Holder in Due Course

Holder In Due Course

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Holder In Due Course Holder In Due Course Introduction Exchange of goods and services is the basis of every business activity. Goods are bought and sold for cash as well as on credit. All these transactions require flow of cash either immediately or after a certain time. In modern business, large number of transactions involving huge sums of money takes place every day. It is quite inconvenient as well as risky for either party to make and receive payments in cash. Therefore, it is a common practice for businessmen to make use of certain documents as means of making payment. Some of these these documents documents are called called negotiable negotiable instruments instruments.. A Negotiabl Negotiable e Instrument Instrument is a piece of paper which entitles a person to a sum of money and which is transferable from person to person by mere delivery or by endorsement and delivery. The person whom it is so transferred becomes entitled to the money and also to the right to further transfer it. The principle principle relating relating to the transfer transfer of property is that no one can become the owner owner of any property property unless he purchases it from the true owner. The maxim of law is nemi dat non-habet(no non-habet (no one can transfer a better title than he himself has). Negotiable Instruments however constitute an exception to this principle, for a person, who takes a negotiable instrument in good faith and for value becomes the true owner even if he takes it from a thief or finder. Every instrument initially belongs to the payee and he is entitled to its possession. The payee can transfer it to any person in payment of his own debt. This transfer is known as ‘negotiation’. Negotiation takes places in two ways. A bearer instrument passes by simple delivery and the person to whom it is delivered becomes the holder. An order instrument on the other hand can be negotiated only by endorsement and delivery and the endorsee becomes the holder. According to the Negotiable Instruments Act, 1881 there are just three types of negotiable instruments i.e., promissory promissory note, bill of exchange exchange and cheque. cheque. However However many other other documents documents are also recognized recognized as negotiable instruments on the basis of custom and usage, like hundis, Negotiable Instruments Instruments treasury bills, share warrants, etc., provided they possess the features of negotiability. Meaning of Holder in Due Course The words ‘holder in due course’ find mention in section 9 of the Negotiable Instruments Instruments Act as “Ho “Hold lder er in due due cour course se”” mean means s any any pers person on who who for for cons consid ider erat atio ion n beca became me the the poss posses esso sorr of a promissory promissory note, note, bill of exchange exchange or cheque cheque if payable payable to bearer, bearer, or the payee or indorsee thereof thereof,, if before before the amount mentioned mentioned in it became payable, payable, and without having having sufficient sufficient cause to believe believe that any defect existed in the title of the person from whom he derived his title.” The phrase holder in due course shortens shortens considerably considerably the English English Equivalen Equivalentt “bonafide holder for value without notice”. The definition contained in section 9 of the Negotiable instruments Act, 1881 imposes more stringent condition on the holder in due course than the definition in the English law contained in section 29(1) (b) of the Bill of Exchange Act, 1882. Numerous courts have articulated this theory of the function of the holder in due course doctrine. In the 1

landmark landmark case of Unic Unico o v. Owen Owen , for exampl example, e, the the New New Jersey Jersey Supre Supreme me Court Court stated stated:: “The “The basic basic philosophy of the holder in due course status is to encourage free negotiability of commercial paper by removing certain anxieties of one who takes the paper as an innocent purchaser knowing no reason why the paper is not as sound as its face would indicate.” The doctrine says that a party who acquires a negotiable instrument in good faith, for 10.30, and without notice of certain facts, and who also meets some additional requirements, takes the instrument free of competing claims of ownership and most defenses to payment. The doctrine thus may relieve a party acquiring a check or note from worries that anyone else owns the instrument or that its maker will have particular legal grounds for refusing to pay it. For example, suppose that a person borrows money from a bank to buy a house and makes a note promising to repay the loan. The bank might later sell the note to an investor. If the note meets the formal requisites of a negotiable instrument, and the investor purchases the instrument in good faith and for value and without notice of various potential problems, the investor may qualify as a “holder in due course.” The investor then will have

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Page 2 assurance that no one else can claim an interest in the note, even if the bank has purported to sell the note to someone else. I. CONDITIONS FOR BECOMING HOLDER IN DUE COURSE A person claiming to be ‘holder in due course’ must show: (i) That for consideration he became the he possessor of a negotiable instrument when it is payable to the bearer or the payee or endorsee thereof when it is payable to order.

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(ii) that he became the holder of the instrument before the amount mentioned in it became payable. (iii) that he became the holder of the instrument, without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title. Consideration It is essential that who claims to be a holder in due course must show that he acquired the instrument for 3

valuable and lawful consideration. The consideration must be so as considered valuable under the law. It can be either positive in that it requires something to be done or either negative in that forebears something to be done. The consideration should have passed at the desire of the promisor. It is also necessary that the consideration should be lawful ie it should not be forbidden by law, fraudulent, immoral or opposed to public policy and should not cause any injury to the person or property of another.

