Opinion ID: 683516
Heading Depth: 2
Heading Rank: 2

Heading: The Dealt [With] Doctrine

Text: 33 Defendants contend that even if AITF is a holder in due course, it is not entitled to recover because it dealt with defendants, within the meaning of NYUCC Sec. 3-305(2), in negotiating the terms of the promissory notes. They also take issue with the district court's concern that denial of holder-in-due-course immunity to AITF here might unduly discourage commercial a forfait  transactions, contending that forfaiting is so rarely used in the United States that it can hardly be [considered] one of those types of financings that were sought to be encouraged by the Code. (Defendants' brief on appeal at 10.) We reject these contentions because they hinge on a literal interpretation of dealt [with] that does not accord with New York law. 34 Section 3-305(2) provides, with exceptions not pertinent here, that [t]o the extent that a holder is a holder in due course he takes the instrument free from ... all defenses of any party to the instrument with whom the holder has not dealt .... NYUCC Sec. 3-305(2) (the  'dealt [with]'  provision). The official comment to this section does not explain the intended scope of the dealt [with] provision. The courts have reasoned, however, that that part of Sec. 3-305(2) was not meant to be given literal or unlimited application, for UCC Sec. 3-302(2) provides that the holder of a negotiable instrument may, if he satisfies the prerequisites set out in Sec. 3-302(1), be a holder in due course even though he is the payee. NYUCC Sec. 3-302(2); see, e.g., Chicago Title & Trust Co. v. Walsh, 34 Ill.App.3d 458, 469, 340 N.E.2d 106, 114 (1975). Further, the official commentary to the latter section notes that such a payee is entitled to holder-in-due-course status regardless of whether he takes the instrument by purchase from a third person or directly from the obligor. NYUCC Sec. 3-302(2) cmt. 2 (emphasis added). Thus, a literal application of the dealt [with] provision of Sec. 3-305(2) would nullify so much of Sec. 3-302(2) as is designed to accord holder-in-due-course status to a payee who has purchased the instrument directly from the obligor. 35 Instead, the dealt [with] provision of Sec. 3-305(2) has been viewed as a limited restriction on Sec. 3-302(2), to be applied to deny holders in due course their normal immunity only when they are found to have been so involved with the disputed transaction that they should not be free from defenses. Chicago Title & Trust Co. v. Walsh, 34 Ill.App.3d at 468, 340 N.E.2d at 113; see also New Bedford Institution for Savings v. Gildroy, 36 Mass.App.Ct. 647, 654-55, 634 N.E.2d 920, 926, review denied, 418 Mass. 1106, 639 N.E.2d 1082 (1994); Village Motors, Inc. v. American Federal Savings & Loan Association, 231 Va. 408, 411-12, 345 S.E.2d 288, 290 (1986). Thus, the dealt [with] provision is frequently applied to deny holder-in-due-course immunity to a holder payee who was a party to the underlying commercial transaction with the instrument's maker, for in those circumstances if there is a failure of consideration in the underlying transaction, the payee will likely be aware of it. See, e.g., New Bedford Institution for Savings v. Gildroy, 36 Mass.App.Ct. at 655, 634 N.E.2d at 926 (dealt [with] exception applies only to payees so directly and personally involved with the disputed aspects of the transaction as to be charged with knowledge of any fraud or other irregularity); James Pair, Inc. v. Gentry, 134 Ga.App. 734, 734-35, 215 S.E.2d 707, 707-08 (1975) (Sec. 3-305(2) precludes holder-in-due-course immunity for payee who induced promisor to sign note based on misrepresentation that payments would later be refunded); Brotherton v. McWaters, 438 P.2d 1, 3-4 (Okla.1968) (similar preclusion of immunity for payee of check drawn in payment for payee's allegedly faulty repairs). As thus applied, the dealt [with] provision denies holder-in-due-course immunity to a person who had such intimate involvement in the underlying transaction as to warrant imputing to him knowledge of its irregularities--an application that essentially replicates two of the preconditions to achievement of holder-in-due-course status, i.e., that the holder must take the instrument in good faith and without notice of defenses. 36 This view that the dealt [with] provision largely mirrors the Sec. 3-302(1) analysis of good faith and notice finds support in the 1990 revision of Article 3 of the UCC--a revision not adopted in New York--which eliminated the dealt [with] language of UCC Sec. 3-305(2) as unnecessary. The revised version, instead of denying the normal holder-in-due-course immunity to holders in due course who have dealt [with] the obligor, provides more simply that a holder in due course shall not be subject to defenses of the obligor ... against a person other than the holder. UCC Sec. 3-305(b), 2 U.L.A. 72 (1991) (emphasis added). The Official Comment to the revised Sec. 3-305 explains that the language of the prior Sec. 3-305(2) was not at all clear and if read literally could have produced the wrong result.... It is not necessary. Id. cmt. 2, 2 U.L.A. 74 (1991). See also 1B J. White & R. Summers, Uniform Commercial Code Sec. 14-5, at 50 (3d ed. 1993) (suggesting that the new language [of Sec. 3-305] ... will make it easier to reach the right result and inferring that there had been no significant changes in policy or substance). 37 Defendants in the present case, noting that the 1990 revision has not been adopted in New York, and relying principally on Fazio v. Loweth, 112 A.D.2d 135, 490 N.Y.S.2d 859 (2d Dep't 1985) (Fazio ), argue that we should apply the undisturbed dealt [with] provision literally. We disagree for several reasons: (a) the Fazio statement on which defendants rely was superfluous dictum; (b) in the circumstances of Fazio itself, application of the dealt [with] provision would have, consistent with both the prevailing interpretation of Sec. 3-305(2) and the premises of the 1990 revision, resulted in the denial of holder-in-due-course status, not just the denial of holder-in-due-course immunity to one having that status; and (c) in other circumstances, the New York courts have not applied the provision literally. 