Real Defenses to Payment of Negotiable Instrument
Defenses Against a Holder or Holder in Due Course
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Does a payor have any defenses to paying an instrument that is presented for payment by a holder in due course?
Real Defenses - Real defenses apply against any holder, including a holder in due course. Common real defenses are as follows:
Forgery - The forger of an instrument or a payees signature on an instrument is not a holder. As such, the non-holder cannot negotiate the instrument to a HDC.
Example: Agnes steals a check from Ben and forges his signature. She negotiates the check to Clark, who would otherwise qualify as an HDC if Clark were a holder. Agnes does not have to pay this instrument.
Bankruptcy - Bankruptcy of the payor is a defense against holders and HDCs. The obligation to pay a negotiable instrument is considered a debt. This debt may be included in the debtors bankruptcy estate. The holder or HDC must submit a claim for payment of the instrument to receive anything from the estate. Discharge of the debt discharges the obligation of the debtor to make payment.
Example: Agnes issues a promissory note. The note is transferred several times to multiple holders in due course. Agnes files for bankruptcy protection and her obligation to pay the instrument is include in the bankruptcy estate. An HDC would have to make an unsecured claim against the bankruptcy estate of Agnes or seek enforcement against a prior transferor or indorser.
Alteration - Alteration is a limited defense against a holder and HDC. It may be a complete defense against a holder, but an HDC can enforce the instrument up to the original or correct amount of the instrument.
Note: If the instrument was blank and then filled out, the HDC can enforce it for the whole amount. This rule places the risk on the issuer who makes an incomplete instrument.
Duress, Mental Incapacity, Illegality - Any of these typical contract defenses can also work against an HDC.
Example: Situations amounting to a defense against an HDC include where the issuer is subject to duress, has lost mental capacity due to disease, or the subject-matter of the contract is illegal due to a trade tariff. The underlying obligation must be void. If the underlying obligation remains voidable (rather than void), it is no defense.
Fraud in Fact - Fraud in fact means that the subject matter of the contract involves an intentional deceit. This is different than fraud in the inducement.
Example: A seller intentionally makes false representations about the nature or quality of a good. This is fraud constituting the subject matter of the contract.
Next Article: Claim in Recoupment Applicable to Negotiable Instrument Back to: COMMERCIAL PAPER
Discussion: Why do you think defenses are separated into real and personal defenses? Are you convinced that each type of defense is appropriate against a holder or HDC? Should any personal defenses be effective against an HDC? Why or why not?
Practice Question: Taylor is the holder of a promissory note that is order paper. Smith steals the paper and forges Taylor's signature. He then transfers the note to Zora. If Zora presents the instrument for payment, what is the likely result?