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Under the Indian Law, an

agreement in which the consideration or object is illegal, immoral or against public policy, is not a contract and money due or paid under such an agreement cannot be recovered by a suit. Consideration for a note or Bill can, however operate as such only once, and when it has so operated for once, it is spent and cannot be used for another and subsequent promise. A single consideration cannot support an indefinite series of subsequent and independent promises or contracts.

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Consideration for a negotiable instrument may

however appear in various ways. Thus a person who discounts a bill is a holder for value and if he satisfies the other requirements of the section, he will be holder in due course. If a bill is discounted with a bank and is indorsed and delivered over to it, the bank becomes an endorsee for value. Where a holder of a bill or note has a lien upon it, he is a holder for consideration to the extent of the advance for which he has a lien.

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Under section 2(d) of the Contracts Act past consideration is a good consideration and will support a negotiable instrument. An antecedent debt or liability is sufficient to constitute a valuable consideration for a 7

negotiable instrument. Consideration being necessary to support the title of a holder in due course it follows that a donee of a negotiable instrument is not a holder in due course and he cannot maintain an 8

action against the donor on the instrument. The reason for this being, if the donor is not holder in due course, the donee merely succeeds to the rights of his transferor. However if the donor is holder in due course, by virtue of the rule contained in s 53 of the Act viz, that a holder without value of a negotiable instrument who derives his title from a holder in due course has the rights thereon of that holder in due course, the donee ipso facto acquires all the rights of the holder in due course. Though valuable consideration is necessary for the validity of a bill or note, the court will go into the 9

question of the adequacy of such consideration. However where the bona fides of the transaction is impeached, the extent of the consideration given is a factor that the court will consider in determining the 10

question of bona fides. The question whether the consideration for negotiable instrument is adequate cannot be subject matter of controversy in the suit when once it is admitted that the negotiable instrument has been executed by the defendant and there was some consideration for it. It is further necessary that in return for a consideration, the holder must become (i) the possessor of the instrument if it is payable to the bearer; or (ii) the payee or indorsee of the instrument, if it is payable to the order. Also in the latter case, his title must be completed by indorsement and delivery of the instrument to him, as no contract on a 11

negotiable instrument is complete without delivery. Before the Amount Became Payable The second essential aspect of the time of acquisition of negotiable instrument by the person who claims to be a holder in due course. The section says that the holder must have become the possessor of the instrument before the amount mentioned in it became payable. Therefore a person who takes a bill or note on the day on which it became payable cannot claim the rights of a holder in due course, because he takes it after it becomes payable, as the bill or note can be discharged by payment at anytime on that day. There is some difficulty in applying the words ‘before the amount mentioned in it became payable’ to cheques and demand bill since they are payable immediately. The words ‘before it was overdue’ appearing in section 29(1) of the Bills of Exchange Act 1882 are preferable.


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Page 3 The fact that a promissory note payable on demand has been outstanding for a long period at the time of negotiation to the holder does not necessarily debar him from claiming as a holder in due course, since according to custom and practice, a promissory note payable on demand is treated as a continuing 12

security. A person who takes a negotiable instrument after the date of maturity cannot be holder in due course, and the rights of such holder are coextensive only with those of his immediate transferor. Several English decisions have established the principle that, as between the immediate parties to a bill of exchange, fact that the defendant may have a counterclaim for unliquidated damages arising out of the same transaction is no defence against an action on a bill of exchange. Also there is no ground on which he can be granted a stay of execution of the judgment in an action for the proceeds of the bill. holder in due course of a post-dated cheque.

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There can be

Without Having Sufficient Cause to Believe That Any Defect Existed I n The Title Of The Person From Whom He Derived His Title There are some minor differences between the Indian Law and the English Law on the subject. (i) English Law The only question to be considered is that whether the holder took the instrument in good faith and once it is proved that he did so, he is entitled to all the rights of a holder in due course notwithstanding that he was careless., that he made no enquiry, that he was informed of facts which would have led a reasonable man to make further inquiry, provided, however, that he had no notice of any defect in the transferor’s 14

