PowerPoint Slides to Accompany BUSINESS LAW E-Commerce and Digital Law International Law and Ethics 5th Edition

by Henry R. Cheeseman

Chapter 24 Holder in Due Course and Liability

Slides developed by Les Wiletzky Wiletzky and Associates, Puyallup, WA
Copyright 2004 by Prentice-Hall. All rights reserved.

Introduction
If payment is not made on a negotiable instrument when it is due, the holder can use the court system to enforce the instrument. Various parties, including both signers and non-signers, may be liable on it. Accommodation parties (i.e., guarantors) can also be held liable.

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Holder Versus Holder In Due Course

Holder A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blank.

Holder in Due Course (HDC) A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue.

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Requirements for HDC Status

To qualify as an HDC, the transferee must meet the requirements established by the UCC. The person must be the holder of a negotiable instrument that was taken:

For value 2. In good faith 3. Without notice that it is overdue, dishonored, or encumbered in any way, and 4. Bearing no apparent evidence of forgery, alterations, or irregularity
1.
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Holder in Due Course

Maker or Drawer

Negotiable Instrument

Payee or Bearer

Negotiable Instrument

Holder in Due Course (HDC)

Holder Takes a negotiable instrument For value In good faith Without notice of defect The instrument bears no apparent evidence of forgery, alterations, or irregularity
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1. 2. 3. 4. 5. 6.

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Acquiring HDC Status Under the Shelter Principle

A holder who does not qualify as a holder in due course in his or her own right becomes a holder in due course if he or she acquires the instrument through a holder in due course. This is called the shelter principle.

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Acquiring HDC Status Under the Shelter Principle (continued)

To qualify as an HDC under the shelter principle, the following rules apply:

The holder does not have to qualify as an HDC in his or her own right. The holder must acquire the instrument from an HDC or be able to trace his or her title back to an HDC. The holder must not have been a party to a fraud or illegality affecting the instrument. The holder cannot have notice of a defense or claim against the payment of the instrument.
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Signature Liability of Parties

A person cannot be held contractually liable on a negotiable instrument unless his or her signature appears on the instrument. The signatures on a negotiable instrument identify those who are obligated to pay it. If it is unclear who the signer is, parol evidence can identify the signer.

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Signature Defined
Any name, word, or mark used in lieu of a written signature. Any symbol that is:

Handwritten, typed, printed, stamped, or made in almost any other manner, and Executed or adopted by a party to authenticate a writing

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Signers of instruments sign in many different capacities, including:

A maker of notes and certificates of deposit A drawer of drafts and checks A drawee who certifies or accepts checks and drafts

An indorser who indorses an instrument An agent who signs on behalf of others An accommodation party

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Signature Liability (continued): Primary Liability

Makers of promissory notes and certificates of deposit have primary liability for the instrument. Upon signing a promissory note, the maker unconditionally promises to pay the amount stipulated in the note when it is due. Makers are absolutely liable to pay the instrument, subject only to certain real defenses.

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Signature Liability (continued): Secondary Liability

Drawers of checks and drafts and unqualified indorsers of negotiable instruments have secondary liability on the instrument. This liability is similar to that of a guarantor of a simple contract. It arises when the party primarily liable on the instrument defaults and fails to pay the instrument when due.

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Signature Liability (continued): Accommodation Party

A party who signs an instrument and lends his or her name (and credit) to another party to the instrument. The accommodation party is obliged to pay the instrument in the capacity in which he or she signs.

Accommodation Maker primarily liable Accommodation Indorser secondarily liable

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Warranty Liability of Parties

The law implies certain warranties on transferors of negotiable instruments. Warranty liability is imposed whether or not the transferor signed the instrument. There are two types of implied warranties:

Transfer Warranties Presentment Warranties

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Transfer Warranties

Transfer Any passage of an instrument other than its issuance and presentment for payment. Transfer Warranties any of the following five implied warranties: 1. The transferor has good title to the instrument or is authorized to obtain payment or acceptance on behalf of one who does have good title. 2. All signatures are genuine or authorized.
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Transfer Warranties (continued)

3. The instrument has not been materially altered. 4. No defenses of any party are good against the

transferor.
5. The transferor has no knowledge of any insolvency

proceeding against the maker, the acceptor, or the drawer of an unaccepted instrument.

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Presentment Warranties

Any person who presents a draft or check for payment or acceptance makes the following warranties to a drawee or acceptor who pays or accepts the instrument in good faith:
The presenter has good title to the instrument or is authorized to obtain payment or acceptance of the person who has good title. 2. The instrument has not been materially altered. 3. The presenter has no knowledge that the signature of the maker or drawer is unauthorized.
1.
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Defenses
The creation of negotiable instruments may give rise to a defense against its payment. There are two general types of defenses:

Real Defenses Personal Defenses

A holder in due course (HDC) takes the instrument free from personal defenses but not real defenses.
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Real Defenses
Real Defenses 1. Minority 2. Extreme duress 3. Mental incapacity 4. Illegality 5. Discharge in bankruptcy 6. Fraud in the inception 7. Forgery 8. Material alteration Effect Real defenses can be raised against a holder in due course

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Personal Defenses
Personal Defenses 1. Breach of contract 2. Fraud in the inducement 3. Mental illness that makes a contract voidable instead of void 4. Illegality of a contract that makes the contract voidable instead of void 5. Ordinary duress or undue influence 6. Discharge of an instrument by payment or cancellation Effect Personal defenses cannot be raised against a holder in due course

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Discharge

Actions or events that relieve certain parties from liability on negotiable instruments. There are three methods of discharge:
1. Payment of the instrument 2. Cancellation 3. Impairment of the right of recourse

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Impairment of the Right of Recourse

Certain parties (holders, indorsers, accommodation parties) are discharged from liability on an instrument if the holder:
1. Releases an obligor from liability, or
2. Surrenders collateral without the consent of

the parties who would benefit by it

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