COMMERCE PAPER No.10: Corporate Legal Framework
MODULE NO.22: Holder And Holder In Due Course Subject COMMERCE
Paper No and Title 10: CORPORATE LEGAL FRAMEWORK Module No and
Title
MODULE22: HOLDER AND HOLDER IN DUE COURSE
Module Tag COM_P10_M22
COMMERCE PAPER No.10: Corporate Legal Framework
MODULE NO.22: Holder And Holder In Due Course TABLE OF CONTENTS
1. Learning Outcomes.
2. Money: A common denominator of economic value 3. Rights under the instruments
4. Holder
a. Definition b. Requirements c. Holder’s Rights 5. Holder in due course
a. Definition
b. Qualifications Required
c. Privileges of a holder in due course 6. Summary
COMMERCE PAPER No.10: Corporate Legal Framework
MODULE NO.22: Holder And Holder In Due Course 1.LEARNING OBJECTIVES:
This module will enable you to understand:
How negotiable instruments supplement money to facilitate trade,
Special features of negotiable instruments regarding transfer of rights,
Who are the persons who acquire rights under the instruments,
The meaning of a ‘holder’ and the nature of his rights,
The meaning of a ‘holder in due course’ and the qualifications required to become so,
How the rights of a holder of an instrument may be found defective,
The special privileges of the ‘holder in due course’ regarding the rights on the instrument.
COMMERCE PAPER No.10: Corporate Legal Framework
MODULE NO.22: Holder And Holder In Due Course 2.MONEY: A COMMON DENOMINATOR OF ECONOMIC VALUE
Money enables us to obtain the required goods or services from the market. In modern economies, money is the common denominator to measure economic value. Paper currency is the most common form of holding money. Suppliers of goods or services are ready to accept paper currency notes or coins in exchange of the goods and services; they do so because of universal acceptability of currency as a valuable thing.
Paper currency has been a great facilitator of business operations but it alone could not keep their wheels going full steam. Use of non-money paper instruments had started among traders even before the advent of paper currency, and it came up for wider use during modern times. These instruments in various forms, such as, the bills of exchange, cheques, bank drafts, hundis etc. have augmented the support provided to trade by money.
These paper instruments, negotiable instruments as they are called, have served the needs of the trading world for money-holding and money-transfer. The emergence of information technology and internet has brought about more innovations in the methods to hold money and transfer it.
3.RIGHTS UNDER THE INSTRUMENTS
The complete rights on the instrument – the value of the negotiable instrument or the right to negotiate- are enjoyed by only a holder of the instrument. The holder would be the original payee or transferee of the instrument through negotiation. The possessor of an instrument merely through an instrument of transfer would not become holder.
Two very important features of negotiable instruments are that:
The transferee of a properly made and acquired negotiable instrument has the right to recover the amount mentioned in the instrument in his own name.
The transferee of a negotiable instrument acquires a title over the instrument which can be superior to the title of the transferor if it happens to be defective in some manner.
The complete and pure rights on the instrument, as indicated above, are enjoyed by only such a holder who fulfils some necessary conditions and becomes what is called a
‘Holder in due course’. If any such condition is not fulfilled, then, he would enjoy only limited rights under the instrument in the capacity of a mere ‘Holder’.
COMMERCE PAPER No.10: Corporate Legal Framework
MODULE NO.22: Holder And Holder In Due Course
The concepts of ‘holder’ and a ‘holder in due course’ are
very significant concepts in the field of negotiable instruments. Let us see the following discussion which would help in understanding them properly.
4.HOLDER
a. Definition: Sec.8- The holder of a promissory note, bill of exchange or cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto.
b. Requirements:
Thus, in order to be called a ‘holder’ a person must satisfy the following two conditions:
i). He must be entitled to the possession of the instrument in his own name.
To be seen as a holder of the instrument, a person must be legally entitled to its possession under some valid title. This means that mere physical possession of the instrument is neither sufficient nor essential. It implies that the possessor must be either the original payee or the endorsee of the instrument, or he must be the lawful bearer thereof.
