Ch. 26: Transferability and Holder in Due Course

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

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

Can an indorsement be written on a paper separate from the instrument itself?

*Yes*, if there is no room on the instrument, the indorsement can be written on a separate piece of paper--this is called an *allonge*. - It must be attached in someway to the instrument like with staples

How is the following indorsement problem addressed? *Alternative or Joint Payees*

- *Alternative, "or"*: requires the indorsement of only one of the payees - *Joint Payees, "and"*: All of the payees' indorsements are necessary - *Ambiguous* (names may just be listed): the instrument is payable to the persons alternatively and only one of the payees need indorse it

Blank Qualified Indorsement

- A blank qualified indorsement ("without recourse, [signed] Jennie Cole") makes the instrument a bearer instrument, and only delivery is required for negotiation. - The "without recourse" indorsement relieves the agent from any liability on the check.

Special Qualified Indorsement

- A special qualified indorsement includes the name of the indorsee as well as the words "without recourse". - The special indorsement makes the instrument an order instrument, and it requires an indorsement, plus delivery, for negotiation. - The "without recourse" indorsement relieves the agent from any liability on the check.

What's the difference between an ordinary holder and a holder in due course?

- An ordinary holder obtains only those rights that the transferor had in the instrument, as mentioned previously. *In this respect, a holder has the same status as an assignee.* Like an assignee, a holder normally is subject to the same defenses that could be asserted against the transferor. - In contrast, a holder in due course (HDC) takes an instrument free of most of the defenses and claims that could be asserted against the transferor.

Once issued, a negotiable instrument can be transferred to others in two ways:

- Assignment - Negotiation

How does a conditional indorsement differ from a conditional promise to pay?

- Conditional indorsement = back of instrument - Conditional language altering promise to pay = appears on front of instrument, makes it nonnegotiable

If an instrument is payable to bearer, it is negotiated by...

- Delivery (Indorsement is not necessary)

Negotiating order instruments requires both of these actions:

- Indorsement (signing) - Delivery (taking it to the bank)

Restrictive Indorsements include the following:

- Indorsements to pay only a named payee - Conditional Indorsements - Indorsements for Deposit or Collection - Trust (Agency) Indorsements

Indorsements for Deposit or Collection

- Makes the indorsee (almost always a bank) a collecting agent of the indorser - In particular, the indorsements "For deposit only" and "For collection only" have the effect of locking the instrument into the bank collection process.

Overdue Time Instruments

- Normally, 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.

Indorsements to pay only a named payee

- Restrictive endorsement - Has the same legal effect as a special indorsement. - Ex: "Pay to Julie Diaz only, [signed] Thomas Fasulo"

In regards to HDC status, who does the good faith requirement apply to?

- The good faith requirement applies only to the holder - It is immaterial whether the transferor acted in good faith Ex: A person may still become an HDC if they unknowingly took a negotiable instrument from a thief

What happens when an instrument is transferred by negotiation?

- The transferee (the person to whom the instrument is transferred) becomes a holder - A holder receives, at the very least, the rights of the previous possessor - A transfer by negotiation can make it possible for a holder to receive more rights in the instrument than the prior possessor had

Overdue Demand Instruments

- When a person takes a demand instrument knowing that demand already has been made. - When a person takes a demand instrument an unreasonable length of time after its date. (For a check, a "reasonable time" is ninety days after the date of the check.)

There are four main categories of indorsements:

- blank - special - qualified - restrictive

Conditional Indorsement

-The effect of a conditional indorsement, which *appears on the back of an instrument*, differs from the effect of conditional language that appears on the face (front) of an instrument.

The final requirement for HDC status concerns notice of defects. 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. It 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.

There are two methods of negotiating an instrument so that the receiver becomes a holder. What are they?

1. Negotiating by delivery AND indorsement (order instrument) 2. Negotiating solely by delivery (bearer instrument)

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 (such as a letter of credit) as payment.

An HDC must 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.

A ___ takes an instrument *free* of most of the defenses and claims that could be asserted against the transferor.

A *holder in due course (HDC)* takes an instrument free of most of the defenses and claims that could be asserted against the transferor.

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

A *restrictive indorsement* requires the indorsee to comply with certain instructions regarding the funds involved but does not prohibit further negotiation of the instrument.

A ___ indorsement 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

A *special indorsement* 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.

A ____ indorsement does not specify a particular indorsee and can consist of a mere signature.

A blank indorsement does not specify a particular indorsee and can consist of a mere signature. - *An order instrument indorsed in blank becomes a bearer instrument*

[DEFINE] Holder in Due Course (HDC)

A holder who acquires a negotiable instrument for value; in good faith; and without notice that the instrument is overdue, that it has been dishonored, that any person has a defense against it or a claim to it, or that the instrument contains unauthorized signatures, alterations, or is so irregular or incomplete as to call into question its authenticity.

