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Chapter 29
LIABILITY OF THE PARTIES UNDER NEGOTIABLE
INSTRUMENTS
RESTATEMENT
There are distinctions in the rights between holders of negotiable instruments and assignees. While ordinary holders
and assignees have the same status, holders in due course enjoy additional protection. To obtain the status of holder
in due course, the holder must have given value for the instrument, acted in good faith, had no knowledge that the
instrument was overdue or dishonored, and had no knowledge of defenses and adverse claims.
It is possible for a party to become a holder in due course by taking an instrument from a holder in due course.
Under the shelter rule, persons who are not a holder in due course, is given the shelter of the status of the holder in
due course who transferred the instrument to them.
Only certain defenses to payment can be raised against a holder in due course. The limited defenses cannot be
used against a holder in due course and include ordinary contract defenses (lack of consideration), fraud in the
inducement, duress, theft, and prior payment. Universal defenses are those available against all holders and include
fraud as to the nature of the instrument, forgery, incapacity, illegality, alteration and duress of a level that violates the
law.
In order to attach the liability of primary and secondary parties, there must be a series of steps: presentment,
dishonor and notice of dishonor.
The Federal Trade Commission rule eliminates the holder in due course protections in consumer transactions.
Regardless of holder in due course status, a consumer in a credit transaction can assert all defenses against even a
holder in due course.
STUDENT LEARNING OUTCOMES
LO.1: Distinguish between an ordinary holder and a holder in due course.
LO.2: List the requirements for becoming a holder in due course.
LO.3: Explain the rights of a holder through a holder in due course.
LO.4: List and explain the limited defenses not available against a holder in due course.
LO.5: List and explain the universal defenses available against all holders.
LO.6: Describe how the rights of a holder in due course have been limited by the Federal Trade Commission.
INSTRUCTOR’S INSIGHTS
Break the chapter down into three components – related Learning Outcomes are indicated in ( ):
1. What are the rights and liabilities of the parties to negotiable instruments?
Cover the types of parties (LO.1)
2. What are the defenses to payment of negotiable instruments?
Cover the classification of defenses (LO.5)
3. What are the liability issues? – How payment rights arise and defenses are used
Discuss the roles of the parties and their primary or secondary liability (LO.6)
CHAPTER OUTLINE
I. What are the Rights and Liabilities of the Parties to Negotiable Instruments?
A. Types of parties
1. Assignee – contract assignment
B. Rights of ordinary holders and assignees (See Figure 29-1 in text)
1. They are subject to defenses of the maker-drawer
2. Remind the students that if a person cannot qualify as a holder in due course, that does not mean that
the person cannot sue and collect on the instrument. It means only that the person is subject to certain
C. The holders-in-due-course protections – go through each of the elements for becoming a holder in due
course. Make sure that the students understand what is involved. Perhaps the easiest way of doing this is to
1. Value
a. Value is not a promise yet to be performed
b. Value can be value given previously – remind the students that if they should receive a check from
2. Good faith
CASE BRIEF: New Randolph Halsted Currency Exchange, Inc. v. Regent Title Insurance Co.
939 N.E. 2d 1024 (Ill. App. 2011)
FACTS: Regent served as a settlement agent for closing real estate transactions. Regent cut checks to
distribute funds to all the parties to such transactions. On December 23, 2005, New Randolph
cashed a check from Regent, made out to Charae Pearson, for $1,945.99. Four days later, New
Randolph cashed another check for Pearson, again from Regent, this time for $2,500. On January
11, 2006, Pearson brought to New Randolph Regent's check number 22221, for $29,588.31. Unlike
the prior checks, which spelled Pearson's name correctly, this check showed the payee as
“CHAREA PAERSON.” The check indicated that Pearson received it as a “LOAN PAYOFF.”
Pearson presented the check to Patrice Keys, manager of New Randolph. Pearson showed Keys
her state identification card, which had been issued on December 30, 2005. Pearson told Keys that
Regent issued the check to her to pay her a commission she earned from the sale of property.
PLS Check Cashers, which owned New Randolph, did not authorize Keys to cash checks in excess
of $5,000 without approval from her supervisor. Keys contacted Sandra Arizaga of PLS. Arizaga
authorized Keys to cash the check. Arizaga, who worked as director of operations for PLS, testified
that she approved about three checks each week for amounts exceeding the amount of Regent's
check number 22221. She spoke with Keys about the check, and then she looked up the phone
number for Regent at Regent's Web site. Arizaga testified that she called the number and asked to
speak with someone about verifying a check. The woman with whom she spoke confirmed that
Regent issued the check to Pearson in the amount shown. Arizaga then contacted American
Chartered Bank, which confirmed that the check came from a valid account with sufficient funds to
cover the check, and Regent had not stopped payment on the check.
