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dynamic business law essentials 3e 2016 chapter 18

Chapter 18
Holder in Due Course, Liability,
and Defenses

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

Copyright © 2016 McGraw-Hill Education.  All rights reserved.

1


Chapter 18 Case Hypothetical
Ira Ofseyer is an eighteen-year-old freshman at Golden State University. He arrives on
campus several days before classes begin, and learns of a party scheduled at Tau Phi
Gamma Fraternity on Friday evening. Ofseyer arrives at the party, confident that a
thorough university education means more much more than mere academics.
Beer is served at the party, and that night, Ira consumes the first alcohol of his young life.
In the haze of the alcohol, and caught up in socializing with the Tau Phi fraternity brothers
(who are trying to convince him of the merits of fraternity membership,) Ofseyer
inadvertently leaves his checkbook on the dining room table.
Three days later, Ira realizes he is missing his checkbook. He returns to the fraternity to

find his checkbook, but to no avail. He hurries to his bank’s university branch on
University Avenue, and learns that one check has been written on his account in the last
three days, for $3,500 at University Stereo Shack. Ofseyer’s remaining checking account
balance is $5.83. His parents will not be happy.
Is Ofseyer’s bank legally obligated to re-credit his account in the amount of $3,500?

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

2


Chapter 18 Ethical Dilemma
According to UCC 3-416(a), “a person who transfers an instrument for consideration warrants to the
transferee, and, if the transfer is by indorsement, to any subsequent transferee that:
(1) the warrantor is a person entitled to enforce the instrument;
(2) all signatures on the instrument are authentic and authorized;
(3) the instrument has not been altered;
(4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted
against the warrantor; and
(5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or
acceptor or, in the case of an unaccepted draft, the drawer.”
The above-referenced implied promises are commonly referred to in the legal profession as “transfer
warranties.” They are implied by law, meaning that the transferor of commercial paper need not expressly
make these warranties; instead, they are recognized automatically by operation of law. Most laypersons are
not familiar with these warranties (that is, until a complainant seeks to hold the transferor liable for breach of
one or more of them!)
From an ethical standpoint, is it fair to hold transferors of commercial paper responsible for transfer
warranties, even though the transferor does not expressly make them?

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

3


Chapter 18 Case Hypothetical
Nora Abbey, eighteen 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 here 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 Nora, the check has slipped out
of her pocketbook, and onto Main Street.
A cross-wind blows the check onto a street corner. An unidentified woman picks up the
check, and later that day, at another Bank of the Homeland branch, she cashes the
check. Four weeks later, Nora 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 Nora’s account?

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

4


Chapter 18 Case Hypothetical
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.
Andre 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 Clint in return for a lot of land Clint deeds to him.
Andre fails to deliver ownership and possession of the car to Timothy the
following Friday. One week later, Clint approaches Timothy, and requests
payment of the $12,000. Clint shows Timothy Andre’s special endorsement to
him on the back of the check. Timothy 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
Timothy have any legal recourse against Andre Hastings?
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5


Holder in Due Course Doctrine
Provides incentive for financial
intermediaries to engage in
transactions, because they receive
greater legal protection by virtue of
“holder in due course” status

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6


Requirements for “Holder In Due Course”
Status
•Be holder of complete and authentic negotiable
instrument
•Take instrument for value
•Take instrument in good faith
•Take instrument without notice that it is overdue
or dishonored, that it has been altered or has an
unauthorized signature, or that it is subject to
adverse claims or defenses to enforceability of
instrument
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7


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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8


Advantage of Holder In Due Course Status
Holder in due course is generally free from following “personal”
defenses:
•Lack or failure of consideration
•Breach of contract
•Fraud in the inducement (in underlying contract)
•Incapacity
•Illegality
•Duress
•Unauthorized completion or material alteration of instrument
•Unauthorized acquisition of instrument

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9


Holder In Due Course Is Subject to Following
“Real” Defenses:
•Fraud in the Essence
•Discharge of the Party Liable Through
Bankruptcy
•Forgery
•Material Alteration of Completed Instrument
•Infancy (When party below legal age of consent)
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10


“Shelter” Principle:
If holder cannot attain holder in due
course status, holder can acquire rights
and privileges of holder in due course, if
item transferred from a holder in due
course

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11


Federal Trade Commission Rule: Negotiation of
consumer notes may not be subject to holder in due
course status, if consumer credit contract or purchase
money loan contains following statement:
“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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12


Signature Liability
General Rule: Party liable for an
instrument only if party has signed
instrument

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13


Parties Signing Negotiable Instrument
•Maker
-Person promising to pay set sum to holder of
promissory note/certificate of deposit
-Promises to pay money
•Acceptor
-Person (drawee) who accepts and signs draft
to agree to pay draft when it is presented
-Pays money (or responsible for paying
money) when it is requested
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14


Parties Signing Negotiable Instrument
(Continued)
•Drawer
•Person ordering drawee to pay
•Orders someone (drawee) to pay
•Endorser
•Person who signs instrument to restrict
payment of it, negotiate it, or incur liability
•Signs instrument at some point during
process of negotiation
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15


“Primary” Liability Versus “Secondary”
Liability
•Primary Liability of Makers and Acceptors: Must
pay stated amount on instrument when it is
presented for payment
•Secondary (Conditional) Liability of Drawers and
Endorsers: Must pay amount on instrument if
following conditions met:
-Presentment (on party with primary liability)
-Dishonor (by party with primary liability)
-Notice of Dishonor (given to party with
© 2013 The McGraw-Hill Companies,
Inc. All rights reserved.
secondary
liability)

16


Proper Presentment of Negotiable
Instrument
•Presented to Proper Party
•Presented in Proper Way
•Presented in Timely Manner

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17


Accommodation Party
Definition: Party who signs
instrument to provide credit for
another party who has also signed
instrument

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18


Unauthorized Signature
General Rule: If signature to
negotiable instrument unauthorized,
signature will not impose liability on
named party

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19


Negotiable Instrument Warranty
Liability
•Transfer Warranty: When party transfers
instrument to another party for consideration,
party makes certain guarantees/warranties
regarding instrument and transfer itself
•Presentment Warranty: When party properly
presents instrument for acceptance, party
makes certain guarantees/warranties regarding
instrument and transfer itself
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20


Transfer Warranties
•Transferor entitled to enforce negotiable instrument
•Signatures on instrument authentic and authorized
•Instrument has not been altered
•Instrument not subject to defense or claim in
recoupment
•Transferor has no knowledge of insolvency
proceedings against maker, acceptor, or drawer of
instrument
© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

21


Presentment Warranties
•Warrantor of instrument is entitled to enforce
instrument
•Instrument has not been altered
•Warrantor has no knowledge that drawer’s
signature or draft is unauthorized

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22


Avoiding Liability for Negotiable
Instruments
Defenses to Liability
•Real Defenses
•Personal Defenses
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23


“Real Defenses” (Applicable to All Parties):
•Infancy (below legal age of consent)
•Duress
•Lack of legal capacity
•Illegality of transaction
•Fraud in factum (fraud in execution, fraud in essence)
•Discharge through insolvency proceedings (bankruptcy)
•Forgery
•Material Alteration

© 2013 The McGraw-Hill Companies, Inc. All rights reserved.

24


Common Law Personal Defenses (Applicable to
Holders, But Not Holders In Due Course):
•Breach of contract/warranty
•Lack or failure of consideration
•Fraud in inducement
•Illegality
•Mental Incapacity
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