When an employer gives an employee a paycheck payable “to the order of Susan Adams,” she is the holder of the check because she is in possession of an instrument payable to an identified person (Susan Adams) and she is that person. A person is a holder if in possession of an instrument (1) that is payable to bearer or (2) made payable to an identified person and she is that identified person [1–201(20)]
Reminder: the word is “ in dorsement” and not “ en dorsement”! The signature must be made by the holder or by someone who is authorized to sign on behalf of the holder, such as “Jane Doe on behalf of Doe & Company, Inc.”
As of 1/1/09, the Bank of New York Mellon was the world's largest depositary for American and global depositary receipts.
Hyperlink is to the court’s opinion on the Maine.gov website in pdf. Except in the case of depositary banks, if an order instrument is transferred without indorsement, the instrument has not been negotiated and the transferee cannot qualify as a holder.
Artwork depicts “blank” check
A qualified indorsement is one where the indorser disclaims her liability to make the instrument good if the maker or drawer defaults on it. Words such as “Without Recourse” are used to qualify an indorsement. They can be used with either a blank indorsement or a special indorsement and thus make it a qualified blank indorsement or a qualified special indorsement. The use of a qualified indorsement does not change the negotiable nature of the instrument. Its effect is to eliminate the contractual liability of the particular indorser.
Hyperlink is to the court’s opinion on the McGraw-Hill Higher Education website.
However, under these circumstances the indorsement is subject to rescission before the instrument has been negotiated to a transferee who can qualify as a holder in due course or a person paying the instrument in good faith and without knowledge of the factual basis for rescission or other remedy [3–202]
Artwork depicts getting free from some burdens, but not others.
Hyperlink is to the court’s opinion on the McGraw-Hill Higher Education website. From 1972 until 1991, Nancy Gabbard, the office manager for the Golden Years Nursing Home, received at the nursing home Social Security checks drawn on the United States Treasury and made payable either to individual patients or to “Golden Years Nursing Home for [an individual patient].” From 1986 until 1991, Gabbard engaged in an embezzling scheme whereby she would have certain patients indorse their own checks in blank, that is, each patient would sign his own name on the back of the check placing no restrictions on the manner in which the check could subsequently be negotiated. Gabbard would then cash the checks and either keep the cash or deposit the funds into her personal bank account.
In 1992, after Gabbard’s scheme was discovered, Golden Years brought suit against Gabbard and also against the Star Bank Corporation where the checks had been cashed. The patients had in other documents assigned their interests in the checks to Golden Years, and the claim against the bank alleged that it had converted Golden Years’ property by cashing checks with forged indorsements. One of the issues in the lawsuit was whether the checks had been properly negotiated to Star Bank. The trial court granted summary judgment to Golden Years, finding that the bank was not a holder in due course because the checks contained “forged indorsements.” Star Bank appealed. On appeal, the court found for Star Bank based on (UCC 3–202): “Thus, in this case, Gabbard became a holder of the checks when the checks, indorsed in blank by the patient-payees, were delivered to her. When Star Bank accepted the checks that were indorsed with the genuine signatures of the payees, the checks bore no indication that they had been assigned to Golden Years. Star Bank cashed the checks in good faith without notice of any defenses and thus became a holder in due course.”
The standard is a reasonable person standard. Examine the check in the photo. Would you negotiate this check? This is an irregular paper! In New Randolph Halstead Currency Exchange, Inc. v. Regent Title Insurance Agency, LLC, the court concluded that a check cashing service could qualify as a holder in due course of a check it took with irregularities that called its authenticity into question because it acted in a commercially reasonable manner in seeking to determine the authenticity of the check.
In the photo, the person is attempting to forge a check.
Personal defenses include: lack or failure of consideration, breach of contract, breach of warranty, fraud in the inducement, incapacity, illegality, duress, unauthorized completion or alteration, defects in issuance, failure to countersign a traveler’s check, modification of contract by separate agreement, payment violating a restrictive indorsement.
