ANSWERS TO - Cengage€¦ · Web viewNegotiability is not affected by the fact that the instrument recites the transaction which gave rise to the instrument and negotiability is

ANSWERS TO

AICPA QUESTIONS

Answers to AICPA Questions 2

CHAPTER 10INTELLECTUAL PROPERTY RIGHTS AND THE INTERNET

1. (a) Computer software is covered under the general copyright laws and is therefore usually copyrightable as an expression of ideas. Answer (b) is incorrect because copyrights in general do not need a copyright notice for works published after March 1, 1989. Answer (c) is incorrect because a recent court ruled that programs in both source codes, which are human readable, and in machine readable object code can be copyrighted. Answer (d) is incorrect because copyrights taken out by corporations or businesses are valid for 100 years from creation of the copyrighted item or 75 years from its publication, whichever is shorter.

2. (c) Computer databases are generally copyrightable as compilations. Answer (a) is not chosen because copies for archival purposes are allowed. Answer (b) is not chosen because in the case of corporations or businesses, the copyright is valid for the shorter of 100 years after the creation of the work or 75 years from its date of publication. Answer (d) is not chosen because computer programs are now generally recognized as copyrightable.

3. (d) Under the fair use doctrine, copyrighted items can be used for teaching, including distributing multiple copies for class use. Answer (a) is incorrect because although he originally purchased this software for personal use, he may still use it for his class, in which case, the fair use doctrine applies. Answer (b) is incorrect because databases can be copyrighted as derivative works. Answer (c) is incorrect because the use of the computer is not the issue but the fair use doctrine is.

4. (c) Both patent and copyright law are used under modern law to protect computer technology rights. Answer (a) is incorrect because copyright law now also protects software. Answer (b) is incorrect because modern law also protects software as patentable. Answer (d) is incorrect because modern law generally protects intellectual property rights in software under both patent law and copyright law.

CHAPTER 12NATURE AND CLASSES OF CONTRACTS: CONTRACTING ON THE INTERNET

1. (a) The offeror made a promise for an act. When the act was performed, a unilateral contract was created and the offeror is bound to pay. Answer (b) is incorrect because unjust enrichment is generally considered only if there was no contract and the court wishes to provide an “equitable solution.” Answer (c) is incorrect because there are no public policy issues involved. Answer (d) is incorrect because a quasi-contract arises only if there was no contract to begin with and the law implies one to prevent an unjust enrichment. Since there was a unilateral contract, there can be no quasi-contract.

CHAPTER 13FORMATION OF CONTRACTS: OFFER AND ACCEPTANCE

1. (c) If sent by a mode of communication expressly or impliedly authorized by the offeror (e.g., mail or telegram), acceptance of an offer is normally effective on dispatch, even if subsequently delayed or lost. Noll’s telegram was an effective acceptance of the offer by Able. The rule applies to any situation in which acceptance is made in a manner expressly or impliedly authorized. This can include telegraph or telephone as well as mail in most circumstances. In this situation the acceptance was effective on dispatch, before Able’s attempted revocation.

2. (b) Common law applies to this contract because it involves real estate. In this situation, Fox’s reply on October 2 is a counteroffer and terminates Summers’ original offer made on September 27. The acceptance of an offer must conform exactly to the terms of the offer under common law. By agreeing to purchase the vacation home at a price different from the original offer, Fox is rejecting Summers’ offer and is making a counteroffer. Answer (a) is incorrect because the fact that Fox failed to return Summers’ letter is irrelevant to the formation of a binding contract. Fox’s reply constitutes a counteroffer as Fox did not intend to accept Summers’ original offer. Answer (c) is incorrect because Summers’ offer was rejected by Fox’s counteroffer. Answer (d) is incorrect because with rare exceptions, silence does not constitute acceptance.

3. (c) Peters’ offer had been revoked. Since revocation notice can be received either directly or indirectly, Mason, in effect, received the revocation notice when he was told the mower had been sold to Bronson; and therefore, Mason’s acceptance was ineffective, even though the specified time of the oral contract had

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not expired. Peters’ offer had been revoked prior to Mason’s acceptance. There was no obligation on the part of Peters to keep the offer open, since there was no consideration for him to do so.

CHAPTER 14CAPACITY AND GENUINE ASSENT

1. (a) Where a mistake is made by only one party (a unilateral mistake), the rule is that the mistaken party is bound by the contract unless the nonmistaken party knew of the mistake or should have known of the mistake. In this question, the nonmistaken party knew of the mistake; thus, the mistaken party is not bound by the contract. Whether the mistake was a result of gross negligence is irrelevant.

2. (a) Answer (b) is incorrect because a disaffirmance need not be in writing. Answer (c) is incorrect because a minor can disaffirm at any time during minority or for a reasonable time thereafter regardless of payment. Answer (d) is incorrect because a minor need only return whatever consideration he/she has, even if damaged or lost. Answer (a) is correct because it is still a reasonable time after majority.

CHAPTER 16LEGALITY AND PUBLIC POLICY

1. (d) There are two types of licensing statutes. First, there are licensing statutes intended primarily for revenue raising. Second, there are licensing statutes (regulatory) intended primarily to protect the public against dishonest or incompetent professionals. An individual without a license can collect his total compensation if the primary purpose of the statute was to raise revenue. However, if the purpose was regulatory in nature (intended to protect the public), the individual can collect nothing since the contract is voidable. Thus, an unlicensed individual who enters into a contract to provide regulated services will not be allowed to enforce the contract or recover even the value of the services rendered.

