BUSINESS LAW 101
By Albert L. Kelley, Esq.
What is a Holder in Due Course
Last week we discussed that the holder of negotiable instrument has the right to require payment of the negotiable instrument. But what if the primary party (either the maker or the acceptor) refuses to pay? In this situation, the item is said to be dishonored. If the item has been dishonored, the maker still retains liability based on their signature. However, secondary parties, such as people who endorse a check to another person, are only liable if the presentor gives them proper notice. If this notice is not given, the secondary parties will not be liable for the dishonored instrument.
Once the note has been dishonored, it may be uncollectable by the holder. This is where the “favored holder” comes in. A favored holder has certain rights over and above those of a mere holder and certain defenses that can be raised against a holder will not be allowed against a favored holder if he attempts to enforce the note.
To be a favored holder, you must be either a holder in due course (also known as a bona fide purchaser) or a holder through a holder in due course. To be a holder in due course you must meet four requirements. First, you must give value for the purchaser of the negotiable instrument. This doesn’t mean money; it may be money or goods or service. You can also give value by using the note as security for a debt or by receiving it as payment for a prior or current debt. It generally doesn’t matter what the value is, so long as there is value (however, if the value is too low, the Court may find that the transfer was made in bad faith and therefore there is no value). The value must be actual and must have been actually paid. A promise of future payment will not suffice.
Second, the buyer must act in good faith. Generally, good faith simply means that the person buying the paper is acting for proper purposes and is dealing honestly with the salesperson. If the buyer is acting in good faith, it doesn’t matter if the seller is.
Third, the buyer must not know that the paper is overdue or has already been dishonored. While paper can still be transferred under these circumstances, if the buyer knows this, he is not a buyer in due course.
Finally, the buyer can’t know about any defenses or adverse claims against the paper. If there is notice of any potential defenses or claims prior to the purchase of the negotiable instrument, the buyer is not in due course. If, however, the buyer learns of defenses or claims after the purchase, they will remain a holder in due course. This status is based on the knowledge at the time of purchase.
A buyer can also be a holder through a holder in due course. This simply means they have purchased the paper from a holder in due course. A holder through a holder does not need to follow all of the requirements of a holder in due course. He may receive the paper without giving something of value, or he may know of defenses or claims. So long as he is not a party to fraud or illegality that affects the paper, he will have all the protection that a holder in due course receives.
Why would a person buy a note if they know it has been dishonored or that there are defenses against it? Well, it allows a buyer to pay a much lower amount (sometimes pennies on the dollar) and then attempt to foreclose on the debt. If they prevail in Court they can then seize assets of the debtor necessary to pay off the paper. If they don’t prevail, they have only paid a small amount for the debt.
Al Kelley is a Florida business law attorney located in Key West and previously taught business law, personnel law and labor law at St. Leo University. He is also the author of “Basics of Business Law” and “Basics of Florida’s Small Claims Court” (Absolutely Amazing e-Books). This article is being offered as a public service and is not intended to provide specific legal advice. If you have any questions about legal issues, you should confer with a licensed Florida attorney.
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