HDC Flashcards
What rights does an assignee of contract rights receive?
Only the rights the assignor had (i.e., assignee takes subject to all defenses that could have been asserted against the assignor).
- ordinary holder of a negotiable instrument also has the same rights as assignee.
What does a HDC gain in regards to negotiable instruments?
A HDC is entitled to payment on a negotiable instrument despite personal defenses that a maker or a drawer of the instrument may have.
What are the requirements for becoming a HDC?
Taker of an instrument must:
1) Be a HOLDER of a properly negotiated negotiable instrument
2) Give value for instrument
3) Take in good faith
4) Take without notice that instrument
a) is overdue,
b) has been dishonored, or
c) that any person has a defense or claim of ownership to the instrument
What qualifies as giving value by the holder?
Holder gives value if he:
1) Pays or performs agreed consideration (an executory promise is NOT value)
- qualifies as a HDC to the extent he provides the agreed upon value (i.e., ratio of consideration actually provided to what was promised = percent of amount of instrument in which the holder is a HDC)
2) Takes as satisfaction of a previous existing debt
3) Gives another negotiable instrument
4) Acquires a security interest in the instrument (e.g., holder takes possession of instrument as collateral for another debt)
- value needn’t be for full face amount (purchase at a reasonable discount is value for full amount - huge discount COULD be okay depending of facts/statements made on CPA question)
- a bank takes for value to the extent that credit has been given for a deposit and withdrawn (FIFO used to determine whether it has been withdrawn - money considered withdrawn from account in order in which it was deposited)
When does holder have notice?
When he knows or has reason to know (as measured by an objective “reasonable person” standard)
- sale of a past due note should raise suspicion
- instrument is not overdue if default is on payment of interest only
- domestic check, although payable on demand, is overdue 90 days after its date
What constitutes a defense or claim against the instrument?
1) Obvious signs of forgery or alteration so as to call into question its authenticity
2) Incomplete or irregular instrument
3) If purchaser has notice of any party’s claim, or that all parties have been discharged
- no notice of defense or claim if:
a) Instrument is antedated or postdated
b) Holder knows that there has been an interest payment default
c) Note was purchased at a reasonable discount
- if notice acquired after becoming holder and giving value, may still be HDC to extent of value given (e.g., ratio of value given at time notice was acquired to value promised X value of instrument = amount holder is HDC)
What are the rights of a HDC?
1) All personal defenses against a HDC are cut off
- are assertable against an ordinary holder or an assignee to avoid payment
2) Real (aka: universal) defenses are still assertable against a HDC
What are types of personal defenses?
What are types of personal defenses?
1) Breach of contract (including breach of warranty)
2) Lack or failure of consideration
3) Prior payment (maker fails to hold note after paying it)
4) Unauthorized completion (i.e., maker gives blank check)
5) Fraud in the inducement (person signs negotiable instrument knowing what he is signing, but was induced into doing so by intentional misrepresentation)
6) Nondelivery (occurs when bearer instrument is lost or stolen)
7) Ordinary duress or undue influence
8) Mental incapacity (personal defense if state law makes transaction voidable - real defense if state law makes it void)
9) Illegality (personal defense if state law makes transaction voidable - real defense if state law makes it void)
10) Theft by holder or subsequent holder after theft
What are real defenses?
1) Forgery (forgery of maker’s or drawer’s signature not considered his signature and allows forger to be held liable)
2) Bankruptcy
3) Fraud in the execution - occurs when a party is tricked into signing a negotiable instrument believing it to be something else (defense will not apply if signer should have known what was up based on age, experience, etc.)
4) Minority (or infancy) - (if minor is allowed to disaffirm contract under state law, then is a real defense for a negotiable instrument)
5) Mental incapacity, illegality, or extreme duress (real defense if state law makes transaction void - personal defense if state law makes transaction voidable)
6) Material alteration of instrument
- Actually only partially a real defense
a) if dollar amount altered - HDC can collect according to original terms (non-HDC collects nothing)
b) if incomplete instrument completed w/o authorization, HDC can enforce as completed (non-HDC gets nothing)
What constitutes a material alteration?
