CHAPTER 22 NEGOTIATION AND HOLDERS IN DUE COURSE / HOLDERS BY DUE NEGOTIATION DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 2 TRANSFERTRANSFER Negotiable instruments are intended to flow through the commercial world. Negotiable instruments are intended to flow through the commercial world. In order to flow, the instrument needs to be transferred from person to person. In order to flow, the instrument needs to be transferred from person to person. Form determines rights that can be asserted by each person gaining possession of the negotiable instrument. Form determines rights that can be asserted by each person gaining possession of the negotiable instrument.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 3 TRANSFERTRANSFER UCC defines transfer as delivery by any person other than issuer for the purpose of giving the person receiving the instrument the right to enforce the instrument. UCC defines transfer as delivery by any person other than issuer for the purpose of giving the person receiving the instrument the right to enforce the instrument. Transfer, by negotiation or not, confers on the transferee the rights possessed by transferor. Transfer, by negotiation or not, confers on the transferee the rights possessed by transferor. Includes rights of a holder in due course (HDC) if transferor has those rights. Includes rights of a holder in due course (HDC) if transferor has those rights.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 4 TRANSFERTRANSFER Transfer of negotiable instrument treated as assignment of a contract right. Transfer of negotiable instrument treated as assignment of a contract right. Transferee receives any and all rights of the transferor. Transferee receives any and all rights of the transferor.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 5 NEGOTIATIONNEGOTIATION Something more needed to protect the possessor of the commercial paper. Something more needed to protect the possessor of the commercial paper. Facilitate free flow of commercial paper through commercial channels. Facilitate free flow of commercial paper through commercial channels.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 6 NEGOTIATIONNEGOTIATION Defined as: Defined as: – Transfer of possession. – Whether voluntary or involuntary. – Of an instrument by a person other than the issuer to a person who becomes a holder.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 7 NEGOTIATIONNEGOTIATION Except for: Except for: – Negotiation by a remitter. – If instrument is payable to an identified person. – Negotiation requires transfer of possession of the instrument and indorsement by holder. – Instrument is payable to bearer. – May be negotiated by transfer of possession alone.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 8 INDORSEMENTSINDORSEMENTS Defined as: Defined as: – A signature, other than that of maker, drawer, or acceptor or other words. – For the purpose of negotiating the instrument, restricting payment of the instrument, or incurring indorsers liability on the instrument. Not an indorsement if circumstances unambiguously indicate signature was made for a purpose other than indorsement. Not an indorsement if circumstances unambiguously indicate signature was made for a purpose other than indorsement.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 9 INDORSEMENTS Reasons for indorsing an instrument: Reasons for indorsing an instrument: – Affect negotiation. (tell holder) Another indorsement is needed to negotiate the instrument further. Another indorsement is needed to negotiate the instrument further. No further indorsements are needed. No further indorsements are needed. Instrument has been restricted to some special channel of commerce. Instrument has been restricted to some special channel of commerce. – Affect liability. Admit/agree to honor the contract of indorsement. Admit/agree to honor the contract of indorsement. Expressly deny any liability on indorsement contract. Expressly deny any liability on indorsement contract.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 10 INDORSEMENTSINDORSEMENTS Special Indorsement: Special Indorsement: – Specifies party to whom instrument is to be paid. – To whose order it is to be paid. – Party specified will have to indorse it before it can be negotiated further.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 11 INDORSEMENTSINDORSEMENTS Blank Indorsements: Blank Indorsements: – Does not state an party to whom instrument is to be paid. – Mere signature by holder. – Negotiable by transfer of possession. – Blank indorsement converted into a special indorsement by writing above signature of indorser.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 12 INDORSEMENTSINDORSEMENTS Restrictive Indorsement: Restrictive Indorsement: – Prohibits any further negotiation of instrument. – Contains a condition restricting further negotiation. – Contains words that indicate it is to be deposited or collected. – Restrict payment or negotiation may be disregarded by indorsee, no effect on rights or liabilities of indorsee. – Restricting instrument to banking channels is a valid restriction.