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Chapter 26
Transferability and Holder in Due Course
INTRODUCTION
This chapter begins with the process of negotiation—that is, the transfer of negotiable instruments from one
person to another. The chapter discusses the types of indorsements that are required whenever certain types of
instruments are being negotiated, and notes some common indorsement problems that may arise during the process
of negotiation, as well as the consequences of various types of indorsements.
A negotiable instrument is not money—but it is payable in money. Article 3 of the Uniform Commercial Code
(UCC) governs a party’s right to payment of a check, draft, note, or certificate of deposit. Problems arise when a
or symbol executed or adopted by a person with present intention to authenticate a writing.” What is
will also bind the signatory if the requisite intent can be demonstrated.
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CHAPTER OUTLINE
I. Negotiation
When a transfer is by negotiation, the transferee can become a holder in due course and acquire greater
rights than the transferor had [UCC 3–203(b), 3–305].
B. NEGOTIATING BEARER INSTRUMENTS
A bearer instrument is negotiated by delivery alone.
II. Indorsements
Generally, by indorsing, an indorser promises to pay the holder or any subsequent indorser the amount of the
A. BLANK INDORSEMENTS
A blank indorsement specifies no particular indorsee and can be a mere signature [UCC 3–205(b)].
CASE SYNOPSIS—
Case 26.1: In re Bass
To buy a house, Tonya Bass signed an adjustable rate note with Mortgage Lenders Network USA, Inc., to
borrow $139,988, repayable with interest in monthly installments of $810.75. The note was transferred by
stamped imprints to Emax Financial Group LLC, Residential Funding Corp., and finally to U.S. Bank N.A.
When Bass stopping paying on the note, U.S. Bank foreclosed. From North Carolina trial and intermediate
appellate decisions in Bass’s favor, based on the lack of a “proper indorsement,” U.S. Bank appealed.
The North Carolina Supreme Court reversed, holding that “with no unambiguous evidence indicating the
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Notes and Questions
What sort of signature is required by the UCC to create a negotiable instrument? UCC 1-201(39)
defines the word “signed” as including “any symbol executed or adopted by a party with present intention to
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requirement because the indorsement creates indorser liability for the indorsing party. Also, it is more efficient
individual assessments of whether checks are order or bearer instruments.
Why do banks require all checks, including bearer instruments, to be indorsed? Banks impose this
B. SPECIAL INDORSEMENTS
A special indorsement names the indorsee [UCC 3–205(a)]. An instrument indorsed in this way is an
order instrument. A blank indorsement converted to a special indorsement converts a bearer instrument
into an order instrument.
CASE SYNOPSIS—
Case 26.2: AS Peleus, LLC v. Success, Inc.
Success, Inc. executed a note for $525,000 payable to Greenpoint Mortgage Funding, Inc. The note was
secured by mortgages on real property in Stratford and Bridgeport, Connecticut. When Success defaulted on
the payments, AS Peleus, LLC filed a suit in a Connecticut state court against Success to foreclose on the
property and recover on the note. The court issued a judgment in the plaintiff’s favor. On appeal, the
defendant claimed that the lower court erred in finding the plaintiff was the owner and holder of the note.
Russell Schaub, the chief operating officer of Gregory Funding, LLC, the plaintiff’s mortgage servicing
company, testified that the plaintiff bought the note from its predecessor in the chain of indorsements six
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Notes and Questions
signature by the indorser, whereas a special indorsement names the person (indorsee) to whom the indorser
intends to make the instrument payable. The words “pay to the order of John Doe,” followed by the indorser’s
What is the difference between a blank and a special indorsement? A blank endorsement is a mere
How do the requirements for negotiation of an instrument with a blank qualified indorsement
differ from those for negotiation of an instrument with a special qualified indorsement? A blank
qualified indorsement makes the instrument a bearer instrument, and only the delivery of the instrument is
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the transfer warranties, which relate to good title, authorized signature, no material alteration, and other
Indorsing a note “without recourse” does not undercut its negotiability. What effect does this type
of indorsement have? The notation “without recourse” is commonly used to create a qualified indorsement
on an instrument. An indorser who does not wish to be liable on the instrument can use a qualified
C. QUALIFIED INDORSEMENTS
Most indorsements are unqualified. A qualified indorsement disclaims an indorser’s liability.
