21. What is a “holder in due course” and what are the benefits?
If certain conditions are met, a holder of a negotiable instrument may further elevate her rights to enforcement (receive payment) of the negotiable instrument. That is, the holder of a negotiable instrument is elevated to a higher status than that of a simple holder if she qualifies as a “holder in due course” (HDC).
• Recap: As discussed above, the holder of an instrument is someone who possesses and is entitled to receive payment of an instrument. A holder may be the original recipient (issuee) of the instrument from the maker or drawer; or the issuee may transfer or negotiate the instrument to a third party who becomes holder. Recall that negotiation requires voluntary or involuntary transfer of the instrument and, if the instrument is order paper, indorsement by the payee. (A forger of paper cannot be a holder, while a thief of bearer paper can be a holder). An instrument is more valuable to the holder if it is negotiable.
Qualifying as a holder in due course (HDC) makes the negotiable instrument more valuable to the holder, as a HDC has a stronger right to payment of the instrument than an ordinary holder. If a holder is not a HDC, her rights in the instrument are the same as the original payee of the instrument prior to transfer. That is, her right to payment of the instrument depends upon the relationship between the issuer and the original payee. Upon receipt of the instrument, she inherits the rights of the original payee along with whatever claims and defenses that the maker or drawer has against the original payee arising out of the contract. HDC status makes the holder immune from these defenses at the time of presenting the instrument. HDC benefits are as follows:
• The payor of the instrument is estopped (stopped from) denying the validity of the instrument or asserting any personal defenses to payment of the instrument.
• The instrument may be purged of any defects that are not apparent to the holder in due course.
• The holder in due course may assert her right to payment against any prior indorsers or immediate transferor of the instrument if the instrument is dishonored (not payed) upon presentment.
Liability of transferors or indorsers of a negotiable instrument is discussed separately.
• Discussion: Why do you think the UCC allows for the elevation of a holder’s rights in an instrument? Do you think a holder should be insulated from a payor’s defenses against payment?
• Practice Question: Martha is a holder in due course of a promissory note. Gary is the payor of the note. She received the note from Sam. When she presents the note to Gary for payment, he rejects it based upon Sam’s failure to perform the underlying contract. What are Martha’s rights in pursuing payment of the instrument?