Defenses to Liability for Negotiable Instruments

There can be situations in which negotiable instruments are not payable. A person or company can assert defenses in court to not be held personally liable for a negotiable instrument that winds up being bad, such as a bounced check. The defenses that can be used depend on whether the negotiable instrument is possessed by a holder or a holder in due course. A holder in due course (HDC) is the payee of a negotiable instrument who is in possession of it. This is the person or entity entitled to recover the amount due on the negotiable instrument from the payee. A person in possession of a negotiable instrument received in good faith without any notice of any defect in the instrument is a holder in due course and has greater enforcement rights than someone who is only a holder of a negotiable instrument. The HDC might be a third party. For instance, Alan (the maker who is making a promise to pay) may write a personal check to Bethany (the payee to whom a promise to pay is made in a promissory note). Bethany may then sign the check over to Cynthia in exchange for Cynthia releasing Bethany from a debt. In this example, Cynthia is the HDC.

A universal defense is a method to avoid payment of a negotiable instrument and is valid against all holders of a negotiable instrument, including a holder in due course. Forgery is an example.

Against an HDC, only universal, or real, defenses can be asserted. For example, if the negotiable instrument is fraudulent or artificially altered in some way; if duress, infancy, or mental capacity is an issue with one of the parties to the transaction; or if it is for an illegal or voidable purpose. Some claims might use a universal defense:

• A forged signature is not binding on the person whose name was forged.
• Even if the signature is valid, if the signer was deceived or otherwise pressured to sign the instrument without knowing what it was, a court may find it invalid.
• If the signer altered the instrument in a way that changes the obligations of the parties, the instrument may be invalid.
• If one party files for bankruptcy, the instrument may not be valid.
• If a party is underage, that can invalidate an instrument.
• If a party lacks the mental capacity to agree to a transaction, then the instrument will be invalid.
• If someone forces the signer to sign the instrument under extreme duress, then the instrument will not be valid.

A personal defense is effective against an ordinary holder but not against an HDC. A breach of contract or warranty for which the negotiable instrument was issued is a personal defense. For example, a payor may put a stop payment on a check to prevent it from being cashed. Anything that can be considered a gift can be a personal defense to an instrument. In other words, someone who receives a check as a gift probably cannot sue the writer of the check if it bounces. This is because there is no consideration that could make this a binding contract. A gift is a voluntary, one-sided benefit going from one person to another that cannot legally bind the giver if the gift does not convey. Finally, a negotiable instrument based on fraudulent statements or actions can be invalid. Personal defenses also include lack of consideration, undue influence, duress, breach of warranty, and prior payment.