain holder who has greater Holder in Due Course: Certain holder who has greater legal rights to the negotiable instrument (compared to legal rights to the negotiable instrument (compared to mere holder), since the holder in due course is free from mere holder), since the holder in due course is free from certain competing claims and defenses to enforceability of certain competing claims and defenses to enforceability of instrumentinstrument

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Negotiation RequirementsNegotiation Requirements

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

Order Paper: Requires endorsement Order Paper: Requires endorsement andand deliverydelivery

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Types of EndorsementsTypes of Endorsements ““Blank”: Payee’s (or last endorsee’s) signatureBlank”: Payee’s (or last endorsee’s) signature

““Special”: Endorser’s signature Special”: Endorser’s signature plusplus named endorsee named endorsee

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

““Restrictive”: Endorser’s signature Restrictive”: Endorser’s signature plusplus restrictions on restrictions on future negotiation of instrumentfuture negotiation of instrument

Endorsement for deposit or collection onlyEndorsement for deposit or collection only Endorsement to prohibit further endorsementEndorsement to prohibit further endorsement Conditional endorsementConditional endorsement Trust endorsementTrust endorsement

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Non-criminal Endorsement ProblemsNon-criminal Endorsement Problems

Misspelled Name: Holder may endorse document with Misspelled Name: Holder may endorse document with misspelled name, holder’s actual name, or bothmisspelled name, holder’s actual name, or both

Payable to Legal Entity: Payable to Legal Entity:

Examples of “legal entity”--Estate, organization, partnershipExamples of “legal entity”--Estate, organization, partnership Instrument may be endorsed by any authorized representative of Instrument may be endorsed by any authorized representative of

entityentity

Alternative/Joint PayeesAlternative/Joint Payees

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

Endorsement by any one of listed payees sufficientEndorsement by any one of listed payees sufficient

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

Endorsement by all listed payees requiredEndorsement by all listed payees required

Holder in Due Course Holder in Due Course DoctrineDoctrine

Provides incentive for financial Provides incentive for financial intermediaries to engage in intermediaries to engage in transactions, because they transactions, because they

receive greater legal protection receive greater legal protection by virtue of “holder in due by virtue of “holder in due

course” statuscourse” status

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Requirements for “Holder In Due Requirements for “Holder In Due Course” StatusCourse” Status

Be holder of complete and authentic negotiable Be holder of complete and authentic negotiable instrumentinstrument

Take instrument for valueTake instrument for value

Take instrument in good faithTake instrument in good faith

Take instrument without notice that it is overdue Take instrument without notice that it is overdue or dishonored, that it has been altered or has an or dishonored, that it has been altered or has an unauthorized signature, or that it is subject to unauthorized signature, or that it is subject to adverse claims or defenses to enforceability of adverse claims or defenses to enforceability of instrumentinstrument

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Holder Takes Instrument “For Value” If Holder Takes Instrument “For Value” If Holder:Holder:

Performs promise for which instrument issuedPerforms promise for which instrument issued

Acquires security interest or other lien in Acquires security interest or other lien in instrumentinstrument

Takes instrument for payment of preceding claimTakes instrument for payment of preceding claim

Exchanges instrument for another negotiable Exchanges instrument for another negotiable instrumentinstrument

Exchanges instrument for an irrevocable Exchanges instrument for an irrevocable obligation to third partyobligation to third party

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Exceptions To Value RequirementExceptions To Value Requirement

Holder is Holder is notnot a holder in due course if a holder in due course if he/she takes instrument by:he/she takes instrument by:

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

Acquiring it through taking over an estateAcquiring it through taking over an estate

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

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Advantage of Holder In Due Course StatusAdvantage of Holder In Due Course Status

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

Lack or failure of considerationLack or failure of consideration

Breach of contractBreach of contract

Fraud in the inducement (in underlying contract)Fraud in the inducement (in underlying contract)

IncapacityIncapacity

IllegalityIllegality

DuressDuress

Unauthorized completion or material alteration of instrumentUnauthorized completion or material alteration of instrument

Unauthorized acquisition of instrumentUnauthorized acquisition of instrument

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

Fraud in the EssenceFraud in the Essence

Discharge of the Party Liable Through Discharge of the Party Liable Through BankruptcyBankruptcy

ForgeryForgery

Material Alteration of Completed InstrumentMaterial Alteration of Completed Instrument

Infancy (When party below legal age of consent)Infancy (When party below legal age of consent)

““Shelter” Principle:Shelter” Principle:If holder cannot attain holder in due If holder cannot attain holder in due

course status, holder can acquire rights course status, holder can acquire rights and privileges of holder in due course, and privileges of holder in due course, if item if item transferred fromtransferred from a holder in due a holder in due

coursecourse

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Federal Trade Commission Rule: Federal Trade Commission Rule: Negotiation of consumer notes may Negotiation of consumer notes may

not be subject to holder in due course not be subject to holder in due course status, if consumer credit contract or status, if consumer credit contract or

purchase money loan contains purchase money loan contains following statement (in 10-point, following statement (in 10-point,

boldface type):boldface type):““ANY HOLDER OF THIS CONSUMER ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO CREDIT CONTRACT IS SUBJECT TO

ALL CLAIMS AND DEFENSES WHICH ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT THE DEBTOR COULD ASSERT

AGAINST THE SELLER OF GOODS OR AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED PURSUANT SERVICES OBTAINED PURSUANT

HERETO OR WITH THE PROCEEDS HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY HEREOF. RECOVERY HEREUNDER BY

THE DEBTOR SHALL NOT EXCEED THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR AMOUNTS PAID BY THE DEBTOR

HEREUNDER”HEREUNDER” 27-13