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A time instrument is overdue if it is taken after its expressed due date [UCC 3–304(b)]. If, on an
installment note or on a series of notes, the maker has defaulted on an installment or one of the
3–302(a)]. Knowledge can be imputed if a claim or defense is apparent on the face of the instrument
or the buyer otherwise had reason to know from facts surrounding the transaction
• A holder has notice if an instrument is so incomplete that an element of negotiability is lacking.
Accepting an instrument without knowing it was incomplete when issued is not notice.
• A holder has notice if an irregularity on the face of an instrument calls into question its validity or
terms of ownership, or creates ambiguity as to who to pay.
• A holder has notice knowing a party to an instrument has a defense that entitles the party to
avoid the obligation. Knowing of one defense bars HDC status to all defenses. Knowing that a
fiduciary has wrongfully negotiated an instrument [UCC 3–307(b)].
ANSWER TO VIDEO QUESTION LTR. A
According to the instructor in the video, what are the two reasons why banks generally require a person to indorse
a check that is made out to cash (a bearer instrument), even when the check is signed in the presence of the teller?
According to the instructor, banks require you to indorse checks made out to cash because (1) the indorsement makes
ANSWER TO VIDEO QUESTION LTR. B
Suppose that your friend makes out a check payable to cash, signs it, and hands it to you. You take the check to
your bank and indorse the check with your name and the words “without recourse.” What type of indorsement is this?
How does this indorsement affect the banks rights? The words “without recourse” indicate that this is a qualified
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ANSWER TO VIDEO QUESTION LTR. C
Now suppose that you go to your bank and write a check on your account payable to cash for $500. The teller gives
you the cash without asking you to indorse the check. After you leave, the teller slips the check into his pocket. Later,
the teller delivers it (without an indorsement) to his friend Carol in payment for a gambling debt. Carol takes your
check to her bank, indorses it, and deposits the money. Discuss whether Carol is a holder in due course. To be a holder
in due course, Carol must have taken the instrument (1) for value: (2) in good faith; and (3) without notice that it is
defective. An instrument is defective if it is overdue, dishonored, irregular, or incomplete; if a defense against it exists;
or it contains unauthorized signatures or alterations. Under UCC 3–303(a), a holder can take an instrument for value in
payment of an antecedent claim. Here, the teller owed money to Carol on a gambling debt, so Carol has antecedent
claim (although it may not have been a legal contract). The circumstances of the transfer would probably call into
question Carol’s good faith, however. Under the UCC, good faith is defined as “honesty in fact and the observance of
reasonable commercial standards of fair dealing” [UCC 3–103(a)(4)]. Because of the good faith requirement, one must
ask whether Carol, at the time she acquired the check, honestly believed that it was not defective. Here, the check was
CASE SYNOPSIS—
Case 25.3: South Central Bank of Daviess County v. Lynnville National Bank
Lynnville National Bank issued a cashier’s check for $31,917.55 payable to Landmark Housing Center, Inc. The
check represented a loan to Bryan and Lisa Fisher to buy a manufactured home. The same day, Landmark deposited
the check in its account with South Central Bank of Daviess County. South Central phoned Lynnville and, on
confirmation of the date, amount, and payee of the check, paid it. Two days later, Lynnville learned that Landmark was
unable to fulfill its contract with the Fishers. Lynnville then told South Central that payment on the cashier’s check
would be refused. South Central filed a suit in an Indiana state court against Lynnville, seeking to recover the amount of
the check, plus interest and fees. The court entered a judgment in the defendant’s favor. South Central appealed.
A state intermediate appellate court reversed and remanded for the entry of a judgment in South Central’s favor
CHAPTER 25: TRANSFERABILITY AND HOLDER IN DUE COURSE 611
for the amount of the check, plus expenses and interest, and for a determination of consequential damages. A
depositary bank can properly pay a cashier’s check on its issuer’s confirmation of the check’s date, amount, and payee.
South Central took the check for value and in good faith, and then asked Lynnville for confirmation. This “means that
South Central was without notice of any problems with the instrument. Indeed, at that time, Lynnville was without
notice of any problems.” South Central accepted the check and became an HDC. None of the defenses available to an
issuer against an HDC were available to Lynnville.
…………………………………………………………..……………………………………………………………………
Notes and Questions
Should Lynnville or South Central have taken steps to mitigate the damages in this case? If so, which bank and
what steps? If either bank should have taken steps to mitigate the loss of the funds represented by the cashier’s check
given to the Fishers, it was Lynnville. The issuing bank was the party best able to prevent any loss from occurring and
should have exercised “due diligence” to determine whether Landmark was likely to comply with its contract. Was the
seller creditworthy? Did it have a history of reneging on its deals? Did it have the home that the Fishers were borrowing
to buy?
