QUESTION: Bill BUYER executes a $1,000 promissory note and delivers it to Sam Se
ID: 371638 • Letter: Q
Question
QUESTION:
Bill BUYER executes a $1,000 promissory note and delivers it to Sam Seller to pay for certain widgets that he bought for his inventory. Sam properly negotiates the note to First National Bank for $500. They have no knowledge of any problems. After delivery, Bill finds the widgets are defective. He refuses to pay the note. Can he do so? Explain.
Chapter 30 NOTES:
The third step in changing the common law rule of assignments for commercial paper is that the negotiable instrument must be negotiated to a “holder in due course”. A holder in due course is defined in 3-302(2). First of all, the transferee must be a holder. A holder is one in rightful possession of an instrument. Second, the transferee must have given value for the instrument. In this instance, value can consist of what would normally been past consideration for contract purposes. As with consideration rules, the courts will not pass judgment on the amount of value, if some is present. If a holder does not give value, they still might get the rights of a HIDC under 3-203(b). Thirdly, the transferee must take the instrument in good faith. This last requirement is expanded upon with 2 specifics: the holder must be ignorant of any defenses or claims against the instrument and they must not have any notice that the instrument is overdue or been dishonored. However, case law has held that the good faith requirement is broader than the 2 listed specific examples. Subsidiaries may be held not to be in good faith even they do not violate the 2 specifics.
If the 3 steps are met, then the HIDC takes free of most defenses. This is the big change in the common law. Assignees took subject to most defenses. Practically, the only 2 defenses that can be raised against a HIDC are minority (infancy) and bankruptcy (3-305(a)(1)). Alteration may be a partial defense. In all other cases, the maker of a note with a good defense would still have to pay the HIDC and seek recovery from the person whom he dealt with, such as the seller. This rule means that if a consumer signs a note because he has been defrauded and the seller skips town after negotiating the note to a bank/ HIDC, between two innocent parties, the consumer loses and the bank wins. The Federal Trade Commission (FTC) has changed that rule to protect consumers. If the transaction involves consumer goods or services, the FTC has done away with the HIDC rule. However, it is still the law for business transactions involving inventory and equipment.
The HIDC issue looked at liability from the standpoint of the maker or drawer raising a defense against the holder. What if the holder wants to sue on the instrument because they have not been paid? Who will they try to hold liable? The maker of a note and the drawer of an unaccepted draft always have primary liability if the instrument is not paid. (CONTRARY TO WHAT THE BOOK SAYS, DRAWERS USUALLY HAVE PRIMARY LIABILITY). In addition, if a drawee accepts the draft they become an acceptor, who is also a primary party for liability purposes. Primary parties are liable without any prerequisites. Endorsers have secondary liability as we saw in the last chapter. In addition, drawees have secondary liability once there is an acceptor. However, secondary parties only have liability if there is a presentment under 3-501, dishonor under 3-502 and they are given notice of dishonor under 3-503 or it excused under 3-504. If notice is required, it must be given by banks before midnight of the next banking day after dishonor. For individuals, it must be within 30 days. A person who has liability on the instrument (primary or secondary) is discharged if the instrument is paid (3-602) or the holder cancels the instrument (3-604). A discharge on an instrument also discharges any underlying debt (3-311(a)). Holders of an instrument, which is backed by collateral discharges endorsers and accommodation parties to the extent the holder may impair the collateral (3- 605(d)), by not selling the collateral promptly or selling it for an unreasonable price. This might be raised as a defense to an action for a deficiency judgment, which we will talk more about in Chapter 34.
Explanation / Answer
He cannot do so , business transactions involving inventory , it means that if a consumer signs a note because he has been defrauded and the seller skips town after negotiating the note to a bank/ HIDC, between two innocent parties, the consumer loses and the bank wins.