A holder would include a possessor through inheritance, a recipient of a gift or any other person becoming entitled by operation of law because such a person is entitled to possess it in his own name.
But, an assignee of an instrument under an assignment deed is not a holder unless the negotiable instrument is payable to bearer or has been properly endorsed also in his favor. This is true in spite of assignee’s right to sue on it.
A thief or a finder of a lost instrument or an endorsee under a forged endorsement may have the possession of the instrument, but he cannot become its holder because he has not acquired a legal title thereto and is not entitled to have possession thereof in his own name. Similarly, a beneficial owner of an instrument who is claiming through a ‘benamidar’ (like a trustee or a guardian) in whose favor the instrument had been made or drawn in place of the beneficial owner, cannot be a holder because he is not entitled to the possession in his own name and cannot by himself maintain an action on the instrument in place of the benamidar (Sarjoo Prasad vs Rampayari).
ii). He must be entitled to receive or recover the amount due thereon.
To be a holder, the person concerned must be entitled to recover the amount from the parties liable thereto and give a valid discharge to the payer. In other words, the person should have derived title to the instrument in a lawful manner.
Further, a person may have become the bearer or the payee or endorsee of an instrument, but if there are legal hurdles in his right to recover money under it, e.g.
he may have been prohibited by court from receiving payment on the instrument, then, he may not be called a holder. An agent or an employee possessing an
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MODULE NO.22: Holder And Holder In Due Course
instrument on behalf of the principal for collection or
safe custody does not become the holder of it although he may receive its payment, because he has no right to sue on the instrument in his own name.
c. Holder’s Rights:
A holder occupies an important position with regard to negotiable instruments. Only a holder can become a holder in due course. Also, only a holder can further negotiate an instrument (Sections 46 and 48). Furthermore, only a holder can give a valid discharge on the instrument to its maker or acceptor (Sec.78).
It must not be assumed that a mere holder has no rights at all under the instrument. If he does not fulfil one or more of the conditions of becoming the holder in due course, it does not mean that he would be without rights. His rights on the instrument would be there but only at par with the rights of the transferor and not superior.
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5.HOLDER IN DUE COURSE
The very rightful holder of an instrument is called the ‘holder in due course’. The main feature of a negotiable instrument is its easy transferability. The full benefit of this feature can be enjoyed by only such a holder who is a ‘holder in due course’.
a. Definition: Sec.9-‘Holder in due course’ means any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or endorsee thereof, if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.
b. Qualifications required:
In order to be called a ‘holder in due course’, the possessor of instrument must fulfil the following qualifications:
i). He must be a ‘holder,’ i.e., he must be entitled to the possession of the instrument in his own name under a legal title and to recover the amount thereof from the parties liable thereto. The possession must have been acquired through original issue or the process of negotiation. As Sec.9 states clearly, the person concerned should be a payee or an endorsee in case of an order instrument or must have become the possessor if it is a bearer instrument. Any other process bringing the instrument to the possessor will not make him the holder in due course.
In addition, the holder must have become the holder by fulfilling certain other conditions laid down in the section and given below.
ii). He must become a possessor for valuable and lawful consideration. The term
‘consideration’ would be understood as defined by Sec.2 (d) of the Indian Contract Act, 1872. A person acquiring title to the instrument by way of gift or donation
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would not be a holder in due course for want of consideration, although he may be a holder.
iii). He must have become the possessor of the negotiable instrument before its maturity, i.e. before it became payable. A person who acquires a negotiable instrument after maturity cannot be a holder in due course (Sec.59). The taking of an overdue instrument would amount to taking it with notice of all the equities or defects attaching to it.
The maturity date of a time instrument is the date on which the payment of the instrument becomes due.