Arizaga admitted that according to PLS's manual, the misspelling of Pearson's name could signal
fraud. Pearson's recent identification card should also raise suspicion. Arizaga did not remember
whether she noticed that the check indicated its purpose as “LOAN PAYOFF,” instead of listing the
payment as a commission.
Regent introduced PLS's manual into evidence. The manual emphasizes that PLS earns its fees by
cashing checks, so the employee should “[s]pend time proving that the check can be cashed and
not looking for excuses not to cash it.” (Emphasis omitted.) The manual identifies several signs that
a check might not be valid, including several of the factors present in this case. According to the
manual, the employee should “verify that the check is good” by “phoning the maker.”
Police arrested Pearson, charging her with check fraud. Two days later, police arrested Tatiana
Auson, an employee of Regent, on the same charge. Regent had hired Auson to work as a funder,
meaning that Regent authorized Auson to cut checks for the parties to real estate transactions.
According to Regent's investigator, Auson cancelled checks intended for parties to real estate
transactions, then issued new checks to different payees for the amounts of the original checks.
Pearson admitted that Auson gave her the three checks New Randolph cashed for Pearson.
Pearson kept about $5,000 of the proceeds from the checks, and she gave the remainder to
Auson. All three checks appeared to bear the signature of Karen Hendricks, who had authority to
sign checks on behalf of Regent.
Regent told its bank to stop payment on the check. New Randolph sued Regent for payment of the
check, claiming that its status as a holder in due course entitled it to payment, despite the evidence
that Auson and Pearson conspired to defraud Regent. New Randolph appealed.
ISSUE: Was New Randolph a holder in due course?
REASONING: Notice that disqualifies a party from being a HDC is something more than a suspicion. The
verification call made in this situation showed the good faith of New Randolph. It checked to be
sure that the check was good and was entitled to payment regardless of the embezzlement and
breaches of fiduciary duties of their respective employees in working through the transactions.
3. Ignorance of the instrument’s being overdue or dishonored
4. Ignorance of defenses and adverse claims
CASE BRIEF: Triffin v. Liccardi Ford, Inc.
10 A. 3d 227 (N.J. Super. 2011)
FACTS: A check dated August 10, 2007, was made payable to one of Liccardi's employees, Charles
Stallone, Jr. Liccardi withheld the check from Stallone because he was suspected of
embezzlement. However, the check disappeared from the company offices, and when the
disappearance was discovered, Liccardi immediately placed a stop payment on the check.
JCNB Check Cashing, Inc. (JCNB), cashed the check for Stallone before the issue date (the check
was postdated) and then deposited the check in its own bank account on August 9, 2007. However,
the issuing bank refused to honor the check. On February 11, 2009, Robert Triffin acquired the
dishonored payroll check from JCNB and sued Liccardi and Stallone for the amount of the check
plus interest. Triffin’s business is buying dishonored checks and attempting to collect on them.
The trial court dismissed Triffin’s complaint on the grounds that he was not a holder in due course.
Triffin appealed.
ISSUE: Was Triffin a holder in due course?
REASONING: The Court held that Triffin was not a holder in due course because he had taken a check that was
already dishonored and that he could not be a holder in due course through JCNB because JCNB
did not follow reasonable commercial standards when it cashed the postdated check because New
Jersey’s statute that regulates check cashing services requires those services to at least examine
the face of the instrument before cashing it. JCNB was, thus, not a holder in due course and Triffin
could not step into its shoes as a HDC.
DISCUSSION POINTS: Ethics & the Law
The Corner Check Cashing Company and Good Faith
Banks and others have an interest in not having these checking-cashing businesses be HDCs because banks often
end up eating the liability. On the other hand, many argue that they provide a service for those without established
credit. Others argue that their fees are excessive. There is an ongoing tension and battle among the banks,
consumer groups and check-cashing services. Some argue that these companies take advantage of both consumers
with their high fees and the immunity of HDC status, that they deliberately remain free of knowledge so that they can
get paid.
5. Holder through a holder in due course: the shelter provision – transferees are not holders in due course,
although they have the rights of a holder in due course, because someone above them in the chain of
II. What are the Defenses to Payment of Negotiable Instruments?
A. Classification of defenses – limited or universal (real) defenses
C. Limited defenses not available against a holder in due course (Use Figure 29-2 in text)
1. Ordinary contract defenses
2. Incapacity of maker or drawer unless the instrument is null (instrument of insane person is void)
3. Fraud in the inducement – validity of assent fraud (like the fraud discussed in contract formation – see
Chapter 13)
4. Miscellaneous defenses
a. Prior payment
b. Non-delivery
c. Breach of warranty
d. Duress (can be a mixed defense depending on nature of conduct)
e. Unauthorized completion – advise the students that any time they, as makers of promissory notes,
pay them, they should obtain return of the notes or boldly mark across the face of the instruments
CASE BRIEF: RR Maloan Investments, Inc. v. New HGE, Inc.
