Holder in Due Course
In our case study, Bridezilla Wedding Planning has issued two checks totaling $150,000 to BabyCakes Bakery for wedding cakes. BabyCakes endorsed the checks to Shark & Shyster law firm to pay for a retainer. Bridezilla suffered a business failure, and, as it had not received all the wedding cakes it had ordered, it stopped payment on the checks. Shark & Shyster claims to be a holder in due course and demands payment. An equipment provider disputes Shark & Shyster’s claim on the check, and asserts its interest in the checks thusly: Shark & Shyster–say the equipment provider–has not, in fact, given value for the Bridezilla checks, and thus is not a holder in due course. We are asked to determine who is correct: is Shark & Shyster a holder in due course?
The relevant article in the Uniform Commercial Code is § 3-102. A holder in due course (HDC) is anyone or any business entity which has possession of (is a “holder” of) a check (or promissory note, or any other legitimately negotiable instrument) which was accepted in “good faith” (holder has no reason to suspect, for example, that a check is overdue, has already been dishonored (example: a bank may have previously refused to honor it if the account it would draw from was already overdrawn or closed), non-negotiable, or forged, which may have a claim on it from another party or parties (see §§ 3-305(a), 3-306), or which is otherwise suspect) in exchange for services or goods of value (Malin, 2012). Rules governing HDC status are intended to protect the purchaser of a debt, typically a third party, from any legal liability or debt resulting from any dispute between the parties associated with the original transaction; a HDC can demand payment from the original drafter of the check (or note, et cetera) (USLegal, 2012).
In our case study, do Shark & Shyster have a claim? UCC § 3-102 requires that a HDC fulfill all the above guidelines (Cornell, n.d.). Shark & Shyster can argue that they were unaware of any problems with the negotiability or authenticity of the checks, so they meet that requirement. Further, Shark & Shyster can also argue that they accepted the checks from BabyCakes in good faith as a payment towards a retainer, and there does not appear to be anything untoward or illegal about the transfer of endorsed checks from BabyCakes signed over to Shark & Shyster, so Shark & Shyster can also argue that this requirement has been met. The next requirement is more complicated: has Shark & Shyster truly given “good value” for those checks?
In Carter & Grimsley v. Omni Trading, Inc., the situation was similar. Omni Trading paid Country Grain two checks for purchased grain. Country Grain endorsed those checks to Carter & Grimsley as a retainer for future legal services. Country Grain then suffered a business failure. Omni stopped payment on the checks because it had not received all the grain that the checks were intended to pay for. The Illinois Department of Agriculture professed an interest in the checks to repay a debt incurred by Country Grain, but Carter & Grimsley claimed to be a HDC. The court ruled in favor of the Department of Agriculture, ordering that the disputed funds be transferred to them. Carter & Grimsley appealed and lost the appeal.
The Court explained that there were no precedent-setting cases in Illinois where UCC § 3-303(a) had been interpreted to include retainers: “an executory promise is not value” (Black, 1999). Carter & Grimsley had not yet performed any legal services for Country Grain. One justice, P. J. Holdridge, dissented, citing Corti v. Fleisher, 93 Ill. App. 3d 517 (1981) and claiming that a payment of a fee or retainer creates a relationship between an attorney and a client, and Holdridge felt that the agreement to perform future legal services had value.
In Coventry Care, Inc. v. United States of America, the Internal Revenue Service (IRS) asserted that it was a HDC of a $35,000 note assigned to it by the CEO of Contemporary Institute, Inc., Robert C. Braumiller. Coventry issued two promissory notes totaling $55,000 to Contemporary Institute as part consideration for purchase of a subsidiary of Contemporary. Contemporary sent the $35,000 check to the IRS and $20,000 to Western Pennsylvania National Bank (WPNB) to pay a debt to the bank. WPNB assigned the $20,000 note back to Contemporary, and Contemporary passed the note on to United Professional Data Processing (UPDP), which in turn passed the note to David Sage, Inc.
United had possession of the $20,000 note when the IRS and neglected to admit to this when the IRS asked for $10,000 on behalf of Contemporary. Sage asserted that it had promised United a 25% interest in a future not-yet-realized business venture. About a year later, Sage’s venture became Energy Management Corporation (Energy), but, at the time the dispute was tried in court, United had not yet received any stock of Energy, nor asked for the promised consideration. Because Sage had not yet provided “good value,” the IRS was found to be a HDC of the $35,000 note, and Sage was found not to be a HDC of the $20,000 note (the court cited 26 U.S.C. § 6323(b)(1)(A) or 26 U.S.C. § 6323(h)(6)). The court awarded the IRS $51,867.10; a future hearing would be required to determine the “priority of other claimants” (Knox, 1973).
In Fernandez v. Cunningham, Sam Kay gave a promissory note for $220,000 to Investments, S. A., Inc., which endorsed the note. Cunningham & Weinstein, law partners, alleged that they were HDCs of the note and that they had made a demand for payment but were denied. Sam Kay died and Marilyn Kay Fernandez was appointed administratrix of his estate; she objected to Cunningham & Weinstein’s claim, denying they were HDCs, and noting that they had failed to provide evidence that they had performed legal services for Kay.
The first court found for Cunningham & Weinstein, but the appellate court overturned this decision. The court found that the law partners had not provided “good value” for the note, as they failed to provide evidence of services provided to the late Kay (Carroll, 1972).
In Korzenik v. Supreme Radio, Inc., Korzenik and another law partner received notes “in the form of trade acceptances” as a retainer from Supreme Radio for “services to be performed.” Once again, the courts held that although Korzenik et al had spent much of the retainer, it had not provided “good value” (per the guidelines of § 3-303(a); nor had Korzenik made “an irrevocable commitment to a third person within § 3-303(c)”) to Supreme Radio and thus were not HDCs (Whittemore, 1964).
The equipment provider can thus argue that Shark & Shyster have not, in fact, given “good value”. The original check was issued by Bridezilla to pay for cakes, and though it is not Shark & Shyster’s fault that BabyCakes failed to deliver all the cakes Bridezilla paid for, the fact remains that no goods of value were ever furnished in exchange for those checks. Shark & Shyster did not provide any goods of value to Bridezilla in exchange for those checks either, unlike the equipment provider, which apparently did. Shark & Shyster also did not acquire the checks as a debtor or payee of Bridezilla, and, as far as we are told, had no prior business dealings with Bridezilla, and thus no claim on any payments from Bridezilla to satisfy a debt incurred by the wedding planning company. Shark & Shyster thus had no contract or invoice or bill directly connected with Bridezilla that would compel Bridezilla to pay the law firm for anything.
Although BabyCakes and Shark & Shyster may have had a business arrangement, assumed due to BabyCakes paying Shark & Shyster a retainer (in other words, a fee to ensure that a representative attorney from Shark & Shyster would handle a legal matter for BabyCakes), a retainer is not the same as a bill for services rendered. A retainer is given to a law firm in exchange for the firm’s promise to perform legal services in the future. Shark & Shyster has not, as far as we can tell, performed those services for BabyCakes yet. A promise to perform is of arguable value to the law firm since they place a price on retainers, but it has no actual value until the promise is kept and services provided. Therefore, Bridezilla, BabyCakes and the equipment provider can all argue that Shark & Shyster has not provided “good value” for the checks, and is thus not, by the guidelines in the UCC, a HDC.
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