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Chapter 27

TRANSFER AND HOLDER IN DUE COURSE

I. Transfer

A. Negotiation

1. Negotiation of Bearer Paper

2. Negotiation of Order Paper

a. The Impostor Rule

b. The Fictitious Payee Rule

3. Negotiations Subject to Rescission

B. Indorsements

1. Blank Indorsements

2. Special Indorsements

3. Restrictive Indorsements

a. Indorsements for Deposit or

Collection

b. Indorsements in Trust

c. Indorsements with Ineffective

Restrictions

4. Qualified and Unqualified

Indorsements

5. Formal Requirements of Indorsements

a. Place of Indorsement

b. Incorrect or Misspelled

Indorsement

II. Holder in Due Course

A. Requirements of a Holder in Due Course

1. Holder

2. Value

a. Executory Promise

b. Security Interest

c. Antecedent Debt

3. Good Faith

4. Lack of Notice

a. Notice an Instrument is Overdue

b. Notice an Instrument Has Been

Dishonored

c. Notice of a Claim or Defense

5. Without Reason to Question Its

Authenticity

B. Holder in Due Course Status

1. A Payee May Be a Holder in Due Course

2. The Shelter Rule

C. The Preferred Position of a Holder in Due

Course

1. Real Defenses

a. Infancy

b. Void Obligations

c. Fraud in the Execution

d. Discharge in Insolvency Proceedings

e. Discharge of Which Holder Has Notice

f. Unauthorized Signature

g. Fraudulent Alteration

2. Personal Defenses

D. Limitations upon Holder in Due Course Rights

Cases in This Chapter

The Hyatt Corporation v. Palm Beach National Bank

State of Qatar v. First American Bank of Virginia

Georg v. Metro Fixtures Contractors, Inc.

Any Kind Checks Cashed, Inc. v. Talcott

Triffin v. Cigna Insurance Co.

Chapter Outcomes

After reading and studying this chapter, the student should be able to:

Distinguish among (a) transfer, (b) negotiation, and (c) assignment.

TEACHING NOTES

Both negotiable and nonnegotiable instruments can be transferred under the law of

assignment, but only negotiable instruments allow a transferee to become a holder; only

a holder can be a holder in due course, giving him rights which may be greater than

*** Chapter Outcomes ***

Distinguish among (a) transfer, (b) negotiation and (c) assignment.

Identify and explain the requirements for becoming a holder in due course.

TRANSFER

A. NEGOTIATION

A holder is a person in possession of an instrument drawn, issued, or indorsed to him or

his order or to bearer or in blank. Negotiation is the transfer of possession, voluntary

Negotiation of Bearer Paper

A bearer instrument is transferred by mere possession and is therefore comparable to

cash. Because bearer paper (an instrument payable to bearer) is payable to whoever is

in possession of it, a nder — or for that matter a thief — can be a holder of bearer

paper.

NOTE: See Figure 25-1: Bearer Paper.

Negotiation of Order Paper

If the instrument is order paper (that is, an instrument payable to order), possession and

indorsement (signature) by all necessary parties are both required for the transferee to

be a holder.

NOTE: See Figure 25-2: Negotiation of Bearer and Order Paper.

CASE 27-1

THE HYATT CORPORATION v. PALM BEACH NATIONAL BANK

Court of Appeal of Florida, Third District, 2003

840 So.2d 300, 49 U.C.C. Rep.Serv.2d 1039

J&D Financial Corporation is a factoring company. Skyscraper Building Maintenance, LLC, had a contract with

Hyatt to perform maintenance work for various Hyatt hotels in South Florida. Skyscraper entered into a factoring

agreement with J&D. As part of the factoring agreement, J&D requested Hyatt to make checks payable for

maintenance services to Skyscraper and J&D. Of the many checks issued by Hyatt to Skyscraper and J&D, two were

negotiated by the bank but indorsed only by Skyscraper. They were made payable as follows:

1Check No. 1-78671 for $22,531 payable to:

J&D Financial Corp.