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 13 INDORSEMENTSINDORSEMENTS Qualified Indorsements: Qualified Indorsements: – Denies contract liability. – Indorser includes such words as without recourse having legal effect of telling later holders that the qualifying indorser will not repay them if the instrument is dishonored.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 14 HOLDERHOLDER Role is important in negotiable instruments. Role is important in negotiable instruments. Holder takes an instrument by negotiation. Holder takes an instrument by negotiation. Which gives holder all rights the transferor possessed. Which gives holder all rights the transferor possessed. Holder also acquires personal rights beyond those conferred with transfer. Holder also acquires personal rights beyond those conferred with transfer. Normally acquires contractual and warranty rights. Normally acquires contractual and warranty rights.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 15 HOLDERHOLDER Essential element before party can become a holder in due course. Essential element before party can become a holder in due course. Defined as: Defined as: – Person in possession of negotiable instruments, drawn, issued, or indorsed to holder, to his/her order, to the bearer, or in blank. Receives original issue from maker or drawer or receives negotiation through indorsement and/or delivery. Receives original issue from maker or drawer or receives negotiation through indorsement and/or delivery.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 16 HOLDERHOLDER Holder has right to transfer, negotiate, discharge, or enforce instrument in holders own name. Holder has right to transfer, negotiate, discharge, or enforce instrument in holders own name. Holder is subject to any defenses on the instrument that a maker or drawer can assert. Holder is subject to any defenses on the instrument that a maker or drawer can assert.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 17 HOLDER IN DUE COURSE To overcome even one defense on instrument available to maker or drawer, holder needs to acquire holder in due course (HDC) status. To overcome even one defense on instrument available to maker or drawer, holder needs to acquire holder in due course (HDC) status. Burden of proof to establish (HDC) lies with person claiming status. Burden of proof to establish (HDC) lies with person claiming status. To establish holder in due course status: To establish holder in due course status: – for value, in good faith, and without notice of defenses or defects.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 18 HOLDER IN DUE COURSE For Value. For Value. – Methods involve actual performance by holder: Instrument issued or transferred for a promise of performance, to extent promise has been performed. Instrument issued or transferred for a promise of performance, to extent promise has been performed. Transferee acquires a security interest other than a lien obtained in a judicial proceeding. Transferee acquires a security interest other than a lien obtained in a judicial proceeding. Taking an instrument as security for, or in payment of, an existing debt. Taking an instrument as security for, or in payment of, an existing debt. Taking an instrument in exchange for another negotiable instrument. Taking an instrument in exchange for another negotiable instrument. Issued or transferred in exchange for an irrevocable obligation of a third party. Issued or transferred in exchange for an irrevocable obligation of a third party.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 19 HOLDER IN DUE COURSE In Good Faith. In Good Faith. – Defined as honesty in fact and the observation of reasonable commercial standards of fair dealing. – Holder needs to show observed reasonable commercial standards to establish good faith.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 20 HOLDER IN DUE COURSE Without Notice of Defenses or Defects. Without Notice of Defenses or Defects. – Holder takes instrument without notice of any defenses or defects. – Notice is present if reasonable person would: Know that there was a defense or a defect. Know that there was a defense or a defect. Or be suspicious and would make further inquiry before accepting the instrument. Or be suspicious and would make further inquiry before accepting the instrument. – UCC provides notice must be received at a time and manner that give reasonable opportunity to act.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 21 HOLDER IN DUE COURSE Without Notice of Defenses or Defects. Without Notice of Defenses or Defects. – Facts That Are Considered Notice: Instrument is incomplete; Instrument is incomplete; Missing signature; Missing signature; Missing amount; Missing amount; Missing date on time and demand instrument; Missing date on time and demand instrument; Visibly altered or bears visible evidence of forgery; Visibly altered or bears visible evidence of forgery; Irregular on its face; or Irregular on its face; or Taking an overdue instrument. Taking an overdue instrument.