428 S.W. 3d 355 (Tex. App. 2014)
FACTS: On September 23, 2011, Houston Gold Exchange issued a $3,500 check as payor to Shelly McKee
as payee to buy a purported Rolex watch from her. The check was post-dated September 26, 2011.
McKee properly endorsed the check and presented it to RR Maloan, which cashed the check for
her on September 24, 2011. On September 24, 2011, Houston Gold Exchange issued a stop
payment order on the check based on information that the watch was counterfeit. RR Maloan
presented the check to Houston Gold Exchange's bank for payment. Houston Gold Exchange's
bank refused to honor the check based on the stop payment order.
RR Maloan sued Houston Gold Exchange to collect on the check. RR Maloan filed a “Statement of
Claim” asserting that it was a holder in due course entitled to collect on the check. Houston Gold
Exchange was not present on the appearance date, and the small claims court signed a default
judgment in RR Maloan's favor. On appeal, the trial court found for Houston Gold Exchange, and
RR Maloan appealed.
ISSUES: Do you lose HDC status because you take a post-dated check? Is fraud in the underlying
transaction a defense against an HDC?
HOLDING: No, you don’t lose HDC status and fraud in the underlying transaction does not affect an HDC’s
REASONING: A holder in due course takes the instrument free from all claims and all defenses of any party to the
instrument with whom he has not dealt unless a defense that bars recovery by a holder in due
course applies. RR Maloan took the check “for value” as required. “Good faith” is defined as
“honesty in fact and the observance of reasonable commercial standards of fair dealing.” The
record here conclusively establishes RR Maloan's good faith as that concept is defined for these
purposes in the statute. No evidence was presented that the owner or any employee of RR Maloan
had knowledge at the time the check was accepted that the watch was not authentic.
As for “reasonable commercial standards,” Texas law holds that knowledge of post-dating by itself
does not (1) give notice of a defense or claim; or (2) impose a duty to “make any investigation to
ascertain whether or not the maker had any defenses which would have justified him in refusing to
pay the payee.” Because the fact of post-dating did not impose a duty on RR Maloan to investigate
the surrounding circumstances, Houston Gold Exchange cannot establish that RR Maloan failed to
observe “reasonable commercial standards of fair dealing” by failing to investigate based on the
post-dating of the check.
UCC case law is very clear that fraud by the payee is not a defense against a holder in due course.
McKee's asserted fraud in selling an allegedly fake Rolex to Houston Gold Exchange does not bar
RR Maloan from collecting on the check as a holder in due course.
Reversed and remanded.
D. Universal (real) defenses available against all holders
1. Fraud as to the nature or essential terms of the paper (fraud infactum)
6. Alteration
a. Unauthorized change or completion that modifies the obligation
E. Denial of holder-in-due-course protection
1. Participating transferee – in credit sale the holder in due course is tied to the seller (closely connected)
2. Federal Trade Commission rule
a. Covers consumer credit transactions
DISCUSSION POINTS: Thinking Things Through
The Corner Check-Cashing Company and Thieves – Who Wins?
On a forged indorsement, the CCCC bears liability for not verifying the customer’s ID and indorsement. If the
indorsement was on the check and in blank, then it was bearer paper, but CCCC should still check ID transaction
rules. On order paper, it is the first party to take the instrument after indorsement because it had the chance to verify.
III. What are the Liability Issues? – How Payment Rights Arise And Defenses Are Used
A. The roles of the parties
1. Primary parties
a. Maker
2. Secondary parties
B. Attaching liability of parties
1. Presentment
2. Refusal of primary party to pay is dishonor
3. Parties must give notice of dishonor
DISCUSSION POINTS: E-Commerce & Cyberlaw
Electronic Presentment: One Fell Swoop, All Rights, All Payments, New Laws
Discuss how presentment has changed with electronic banking and how difficult catching issues has become.
Federal laws now govern much of the old paper.
ANSWERS TO QUESTIONS AND CASE PROBLEMS
1. Value for holder in due course. UCC § 3-302(1) and (4) [§ 3-302(a) and (e)] provide that a holder in due course
(HDC) is a holder who takes the instrument (a) for value; and (b) in good faith; and (c) without notice that it is
UCC § 3-303 defines “value” as used in the context of Bocian and UCC § 3-302. If an instrument is not issued
for consideration, the issuer has a defense to the obligation to pay the instrument. UCC § 3-303 Comment 1.