1. The Effect of Qualified Indorsements
2. Special v. Blank Qualified Indorsements
A qualified indorsement is accompanied by a special or blank indorsement that determines further
D. RESTRICTIVE INDORSEMENTS
Restrictive indorsements require indorsees to comply with certain instructions.
1. Indorsements to Pay Only a Named Payee
2. Conditional Indorsements
A conditional indorsement conditions payment on the occurrence of a specified event [UCC 3–
3. Indorsements for Deposit or Collection
An indorsement for deposit or collection makes the indorsee the indorser’s collecting agent.
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4. Trust (Agency) Indorsements
Indorsements that state they are for the benefit of the indorser or a third person are trust in-
E. HOW INDORSEMENTS CAN CONVERT ORDER INSTRUMENTS TO BEARER INSTRUMENTS AND VICE VERSA
Before negotiation, an order instrument can be converted to a bearer instrument and vice versa through
III. Miscellaneous Indorsement Problems
A. MISSPELLED NAMES
An indorsement should be identical to the name that appears on the instrument. A payee or indorsee
B. INSTRUMENTS PAYABLE TO ENTITIES
An instrument payable to two or more persons in the alternative requires the indorsement of only one for
negotiation.
C. ALTERNATIVE OR JOINT PAYEES
If an instrument is payable to two or more persons jointly, then all the payees’ indorsements are
necessary.
1. If the Instrument Is Ambiguous
2. Suspension of the Drawer’s Obligation
Giving one alternative or joint payee a check suspends the drawer’s obligation [UCC 3–310(b)(1)].
The payee holds the check for the benefit of all payees.
IV. Holder in Due Course (HDC)
A. HOLDER V. HOLDER IN DUE COURSE
A holder has the status of an assignee of a contract right. A holder obtains only those rights that the
B. REQUIREMENTS FOR HDC STATUS
First, the instrument must be negotiable, and whoever seeks HDC status must be a holder. Then, the
following requirements must be met [UCC 3–302].
1. Taking for Value
A gift or inheritance does not meet the requirement of value for HDC status, nor does a promise to
give value in the future. A holder takes an instrument for value by—
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• Performing the promise for which the instrument was issued or transferred.
a. Value Is Distinguishable from Consideration
A promise to give value in the future may meet the requirement of consideration to form a
contract, but it does not meet the requirement of value for HDC status. Also, a holder takes an
instrument only to the extent that the promise has been performed [UCC 3–303(a)(1)].
b. Exceptions
A holder may pay for an instrument but not acquire HDC status by—
ADDITIONAL BACKGROUND—
Value and Consideration
The Official Comments of the Uniform Commercial Code explain the purposes and the changes in the
prior law that were effected by the UCC. The following is from the text of UCC 3–303, Comment 1.
1. . . . The distinction between value and consideration is a fine one. Whether an instrument is taken
for value is relevant to the issue of whether a holder is a holder in due course. If an instrument is not issued
for consideration the issuer has a defense to the obligation to pay the instrument. . . . [O]utside Article 3,
anything that is consideration is also value. A different rule applies in Article 3. Subsection (b) of Section 3–
303 states that if an instrument is issued for value it is also issued for consideration.
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2. Taking in Good Faith
The holder must have acted honestly in the process of acquiring the instrument. Good faith is
CASE SYNOPSIS—
Case 26.3: Georg v. Metro Fixture Contractors, Inc.
