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21.4 Summary and Exercises

Summary

A holder is a holder in due course (HDC) if he takes the instrument without reason to question its authenticity on account of obvious facial irregularities, for value, in good faith, and without notice that it is overdue or has been dishonored, or that it contains a forgery or alteration, or that that any person has any defense against it or claim to it. The HDC takes the paper free of most defenses; an ordinary holder takes the paper as an assignee, acquiring only the rights of the assignor.

Value is not the same as consideration; hence, a promise will not satisfy this criterion until it has been performed. The HDC must have given something of value other than a promise to give.

Good faith means (1) honesty in fact in the conduct or transaction concerned and (2) the observance of reasonable commercial standards of fair dealing. Honesty in fact is a subjective test, but the observance of reasonable commercial standards is objective.

Notice is not limited to receipt of an explicit statement of defenses; a holder may be given notice through inferences that should be drawn from the character of the instrument. Thus an incomplete instrument, one that bears marks of forgery, or one that indicates it is overdue may give notice on its face. Certain facts do not necessarily give notice of defense or claim: that the instrument is antedated or postdated, that the instrument was negotiated in return for an executory promise, that any party has signed for accommodation, that an incomplete instrument has been completed, that any person negotiating the instrument is or was a fiduciary, or that there has been default in payment of interest or principal.

A person who could not have become an HDC directly (e.g., because he had notice of a defense or claim) may become so if he takes as transferee from an HDC as long as he was not a party to any fraud or illegality affecting the instrument or had not previously been a holder with notice of a defense or claim. This is the shelter rule.

Holders in due course are not immune from all defenses. A real, as opposed to a personal, defense may be asserted against the HDC. Personal defenses include fraud in the inducement, failure of consideration, nonperformance of a condition precedent, and the like. Real defenses consist of infancy, acts that would make a contract void (such as duress), fraud in the execution, forgery, and discharge in bankruptcy. A 1976 trade regulation rule of the Federal Trade Commission abolishes the holder-in-due-course rule for consumer transactions.

Exercises

  1. Mike signed and delivered a note for $9,000 to Paul Payee in exchange for Paul’s tractor. Paul transferred the note to Hilda, who promised to pay $7,500 for it. After Hilda had paid Paul $5,000 of the promised $7,500, Hilda learned that Mike had a defense: the tractor was defective. How much, if anything, can Hilda collect from Mike on the note, and why?
  2. In Exercise 1, if Hilda had paid Paul $7,500 and then learned of Mike’s defense, how much—if any of the amount—could she collect from Mike?
  3. Tex fraudulently sold a boat, to which he did not have title, to Sheryl for $30,000 and received, as a deposit from her, a check in the amount of $5,000. He deposited the check in his account at First Bank and immediately withdrew $3,000 of the proceeds. When Sheryl discovered that Tex had no title, she called her bank (the drawee) and stopped payment on the check. Tex, in the meantime, disappeared. First Bank now wishes to collect the $3,000 from Sheryl, but she claims it is not an HDC because it did not give value for the check in that the payment to Tex was conditional: the bank retained the right to collect from Tex if it could not collect on the check. Is Sheryl correct? Explain.
  4. Corporation draws a check payable to First Bank. The check is given to an officer of Corporation (known to Bank), who is instructed to deliver it to Bank in payment of a debt owed by Corporation to Bank. Instead, the officer, intending to defraud Corporation, delivers the check to Bank in payment of his personal debt. Bank has received funds of Corporation that have been used for the personal benefit of the officer. Corporation asserts a claim to the proceeds of the check against Bank. Is Bank an HDC of the check?
  5. Contractor contracted with Betty Baker to install a new furnace in Baker’s business. Baker wrote a check for $8,000 (the price quoted by Contractor) payable to Furnace Co., which Contractor delivered to Furnace Co. in payment of his own debt to it. Furnace Co. knew nothing of what went on between Contractor and Baker. When Contractor did not complete the job, Baker stopped payment on the check. Furnace Co. sued Baker, who defended by claiming failure of consideration. Is this a good defense against Furnace Co.?

  6. Benson purchased a double-paned, gas-filled picture window for his house from Wonder Window, making a $200 deposit and signing an installment contract, which is here set out in its entirety:

    October 3, 2012

    I promise to pay to Wonder Window or order the sum of $1,000 in five equal installments of $200.

    [Signed] Benson

    Wonder Window negotiated the installment contract to Devon, who took the instrument for value, in good faith, without notice of any claim or defense of any party, and without question of the instrument’s authenticity. After Benson made three payments, the window fogged up inside and was unacceptable. Benson wants his money back from Wonder Window, and he wants to discontinue further payments. Can he do that? Explain.

  7. The Turmans executed a deed of trust note (a note and mortgage) dated November 12, 2012, for $100,000 payable to Ward’s Home Improvement, Inc. The note was consideration for a contract: Ward was to construct a home on the Turmans’ property. The same day, Ward executed a separate written assignment of the note to Robert L. Pomerantz, which specifically used the word “assigns.” Ward did not endorse the note to Pomerantz or otherwise write on it. Ward did not complete the house; to do so would require the expenditure of an additional $42,000. Pomerantz maintained he is a holder in due course of the $100,000 note and demanded payment from the Turmans. Does he get paid? Explain.Turman v. Ward’s Home Imp., Inc., 1995 WL 1055769, Va. Cir. Ct. (1995).

Self-Test Questions

  1. Which defeats a person from being an HDC?

    1. She takes the paper in return for a promise by the maker or drawer to perform a service in the future.
    2. She subjectively takes it in good faith, but most people would recognize the deal as suspect.
    3. The instrument contains a very clever, almost undetectable forged signature.
    4. The instrument was postdated.
    5. All these are grounds to defeat the HDC status.

  2. Personal defenses are

    1. good against all holders
    2. good against holders but not HDCs
    3. good against HDCs but not holders
    4. not good against any holder, HDC or otherwise
    5. sometimes good against HDCs, depending on the facts

  3. Fraud in the inducement is a ________________ defense.

    1. real
    2. personal

  4. A person would not be an HDC if she

    1. was notified that payment on the instrument had been refused
    2. knew that one of the prior indorsers had been discharged
    3. understood that the note was collateral for a loan
    4. purchased the note at a discount

  5. Rock Industries agreed to sell Contractor gravel to repair an airport drain field. Contractor was uncertain how many loads of gravel would be needed, so he drew a check made out to “Rock Industries” as the payee but left the amount blank, to be filled in on the job site when the last load of gravel was delivered. Five truckloads, each carrying ten tons of gravel, were required, with gravel priced at $20 per ton. Thus Contractor figured he’d pay for fifty tons, or $1,000, but Rock Industries had apparently filled in the amount as $1,400 and negotiated it to Fairchild Truck Repair. Fairchild took it in good faith for an antecedent debt. Contractor will

    1. be liable to Fairchild, but only for $1,000
    2. be liable to Fairchild for $1,400
    3. not be liable to Fairchild because the check was materially altered
    4. not be liable to Fairchild because it did not give “value” for it to Rock Industries

Self-Test Answers

  1. a
  2. b
  3. b
  4. a
  5. b