Skyscraper Building Maint

P.O. Box 610250

J&D filed a complaint against Skyscraper and its principals on the guarantee, Hyatt and the bank. J&D sought

damages against Skyscraper under the factoring agreement and separately against Hyatt and the bank for negotiation

of the two checks. Hyatt answered and raised the bank’s “fault” as an affirmative defense. * * * The bank, Hyatt and

J&D then moved for summary judgment on the issue of whether the bank properly negotiated the checks. It was

uncontested that the bank had a duty to negotiate the checks only on proper indorsement, and if it did not, it would

be liable.

The bank argued that the checks were payable to J&D and Skyscraper alternatively, and thus the bank could

properly negotiate the checks based upon the indorsement of either of the two payees. The bank further argued that

the checks were drafted ambiguously as to whether they were payable alternatively or jointly, and thus under [UCC]

Section [3–110(d)], Florida Statutes, the checks would be construed as a matter of law to be payable alternatively.

Hyatt’s position was that the checks were not ambiguous, were payable jointly and not alternatively, and thus

under Section [3–110], the checks could only be negotiated by indorsement of both of the payees. J&D similarly

J&D Financial Corporation

Skyscraper Building Maintenance

(stacked payees) is payable jointly to both payees requiring the indorsement of both, or whether it is ambiguous

regarding whether the check was drafted payable alternatively, so that the bank could negotiate the check when it

was indorsed by only one of the two payees.

In 1990, Article 3 of the UCC was revised, and the language of UCC Section 3–116 was added to UCC section

3–110 and became subsection (d). Revised UCC Section 3–110(d), which added language to follow former 3–116(a)

and (b), states, “If an instrument payable to two or more persons is ambiguous as to whether it is payable to the

persons alternatively, the instrument is payable to the persons alternatively.” The net effect of the amendment was to

change the presumption. What was unambiguous before is now ambiguous.

Turning to our jurisdiction, Florida has adopted the statutory revision to UCC 3–110, * * *.

* * *

We conclude that based on the 1990 amendment to the Uniform Commercial Code, when a check lists two

payees without the use of the word “and” or “or”, the nature of the payee is ambiguous as to whether they are

* * *

* * * Thus, we hold that the trial court was correct in granting the Summary Final Judgment.

Affirmed.

Impostor Rule — Deals with situations where someone impersonates another person,

and deceives a third party into delivering a negotiable instrument to the impostor in the

name of the other person. The UCC provides that in this situation the indorsement of the

impostor in the name of the named payee is effective — blaming the drawer or maker for

failing to detect the impersonation.

Negotiations Subject to Rescission

If the transfer conforms to the technical requirements, it is an effective negotiation even

if the underlying situation involves a void or voidable transaction.

B. INDORSEMENTS

The revised Article 3 provides a de nition of indorsement as: a signature, other than

that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words

is made on an instrument for the purpose of (i) negotiating the instrument, (ii) restricting

payment of the instrument, or (iii) incurring indorser’s liability on the instrument, but

regardless of the intent of the signer, a signature and its accompanying words is an

indorsement unless the accompanying words, terms of the instrument, place of the

signature, or other circumstances unambiguously indicate that the signature was made

for a purpose other than indorsement.

Every indorsement is (1) blank or special, (2) restrictive or nonrestrictive, and (3)

quali ed or unquali ed.

Thus, all indorsements disclose three things:

Blank Indorsements

Consists of the indorser’s signature alone and transforms order paper into bearer paper.

Note that this bearer paper may then be negotiated by mere delivery or the holder may

convert it back into order paper. This is done by altering the blank indorsement with

words “Pay to ________.” A special indorsement is thereby created, and the holder does

not have to be as concerned about the theft of the instrument.

Special Indorsements

A special indorsement identi es a certain person as indorsee and thereby renders the

instrument as order paper. The indorsee’s signature will be required for future

negotiation.

Restrictive Indorsements

A restrictive endorsement attempts to restrict the rights of an indorsee. Includes:

•indorsements for deposit or collection — in a bank account effectively limit

future negotiation to the banking system (EFFECTIVE)

CASE 27-2

STATE OF QATAR v. FIRST AMERICAN BANK OF VIRGINIA

United States District Court, Eastern District of Virginia, 1995

885 F.Supp. 849

http://scholar.google.com/scholar_case?case=1102569369018879687&q=885+F.Supp.