Cassandra Demery worked as a bookkeeper at Clinton Georg’s business Freestyle until he discovered
she had embezzled over $200,000 and failed to pay $240,000 of Freestyle’s taxes. Georg fired Demery and
demanded repayment. Demery went to work for her parents’ firm Metro Fixtures. She wrote a check to
Freestyle for $189,000 on Metro’s account without authorization and deposited it directly into Freestyle’s
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Notes and Questions
In an attempt to describe how the standard of “good faith” under Article 3 should be applied, a different
state court articulated the following test in Maine Family Federal Credit Union v. Sun Life Assurance Co. of
Canada, 727 A.2d 335 (Sup. Jud. Ct. 1999).
The factfinder must therefore determine, first, whether the conduct of the holder comported with industry
What do your students think about this standard of “good faith”?
Why is good faith required to attain HDC status? To allow otherwise would provide an incentive for
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was believable. Demery knew criminal charges could be pressed if she did not repay, so the family might help
Was it right for Georg to let the loss fall on Metro, and was it reasonable for him to believe that
Demery’s parents had loaned her the funds? Because there was a family relationship, the claim of a loan
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Taking in Good Faith
Cases in which a party’s good faith to attain HDC status was at issue include the following.
• In re AppOnline.com, Inc., __ Bankr. __ (E.D.N.Y. 2002) (the purchaser of mortgage notes from the
original mortgagee for value and in good faith, and without actual knowledge that the checks to closing agent
would be dishonored or of the seller’s claims, qualified as HDCs).
released funds represented by a check to the person to whom the check was issued through fraudulent
inducement did not qualify as holder in due course because the store failed to comport with reasonable
ENHANCING YOUR LECTURE—
GOOD FAITH, INTERNATIONALLY
Good faith is an issue not only in domestic transactions involving negotiable instruments but also
internationally. Under the United Nations Convention on International Bills of Exchange and International
Promissory Notes (CIBN), the equivalent of a holder in due course is known as a “protected holder.” As
under the UCC, a protected holder is afforded greater protection than an ordinary holder.
what constitutes good faith. The CIBN, in contrast, qualifies someone as a protected holder if she or he was
protected-holder status is easily passed. In fact, every holder is presumed to be a protected holder unless
there is proof to the contrary.
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FOR CRITICAL ANALYSIS
What might be a reason that the CIBN contains only a very broad and subjective definition of good
faith?
3. Taking without Notice
A person will not be afforded HDC protection if he or she knew or should have known at the time
the instrument was acquired that it was defective because—
• It was overdue.
a. What Constitutes Notice?
A person has notice of a fact when he or she has—
• Actual knowledge of the fact.
b. Overdue Demand Instruments
A demand instrument is overdue if it is taken after demand has been made or an unrea–
sonable time after its issue (ninety days in the case of a check) [UCC 3–304(a)].
c. Overdue Time Instruments
A time instrument is overdue if it is taken after its expressed due date [UCC 3–304(b)]. If, on
d. Dishonored Instruments
A holder has notice if he or she knows an instrument has been dishonored, or knows of facts
that would lead him or her to suspect that an instrument has been dishonored [UCC 3–
302(a)(2)].
e. Notice of Claims or Defenses
• A holder cannot be an HDC if he or she knows of a claim to the instrument or defense
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• A holder has notice if he or she knows that a party to an instrument has a defense
f. Incomplete Instruments
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.
g. Irregular Instruments
• A holder has notice if an irregularity on the face of an instrument calls into question its
ENHANCING YOUR LECTURE—
HOW TO BUY NEGOTIABLE INSTRUMENTS
Negotiable instruments are transferred every business day of the year. Most purchasers of negotiable
instruments do not encounter any problems in further negotiating and transferring the instruments or in
collecting payment on them if they are time instruments. Potential problems exist, however, and purchasers
should take precautions against them.
OVERDUE INSTRUMENTS
any doubt about whether a demand instrument is overdue, you should investigate.
Suppose that you wish to purchase a demand instrument as a holder in due course (HDC). By definition,
NOTICE OF DEFECTS
transfer will qualify you for HDC status.
