2023 New Mexico Statutes › Chapter 55 - Uniform Commercial Code › Article 3 - Negotiable Instruments › Part 3 - ENFORCEMENT OF INSTRUMENTS › Section 55-3-305 - Defenses and claims in recoupment.

(a) Except as otherwise provided in this section, the right to enforce the obligation of a party to pay an instrument is subject to the following:
(1) a defense of the obligor based on: (i) infancy of the obligor to the extent it is a defense to a simple contract; (ii) duress, lack of legal capacity or illegality of the transaction that, under other law, nullifies the obligation of the obligor; (iii) fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms; or (iv) discharge of the obligor in insolvency proceedings;
(2) a defense of the obligor stated in another section of Chapter 55, Article 3 NMSA 1978 or a defense of the obligor that would be available if the person entitled to enforce the instrument were enforcing a right to payment under a simple contract; and
(3) a claim in recoupment of the obligor against the original payee of the instrument if the claim arose from the transaction that gave rise to the instrument; but the claim of the obligor may be asserted against a transferee of the instrument only to reduce the amount owing on the instrument at the time the action is brought.
(b) The right of a holder in due course to enforce the obligation of a party to pay the instrument is subject to defenses of the obligor stated in Subsection (a)(1) of this section, but is not subject to defenses of the obligor stated in Subsection (a)(2) of this section or claims in recoupment stated in Subsection (a)(3) of this section against a person other than the holder.
(c) Except as stated in Subsection (d) of this section, in an action to enforce the obligation of a party to pay the instrument, the obligor shall not assert against the person entitled to enforce the instrument a defense, claim in recoupment or claim to the instrument (Section 55-3-306 NMSA 1978) of another person, but the other person's claim to the instrument may be asserted by the obligor if the other person is joined in the action and personally asserts the claim against the person entitled to enforce the instrument. An obligor is not obliged to pay the instrument if the person seeking enforcement of the instrument does not have rights of a holder in due course and the obligor proves that the instrument is a lost or stolen instrument.
(d) In an action to enforce the obligation of an accommodation party to pay an instrument, the accommodation party may assert against the person entitled to enforce the instrument any defense or claim in recoupment under Subsection (a) of this section that the accommodated party could assert against the person entitled to enforce the instrument, except the defenses of discharge in insolvency proceedings, infancy and lack of legal capacity.
(e) In a consumer transaction, if law other than this chapter requires that an instrument include a statement to the effect that the rights of a holder or transferee are subject to a claim or a defense that the issuer could assert against the original payee and the instrument does not include such a statement:
(1) the instrument has the same effect as if the instrument included such a statement;
(2) the issuer may assert against the holder or transferee all claims and defenses that would have been available if the instrument had included such a statement; and
(3) the extent to which claims may be asserted against the holder or transferee is determined as if the instrument included such a statement.
If an instrument includes or is deemed to include a statement under this subsection, a holder or transferee who is liable under the statement to the issuer, but who is not the seller of the goods or services, shall be entitled to full indemnity from the seller for any liability under the statement incurred by the holder or transferee that results from the issuer's claims or defenses against the seller, plus reasonable attorney fees. The provision in this section for express indemnity does not affect any right of indemnity, subrogation or recovery to which a holder or transferee may be entitled under a contract or other law. This section is not intended to provide a holder or transferee indemnity from the seller with respect to the holder or transferee's direct liability to the issuer for the holder or transferee's own actionable misconduct unrelated to derivative liability under the statement.
(f) This section is subject to law other than this article that establishes a different rule for consumer transactions.
History:
1978 Comp., § 55-3-305, enacted by Laws 1992, ch. 114, § 118; 2009, ch. 234, § 6.
OFFICIAL COMMENTS
UCC Official Comments by ALI & the NCCUSL. Reproduced with permission of the PEB for the UCC. All rights reserved.
1. Subsection (a) states the defenses to the obligation of a party to pay the instrument. Subsection (a)(1) states the "real defenses" that may be asserted against any person entitled to enforce the instrument.
