Because being a holder in due course offers a significant amount of protection from the actions of other parties in the chain of negotiations for a given negotiable instrument, there are a number of requirements which must be fulfilled in order for a party to qualify as a holder in due course. These requirements are mostly there so as to prevent the status of being a holder in due course from being overly abused by parties seeking to perpetrate fraud and protect themselves from any lawsuits or defenses.
These requirements include stipulations that: the negotiable instrument cannot have clear evidence of forgery, alteration, or other elements that might make it inauthentic; it must have been taken for value; it must have been taken in good faith; it must have been taken without any notice that it is dishonored, or there is an "uncured default," or that it is overdue; it does not contain an unauthorized signature or has not been altered significantly; it must have been taken without notice that another party has a claim to the instrument; and it must have been taken without notice that any other party has attempted to defend itself against recoupment.
Each of these requirements is designed to ensure that the party claiming holder in due course status is not obtaining the negotiable instrument for fraudulent purposes or with fraudulent intent. To find out more information about each of these requirements and exactly how they need to be fulfilled, follow the link.
Violations of HDC Doctrine
The holder in due course (HDC) doctrine is designed to protect holders from culpability in situations where they performed no wrongdoing, but might be affected by another party's attempt at a defense because they hold the negotiable instruments being contested. But HDC doctrine has been violated a number of times, as it has been turned to fraudulent purposes.
The most common practice of the 20th Century involved sellers making deals with low-income customers that would require those customers to give the sellers some form of promissory note or negotiable instrument. The sellers would then sell those promissory notes to banks and would gain a profit on them.
Because the banks, then, would have acquired those promissory notes in good faith and would fulfill all the other important elements of being holders in due course, they would be protected when the low-income customers would be unable to pay off those debts. Even if those low-income customers attempted a defense based on the fact that they were deceived by the sellers into believing that they could afford these debts, the banks would be protected thanks to their HDC status.
This is not violation of HDC doctrine in the sense of outright law-breaking, but is instead violation of HDC doctrine in that it is a manipulation of the point and purpose of HDC doctrine. The Federal Trade Commission has since taken steps to attempt to combat this type of manipulative, deceptive practice, but it continues in a different form in the modern world. Click the link for more information about these manipulative violations of HDC doctrine and their current form in America.
Taking for Value
One of the requirements for a given holder to be deemed a holder in due course is for he or she to have taken the negotiable instrument in question for value, instead of as a gift or otherwise without making equal compensation to the party from which the holder received the negotiable instrument. There are five different possible ways of taking for value.
The first way is if the current holder fulfills the promise he or she made when he or she obtained the negotiable instrument. If a negotiable instrument is exchanged for some kind of promised service, then the transaction is not considered to be "taking for value" until such a time as the promise is fulfilled. Until that point, the transaction is unequal and the recipient cannot be deemed a holder in due course.
The second way to take for value is to obtain a security interest or other lien in the negotiable instrument without having obtained that lien through a judicial proceeding such as a bankruptcy sale. The third way to take for value is to have obtained the negotiable instrument as a payment for a preexisting debt such that the negotiable instrument is worth the same value as the debt.
The fourth way to take for value is to obtain the negotiable instrument in exchange for another negotiable instrument of equal value, but likely of a different nature. The fifth and final way to take for value would be to obtain the negotiable instrument in exchange for an irrevocable obligation to a third party. To find out more about each of these five ways of taking for value and thereby attaining holder in due course status, follow the link.
Taking in Good Faith
Another requirement for being considered a holder in due course under commercial law is that the holder must have taken the negotiable instrument in good faith. This is one of the more important requirements for being considered a holder in due course, not in the sense of legality, but in the sense of the intent of HDC doctrine.
The entire point of HDC doctrine is to protect those parties that had absolutely nothing to do with any wrongdoing surrounding a given negotiable instrument from attempts to seek restitution, as those parties have clearly done nothing that would require them to make reparations to an injured party. Taking in good faith is the requirement of the HDC doctrine that codifies this element, as it requires the holder to have obtained the negotiable instrument while having no part in illegitimate actions and while under the belief that the transaction as a whole was legitimate.
A party cannot have taken the negotiable instrument in good faith if that party has strong reason to suspect that the negotiable instrument has somehow been made inauthentic or manipulated illegitimately. For instance, if the would-be holder perceives that the instrument has a seemingly forged signature, then that would-be holder has a duty not to go through with the transaction. If the party does go through with the transaction, then the party would have lost any "good faith" status, as would be judged in a court.
Similarly, if the negotiable instrument is clearly obtained under questionable circumstances, such as a deal made in a back alley in which a $700 promissory note is exchanged for $50, then there is good reason to believe that the negotiable instrument was not taken in good faith.
If, however, there was nothing to have clued the holder in to any fraudulent elements of the transaction and that holder treats the transaction properly under commercial law, then that holder will have taken the negotiable instrument in good faith. For more information about taking in good faith and some of the problems surrounding this practice, click the link.
Taking Without Notice
A further requirement for gaining status as a holder in due course is that the current holder must have taken the negotiable instrument without notice as to any of the myriad forms of wrongdoing or warning that might have clued that holder in to the fact that the negotiable instrument was not fully supported or was inauthentic. For example, if the holder received a notice to the effect that the negotiable instrument bore a forged signature and yet went through with the transaction anyway, the holder would have forfeited all possible holder in due course status, as he or she would have taken the negotiable instrument with notice.
Such notice need not take as overly blatant of a form as this, however. Instead, such notice could take the form simply of a notice that another party to the negotiable instrument has attempted to mount a defense against paying for the negotiable instrument. If the party has been successfully notified of any of these things in a timely manner that would allow that party to take action and back out of the transaction, or at least perform a deeper investigation, then that party cannot claim holder in due course protection, as it could have remedied the situation on its own.
The problems of this particular requirement lie in that it is possible that the third parties to whom negotiable instruments are sold will never have the appropriate information given to them. To find out more about the notices that might invalidate a party's claim to being a holder in due course, follow the link.