title. Section 90 of the Bill of Exchange Act states that : ‘…a thing is deemed to be done in good faith within the meaning of this Act, where it is in fact done honestly, whether it is done negligently or not.’ Accordingly no man should be deemed to be a bona fide holder of a negotiable instrument, if at the time of taking it, he suspected that some wrong was perpetrated by the person with whom he was dealing, but did not make reasonable inquiries to get the suspicion cleared. It is not necessary that the a holder should have actual knowledge of what the particular wrong was, and if he, suspecting that there is something wrong, avoids inquiry, lest he should come to know of any defect in the title, he cannot be deemed to acting honestly. (ii) Indian Law As regards the Indian Law, prior to the passing of the Act, it was held by the Privy Council, relying upon English Decisions that the defective title of the transferor would not attach to the transferee merely because 15

of the latter’s negligence. However under Act the words used are ‘…without having sufficient cause to believe….’ Therefore the legislature seems to have intended to make due care and caution on the part of the holder, a test of his bonafides, and that mere good faith on his part would not suffice. Accordingly, it seems negligence on the part of the holder at the time of taking a negotiable instrument, would disentitle him to the rights of a holder in due course. There will be a sufficient cause to believe in the existence of defects if the holder was in fact negligent or careless, though he was acting honestly and in good faith. Thus a transferee, neglecting to avail himself of any means at his disposal to detect he defects in the title of the transferor, cannot claim to be a holder in due course. Under the Indian Law it is not enough to show that the holder acquired the instrument honestly, if in fact, he was negligent or careless 16

The Supreme Court in U Ponappa Moothan and Sons v. Catholic Syrian Bank Ltd held that the Indian definition of ‘holder in due course’ imposes a more stringent condition than the English Decision. The Indian definition requires that he should act in good faith and with reasonable caution. The court agreed with the Allahabad High Court’s decision in Durga Shah Mohan Lal Bankers v. Governor General in Council

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that

mere failure of the plaintiff to prove bona fides or absence of negligence on his part would not negative his claim as a holder in due course. However the Supreme Court added that, if in the circumstances of a given case, there was patent gross negligence on his part, it could negate his claim for he could not negligently discard a ‘red flag’ which aroused suspicion regarding the title. There are many circumstances due to which an honest holder may have sufficient cause to believe that there is something wrong with the instrument he is taking. E.g. if there is an irregularity patent upon the face of the instrument, it puts the holder on the guards, and if ion spite of such irregularity he takes it, he does so, at his own peril. As the instrument itself carried the warning the rule of caveat emptor applies. However the fact that a cheque is post dated does not make it irregular so as to preclude a bonafide purchaser of the instrument from claiming the rights of a holder in due course.

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Another circumstance that sought to put an honest an honest holder on his guard is inadequacy of consideration. As a general rule courts do not inquire into the adequacy of consideration given bona fide. Though neither adequacy not inadequacy of consideration by itself is conclusive of holder’s good faith or lack of it, sometimes inadequacy may leave no doubt that the bill was not taken in good faith and sometimes adequacy may alone be sufficient to establish good faith. II. CONDITIONS AGAINST BECOMING HOLDER IN DUE COURSE


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Page 4 A person would not be called to be a holder in due course if the transaction comes under any of the following heads: 1. Notice of Defects If, at the time the holder acquires his title as such, he has sufficient notice that a defect exists in the title of his transferor, he is not a holder in due course. Notice means knowledge of the facts or a suspicion that something is wrong combined with a willful disregard of the means of knowledge. Notice of defects may be either actual or constructive. All circumstances in connection with the transaction, whereby the holder became the owner of the instrument, have a bearing on the question whether he had sufficient cause to believe that any defects existed in the title of his transferor. The ordinary rules of principal and agent apply. 19

In Mehrunissa Begum v. Sheik Chand Bi a prize money winning subscriber to a chit fund executed a promissory note in favour of the chit fund company as collateral security for the due payment of future monthly installment payable by him to the company. Two sureties signed the note. It was transferred to the plaintiff, another subscriber, with an endorsement purportedly made by the chairman of the company. In an action by the plaintiff against he maker of the note and the sureties, it was held that the plaintiff was not a holder in due course. It was held that she should have known that it was offered as a collateral security. The time when notice affects the title of a holder is when he takes the instrument, for it is then that his relation to the bill is formed; notice received subsequent to perfecting his title will not affect his title or his right o sue upon it. 2. Irregular Endorsement If a cheque is not indorsed in favour of the purchaser, he does not become holder in due course.

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Where

Bill was drawn in favour of AB & Co., but was indorsed AB, without the addition of the words ‘& Co.’. it was held that the endorsement was irregular and that the endorsee was not holder in due course, though he might be a holder for value. Titles and descriptions can often be omitted without impairing the regularity of the endorsement, but the word company is one of considerable legal significance and its omission makes the allotment irregular.