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 22 HOLDER IN DUE COURSE Without Notice of Defenses or Defects (Contd) Without Notice of Defenses or Defects (Contd) – Facts That Are Not Considered Notice: Instrument was antedated or postdated; Instrument was antedated or postdated; Instrument issued or negotiated for an executory promise, unless holder has notice of defenses to the promise; Instrument issued or negotiated for an executory promise, unless holder has notice of defenses to the promise; Any party has signed as an accommodation party; Any party has signed as an accommodation party; A formerly incomplete instrument was completed; A formerly incomplete instrument was completed; Any person negotiating the instrument is or was a fiduciary; or Any person negotiating the instrument is or was a fiduciary; or Default on an interest payment on the instrument. Default on an interest payment on the instrument.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 23 EFFECT OF HDC STATUS HDC is a preferred legal position. HDC is a preferred legal position. HDC takes an instrument free of personal defenses. HDC takes an instrument free of personal defenses. HDC subject to real defenses. HDC subject to real defenses. Any defense, whether personal or real, may be used to negate right to be paid of a mere holder. Any defense, whether personal or real, may be used to negate right to be paid of a mere holder.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 24 EFFECT OF HDC STATUS Personal Defenses. Personal Defenses. – Affects the agreement for which the instrument was issued. – Types: Failure of consideration; Failure of consideration; Fraud In the inducement (personal defense); Fraud In the inducement (personal defense); Duress; Duress; Breach of warranty; or Breach of warranty; or Non-delivery. Non-delivery.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 25 EFFECT OF HDC STATUS Real Defenses. Real Defenses. – Questions the legal validity of the instrument. – Negotiable instrument voided by operation of law. – No one can enforce it. – Maker or drawer must establish defense as real. – Failure to do so will normally leave a valid personal defense.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 26 EFFECT OF HDC STATUS Real Defenses. Real Defenses. – Types: Infancy (minority); Infancy (minority); Duress, Lack of Legal Capacity, or Illegality; Duress, Lack of Legal Capacity, or Illegality; Fraud; Fraud; Discharge in Insolvency; Discharge in Insolvency; Forgery; or Forgery; or Material Alternation. Material Alternation.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 27 SHELTER PROVISION Assignee takes same rights as assignor; Same is true of negotiable instrument. Assignee takes same rights as assignor; Same is true of negotiable instrument. Once an HDC is involved with the instrument, every subsequent holder can assert the rights of an HDC without having to prove his status. Once an HDC is involved with the instrument, every subsequent holder can assert the rights of an HDC without having to prove his status.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 28 STATUTORY LIMITATIONS Federal Trade Commission rules require a transaction involving consumer credit that the holder or holder in due course is subject to all personal and real defenses which could be raised against the transferor. Federal Trade Commission rules require a transaction involving consumer credit that the holder or holder in due course is subject to all personal and real defenses which could be raised against the transferor. The effect of this FTC rule is to make even a HDC subject to any defenses available against the payee, a tremendous protection for the consumer. The effect of this FTC rule is to make even a HDC subject to any defenses available against the payee, a tremendous protection for the consumer.

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 29 HOLDER BY DUE NEGOTIATION Document of title duly negotiated when: Document of title duly negotiated when: – Person purchases instrument in good faith. – Purchaser takes document without notice of any defense against or claim to the goods or documents. Makes recipient of document a holder by due negotiation (HDN). Makes recipient of document a holder by due negotiation (HDN).

BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. © 2004 West Legal Studies in Business A Division of Thomson Learning 30 HOLDER BY DUE NEGOTIATION Holder by due negotiation is assured the following rights: Holder by due negotiation is assured the following rights: – Title to document; – Title to goods; – All rights under laws of agency or estoppel; and – Obligation of issuer to hold or deliver according to terms of the document and free of any claims.