Opinion ID: 1998107
Heading Depth: 1
Heading Rank: 8

Heading: Holders in Due Course

Text: We next need to determine the status of the answering warrant holders. At all material times Neb.U.C.C. § 3-302 (Reissue 1980) has provided in part: (1) A holder in due course is a holder who takes the instrument (a) for value; and (b) in good faith; and (c) without notice that it is overdue or has been dishonored or of any defense against or claim to it on the part of any person. A holder has consistently been defined as one who is in possession of an instrument issued or endorsed to him or to his order, or to bearer or in blank. Neb.U.C.C. § 1-201(20) (Reissue 1980). Each of the answering warrant holders is in possession of warrants which had been endorsed to him or it by Continental Western or the latter's transferee. Each is therefore a holder. The question now becomes whether each is a holder in due course. Each answering warrant holder gave value. It was stipulated that The Judy Company, Alexander & Alexander, Inc., and American Savings Company, which at various relevant times was also known as American Securities Company and American Thrift and Loan, Inc., gave value. Frankson and Robertson each testified that he gave value. We deal with the good faith and without notice requirements of § 3-302(1)(b) and (c) together, for although they are separate elements, the same set of facts at times may, as they do in this case, resolve both issues. Good faith has always been defined in § 1-201(19) as honesty in fact in the conduct or transaction concerned. Whether one has taken a negotiable instrument in good faith is determined subjectively, that is to say, whether there was honesty of intent rather than the absence of circumstances which would put an ordinarily prudent holder on inquiry. Leininger v. Anderson, 255 N.W.2d 22 (Minn.1977); Frantz v. First Nat. Bank of Anchorage, 584 P.2d 1125 (Alaska 1978); Favors v. Yaffe, 605 S.W.2d 342 (Tex.Civ.App.1980); Breslin v. New Jersey Investors, Inc., 70 N.J. 466, 361 A.2d 1 (1976). See, also, J. White & R. Summers, Handbook of the Law Under the Uniform Commercial Code § 14-6 (2d ed. 1980). Compare, however, Saka v. Sahara-Nevada Corp., 92 Nev. 703, 558 P.2d 535 (1976), stating that bad faith may be presumed from a reckless refusal to inquire. Under the provisions of § 1-201(25) one has at all relevant times had notice of a fact when (a) he has actual knowledge of it; or (b) he has received a notice or notification of it; or (c) from all the facts and circumstances known to him at the time in question he has reason to know that it exists.... Neb.U.C.C. § 3-304 (Reissue 1980) has listed a variety of circumstances in which a purchaser is deemed to have notice, and others which do not of themselves give the purchaser notice of a claim or defense. We therefore analyze the evidence in light of § 3-304. It was stipulated that the purchase of the warrants by The Judy Company and Alexander & Alexander, Inc., was without notice of any adverse claim to, or defect in, said warrants. The former president of American Savings testified, without contradiction, that he had no knowledge as to how Continental Western acquired the warrants purchased by American Savings, did not know the specific purpose for which they were issued, had no knowledge of any adverse claim or defense with respect to them, and, in fact, had been assured by the district's attorney that the warrants had been properly issued. Frankson testified that although he at some time served on Continental Western's board, he did not know the purpose for which the warrants he had purchased were issued, and had no knowledge of any defect or infirmity or of any adverse claim or defense against them. He, too, had been assured by the district's attorney that the warrants were a sound investment. Robertson also served on the board at some time. He knew the warrants he had purchased were for the golf course, in connection with which he had made an inspection and had seen pipe and all the other things. He testified he had no knowledge of any defects or infirmity in or defenses to the warrants. He also had been assured by the district's attorney that the matter had been handled properly and [there] was nothing to be afraid of. Under these circumstances it cannot be said the trial court was clearly wrong in concluding that the answering warrant holders took the warrants for value and in good faith. All of the requirements of § 3-302 having thus been met, the answering warrant holders are holders in due course. One of the more important consequences of being a holder in due course of a negotiable instrument is that such a holder is not subject to certain defenses or claims which may exist between the original parties to the instrument. The rule has been set forth in Neb.U.C.C. § 3-305 (Reissue 1980) as follows: To the extent that a holder is a holder in due course he takes the instrument free from (1) all claims to it on the part of any person; and (2) all defenses of any party to the instrument with whom the holder has not dealt except (a) infancy, to the extent that it is a defense to a simple contract; and (b) such other incapacity, or duress, or illegality of the transaction, as renders the obligation of the party a nullity; and (c) such misrepresentation as has induced the party to sign the instrument with neither knowledge nor reasonable opportunity to obtain knowledge of