Material alteration includes:
1) Changes in amount, interest rate, or days
2) Additions to writing or removal of part of instrument
3) Completion of instrument w/o authorization
- Considered material for any change, even 1 cent.
- Not considered material if done to correct an error on address, miscalculations, or to place marks on instrument for audit purpose.
- Non-material alterations are neither real nor personal defenses.
- Not real defense if maker’s or drawer’s negligence substantially contributed to the alteration - is a personal defense.
What is the “Shelter Rule”?
A holder through a holder in due course obtains all rights of a HDC (based on assignee getting same rights as assignor)
- HDC “washes” the negotiable instrument so that any holder thereafter can be a holder through a HDC.
EXCEPTIONS:
- If party were to reacquire an instrument, his status remains what it originally was
- One involved in fraud or illegality affecting the instrument may not subsequently become a holder through a HDC
What effect does the FTC rule regarding HDC status in consumer credit transactions have?
Significantly limits HDC status.
- Federal law that takes precedence over state UCCs
protects consumers who sign notes promising to pay retailers for purchases of defective goods
- retailer could then sell notes to others cutting the remedies against retailer selling defective goods.
When does the FTC rule apply?
Applies to consumer credit transactions when:
1) Consumer signs installment sales contract containing waiver of defenses
2) Consumer signs sales contract containing promissory note
3) Retailer arranges financing with a separate party for consumer financing
- lenders and sellers of negotiable instruments must put notice of the defenses consumers could use against sellers
- doesn’t include payments using checks
- doesn’t apply to nonconsumer transactions or consumer noncredit transactions
Can someone who gives no value for negotiable instrument (e.g., receives as a gift) acquire the rights of a HDC?
Yes, the individual becomes a holder through a HDC and acquires all the rights of the HDC in the negotiable instrument.
Can an individual who has knowledge of a personal defense against the instrument become a HDC?
No, but the individual can become a holder through a HDC even if they have knowledge of a personal defense the maker has against the negotiable instrument.
What types of warranties apply to negotiable instruments?
1) Contractual
a) liability for payment of instrument’s FACE VALUE
b) applies to any party who signs instrument (maker, drawer, acceptor of draft, or endorser)
c) is primary liability
- HDC must first seek payment from this party
- maker is primary party on a note
- on draft is the acceptor of draft (i.e., the drawee who accepts instrument for payment) - if drawee dishonors, then no primary liability on draft
2) Warranty liability
a) Transfer
b) Presentment
What is secondary liability?
If primary party doesn’t pay, then holder or HDC can either:
1) Sue primary party to force payment
2) Seek payment from a secondary party, including:
a) Endorsers of any instrument
b) Drawers on a draft (no secondary liability on draft that was accepted by drawee)
What conditions need to be met before holding a secondary party liable for payment?
1) Presentment (demand for payment) of instrument to primary party by holder/HDC
2) Dishonor (refusal to pay) of instrument by primary party
3) Timely notice of the dishonor must be provided to endorsers (notice not required for a drawer)
- banks, and similar institutions must provide notice by midnight of the next banking day
- all other parties have 30 days to provide notice of dishonor
- a holder/HDC may only seek to collect from prior signatory parties, not subsequent signers
How can a drawer or endorser avoid secondary liability for a negotiable instrument that has been dishonored by the primary party?
Drawers (except drawers of a check) and endorsers may avoid secondary liability by signing w/o recourse.
- certification of a check by bank discharges drawer and all previous endorsers from liability because the bank has accepted the check and agreed to pay it.
Can lack of notice of dishonor or late presentment be excused?
Yes, when the delay is beyond the party’s control or the presentment is waived.
- normally they will discharge all endorsers though
- also, if endorsement uses words of guaranty (e.g., “payment guaranteed” or “collection guaranteed”) presentment or notice of dishonor are not required in order to hold those using the words of guaranty liable.
What is a transfer warranty?
