Subsequent Holders of Commercial Paper and Defenses

Question 1

How does one negotiate an instrument?

Answer 1

Order Paper:

• By transfer of possession; and
• Indorsement by the Holder

NOTE: holder–the identified person to whom the instrument is payable

Bearer Paper:

• By transfer of possession alone

Question 2

What are the kinds of indorsements available?

Answer 2

Special indorsement

• specifies the person to whom the instrument is payable
• continues the instrument as “order paper”

Blank indorsement

• does not specify the person to whom the instrument is payable
• generally consists of a mere signature
• transforms previous order paper into “bearer paper”

Question 3

What is the impact of a blank indorsement versus a special indorsement?

Answer 3

Blank indorsement

• a thief can take and be a “holder” and properly transfer on

Special indorsement

• a thief cannot take and properly transfer on
• if forges signature on the instrument, none of the subsequent parties from the forger are holders–no good title–converted the check

NOTE: different rule for banks

• a depository bank** that takes an **unindorsed instrument for collection** becomes a **holder of the instrument if the customer was a holder at the time of delivery (even if no indorsement)
• valid business reason for honest mistakes by depositing holders

Question 4

Define a holder in due course.

Answer 4

A holder

• bearer paper–in possession
• order paper–1) in possession; 2) been issued or properly indorsed to him

Who gives value

• examine for executed consideration–consideration that has been performed
• may be pro rata consideration
• value exists when someone take the instrument in payment of or as security for an antecedent claim OR when makes irrevocable commitment to a third person
• Bank deposits–value given if the customer is permitted to draw against a deposited item, bank becomes a holder up to the extent of the withdrawal (First in, First out rule)

In good faith

• Subjective–honesty in fact; and
• Objective–observance of reasonable commercial standards of fair dealing

Without notice–no actual knowledge or reason to know that:

• instrument is so irregular or incomplete as to call into question its authenticity;
• instrument is overdue or has been dishonored;
• the instrument contains an unauthorized signature or has been altered;
• there is a claim on the instrument
• any party has a defense or a claim in recoupment on the instrument

NOTE: some particulars

• a check becomes overdue 90 days after its date
• alterations are based on a matter of degree
• knowledge of a default in an interest payment is harmless, but NOT principal
• discounted notes for huge discounts are probably not in good faith
• close-connectedness doctrine–the more that the holder knows about underlying transaction, the less it fits into good faith w/o notice if deficiencies
• knowledge that a fiduciary has negotiated the instrument in payment of or as security for the fiduciary’s own debt or benefit, notice of claim

Question 5

What transactions preclude “holder in due course” status?

Answer 5

Instruments taken by:

• legal process or by purchase in an execution, bankruptcy, or creditor’s sale
• purchase as part of a bulk transaction not in the ordinary course of business** of the **transferor; or
• successor in interest to an estate or other organization

Question 6

What is the shelter rule?

Answer 6

A subsequent transferee** of a **holder in due course** takes **free of _personal defenses _(acts as if an HDC), even if the subsequent transferee does not satisfy the requirements for a holder in due course.

NOTE: the shelter rule is inapplicable if the subsequent transferee participated in the actions giving rise to the defense (e.g., fraud in the inducement)

Question 7

How does the Federal Trade Commission rule change the law on holders in due course?

Answer 7

Every consumer credit contract contains a notice that

any holder or assignee** is **subect** to **all claims and defenses that

the debtor could assert against** the **seller of the goods or services

• applies also to direct lender loans made to a consumer where the creditor is “affiliated” with the seller or referrals

Question 8

What defenses does a holder in due course take subject to?

Answer 8

Real defenses

• infancy
• other incapacity, duress, illegality as that renders the obligation of the party a nullity
• 1) misrepresentation as has induced the party to sign the instrument with neither knowledge nor reasonable opportunity to obtain knowledge of its character or its essential terms (fraud in the factum); 2) excusable ignorance
• discharge in insolvency proceedings
• any other discharge of which the holder has notice when he takes the instrument

Question 9

What must a payee as a holder in due course be aware of?

Answer 9

If the issuer** and the **payee** are the **only parties**, the **holder in due course doctrine is irrelevant in determining the rights been the obligor and obligee

NOTE: if the payee does not deal directly with the issuer and instead obtains the instrument from a remitter, HDC and takes free of any defense based on the remitter’s wrongdoing