Subsection (a)(1)(i) allows assertion of the defense of infancy against a holder in due course, even though the effect of the defense is to render the instrument voidable but not void. The policy is one of protection of the infant even at the expense of occasional loss to an innocent purchaser. No attempt is made to state when infancy is available as a defense or the conditions under which it may be asserted. In some jurisdictions it is held that an infant cannot rescind the transaction or set up the defense unless the holder is restored to the position held before the instrument was taken which, in the case of a holder in due course, is normally impossible. In other states an infant who has misrepresented age may be estopped to assert infancy. Such questions are left to other law, as an integral part of the policy of each state as to the protection of infants.
Subsection (a)(1)(ii) covers mental incompetence, guardianship, ultra vires acts or lack of corporate capacity to do business, or any other incapacity apart from infancy. Such incapacity is largely statutory. Its existence and effect is left to the law of each state. If under the state law the effect is to render the obligation of the instrument entirely null and void, the defense may be asserted against a holder in due course. If the effect is merely to render the obligation voidable at the election of the obligor, the defense is cut off.
Duress, which is also covered by subsection (a)(ii), is a matter of degree. An instrument signed at the point of a gun is void, even in the hands of a holder in due course. One signed under threat to prosecute the son of the maker for theft may be merely voidable, so that the defense is cut off. Illegality is most frequently a matter of gambling or usury, but may arise in other forms under a variety of statutes. The statutes differ in their provisions and the interpretations given them. They are primarily a matter of local concern and local policy. All such matters are therefore left to the local law. If under that law the effect of the duress or the illegality is to make the obligation entirely null and void, the defense may be asserted against a holder in due course. Otherwise it is cut off.
Subsection (a)(1)(iii) refers to "real" or "essential" fraud, sometimes called fraud in the essence or fraud in the factum, as effective against a holder in due course. The common illustration is that of the maker who is tricked into signing a note in the belief that it is merely a receipt or some other document. The theory of the defense is that the signature on the instrument is ineffective because the signer did not intend to sign such an instrument at all. Under this provision the defense extends to an instrument signed with knowledge that it is a negotiable instrument, but without knowledge of its essential terms. The test of defense is that of excusable ignorance of the contents of the writing signed. The party must not only have been in ignorance, but must also have had no reasonable opportunity to obtain knowledge. In determining what is a reasonable opportunity all relevant factors are to be taken into account, including intelligence, education, business experience, and ability to read or understand English of the signer. Also relevant is the nature of the representations that were made, whether the signer had good reason to rely on the representations or to have confidence in the person making them, the presence or absence of any third person who might read or explain the instrument to the signer, or any other possibility of obtaining independent information, and the apparent necessity, or lack of it, for acting without delay. Unless the misrepresentation meets this test, the defense is cut off by a holder in due course.
Subsection (a)(1)(iv) states specifically that the defense of discharge in insolvency proceedings is not cut off when the instrument is purchased by a holder in due course. "Insolvency proceedings" is defined in Section 1-201(22) [55-1-201 NMSA 1978] and it includes bankruptcy whether or not the debtor is insolvent. Subsection (2)(e) of former Section 3-305 is omitted. The substance of that provision is stated in Section 3-601(b) [55-3-601 NMSA 1978].
2. Subsection (a)(2) states other defenses that, pursuant to subsection (b), are cut off by a holder in due course. These defenses comprise those specifically stated in Article 3 and those based on common law contract principles. Article 3 defenses are nonissuance of the instrument, conditional issuance, and issuance for a special purpose (Section 3-105(b)) [55-3-105 NMSA 1978]; failure to countersign a traveler's check (Section 3-106(c)) [55-3-106 NMSA 1978]; modification of the obligation by separate agreement (Section 3-117) [55-3-117 NMSA 1978]; payment that violates a restrictive indorsement (Section 3-206(f)) [55-3-206 NMSA 1978]; instruments issued without consideration or for which promised performance has not been given (Section 3-303(b)) [55-3-303 NMSA 1978], and breach of warranty when a draft is accepted (Section 3-417(b)) [55-3-417 NMSA 1978]. The most prevalent common law defenses are fraud, misrepresentation or mistake in the issuance of the instrument. In most cases the holder in due course will be an immediate or remote transferee of the payee of the instrument. In most cases the holder-in-due-course doctrine is irrelevant if defenses are being asserted against the payee of the instrument, but in a small number of cases the payee of the instrument may be a holder in due course. Those cases are discussed in Comment 4 to Section 3-302 [55-3-302 NMSA 1978].
