Chapter 27 Negotiation, Holder in Due Course, and Defenses Copyright © 2017 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGrawHill Education Overview • LO27-1: What is negotiation? • LO27-2: What is a holder in due course? • LO27-3: What requirements must be met to obtain holder-in-due-course status? • LO27-4: What is the shelter principle? • LO27-5: In what ways has the holder-indue-course doctrine been abused? 27-2 Chapter 27 Hypothetical Case • Nora Abbey, 18 years old, is overjoyed to have received her first paycheck from her first employer, Nightingale Fashions, Inc The check is in the amount of $542.00, and is drawn on the Bank of the Homeland Eager to document her entitlement to the paycheck, Abbey turns the check over, and signs her name in the "endorsement" section She gets into her car, and heads to the Bank of the Homeland, where she has a checking account, to make a deposit Unbeknownst to Abbey, the check has slipped out of her purse and onto Main Street A cross-wind blows the check onto a street corner An unidentified woman picks up the check Later that day, at another Bank of the Homeland branch, she cashes the check Four weeks later, Abbey notices that the check has been processed, and she immediately calls the vice president of the Bank of the Homeland branch she frequents, requesting that the $542 be credited to her account The bank vice president assures Nora that she will "look into it," but offers no assurances • Must the bank credit Abbey's account? 27-3 Chapter 27 Hypothetical Case • Johan Sebastian is in possession of a check written by Amanda Yang and made payable to "John Sebastian." (Yang inadvertently misspelled Sebastian's first name.) Sebastian endorses the check by signing "John Sebastian" on the back and transfers the check to Alexis Hawley in payment for a debt he owes her • Has this check been property endorsed and negotiated? 27-4 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 • Negotiation: Transfer of rights to a negotiable instrument to third party • Holder: Party who possesses negotiable instrument • Holder in due course (HDC): Party who acquires negotiable instrument in good faith 27-5 Bearer and Order Papers • Bearer paper • Payable to cash or whoever is in possession of instrument • Requires only delivery of instrument to holder by payee • Order paper • Payable to specific, named payee • Requires endorsement and delivery 27-6 Types of Endorsements • Blank: Payee's (or last endorsee's) signature; unqualified • Special: Endorser's signature plus named endorsee; unqualified • Blank qualified: Blank endorsement containing words limiting enforceability • Special qualified: Special endorsement containing words limiting enforceability • Restrictive: Endorsement limiting transferability of instrument or controls manner of payment • Endorsement for deposit or collection only • Endorsement to prohibit further endorsement • Conditional endorsement • Trust endorsement 27-7 Noncriminal Endorsement Problems • Misspelled name: Holder may endorse document with misspelled name, holder's actual name, or both • Payable to legal entity • Examples of legal entity: Estate, organization, partnership • Instrument may be endorsed by any authorized representative of entity • Alternative/joint payees • 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") • Endorsement by all listed payees required 27-8 Holder-in-Due-Course Status • Holder-in-due-course (HDC) doctrine: Provides incentive for financial intermediaries to engage in transactions; they receive greater legal protection by virtue of holder-in-due-course status • Requirements: • • • • Be holder of complete and authentic negotiable instrument Take instrument for value Take instrument in good faith Take instrument without notice of defects 27-9 Take Instrument for Value • Holder takes instrument for value if holder: • • • • Performs promise for which instrument issued Acquires security interest or other lien in instrument Takes instrument for payment of preceding claim Exchanges instrument for another negotiable instrument • Exchanges instrument for an irrevocable obligation to third party 2710 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 under legal process • Acquiring it through taking over an estate • Purchasing it as part of bulk transaction not in regular course of transferor's business 2711 Advantages of HDC Status • HDC is generally free from following personal defenses: • • • • • • • Lack or failure of consideration Breach of contract Fraud in the inducement in underlying contract Illegality Duress Unauthorized completion or material alteration of instrument Unauthorized acquisition of instrument 2712 Real Defenses • HDC is subject to the following real defenses: • Fraud in the essence • Forgery • Material alteration of completed instrument • Infancy (party below legal age of consent) 2713 Shelter Principle—Definition • Holds that when an item is transferred, the transferee acquires all the rights the transferor had to the item 2714 Protection Against HDC Abuse • Negotiation of consumer notes may not be subject to HDC 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." 2715 Chapter 27 Hypothetical Case • Timothy Jones drafts a check in the amount of $12,000 in full and final payment for a car that Andre Hastings is scheduled to deliver to him the following Friday Hastings immediately completes a special endorsement to Clint Patterson on the back of the check ("Pay to Clint Patterson, Signed, Andre Hastings"), and transfers the check to Patterson in return for a lot of land Patterson deeds to him Hastings fails to deliver ownership and possession of the car to Jones the following Friday One week later, Patterson approaches Jones and requests payment of the $12,000 Patterson shows Jones Hastings' special endorsement to him on the back of the check Jones states, "I don't owe you anything Andre never delivered the car I was supposed to get for that $12,000 If you have problems with what I've just said, go talk to Andre." • Is Clint Patterson entitled to the $12,000 from Timothy Jones? If so, does Jones have any legal recourse against Andre Hastings? 2716 Chapter 27 Hypothetical Case • Steven McMurtry stops by his bank to make a deposit On his way into the bank, he follows Susan Stroup, who's there for the same reason As Stroup opens the door of the bank, one of the endorsed checks she is holding blows out of her hand, but she doesn't notice McMurtry quickly grabs the check and pockets it Later that afternoon, he passes the check on to his brother, Kelly McMurtry, and tells him to cash the check at the local check-cashing store as soon as he can • In terms of the concept of delivery, and other than the fact that he'd rather his brother go to jail than go himself, why did McMurtry give the check to his brother to cash? 2717 ... over an estate • Purchasing it as part of bulk transaction not in regular course of transferor's business 2711 Advantages of HDC Status • HDC is generally free from following personal defenses: