What does it mean to receive an instrument without notice of a valid defense to enforcement?

A recipient of a negotiable instrument cannot become a holder in due course if she is aware (or has reason to know) that there are some valid defenses that the payor may assert against payment of the instrument. Remember, status as holder in due course would insulate the holder against these defenses.

What are some defenses to enforcement?

Valid defenses of the payor against payment of the instrument may include:

Overdue - If the instrument has a stated time for payment and that time or date has passed, it is overdue.

Example: Checks are overdue 90 days after its posted date. A demand instrument is overdue the day after it is presented for payment or upon a reasonable time after it was issued. If the individual is subjectively aware that the instrument was presented for payment with no luck, that can indicate overdue status.

Dishonored - If the instrument has been presented for payment and is dishonored.

Example: If the note or draft has been dishonored by the maker or drawee, there is a defect. Also, checks drawn on insufficient funds, once presented, cannot be transferred to a holder in due course.

Default on Collateral Instrument - This generally arises when the instrument is issued as part of a series of transactions. Knowledge of an uncured default in another instrument issued as part of the same series is notice of a valid defense.

Instrument is Altered, Forged, or Incomplete - An unauthorized alteration, unauthorized filling in of an incomplete instrument, or a forgery of an instrument is a valid defense against payment. Notice of these defenses may be actual or constructive. That is, if the name signed on the instrument is wrong or incorrect, this could be considered constructive notice of a valid defense.

Note: Remember that an alteration or completion of an incomplete (blank) note or check that is signed by an individual makes her liable for any amount filled in.

Notice of Claims or Disputes - A valid defense includes when a third party has a claim to the instrument or there is a dispute between the original parties to the instrument. This places the risk on the maker or drawer responsible for creating the incomplete instrument.

Example: A party enters into two contracts where they purport to transfer the same promissory note as value. The other partys claim to the instrument is a valid defense against payment. Also, if the instrument was created as part of a contractual agreement, a dispute between the parties to the contract may be a valid defense to the instrument.

The UCC specifically excludes a list of individuals from HDC status based upon the manner in which they became holder of the instrument. Judgment creditors, bulk instrument purchasers, and heirs inheriting the instrument, for example, do not qualify as HDCs.

Related Topics

• Commercial Paper (Intro)
• What is Commercial Paper?
• Negotiable Instrument
• What are the common types of commercial paper?
• Promissory Note
• Cashier's Check
• Convenience Check
• Certified Check
• Substitute Check
• Bill of Exchange
• Bank Draft Definition
• Sight Draft Definition
• Bankers Acceptance 
• Who is a Holder of a negotiable instrument?
• Commercial Paper Funding Program
• What is Negotiability and why is it important?
• What is required for commercial paper to be negotiable?
• Sum Certain (Contracts)
• Inflation Adjustment Clause
• When does commercial paper contain an Unconditional promise to pay?
• Backup Line of Credit
• What is Payable on Demand or Payable on Time?
• What is Order Paper and Bearer Paper?
• Bearer Form
• How is a payee identified on the negotiable instrument?
• What rules does the court apply in determining negotiability?
• How is commercial paper negotiated to a holder?
• What is Transfer of a negotiable instrument?
• What is Indorsement of a negotiable instrument?
• What are the various types of indorsement?
• Bank Endorsement
• Blank Endorsement
• Accommodation Endorsement
• How does a holder receive payment on a negotiable instrument?
• Who is potentially liable on (or obligated to pay) a negotiable instrument?
• When is an individual liable for a representative signing a negotiable instrument?
• What rules apply if a holder loses a negotiable instrument?
• When is payment of a negotiable instrument overdue?
• What effect does a negotiable instrument have on the underlying obligation?
• What is a holder in due course?
• What are the requirements for a holder to become a holder in due course?
• Receive an instrument for value?
• Receive an instrument in good faith?
• Receive an instrument without notice of a valid defense?
• How does discharge of the Underlying Obligation affect a holder in due course?
• What is the Shelter Rule?
• Can you limit a transferee from becoming a holder in due course?
• Personal Defenses?
• Real Defenses?
• What is a Claim in Recoupment?
• What are the rights of a holder in due course if the instrument involves a consumer transaction?
• What happens if a negotiable instrument is Forged?
• What happens if a negotiable instrument is Stolen?
• Guaranty or Guarantee
• Letter of Guarantee
• Personal Guarantee
• What is the role of a Guarantor or Surety of a negotiable instrument?
  
• Surety 
  
• Cosign
• Accommodation Paper Definition
• Secondary Liability
• Avalize Definition
• What is an Accord & Satisfaction?
• What is primary and secondary liability on an instrument?
• What is Drawer or Maker Liability for a negotiable instrument?
• What is Transferor Warranty of a negotiable instrument?
• What is Indorser Warranty of a negotiable instrument?
• What is Presentment Warranty of a negotiable instrument?
• What is a warrantors liability for a dishonored note or draft?
• What is the time limitation for warranty of a negotiable instrument?
• When are the warranties of a negotiable instrument discharged?