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Requirements for Holder in Due Course Status

22. What are the requirements for a holder of an instrument to become a holder in due course?

To qualify as a HDC, the holder of the commercial paper must meet the following requirements:

•    Value – The holder must take the instrument for value. This means that the holder must provide money or goods for the instrument. The transfer cannot be a gift or inheritance.

•    Good Faith – The holder must receive the instrument in good faith. This means that the holder cannot have the intent to defraud anyone in receiving the instrument. It is easy to imagine any number of schemes in which a transferor would try to manipulate the law by transferring an instrument to a holder with a greater right to repayment.

•    Unaware of Defenses – The holder cannot have notice that there is a valid defense to enforcement of the instrument. This is generally deemed to be actual notice, but constructive notice from the situation could disqualify the individual as well.

HDC status is determined at the time that the holder receives the instrument. If the holder meets the above requirement at the moment when she takes possession, she is a HDC. It does not matter if afterwards she learns of a potential defense. Each of the elements for HDC status is discussed separately.

•    Discussion: What do you think about the requirements to qualify as a HDC? Can you identify any objectives behind these requirements? Should there be more or less requirements? Why or why not?

•    Practice Question: Brad enters into a contract to purchase equipment from Claire. Brad issues a promissory note to Claire as payment. Claire delivers the equipment, but Brad believes that the equipment does not meet the standards represented in the contract. He demands that Claire replace the equipment or he will not pay the note if presented. Claire immediately sells the instrument to Doug, who is unaware of the dispute between Brad and Claire. If Doug refuses to pay the note when Doug presents it, what are Doug’s rights? How does that affect Brad and Claire’s position?

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