The shelter principle refers to the principle that a party which does not and cannot qualify as a holder in due course (HDC) with regard to a given negotiable instrument can actually still obtain those rights and privileges if that party obtained the instrument through an HDC. In other words, if an HDC at some point possessed the negotiable instrument, then every possessor of that negotiable instrument after that point will have access to the same rights and privileges.
The reasoning behind this shelter principle is actually a core reasoning of negotiation and basic ownership. Every time a negotiable instrument transfers to a new possessor, that new possessor is always accorded at least the rights of the previous possessor, the transferor. This means that if the transferor is an HDC, then the HDC’s rights and privileges are passed along with the negotiable instrument.
This might, at first glance, seem counter-intuitive and entirely against the point of an HDC. After all, if the shelter principle allows for parties to simply “inherit” the rights of an HDC through transfer of ownership of a negotiable instrument, then it nullifies the restrictive measures placed upon HDCs in commercial law. While this may be true, keeping the shelter principle is important for the functioning of negotiable instruments in general.
The shelter principle allows any given HDC to dispose of a negotiable instrument with much greater ease, thereby increasing the overall flow of commerce. Without the shelter principle, then potential purchasers of a negotiable instrument might not be interested in doing so, as any one of those purchasers might not fulfill the requirements for becoming an HDC.
The shelter principle does allow a new holder to ignore the requirements for becoming an HDC. If a new holder received the negotiable instrument as a gift from an HDC, for example, then that new holder would still qualify as a holder through an HDC, even though that new holder was not taking the negotiable instrument for value.
This would also cover situations in which the transferee received notice of other claims or defenses regarding the negotiable instrument. So long as the transferee is receiving the negotiable instrument from an HDC, then the transferee will have the same rights as an HDC as given to him under the shelter principle.
The shelter principle is not actually solely focused on negotiable instruments and their place in commercial law. In actuality, the reason that the shelter principle is effective in terms of negotiable instruments is because negotiable instruments have been designed to fall under the same provisions as other forms of contract law.
The shelter principle affects the transfer of real property just as much as it matters in terms of negotiable instruments. In real property transfers, the role of an HDC is essentially that of a bona fide purchaser and the shelter principle provides the same basic protections: that a new purchaser will receive the same status as the transferor.
The reason for the shelter principle in property law in general is that it helps to expedite the use and resale of property, instead of letting such use and resale become held up by litigation. The same reasoning applies to negotiable instruments and the shelter principle’s effects of creating holders through an HDC.