Negotiation and Endorsement
Persons other than the original obligor and obligee can become parties to a negotiable instrument. The most common manner in which this is done is by placing one's signature on the instrument (“endorsement”): if the person who signs does so with the intention of obtaining payment of the instrument or acquiring or transferring rights to the instrument, the signature is called an endorsement. There are five types of endorsements contemplated by the Code, covered in UCC Article 3, Sections 204–206:
- An endorsement which purports to transfer the instrument to a specified person is a special endorsement – for example, "Pay to the order of Amy";
- An endorsement by the payee or holder which does not contain any additional notation (thus purporting to make the instrument payable to bearer) is an endorsement in blank or blank endorsement;
- An endorsement which purports to require that the funds be applied in a certain manner (e.g. "for deposit only", "for collection") is a restrictive endorsement; and,
- An endorsement purporting to disclaim retroactive liability is called a qualified endorsement (through the inscription of the words "without recourse" as part of the endorsement on the instrument or in allonge to the instrument).
- An endorsement purporting to add terms and conditions is called a conditional endorsement – for example, "Pay to the order of Amy, if she rakes my lawn next Thursday November 11th, 2007". The UCC states that these conditions may be disregarded.
If a note or draft is negotiated to a person who acquires the instrument
- in good faith;
- for value;
- without notice of any defenses to payment,
the transferee is a holder in due course and can enforce the instrument without being subject to defenses which the maker of the instrument would be able to assert against the original payee, except for certain real defenses. These real defenses include (1) forgery of the instrument; (2) fraud as to the nature of the instrument being signed; (3) alteration of the instrument; (4) incapacity of the signer to contract; (5) infancy of the signer; (6) duress; (7) discharge in bankruptcy; and, (8) the running of a statute of limitations as to the validity of the instrument.
The holder-in-due-course rule is a rebuttable presumption that makes the free transfer of negotiable instruments feasible in the modern economy. A person or entity purchasing an instrument in the ordinary course of business can reasonably expect that it will be paid when presented to, and not subject to dishonor by, the maker, without involving itself in a dispute between the maker and the person to whom the instrument was first issued (this can be contrasted to the lesser rights and obligations accruing to mere holders). Article 3 of the Uniform Commercial Code as enacted in a particular State's law contemplate real defenses available to purported holders in due course.
The foregoing is the theory and application presuming compliance with the relevant law. Practically, the obligor-payor on an instrument who feels he has been defrauded or otherwise unfairly dealt with by the payee may nonetheless refuse to pay even a holder in due course, requiring the latter to resort to litigation to recover on the instrument.