This section is from the book "American Commercial Law Series ", by Alfred W. Bays. Also available from Amazon: American commercial law series.
It has been seen that to accord circulability to an obligation to pay money, which is one of the chief objects of the law of negotiable paper, it must be established that a paper to which it is sought to give such negotiable quality shall, in its course of transfer, become detached from the original transaction as such and circulate as an independent obligation to pay the certain sum of money therein provided for. This means that the defenses that a person who has given negotiable paper who might successfully defend for some reason against the other contracting party must not be allowed to interpose such defenses against a transferee, for thereby he would destroy the independent character of the paper and subject it to all of its original contractual connections. A negotiable paper must be a craft that can be cut away from its moorings. If all promises or orders to pay money were enforceable between the parties, strictly as drawn, our inquiry here would not have to be made. But such is not the case, and justice requires that as between the parties, the merits be ascertained. But a man's negotiable instrument is his bond to any holder in the world and not merely to his immediate party. Therefore, defenses possible against the party to the contract out of which the instrument arose must not be possible as against others, provided they are holders in due course, as described in the chapter immediately preceding.
We will find that notwithstanding this general rule, there are some defenses which may be made, even against a holder in due course. Therefore it is necessary to inquire into the various kinds of defenses. In the present chapter we will mention and consider all of those defenses which cannot be made against a holder in due course. They are called personal defenses and are the usual defenses, that is, defenses going to the merits of the indebtedness, defenses arising out of the transaction. The so-called "real defenses" (defenses good against any one) are discussed in the following chapter are what we might term unusual - defenses consisting in some circumstance usually extrinsic to the merits themselves, such as forgery, minority and the like.
In the following sections the various personal defenses are enumerated.
If one pays the sum, or any part thereof, owing but not overdue, on paper which he fails to take up, or fails to have cancelled, or upon which he omits to see that the proper indorsement is made, and such paper is acquired by a holder in due course, such defense of payment is not good against such holder in due course.
A defense of payment before an instrument is overdue is a personal defense only and not good against a holder in due course.
Example. M made a note to order of P. M desiring to pay the note before it was due, P represented same was lost, but gave M a receipt. P then sold the note to H, a holder in due course. Defense of payment not good against H.110
Set-off of counter claims not good against a holder in due course.
A holder in due course is not subject to counter claims between the parties.
The fact that an instrument is not supported by a consideration is no defense against a holder in due course.
A person who as a holder in due course acquires an instrument may assume that it is supported by a consideration, and that defense, though it might have been successfully interposed against the original party to the transaction, cannot be interposed as against him.111
The fact that the consideration has failed or the contract has been broken is not a defense that can be set up against a holder in due course.
If the consideration for the instrument fails or the contract is broken, the holder in due course is not thereby concerned.
Example 47. A bought a machine and gave his note in payment. The machine was not as represented and was returned. The seller of the machine sold the note no. Wilcox v. Aultman, 64 Ga. 544.
to H, a holder in due course. H is not subject to the defense and can hold A on the note.
111. First Nat. Bk. v. Skeen, 101 Mo. 683.
Fraud in inducement or consideration is not a defense that can be made against a holder in due course.
If a person has been led into a bargain by fraudulent representations, which would entitle him to avoid the contract and defend against the payment of any instrument therein as far as the right of the other party to the contract is concerned, a transfer to a holder in due course cuts off such defense.
Example 48. A sold B a horse which he knew to have a hidden disease which B could not discover, and which he fraudulently concealed. B gave a note in payment which A sold to C, a holder in due course. C is not subject to this defense.112
Duress is not a defense that can be set up against a holder in due course.
By the weight of authority, and independent of local statute, duress is a personal defense and is regarded as a species of fraud.112a
Example 49. Note was executed by wife under threats of criminal prosecution of husband for embezzlement. Held, no defense against innocent holder.
That an instrument arose out of an illegal transaction does not af112. Grooms v. Oliff, 93 Ga. 789.
112a. Porter v. First Nat. Bk., 212 111. Ap. 251; State v. Wegener, 162 N. W. (la.) 1040.
fect it in the hands of a holder in due course; except where local statute makes an instrument void if founded on specified illegal consideration.
In some jurisdictions it is provided that instruments given in certain illegal transactions are void for all purpose, e. g., a gambling transaction; but the general principle is that the illegality of the consideration or transaction cannot be set up against a holder in due course.
If an agent purports to bind his principal upon paper which the payee knows he has no authority to bind his principal upon, a holder in due course has generally no right to hold such principal.
As a general rule of the law of agency, a person is not bound by the act of another unless he assents to be bound either by prior authorization or subsequent ratification; or unless he has apparently assented by what he has done or said. If an agent have actual or apparent power to bind his principal upon negotiable paper, as far as the immediate party is concerned, certainly in that case, no right would be lost by transfer to a holder in due course. If as to the immediate party there is no representation by the principal of authority in the agent, so that such party could not hold the principal, generally a holder in due course could not hold the principal.
Example 50. A having no authority, either real or apparent to bind P on negotiable paper, makes a negotiable promissory note in P's name and signed "P, by A, his agent." The payee sells this to H under the requisite circumstances to make H a holder in due course. P is not bound.113
If, however, an agent has been given general power to bind his principal upon negotiable paper as the business might require, and a holder in due course relies on that fact, in purchasing certain particular paper not made for a proper purpose, the principal would be bound. Most of the cases coming up on this point involve partnerships or corporations, but there is no reason for a distinction in principle. See following sections.
If a partner purports to bind the partnership upon negotiable paper and lacks real or apparent power to do so, a holder in due course (ignorant of the lack of authority in the specific instance) may hold the partners if it is a trading concern, and if not a trading concern may hold the partners if a course of trade has been established on which in the specific instance the holder relies.
Partners in a trading concern (one that buys and sells) have apparent or implied power to bind the other partners in partnership matters. A holder in due course may rely on this fact.
Example 51. A being of the trading firm of A, B & Co. (a firm composed of A, B, C, D and E) borrows money for his own personal purposes from X, who takes the firm note of "A, B & Co., by A." X, obviously, cannot hold the firm, but before the note is due, X transfers for value to H, who has no knowledge of the facts of the transaction. H can hold the partners of A, B & Co.114
113. See "Agency" in this Series.
If the firm is non-trading the presumption does not hold, but in that case, there must be some custom established of issuing paper upon which the holder relies.115
Where a corporation has power to bind itself on negotiable paper, a holder in due course of paper signed in the corporate name by some officer thereof can hold the corporation thereon although in the specific instance the paper was issued without authority.
Even assuming that as between the immediate parties, the corporation could defend because the corporation representative had not even apparent power, a transfer to a holder in due course is effectual to create a right against the corporation. This would be true in case of a signature by any officer having apparent or real power or a presumption of power from the office held by him.116
Example 52. P, president of M. Co., bought stock for himself in X Co., and gave the note of the M. Co. signed by himself as president in payment therefor. Note was transferred before maturity to H, who had no knowledge that note was not for a proper corporate purpose. H can hold M. Co.
114. Wright v. Brosseau, 73 111. 381.
115. Dowling v. Nat. Exch. Bk., 154 U. S. 512.
116. Jefferson Bk. v. Chapman-White-Lyons Co., 122 Tenn. 415, 123 S. W. 641.