When Being a Holder in Due Course Becomes Irrelevant
Becoming a "holder in due course" of a note or check usually entitles the payee to enforce the instrument without regard to the claims or defenses that other entities may have against the payor. In short, the payee, if considered a holder in due course, is entitled to payment on the note regardless of whether the payor breached some obligation to a third party by making the payment.
However, the Court of Appeals issued an opinion yesterday reaffirming the fact that the holder in due course doctrine does not apply in the typical situation involving only a two party transaction and a claim by the payee against the payor. The case, Fleenor v. American Title Co., involved a mortgage loan agreement between two non-parties. The closing agent handling the loan issued a check to one of the mortgagee’s debtors, but subsequently placed a stop order on the check when the loan fell through. The payee of the check sued the closing agent claiming that she was a holder in due course and therefore entitled to payment on the check regardless of the disposition of the third party loan arrangement. Both the Circuit Court and the Court of Appeals disagreed with this argument.
Both Court's noted that the defenses to the payee's claim were not those of some third party, but those held directly by the closing agent. Namely, any agreement between the closing agent and the payee was subject to a condition precedent that the mortgage not being rescinded. Because this condition was not fulfilled, and because the parties were operating under the mutual mistake that it would be fulfilled, the agreement did not become a binding contract. Because this is a defense that was held directly by the payor against the payee, both courts held that whether the payee was a holder in due course was irrelevant. Accordingly, the closing agent was not liable for payment on check.
This is the long way of reiterating that becoming a holder in due course does not equate to an unassailable right to payment.