Do you write many checks? If you do, you should know something about the Holder in Due Course (“HDC”) rule contained in Article 3 of the Uniform Commercial Code. The rule was developed so that negotiable instruments (checks for our purposes) could be moved from bank to bank without concern over the defenses the check writer might have in the underlying transaction.
Here’s an example: Buyer pays for a widget with a check. Seller deposits the check into his account at Friendly Bank but fails to send the widget to Buyer. Without the HDC rule Friendly Bank would have to be concerned that Buyer did not receive the widget because it would affect Bank’s ability to collect on the check. Bank’s collection effort against Buyer on his check would be subject to the defense that Buyer never received the widget. However, if Bank is a HDC, it can take the check without fear of a problem in the underlying transaction. In short, a HDC is a super-plaintiff who is immune from most defenses that Buyer could assert against Seller.
A HDC is anyone who is:
- a “holder”;
- of a check or other negotiable instrument;
- who took the check in exchange for value;
- in “good faith”;
- without notice of a defect in the check or transaction.
- The typical HDC is a bank which receives a check not issued on an account with that bank. The bank is a HDC because it is a holder (i.e., it has the check in its possession), the check is a negotiable instrument, the check was exchanged for value because it was credited to the account of the depositor, the check was taken in good faith if the bank acted reasonably in taking the check, and the bank took the check without notice of a defect (assuming the check appeared normal on its face).
If you write a check to someone who deposits the check, the depository bank normally will be a HDC.
So why does this matter to you? Consider this scenario: You buy a car from a friend. In exchange for the car, you give him a $5,000 check. He calls you the next day and says that he lost the check, and asks you to give him another check and stop payment on the one he lost. Thinking you are doing the right thing for your friend and protecting yourself, you issue the stop payment and give your friend a new check. A few weeks later, your absent-minded friend finds the first check, takes it to his bank, deposits it, then withdraws the $5,000 and moves to the Cayman Islands. The bank presents the first check to your bank for payment, and your bank instructs them that a stop payment was issued and rightfully refuses to pay the check. Your former friend’s bank sues you to recover the $5,000 it paid to him. Does the bank have a case? In short, yes: the bank is a HDC and takes the check free of defenses that you have against your former friend. If your friend sued you on the first check, you would have the defense of accord and satisfaction, i.e., you paid him. Because the bank is a super-plaintiff HDC, however, you do not have that defense and may be forced to pay the bank.
Before you repay anyone to whom you issue a check that was or may be dishonored (stop payment, insufficient funds, or account closed), keep in mind the HDC rule. If you know the rule, you know that you might end up paying twice if you are not careful.
— Mike Malin