2. (d) Answer (a), (b), and (c) are correct statements because covenants not to compete must be reasonable in time and geographic scope. The answer is (d) because it is an incorrect statement regarding the value of goodwill.

CHAPTER 17WRITING, ELECTRONIC FORMS, AND INTERPRETATION OF CONTRACTS

1. (d) The contract terms need not appear in a single document so long as the several documents refer to the same transaction. Only the signature of the party against whom enforcement is sought is required. If the performance could occur within a one-year period, the contract is not within the statute and need not be written. Only contracts of $500 or more that involve the sale of goods fall under the Statute of Fraud and must be in writing.

2. (c) The Statute of Frauds requires only that the written contract be signed by the party to be charged, not by all parties to the contract. Answer (a) is incorrect because it is not required that the contract be formalized in a single writing. Two or more documents can be combined to create a sufficient writing to satisfy the Statute of Frauds as long as one of the documents refers to the others. Answer (b) is incorrect because the Statute of Frauds does not require consideration to be fair and adequate. Answer (d) is incorrect because while the Statute of Frauds is applicable to the sale of goods only if the purchase price is $500 or more, it is always applicable to the sale of real estate, regardless of purchase price.

3. (c) The parole evidence rule will prevent the admission of evidence concerning the oral agreements regarding who pays the utilities, since the rule excludes evidence of prior or contemporaneous oral agreements, which would vary the written contract. However, the parol evidence rule will not prevent the admission of the fraudulent statements by Kemp during the original negotiations. Therefore, answers (a), (b), and (d) are incorrect.

CHAPTER 18THIRD PERSONS AND CONTRACTS

1. (c) An assignment is rebuttably presumed to be an assignment of rights and a delegation of duties. Here, assignee Deep Sea Lobster Farms presumably could carry out the lobster delivery duties.



2. (c) Long is merely an incidental beneficiary B part of a large group that benefits from another’s contract.

3. (a) Union is a creditor beneficiary under the insurance policy. It is not a donee or incidental beneficiary. Privity of contract is not the issue in this question.

CHAPTER 19DISCHARGE OF CONTRACTS

1. (b) Glaze will win because he “substantially performed” on the contract. Glaze should receive the contract price less the cost of damages due to minor deviations from the required performance. Glaze can also collect because Parc refused to allow Glaze the opportunity to complete the contract. Glaze can recover for substantial performance of the contract. The breach was a minor breach. Glaze breached the contract by purchasing minor accessories not allowed under the contract. In response, Parc refused to allow Glaze to complete the contract. This is not considered to be anticipatory breach by Parc.

2. (b) The statute of limitations in an action for breach of contract begins to toll from the time the contract is breached.

3. (c) No official explanation given.

CHAPTER 20BREACH OF CONTRACT AND REMEDIES

1. (a) Answer (a) is correct because liquidated damage clauses are valid if they are not a penalty on top of other damages and are agreed to as a reasonable projection of damages.

2. (b) The repudiation or renunciation of the contract before performance is due is known as anticipatory breach. Answers (a) and (c) are alternative choices for Foster. Answer (d) is the usual remedy for a breach of contract. Answer (b), which asks for the remedy of specific performance, is not available where the breaching party’s performance requires personal services.

3. (a) No discussion provided.

CHAPTER 21PERSONAL PROPERTY AND BAILMENTS

1. (a) In order for there to be a valid bailment, personal property must be delivered to the intended bailee, who must then retain possession of the property. Although the bailee has a duty to hold the property for the bailor and to follow any of the bailor’s reasonable instructions as to the disposition of the property, the bailee’s duty is not an absolute one.

CHAPTER 22LEGAL ASPECTS OF SUPPLY CHAIN MANAGEMENT

1. (d) A common carrier has liability for even slight negligence. A common carrier would thus be liable if the goods were stolen while in the carrier’s custody. The carrier would also be liable if the goods were destroyed as a result of its employees’ negligence. The carrier would not, however, have any knowledge of or control over how the goods were packed by the bailor or other party.

2. (d) Under a nonnegotiable bill of lading, a carrier who accepts goods for shipment, must deliver the goods to the consignee of the bill of lading. Answers (a), (b), and (c) would be correct if the bill of lading was negotiable.

3. (a) A negotiable warehouse receipt is a document issued as evidence of the receipt of goods by a person engaged in the business of storing goods for hire. The warehouse receipt is negotiable if the face of the document contains the words of negotiability (order or bearer).

4. (d) No discussion provided.



CHAPTER 23NATURE AND FORM OF SALES

1. (a) The Statute of Frauds requires that a contract for goods of $500 or more be in writing. UCC 2-207, however, provides that in a contract between merchants, the Statute of Frauds is satisfied if a written confirmation is sent within a reasonable time. The confirmation must be received by the other party who knows or should know the confirmation’s contents. If the recipient merchant fails to object to the confirmation’s contents within a reasonable time they will be bound to the contract.

2. (c) Merchant’s firm offers cannot be revoked.

3. (b) An agreement for the sale of goods under $500 need not be in writing to be enforceable. Thus, Bond and Spear had a valid oral contract, and Spear has breached the contract by agreeing to sell the car to a third party. The adequacy of consideration is not a contract issue. The agreement does not need to be in writing because it was under $500. Paying a deposit is not the deciding factor in this case. The key point is that the agreement was for the sale of goods under $500.