+849&hl=en&as_sdt=2,10

Ellis, J.

At issue in this sequel to State of Qatar v. First American Bank of Virginia (“Qatar I”) is the meaning and legal

significance of the phrase “for deposit only” following an indorsement on the back of a check. More specifically, the

question presented is whether a depository bank complies with the restrictive indorsement “for deposit only” when it

deposits a check bearing that restriction into any person’s account, or whether that restriction requires a depository

bank to deposit the check’s proceeds only into the account of the named payee. For the reasons that follow, the court

holds that the unqualified language “for deposit only” following an indorsement on the back of a check requires a

depository bank to place the check’s proceeds into the payee’s account, and the bank violates that restrictive

indorsement when it credits the check to any other account.

* * *

Plaintiffs are the State of Qatar and certain of its agencies (collectively, “Qatar”). From approximately 1986 to

1992, one of Qatar’s employees, Bassam Salous, defrauded his employer by having checks drawn on Qatar’s

checks into his own personal accounts with Defendant First American Bank of Virginia (“First American”) and

Central Fidelity Banks, Inc.(collectively, “the depository banks”).

After Qatar discovered this fraudulent scheme in 1992, it brought suit against the depository banks for

conversion. * * *

Only one category of checks remains in dispute. These checks all bear the forged indorsement of the payee

named on the face of the check, followed by a stamped “for deposit only” restriction.

* * *

It is now established that First American may be liable to Qatar for handling a check’s proceeds in violation of a

restrictive indorsement. [Citation.] Under §3–205(c) of the pre-1993 Uniform Commercial Code (“UCC” or “Code”)

[Virginia adopted Revised Article 3 in 1993] restrictive indorsements are defined to “include the words ‘for

collection,’ ‘for deposit,’ ‘pay any bank,’ or like terms signifying a purpose of deposit or collection.” Thus, the UCC

This construction of “for deposit only” is commercially sensible and is adopted here. The clear purpose of the

restriction is to avoid the hazards of indorsing a check in blank. Pursuant to former §3–204(2), a check indorsed in

blank “becomes payable to bearer.” It is, essentially, cash. Thus, a payee who indorses her check in blank runs the

risk of having the check stolen and freely negotiated before the check reaches its intended destination. To protect

against this vulnerability, the payee can add the restriction “for deposit only” to the indorsement, and the depository

bank is required to handle the check in a manner consistent with that restriction. §3–206(3). And in so adding the

restriction, the payee’s intent plainly is to direct that the funds be deposited into her own account, not simply that the

funds be deposited into some account. [Citation.] Any other construction of the phrase “for deposit only” is illogical

and without commercial justification or utility. Indeed, it is virtually impossible to imagine a scenario in which a

payee cared that her check be deposited, but was indifferent with respect to the particular account to which the funds

would be credited.

* * *

Finally, it is worth noting that the new revisions to the negotiable instruments provisions of the UCC, [Revised

Article 3], support the result reached here. Although these revisions are inapplicable to this case, the commentary

following §3–206 states that the new subdivision dealing with “for deposit only” and like restrictions “continues

previous law.” §3–206 comment 3. Shortly thereafter, the commentary provides an example in which a check bears

Qualified and Unqualified Indorsements

The “without recourse” indorsement disclaims the indorser’s contract liability. Even

though payment is not guaranteed by the indorsee a quali ed indorsement does not

prevent future negotiation of the instrument. Note that the transferor may still be liable

under a warranty theory.

Formal Requirements of Indorsements

Place of Indorsement — An indorsement must be written on the instrument or on a

separate piece of paper called an allonge that has been a8xed to the instrument. An

allonge may be used even if there is suffcient space for an indorsement on the

document itself.

NOTE: See Figure 25-3 for an illustration of Federal Reserve Board guidelines.

HOLDER IN DUE COURSE

*** Chapter Outcome ***

Identify and explain the requirements for becoming a holder in due course.