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3. Forged Endorsement It is an established rule that forgery conveys no title. Hence there can be no holder in due course under a forged endorsement. III. RIGHTS AND PRIVILEGES OF HOLDER IN DUE COURSE Presumptions The first privilege is that every holder is deemed prima facie to be a holder in due course. The burden of proving his title does not lie on him. If the defendant intends to set up the defence that there was something wrong in the inception or subsequent negotiations of the bill the burden of proving that lies on him. Once it is shown that the history of the bill is tainted with fraud or illegality the burden is shifted to the holder to prove that he is a holder in due course.

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Fictitious Drawer or Payee [Section 42] The acceptor of the bill of exchange cannot, as against the holder in due course, say that the other parties to the bill were fictitious Section 42. Acceptance of bill drawn in fictitious name - An acceptor of a bill of exchange drawn in a fictitious name and payable to the drawer’s order is not, by reason that such name is fictitious, relieved from liability to any holder in due course claiming under an endorsement by the same hand as the drawer's signature, and purporting to be made by the drawer. 23

The leading authority on this proposition is Bank of England v. Vagliano . Vagliano used to accept bills of exchange drawn on him by a foreign agent and payable to a foreign firm. Vagliano’s clerk who used to handle his correspondence, obtained from time to time Vagliano’s acceptance on false bills. He endorsed in the name of P& Co. and obtained payment at the counter of Bank of England. The bank debited Vagliano’s account accordingly. On discovering the fraud he contended that all such bills were fake made without any consideration, the signatures being forged, the banker could not get good title to the bills. But it was held that the banker being a holder in due course, was protected against all such defences. The words ‘fictitious payee’ mean a person who is not in existence, or being in existence, is never intended by the drawer to have the payment. Where the drawer intends the payee to have payment, then he is not a fictitious payee and the forgery of his signature will affect the validity of the cheque1 Thus in North and 24

South Wales Bank v. Macbeth W induced M by fraud to draw a cheque payable to K or order. W obtained the cheque, forger K’s endorsement and collected proceeds of the cheque through his bankers. The collecting banker was held liable as K’s title was derived through forger endorsement. K was not a fictitious


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Page 5 payee because the drawer intended him to receive the payment. The result would have been different if the payee was not a real person or was not intended to have the payment. Prior Defects [Sec.58] The party liable to pay an instrument cannot, as against a holder in due course, contend that he had lost the instrument or that it was obtained from him by means of an offence or fraud, or for an unlawful consideration. In a case before the Kerala High Court, a cheque was given to an employee of a company to enable him to withdraw money for payment of workmen’s wages. He instead transferred the cheque to a bank for consideration. The bank having acted in good faith, was held to be not affected by the employee’s fraud. Holder deriving title from holder in due course [Sec. 58] Section 53 states that: H o l de r d e r i vi n g t i t l e f r o m h o l d er i n d u e c o u r se - A holder of a negotiable instrument who derives title from a holder in due course has the rights thereon of that holder in due course. A holder who receives an instrument from a holder in due course gets the rights of the holder in due course, even if he had knowledge of the prior defects, provided that he was not a party to them. In a case 25

before the Bombay High Court where it was alleged that the holder, who had received the hundi from a holder in due course, had himself given no consideration, the court held that under section 118 the presumption is in the favour of the holder in due course; and under Section 53 of the Act any subsequent holder whether for or without consideration stands in his shoes and can enforce his rights against the drawer. This will apply to the case of a drawer also who has received back his bill from a holder in due course. CONCLUSION The standard justification for immunizing a holder in due course from claims and defenses is that the immunity will encourage beneficial commercial transactions. For instance, in the example above, the doctrine arguably encourages the investor to buy the note from the bank, and thus makes the bank more willing to lend money to the homeowner. The standard explanation for the various requirements for attaining holder in due course status--good faith, value, lacking notice of certain facts--is that these requirements promote fairness and properly limit the incentives that the doctrine creates. There have been arguments that there is no need for such a doctrine, as it can be suitably replaced by “waiver of defense” clause in ordinary contracts. Pursuant to these clauses, parties may specify the precise circumstances under which an assignee of contractual rights takes those rights free from claims and defenses.