The photo is a “hint” for the upcoming case, Music Acceptance Corp. v. Lofing
Hyperlink is to the court’s opinion on the Justia.com website. Dan Lofing purchased a Steinway grand piano from Sherman Clay & Co., Steinway & Sons’ Sacramento dealer, and received financing through Sherman Clay’s finance company, Music Acceptance Corporation (MAC). The consumer note for $19,650.94 prepared by MAC and signed by Lofing included the following in boldface type: NOTICE 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 HEREIN OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER. Lofing received a warranty from Steinway that provided the company “will promptly repair or replace without charge any part of this piano which is found to have a defect in material or workmanship within five years” from the date of sale. Lofing became disenchanted with the piano after experiencing a variety of problems with it. There was a significant deterioration in the action and tonal quality of the piano which the Sherman Clay piano technician was unable to remedy despite lengthy and repeated efforts. A Steinway representative who was called in to inspect the piano concluded that it was in “terrible condition” and expressed surprise that it had ever left the factory. He concluded that the piano would have to be completely rebuilt at the factory. Because the piano was impossible to play and was ruining his technique, Lofing stopped making payments on the piano. To mitigate his damages, Lofing sold the piano for $7,000 and purchased a Kawai piano from another dealer. He brought suit against Sherman Clay, Steinway, and MAC for, among other things, breach of warranty. One of the issues in the litigation was whether the Notice in the note allowed him to assert the breach of warranty as a grounds for not continuing to pay off the note to MAC.
Court: “The FTC adopted a rule…identical to that included in Lofing’s sales contract…. In abrogating the holder in due course rule in consumer credit transactions, the FTC preserved the consumer’s claims and defenses against the creditor-assignee. The FTC rule was therefore designed to reallocate the cost of seller misconduct to the creditor…. More importantly, it is irrelevant whether the FTC rule applies. Even if such a notice was not required to be given, the fact remains that it was: Lofing’s contract included the precise language mandated by the FTC rule. Put simply, Lofing is in the same position whether we apply the FTC rule or the language of his particular contract. The jury’s finding that Sherman Clay breached its warranties mandates that the judgment in favor of MAC and against Lofing be reversed. Judgment in favor of Lofing.”
False. Order paper is an instrument payable to the order of a specific payee . Bearer paper is payable “to bearer” or “to cash. True. False. Signature may not be that of the maker, drawer, or acceptor False. This is a restrictive indorsement, but it does not render the check non-negotiable.
True. True. False. The check is overdue. A check is payable on demand and it is overdue if presented 90 days after its date. The holder, Bryan’s, is not a holder in due course since it had notice that the check was overdue by reading the date on the check.
The correct answer is (a).
The correct answer is (d).
Opportunity to discuss policy issues of consumer protection and negotiable instruments.
Chapter 32 – Negotiation and Holder in Due Course
C H A P Negotiation and T E R 32 Holder in Due CourseBehind all its global responsibilitiesand impersonal style banking is stilla ‘people business’…it may be themost personal business of all for italways depends on the originalconcept of credit, meaning trust.Anthony Sampson, TheMoneylenders: Bankers in aDangerous World (1981) 32-1
Learning Objectives• Explain the process of transferring negotiable instruments from one person to another• Distinguish order paper from bearer paper, and blank, special, restrictive, and qualified indorsements• Identify and explain requirements for becoming a holder in due course 32-2
Overview• A negotiable instrument is a contract with assignable rights• Under UCC Revised Article 3, negotiation is the transfer of voluntary or involuntary possession of a negotiable instrument by a person (other than issuer) to another person who becomes its holder [3–201] – Example: when an employer pays employee with paycheck, the employee is a holder 32-3
Requirements for Negotiation• Order paper: instrument is payable to the order of a specific payee – Negotiated by transfer of possession of paper after indorsement by the payee [3–201(b)]• Bearer paper: instrument is payable “to bearer” or “to cash” – Negotiated by mere transfer of possession of paper [3–201(b)] 32-4
Indorsement• Indorsement is a signature that, alone or with other words, is made on an instrument for a specific purpose – Signature may not be that of the maker, drawer, or acceptor – Proper purposes: (i) negotiating the instrument, (ii) restricting payment of the instrument, or (iii) incurring indorser’s liability on the instrument” [3–204(a)] 32-5
Exception to Indorsement• Indorsement is required for negotiation except in the case of depositary banks• Depositary banks often receive unindorsed checks under “lockbox” arrangements with customers receiving a high volume of checks – Depositary bank becomes a holder and warrantor of an item delivered to it for collection, whether or not indorsed by customer, if the customer at the time of delivery qualified as a holder [4–205] 32-6