its character or its essential terms; and (d) discharge in insolvency proceedings; and (e) any other discharge of which the holder has notice when he takes the instrument. The district claims its obligation is a nullity because its warrants were issued in relationship with an illegal transaction. Therefore, it argues, the answering warrant holders took the warrants subject to that defense pursuant to the provision of § 3-305(2)(b). In support of its position the district cites what it characterizes as black letter law, which holds that contracts between municipal corporations and others which involve a conflict of interest because of employee, officer, director, or attorney relationships are void as against public policy. The district further contends that since, at the time of the golf course transaction, (1) Continental Western's attorney was also the district's attorney, (2) several members of the board of trustees of the district were employees of Continental Western, and (3) the others were subject to removal at Continental Western's desire, the transaction should be declared illegal and a nullity. We do not agree. In 1976 the Legislature specifically provided, Neb.Rev.Stat. § 31-740 (Reissue 1978), that any purchase by a sanitary and improvement district of public parks, play-grounds and recreational facilities so approved may be completed and shall be valid notwithstanding any interest of any trustee of the district in the transaction. 1976 Neb.Laws, L.B. 313. The approval referred to in the quoted portion of § 31-740 is that of either the county board or a municipality's governing body. Such approval was required by statute at the time of the golf course transaction in the present case. 1974 Neb. Laws, L.B. 629 (passed with an emergency clause, making the statute effective on March 22, 1974). The district argues that the 1976 legislative pronouncement is evidence that the common law governing conflicts of interest in contracts with municipal corporations, which we accept for purposes of this analysis but do not decide to be as characterized by the district, was applicable to sanitary and improvement districts prior to 1976. It argues that the Legislature was not willing to change the applicability of that common-law rule until it required that an outside, independent body review the transaction. The answering warrant holders, on the other hand, argue that the 1976 legislative pronouncement was one which merely clarified a point of possible confusion. While the district's argument on this issue is not without some logical basis, we are not convinced by it. The approval requirement was changed in 1974, some 2 years prior to the L.B. 313 additions. Moreover, the unvarnished fact of the matter is that, to a certain extent, a sanitary and improvement district is designed to be a government of, by, and for developers. The sanitary and improvement districts law, Neb.Rev.Stat. §§ 31-727 et seq. (Reissue 1978), has always contemplated that owners of land may form a sanitary and improvement district, name the board of trustees, and carry out its corporate purposes. A largely undeveloped sanitary and improvement district which consists of but one or several large landowners could not function without some amount of self-dealing. The sewer systems, streets, and other necessary improvements must be located somewhere in the district. Land for parks, golf courses, and other recreational facilities must be purchased from someone owning land in the district. Such an owner may also be a member of the board of trustees or exert some influence upon it. We also note that, at the relevant time, §§ 31-749 to 31-759 (Reissue 1974) required that the details of the purchase be published and provided for a hearing on any objection to the purchase, and the issuance of bonds to pay for the purchase was ultimately subject to the approval of the District Court. Although a decree of the District Court confirming the legality and validity of the bond issue does not determine the validity or invalidity of every contract made by the district in connection with the project which the bond issue was designed to finance, Hayes v. Sanitary & Improvement Dist. No. 194, 196 Neb. 653, 244 N.W.2d 505 (1976), there was nonetheless a mechanism for independent review of the transaction, which was utilized in this case. We hold that a transaction between a sanitary and improvement district and an entity with which it shares common directors, officers, or attorneys need not be, on that ground alone, illegal and a nullity. Consequently, that defense, as asserted by the district, does not fall within the ambit of § 3-305(2)(b). It is therefore unavailing against the answering warrant holders who, as we have said previously, are holders in due course. As we noted earlier, the approval provisions of § 31-740 were changed on March 22, 1974, by L.B. 629, which added the language which is bracketed in the following quoted portion: Prior to the installation of any of the improvements provided for in this section, the plans for such improvements, other than for public parks, playgrounds and recreational facilities, shall be approved by the public works department of any municipality when such improvements or any part thereof are within the area of the zoning jurisdiction of such municipality [ ; Provided, that if such improvements are without the area of the zoning jurisdiction of any municipality, plans