Assume Buyer issues a note to Seller in payment of the price of goods that Seller fraudulently promises to deliver but which are never delivered. Seller negotiates the note to Holder who has no notice of the fraud. If Holder is a holder in due course, Holder is not subject to Buyer's defense of fraud. But in some cases an original party to the instrument is a holder in due course. For example, Buyer fraudulently induces Bank to issue a cashier's check to the order of Seller. The check is delivered by Bank to Seller, who has no notice of the fraud. Seller can be a holder in due course and take the check free of Bank's defense of fraud. This case is discussed as Case #1 in Comment 4 to Section 3-302 [55-3-302 NMSA 1978]. Former Section 3-305 stated that a holder in due course takes free of defenses of "any party to the instrument with whom the holder has not dealt." The meaning of this language was not at all clear and if read literally could have produced the wrong result. In the hypothetical case, it could be argued that Seller "dealt" with Bank because Bank delivered the check to Seller. But it is clear that Seller should take free of Bank's defense against Buyer regardless of whether Seller took delivery of the check from Buyer of Bank. The quoted language is not included in Section 3-305 [55-3-305 NMSA 1978]. It is not necessary. If Buyer issues an instrument to Seller and Buyer has a defense against Seller, that defense can obviously be asserted. Buyer and Seller are the only people involved. The holder-in-due-course doctrine has no relevance. The doctrine applies only to cases in which more than two parties are involved. Its essence is that the holder in due course does not have to suffer the consequences of the defense of an obligor on the instrument that arose from an occurrence with a third party.
3. Subsection (a)(3) is concerned with claims in recoupment which can be illustrated by the following example. Buyer issues a note to the order of Seller in exchange for a promise of Seller to deliver specified equipment. If Seller fails to deliver the equipment or delivers equipment that is rightfully rejected, Buyer has a defense to the note because the performance that was the consideration for the note was not rendered. Section 3-303(b) [55-3-303 NMSA 1978]. This defense is included in Section 3-305(a)(2) [55-3-305 NMSA 1978]. That defense can always be asserted against Seller. This result is the same as that reached under former Section 3-408.
But suppose Seller delivered the promised equipment and it was accepted by Buyer. The equipment, however, was defective. Buyer retained the equipment and incurred expenses with respect to its repair. In this case, Buyer does not have a defense under Section 3-303(b) [55-3-303 NMSA 1978]. Seller delivered the equipment and the equipment was accepted. Under Article 2, Buyer is obliged to pay the price of the equipment which is represented by the note. But Buyer may have a claim against Seller for breach of warranty. If Buyer has a warranty claim, the claim may be asserted against Seller as a counterclaim or as a claim in recoupment to reduce the amount owing on the note. It is not relevant whether Seller is or is not a holder in due course of the note or whether Seller knew or had notice that Buyer had the warranty claim. It is obvious that holder-in-due-course doctrine cannot be used to allow Seller to cut off a warranty claim that Buyer has against Seller. Subsection (b) specifically covers this point by stating that a holder in due course is not subject to a "claim in recoupment * * * against a person other than the holder."
Suppose Seller negotiates the note to Holder. If Holder had notice of Buyer's warranty claim at the time the note was negotiated to Holder, Holder is not a holder in due course (Section 3-302(a)(2)(iv)) [55-3-302 NMSA 1978] and Buyer may assert the claim against Holder (Section 3-305(a)(3)) [55-3-305 NMSA 1978] but only as a claim in recoupment, i.e. to reduce the amount owed on the note. If the warranty claim is $1,000 and the unpaid note is $10,000, Buyer owes $9,000 to Holder. If the warranty claim is more than the unpaid amount of the note, Buyer owes nothing to the Holder, but Buyer cannot recover the unpaid amount of the warranty claim from Holder. If Buyer had already partially paid the note, Buyer is not entitled to recover the amounts paid. The claim can be used only as an offset to amounts owing on the note. If holder had no notice of Buyer's claim and otherwise qualifies as a holder in due course, Buyer may not assert the claim against Holder. Section 3-305(b) [55-3-305 NMSA 1978].
