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CHAPTERASSESSMENTSection 26.1 Holders of Instrumentsand Defenses● Even when certain defenses are introduced incourt, if a holder has preferred status, the holdermay still be able to collect on the instrument.Preferred status is given to a party called a holderin due course. A holder in due course is a holderwho takes an instrument for value, in good faith,and without notice. To be a holder, the instrumentmust have been issued or indorsed to you. Youmust give value when you accept an instrument;a gift would not allow you to qualify as a holderin due course. You give value when you give theconsideration that was agreed upon or when youaccept an instrument in payment of a debt. Theholder must also act honestly to qualify under the“good faith” requirement. Whether a person tookan instrument in good faith is determined at thetime of taking the instrument. If a person actedin good faith at the time, but later learned ofdisturbing facts, he or she is still regarded ashaving taken the instrument in good faith. Aholder must not have notice of any claim ordefense to the instrument. A holder has notice ofa claim or defense if the instrument bears visibleevidence of forgery or alteration. The same is trueif the instrument is so incomplete or irregularthat its legal acceptance is doubtful. Notice of aclaim or defense is also given if the holder noticesthat the obligation of any party is voidable. Holdersin due course are treated more favorably thanmere holders are treated. They receive more rightsin negotiable instruments than other parties. Forthis reason, negotiable instruments are passedalmost as freely as money from one person toanother. To be a holder in due course, you mustfirst be a holder.● Two kinds of defenses against a holder are recognized:personal and real. Real defenses may beused against holders in due course; personaldefenses may not. Personal defenses such asbreach of contract, failure or lack of consideration,fraud in the inducement, and lack of delivery andpayment may not be used against holders in duecourse. A real defense is a defense directedagainst the instrument itself. The contention isthat no valid instrument ever came into existence;therefore, the instrument could not be real orgenuine. Some examples of real defenses areinfancy and mental incompetence, illegality andduress, fraud as to the essential nature of thetransaction, bankruptcy, unauthorized signature,and alteration.Section 26.2 Liabilities of Parties● Primary liability is an absolute liability to pay.A party with primary liability has promised topay the instrument without reservation. Makersof promissory notes and acceptors of draftshave primary liability. When there are comakerson notes, they have primary liability and areconsidered makers regardless of whether theyreceive any consideration.● A party with secondary liability has a liability topay only after certain conditions have been met:(1) the instrument must be properly presented tothe primary party or drawee; (2) payment mustbe demanded; (3) payment must be dishonored(refused by the primary party) or be impossible;and (4) notice of refusal must be given to thesecondary party within the time and in the mannerprescribed by law. There are two types of partieswho may have secondary liability for the paymentof an instrument. They are (1) the drawer of adraft (a check is the most common kind of draft)and (2) the indorser or indorsers of either a draftor note.572 Unit 5: Using Your Purchasing Power