Could South Central have rightfully refused to pay the cashier’s check on its presentment by Landmark? Explain.
Lynnville did.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 25.2
How would a decision in favor of Lynnville have affected the status of a cashier’s check as a substitute for cash? In
the business community, cashier’s checks are treated as the next best thing to cash. This is partly because, under UCC
4–403, the buyer of a cashier’s check has no right to stop payment on it. A ruling under which its issuer could stop
payment, however, would significantly erode the check’s status as a cash equivalent, effectively making a cashier’s
check little different from an ordinary check.
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 25.2
Suppose that Landmark had a history of unreliability as a South Central customer. Would South Central’s
acceptance of the check have then constituted a failure to act reasonably? Explain your answer. No. A history of
unreliability as a South Central customer would not have led to the conclusion that the bank failed to act reasonably by
giving Landmark immediate access to the funds represented by Lynnville’s cashier’s check. South Central’s call to
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confirm that the check was genuine by verifying the date, amount, and payee of the check was not an obligation. South
Central’s decision to rely on the issuer’s assurance was not a lack of reasonable care.
V. Holder through an HDC
Anyone who can trace his or her title to a negotiable instrument back to an HDC has the rights of an HDC [UCC 3–
203(b)]. This is the shelter principle.
A. THE PURPOSE OF THE SHELTER PRINCIPLE
This principle helps an HCD to readily dispose of a negotiable instrument, promoting its marketability and
transferability.
B. LIMITATIONS ON THE SHELTER PRINCIPLE
If a holder was a party to fraud or some other illegality affecting an instrument, he or she cannot acquire HDC
rights by reacquiring the instrument from an HDC.
ENHANCING YOUR LECTURE—
HOW CAN YOU AVOID PITFALLS
WHEN WRITING AND INDORSING CHECKS?
As a businessperson (or as a consumer), you will certainly be writing and receiving checks. Both activities can
involve pitfalls.
CHECKS DRAWN IN BLANK
The danger in signing a blank check is clear. Anyone can write in an unauthorized amount and cash the check.
Although you may be able to assert lack of authorization against the person who filled in the unauthorized amount,
subsequent holders of the properly indorsed check may be able to enforce the check as completed. While you are
haggling with the person who inserted the unauthorized figure and who may not be able to repay the amount, you will
also have to honor the check for the unauthorized amount to a subsequent holder in due course.
CHECKS INDORSED IN BLANK
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Just as a check signed in blank or payable to cash may be dangerous, a negotiable instrument with a blank
indorsement also has dangers; as a bearer instrument, it is as easily transferred as cash. When you make a bank
deposit, therefore, you should sign (indorse) the back of the check in blank only in the presence of a teller. If you
choose to sign it ahead of time, make sure you insert the words “For deposit only” before you sign your name. As a
precaution, you should consider obtaining an indorsement stamp from your bank. Then, when a check is received
payable to your business, you can indorse it immediately. The stamped indorsement will indicate that the check is for
deposit only to your business account specified by the number.
CHECKLIST FOR THE USE OF NEGOTIABLE INSTRUMENTS
1. A good rule of thumb is never to sign a blank check.
2. Another good rule of thumb is never to write and sign a check payable to “cash” until you are actually at the bank.
3. Be wary of indorsing a check in blank unless a bank teller is simultaneously giving you a receipt for your deposit.
4. Consider obtaining an indorsement stamp from your bank so that when you receive checks you can immediately
indorse them “For deposit only” to your account.
TEACHING SUGGESTIONS
1. The concept of negotiability is often confusing to students because it refers to the process by which instruments
are transferred from one party to another. Ask the class to discuss the process by which negotiable instruments are
progress of the check, pointing out the various conditions imposed by each indorsement, as well as when an order
2. Ask the students to compare the concept of value in commercial law with that of consideration in contract law.
Not all consideration is value. The extraordinary protection conferred on an HDC is given only when an individual has
negotiable instrument given in exchange. Ask the students to consider whether some things that are not consideration
3. When considering whether a specific party is an HDC, students might find it helpful to divide the question into two
parts: (1) the party must first be a holder, and (2) if the party is a holder, he or she must be in dues course. To qualify as
an HDC, all of the requirements must, of course, be met.
Cyberlaw Link
614 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
Is there any part of the HDC concept that would need to be changed to adapt it to an electronic payment system?