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There have been suggestions advanced for an alternative economic justification for the doctrine that takes into account the possibility of using waiver of defense clauses as an alternative to making negotiable instruments. While parties could replicate the doctrine through waiver of defense clauses, the holder in due course doctrine spares them the effort. In this way, the doctrine serves as a default rule that may reduce transaction costs, and thus may promote efficiency. That the requirements for attaining holder in due course status should exist because they probably establish limitations that people who use negotiable instruments want, and that they would include in waiver of defense clauses if they could not make negotiable instruments. The conventional policy argument in favour of the doctrine has been as follows: 1. The Argument that Stripping Claims and Defenses Encourages Commercial Transactions. 2. The Argument that Increased Transactions May Benefit Society. Although the holder in due course doctrine theoretically might have these effects, critics have expressed several reasons for discounting the overall benefit of the doctrine. Many scholars, for example, have argued that the holder in due course doctrine has less value now than it may have had in prior centuries because 27

commercial practices have changed. They argue that despite the theoretical benefits of the holder in due course doctrine, consumers, businesses, and banks now rely on it only in a small percentage of payment transactions. This criticism, if valid, would suggest that legislatures probably have more important topics to worry about than the holder in due course doctrine. The criticism, however, does not undermine the theory behind the conventional policy argument. Even if commercial practices have changed in general, the doctrine still could encourage beneficial transactions in some circumstances. Other critics have argued that the holder in due course doctrine might sometimes encourage transactions for inappropriate reasons. Most significantly, if applicable, the doctrine might make it easier for unscrupulous merchants to defraud unsophisticated consumers.

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For example, merchants might take notes in payment for goods or services,

sell the notes to a holder in due course, and then fail to perform to the consumer’s satisfaction. The holder in due course doctrine would strip away the unwary consumer's defenses, and require the consumer to pay the note.

1 232 A. 2d 405 (N.J.1967)


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Page 6 2 Punjab National Bank v. Himgiri (2004) 1 JCC 1 (P&H). 3 See Section 2(d) of the Indian Contracts Act, 1872. 4 Section 23 of the Indian Contracts Act, 1872. 5 Ramaswami Pandia v. Anthappa Chettiar (1907) 16 MLJ 422. 6 Collins v. Martin (1797) IB & P 648. 7 JMS Pinto v. AC Rodrigues, AIR 1976 Goa 8. 8 Milnes v. Dawson (1850) 5 Ex 948. 9 Section 25 of the Indian Contracts Act. 10 Jones v. Gordon (18770 2 App Cas 616, p.631. 11 Chapman v. Cottrel (1865) 34 LJ Ex 186. 12 Ramanandan Chettiar v. Gundu Aiyyar AIR 1928 Mad 1238. 13 Montecchi v. Shimco Ltd (1980) 1 Llyod’s Rep 50. 14 Jones v. Gordon (18770 2 App Cas 616. 15 Bank of Bengal v. Fagan (1851) 5 MIA 27. 16 AIR 1991 SC 441. 17 AIR 1952 All 590. 18 Royal Bank of Scotland v. Tottenham [1894] 2 QB 715. 19 (1985) 58 Comp Cas 197. 20 Punjab National Bank v. Himgiri, (2004) 1 JCC 1 (P&H). 21 Arab Bank Ltd . v. Ross , [1952] 1 All ER 709. 22 Banku Bihari Sridhar v. Secy of India, (1908) 36 Cal 239. 23 [1891] AC 107. 24 [1908] AC 137. 25 Subrao v. Sitaram, (1900) 2 Bom LR 891. 26 Gregory E. Maggs, The Holder In Due Course Doctrine As A Default Rule, 32 Ga. L. Rev. 783. 27 Ronald J. Mann, Searching for Negotiability in Payment and Credit Systems, 44 UCLA L. REV. 951 passim (1997); James S. Rogers, The Irrelevance of Negotiable Instrument Concepts in the Law of the Check-Based Payment System, 65 TEX. L. REV. 929 (1987); see also James S. Rogers, The Myth of Negotiability, 31 B.C. L. REV. 265, 317-18 (1990); Albert J. Rosenthal, Negotiability--Who Needs It?, 71 COLUM. L. REV. 375, 401 (1971) (concluding that “today, negotiability, and specifically the protections of holders in due course, are not necessary or even helpful in fostering the flow of commerce”); 28 See Vern Countryman, The Holder in Due Course and Other Anachronisms in Consumer Credit, 52 TEX. L. REV. 1, 2-11 (1973) (explaining how holder in due course doctrine presents obstacle to consumer defrauded by merchant); Ralph J . Rohner, Holder in Due Course in Consumer Transactions: Requiem, Revival, or Reformation, 60 CORNELL L. REV. 503, 515 (1975) (noting that holder in due course doctrine has negative consequences for those “victimized by deceptive sales practices, shoddy goods, and inept services”). Total shows: 236 Author: Chandan P Pandey CNLU, PATNA 9570803168 Rating: 3.3 Back to the list 1

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Holder in Due Course

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