A. REQUIREMENTS OF A HOLDER IN DUE COURSE

A holder in due course must

a) be a holder of a negotiable instrument;

b) take it for value;

c) take it in good faith;

d) take it without notice that it is overdue or dishonored, or that the instrument

contains an unauthorized signature or an alteration, or that any person has any

Holder

A holder must have in his possession a negotiable instrument that is payable to bearer or

payable to himself by name. The instrument must also have all necessary (valid)

indorsements. If order paper, a forged indorsement will preclude someone from

becoming a holder.

NOTE: See Figure 26-2 and Figure 26-3.

CASE 27-3

GEORG v. METRO FIXTURES CONTRACTORS, INC.

Hobbs, J.

We granted certiorari in this case to address an issue of first impression in Colorado regarding whether under [UCC]

§ 1-201(b)(20) and [UCC] § 3-302, Colorado’s codification of the Uniform Commercial Code (“UCC”), a person

can be a holder of a negotiable instrument entitled to holder in due course status under a theory of constructive

possession of a negotiable instrument. The court of appeals partially reversed the trial court’s grant of summary

judgment in favor of Freestyle Sports Marketing, Inc. (“Freestyle”), ruling that Freestyle was not a holder in due

course because it was not a holder who had actual possession of the negotiable instrument at issue in this action.

* * *

Freestyle employed Cassandra Demery as a bookkeeper for several years before it discovered that Demery had

embezzled over $200,000 for personal use and had failed to pay, on Freestyle’s behalf, approximately $240,000 in

state and federal employment taxes. Freestyle terminated Demery’s employment, demanded that she repay Freestyle,

and threatened to notify the authorities if she did not.

After leaving Freestyle, Demery went to work as a bookkeeper at Metro Fixtures Contractors, Inc. (“Metro”), a

company owned by her parents. Demery’s bookkeeping position at Metro included balancing the accounting books,

invoicing customers, and paying outstanding bills on behalf of the company. In her position as bookkeeper, Demery

wrote a check from Metro’s bank account and made it payable to Freestyle in the amount of $189,000. Demery

Freestyle moved for summary judgment, contending that it qualified as a holder in due course under [UCC] §

3-302 and [UCC] § 3-306. The trial court agreed that Freestyle was a holder in due course and granted the motion.

Metro appealed and the court of appeals partially reversed. The court of appeals held that Freestyle could not

have been a holder in due course because it was not a holder with actual possession of the check. Freestyle then

appealed to us arguing that it had constructive possession of the instrument when the check was deposited at its

bank.

* * *

If Freestyle is a holder in due course under [UCC] § 3-306, it takes free of Metro’s claims. [Citations.]

* * *

Holder in Due Course

* * *

A check is a negotiable instrument. [UCC] § 3-104. The holder in due course doctrine is designed to encourage

the transfer and usage of checks and facilitate the flow of capital. [Citation.] An entity may qualify as a holder in due

course even if the instrument at issue may have passed through the hands of a thief. [Citation.] (“The holder in due

course is one of the few purchasers in Anglo-Saxon jurisprudence who may derive a good title from a chain of title

that includes a thief in its links.”)

An otherwise authorized signature on a negotiable instrument is not converted into an unauthorized forgery

when an agent, authorized to sign negotiable instruments in his principal’s name, abuses that authority by

negotiating the instrument to a holder in due course for the agent’s own personal benefit. [Citations.] [UCC] § 3-402.

Constructive Possession

Section 4-201(a), states that a collecting bank “is an agent or sub-agent of the owner of the item.” Further, the statute

states, “This provision applies regardless of the form of indorsement or lack of indorsement ….” [Citation.] A check

payable to a party and deposited in that party’s account makes the party the “owner” of the check under the UCC.