for such improvements shall be approved by the county board of the county wherein such improvements are located ], and plans and exact costs for public parks, playgrounds and recreational facilities shall be approved by resolution of the governing body of such municipality [ or county ]. Such approval shall relate to conformity with the master plan and the construction specifications and standards theretofore established by such municipality [ or county ]; Provided, where no master plan and construction specifications and standards have been established such approval shall not be required. From our review of the record it appears that neither the district nor Continental Western was aware of this legislative action which took place a little more than a month prior to the golf course transaction. In their brief the answering warrant holders state that approval was not required at the time of the purchase. In its brief the district appears to be under the erroneous assumption that the approval changes made by the Legislature in 1974 were not accomplished until 1976. Neither in its pleadings nor in its brief does the district raise any contentions that since the approval required by L.B. 629 was not obtained, the transaction between it and Continental Western was an illegal one. On the other hand, the answering warrant holders do not contend that such approval was unnecessary because of the lack of a municipal or county master plan or construction specifications and standards. The district has not established that the approval of a county or municipal governmental body was necessary. Lack of such approval, if it was required, may have been such a defect as to render the golf course transaction illegal and, thus, render the obligation of the district on the warrants a nullity. This type of defense would be good against a holder in due course. § 3-305(2)(b). See, also, City of Plattsmouth v. Murphy, 74 Neb. 749, 105 N.W. 293 (1905), 78 Neb. 163, 110 N.W. 749 (1907), voiding a public contract made in violation of a mandatory provision of a city charter requiring a prior estimate of cost and its submission to the city council. Neb.U.C.C. § 3-307 (Reissue 1980) places the burden of pleading and proving defenses to a negotiable instrument upon the party attempting to avoid liability on the instrument. Bank of Valley v. Mattson, 215 Neb. 596, 339 N.W.2d 923 (1983); Columbus Bank & Trust Co. v. High Country Stable, 202 Neb. 724, 277 N.W.2d 81 (1979). Since the district has not carried its burden in proving this defense, it is likewise unavailing against the answering warrant holders. On the facts presented by this record it cannot be said the trial court's finding that the transaction was not illegal and a nullity was clearly wrong. The district further argues it should not be liable on its warrants, since retention of the warrants by Continental Western after the failure of the bond issue amounted to a fraud and resulted in a conversion of the warrants by Continental Western. In essence, these claims are contractual defenses based upon a failure of consideration or, in the worst light, a fraudulent intent by Continental Western when it entered into the golf course transaction. It has long been the law of this jurisdiction that failure of consideration is no defense to a negotiable instrument in the hands of a holder in due course. Farmers State Bank v. Lydick, 112 Neb. 586, 200 N.W. 50 (1924); Bank of Commerce & Savings v. Randell, 107 Neb. 332, 186 N.W. 70 (1921); Second Nat. Bank v. Snoqualmie Trust Co., 83 Neb. 645, 120 N.W. 182 (1909); Blue Valley Lumber Co. v. Smith, 48 Neb. 293, 67 N.W. 159 (1896). It has also long been the law of this jurisdiction that although fraud in the factum is a defense as against a holder in due course of a negotiable instrument, fraud in the inducement is not. Therefore, we have held the fraud practiced upon an illiterate which induced him to believe that the instrument signed was of some other character was a good defense as against a holder in due course. Shenandoah Nat. Bank v. Gravatte, 4 Neb. (Unoff.) 591, 95 N.W. 694 (1903); Willard v. Nelson, 35 Neb. 651, 53 N.W. 572 (1892); First National Bank of Omaha v. Lierman, 5 Neb. 247 (1876). On the other hand, we have held that the fraud practiced by misrepresenting the quality of a product is not a valid defense as against a holder in due course. Broadway Bank of Kansas City v. Sager, 122 Neb. 894, 240 N.W. 561 (1932); Farmers State Bank v. Lydick, supra . In Second Nat. Bank v. Snoqualmie Trust Co., supra, a misrepresentation concerning the ownership of personal property was held not to be a valid defense against a holder in due course. We have also held that the fraud practiced by an imposter in inducing one to endorse a negotiable instrument under a mistaken belief as to the imposter's identity is not available as a defense to a holder in due course. Hoffman v. American Exchange Nat. Bank, 2 Neb. (Unoff.) 217, 96 N.W. 112 (1901), aff'd on rehearing 2 Neb. (Unoff.) 222, 96 N.W. 112 (1902). See, also, Comment 7 to § 3-305(2)(c). We conclude that even if Continental Western possessed a fraudulent intent with respect to its performance when entering into the golf course transaction, it would amount to no more than fraud in the inducement. Therefore, the district has no defenses to the validity of its warrants which are in the hands of the answering warrant holders.