New York Law Review

Tag: Voidable Obligation

  • Israel Discount Bank Ltd. v. L. Blankstein & Son, Inc., 58 N.Y.2d 436 (1983): Notice of Voidable Obligations and Holder in Due Course Status

    Israel Discount Bank Ltd. v. L. Blankstein & Son, Inc., 58 N.Y.2d 436 (1983)

    A holder of a promissory note is not a holder in due course if they had notice that the obligation of any party is voidable in whole or in part, but knowledge that a note was issued in return for an executory promise does not give the holder notice of a defense unless they know a defense has arisen from the terms thereof.

    Summary

    Israel Discount Bank (the Bank) sued L. Blankstein and Son, Inc. (Blankstein) and Jacob Klein and Son, Inc. (Klein) to recover on promissory notes. The notes were initially issued to Leo Siegman, a diamond merchant, who then endorsed and delivered them to the Bank as security for a loan. Blankstein and Klein argued that the Bank was not a holder in due course because it knew the notes were related to diamond sale agreements where Siegman could refuse delivery, or they could return diamonds without obligation. The New York Court of Appeals held that the Bank was a holder in due course because Blankstein and Klein failed to prove the Bank had actual knowledge that the notes were predicated on voidable obligations, not binding executory contracts. Therefore, the Bank took the notes free of personal defenses.

    Facts

    Leo Siegman, a diamond merchant, received promissory notes from Blankstein and Klein for diamond sales/consignments. Siegman endorsed these notes in blank and delivered them to Israel Discount Bank as security for a loan. When the Bank presented the notes for payment, they were dishonored (returned unpaid). The Bank then sued Blankstein and Klein.

    Procedural History

    The Supreme Court initially denied the Bank’s motion for summary judgment. The Appellate Division reversed and granted summary judgment to the Bank, holding that the Bank was a holder in due course and parol evidence was inadmissible to contradict the notes. The New York Court of Appeals affirmed the Appellate Division’s order granting summary judgment to the bank, but based its holding on different reasoning regarding the Bank’s status as a holder in due course and the knowledge it possessed.

    Issue(s)

    Whether the Bank was a holder in due course of the promissory notes, and therefore took the notes free of personal defenses asserted by Blankstein and Klein.

    Holding

    Yes, the Bank was a holder in due course, because Blankstein and Klein failed to present sufficient evidence that the Bank had actual knowledge that the notes were based on voidable obligations, rather than binding executory contracts. Consequently, the Bank took the notes free of the makers’ personal defenses.

    Court’s Reasoning

    The court reasoned that under UCC § 3-302, a holder in due course takes an instrument (1) for value; (2) in good faith; and (3) without notice that it is overdue or has been dishonored or of any defense against or claim to it. The court found that the Bank gave value and acted in good faith. The critical issue was whether the Bank had “notice of a claim or defense.” Under UCC § 3-304(1)(b), a holder has notice of a defense if they know the obligation is “voidable.” Blankstein and Klein argued the notes were referable to nonbinding agreements. The Bank countered that its knowledge of an executory promise (future diamond delivery) did not constitute notice of a defense unless it knew a defense had arisen (UCC § 3-304(4)(b)).

    The court distinguished between executory promises and voidable obligations. An executory contract is one where a party binds itself to perform in the future. Knowledge of an executory contract alone is insufficient to defeat holder in due course status. However, knowledge that an agreement is rescindable at will provides notice that a defense has arisen. The burden was on Blankstein and Klein to prove the Bank had actual knowledge that the notes were predicated on voidable obligations. The court emphasized that while the defendants alleged a general custom in the diamond trade that notes were merely evidence of transactions, they failed to provide evidentiary facts showing the bank had *actual knowledge* of the voidable nature of the instruments. The court stated, “Summary judgment on a note will be defeated only where material issues of fact are raised which are ‘genuine and based on proof, not shadowy and conclusory statements’.” Because they failed to demonstrate this, the Bank was a holder in due course and took the notes free of personal defenses. The court also clarified that parol evidence is admissible to show a holder did not take the instrument for value, in good faith, or without notice of claims/defenses, even if the note is unconditional on its face; this evidence isn’t to vary the terms of the note, but to show the bank wasn’t a holder in due course.

  • Israel Discount Bank Ltd. v. Rosen, 59 N.Y.2d 428 (1983): Enforceability of Promissory Notes and Holder in Due Course Status

    Israel Discount Bank Ltd. v. Rosen, 59 N.Y.2d 428 (1983)

    A bank cannot claim holder in due course status on promissory notes if it had knowledge that the underlying agreement for which the notes were issued was rescindable at will, rendering the notes voidable.

    Summary

    Israel Discount Bank sought summary judgment against diamond merchants Rosen and Consolidated Jewelry Co. to enforce promissory notes. These notes were initially made out to a diamond seller, Siegman, who then endorsed them to the bank as collateral. The defendants argued failure of consideration because the underlying diamond transactions allowed for rescission without liability, a fact allegedly known to the bank. The New York Court of Appeals reversed the lower courts’ decisions, holding that the defendants presented sufficient evidence to raise triable issues of fact regarding the bank’s knowledge of the voidability of the notes, precluding summary judgment for the bank as a holder in due course.

    Facts

    Rappaport and Fishman, operating as Consolidated Jewelry Co., and Rosen, regularly purchased diamonds from Siegman, issuing promissory notes in his favor as payment. Siegman then endorsed these notes to Israel Discount Bank to secure loans and collateralize existing debt. The bank later presented the notes for payment, but they were dishonored by Rosen and Consolidated. The bank sued, seeking to enforce the notes as a holder in due course.

    Procedural History

    The Supreme Court initially denied the bank’s motion for summary judgment in the Rosen case, finding factual issues regarding the bank’s knowledge of the transactions. However, the Supreme Court granted the motion in the Consolidated case. The Appellate Division reversed in Rosen and affirmed in Consolidated, relying on a prior decision, but the Court of Appeals reversed both appellate decisions.

    Issue(s)

    1. Whether the promissory notes issued to Siegman were predicated on agreements rescindable at will, thereby rendering the notes voidable obligations.
    2. Whether Israel Discount Bank had knowledge of the alleged voidability of the notes at the time it accepted them.

    Holding

    1. Yes, because the defendants presented evidence suggesting that the underlying diamond transactions allowed any party to rescind the agreement without liability, effectively making the agreements and related notes nullities.
    2. Yes, because the bank’s own invoices and conduct indicated its awareness of the customers’ right to return or refuse diamonds, which would make the bank aware that the obligations were voidable.

    Court’s Reasoning

    The court reasoned that to claim holder in due course status, the bank must have taken the notes for value, in good faith, and without notice of claims or defenses against them. If the bank knew the underlying agreements were voidable, it could not be a holder in due course. The court found that the defendants submitted sufficient evidence to raise triable issues of fact on this point. Affidavits from all parties stated the agreements were rescindable at will, which meant the notes could be considered voidable obligations. The bank’s own invoices contained a return/refusal clause, providing further evidence the bank was aware of the non-binding nature of the transactions. The Court distinguished this case from First Int. Bank of Israel v Blankstein & Son, where the evidence was insufficient to demonstrate the bank’s knowledge. The Court quoted U.C.C. § 3-304(4)(b) stating that knowledge that the instrument was issued in return for a binding executory promise does not of itself give the purchaser notice of a defense or claim because the code does not require the holder to presume that a party will breach his promise and thereby give rise to a defense to performance.