Transferor gives certain warranties whenever negotiable instrument is transferred for consideration. Including:
1) Transferor has good title
- no missing endorsements
- no unauthorized endorsements
2) All signatures are genuine or authorized
3) Instrument has not been materially altered
4) No defense of any party is good against the transferor
5) Transferor has no notice of insolvency of maker, drawer, or acceptor
Transfer warranties generally allocate loss to parties that dealt face to face with the wrongdoer and thus were in the best position to prevent or avoid forged, altered, or stolen instruments
(party bearing loss then must seek payment from one who forged, altered, stole, etc)
- If transferor did not endorse, he makes all five warranties only to immediate transferee
- If transferor did endorse, then he makes all five warranties to all subsequent holders who take in good faith
What is a presentment warranty?
A holder or HDC presenting negotiable instrument for payment or acceptance (and all prior transferors of the instrument) provide presentment warranties to the party who pays on the instrument that include:
1) Warrantor entitled to enforce the instrument (i.e., warrantor has good title)
2) Warrantor has no knowledge that drawer’s signature is forged or unauthorized
3) Instrument has not been altered.
- presentment warranty for all instruments other than unaccepted drafts is only good title
What is the allowed recovery under warranty theory?
Injured party is only allowed to recover what they paid for the instrument. (not entitled to face value - as under contract liability - unless they paid face value)
- need not meet conditions required under contract liability (proper presentment, dishonor, or timely notice) in order to recover under warranty liability.
When is an agent not personally liable on a negotiable instrument?
An agent is not personally liable (drawer or maker is) on a negotiable instrument if his signature clearly discloses both agency status and identity of the drawer or maker.
- if agent signs principal’s name only (even if properly authorized to) this would bind the agent also (must identify self as acting as an agent for the principal).
- if agent signs their own name only, the agent is the only one liable because principal’s name is lacking.
To what extent is an accommodation party on a negotiable instrument liable?
An accommodation party is liable on the instrument in the capacity in which he signed even if taker of instrument knows of his accommodation status.
- accommodating maker is liable as a maker would be
- accommodating endorser is liable as an endorser would be
- notice of default needn’t be given to accommodation party
- accommodation party has right of recourse against accommodated party if held liable
How are the parties discharged from liability for negotiable instrument?
Once primary party pays, all endorsers are discharged.
- Cancellation of prior party’s endorsement discharges that party from liability (oral renunciation or oral attempt to discharge a party is not effective)
- Intentional destruction of instrument by the holder discharges prior parties to instrument.
What is the liability on an instrument with a forged signature?
Person whose signature was forged is not liable, unless he later ratifies it.
- Forged signature operates as the signature of the forger
- Thus, if signature of maker or drawer is forged, instrument can still be negotiated between parties, allowing a holder to acquire good title (since forgery is a real defense, an innocent maker or drawer cannot be forced to pay - even if presenter is a HDC).
- A forged endorsement does NOT transfer title - persons receiving it after forgery cannot collect on it; with three exceptions:
1) Imposter rule
2) Fictitious payee rule
3) Negligence of the maker or drawer
What is the imposter rule?
Maker or drawer issues a note or draft to an imposter thinking he is the real payee. When the imposter forges the real payee’s name it effectively negotiates the note or draft so that a subsequent holder can collect from maker or drawer (unless holder is part of scheme to defraud)
- Original maker or drawer can proceed against the imposter
- This rule places loss on person in best position to avoid the scheme.
- If maker/drawer had given the check to real payee who loses it and is found by person who forges endorsement then imposter rule does NOT apply - no one after forgery can collect on it
- Imposter rule applies even if imposter pretends to be an agent of the named payee.
What is the fictitious payee rule?
Maker, drawer, or agent (employee) issues a note or check to a fictitious payee, then forges the fictitious payee’s endorsement - subsequent parties can enforce the note or check against the maker or drawer.
- Payee can be a real person so long as maker, drawer, or other person supplying name never intended payment to that payee.
What effect does the negligence of the maker or drawer have on liability for a forged endorsement?
If person’s negligence substantially contributes to the forgery that person is prevented from raising the defense of forgery and thus the holder wins.
- person still has right to proceed against the forger.
What is a trade acceptance?
Trade acceptance is a draft made by seller of goods which extends credit to a buyer and directs him to pay seller a certain sum on a specified date.
- Requires signature of both seller and buyer on the face of the instrument (this is called acceptance and buyer is then called the acceptor)
- Allows seller to negotiate instrument to a 3rd party at a discount to receive cash immediately.
- Seller is both drawer and payee