4. (a) Under common law, an acceptance must be unequivocal and unqualified in agreeing to the precise terms specified by the offer. However, the Uniform Commercial Code alters this general rule as far as the sale of goods is concerned. Under the UCC, an acceptance containing additional term sis a valid acceptance unless the acceptance is expressly conditional upon the offeror’s agreement to the additional terms. In this situation, a valid contract has been formed between Cookie Co. and Distrib Markets. Answer (b) is incorrect because Distrib Markets’ acceptance was not conditional upon Cookie’s agreement to the additional term and, thus, a contract is formed regardless of Cookie’s agreement or objection to the additional term. Answers (c) and (d) are incorrect because this contract was for the sale of goods and is governed by the UCC rather than by common law. Under common law, Distrib Markets’ reply would have been a rejection and counteroffer, but under the UCC, a contract was formed.

CHAPTER 24TITLE AND RISK OF LOSS

1. (a) Risk of loss passes upon tender of delivery when the seller is not a merchant. If the seller was a merchant, risk of loss would pass upon the buyer’s receipt of the goods. In this problem, the facts clearly specify that Wool is not a merchant in the goods being sold, so we can determine that risk of loss passed to Bond upon tender of delivery.

2. (c) The purchase of goods on a sale on approval allows the buyer to return the goods even if they conform to the contract. Therefore, the seller retains the title and the risk of loss until the buyer accepts the goods. Thus, answer (d) is incorrect. Answers (a) and (b) are incorrect because these are not requirements for a sale on approval to be valid.

3. (d) Under a sale or return contract, the sale is considered as completed although it is voidable at the buyer’s election. As such, risk of loss passes to the buyer, who also has title to the goods until they are returned; therefore, answer (c) is incorrect. Furthermore, the return of the goods is at the buyer’s risk and expense; thus, answer (b) is incorrect. Answer (a) is incorrect because, under the definition of a sale or return contract, the buyer is acquiring the goods for resale.

4. (d) The UCC places risk of loss on the breaching party. Since Cey shipped nonconforming goods, it breached the contract and would have risk of loss until the nonconforming goods were accepted by the buyer or until the goods were cured by Cey. Since Deck rejected the goods and Cey did not cure the goods, risk of loss remained with Cey. Shipping terms have no bearing on risk of loss in this situation because the goods did not conform to the contract. Answer (a) is incorrect because Deck would only bear risk of loss if the goods conformed to the contract. Answer (b) is incorrect because the risk of loss was never transferred to Deck since the goods were nonconforming. Answer (c) is incorrect because if the goods were conforming, risk of loss would pass to Deck at Cey’s warehouse based on the shipping terms AFOB Cey’s warehouse.

5. (c) Under an FOB place of shipment contract, the risk of loss passes when the goods arrive at their destination and are available to the buyer (tender). In this case, arrival at the loading dock is tender.

CHAPTER 25



PRODUCT LIABILITY: WARRANTIES AND TORTS

1. (c) Warranty of title may be given as well as disclaimed by merchants or non-merchants, orally or in writing. The disclaimer must be in specific language or circumstances, not simply a phrase such as “AS IS”.

2. (a) Any description of goods that is part of the basis of the bargain creates an express warranty that the goods shall conform to that description. Express warranty is not formed when the seller selects goods knowing the buyer’s intended use. Therefore, answer (b), (c), and (d) are incorrect.

3. (b) An injured plaintiff may sue any seller of a good under strict liability if the plaintiff can show that the good was sold in a defective or unreasonably dangerous condition. The plaintiff need not prove fault or wrongdoing by the defendant; thus, not having an opportunity to inspect or following industry customers are not defenses available to the defendant. Although contributory negligence is a defense available in negligence, it is generally not a defense in strict liability actions.

4. (c) An implied warranty of merchantability automatically arises in all sales of goods made by a merchant who deals in such goods. Handy Hardware did not specify a use for the goods or rely on the seller’s judgment in making the purchase, so there is no implied warranty of fitness for a particular purpose. An implied warranty of title arises automatically in most sales contracts. There is no evidence to the contrary in this problem, so we can assume that the warranty of title does exist.

CHAPTER 26OBLIGATIONS AND PERFORMANCE

1. (a) UCC 1-102(3) imposes an obligation on the parties to contract in good faith. Merchants are frequently treated differently under UCC 2 provisions. UCC 2 covers contracts for goods regardless of the contract price, and the UCC permits the parties to a contract to disclaim many if the UCC’s provisions.

2. (c) The Sales Article of the UCC provides that a buyer has the right to reject goods which are not in conformity with the terms of contract between seller and buyer. The buyer also has the option to accept nonconforming goods and recover damages resulting from the nonconformity. Answers (a) and (b) are incorrect because the UCC allows the buyer to inspect the goods before payment except when they are shipped COD. Answer (d) is incorrect because when goods are shipped COD, the buyer’s payment for the goods is required for delivery.

3. (a) Answer (a) is correct since the buyer has a reasonable time in which to reject defective goods. Discovering the defect on Monday would be considered within a reasonable time, considering the goods had been delivered on Friday. Answer (d) is incorrect since the specification concerning the linings in the sales contract would be an express warranty which was breached when the linings were found to be inferior to what had been stated. Thus, the merchantable quality of the linings would be irrelevant.

