Part 7- Credit, Chapter 32: Negotiation and Holder in Due Course, Doc 4

Summary: Holder in Due Course (HDC) Protections and Defenses Importance of HDC Status A Holder in Due Course (HDC) acquires a negotiable instrument free from most defenses and claims, enhancing the instrument's utility as a substitute for money. HDCs can enforce payment even if disputes exist between the original parties. Categories of Defenses and Claims Revised Article 3 distinguishes four categories of defenses and claims: 1. Real Defenses: These are defenses that challenge the validity of the instrument. They are effective against all holders, including HDCs. 2. Personal Defenses: These arise from issues in the transaction and cannot be used against an HDC. They are valid only against ordinary holders. 3. Claims to the Instrument: These involve property or possessory rights over the instrument. Example: A stolen check. 4. Claims in Recoupment: Claims arising from the same transaction as the negotiable instrument, used to reduce the obligation. Real Defenses (Effective Against HDCs) Real defenses include: 1. Minority or Infancy: If the signer is a minor under state law, the instrument may be void or voidable. 2. Incapacity: If a person is legally declared incompetent, instruments signed by them are void. 3. Duress: When the instrument was signed under coercion (e.g., at gunpoint), the obligation is void. 4. Illegality: If the transaction is illegal under state law (e.g., a check for a gambling debt in certain states), the instrument is void. 5. Fraud in the Execution: If a party is deceived into signing without understanding the nature of the instrument (e.g., thinking it was a different document). 6. Discharge in Bankruptcy: Obligations on negotiable instruments are void if the debtor is discharged in bankruptcy. 7. Forgery and Unauthorized Signatures: If a signature is forged or unauthorized, the instrument is void. 8. Material Alteration: Any unauthorized change that modifies the obligation (e.g., changing the amount on a check). Personal Defenses (Not Effective Against HDCs) Personal defenses are valid against ordinary holders but not against HDCs: 1. Breach of Contract or Warranty. 2. Failure of Consideration: Example: Goods were never delivered. 3. Fraud in the Inducement: The signer was misled about the nature of the transaction, not the instrument itself. 4. Unauthorized Completion of an Incomplete Instrument: If a signed instrument is later filled out improperly but appears complete when negotiated. Examples of HDC Advantages   Scenario 1: Fraudulent Endorsement A fraudulent endorser passes a check to a third party. If the third party qualifies as an HDC, they can enforce the check despite claims of fraud. Scenario 2: Payment Dispute If a buyer disputes payment due to a defective product and the seller negotiated the buyer’s note to a bank, the bank, as an HDC, can demand payment despite the buyer’s claim. Shelter Rule The shelter rule extends HDC rights to transferees of HDCs, even if the transferee doesn't meet HDC criteria themselves. However, this protection does not apply if the transferee was involved in fraud or illegality. Case Example: New Randolph Currency Exchange v. Regent Title Insurance   Facts: A check-cashing service took a large check with some irregularities but verified its authenticity by contacting the issuer. Ruling: The court held that the service qualified as an HDC because it acted in good faith and followed reasonable procedures to confirm the check’s validity. This case illustrates how acting in good faith and performing reasonable due diligence can establish HDC status even when irregularities exist.