Chapter 27 Negotiation, Holder in Due Course, and Defenses Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

27-2 “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 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 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: 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 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

27-3 Negotiation Requirements Bearer Paper: Merely requires payee’s delivery of instrument to holder (Physical transfer of negotiable instrument) Bearer Paper: Merely requires payee’s delivery of instrument to holder (Physical transfer of negotiable instrument) Order Paper: Requires endorsement and delivery Order Paper: Requires endorsement and delivery

27-4 Types of Endorsements “Blank”: Payee’s (or last endorsee’s) signature “Blank”: Payee’s (or last endorsee’s) signature “Special”: Endorser’s signature plus named endorsee “Special”: Endorser’s signature plus named endorsee “Qualified”: Endorser’s signature plus use of language “without recourse” (limits endorser liability) “Qualified”: Endorser’s signature plus use of language “without recourse” (limits endorser liability) “Restrictive”: Endorser’s signature plus restrictions on future negotiation of instrument “Restrictive”: Endorser’s signature plus restrictions on future negotiation of instrument Endorsement for deposit or collection only Endorsement for deposit or collection only Endorsement to prohibit further endorsement Endorsement to prohibit further endorsement Conditional endorsement Conditional endorsement Trust endorsement Trust endorsement

27-5 Non-criminal Endorsement Problems Misspelled Name: Holder may endorse document with misspelled name, holder’s actual name, or both Misspelled Name: Holder may endorse document with misspelled name, holder’s actual name, or both Payable to Legal Entity: Payable to Legal Entity: Examples of “legal entity”--Estate, organization, partnership Examples of “legal entity”--Estate, organization, partnership Instrument may be endorsed by any authorized representative of entity Instrument may be endorsed by any authorized representative of entity Alternative/Joint Payees Alternative/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 sufficient Joint payees (“Pay to order of John Smith and Jane Smith)— Joint payees (“Pay to order of John Smith and Jane Smith)— Endorsement by all listed payees required

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 27-6

27-7 Requirements for “Holder In Due Course” Status Be holder of complete and authentic negotiable instrument Be holder of complete and authentic negotiable instrument Take instrument for value Take instrument for value Take instrument in good faith 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 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

27-8 Holder Takes Instrument “For Value” If Holder: Performs promise for which instrument issued Performs promise for which instrument issued Acquires security interest or other lien in instrument Acquires security interest or other lien in instrument Takes instrument for payment of preceding claim Takes instrument for payment of preceding claim Exchanges instrument for another negotiable instrument Exchanges instrument for another negotiable instrument Exchanges instrument for an irrevocable obligation to third party Exchanges instrument for an irrevocable obligation to third party

27-9 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 Purchasing it at a judicial sale, or by taking it under legal process Acquiring it through taking over an estate Acquiring it through taking over an estate Purchasing it as part of “bulk” transaction, not in regular course of transferor’s business Purchasing it as part of “bulk” transaction, not in regular course of transferor’s business

27-10 Advantage of Holder In Due Course Status Holder in due course is generally free from following “personal” defenses: Lack or failure of consideration Lack or failure of consideration Breach of contract Breach of contract Fraud in the inducement (in underlying contract) Fraud in the inducement (in underlying contract) Incapacity Incapacity Illegality Illegality Duress Duress Unauthorized completion or material alteration of instrument Unauthorized completion or material alteration of instrument Unauthorized acquisition of instrument Unauthorized acquisition of instrument

27-11 Holder In Due Course Is Subject to Following “Real” Defenses: Fraud in the Essence Fraud in the Essence Discharge of the Party Liable Through Bankruptcy Discharge of the Party Liable Through Bankruptcy Forgery Forgery Material Alteration of Completed Instrument Material Alteration of Completed Instrument Infancy (When party below legal age of consent) Infancy (When party below legal age of consent)

“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 27-12

Federal Trade Commission Rule: Negotiation of consumer notes may not be subject to holder in due course status, if consumer credit contract or purchase money loan contains following statement (in 10-point, boldface type): “ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED PURSUANT HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER” 27-13