4. a. Yesb. Noc. Yesd. Yese. Yes

CHAPTER 27REMEDIES FOR BREACH OF SALES CONTRACTS

1. (b) A seller who discovers that an insolvent buyer has received goods on credit may reclaim the goods by making a demand for their return within ten days after receipt of the goods by the buyer. This ten day limitation, however, does not apply if the buyer made a written misrepresentation of its solvency within three months prior to its receipt of the goods. Anker’s fraudulent financials constitute a written misrepresentation of solvency; therefore, Bold may demand return of goods even though 14 days have passed. Answer (b) is incorrect because the seller’s right to reclaim the goods is subject to the rights of a third party who purchases the goods in good faith from the insolvent buyer. Answer (c) is incorrect because the ten day limitation does not apply when the buyer (Anker) provides the seller (Bold) with a written misrepresentation of solvency (the financial statements) within three months prior to receipt of the



goods. Answer (d) is incorrect because Anker may make a demand for the goods rather than sue for damages.

2. (a) By advising Mazur on June 1 that it would not accept or pay for the wheat, Good was engaged in anticipatory repudiation. Anticipatory repudiation occurs when a party renounces the duty to perform the contract before the party’s obligation to perform arises. Anticipatory repudiation discharges the nonrepudiating party (Mazur) from the contract and allows this party to sue for breach immediately. In this situation, Mazur could successfully sued Good for the difference between the resale price and the contract price on June 2. Answer (b) is incorrect because Mazur was discharged from the contract on June 1 and would not have to wait until after June 23 to resell the wheat. Answer (c) is incorrect because Good would only be allowed to retract its anticipatory breach if Mazur had ignored this breach and awaited performance at the appointed date. Answer (d) is incorrect because specific performance is only allowed for unique goods or for other situations in which monetary damages are not appropriate.

3. (b) A seller has the right to resell goods to another if the buyer refuses to accept the goods upon delivery. Answer (a) is incorrect because specific performance is not a remedy available to the seller. Baker cannot force Lazur to accept the word processor. Answer (c) is incorrect because Baker has a couple of additional remedies available. Baker can recover the full contract price plus incidental damages if he is unable to resell the identified goods. Alternatively, if the difference between the market value and contract price is inadequate to place Banker in as good a position as performance would have, then Banker can sue for lost profits plus incidental damages. Answer (d) is incorrect because Baker could sue for consequential damages that Lazur had reason to know Baker would incur as a result of Lazur’s breach.

CHAPTER 28KINDS OF INSTRUMENTS, PARTIES, AND NEGOTIABILITY

1. (a) To be negotiable, an instrument must be in writing, signed by the maker or drawer, contain an unconditional promise or order to pay a sum certain in money on demand or at a specific time, and be payable to order or to bearer. Negotiability is not affected by the fact that the instrument recites the transaction which gave rise to the instrument and negotiability is not affected by the fact that it is stated with a specific rate of interest. The note is negotiable from the time it is made on October 2, 2007. It is a note (two-party instrument between maker and bearer-payee) and not a draft (which is a three-party instrument).

2. (a) This instrument is a draft because it is a three-party instrument where a drawer (Dexter) orders a drawee (Middlesex National Bank) to pay a fixed amount in money to the payee (Silver). Answer (b) is incorrect because in order for the instrument to qualify as a check, the instrument must be payable on demand. In this situation, the instrument held by Silver is a time draft which specifies the payment date as October 1, 1998. Answer (d) is incorrect because a promissory note is a two-party instrument in which one party promises to pay a fixed amount in money to the payee. Answer (c) is incorrect because a trade acceptance is a special type of draft in which a seller of goods extends credit to the buyer by drawing a draft on that buyer directing the buyer to pay a fixed amount in money to the seller on a specified date. The seller is therefore both the drawer and payee in a trade acceptance.

3. (a) Under the Commercial Paper Article of the UCC, for an instrument to be negotiable, it must be in writing, signed by the drawer or maker, contain an unconditional promise or order to pay a sum certain in money, on demand, or at an ascertainable time, and be payable to order or to bearer. Answers (b), (c), and (d) do not contain requirements for negotiability.

4. (a) This instrument satisfies all of the requirements for negotiability except for the requirement that it be payable on demand or at a definite time. Since it is payable 10 days after the sale of the maker’s diamond ring, the time of payment is not certain as to the time of occurrence. Answer (b) is incorrect because a negotiable instrument may contain a promise to provide collateral. Answer (c) is incorrect because although it is a two-party note, it is not negotiable because it is not payable at a definite time. Answer (d) is incorrect because it is not negotiable and is not a draft. A draft requires a drawer ordering a drawee to pay the payee.

5. (c) No model answer given. New question released in 2000.

CHAPTER 29



TRANSFERS OF NEGOTIABLE INSTRUMENTS AND WARRANTIES OF PARTIES

1. (d) Rex’s endorsement did not specify the person to whose order the instrument was then payable; it was, therefore, a blank endorsement. As executed by Hand, the instrument was bearer paper since it was made payable to “Rex or bearer.” Ford could, therefore, qualify as a holder without Rex’s endorsement. Bearer paper can be converted to order paper by making the last endorsement in the chain of endorsement a special endorsement.