Bocian was decided under pre-revision Article 3. The Article 3 sections cited in this case have the following
current equivalents:
Old Article 3 Current Article 3
§ 3-302(1) and (4) § 3-302(a) and (e)
2. Holder in due course. UCC § 3-302(1) [§ 3-302(a)] provides the requirements for a holder in due course. The
value is not disputed. The issues are “good faith” and “without notice.” No evidence suggested that Money Mart
Nothing is more important in a negotiable instrument dispute than being declared a holder in due course. Once
Sometimes it is helpful to take a look at the public policy implications of an opinion that decided just the opposite.
Given the numbers of checks in circulation at any given time, to inquire into the validity of each one before
acceptance would be nearly impossible and the resulting obstruction to commerce would be a serious drag on
Money Mart was decided under pre-revision Article 3. The Article 3 sections cited in this case have the following
current equivalents:
Old Article 3 Current Article 3
3. Ordinary holders. The plaintiff made a prima facie case by producing the paper in court and establishing that the
defendant signed it. It is not necessary that the plaintiff prove that the note had been issued for consideration.
4. Value/holder in due course. Miller’s failure of consideration argument lacks merit. Under OCGA § 11-3-408, “no
consideration is necessary for an instrument or obligation thereon given in payment of or as security for an
antecedent obligation of any kind.” Here, the promissory note was created to settle Miller’s antecedent
obligation, notwithstanding Miller’s subsequent denials that any such obligation existed. Although Miller testified
5. Defenses; holder in due course. Grantham could not be a holder in due course, both because it did not give
value and also because it was aware of the problems in the original transaction. Grantham tried to ship the
6. Good faith; holder in due course. The key to the discussion on check cashing companies as holders in due
course is whether they take without notice. The interesting argument to make is a twist on the close connection
7. Holder in due course and good faith. The maker of the note will succeed. Jackson Corporation was not a holder
8. Holder in due course, value; ignorance of defenses and adverse claims. Financial Associates is a holder in due
course. Knowledge that an instrument is postdated does not prevent a purchaser from becoming a holder in due
9. What constitutes a holder in due course. No. The circumstances described in the question do not indicate
anything of a nature that bars a holder from being a holder in due course. The facts in question indicate that
10. Holder in due course. The Credit Union was found not to be a holder in due course and thereby subject to any
Fraud is an affirmative defense to a contract. To prevail on their fraud defense, the Guerrettes were required to
prove, by clear and convincing evidence, that a fraudulent or material misrepresentation induced them to transfer
the proceeds of their father’s life insurance policy, in the form of the Sun Life checks, to Steven Hall and Paul
Sun Life, however, may not raise the fraud as a defense to its liability on the instrument. Section 3-1305(3)
provides generally that:
In an action to enforce the obligation of a party to pay [an] instrument, the obligor may not assert
Accordingly, a defense to liability on an instrument – such as fraud in the underlying transaction – raised by one
The Guerrettes, however, made no claim that they were entitled to possession of the instruments held by the
Credit Union. Instead, they merely argued that they were not liable as indorsers of the checks held by the Credit
Therefore, Sun Life may not raise the fraud against the Guerrettes as a defense to its own liability. [Maine
Family Federal Credit Union v. Sun Life Assur. Co. of Canada, 727 A. 2d 335 (Me.)]
11. Forgery; fraud. The court held that while PCDC might have a cause of action against its bank for processing the
checks Vincent stole, Citibank was a holder in due course that took the payments from the personal checking
12. Incomplete instrument; alteration; HDC. Yes. Sanders was negligent in leaving the check amount open.
Lawrence is a HDC without notice and can recover the full amount. Sanders is left to seek recovery from Clary.
13. Holder in due course. MBNA meets all of these requirements with regard to the GRAS checks. First, there is no
evidence that a forgery or alteration was apparent from the face of the checks. Second, MBNA took the checks
"for value," even though GRAS did not receive the value. An instrument is transferred for value if it "is issued or
transferred as payment of...an antecedent claim against any person." Here, the checks were issued to MBNA as
payment for the antecedent debt of Stewart's husband. Third, MBNA took the checks in "good faith." "Good faith"
MBNA need not listen to the defenses of GRAS. [Grand Rapids Auto Sales, Inc. v. MBNA America Bank, 227 F.
14. Forgery; fraud. A holder loses status as holder in due course only if holder had knowledge of drawer's fiduciary
status, not just warning clues. In this case there were questions, but not actual knowledge of any kind of
15. Holder in due course. Carter & Grimsley was not a holder in due course. It had not given value with the promise
of future services. There was no evidence of any work performed prior to the time of the check indorsement
LAWFLIX
Ghost (1990) (PG-13)
Whoopi Goldberg plays a psychic who is asked y a deceased (the late Patrick Swayze) to help get back at his
murdered (a co-worker at his finance firm) by posting as a character to obtain a check made payable to her, a
management system for classroom use.
