Questions & Answers Series

Payment Systems Topics: Negotiable Instruments (Definitions; Holder in Due Course Doctrine)

Negotiable Instruments: Holder in Due Course Doctrine

Question:

A holder in due course takes an instrument free of which of the following defenses?

(A) A defense that making the note was an ultra vires act nullifying the obligation of its corporate maker.

(B) A defense that the maker was tricked into signing the note in the belief that the note was merely a receipt and not a promissory obligation.

(C) A defense that the obligation of the note was discharged by a bankruptcy court.

(D) A defense that the note is voidable at the option of the maker because its making was induced by duress.

Answer:
Answer (D) is the correct answer. The holder in due course doctrine will strip away a defense of duress unless, under applicable law, the defense makes an obligation entirely null and void. §§ 3-305(a)(1)(ii) & cmt. 1; 3-305(b). The defense described in Answer (D) makes the obligation merely voidable, and not void. The defense therefore is stripped away.

Answer (A) is incorrect. The holder in due course doctrine does not strip away a defense that the making of a note was an ultra vires act of a corporation if the defense renders the obligation completely null. §§ 3-305(a)(1)(ii) & cmt. 1; 3-305(b).

Answer (B) is incorrect. A defense that the making of a note was induced by this particular kind of fraud -- often called real fraud or fraud in the factum -- is not stripped away by the holder in due course doctrine. §§ 3-305(a)(1)(iii) & cmt. 1; 3-305(b).

Answer (C) is incorrect. A defense based on discharge in bankruptcy is not stripped away. §§ 3-305(a)(1)(iv); 3-305(b).

Negotiable Instruments: Definitions; Basic Principles

Question:

Lucy buys a new car from Dealer on credit. At Dealer's request, Lucy signs a negotiable promissory note in which she promises to make monthly payments to Dealer.

Under UCC Article 3, Lucy's signature on the note makes her a(n)

(A) drawer.

(B) maker.

(C) accommodation party.

(D) borrower.

Answer:
Answer (B) is the correct answer. As Lucy is executing a note in which she is promising to make payments, she fits the definition of "maker" at section 3-103(a)(7): "a person who signs or is identified in a note as a person undertaking to pay."

Answer (A) is incorrect. Lucy is not a "drawer" under section 3-103(a)(5) because she executed a note, rather than a draft (e.g., a check).

Answer (C) is incorrect. Lucy is not an "accommodation party" under section 3-419(a) because she is the direct beneficiary of the value given for the note - the new car. An "accommodation party" cannot be the direct beneficiary of the value given for the note. 

Answer (D) is incorrect. Lucy may be a "borrower" under the common understanding and use of that term, but that term is not defined by UCC Article 3.