2. (c) If the last endorsement on a negotiable instrument is a special endorsement, the instrument is order paper. A special endorsement specifies the person to whom or to whose order it makes the instrument payable. Answer (a) is incorrect because a check made payable to the order of cash is bearer paper. Answers (b) and (d) are incorrect because a check endorsed in blank is bearer paper.

3. (c) The endorsement is restrictive, since it is “for collection only,” and it is not special, since it does not specify the person to whose order the instrument is now payable. A special endorsement on bearer paper converts it to order paper.

4. a. Nob. Noc. Yesd. Yese. Yes

CHAPTER 30LIABILITY OF THE PARTIES UNDER NEGOTIABLE INSTRUMENTS

1. (b) Under the Commercial Paper Article of the UCC, in order for a person to qualify as a holder in due course of a promissory note, (1) they must qualify as a holder, (2) the note must be negotiable, and (3) they must take the note for value, in good faith, and without notice that it is overdue, dishonored, or there is a defense against it. Answers (a), (c), and (d) do not contain requirements for becoming a holder in due course.

2. (d) A maker of a note may use real defenses against a holder in due course but not personal defenses. Lack of consideration is a personal defense. Answers (a), (b), and (c) are incorrect because discharge in bankruptcy, forgery, and fraud in the execution are all real defenses, which create a valid defense against a holder in due course.

3. (b) Under the Commercial Paper Article of the UCC, real (or universal) defenses available against a holder in due course include material alteration of the instrument and discharge of a person with primary or secondary liability in bankruptcy. Breach of contract is a personal defense not available against a holder in due course.

4. (c) An unauthorized completion of an incomplete instrument is a personal defense, and, as such, will not be valid against a HDC. Answers (a), (b), and (d) are incorrect because infancy (unless the instrument is exchanged for necessaries), bankruptcy of the maker, and extreme duress are all real defenses which are good against a HDC.

5. (d) Corner Check Cashing Company must bear the loss because as a holder obtaining payment, it warrants that it has good title to the instrument. However, it does not have good title because the forgery presented good title from passing. Therefore, answers (a) and (c) are incorrect because of Corner Check Cashing Company’s warranty of good title. Answer (b) is incorrect because Duval has a real defense in that his indorsement was forged. Corner Check Cashing Company’s only recourse is to recover from Mask.

6. (b) If the drawee bank (Unity Trust Company) pays a check on which the drawer’s signature (Markum) was forged, the bank is bound by the acceptance and the drawee can only recover the money paid from the forger (Robb). Normally a person who presents an instrument for payment makes three warranties. These warranties are: warranty of title; warranty of no knowledge that the signature of the drawer is unauthorized; warranty of no material alterations. However, a holder in due course or someone with the rights of a holder in due course does not warrant to the drawee bank that the drawer’s signature is genuine because the drawer bank is in a better position to determine the genuineness of the drawer’s signature. Therefore, the drawee bank should bear the loss.



CHAPTER 31CHECKS AND FUNDS TRANSFERS

1. (d) When a holder procures certification of a check, all prior endorsers are discharged. This is true because when a bank certifies a check, it has accepted the check and agreed to honor it as presented. Answers (a) and (b) are incorrect because although lack of notice of dishonor to other endorsers and late presentment of the instrument will normally discharge all endorsers, this is not true if the lack of notice of dishonor or the late presentment is excused. They can be excused in such cases as the delay is beyond the party’s control or the presentment is waived. Furthermore in this fact pattern, Hopkins endorsed the check “payment guaranteed” and Quarry endorsed it “collection guaranteed.” When words of guaranty are used, presentment or notice of dishonor are not required to hold the users liable. Answer (c) is incorrect because when the maker is insolvent the endorsers will likely be sought after for payment.

2. (c) Certification procured by the holder discharges the drawer and any prior endorsers; the bank becomes primarily liable. An endorser might still be held liable for breach of warranty even if the check is presented late. An endorser would have to cause an instrument to be dishonored for the notice of dishonor to be excused. The insolvency of the maker does not affect the responsibilities of the endorsers.

3. (a) A bank may charge checks against an account in any order it deems convenient.

CHAPTER 32NATURE OF THE DEBTOR-CREDITOR RELATIONSHIP

1. (d) Marbury Surety, Inc., agreed to act as a guarantor of collection. As such, Marbury is not required to indemnify the obligee, Madison, until the obligee has exhausted collection efforts. Ordinarily, this point is reached when the obligee has exhausted legal remedies and a judgment against the obligor debtor has been returned unsatisfied. In contrast, in a guarantor of payment agreement, the guarantor-surety is primarily liable on the debt with the obligor. No separate demand need be made on the guarantor-surety after the obligor’s default. Upon default, both obligor and guarantor of payment are liable. Surety and guaranty agreements are not within the purview of Article 9; thus, there are no filing or recording requirements. Finally, Marbury is not a del credere agent because it is not guaranteeing payment for products sold on credit.

2. (c) Under the right of exoneration, the surety may sue to compel the principal debtor to pay the obligation owed by the creditor when the debtor has sufficient assets to do so and is wrongfully withholding payment. In this case, where Pax has not yet made any payments to Squire, the appropriate action is to seek the right of exoneration against Queen. Answer (a) is incorrect because the right to reimbursement would be the appropriate action only if Pax had already made payments to Squire. Answer (b) is incorrect because the right of contribution applies to one co-surety who has paid more than his proportionate share of the debtor’s obligation and can therefore take action against the other co-sureties. Answer (d) is incorrect because the right of subrogation applies only in cases where the surety has already paid the creditor. When this occurs, the surety obtains the same rights that the creditor had against he debtor (i.e., the surety stands in the shoes of the creditor).

