The Holder in Due Course Doctrine as a Default Rule

Abstract:     
The "holder in due course" doctrine, as implemented by Article 3 of the Uniform Commercial Code, says that a party who acquires a negotiable instrument in good faith, for value, and without notice of certain facts, and who also meets some additional requirements, takes the instrument free of competing claims of ownership and most defenses to payment. The standard justification for immunizing a holder in due course from claims and defenses is that the immunity will encourage beneficial commercial transactions. The standard explanation for the various requirements for attaining holder in due course status - good faith, value, lacking notice of certain facts - is that these requirements promote fairness and properly limit the incentives that the doctrine creates. This Article questions these conventional policy arguments. It contends that parties can generally recreate the effects of the holder in due course doctrine by using "waiver of defense" clauses in ordinary contracts. Pursuant to these clauses, parties may specify the precise circumstances under which an assignee of contractual rights takes those rights free from claims and defenses. As a result, this Article argues, a justification for the holder in due course doctrine must do more than show that stripping claims and defenses encourages beneficial transactions; it must explain why maintaining the doctrine as a matter of law is preferable to leaving the rules regarding the transfer of instruments to private contract. This Article suggests an alternative economic justification for the doctrine that takes into account the possibility of using waiver of defense clauses as an alternative to making negotiable instruments. It asserts that, while parties could replicate the doctrine through waiver of defense clauses, the holder in due course doctrine spares them the effort. In this way, the doctrine serves as a default rule that may reduce transaction costs, and thus may promote efficiency.

Keywords: negotiability, negotiable instrument, holder in due course, default rule, Uniform Commercial Code, UCC, U.C.C., good faith purchase doctrine, waiver of defense

JEL Classifications: K12

Accepted Paper Series