By negotiation, an instrument is transferred in such a form that the transferee becomes a holder. The holder, at the very least, receives the rights of the previous possessor. Unlike assignment, a transfer by negotiation can make it possible for a holder to receive more rights in the instrument than the prior possessor had. The holder who receives greater rights in known as a holder in due course.
We will see, first, how a person becomes a holder and then examine the qualifying requirements to give him a holder in due course status.
Generally, a person becomes a holder of a negotiable instrument if he acquires it through the rules of negotiation. He is said to be a holder of a bearer instrument if he is in possession of that instrument. The criterion to be a holder of a bearer instrument as indicated in Art 725(2) is “Sole fact of presentment” Possession and fact of presentment each convey the message that a person will be able to present an instrument to the drawee or maker provided he is in possession of that instrument.
If the type of instrument is order instrument it can be said that A person becomes holder of that instrument provided he had it under his possession and his name is specified on it either as a payee or an endorsee.
- Gebeyehu will be a holder of a bill issued as “pay to Gebeyehu Mola or order” because his name is specified and he is that specified person.
- Gebeyehu endorses the above instrument as
“pay to Fatuma or order”
Gebeyehu Mola (signed)
If Fatuma is in possession of such instrument she is the holder because her name is specified as endorsee and she is that specified person.
The commercial code in determining holder of an order instrument does not expressly employ the test of “possession” plus “specified name.” Article 724(2), which is a general provision and similar with Art 751 and Art 847 makes a person holder of an order instrument if his right could be established through “uninterrupted series of Endorsement.”
Possession as an additional requirement is not mentioned in the code. However one should take it as an implied requirement because no one becomes holder of either bearer or order instrument with out actually possessing it.
“Series of endorsements” implyies the previous history of negotiation and it should be uninterrupted. For instance, hen one of the endorsement is forged or unauthorized the series of endorsement should be taken as interrupted.
- A bill of exchange issued as “pay X or order” is endorsed on the back in the following sequence.
- ———– X (signed)
- ———– [ Pay to Kelemua or order
- ———– [ Pay to Kebebush or order
- A promissory note issued payable to X or order was endorsed on the in the following sequence.
1.————– [ Pay Tilahun or order
2. ————- [ pay Tefaye or order
Pay Fitun or order
In the above two examples there is no series of interruption in the first case, hence the last endorsee i.e. w/o Kebebush if she is in possession of the instrument will become the holder. In the second example, there is interruption on the last endorsement. It was endorsed by Zinabu to Fitun, Zinabu is an outsider. There is no way he could negotiate it by endorsement. The last person to endorse it is Tesfaye. For this reason, Fitun, even though he is in possession of that promissory note could not qualify as a holder. However, if the last endorsement was in blank. (Article 724(2), 751,847), the last possessor be it Fitun or any other person becomes a holder. Blank endorsement converts the order instrument into bearer and it could simply be negotiated through delivery. For the purpose of determining liability, a person who acquires an instrument lastly endorsed in blank will be presumed to acquire it through blank endorsement.
A cheque was issued payable to Tibebu or order. Tibebu negotiates it using special endorsement to Tewodros. Tewodros again using the same special endorsement endorses it to Ayelu. Ayelu, then using blank endorsement negotiates it Hana. Now the order instrument is converted to bearer. Let’s say Hana, by delivering it to Thomas has negotiated it to him. Thomes got the cheque through delivery only. Since the last endorsement is in blank he will be presumed to have acquired it through the last blank endorsement from Ayelu. This legal presumption creates a legal relationship between Ayelu and Thomas, hence making her liable to him as an endorser.
Holder in due course
A holder in due course is a special type of holder. A person who qualifies as a holder in due course of a negotiable instrument gets special rights. The advantage lies in the fact that while acquiring the instrument, he takes it free of personal defenses and claims to the instrument.
In order to qualify as a holder in due course, a person must meet some legal requirements. The provisions of the commercial code, which talk about a holder in due course, dooe not expressly enumerate legal requirements for such status. Art 718 generally requires that the person should get the instrument in due course and in accordance with the rules applying to negotiation. There is also the requirement of good faith or knowledge in Art 717(3), 752 and 849. Actually this later provisions refer to the advantages of being a holder in due course rather than determining such status.
Requirements for holder in due course status
Due to lack of clarity in the commercial code it is very essential to have a brief overview of requirements for a holder in due course under the uniform commercial code [U.S.]. Accordingly, a person to become a holder in due course, he must be a holder, and take the instrument for value, in good faith and with out notice. The meaning of holder has already been explained. A holder in due course is a special type of holder. Therefore, a person should first become a holder before qualifying as a holder in due course.
To qualify as a holder in due course of a negotiable instrument a person must give value for it. A person who receives an instrument as a gift or who inherits it has not met the requirement of value. The concept of value here is not identical with consideration in the law of contracts. Negotiation of an instrument for a promise to give value in the future does not fulfill the requirement of taking it for value. For instance a cheque payable to X or order was endorsed to Z by X. Z while taking or acquiring the instrument promised to pay x the value of the cheque after 5 days or let’s assume he has promised to give him a golden watch. In this case until the promise is actually performed, there is no value given to the instrument and the holder can not qualify as a holder in due course. In addition to performance of promise, value will be presumed to be given when the holder takes an instrument by acquiring a security interest, by taking it in payment of an antecedent debt (a preexisting claim) by taking a negotiable instrument as a payment for a certain transaction, by giving a negotiable instrument as payment etc.
To qualify as a holder in due course of a negotiable instrument, a person must take it in good faith which means that the person should obtain it in the observance of reasonable commercial standards of fair dealing. Acquiring an instrument by trickery or with knowledge that it has been stolen does not give the status of holder in due course to that person. Because, there is no good faith acquisition. The good faith requirement applies only to the holder. It is immaterial whether the transferor acted in good faith. Thus, a person who in good faith takes a negotiable instrument from a thief may become a Holder in due course.
Taking without notice
Notice is one of the basic requirements for a holder in due course status. A person will not be afforded holder in due course protection if he or she acquires the instrument knowing, or having reason to know, that it is defective. Notice of a defective instrument is given whenever the holder has (1) actual knowledge of the defect; (2) received notice about a defect, or (3) had reason to know that a defect exists. Such defect may exist in any one of the following ways.
A negotiable instrument has its own maturity date. Expiry of the due date or time of payment renders such instrument overdue. With regard to cheques and instruments payable at sight or on demand, they become overdue if the time of presentment for payment elapses. A person who acquires overdue instruments could not qualify as holder in due course.
To be a holder in due course a person not only must take it before he has notice that it is overdue but also must take it before it has been dishonored. A negotiable instrument has been dishonored when the holder has presented it for acceptance or payment and such acceptance or payment has been refused. Thus, a person who takes a check clearly stamped “insufficient funds” is put on notice.
Defenses against or claims to an instrument
A holder cannot become holder in due course if he or she has notice of any claim to the instrument or defense against it. For instance, if the instrument is incomplete on its face to call into question its authenticity or if the holder knows it was completed contrary to the instruction given by the maker or drawer, he could not qualify as holder in due course. Similar any irregularity on the face of the instrument that calls in to question its validity or terms of ownership or creates an ambiguity as to the party to pay will bar HDC status. Notice of voidable obligations is also another reason a holder may not get a HDC status. A purchaser who knows that a party to an instrument has a defense that entitles that party to avoid the obligation cannot qualify as an HDC. At the very least, good faith requires honesty in fact and the observance of reasonable commercial standards of the purchaser in a transaction.