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Personal Defenses to Negotiable Instrument

29. Does a payor have any defenses to paying an instrument that is presented for payment by a holder in due course?

A holder in due course (HDC) has greater rights to enforce an instrument against the payor than does a mere holder of the instrument. The HDC is shielded from certain defenses against enforcement of an instrument. Generally, a payor may assert any number of “personal and real defenses” against enforcement of a note by a holder. The payor, however, can assert only real defenses, not personal defenses, against the holder in due course.

Personal Defenses – Personal defenses are generally defenses applicable to the underlying agreement or between the original parties to the underlying agreement. Common personal defenses are as follows:

•    Breach of Contract – Any party to a contract who breaches the agreement cannot enforce payment of a negotiable instrument issued as part of that agreement.

•    Failure of a Condition – Contracts may be subject to conditions precedent and subsequent. The occurrence or non-occurrence of which could discharge an individual from her obligations under a contract.

•    Lack or Failure of Consideration – If the underlying contract fails for lack of consideration it may constitute a defense to enforcement of an instrument. Further, if a promissory note is given as a gift, it may be a defense against later enforcement. Since a gift promissory note is a promise to make a future payment, the obligation itself is not supported by consideration. The gift is the underlying payment, rather than the promise of payment. As such, it may not be enforceable for lack of consideration.

•    Mistake – Bilateral and, in some cases, unilateral mistake in entering into a contract can affect enforceability of an agreement. This will serve as a defense against the enforceability of a negotiable instrument used as consideration for the agreement.

•    Waiver – If a party to the underlying agreement waives the obligation of the other party (the party issuing the negotiable instrument), it can serve as a defense to enforcement of the instrument by the holder.

•    Prior Payment – A note should be presented for payment, collected by the payor, and paid. If the note is paid, but not collected, it could fall into the hands of a subsequent holder. A subsequent holder of the instrument does not acquire the right of payment unless she qualifies as a holder in due course.

•    Theft of the Instrument – Someone who steals a negotiable instrument may qualify as holder of the instrument. The payor may assert a defense against payment to a holder.

⁃    Note: A forger does not qualify has a holder.

•    Unauthorized Completion – In some cases, a holder may be charged with completing or entering information on an instrument. Notably, if a holder receives blank or incomplete instrument and completes it in an unauthorized manner, this is a defense against that holder and any subsequent holder, unless she is a HDC.

⁃    Note: This does not include a forgery, which is a defense against an HDC.

•    Fraud in the Inducement – Fraud in the inducement is when a party defrauds the other party in order to have her enter into the agreement. This normally means providing information that is untrue or deceptive information, but the information is not the subject matter of the contract.

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