Effects of Indorsement• The form or lack of indorsement may affect future attempts to negotiate instrument – See Town of Freeport v. Ring• Indorsement makes a person indorsing the item liable for payment if person primarily liable (e.g., maker of a note) does not pay – Example: If promissory note indorsed by the original promisee to a bank and bank can’t recover funds from original promisor, promisee still owes the bank 32-7
Kinds of Indorsement• A special indorsement is the indorser’s signature plus words indicating to whom, or to whose order, the instrument is payable• An instrument is indorsed in blank if the indorser signs without specifying to whom the item is payable• A restrictive indorsement specifies purpose of the indorsement or how the instrument must be used 32-8
Examples of Indorsement• A special indorsement: – Alfie indorses a check payable to him with “Payable to Brenda,” thus Brenda must indorse it with her signature to negotiate the item further• Indorsement in blank: – John Woo indorses a check payable to him with his signature “John Woo;” check is now bearer paper and bearer could negotiate it immediately or transform it into special indorsement by adding “Pay to the order of ________” above Woo’s indorsement 32-9
Examples of Restrictive Indorsements• Indorsements for deposit: “For Deposit Only” or “For Deposit to Account ## at First State Bank” – Lehigh Presbytery v. Merchants Bancorp. Inc.: bank failed to apply value given for checks consistently with restrictive indorsements on the checks• Indorsements for collection: “Pay any bank, banker, or trust company” or “For collection only” (added by banks for collection process)• Beneficial indorsements: “Pay to Abe Lincoln, Attorney at Law, in Trust for Clarence Darrow” 32-10
Recission of Indorsement• Negotiation effects an instrument transfer even if the negotiation is made: – (1) by a minor, a company exceeding its powers, or any other person without contractual capacity; (2) by fraud, duress, or mistake of any kind; (3) in breach of duty; or (4) as part of an illegal transaction• Under these circumstances, the indorsement is subject to rescission before negotiation to a holder in due course [3–202] 32-11
Holder in Due Course• A holder in due course takes a negotiable instrument free of all personal defenses, claims to the instrument, and claims in recoupment of the obligor or a third party• A holder in due course does not take free of the real defenses regarding validity of the instrument or claims that develop after s/he becomes a holder 32-12
Requirements for “Holder in Due Course” Status• Person must be a holder of a negotiable instrument, and take it (1) for value, (2) in good faith, (3) without notice of defects or evidence of apparent forgery or alteration that raises a question of authenticity – See Golden Years Nursing Home, Inc. v. Gabbard 32-13
Golden Years Nursing Home, Inc. v. Gabbard• Facts: – Golden Years Nursing Home received Social Security checks made payable either to individual patients or to “Golden Years Nursing Home for [an individual patient]” – For 5 years, office manager Gabbard embezzled by having some patients indorse their checks in blank, then she would cash or deposit the checks for herself 32-14
Golden Years Nursing Home, Inc. v. Gabbard• Procedural History & Appellate Decision: – Golden Years Nursing Home sued Gabbard and bank where checks had been cashed • Basis for suing bank was that patients had assigned interest in checks to nursing home – Appellate court found for bank because checks provided to bank cashed checks in good faith without notice of defenses, thus became holder in due course 32-15
Notice of Defects• A holder in due course must not have notice that the instrument is overdue or dishonored, has an uncured default, contains unauthorized signature or alteration, has a property or possessory interest claim, or has any defense against it or claim in recoupment to it 32-16
Overdue Instruments• If a negotiable instrument is payable on demand, it is overdue: – (1) day after demand for payment made; (2) 90 days after its date if a check; and (3) if other than a check, if outstanding for an unreasonable time for the instrument and trade practice [3–304(a)]• If a negotiable instrument due on a certain date is not paid by that date, it becomes overdue at the beginning of the next day after the due date 32-17
Dishonored Instruments• A negotiable instrument has been dishonored when the holder presented it for payment (or acceptance) and payment (or acceptance) was refused The classic “bounced” check 32-18
Notice of Claims• If a person taking a negotiable instrument would be on notice of adverse claim, alteration, forged signature, or irregularity, person is not a holder in due course – Cannot negotiate instrument – But see New Randolph Halstead Currency Exchange, Inc. v. Regent Title Insurance Agency, LLC – Potential defenses: fraud, duress, infancy, failure of consideration 32-19
Shelter Rule• Article 3 shelter rule: the transferee of an instrument obtains rights the transferor had, including the transferor’s right to enforce the instrument and any right as a holder in due course [3–203(b)] – Exception: a transferee involved in fraud or illegality affecting the instrument 32-20