But an accommodation bill can be negotiated after maturity with all benefits of a holder in due course to the transferee (proviso to Sec.59). In the case of a holder of an instrument payable on demand, e.g. a cheque, he must have taken the instrument within a reasonable time of its issue.
iv) The acquired instrument must, on the face of it, be complete and regular in the technical sense. If it contains any alterations not authenticated by the drawer through his signature, or if it is incomplete, say, drawer’s name is not there or if it is not properly stamped, the instrument will not be such as to make the possessor a holder in due course.
v) He must have become holder without having sufficient cause to believe that any defect existed in the title of the transferor. He must not be negligent and should take great care and exercise necessary precautions in scrutinizing the transferor’s title. If something was there to arouse his suspicion but he takes the instrument without making proper inquiries, he would not be said to be acting honestly and would not become a holder in due course.
This requirement is wider than the requirement of a mere ‘good faith’ on the part of the holder since the implication of the requirement of good faith is that if the holder had taken the instrument in good faith although negligently, he would still become a holder in due course.
A ‘holder in due course’ is different from a mere ‘holder for value’. A ‘Holder for value’ is the holder who has acquired the instrument for consideration but may not have fulfilled some other qualification whereas the former is the person who has fulfilled all other conditions also.
Examples of persons who may be ‘holder’ but not ‘holder in due course’: A holder under inheritance or a gift, a holder who acquires the instrument after the date of maturity, a holder who does not acquire it in good faith or with the belief that the transferor had a proper title over it.
c. Privileges of a holder in due course:
The ‘holder in due course’ enjoys a privileged position under the Negotiable Instruments Act in comparison to a mere ‘holder’. He has rights superior to those of the holder. The following points would make it clear.
i) Better title than that of the transferor. A person who is only a ‘holder’ gets a title over the instrument which is at par with that of his transferor. If there is a defect in
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transferor’s title, the holder would suffer from the
same defect. But the holder in due course would acquire a defect-free title which shall be better than that of the transferor. Such defenses cannot be pleaded against a holder in due course by the person liable that the instrument has been lost (in case of a bearer instrument), or has been obtained from the holder thereof by means of an offence or fraud or for an unlawful consideration (Sec.58).
The following are some examples of a defect in the rights of the transferor of the instrument:
a) M signed a blank cheque and left it with his employee who filled it in his own name as payee and endorsed it to J, a holder in due course, for valuable consideration. J was entitled to recover the amount from M.
b) K owed Rs 17000 to R. He endorsed in favor of R a bill for Rs 32000, of which he was an endorsee, telling that on maturity he should collect the amount on the bill, keep Rs 17000 and return him the remaining 15000. Instead, R endorsed the bill to S, a holder in due course. S would be entitled to recover full amount from the parties liable.
c) C purchased goods from D for Rs 15000 and gave as payment a promissory note of that amount. C found later that D was guilty of fraud and C was liable to pay Rs 7000 only. D agreed to return the note to C but he endorsed it in favour of F without any consideration. F can recover from C only Rs 7000 on the note, the amount that D, the transferor, was himself entitled to get.
Further, the holder in due course would serve as a channel to protect all subsequent holders. This means that once the instrument passes through the hands of the holder in due course, it is cleaned of all its previous defects. Section 53 states that “a holder of a negotiable instrument who derives title from a holder in due course has the rights thereon of that holder in due course”.
Thus, the transferee from a holder in due course would also be like a holder in due course and can recover the amount from all prior parties, even if he had knowledge of the prior defects, e.g. the use of fraud by an earlier holder, unless he was himself a party to that fraud (Guildford Trust vs Goss 1926 43 TLR 167).
Example: C draws a bill, payable to himself, on K and obtains K’s acceptance by fraud. In such a case, C’s rights on the bill against K shall be defective. Suppose C endorses the bill to R who takes it as a holder in due course. R will have full rights on the bill against K. If R further endorses the bill to M without consideration, M will not become a holder in due course but he will have a good title over the bill even if he knew of C’s fraud.
Now, suppose, R endorses the bill in favour of the drawer C itself, C will not acquire any good title over it because he was a party to the fraud.