3. (a) A suretyship agreement is a contract which must be supported by consideration. When the suretyship agreement is contemporaneous with the primary contract, there is no need for separate consideration. The surety may exercise any real defenses on the contract which are available to the debtor. Thus, fraud, duress, illegality, forgery, etc., will discharge both surety and debtor. However, the surety ma not rely on the debtor’s personal defenses (e.g., incapacity, insolvency, or death) to avoid the suretyship obligation. The surety is also discharged from liability if the surety agreement was procured by duress or fraudulent misrepresentation by the creditor. Thus, if the creditor fraudulently contracts with the debtor or fraudulently procures the suretyship agreement itself, the agreement is voidable.

4. (1) e (6) b(2) a (7) h(3) d (8) i(4) f (9) j(5) c (10) g



CHAPTER 34SECURED TRANSACTIONS IN PERSONAL PROPERTY

1. (c) Attachment occurs when (1) value is given by the secured party, (2) the debtor attains rights in the collateral, and (3) the debtor and creditor acknowledge the creation of a security interest by a signed security agreement or by collateral in the possession of the secured party. In this situation, attachment occurred on March 10 because the following occurred on or before that date: (1) Easy picked up the car, (2) the car had been identified to the contract, therefore Green had a right in the property, and (3) Green signed a security agreement. Therefore, answers (a), (c), and (d) are incorrect.

2. (d) Carr has an automatic PMSI in consumer goods that does not require filing a financing statement for perfection.

3. (b) Under UCC 9-307, a buyer in the ordinary course of business takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence. Neither Cray nor Zone is subject to the security interest; therefore, answer (a) is incorrect. Answer (d) is incorrect because a security agreement may provide that any or all obligations covered by the agreement are to be additionally secured by property later acquired by the debtor. Answer (c) is incorrect because unless otherwise provided in the security agreement, the secured party has a continuously perfected security interest in the proceeds that result from the debtor’s sale or transfer of the collateral.

4. (b) Hamilton took a purchase money security interest in the TV set which would be considered consumer goods in Fogel’s possession. Consequently, Hamilton’s security interest was perfected automatically upon attachment. Therefore, Hamilton can defeat Reliable because Hamilton’s security interest was perfected prior to the time Reliable perfected its security interest by filing. Hamilton can also defeat Harp because Harp’s judgment was subsequent to Hamilton’s perfection. Normally Mobray, as a good faith purchaser for personal use, would defeat a prior perfected secured party who gained his/her perfection through automatic perfection by attachment. However, Hamilton engaged in a second method of perfection (filing a financing statement) prior to the sale of the TV set to Mobray, allowing Hamilton to defeat the good faith purchaser for personal use. Therefore, answers (a), (c), and (d) are incorrect.

CHAPTER 35BANKRUPTCY

1. (d) Voluntary bankruptcy petition is a formal request by the debtor for an order of relief. This voluntary bankruptcy petition may be filed jointly by a husband and a wife. Answer (b) is incorrect because the debtor in a voluntary bankruptcy petition need not be insolvent but needs to state that s/he has debts. Answers (a) and (c) are incorrect because there is no requirement as to the minimum amount of the debtor’s liabilities in a voluntary proceeding.

2. (d) Most debtors may file a voluntary bankruptcy petition. Among those that may not are insurance companies, banks, and saving and loan associations. Answer (a) is incorrect because the number of creditors is not relevant for a voluntary bankruptcy petition. Answer (b) is incorrect because there is no need to show that a Chapter 11 bankruptcy would have been unsuccessful. Answer (c) is incorrect because the inability of the debtor to pay its debts as they become due is not relevant to a voluntary bankruptcy.

3. (d) The answer is (d). The standard for declaring voluntary bankruptcy is only that the debtor have debts. Answer (a) is incorrect because Chapter 11 is not a prerequisite for a Chapter 7 filing. Answer (b) is incorrect because the automatic stay applies to all creditors. Answer (c) is incorrect because in a VOLUNTARY bankruptcy, the number of creditors is not an issue in declaration because the debtor himself or herself declares bankruptcy.

4. (d) A debtor may file a voluntary bankruptcy petition without showing that s/he is insolvent. The debtor may

merely state that s/he has debts. There is also no requirement as to the number of creditors needed. Therefore, answers (a), (b), and (c) are incorrect.

5. (d) The fees to Best & Co. predated the bankruptcy (unsecured creditor). The wages have no priority because they predate the priority period, so the taxes have priority over these two unsecured creditors.



6. (c) The trustee in bankruptcy may set aside preferential transfers made within 90 days before the filing of the bankruptcy petition while the debtor is insolvent. The time is extended to the previous 12 months if the preferential transfer was made to an insider. In this question, Quick’s solvency when the loan was made by Erly is not relevant because this loan was made 13 months before the filing of the petition for bankruptcy. Answer (a) is incorrect.

CHAPTER 36INSURANCE

1. (a) For an insurable interest to arise, there must exist such an interest between the insured and the risk covered, so that if specified events occur, the insured will suffer some substantial loss or injury. Such an interest includes the possessory interest of a tenant of property and the interests of secured creditors, including mortgages.

