Situations arise wherein a transaction is made with a substitute for cash payment. This substitute is referred to as a negotiable instrument and is usually in the form of a promissory note. This negotiable instrument is in the possession of a third party that knows nothing regarding the defects or damages the negotiable instrument may have suffered as well as for the actions of the original creditor. This third party is referred to as a holder in due course or HDC.
For a person or entity to become a holder in due course, he, she, or it is sold a credit contract that has been entered into by another individual or entity with the original creditor. The person or entity receives this credit contract without any defect, misrepresentations committed by the original creditor, and anything that may allow the debtor to make a legal claim against the original creditor. The holder in due course essentially becomes the new creditor in the transaction.
For example, an individual may take out a mortgage on his or her house from bank A. It is within the rights of bank A to sell this mortgage to another bank, bank B. This bank B becomes the holder in due course since it has paid or given something of value to bank A in exchange for the mortgage, or essentially the repayment of it. Bank B now legally owns the mortgage and has the capacity to take legal action against the debtor in the event of a default or failure to meet the conditions or payment of the mortgage.