Chapter 26: Transferability and Holder in Due Course

a person is considered to have notice if she or he has any one of the following:

1. Has actual knowledge of the defect. 2. Has received a notice or notification about the defect (such as a letter from a bank identifying the serial numbers of stolen bearer instruments). 3. Has reason to know that a defect exists, given all the facts and circumstances known at the time in question.

A person cannot be an HDC if she or he knows or has reason to know that the instrument is defective in any one of the following ways:

1. It is overdue. 2. It has been dishonored. 3. It is part of a series in which at least one instrument has an uncured (uncorrected) default. 4. The instrument contains an unauthorized signature or has been altered. 5. There is a defense against the instrument or a claim to the instrument. 6. The instrument is so incomplete or irregular as to call into question its authenticity.

a holder takes an instrument for value if the holder has done any of the following:

1. Performed the promise for which the instrument was issued or transferred 2. Acquired a security interest or other lien in the instrument, excluding a lien obtained by a judicial proceeding 3. Taken the instrument in payment of, or as security for, a preexisting obligation (sometimes called an "antecedent claim"). 4. Given a negotiable instrument as payment. 5. Given an irrevocable commitment (i.e. letter of credit) as payment.

a demand instrument is overdue in two situations:

1. when a person takes a demand instrument knowing that demand has been made. 2. The other situation occurs when a person takes a demand instrument an unreasonable length of time after its date (i.e. more than 90 days after the date of the check)

special indorsement

A ____________ contains the signature of the indorser and identifies the person to whom the indorser intends to make the instrument payable— that is, it names the indorsee. (i.e. "pay to the order of xxxx") When an instrument is indorsed in this way, it is an order instrument

Notice of Claims or Defenses

A holder cannot become an HDC if he or she has notice of any claim to the instrument or defense against it

shelter principle

A person who does not qualify as an HDC but who derives his or her title through an HDC can acquire the rights and privileges of an HDC. (based on the legal theory that the transferee of an instrument receives at least the rights that the transferor had)

indorser

A person who transfers a note or a draft by signing (indorsing) it and delivering it to another person

Incomplete Instruments

A purchaser cannot become an HDC of an instrument so incomplete on its face that an element of negotiability is lacking (minor omissions are okay)

Value Is Distinguishable from Consideration

Although a promise to give value in the future is valid consideration to support a contract, it does not constitute sufficient value to make the promisor an HDC. A holder takes an instrument for value ONLY TO THE EXTENT that the promise has been performed. Exception: when the instrument is purchased at a judicial sale, such as a bankruptcy or creditor's sale, the holder will not be an HDC.

Requirements for HDC Status

An HDC must first be a holder of a negotiable instrument and must have taken the instrument (1) for value, (2) in good faith, and (3) without notice that it is defective (such as when the instrument is overdue, dishonored, irregular, or incomplete).

Taking for Value

An HDC must have given value for the instrument. A person who receives an instrument as a gift or inherits it has NOT met the requirement of value

Misspelled Names

An indorsement should be identical to the name that appears on the instrument. A payee or indorsee whose name is misspelled can indorse with the misspelled name, the correct name, or both ("Marley Ellison" or "Mary Ellison.")

qualified indorsement

An indorser who does not wish to be liable on an instrument can use a ___________ to disclaim this liability (add "without recourse") often used by agents (i.e. insurance agents who receive checks payable to them from clients but that are really intended as payment to the company, this relives the agent from liability on the check)

Dishonored Instruments

An instrument is dishonored when the party to whom the instrument is presented refuses to pay it.