The result under Section 3-305 [55-3-305 NMSA 1978] is consistent with the result reached under former Article 3, but the rules for reaching the result are stated differently. Under former Article 3 Buyer could assert rights against Holder only if Holder was not a holder in due course, and Holder's status depended upon whether Holder had notice of a defense by Buyer. Courts have held that Holder had that notice if Holder had notice of Buyer's warranty claim. The rationale under former Article 3 was "failure of consideration." This rationale does not distinguish between cases in which the seller fails to perform and those in which the buyer accepts the performance of seller but makes a claim against the seller because the performance is faulty. The term "failure of consideration" is subject to varying interpretations and is not used in Article 3. The use of the term "claim in recoupment" in Section 3-305 (a)(3) [55-3-305 NMSA 1978] is a more precise statement of the nature of Buyer's right against Holder. The use of the term does not change the law because the treatment of a defense under Subsection (a)(2) and a claim in recoupment under subsection (a)(3) is essentially the same.
Under former Article 3, case law was divided on the issue of the extent to which an obligor on a note could assert against a transferee who is not a holder in due course a debt or other claim that the obligor had against the original payee of the instrument. Some courts limited claims to those that arose in the transaction that gave rise to the note. This is the approach taken in Section 3-305(a)(3) [55-3-305 NMSA 1978]. Other courts allowed the obligor on the note to use any debt or other claim, no matter how unrelated to the note, to offset the amount owed on the note. Under current judicial authority and non-UCC statutory law, there will be many cases in which a transferee of a note arising from a sale transaction will not qualify as a holder in due course. For example, applicable law may require the use of a note to which there cannot be a holder in due course. See Section 3-106(d) [55-3-106 NMSA 1978] and Comment 3 to Section 3-106 [55-3-106 NMSA 1978]. It is reasonable to provide that the buyer should not be denied the right to assert claims arising out of the sale transaction. Subsection (a)(3) is based on the belief that it is not reasonable to require the transferee to bear the risk that wholly unrelated claims may also be asserted. The determination of whether a claim arose from the transaction that gave rise to the instrument is determined by law other than this Article and thus may vary as local law varies.
4. Subsection (c) concerns claims and defenses of a person other than the obligor on the instrument. It applies principally to cases in which an obligation is paid with the instrument of a third person. For example, Buyer buys goods from Seller and negotiates to Seller a cashier's check issued by Bank in payment of the price. Shortly after delivering the check to Seller, Buyer learns that Seller had defrauded Buyer in the sale transaction. Seller may enforce the check against Bank even though Seller is not a holder in due course. Bank has no defense to its obligation to pay the check and it may not assert defenses, claims in recoupment, or claims to the instrument of Buyer, except to the extent permitted by the but clause of the first sentence of Subsection (c). Buyer may have a claim to the instrument under Section 3-306 [55-3-306 NMSA 1978] based on a right to rescind the negotiation to Seller because of Seller's fraud. Section 3-202(b) [55-3-202 NMSA 1978] and Comment 2 to Section 3-201 [55-3-201 NMSA 1978]. Bank cannot assert that claim unless Buyer is joined in the action in which Seller is trying to enforce payment of the check. In that case Bank may pay the amount of the check into court and the court will decide whether that amount belongs to Buyer or Seller. The last sentence of Subsection (c) allows the issuer of an instrument such as a cashier's check to refuse payment in the rare case in which the issuer can prove that the instrument is a lost or stolen instrument and the person seeking enforcement does not have rights of a holder in due course.
5. Subsection (d) applies to instruments signed for accommodation (Section 3-419) [55-3-419 NMSA 1978] and this subsection equates the obligation of the accommodation party to that of the accommodated party. The accommodation party can assert whatever defense or claim the accommodated party had against the person enforcing the instrument. The only exceptions are discharge in bankruptcy, infancy and lack of capacity. The same rule does not apply to an indorsement by a holder of the instrument in negotiating the instrument. The indorser, as transferor, makes a warranty to the indorsee, as transferee, that no defense or claim in recoupment is good against the indorser. Section 3-416(a)(4) [55-3-416 NMSA 1978]. Thus, if the indorsee sues the indorser because of dishonor of the instrument, the indorser may not assert the defense or claim in recoupment of the maker or drawer against the indorsee.