2. (a) In the case of property insurance, the insurable interest must exist when the loss occurs. It need not exist when the policy is issued. Therefore, answer (b) is incorrect. Answers (c) and (d) are incorrect because there are no such requirements that the property be owned in fee simple or by individuals.

3. (c) The formula is:

Face Value of Insurance x Actual LossFair Market

Coinsurance x Value of Percentage Property

Lawfo’s insurance recovery will be:

$200,000 x $30,000 = $25,000 80% x $300,000

4. (c) Under principles of co-insurance, the insured must carry at least the policy percentage (here 80%). Here the policy owner carries two policies that put him over the required amount of $240,000 (80% of the FMV of the property of $300,000).

The equation is in the numerator ($250,000 – total insurance) over the denominator of 80% or .8 times the FMV of $300,000. The result is $250,000 over $240,000 or full insurance. The only question is how much of the loss Omni must cover. The ratio is 20 over 25 or 4/5, and the loss is $200,000, so Omni must cover $160,000.

CHAPTER 37AGENCY

1. (c) The agent’s renunciation of the agency does not automatically terminate by operation of law. The other answers listed do terminate an agency.

2. (d) Ratification occurs when there is a subsequent approval by the principal of an agent’s unauthorized action. In order for ratification to take place, the principal must have knowledge of all material facts regarding the contract. Answer (a) is incorrect because it is not necessary that the principal expressly communicate an intent to be bound. If the principal acts in a manner as to imply ratification (e.g., by taking advantage of the benefits of the contracts), then the principal’s actions will be interpreted as ratification. Answer (b) is incorrect because it makes no difference whether or not the agent acts reasonably and in the best interest of the principal. The principal may ratify any contract as long as the requirements for ratification are satisfied. Answer (c) is incorrect because a principal may ratify a contract entered into by any type of agent.

3. (b) It is generally not necessary for an agent to have a written agency agreement. An exception to the general rule exists if the agent’s duties will involve the buying and selling of real property, or if the agency agreement is to last more than one year.



4. (c) Simmons exceeded his express authority when he granted the 10% price discount to Hemple; therefore, Simmons would be liable to Jensen for the amount of damage caused by Simmons’ breach, $50 [(10% - 5%) x $1,000]. Answers (a), (b), and (d) are incorrect because Hemple had not previously dealt with Simmons or Jensen; therefore, Simmons was acting with apparent authority when he granted the 10% price discount to Hemple. Consequently, Jensen would not be able to void the sale or recover from Hemple.

5. (a) An agent has a fiduciary duty to be loyal to his principal. The agent cannot compete with his principal without the principal’s consent, and the agent cannot deal for his own interests that are adverse to the principal. Answer (c) is incorrect because a principal generally has the power to terminate an agency relationship, although he may not have the right. In such a case, the agency may be terminated even though he or she could be liable for breach of the agency contract. However, a principal may not revoke an “agency coupled with an interest.” This type of agency is created when the agent is given an immediate interest in the subject matter of the agency. An “interest in the subject matter” should not be confused with an agent’s contract for compensation. In this instance, Thorp has not received an “interest”; he or she has merely agreed that compensation will be calculated in part as a percentage as sales. Thus, answer (b) is also incorrect because the right of the agent to receive a percentage of proceeds is not sufficient to constitute an agency coupled with an interest. Answer (d) is incorrect because the agency relationship need not be in writing because it can be performed within one year.

6. (c) Frost’s agent can perform customary business transactions like getting insurance but not extraordinary transactions such as mortgaging property, obtaining loans or selling property.

CHAPTER 38THIRD PERSONS IN AGENCY

1. (b) Specific performance is appropriate only when the subject matter is so unique that the aggrieved party cannot be fairly compensated with money damages; therefore, answer (b) is the proper response. The agent of an undisclosed principal binds himself and has the right to sue the third person in his own name; money damages are the appropriate remedy, so answer (a) is not correct. If the principal discloses himself and asserts his rights under the contract, he may also sue the third party as long as the contract does not involve personal services, trust, or confidence; thus, answer (c) is incorrect.

2. (b) Generally, a principal is not liable to a third party for torts committed by an agent. The major exception is if the agent is acting within the authority of the principal; i.e., within the scope of the agency relationship. If the agent is acting with the scope of the agency relationship, the principal is liable. Answer (a) is incorrect because the tort must be committed within the scope of the agency relationship for the principal to be liable. An agent’s instructions from the principal to commit the tort is not within the scope of the agency relationship. Answer (c) is incorrect because the principal cannot limit his/her liability in the agency agreement for torts committed by the agent. Answer (d) is incorrect because the fact that the tort may also be a criminal act does not protect the principal.

3. (d) As an agent for an undisclosed principal, Datz is solely liable on the contract unless the third party later discovers the identity of the principal, in which case either Datz or Cox may be held liable. Therefore, answers (a) and (b) are incorrect. Answer (c) is incorrect because Cox, as an undisclosed principal, has the right to enforce the contract against the third part as long as it does not involve personal services, trust, or confidence.

4. (c) No discussion provided.