DISCUSSION QUESTIONS
1. Why is a transfer by negotiation preferable to a transfer by assignment? In a transfer of an instrument by negotiation,
2. What is the difference between qualified and unqualified indorsements? A qualified indorsement is one which
3. What is the difference between a holder and a holder in due course? A holder is a person who possesses a negotiable
4. How can a holder take an instrument for value? Under UCC 3–303(a), a holder can take an instrument for value by (1)
5. In what situations can a holder take an instrument for value but still not be accorded HDC status? In a few exceptional
6. What is good faith? For purposes of revised Article 3, good faith is “honesty in fact and the observance of reasonable
7. What kinds of defects in an instrument will prevent a holder knowing about those defects from acquiring HDC status?
8. What are some of the circumstances that, as a matter of law, constitute notice of a particular fact in commercial law?
9. What sorts of omissions on the face of a financial instrument will prevent a purchaser from becoming a holder in due
course? A purchaser cannot expect to become an HDC of an instrument so incomplete on its face that an element of
negotiability is lacking (for example, the amount is not filled in) [UCC 3–302(a)(1)]. Minor omissions are permissible, because
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ACTIVITY AND RESEARCH ASSIGNMENT
Have students research the shelter principle, and find and read cases that involve this rule. What are the positive and
negative features of the shelter principle? Because this principle may permit one who has acted in bad faith or taken an
overdue instrument, for example, to recover as though that person were an HDC, the students should consider the purposes
served by this rule, as well as whether some alternative rule might be more appropriate.
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 2: Skyscraper Building Maintenance, LLC, contracted with Hyatt Corp. to perform maintenance services
for some hotels in Florida. Under an agreement with Skyscraper, J & D Financial Corp. asked Hyatt to make checks for the
services payable to Skyscraper and J & D. Of the many checks issued by Hyatt to the two payees, Palm Beach National Bank
negotiated two that were indorsed only by Skyscraper. These two checks were made payable to “J & D Financial Corp.
Skyscraper Building Maint.” J & D filed a suit in a Florida state court against Hyatt, and others, seeking in part the amount of the
two checks, asserting that they were payable jointly. The court issued a summary judgment in the bank’s favor. J & D and Hyatt
appealed. In Hyatt Corp. v. Palm Beach National Bank, a state intermediate appellate court affirmed. UCC 3–110(d) provides, “If
an instrument payable to two or more persons is ambiguous as to whether it is payable to the persons alternatively, the in–
strument is payable to the persons alternatively.” Under the previous version of this provision, if an ambiguity existed as to
whether multiple payees were intended as joint or alternative payees, they were deemed joint payees, but an amendment
“reverse[d] the prior rule.”
Footnote 3: Vernon and Shirley Graves leased a commercial building in Indiana to John and Tamara Johnson, who
operated Johnson’s Towing & Recovery. The Johnsons’ insurer was Westport Insurance Co. A fire destroyed the building in 2003.
Westport hired Claims Management Services, Inc. (CMS), to pay the claim. On CMS’s behalf, Robert Davis met with Vernon, who
was acting as the rebuilding contractor, and agreed that Westport would pay with three checks “co–payable” to Johnson’s
Towing and Vernon. Westport gave two checks to Vernon, who deposited them in his account. A third check was tendered to
the Johnsons. They did not remit the funds to the Graveses, who filed a suit in an Indiana state court against the Johnsons and
Westport. The court entered a judgment in Westport’s favor. The Graveses appealed. In Graves v. Johnson, a state intermediate
appellate court affirmed. Westport’s tender of the third check to the Johnsons suspended the insurance company’s obligation
to both payees, including the Graveses. Payment of the check “extinguished” the firm’s obligation on it. “[W]here one joint
CHAPTER 25: TRANSFERABILITY AND HOLDER IN DUE COURSE 617
payee takes and possesses a check, it suspends all obligations as to other joint payees not in actual possession of the check as
the party possessing the draft holds the draft for the benefit of himself and the other payee.”
Would it have made any difference to the outcome of this case if the Graveses had proved that the Johnsons forged
their co-payee’s indorsement? No. A drawer’s obligation is discharged as a matter of law when a check or other draft, properly
issued to joint or alternative payees, is delivered, honored and paid, even if one of the payees forged the other’s endorsement
and embezzled the funds. Of course, the unpaid co-payee may have a cause against the other co-payee, or a bank.
