This section is from the book "The Law Of Contracts", by William Herbert Page. Also available from Amazon: Commercial Contracts: A Practical Guide to Deals, Contracts, Agreements and Promises.
The important question in negotiable contracts is, therefore, whether it is in the hands of a bona fide holder. The holder must take without notice of the defense sought to be interposed, to constitute him a bona fide holder. If he has notice of defense he is not a bona fide holder even if he pays full value.1 Thus if the holder knows that a surety executed a note for the purpose of having it discounted for value, and that it has been endorsed without consideration,2 or that an indorser for accommodation has ordered that his name should be erased before the note was negotiated,3 he cannot enforce the note against such partf, The mere fact, however, that the circumstances are such as would suggest suspicion, and that if the holder had made such inquiries as a prudent man would have made, he would have learned of the defense, does not prevent him from being a bona fide holder.4 The facts must create a "presumption that he knew facts impeaching its validity."5 This result has not been reached without a vigorous conflict. The original English rule was in accordance with that laid down in the text.6 Subsequently Lord Tenterden expressed the view that one who takes a negotiable instrument under circumstances that would arouse the suspicions of a reasonable and prudent man cannot be a technical bona fide holder.7 This decision had a depressing effect on the value of English paper on the continent, and after taking the intermediate position that gross negligence, and that alone, could operate to prevent one who took without notice from being a bona fide holder,8 the English courts adopted the original rule.9 Direct evidence of bad faith is not necessary however. The fact that the holder takes under circumstances which, should arouse suspicion, or is guilty of gross negligence is a circumstance to be considered in determining whether he takes in good faith. The transferee may know facts extrinsic to the note which raise so strong an inference of its irregularity that a finding of fact that he did not take in good faith may he warranted.10 Thus if the transferee knows that the note was given for " Hull-less oats " and that the " Hull-less oats " scheme as operated by the Hull-less Oats company, the payee, is a fraud,11 or if he knows that the amount of the note is disproportionately large for the means of the maker,12 or if he knows that the maker and his sons have been under arrest on a charge of murder that the payee is their attorney and that the amount of the note is exorbitant,13 or that his indorser is a gambler, the certificate of deposit being sold at much less than its face value,14 such knowledge may justify a finding of bad faith as a fact. The holder is charged with notice of everything that appears from the contents of the instrument.15 Thus if an agent pays personal debts with a check of his principals,16 or a partner discounts a note given by the firm and has the proceeds deposited to his individual account,17 or if a note appears on its face to have been issued by an unauthorized agent,18 one who takes with knowledge of such facts is bound at his peril to ascertain the authority of the agent or partner to make such use of the funds. So where a note shows that a hank indorsed it out of the chain of title and hefore delivery, the holder is hound to inquire whether such indorsement is not ultra vires.10 So memoranda on an instrument showing that it had been refused discount at the bank at which it was payable,20 or that it is " to be held as collateral "21 operate as notice. But a memorandum " C. I. P." on the face of a note is not notice that it was given for a patent right so as to be subject to defenses.22 The fact that default has been made in payment of interest,23 or in one of a series of notes,24 is not notice. So the fact that the consideration is recited on the face of the note,25 or is known to the holder,26 is not notice of any defenses arising by reason of failure of the consideration, unless the holder knows that the consideration has failed,27 or must fail.28 Analogous to this last question is one often presented in slightly differing forms under modern methods of business. A consigns goods, takes a bill of lading, and attaches it to a (Wbere the consideration is a promise made bv a cordraft. The draft is accepted by the drawee in reliance on the bill of lading. Either before or after acceptance it is indorsed over to a bona fide purchaser. Is the bill of lading a part of the draft; or is it notice to the indorsee of the entire transaction? The question becomes material if the quality or title of the goods covered by the bill of lading is defective. In such case the drawee either tries to avoid paying the draft or if he has paid it to the indorsee, he seeks to recover such payment. The weight of authority is that the bill of lading is neither part of the draft nor notice to the indorsee of the entire transaction; and accordingly such defect in quality or in title creates no liability against him.29 Under this view the acceptor is liable to the payee.30 If the acceptor has paid the bill of exchange and the property covered by the bill of lading is then attached, he cannot recover such payment.31 A minority of the courts hold that such defense can be interposed by the acceptor.32 Of these cases Landa v. Lattin, decided by an intermediate court,33 has been overruled by the court of last resort of that state.3* Indorsement "for collection" is notice that the holder is not the beneficial owner,35 even if such indorsement has been erased, poration which has become insolvent.) as long as it is still legible.36 Indorsement "for account" of in-dorsers has been held to have the same effect;37 but " for deposit to the credit of" the indorser has been held not to have this effect but to make the indorsee the absolute owner.38 Since accommodation paper is intended as a loan of credit by the accommodation party, one who takes such paper with notice that it is accommodation paper is, not thereby charged with notice of defects.39 The fact that by oversight a note issued while the War Revenue Act was in force was unstamped is not notice of defenses.40 The fact that the indorsee required a very full guaranty from his indorser does not show as a matter of law that he had notice of defenses.41 An indorsement without recourse is not notice of defenses.42 A note of a principal, payable to the agent executing it,43 or to a former president of such corporation,44 or a note of a partnership payable to a member of the firm,45 is not in either case notice of any irregularity in the execution. Notice by publication in a newspaper is not notice to one who is not shown to have actually known thereof.46 Notice to an agent of the holder of defenses,47 such as want of consideration48 is notice to the principal if within the scope of the agent's authority. Thus if a mortgagor sells the mortgaged property as agent of the mortgagee and makes false statements about such property to the vendee to induce him to buy, the mortgagee, when taking a check for such property indorsed over by the mortgagor, does not take without notice.49 One who holds a note as collateral before notice and buys it after notice,50 or who has made some advances before notice and other advances after notice,51 does not take as a bona fide holder as to what he pays after notice. An instrument purporting on its face to be executed by the officer of a corporation,02 or to be accepted,53 or indorsed,54 by a public officer, is notice to subsequent holders sufficient to put them on inquiry as to the powers of such officers. Whether the addition of "trustee" or some word of similar import to the name of the payee is notice to those claiming under him by indorsement is a question on which there has been a division of authority. The weight of authority holds that the addition of "trustee"55 or "guardian,"56 is notice to subsequent holders that other persons have equities in such instruments. In other jurisdictions the addition of "trustee,"57 or "agent,"58 or " sheriff,"59 has been held not to amount to notice. Notice of one defect does not prevent a holder from taking without notice as to other defects and hence being, as to them, a bona fide holder. Thus a notice that a note is given for a patent right does not prevent a holder from taking free from a defense of payment.60 The maker may estop himself from claiming notice, by expressly promising to pay the transferee, thereby inducing him to accept the note.61