38 In Fazio, the plaintiff, claiming to be a holder in due course, sought summary judgment enforcing a dated document bearing what seem[ed] to be the signature of Dominic Loweth, stating,  '[t]his is to certify that I borrowed $15,000 from Philip N. Fazio on this day to be returned within 10 days.'  Id. at 135, 490 N.Y.S.2d at 860. The Appellate Division upheld the denial of summary judgment, holding that the document was not a negotiable instrument because it was not payable to order or to bearer and hence does not fulfill the requirements of UCC 3-104(1)(d). 112 A.D.2d at 136, 490 N.Y.S.2d at 861. Since the document was not a negotiable instrument, the plaintiff could not be a holder in due course. 39 After so holding, the Fazio court noted that even if the document had been a negotiable instrument, there were other possible defects in the plaintiff's case. In the statement on which defendants focus, the court stated that even were plaintiff to be considered a holder in due course, he would still be subject to any valid defense asserted by defendant Loweth because Loweth is a party with whom he has dealt (see, UCC 3-305. 112 A.D.2d at 136, 490 N.Y.S.2d at 861. The court went on to observe, however, that Fazio might have been precluded from even becoming a holder in due course because Loweth claimed to have been acting merely as a messenger who had signed a receipt for a check made out to Loweth's employer and claimed that the paper on which Fazio based his suit was not the paper Loweth had signed. The Fazio court noted that if Loweth's version of the facts were true, it would have been impossible for plaintiff not to have knowledge of the defense asserted by Loweth. 112 A.D.2d at 137, 490 N.Y.S.2d at 861. Given the fraud claimed in Fazio, it seems clear that any application of the dealt [with] provision would have been no more than a replication of the initial holder-in-due-course inquiry. 40 Further, even if the dictum of the Appellate Division in Fazio could be read as suggesting a literal application of the dealt [with] provision to circumstances other than those confronting the Fazio court, that provision has not been so applied. Prior to Fazio, New York courts had, consistent with the actual-knowledge standard discussed in Part II.A.2. above, rejected any blanket exclusion from holder-in-due-course status for all payees with a definable relation to the underlying transaction. Saale v. Interstate Steel Co., 27 A.D.2d 1, 5, 275 N.Y.S.2d 532, 535 (1st Dep't 1966) (Saale ), aff'd, 19 N.Y.2d 933, 281 N.Y.S.2d 340, 228 N.E.2d 397 (1967). In Saale, which involved an alleged fraudulent substitution of goods, the plaintiff, who had technical title to goods that were put up for salvage sale by its insurer, was not involved in the sale transaction until the defendants sought to buy the goods on credit. The plaintiff and the defendants then negotiated credit terms that resulted in the corporate defendant's issuance of promissory notes payable to the plaintiff. The Saale court noted the plaintiff's very limited role in the transaction, pointing out that [o]nly after the sale and because defendant sought credit was plaintiff brought back into the picture; and it noted that there was no suggestion anywhere that plaintiff played any knowing role in the underlying transaction. 27 A.D.2d at 3, 275 N.Y.S.2d at 534. Stating that [n]o one has suggested that being a party to the underlying transaction bars the holder from being one in due course, id. at 4, 275 N.Y.S.2d at 535, the court held that the plaintiff was a holder in due course and was not subject to the defendant's defense of fraudulent substitution. Plainly the Saale court concluded that holder-in-due-course immunity is available notwithstanding the holder's having dealt directly with the promisor in the negotiation of credit terms, so long as the holder's role in the underlying transaction was limited and the holder had no notice of any defects in that transaction. On appeal, the New York Court of Appeals, after briefly describing the facts, affirmed Saale on the opinion of the Appellate Division. See Saale v. Interstate Steel Co., 19 N.Y.2d 933, 281 N.Y.S.2d 340, 228 N.E.2d 397 (1967). 41 Thus, though the courts in Saale did not directly address Sec. 3-305(2), their holding was consistent with both (a) the general view that the dealt [with] limitation is essentially the equivalent of the good-faith and lack-of-notice requirements, and (b) the 1990 revision's premises that the dealt [with] provision should not be taken literally and, if applied properly, is unnecessary. The correctness of this interpretation of Saale, and the viability of its holding notwithstanding the 1985 dictum in Fazio, are confirmed by the New York Court of Appeals discussion in Hartford Accident & Indemnity Co. v. American Express Co., 74 N.Y.2d at 159, 544 N.Y.S.2d at 576, 542 N.E.2d at 1092-93, a 1989 decision. The Hartford court, after noting the requirements for holder-in-due-course status, including good faith and lack of notice, stated, citing its affirmance of Saale, that [s]atisfaction of these requirements is all that is necessary for a payee to obtain the special protections of a holder in due course. Id. at 159, 544 N.Y.S.2d at 576, 542 N.E.2d at 1093 (emphasis added). 42 In sum, we conclude that under New York law, a holder's having participated in the financing aspects of an underlying commercial transaction does not compromise his holder-in-due-course status or immunity, provided that his involvement did not result in actual notice of defenses to the underlying contract. Since, as discussed in Part II.A.2. above, defendants failed to present facts sufficient to create a triable issue as to AITF's good faith or lack of notice, we conclude that their dealt [with] defense must also fail.