It is anticipated that negotiable instruments
will be transferred to an intermediate transferee one of more times before
payment is due. The transfer of notes is
huge business in the United States, particularly in the mortgage industry. These transfers are quite different than the
ones discussed previously which have been transfers of notes between
individuals or small businesses. The
mortgage industry often involves transfers of notes with mortgages in large bundles
of hundreds or thousands of notes, dramatically changing the dynamic of the
historical typical transfer of a negotiable instrument.
Given the
superior rights given to the ‘holder in due course’, one should expect that the
circumstances under which this legal status is obtained must conform to sound
commercial policy. Consistent with
general Uniform Commercial Code policy, one can expect that the circumstances
must comport to criteria which facilitate commerce while at the same time, protect
the integrity of the market place.
We have
discussed the first three elements required for HDC status—there must be a
‘holder’; the writing must be a negotiable instrument; the writing must appear
regular on its face.
Once
the first three elements are in place—the remaining criteria can be
examined. These are simple: ‘value’ must
be given for the instrument; the instrument must be taken in ‘good faith’; the
instrument must be taken ‘without notice’ of any claims or defenses to the
instrument. Each of these terms is
defined under the Code.
Value is defined under Section 3-303
as follows:
(1) the instrument is issued or transferred for
a promise of performance, to
the extent the promise has been performed;
(2) the transferee acquires a security interest or other lien
in the instrument other than a lien
obtained by judicial proceeding;
(3) the instrument is issued or transferred as
payment of, or as security for, an antecedent claim against any person, whether
or not the claim is due;
(5) the instrument is issued or transferred in
exchange for the incurring of an irrevocable obligation to a third party by the person
taking the instrument.
The giving of value for an instrument is not
complicated. For purposes of this
initial discussion, value can simply be thought of as the payment of money for
the instrument, using the instrument as collateral, or performing an agreed
task for the instrument, such as painting the obligor’s house in exchange for
the instrument.
It is the
two remaining requirements that create difficulty and challenges. First among these is our old friend ‘good
faith’. The distinction between the amended version and unamended version of
Article 1 has great significance here.
Remember, under the unamended version, ‘good faith’ means ‘honesty in
fact in the conduct and transaction concerned’, while under the amended
version, the good faith requirement further requires ‘the observance of
reasonable commercial standards of fair dealing’.
Special
Note
It is
particularly significant that New York, clearly the most active and
sophisticated financial market in the United States, recently enacted most of
revised Article 1, but chose to retain the ‘honesty in fact’ version of good
faith. Of equal and perhaps greater significance
for purposes of the discussion of negotiable instruments, is the fact that New
York has not enacted the 1990 version of Article 3, joined by South Carolina as
the only two states to have not done so. Hence, good faith in matters
pertaining to negotiable instruments does not incorporate ‘reasonable
commercial standards of fair dealing in the trade’ as would be the case in
other jurisdictions which have not enacted the amended definition contained in
Article 1, but which have enacted the amended version of Article 3 which does
incorporate ‘reasonable commercial standards of fair dealing’ for purposes of
good faith under that Article.
We therefore find ourselves in the
following situation in New York: the
definition of ‘good faith’ under Article 1 is ‘honesty in fact in the conduct
or transaction concerned’; the definition of ‘good faith’ under Article 3 in
New York is ‘honestly in fact in the conduct or transaction concerned’. Hence, one can become a holder in due course
in New York without being required to observe ‘reasonable commercial standards
of fair dealing’. While this may be a
just result when only one of the parties is a nonprofessional, the same
policies do not apply if both parties are professionals. Regardless, the law in New York on ‘good
faith’ requires only honesty in fact.
The significance of this will be explored when cases are discussed.
Finally, for a party to become a holder in due
course, he or she must not be on notice of anything stated in Section
3-302(a)(2)(iii). Hence the instrument
must be taken:
(iii)
without notice that the instrument is overdue or has been dishonored or that
there is an uncured default with respect to payment of another instrument issued as part of the same
series, (iv) without notice that the instrument contains an unauthorized
signature or has been altered, (v) without notice of any claim to the instrument
described in Section 3-306, and (vi)
without notice that any party has a defense or claim in
recoupment described in Section 3-305(a).
The gist of Section 3-302(a)(2)(iii) is
that the purchaser of the instrument has no notice of anything that would call
the ultimate enforceability of the note into question. Which brings us to the basic question of
‘notice’, a pervasive concept throughout the UCC.
Notice and related definitions are defined under
Section 1-202. Notice itself is
specifically defined in Section 1-202(a):
(a)
Subject to subsection (f), a person has "notice" of a fact if the
person: (1) has actual knowledge of it; (2) has received a notice or
notification of it; or (3) from all the facts and circumstances known to the
person at the time in question, has reason to know that it exists.
It is clear, as stated in Subsection 1-202(a) that a person has ‘notice’
of a fact if he or she has actual knowledge of the fact in question. The question of when a person has received
notice or notification stated in Section 1-202(a)(2) is answered in Section 1-202(e):
Subject to subsection (f), a person "receives" a notice or notification when: (1) it
comes to that person's attention; or (2) it is duly delivered in a form
reasonable under the circumstances at the place of business through which the contract was made or at
another location held out by that person as the place for receipt of such
communications.
Section
1-202(e)
Person is
defined under Section 1-201(b)(27)
"Person"
means an individual, corporation, business trust, estate, trust, partnership, limited liability company,
association, joint venture, government, governmental subdivision, agency, or
instrumentality, public corporation, or any other legal or commercial entity.
(f) Notice, knowledge, or a notice or notification received
by an organization is effective for a particular
transaction from the time it is brought to the attention of the individual
conducting that transaction and, in any event, from the time it would have been
brought to the individual's attention if the organization had exercised due
diligence….
Once again, we see the focus on the behavior of the person or entity
giving notice, rather than the actual receipt of notice. Once certain steps have been taken, notice is
deemed given and received even if it is not actually received:
(d) A person "notifies" or "gives"
a notice or notification to another person by taking such steps as may be
reasonably required to inform the other person in ordinary course, whether or
not the other person actually comes to know of it. Section 1-202(d)
The
final way in which a person can be held to have notice is stated in Section
1-202(a)(3). Under that section a person
has ‘notice’ of a fact if the person:
from all the facts and circumstances known to
the person at the time in question, has reason to know that it exists.
This relatively simple language raises many questions. First, does a subjective or objective
standard apply? Does the amended
definition of ‘good faith’, and the universal obligation to act in good faith
under Section 1-304 minimize the importance of the objective/subjective
standard by requiring that all duties under the Code require the observance of
reasonable commercial standards of fair dealing? There is ample case support for both the
objective and subjective standard, and good policy arguments as well.
____________________________________________________________________________
As of this post, we
have established the basic requirements to establish negotiability under
Section 3-104 and related sections. This
was done to create a basis for discussing the transferability of negotiable
instruments in the commercial setting, and hence to give a context in which to
access the value and importance of negotiable instruments. We know that if the writing is negotiable,
and taken by a holder in ‘good faith’, for ‘value’ and without notice of a
claim or defect to the instrument, the taker will become a holder in due
course, and cut off all personal defenses on the instrument per Section
3-305(2).
With this basic
foundation, the next two posts will discuss cases which bear on the issues
discussed. For those seeking to learn
this material, I suggest a review, in sequence, of the statutory provisions of
Article 3 covered to date.
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