Story Case

Francis Lavery represented to Gideon Lanahan that the stock of the Rio Grande Plantation Company was worth $100 a share. In reliance on this statement, which was untrue, Lanahan purchased ten shares, paying $500 in cash and giving his promissory note due in three months for $500. Upon receipt of the note, Lavery indorsed it to the Empire Security Company, who paid $450 for it, not knowing of the fraud committed upon Lanahan.

Lanahan learned of the fraud and when the note was due, refused to pay anything, on the ground that the consideration was fraudulent. Is this a good defense against the Empire Security Company?

Ruling Court Case. Perkins Vs. Challis, Volume 1 New Hampshire Reports, Page 254

One Amos Brewster was the owner of a patent called "The Farmer's Spinner." He sold it to Challis, representing that it was a good machine and well worth the money. As a matter of fact, the patent was worthless, and Brewster was aware of this when he sold it. Challis executed a note to Brewster for $125 in payment thereof. This note Brewster immediately sold to Perkins, who was ignorant that the machine in question was worthless. At maturity he brought suit upon it. Challis contended that he was not liable upon the note, because the consideration had failed.

Decision: Failure or lack of consideration may be shown between the immediate parties to an instrument, but it cannot be shown against a person who purchases before maturity, pays value, and has no notice of the failure or lack of consideration. Thus, in this case, Perkins may recover, since he paid value for the note before maturity, and had no notice of the lack or failure of consideration. Judgment was given for Perkins.

Ruling Law. Story Case Answer

When an instrument has passed into the hands of a bona fide purchaser for value, lack or failure of consideration cannot then be raised. A bona fide purchaser for value is one who buys the instrument before maturity, who pays value for it, and has no notice of any defect in the instrument. Since it is the purpose of negotiable instruments to serve as a substitute for money, a bona fide purchaser is the very person that the rules of commercial law are designed to protect.

However, it is clear that one who knows of a defense, or one who takes an instrument without paying value for it, deserves little or no protection. But when a person pays value for an instrument, and has no notice or knowledge of lack of consideration between prior parties, it is the policy of the law to protect him. Therefore, in the Story Case, the Empire Security Company can collect the face value of the note.