Section 3-305(d) [55-3-305 NMSA 1978] must be read in conjunction with Section 3-605, which provides rules (usually referred to as suretyship defenses) for determining when the obligation of an accommodation party is discharged, in whole or in part, because of some act or omission of a person entitled to enforce the instrument. To the extent a rule stated in Section 3-605 [55-3-605 NMSA 1978] is inconsistent with Section 3-305(d), the Section 3-605 rule governs. For example, Section 3-605(a) provides rules for determining when and to what extent a discharge of the accommodated party under Section 3-604 will discharge the accommodation party. As explained in Comment 2 to Section 3-605, discharge of the accommodated party is normally part of a settlement under which the holder of a note accepts partial payment from an accommodated party who is financially unable to pay the entire amount of the note. If the holder then brings an action against the accommodation party to recover the remaining unpaid amount of the note, the accommodation party cannot use Section 3-305(d) to nullify Section 3-605(ba) by asserting the discharge of the accommodated party as a defense. On the other hand, suppose the accommodated party is a buyer of goods who issued the note to the seller who took the note for the buyer's obligation to pay for the goods. Suppose the buyer has a claim for breach of warranty with respect to the goods against the seller and the warranty claim may be asserted against the holder of the note. The warranty claim is a claim in recoupment. If the holder and the accommodated party reach a settlement under which the holder accepts payment less than the amount of the note in full satisfaction of the note and the warranty claim, the accommodation party could defend an action on the note by the holder by asserting the accord and satisfaction under Section 3-305(d). There is no conflict with Section 3-605(ba) because that provision is not intended to apply to settlement of disputed claims.
6. Subsection (e) is added to clarify the treatment of an instrument that omits the notice currently required by the Federal Trade Commission Rule related to certain consumer credit sales and consumer purchase money loans (16 C.F.R. Part 433). This subsection adopts the view that the instrument should be treated as if the language required by the FTC Rule were present. It is based on the language describing that rule in Section 3-106(d) [55-3-106 NMSA 1978] and the analogous provision in Section 9-404(d) [55-9-404 NMSA 1978].
7. Subsection (f) is modeled on Sections 9-403(e) [55-9-403 NMSA 1978] and 9-404(c) [55-9-404 NMSA 1978]. It ensures that Section 3-305 is interpreted to accommodate relevant consumer-protection laws. The absence of such a provision from other sections in Article 3 should not justify any inference about the meaning of those sections.
8. Articles 28 and 30 of the Convention on International Bills of Exchange and International Promissory Notes includes a similar dichotomy, with a narrower group of defenses available against a protected holder under Articles 28(1) and 30 than are available under Article 28(2) against a holder that is not a protected holder.
ANNOTATIONS
Repeals.
— Laws 1992, ch. 114, § 237 repealed former 55-3-205 NMSA 1978, as enacted by Laws 1961, ch. 96, § 3-305, relating to rights of a holder in due course, effective July 1, 1992. Laws 1992, ch. 114, § 118, enacted a new section, effective July 1, 1992.
The 2009 amendment,
effective January 1, 2010, added Subsections (e) and (f).
I. DEFENSES HOLDER IN DUE COURSE FREE FROM.
Notes not voided by lack of knowledge.
— Plaintiffs, who signed contract for installation of aluminum siding on their home under the mistaken impression they would get a discount price as a "show home," but failed to read the contract itself, may not have notes and mortgages in hands of a holder in due course cancelled and voided on ground they did not have knowledge or reasonable opportunity to understand the notes.
Burchett v. Allied Concord Fin. Corp.
, 1964-NMSC-231, 74 N.M. 575, 396 P.2d 186.
Because loss on person who occasions it.
— The reason for the rule is that when one or two innocent persons must suffer by the act of a third, the loss must be borne by the one who enables the third person to occasion it.
Burchett v. Allied Concord Fin. Corp.
, 1964-NMSC-231, 74 N.M. 575, 396 P.2d 186.
Failure of consideration may be defense.
— Knowledge on the part of an endorsee of a promissory note that it had been given in consideration of some executory contract of the payee which said payee afterwards fails to perform will not deprive such endorsee of his character of a bona fide holder in due course, unless he had actual notice of the breach prior to acquiring the note.
