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Rights of Holder in Due Course

Some time ago we discussed the assignment of contract rights. Assignment follows the general rule that a person can transfer no greater interest than he owns. 

As a result, the assignee steps into the shoes of the assignor—He is subject to the same defenses and claims that the original contraact debtor might have against the assignor.

However, to facilitate the flow of commerce the transferee of commercial paper needs to be given greater protection, and assurance of payment.1 He should be insulated from most of the defenses that the maker or drawer might have against the payee.

To accomplish this. Article 3 of the UCC provides that if a holder of a negotiable instrument is a holder in due course,he take the instrument free from all the personal defenses of the parties to the instrument.

To qualify as a holder in due course, the transferee must meet the following requirements. 1) He took the instrument from a holder, i. e. , from a person who was in actual possession of a paper which was properly drawn, issued or indorsed to him or to his order, or to bearer.3 2) He took the instrument for value, which means that he had rendered performance for the transfer of the instrument. A mere promise for performance is consideration but does not constitute value. 3) He took the instrument in good faith, which is defined as honesty in fact in the conduct or transaction concerned. If a person takes an instrument under circumstances that clearly indicate a defense to the instrument (e. g. , taking a note on large discount), he does not take it in good faith.4 4) He took the instrument without notice of its defect, namely, without knowledge of any claim or defense to the instrument ,that it was overdue or had been dishonored.

If a person meets all these requirements, he is a holder in due course. This means that though he is still subject to the real defenses on the instrument, he is protected against the personal defenses of the parties to the instrument. Personal defenses usually relate to the transaction resulting in the transfer of the instrument and include failure of consideration, breach of warranty and unconscionability. Real defenses involve more serious matters that go to the very existence of the instrument. They include forged signature of the maker or drawer,material alterations, illegality and lack of capacity.

To illustrate, lets assume that A purchases a computer from B. A owes B $ 1,000 and the debt is evidenced by a purchase agreement. Assume also that B assigns his right under the contract to C. The right C purchases from B is governed by the law of contracts and is subject to all the legal defenses of A. If A finds the computer defective, or the purchase of the computer is a result of fraud, or B lacks capacity in the transaction,C will not be able to collect, at least not in full.

In the example given above > if the evidence of the debt is not a simple contract for money but a negotiable promissory note given by A to B and it is properly negotiated to C, the transfer of the note is governed by Article 3 of the UCC. As a consequence« C, as a holder in due course, is in a superior position than he would have been in as an assignee. The right he negotiates is not subject to A,s personal defenses such as failure of consideration (because of the defective performance). C,s right is only subject to Afs real defenses, such as material alteration (if the note has been raised)« or B^s lack of capacity in the transaction.

Critics of the holder in due course principle argue that protection of the consumer is more important than the reasons for the holder in due course concept. They think that the best protection to the consumer is the right to withhold payment if goods are defective or not delivered.

Several states have enacted statutes prohibiting the use or enforcement of clauses that cut off defenses. Courts in many states have held that a finance company was not a holder in due course when it was closely connected with the seller.5 Courts have also strictly construed the application of the holder ih due course rule. Doubts about the negotiability of instruments have been resolved against negotiability.

The Uniform Consumer Credit Code7 offers two alternative approaches to the problem of consumer protection. One allows the consumer to assert all claims and defenses against the assignee of any paper that the former signed. The other provides that the assignee can give written notice of the assignment to the debtor, who is then given the right to assert defenses within three months. Several states have enacted the UCCC.

Answer the following questions :
1. What law governs the assignment of contract rights?
2. What law governs the negotiation of commercial paper?
3. What is the major difference between the law of contracts and the law of commercial paper with regard to transfer of contract rights?
4. If a holder of a negotiable instrument does not qualify as a holder in due course, what legal consequences will follow?
5. What are the factors that will affect the holder in due course status of a holder?
6. If you are a holder in due course of a check with a forged signature, on what theory will the bank deny you payment?
7. Explain "value" and "consideration".
8. In what way will the holder in due course principle work against the consumer?
9. What do critics of the holder in due course principle say?
10. How do courts in America react to the holder in due course principle?

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