[Citation.] Further, the White & Summers treatise on the UCC speaks to a collecting bank as an agent for the

owner’s possession:

Sometimes the one claiming to be a holder in due course will not have possession of the instrument at the time

of the suit. When a collecting bank holds the check, the solution is simple, for section 4-201 makes that bank

the agent of the owner of the check. Under traditional analysis, the agent’s possession would be the owner’s

* * *

Application to This Case

In the case before us, Demery was Metro’s agent, specifically its employee. As a bookkeeper for Metro, Demery’s

authority included the power to write checks on Metro’s behalf. Despite the fact that Metro did not specifically

authorize Demery to write a check to Freestyle, Metro placed her in a position to do so. Subsequently, Demery

informed Freestyle that she had obtained authority from Metro’s owners, her parents, to issue the check and had

directly deposited the funds into Freestyle’s account. Freestyle verified with its bank the deposit of these funds into

its account and then, relying on the availability of those funds, paid the delinquent taxes to the state and federal

authorities.

The court of appeals held that Freestyle could not be a holder in due course because it lacked possession of the

check. However, this is too narrow a reading of section 3-302, which includes circumstances where the instrument

does not bear apparent evidence of forgery and the person to whom the instrument is drawn took the instrument for

value, in good faith, and without notice that it contained an unauthorized signature. * * *

The trial court found that Freestyle was a holder in due course based on the undisputed facts of this case.

Demery delivered the check by depositing it into Freestyle’s bank account. Section 1-201(b)(14) defines delivery

with respect to an instrument as a voluntary transfer of possession. Two elements are required for delivery of an

instrument: (1) intent of the transferor to transfer possession of an instrument, and (2) the actual transfer of the

instrument. [Citation.]

a negotiable instrument is not converted into an unauthorized forgery when an agent, authorized to sign negotiable

instruments in his principal’s name, abuses that authority by negotiating the instrument to a holder in due course for

the agent’s own personal benefit. [Citation.] A check payable to a party and deposited in that party’s account makes

it the “owner” of the check under the UCC. [Citation.]

While Metro claims Freestyle was not a holder, it does not simultaneously argue that it was a competing holder.

There is no other possible holder under the facts of this case. ***

Freestyle was not only a holder under the facts of this case, it was a holder in due course. * * *

Freestyle argues that under section 3-303(a)(3), the instrument was issued as payment for Demery’s outstanding

debt to Freestyle. Metro does not contest that Demery embezzled funds from Freestyle and therefore owed Freestyle

funds; rather, it asserts that it did not authorize Demery to issue the check. A pre-existing debt is sufficient

consideration. [Citation.] Thus, Freestyle took the check for value.

Freestyle acted in good faith. Bad faith for the holder in due course standard means guilty knowledge or willful

ignorance. [Citation.] Here, Freestyle lacked guilty knowledge or willful ignorance. The record contains no facts

asserted by Metro that, if proven, would support a bad faith claim. * * *

Reasons to place the risk on the principal of an agent in commercial transactions include: (1) the increased

incentive for a principal to exercise care in selecting agents; (2) the fact that the principal is in a better position to

supervise the actions of the agent; and (3) the fact that the principal bears the fruit of a principal/agent relationship.

[Citation.]

Applied to this case, Demery acted as a bookkeeper for Metro for several years. Metro was in the best position

to have instituted internal procedures and mechanisms regarding the company’s accounting. Attesting to its lack of

internal procedure, Metro did not uncover the embezzlement until two years after Demery deposited the check into

Freestyle’s bank account. Freestyle was not in a position, as a third party, to dictate Metro’s internal control

procedures to prevent employee theft.

Value

The law requires that a holder in due course give value for the instrument; it cannot be

received as a gift with no exchange of value.

Value, for purposes of negotiable instruments, is de ned as

(1) the actual performing of the agreed promise;

(2) the acquiring of a security interest or a lien in the instrument, other than a judicial

lien;

(3) the taking of the instrument in payment of or as security for an antecedent debt;

(4) the giving of a negotiable instrument; or

(5) the giving of an irrevocable obligation to a third party.

Executory Promise — Because an executory promise has yet to be performed, it

cannot confer holder-in-due course status on the person who promises it.

The Uniform Commercial Code does provide exceptions to the executory promise rule in

two situations: (1) the giving of a negotiable instrument, and (2) the making of an

irrevocable obligation to a third party.

Security Interest — Where an instrument is given as security for an obligation, the

lender is regarded as having given value to the extent of his security interest.