Azar v. Slack
, 1924-NMSC-025, 29 N.M. 528, 224 P. 398 (decided under former law).
II. DEFENSES HOLDER IN DUE COURSE NOT FREE FROM.
Fraud in the inception nullifies instrument.
— Although a holder in due course holds an instrument free from any defect of title, and free from defenses available to prior parties among themselves insofar as a voidable instrument is concerned, where fraud in the inception is present, such fraud makes the instrument an absolute nullity and not merely voidable.
United States v. Castillo
, 120 F. Supp. 522 (D.N.M. 1954)(decided under former law).
Must be mistaken belief induced by payee.
— To completely invalidate the enforceability of a negotiable promissory note, the fraud perpetrated must have been such as to induce the maker of the note to execute the same under the mistaken belief that the instrument being signed was something other than a promissory note and must have come about as a direct result of misrepresentation on the part of the payee or his agent.
United States v. Castillo
, 120 F. Supp. 522 (D.N.M. 1954)(decided under former law).
Maker must exercise reasonable prudence.
— The maker cannot be guilty of negligence in signing a written instrument and then defend upon the ground of lack of knowledge where in the exercise of reasonable prudence the attempted fraud could be discovered; and it is not a defense to the enforcement of an obligation to insist that a fraud has been wrought where the maker did not take the care to read the instrument being signed, inasmuch as such an omission generally constitutes negligence.
United States v. Castillo
, 120 F. Supp. 522 (D.N.M. 1954).
Failure to read an instrument is not negligence per se
but is to be considered in light of all surrounding facts and circumstances with particular emphasis on the maker's intelligence and literacy.
United States v. Castillo
, 120 F. Supp. 522 (D.N.M. 1954).
Illiteracy deemed not negligence.
— Where defendants are nearly illiterate in the English language and had no reason to believe the agent of the payee in question was misrepresenting the character of the paper signed, they were not guilty of negligence in failing to verify that the instrument was in fact a note rather than a contract for repairs as fraudulently represented, and the sued upon instrument was void from its inception.
United States v. Castillo
, 120 F. Supp. 522 (D.N.M. 1954).
Bill won at gambling unenforceable.
— The Uniform Negotiable Instruments Law is merely declaration of the law merchant heretofore in effect and is not intended to modify the gaming law so as to allow enforcement by holder in due course of note or bill won at gambling.
Farmers' State Bank v. Clayton Nat'l Bank
, 1925-NMSC-026, 31 N.M. 344, 245 P. 543, 46 A.L.R. 952 (1925)(decided under former law).
Law reviews.
— For comment, "Assignments - Maker's Defenses Cut Off - Uniform Commercial Code § 9-206," see 5 Nat. Resources J. 408 (1965).
For note, "Self-Help Repossession Under the Uniform Commercial Code: The Constitutionality of Article 9, Section 503," see 4 N.M. L. Rev. 75 (1973).
Am. Jur. 2d, A.L.R. and C.J.S. references. —
11 Am. Jur. 2d Bills and Notes §§ 255, 263, 264, 275, 279, 333, 398, 421, 652, 666, 670, 672, 676, 679, 690, 693, 695, 715, 716, 719, 720, 725; 12 Am. Jur. 2d Bills and Notes §§ 1158, 1170.
Deception as to character of paper signed as defense as against bona fide holder of negotiable paper, 160 A.L.R. 1295.
Insanity of maker, drawer or endorser as defense against holder in due course, 24 A.L.R.2d 1380.
Fraud in the inducement and fraud in the factum as defenses under U.C.C. § 3-305 against holder in due course, 78 A.L.R.3d 1020.
Economic duress or business compulsion in execution of promissory note, 79 A.L.R.3d 598.
What constitutes "dealing" under UCC § 3-305(2), providing that holder in due course takes instrument free from all defenses of any party to instrument with whom holder has not dealt, 42 A.L.R.5th 137.
Duress, incapacity, illegality, or similar defense rendering obligation a nullity as affecting enforceability of negotiable instrument against holder in due course under UCC [rev] § 3-305(a)(1)(ii), 89 A.L.R.5th 577.
10 C.J.S. Bills and Notes § 190 et seq.