Holder in Due Course Rights & Limitations• Revised Article 3 establishes four categories of claims and defenses relevant to a holder in due course: – Real defenses, personal defenses, claims to an instrument, and claims in recoupment• Real defenses attack the instrument’s validity and may be used as reasons against payment of a negotiable instrument to any holder, including a holder in due course 32-21
Real Defenses• Real defenses limit the rights of a holder in due course and refer to maker’s status, or creation or discharge of the instrument:– Status: maker’s minority, infancy or lack of capacity status– Instrument creation: illegality, duress, or fraud– Discharge: by bankruptcy or payment 32-22
Personal Defenses• Personal defenses are legal reasons for avoiding or reducing a person’s liability for payment of a negotiable instrument and arise out of the transaction that issued the negotiable instrument• A holder in due course of a negotiable instrument (or one who can claim the rights of one) is not subject to personal defenses or claims 32-23
Personal Defenses• Personal defenses include basic defects in contracts as well as defects in the creation of the instrument• In General Credit Corp. v. New York Linen Co., Inc. , a holder in due course of a check was not subject to the personal defense of the failure of consideration that the drawer of the check had against the payee of the check 32-24
Holder in Due Course Rights & Limitations• Claims to an instrument concern property or possessory rights in an instrument or its proceeds: claim to instrument ownership because owner wrongfully deprived of possession, claim of a lien, or claim for rescission of an indorsement• A holder in due course takes free of claims that arose before the holder status, but is subject to those arising after holder status 32-25
Holder in Due Course Rights & Limitations• Claims in recoupment arise out of the transaction that gave rise to the instrument and offset, rather than prevent, liability – A holder in due course is protected Primarily based in warranty or breach of contract disputes 32-26
Consumer Protection Issues• Holder in due course rules may harm consumers, thus some states and the Federal Trade Commission limited the holder in due course rule as it affects consumers 32-28
FTC Notice• FTC requires sellers who extend credit by note or installment contract to include the following statement: – NOTICE: ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF THE 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. 32-29
Music Acceptance Corp. v. Lofing• Facts: – Lofing bought a Steinway piano from a Steinway dealer financed by an installment note from MAC – Consumer note contained the FTC notice – The piano was defective and Lofing stopped paying on the note, selling the piano to mitigate damages, then sued dealer, Steinway, and MAC• Issue: Did the Notice allow plaintiff to assert the breach of warranty as grounds for not continuing to pay off the note to MAC? 32-30
Music Acceptance Corp. v. Lofing• Legal Reasoning and Holding: – The FTC adopted a rule…identical to that in Lofing’s sales contract – In abrogating the holder in due course rule for consumer credit transactions, FTC reallocated the cost of seller misconduct to creditor – The jury’s finding that dealer breached its warranties mandates that the judgment in favor of MAC and against Lofing be reversed. Judgment in favor of Lofing. 32-31
Test Your Knowledge• True=A, False = B – Order paper is a negotiable instrument payable to the order of cash. – Indorsement is a signature that is made on an instrument for a specific purpose – If Jamil writes a check to Mary, Jamil may indorse the back himself to negotiate it. – A check is rendered non-negotiable if it is indorsed on the back, “For Deposit to Account #5000005 at First State Bank.” 32-32
Test Your Knowledge• True=A, False = B – Indorsement is required for negotiation except in the case of depositary banks. – The shelter rule states that a transferee of a negotiable instrument obtains all rights that the transferor had. – Megan writes Sam a check dated Jan. 2, 2007 and Sam indorses the check the next day to Bryan’s Grocery. Bryan’s presented the check for payment to a bank on July 1, 2007. The bank must honor the negotiable instrument. 32-33
Test Your Knowledge• Multiple Choice – Dan (16 years old) signed an installment note with Dude’s for a surfboard. Dude’s sold the note at a discount to Factors Co. The board broke after 1 month and Dan stopped paying. Factors Co. is: a) a holder in due course, but Dan is a minor and like any contract, may assert minority status to void the contract b) not a holder in due course & has no rights c) is a holder in due course and Dan must continue to pay on the note or be in breach of contract 32-34
Test Your Knowledge• Multiple Choice – Requirements for holder in due course status include: a) take a negotiable instrument for value b) take the instrument in good faith c) take without notice of defects or claims against the instrument d) all of the above e) all of the above plus be in the business of taking negotiable instruments 32-35
Thought Questions• What do you think of the FTC rule limiting the rights of a holder in due course in consumer transactions?• Do you think the FTC rule achieves the underlying policy to protect consumers? 32-36