It must be understood that a forged instrument, even if it passes through the hands of a holder in due course, cannot be cured of its defect. The reason is that forgery leads to a total lack of title and not just a defect in the title.
ii) Privilege in case of inchoate stamped instruments (Sec.20). In the case of inchoate stamped instrument, if it’s original payee or holder fills an amount more than what
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was authorised, he cannot enforce the instrument for
the entire amount. Only the amount actually authorised can be recovered. If such an instrument is transferred to a holder in due course, he would be entitled to the whole of the amount so entered provided that the amount stated is covered by the amount of stamp affixed thereon.
iii) Rights against prior parties (Sec.36). All prior parties to a negotiable instrument, i.e.
its maker or drawer, acceptor and intervening endorsees, continue to remain liable to a holder in due course both jointly and severally, i.e. he can hold any or all prior parties liable, until the instrument is duly satisfied. An instrument is deemed to be duly satisfied if the liability of all the parties is extinguished and the instrument is discharged by payment by the person primarily liable on it at or after maturity.
If the acceptor of a bill makes the payment before maturity, he may negotiate it further and the holder in due course will get a good title over it against all prior parties. An ordinary holder in such a case would have rights against the transferee acceptor only and not against the prior parties against whom such an acceptor would also not have any rights.
iv) Privilege in case of fictitious bills (Sec.42). When a bill of exchange is drawn in a fictitious name and is made payable to another fictitious person, i.e. where both drawer and payee of a bill are fictitious persons, the bill is said to be a fictitious bill.
But, if such a bill, during its negotiation, comes into the hands of a holder in due course, the acceptor of such a bill would be liable to him, provided the former can show that the first endorsement on the bill and the signature of the supposed drawer are in the same handwriting.
v) Right under an instrument delivered conditionally. When a negotiable instrument is endorsed or delivered conditionally or for a special purpose only, such as, to make it a collateral security or for safe custody, and not with the idea of transferring the rights therein, the property in the instrument does not pass to an endorsee, and he becomes merely a Bailee with limited title and power of negotiating it. This, however, does not affect the rights of a holder in due course (Sections 46 and 47).
vi) Estoppel against denying original validity of instrument. The defense of original invalidity of the instrument may be adopted by a person liable under the instrument.
For example, it may be claimed by the maker of a note that no consideration actually passed between the maker and the payee. This defense cannot be put forward against the holder in due course by the drawer of a bill of exchange or cheque, or by the maker of a promissory note or by an acceptor of a bill for the honour of the drawer (Sec.120).
However, certain invalidities of the instrument may affect the rights of a holder in due course. For example, the person being held liable may claim that he was a minor when he signed it or his signature had been forged or the instrument is otherwise void ab initio, being in violation of the provisions of the Reserve Bank of India Act.
vii) Estoppel against denying capacity of payee to endorse. No maker of a note and no acceptor of a bill payable to order shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity, at the date of the note or the bill, to endorse the same (Sec.121). The payee must be competent to endorse an instrument
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otherwise the endorsee does not become the holder
thereof entitled to enforce payment in his own name. While Sec.26 gives to a minor or an insane person competence to endorse, an insolvent, however, is not competent to endorse. By virtue of Section 121, a holder in due course can claim payment in his own name despite the payee’s incapacity (being an insolvent) to endorse the instrument.
6.SUMMARY
Money enables us to obtain the required goods or services from the market.
Holder in due course’ means any person who for a consideration became the possessor of a negotiable instrument, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.
The holder of a negotiable instrument means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto.
A Holder in Due Course enjoys the following rights:
Better title than that of the transferor
Privilege in case of inchoate stamped instruments (Sec.20)
Rights against prior parties (Sec.36).
Privilege in case of fictitious bills (Sec.42)
Right under an instrument delivered conditionally
Estoppel against denying original validity of instrument (Sec. 120)
Estoppel against denying capacity of payee to endorse. (Sec.121)