Footnote 8: First Service Title Agency (FSTA) issued three checks drawn on its account with Key Bank. The first
check, for $850, was payable to “Richard G. Knostman, Atty. and Mark F. Foster, Atty. and Resa Kermani & Badri Kermani.” The
second, for $36,295.80, was payable to “JD Properties and Reza Kermani & Badri Kermani.” The third, for $4,010, was payable to
“Knab Mortgage.” The next day, FSTA put stop-payment orders on the checks. Meanwhile, Randall Davis, who had accounts at
Firstar Bank, N.A., presented the checks to Firstar. Davis was not a party to any of them, they included multiple indorsements
that appeared to be in the same handwriting, and they were marked “for deposit only,” but Firstar paid them. Key Bank
returned the checks with the notation “Payment Stopped.” Firstar filed a suit in an Ohio state court against FSTA. The court
granted a summary judgment in FSTA’s favor. Firstar Bank appealed. In Firstar Bank, N.A. v. First Service Title Agency, Inc., a
state intermediate appellate court affirmed. Over Firstar’s argument to the contrary, the court held that Firstar was not an HDC
of the checks because it failed to exercise ordinary care as to whether the indorsements were forged or were otherwise
deficient. Because Firstar was not an HDC, FSTA could successfully assert its defenses to Firstar’s demand for payment. “[A]n
instrument, when issued or negotiated to the holder, cannot bear evidence of forgery or alteration that is so apparent, or
cannot otherwise be so irregular or incomplete, as to call into question its authenticity.”
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ANSWERS TO ESSAY QUESTIONS IN
STUDY GUIDE TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
BY HOLLOWELL & MILLER
1. How are instruments negotiated? Negotiation is the transfer of an instrument in such form that the transferee becomes a
2. How is a person who acquires a time instrument or a demand instrument put on notice that the instrument is overdue?
3–302(a)(2)(iii)]. UCC 3–304(b)(3) provides that an instrument becomes overdue on the day after the accelerated due date. A
purchaser may still qualify as an HDC, however, if he or she has no reason to know that acceleration has occurred [UCC 3–
302(a)(2)(iii)]. Demand instruments. A purchaser has notice that a demand instrument is overdue if he or she takes the
instrument knowing that demand has been made the day before [UCC 3–304(a)(1)]. A purchaser has notice if he or she takes a
demand instrument that has been outstanding for an unreasonable period of time after its date [UCC 3–304(a)(3)]. A
reasonable time for a check is ninety days [UCC 3–304(a)(2)]. A reasonable time for other demand instruments depends on the
circumstances [UCC 3–304(a)(3)].
REVIEWING—
TRANSFERABILITY AND HOLDER IN DUE COURSE
The Brown family owns several companies, including the J.H. Stevedoring Company and Penn Warehousing and
Distribution, Inc. The companies are intertwined in many of their operations and management. Dennis Bishop began
working for J.H. and Penn in 1994. By 2003, Bishop was financial controller at J.H. where he was responsible for
approving invoices for payment and reconciling the corporate checkbook. In December, Bishop began stealing from
1. What method was most likely used to negotiate the instruments described here? An instrument, such as a check, is
delivered with necessary indorsements when it is properly issued payable to the order of the payee and is then
indorsed over to the bank for payment.
2. Suppose that all of the checks issued to the defendants were made payable to “Fasig-Tipton Co., Fasig-Tipton
Midlantic, Inc.” Under the Uniform Commercial Code, were the instruments payable jointly or in the alternative? Why
is this significant? Under UCC 3-110, when two names appear on a check, it is presumed to be payable alternatively if it
3. Do the defendants in this situation (the two Fasig-Tipton firms) meet the requirements of a holder in due course
(HDC)? Why or why not? The payees met the definition of an HDC: value was given, the checks were taken in good
faith, and there never was a reason to suspect a problem.
4. In whose favor should the court rule, and why? The checks were properly presented and paid to a holder in due
course. Further, the plaintiffs were negligent for never reviewing their bank statements, which would have revealed
that Bishop was using the money for improper purposes.
DEBATE THIS:
We should eliminate the status of holder in due course for those who possess negotiable instruments. No one can
deny that HDC status allows holders of negotiable instruments to collect payment even when there has been some
underlying misrepresentation or even fraud. Thus, if holder in due course were eliminated, such misrepresentation or
fraud would no longer be as easily avoided by those who perpetuate it.
If we eliminated the possibility of HDC status for negotiable instruments, we would reduce severely the amount
of negotiable instruments use in commerce. Hence, eliminating HDC status would cause a reduction in economic
activity and therefore cause a reduced rate of economic growth. On net, we would be worse off.