Commercial Paper

A holder of a negotiable instrument who has been refused payment when payment was due has a CAUSE OF ACTION against the party or parties liable for payment. Ordinarily, when an individual is sued on a negotiable paper, he or she will try to defend his or her right to refuse payment. Certain defenses, known as real defenses, are valid against ordinary holders as well as holders in due course, whereas personal defenses are only valid against ordinary holders.

Normally, any defense that can be asserted in an action concerning a contract may also be used in an action brought to enforce payment of a negotiable instrument. The legal incapacity of the maker, drawer, or endorser, a signature effected by duress, illegality, or fraud, and alteration of the instrument qualify as real defenses.

One of the most prevalent legal incapacity defenses asserted is infancy. The law affords protection to INFANTS by permitting them to evade their contractual obligations, even when, in some instances, they have reaped the benefits. A holder is usually excluded from receiving payment on a note from a minor.

Another incapacity defense is legal insanity or INCOMPETENCY. A party who has been legally declared insane or incompetent is not liable for any contractual obligations entered during that time so that if such a person signs or endorses a negotiable instrument, the transaction is nullified. Intoxication is not a valid defense to dishonor of a commercial paper.

Duress may be used as a defense in the event that the individual against whom a suit is brought can prove that he or she was subject to extreme pressure caused by another at the time of the execution of the paper. If the defendant signed the instrument subject to a threat of immediate physical violence or death, he or she is not legally bound to honor its terms since he or she had not freely entered into the transaction. Certain types of duress, such as a threat to report a wrongdoing to the police or to bring a civil lawsuit, are not valid against a holder in due course, although they can be used as valid personal defenses against an ordinary holder.

Certain jurisdictions deem a paper that has been negotiated to pay a usurious loan or gambling debt null and void. An individual can legally avoid payment to the holder in due course of such an instrument based on the illegal nature of the debt it was meant to pay.

Two basic types of fraud exist: fraud in the essence and fraud in the inducement. Fraud in the essence occurs when an individual is intentionally lied to about the nature of the instrument or its terms. It is a defense that is valid against both an ordinary holder and a holder in due course. Fraud in the inducement takes place when the party signing the paper is cognizant of its nature and terms but is misled into believing that the reasons for its creation have been satisfied when in actuality they have not. For example, an individual might be induced to issue a check for a certain amount to a mechanic who claims to have repaired a car. If the individual subsequently discovers that the car was not repaired, fraud may be used as a personal defense against the mechanic who has not performed his or her part of the contract to repair the car. Fraud in the inducement is only valid against an ordinary holder, not a holder in due course.

A material alteration is an addition or deletion of the language of an instrument, which changes the obligations of any party to it. A defendant may avoid liability for payment of a commercial paper if its terms have been materially altered. Examples of such alterations are a change in the date of payment or amount to be paid. When an individual's own negligence is a contributing factor to a material alteration, that negligence may not be asserted by him or her as a defense against someone who pays the instrument in good faith or against a holder in due course.

An alteration made by a holder that is both material and fraudulent can be used as a defense against enforcing the payment of the document by all those people whose agreements were changed. If these two conditions of materiality and fraud are not met, the instrument is ordinarily enforceable according to the way it was initially written, and none of those involved can use the alteration as a defense against payment.

When a holder in due course takes a paper following its fraudulent alteration by the previous holder, he or she is entitled to receive payment according to the original terms of the instrument prior to its alteration. None of the parties responsible for payment can use the alteration as a defense against a holder in due course, but it may be used against an ordinary holder.