A holder who receives greater rights than the transferor who gave them the instrument is known as a ___.

A holder who receives greater rights than the transferor who gave them the instrument is known as a *holder in due course*.

How is the following indorsement problem addressed? *Instruments Payable to Entities*

A 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.

What constitutes notice?

A person is considered to have notice in any of the following circumstances: 1. The person has actual knowledge of the defect. 2. The person 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. The person has reason to know that a defect exists, given all the facts and circumstances known at the time in question.

[DEFINE] Indorsee

A person to whom a negotiable instrument is transferred by indorsement.

A person who transfers a note or a draft by signing (indorsing) it and delivering it to another person is an ___. The person to whom the check is indorsed and delivered is the ___.

A person who transfers a note or a draft by signing (indorsing) it and delivering it to another person is an *indorser*. The person to whom the check is indorsed and delivered is the *indorsee*.

[DEFINE] Indorser

A person who transfers an instrument by signing (indorsing) it and delivering it to another person.

[DEFINE] Antecedent Claim

A preexisting claim. In negotiable instruments law, taking an instrument in satisfaction of an antecedent claim is taking the instrument for value.

[DEFINE] Indorsement

A signature placed on an instrument for the purpose of transferring ownership rights in the instrument.

How do consideration and value differ?

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. If a person promises to perform or give value in the future, rather than at present, that person is not an HDC. - A holder takes an instrument for value *only to the extent that the promise has been performed*.

A ___ is a holder who meets certain acquisition requirements and therefore receives a higher level of protection from defenses and claims asserted by other parties.

An *HDC* is a holder who meets certain acquisition requirements and therefore receives a higher level of protection from defenses and claims asserted by other parties.

[DEFINE] Trust Indorsements

An indorsement for the benefit of the indorser or a third person; also known as an agency indorsement. The indorsement results in legal title vesting in the original indorsee.

[DEFINE] Qualified Indorsement

An indorsement on a negotiable instrument in which the indorser disclaims any contract liability on the instrument; the notation "without recourse" is commonly used to create a qualified indorsement.

[DEFINE] Special Indorsement

An indorsement on an instrument that indicates the specific person to whom the indorser intends to make the instrument payable--that is, it names the indorsee.

How is the following indorsement problem addressed? *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.* Usual practice is to indorse with the name as it appears on the instrument followed by the correct name.

[DEFINE] Blank Indorsement

An indorsement that specifies no particular indorsee and can consist of a mere signature. An order instrument that is indorsed in blank becomes a bearer instrument.

When is an instrument dishonored?

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

[DEFINE] Restrictive Indoresement

Any indorsement on a negotiable instrument that requires the indorsee to comply with certain instructions regarding the funds involved. A restrictive indorsement does not prohibit the further negotiation of the instrument.

Indorsements are required for ___ instruments but it is not required for ___ instruments.

Indorsements are required for order instruments but it is not required for bearer instruments.

Trust (Agency) Indorsements

Indorsements to persons who are to hold or use the funds for the benefit of the indorser or a third party are called *trust indorsements*

Stacked Payees

Parties listed without an "and" or "or" between them - Treated as alternative payees Ex: "Pay to the order of Sam, Kat, Freddy, Paulie"

Who typically uses qualified indorsements?

Qualified indorsements are often used by persons acting in a representative capacity (agents).

When does counting begin on an instrument?

The day *after* the instrument is dated - Ex: a note dated December 1 that is payable in thirty days is due by midnight on December 31. - If the payment date falls on a Sunday or holiday, the instrument is payable on the next business day.

[DEFINE] Shelter Principle

The principle that the holder of a negotiable instrument who cannot qualify as a holder in due course (HDC), but who derives his or her title through an HDC, acquires the rights of an HDC.

There are two methods of negotiating an instrument so that the receiver becomes a holder. The method used depends on....

There are two methods of negotiating an instrument so that the receiver becomes a holder. The method used depends on *whether the instrument is an order instrument or a bearer instrument.*

Suspension of the Drawer's Obligation

When a drawer gives one alternative or joint payee a check, the drawer's obligation on the check to other payees is suspended. - The drawer has no obligation to make sure that the funds are allocated or distributed among the joint payees.

Whenever a transfer fails to qualify as a negotiation because it fails to meet one or more of the requirements of a negotiable instrument, it is treated as....

Whenever a transfer fails to qualify as a negotiation because it fails to meet one or more of the requirements of a negotiable instrument, it is treated as *an assignment*.