Dynamic business law 4e kubasek 4e CH27

Chapter 27
Negotiation, Holder in Due Course,
and Defenses

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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?
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Chapter 27 Hypothetical Case 1
• 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?

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Chapter 27 Hypothetical Case 2
• 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?

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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
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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

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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

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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
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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

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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
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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

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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

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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)

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Shelter Principle—Definition
• Holds that when an item is transferred, the
transferee acquires all the rights the
transferor had to the item

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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."

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Chapter 27 Hypothetical Case 3
• 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?

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Chapter 27 Hypothetical Case 4
• 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?

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