Question

Laws for Accountants

There are several terms you must know to be able to handle commercial paper issues. Here are the terms you need to begin with-what is the definition and what are the specific elements required?

1. commercial paper

2. holder

3. holder in due course

4. real defenses

5. personal defenses

6. elements of negotiability

7. shelter principle

a. Let's begin with these terms-their definitions and the elements required to fulfill the requirements for these various terms are quite detailed and specific. Let's stay away from broad, general statements and be very specific in our answers.

b. Now we need to understand how all of these rules, definitions and requirements work to make the commercial paper market work.

Answer 1

a) Commercial paper

Commercial paper is short term instrument issued by a company, it is a form of financing used by the company to finance its short term business decision.These are unsecured hence more risky for the investor.These unlike other debt instrument need not be registered with the Securities exchange owing to its short term nature.

A company in need of cash for short term can issue commercial paper which would be bought by the investors, interest would be paid by the company along with the principal at the end of agreed period of the instrument.

b) Holder

Holder is the person who has the physical possession of the instrument, it is him who enforces the instrument at the time of maturity or as per the terms of issue.

If Mr.X invests in the aforesaid commercial paper then he becomes the holder of the commercial paper

c) Holder in due course

Holder in due course is a person who has taken the negotiable instrument for a value in a good faith regarding its repayability.He is a person who is said to be not aware of any defects in his title to the instrument.He can proceed to the court to recover the value of the instrument.

Example - Subsequent purchases of the commercial paper is a holder in due course.

d)Real defenses

When an individual is sued on a negotiable paper, he or she will try to defend his or her right to refuse payment.There are two types of defenses - Real and Personal. Real defenses are valid even against holders in due course.The legal incapacity of the maker, drawer, or endorser, a signature effected by illegality, or fraud, and alteration of the instrument qualify as situations giving rise to real defenses.

e) Personal defenses

Personal defenses are valid only against holder and not the holder in due course.A breach of contract or warranty for which the negotiable instrument was issued is a example of personal defense.Personal defenses also include lack of consideration, undue influence, duress, breach of warranty, and prior payment.

f) Elements of negotiability

A instrument to be negotiable must have the following features

It must be in writing.; It must be signed by the maker or drawer.; It must be an unconditional promise or order to pay.; It must be for a fixed amount in money.; It must be payable on demand or at a definite time.; It must be payable to order or bearer, unless it is a check.

g) Shelter Principle

When a holder may not qualify as a holder in due course, the shelter principle may protect his/her rights. Pursuant to the shelter rule, the transferee of a negotiable instrument receives all of the rights of the transferor of the instrument, unless the transfer is carried out by fraud or illegal means. This is important in situations where the transferor is a holder in due course, but the transferee is not.