Business Law and the Regulation of Business 11th Edition by Richard Mann, Barry Roberts

Exercise 21

FACTS The defendant, James Mills, received a draft in the amount of $484.12, dated July 7, 1993, from one of Cigna's constituent companies, Atlantic Employers Insurance Co. (Atlantic). The draft had been issued for workers' compensation benefits. Mills falsely indicated to Atlantic that he had not received the draft due to a change in his address and requested that payment be stopped and a new draft issued by defendant. Atlantic complied and stopped payment on the initial draft. Mills nevertheless negotiated the initial draft to Sun's Market (Sun), before the stop payment notation was placed on the draft. Sun was a holder in due course. Atlantic's bank dishonored the draft in accordance with its customer's direction, stamped it ''Stop Payment,'' and returned the draft to Sun. There is no question that had Sun at that point pressed its claim against the insurer as the issuer of the instrument, Sun would have been entitled to a judgment because of its status as a holder in due course.
Thereafter, plaintiff, who is in the business of purchasing dishonored instruments, obtained Sun's interests in this instrument and proceeded with this lawsuit. Plaintiff does not contend that he is a holder in due course of the instrument by virtue of it being negotiated to him for value, in good faith, without notice of dishonor, under the former holder in due course statute, Uniform Commercial Code (UCC) Section 3-302, nor under the present statute: 3-302a(2). The trial court issued summary judgment in favor of Atlantic and Sun appeals.
DECISION Reversed and remanded.
OPINION Dreier, J. There exists a second method by which one may become a holder in due course. The shelter provisions of former UCC (§ 3-201), which was in effect when plaintiff obtained his assignment of this instrument, state clearly that ''[t]ransfer of an instrument vests in the transferee such rights as the transferor has therein ***.'' Official Comment 3 to that section sets to rest any question of whether this section applies to the transfer by assignment of the rights of a holder in due course. The Comment reads: ''A holder in due course may transfer his rights as such ***. [The] policy is to assure the holder in due course a free market for the paper, ***.'' Example (a) following this comment could have been drawn from this case, but is even stronger because it adds an element of fraud and posits a gratuitous transfer rather than a purchase, as in our case:
(a) A [Mills] induces M [Cigna] by fraud to make an instrument payable to A. A negotiates it to B [Sun Corp.], who takes as a holder in due course. After the instrument is overdue B gives it to C [plaintiff], who has notice of the fraud. C succeeds to B's rights as a holder in due course, cutting off the defense.
If the 1995 amendments are to be given retroactive effect, the law governing the rights of a transferee who merely has accepted the transfer of the instrument is now found in Revised UCC [§ 3-203]. It restates the principle of the former Official Comment 3, example (a), as substantive law.
***
The Uniform Commercial Code Comment 2 to this [Revised] section similarly states:
Under subsection (b) a holder in due course that transfers an instrument transfers those rights as a holder in due course to the purchaser. The policy is to assure the holder in due course a free market for the instrument.
***
These sections could not be clearer. Plaintiff received by [negotiation] the right of a holder in due course to this instrument, which apparently had been presented and then dishonored because of defendant's stop payment order.
INTERPRETATION Through operation of the shelter rule, the transferee of an instrument acquires the same rights in the instrument as the transferor had.
CRITICAL THINKING QUESTION Do you agree with the shelter rule? Explain.