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Negotiable Instruments – Holder in Due Course (HDC)

Holder in Due Course

A holder in due course (HDC) has more protections than a regular holder. These extra protections exist because the HDC takes the instrument and meets additional requirements at the time the note is negotiated to the holder and the holder gives value. The extra requirements to take the note as an HDC fall into three general areas: taking the note for value, in good faith, and without notice.

Value:

Value can include performance of consideration, acquisition of the instrument, taking the instrument for payment of a preexisting debt, giving a negotiable instrument for the instrument, or giving the instrument in exchange for an irrevocable obligation. The value does not need to match the face amount of the instrument. The time the value is given determines whether the holder took the instrument in good faith and without notice.

Good Faith:

Good faith means that the holder acted honestly in acquiring the instrument. The holder must have also observed standards of fair dealing. Bad faith can come from something as simple as giving too little value for the instrument. The standard for honesty is subjective, while fair dealing is objective-uses the reasonable person standard.

Without Notice:

To be an HDC, the holder must obtain the instrument without notice under one of these conditions:

  • That the instrument is overdue
  • That the instrument has an unauthorized signature or altered signature
  • There are claims on the instrument
  • There are no defenses or claims in recoupment

The notice must occur in a way that gives the holder a reasonable opportunity to act on that notice. As it often does, the law has decided to balance the scales if there is a problem with who had the best opportunity to prevent the problem from occurring.

If a person is an HDC, then that individual or entity did nothing to perpetuate the problem. He or she cannot have knowledge that anything was wrong. Thus, he or she receives extra protections.

Transferees after the HDC are sheltered by the rights of the HDC In a sense, the transferee steps into the shoes of the HDC who transferred the instrument to them and acquires all of the rights and protections of the HDC

Defenses to Payment

An HDC can often obtain payment because of the added protection that status affords despite any underlying problems between the original parties to the instrument. That is why that status is so valuable. The defenses break into two categories: those available against HDCs and those available to everybody else. All of the defenses can be used against a general holder.

One benefit of attaining HDC status is that several defenses cannot be raised against a claim from an HDC. Those include ordinary contract defenses, incapacity of the maker or drawer, and fraud in the inducement. Instead, the defending party has very limited defenses.

However, there are certain defenses that can be used when defending a claim made by an HDC These defenses are called universal defenses because public policy dictates the defense should apply to everybody. For example, the fact that one party had the inability to contract due to minority or another capacity issue is a universal defense.

If the contract was illegal, that is a defense to HDC status, as are forgery, alteration, fraud in the execution or terms of the paper, and duress.

Negotiable Instruments in a Nutshell:

  • Negotiable instruments fall under two main categories: notes and drafts.
  • A negotiable instrument is transferred differently depending on whether it is bearer or order paper.
  • To be negotiable, an instrument must have a record, be signed or authenticated, with an unconditional promise to pay sum certain of money at a set time with the words of negotiability (pay to bearer or pay to order).
  • A holder in due course has extra protection because that holder takes for value in good faith and without notice that there are certain problems with the instrument.

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