As a prospective holder, you cannot afford to ignore a defect in any negotiable instrument. A four–month-
CHECKLIST FOR THE PURCHASE OF NEGOTIABLE INSTRUMENTS
1. Make sure that a demand instrument is not overdue before purchasing it.
2. Make sure that the negotiable instrument has no obvious defects—look for indications that the maker or
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drawer of the instrument might have a valid reason for refusing to pay.
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
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
ENHANCING YOUR LECTURE—
HOW TO 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
as completed. While you are haggling with the person who inserted the unauthorized figure and who may not
subsequent holder in due course.
The danger in signing a blank check is clear. Anyone can write in an unauthorized amount and cash the
CHECKS PAYABLE TO “CASH”
It is equally dangerous to write out and sign a check payable to “cash” until you are actually at the bank.
CHECKS INDORSED IN BLANK
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
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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.
4. Consider obtaining an indorsement stamp from your bank so that when you receive checks you can
TEACHING SUGGESTIONS
1. The concept of negotiability is often confusing to students because it refers to the process by which in-
struments are transferred from one party to another. Ask the class to discuss the process by which
negotiable instruments are transferred. Ask students to play the roles of different parties to a transaction and
some things that are not consideration can be value (such as antecedent obligations or debts).
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
course. To qualify as an HDC, all of the requirements must, of course, be met.
3. When considering whether a specific party is an HDC, students might find it helpful to divide the question
Cyberlaw Link
Is there any part of the HDC concept that would need to be changed to adapt it to an electronic
payment system?
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DISCUSSION QUESTIONS
1. How are instruments negotiated? Negotiation is the transfer of an instrument in such form that the
transferee becomes a holder. If the instrument is an order instrument, it is negotiated by indorsement and delivery. A
2. Why is a transfer by negotiation preferable to a transfer by assignment? In a transfer of an instrument
by negotiation, unlike a transfer by assignment, the transferee (the party to whom the instrument is transferred) not
3. What is the difference between qualified and unqualified indorsements? A qualified indorsement is one
which contains words disclaiming the indorser’s contractual liability (but not warranty liability) on the instrument. A
4. What is the difference between a holder and a holder in due course? A holder is a person who pos–
sesses a negotiable instrument drawn, issued or indorsed to him or his order or to bearer or in blank. To be a holder,
5. How can a holder take an instrument for value? Under UCC 3–303(a), a holder can take an instrument for
value by (1) performing the promise for which the instrument was issued or transferred, (2) acquiring a security
6. In what situations can a holder take an instrument for value but still not be accorded HDC status? In a
few exceptional circumstances, a holder can take an instrument for value but still not be accorded HDC status. UCC
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7. What is good faith? For purposes of revised Article 3, good faith is “honesty in fact and the observance of
8. What kinds of defects in an instrument will prevent a holder knowing about those defects from acquir-
ing HDC status? A person will not be afforded HDC protection if he or she acquires an instrument knowing, or
9. What are some of the circumstances that, as a matter of law, constitute notice of a particular fact in
commercial law? A holder has notice of a defective instrument if he or she has (1) actual knowledge of the defect;
10. 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
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
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,
CHAPTER 26: TRANSFERABILITY AND HOLDER IN DUE COURSE 15
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 instrument 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.”
Under the previous version of this provision [UCC 3–116], if an ambiguity existed as to whether multiple
payees were intended as joint or alternative payees, they were deemed joint payees. Earlier versions of alternative
and joint payee statutes were less clear. Other than negotiation, what is the significance of the UCC provision at
If a stacked payee designation was considered unambiguous and payable jointly before the amendment
of this provision of the UCC, should that same payee designation be considered unambiguous after the
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 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
Does a drawer who acts as Westport did—consulting with, and delivering the first two checks to, the
Graveses—create an ethical obligation with respect to the delivery of the third check? Why or why not? Yes,
because the Graveses depended on Westport, with whom they came to terms about the cost of the reconstruction, to
Is there a method, other than payment, that would have discharged Westport’s obligation as the drawer
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