A holder in due course refers to a party who has accepted a negotiable instrument and exchanged something valuable for it. More simply, such a party “holds” a negotiable instrument, which in the case of real estate is a mortgage note.
It is common for lenders to sell mortgage debt to interested buyers prior to a borrower’s default on the debt as a way of protecting its financial interests, cutting financial losses before they get any worse or to make a profit. It is usually sold for less than the principal loan amount.
A holder in due course may purchase a note with the intent of collecting interest or foreclosing on the note and recouping payment through a foreclosure and subsequent sale. A note holder may sell the debt to another party to free up capital for new mortggae originationor to reduce liability from bad debt.
A holder of due course may purchase a negotiable instrument held by a lender, therefore becoming the new “lender”. This entitles the holder in due course to receive the borrower’s future payments.
A holder in due course is granted superior protection to other governing or conflicting laws.
Uniform Commercial Code Section § 3-302. desribes a holder in due course as:
(a) Subject to subsection (c) and Section 3-106(d),”holder in due course” means the holder of an instrument if:
(1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alterationor is not otherwise so irregular or incomplete as to call into question its authenticity; and
(2) the holder took the instrument (i) for value, (ii) in good faith, (iii) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series, (iv) without notice that the instrument contains an unauthorized signature or has been altered, (v) without notice of any claim to the instrument described in Section 3-306, and (vi) without notice that any party has a defense or claim in recoupment described in Section 3-305(a).
In the event that a borrower’s debt is sold, the lender is not required to give that borrower notice. Should a borrower pay the old lender not knowing of the transfer to the holder in due course, the wrongful payment must be transferred to the new lender. In this situation, payment to the old lender qualifies as a valid attempt by a borrower to make a payment.
Valid defenses against a holder in due course:
Incapacity: The seller of the debt lacked the capacity to sell the debt
Illegal: The transfer of the debt was illegal
Forgery: The transferee was forged and not the intent of the maker or payee
Alteration: Alteration of the terms of the sale without the approval of either party is illegal and serves as a valid defense
Case Law As It Relates to Holder in Due Course
Case Review: Wilson v. Steele (1989)
The case, Wilson v. Steele (1989) 211 Cal.3d 1053., involved real estate buyers who purchased a note secured by a trust deed. The deed was purchased from an unlicensed contractor who lent the homeowner, Williams, the money for construction. When the assignee, Steele, tried foreclosing on the property he was prevented. Steele claimed he was protected as the holder in due course and therefore should be entitled to the interest in the property.
The issue the court was tasked to answer was whether a contractor’s unlicensed status is a defect which may be asserted against the contractor’s assignee who is a holder in due course. The superior court granted judgment in favor of the Steele’s and terminated an injunction that prevented the Steele’s from foreclosing on the property.
The plaintiff, Wilson, who was the William’s family estate special administrator, reasoned that the unlicensed status of the contractor who sold the note meant that the contract was invalid, void, and otherwise not enforceable. The court of appeal agreed on the basis that the contracts formation was invalid because the contractor was not licensed and therefore could not legally be a part of a construction agreement. Although a holder in due course has an interest or stake in a particular property, the illegality of the agreement terminates the contract.
