CHAPTER 22
NEGOTIATION AND HOLDERS IN DUE
COURSE / HOLDERS BY DUE
NEGOTIATION
DAVIDSON, KNOWLES & FORSYTHE
Business Law: Cases and Principles
in the Legal Environment (8th Ed.)
BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
TRANSFER

Negotiable instruments are intended to
“flow” through the commercial world.
 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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
TRANSFER

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.
 Includes rights of a holder in due course
(HDC) if transferor has those rights.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
TRANSFER

Transfer of negotiable instrument treated as
assignment of a contract right.
 Transferee receives any and all rights of the
transferor.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
NEGOTIATION
“Something more” needed to protect the
possessor of the commercial paper.
 Facilitate free flow of commercial paper
through commercial channels.

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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
NEGOTIATION

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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
NEGOTIATION

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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
INDORSEMENTS

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 indorser’s liability on the instrument.

Not an indorsement if circumstances
unambiguously indicate signature was made
for a purpose other than indorsement.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
INDORSEMENTS

Reasons for indorsing an instrument:
– Affect negotiation. (tell holder)
 Another indorsement is needed to negotiate the
instrument further.
 No further indorsements are needed.
 Instrument has been restricted to some special
channel of commerce.
– Affect liability.
 Admit/agree to honor the contract of indorsement.
 Expressly deny any liability on indorsement
contract.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
INDORSEMENTS

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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
INDORSEMENTS

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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
HOLDER

Role is important in negotiable instruments.
 Holder takes an instrument by negotiation.
 Which gives holder all rights the transferor
possessed.
 Holder also acquires personal rights beyond
those conferred with transfer.
 Normally acquires contractual and warranty
rights.
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BUSINESS LAW: Cases & Principles
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HOLDER

Essential element before party can become
a holder in due course.
 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.
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BUSINESS LAW: Cases & Principles
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HOLDER

Holder has right to transfer, negotiate,
discharge, or enforce instrument in holder’s
own name.
 Holder is subject to any defenses on the
instrument that a maker or drawer can
assert.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
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.
 Burden of proof to establish (HDC) lies
with person claiming status.
 To establish holder in due course status:
– for value, in good faith, and without notice of
defenses or defects.
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BUSINESS LAW: Cases & Principles
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HOLDER IN DUE COURSE

“For Value.”
– Methods involve actual performance by holder:
 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.
 Taking an instrument as security for, or in payment
of, an existing debt.
 Taking an instrument in exchange for another
negotiable instrument.
 Issued or transferred in exchange for an irrevocable
obligation of a third party.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
HOLDER IN DUE COURSE

“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.
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BUSINESS LAW: Cases & Principles
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HOLDER IN DUE COURSE

“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.
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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
HOLDER IN DUE COURSE

Without Notice of Defenses or Defects.
– Facts That Are Considered Notice:
 Instrument is incomplete;
 Missing signature;
 Missing amount;
 Missing date on time and demand instrument;
 Visibly altered or bears visible evidence of forgery;
 Irregular on its face; or
 Taking an overdue instrument.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
HOLDER IN DUE COURSE

Without Notice of Defenses or Defects (Cont’d)
– Facts That Are Not Considered Notice:
 Instrument was antedated or postdated;
 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;
 A formerly incomplete instrument was completed;
 Any person negotiating the instrument is or was a
fiduciary; or
 Default on an interest payment on the instrument.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
EFFECT OF HDC STATUS

HDC is a preferred legal position.
 HDC takes an instrument free of personal
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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
EFFECT OF HDC STATUS

Personal Defenses.
– Affects the agreement for which the instrument
was issued.
– Types:





Failure of consideration;
Fraud In the inducement (personal defense);
Duress;
Breach of warranty; or
Non-delivery.
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BUSINESS LAW: Cases & Principles
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EFFECT OF HDC STATUS

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.
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BUSINESS LAW: Cases & Principles
Davidson • Knowles • Forsythe 8th Ed.
EFFECT OF HDC STATUS

Real Defenses.
– Types:
Infancy (minority);
 Duress, Lack of Legal Capacity, or Illegality;
 Fraud;
 Discharge in Insolvency;
 Forgery; or
 Material Alternation.

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BUSINESS LAW: Cases & Principles
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SHELTER PROVISION

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.
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BUSINESS LAW: Cases & Principles
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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.
 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.
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BUSINESS LAW: Cases & Principles
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HOLDER BY DUE NEGOTIATION

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).
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BUSINESS LAW: Cases & Principles
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HOLDER BY DUE NEGOTIATION

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.
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