Alternative Payees

An instrument payable to two or more persons in the alternative (i.e. pay to the order of A or B) requires the indorsement of ONLY ONE of the payees

Irregular Instruments

Any irregularity on the face of an instrument (such as an obvious forgery or alteration) that calls into question its validity or ownership will bar HDC status (i.e. a bank that accepts a check despite evidence on the check's face that it is irregular will bear the loss if the check later turns out to be forged)

Limitations on the Shelter Principle

If a holder participated in fraud or illegality affecting the instrument, that holder is not allowed to improve her or his status by repurchasing the instrument from a later HDC. Similarly, a holder who had notice of a claim or defense against an instrument cannot gain HDC status by later reacquiring the instruments from HDCs

TRUE The same principles apply to special indorsements that identify more than one person to whom the indorser intends to make the instrument payable

If an instrument payable to two or more persons does not clearly indicate whether it is payable in the alternative or payable jointly, then "the instrument is payable to the persons alternatively.

allonge

If there is no room on the instrument, the indorsement can be written on a separate piece of paper (called an ___________) that is firmly affixed to the instrument, such as with staples A paper firmly attached to a negotiable instrument is part of the instrument

trust indorsements (agency indorsements)

Indorsements to persons who are to hold or use the funds for the benefit of the indorser or a third party. legal rights in the instrument are transferred to the original indorsee.

TRUE Check book exemple.

Knowledge of one defense precludes a holder from asserting HDC status in regard to all other defenses

Negotiating Order Instruments

Negotiating order instruments requires both delivery and indorsement. Delivery: the teller Indorsement: signing name on the back of the check When a transfer fails to meet one or more of the requirements it's treated as an assignment.

Negotiating Bearer Instruments

Requires only delivery. Thus involves a greater risk of loss or theft than the use of order instruments.

Taking without Notice

The final requirement for HDC status concerns notice of defects

indorsee

The person (xxx) to whom the check is indorsed and delivered ("pay to xxx")

Taking in Good Faith (applies only to the holder)

The second requirement for HDC status is that the holder must take the instrument in good faith (must have acted honestly in the process of acquiring the instrument)

TRUE. the drawer has no obligation to make sure that the funds are allocated or distributed among the joint payees. The payee who has possession of the check holds it for the benefit of all of the payees.

When a drawer gives one alternative or joint payee a check, the drawer's obligation on the check to other payees is suspended

Conditional Indorsements (does NOT affect the right of the indorsee to enforce the instrument/future negotiation) In contrast, an instrument with conditional language on its face is not negotiable

When payment depends on the occurrence of some event specified in the indorsement, the instrument has a ___________ (i.e. "pay to xxx if he completes the renovation of my kitchen by June 1 2015")

indorsement

a signature with or without additional words or statements

Overdue Time Instruments

a time instrument is overdue on the day after its due date. Anyone who takes a time instrument after the due date is on notice that it is overdue. Default of any one installment will make the instrument overdue. BUT an instrument does not become overdue if there is a default on a payment of interest only, For this reason, most installment notes provide that any payment will be applied first to interest and then the balance will be applied to the principal.

Joint Payees

an instrument is made payable to two or more persons jointly (i.e. "Pay to the order of Bridgette and Tony Van Horn"), ALL of the payees' indorsements are necessary for negotiation.

four main categories of indorsements

blank, special, qualified, and restrictive Note: these categories are not mutually exclusive

blank indorsement

does not specify a particular indorsee and can consist of a mere signature. (it then converts an order instrument to a bearer instrument)

Instruments Payable to Entities

negotiable instrument can be drawn payable to an entity such as an estate, a partnership, or an organization. In this situation, an authorized representative of the entity can negotiate the instrument

two methods of negotiating an instrument

order instrument or bearer instrument

restrictive indorsement

requires the indorsee to comply with certain instructions regarding the funds involved but does not prohibit further negotiation of the instrument

unqualified indorsements.

the indorser is guaranteeing payment of the instrument in addition to transferring title to it (in the event that the drawer/maker defaults on the payment)

negotiation

the transfer of an instrument in such form that the transferee becomes a holder.

holder in due course (HDC)

whether a holder is entitled to obtain payment will depend on whether she or he is an HDC. a ___________ takes an instrument free of most of the defenses and claims that could be asserted against the transferor. (receives a higher level of protection from defenses and claims asserted by other parties.)