CHAPTER 41TYPES OF BUSINESS ORGANIZATIONS

1. (d) A joint venture resembles a partnership, except that it is formed for only one transaction (or in some cases, a limited number of transactions). Answer (a) is incorrect because it is possible to have more than two persons as part of the joint venture. Answer (b) is incorrect because a joint venture is a for-profit undertaking, not a nonprofit undertaking. Answer (c) is incorrect because a joint venture is treated as a partnership and not as a corporate enterprise.

CHAPTER 42



PARTNERSHIPS

1. (c) In a general partnership, any partner may bind the partnership and other partners to all transactions within the apparent scope of the partnership business. Each partner is an agent for the other partners and for the partnership and may bind the partnership based upon apparent authority, such as what is customary in the business or by previous dealings. Note how there is no apparent authority if the third party is aware of the partner’s limitation, and there is no apparent authority to transact business outside the normal scope of the business. Answer (c) is correct because a partner would have apparent authority to do normal partnership business, such as order tractors for a farm machinery business. Answers (a) and (b) are incorrect because there can be no implied authority if there is no actual authority. Answer (d) is incorrect because express limitations in a partnership agreement have no bearing on apparent authority unless the third party was aware of the limitation.

2. (d) Under the UPA, the order of distribution is: outside creditors; partners’ advances; capital contributions and then profits.

3. (c) It is permissible for a general partner to be a secured creditor of the limited partnership. Answer (a) is incorrect because a limited partner may loan money to and transact other business with a partnership. Answer (b) is incorrect because a general partner may be a limited partner at the same time. Answer (d) in incorrect because only limited partners have limited liability; the general partners are personally liable for the partnership debts.

4. (b) No discussion given.

CHAPTER 43LPs, LLCs, AND LLPs

1. (c) A general partner can also hold a limited partnership interest. There must always be at least one general partner with unlimited personal liability to create a limited partnership. Limited partners can also be creditors.

CHAPTER 44CORPORATION FORMATION

1. (a) Both a limited partnership and a corporation may be created only under a state statute, and each must file a copy of its certificate with the proper state authorities. Further, both a corporation’s stock and a limited partnership interest are subject to the federal securities laws registration requirements if they are “securities” under the federal securities laws. Answer (b) is incorrect because general partners in a limited partnership do not have limited liability. Answer (c) is incorrect because partnerships are not recognized for federal income tax purposes as taxable entities. Instead, the income flows through to the partners and is taxed on their individual returns. Answer (d) is incorrect because partnerships do not have perpetual existence. Their existence can be affected by the death of a partner.

2. (a) When a promoter enters into contracts on behalf of a corporation yet to be formed, the promoter is personally liable on the contracts unless the promoter explicitly states that s/he is contracting for the corporation. After the corporation is formed, the promoter remains liable on the contracts until a novation occurs substituting the corporation for the promoter in the contracts. The corporation’s adoption, either explicit or implicit, of the contracts does not relieve the promoter of liability. Dex implicitly adopted the contract with Roe by continuing to accept the accounting services, thus making Dex liable on the contract. Since a novation did not occur, Rice remains liable on the contract to Roe. Answers (b), (c), and (d) are incorrect because both parties (Rice and Dex) are liable on the contract.

3. (d) Generally, state law requires certain mandatory items to be included in a corporation’s articles of incorporation. While the requirements vary from state to state, they usually include the name of the corporation, the incorporators, corporate duration and purpose, location of its initial registered office and the name of its initial registered agent, number of directors, number of authorized shares of stock, and if the shares are to be divided into classes, the designation of each class along with its preferences, limitations, and rights. Therefore, answers (a), (b), and (c) are incorrect.

CHAPTER 45



SHAREHOLDER RIGHTS IN CORPORATIONS

1. (a) No explanation given.




CHAPTER 46SECURITIES REGULATION

1. (c) Under the Securities Act of 1933, securities are defined broadly as any security that allows an investor to make a profit on an investment through the efforts of others rather than through his or her own efforts. Therefore, a general partnership interest would not likely be considered a security under the 1933 Act since partners in a general partnership have a right to manage and are considered active in the management of the business. Answers (a), (b), and (d) are incorrect because under the 1933 Act, securities are broadly defined to include stock options, warrants, and limited partnership interests.

2. (b) The 1933 Act makes it unlawful for any person, directly or indirectly, to make use of any means or instruments of interstate commerce to carry or transmit for the purpose of sale, any security, including common stock, unless such security is accompanied or preceded by a prospectus that meets the requirements of the Act.

3. (c) Under Rule 505, sales can be made to no more than 35 nonaccredited investors and to an unlimited number of accredited investors. Answer (a) is incorrect since an audited balance sheet and other financial statements must be supplied to the nonaccredited investors. Answer (b) is incorrect since no general solicitation is ever allowed under Regulation D. Answer (d) is incorrect since sales to nonaccredited investors cannot exceed 35 in number.

4. (c) Due diligence as a defense is difficult to establish, but showing both of these (checking again on the number and GAAS) offers some proof of due diligence.

5. (a) The standard for periodic reports is that the company has 500 or more shareholders and $5 million in assets or is listed on a national stock exchange.

CHAPTER 47ACCOUNTANTS’ LIABILITY AND MALPRACTICE

1. (d) A third-party (primary) beneficiary of audited financial statements is one specifically intended by the CPA and the client to be the primary user of the financial statements. The CPA will be liable for negligence to a third party only if it can be established that the party was intended to be the primary beneficiary. Since a CPA is generally liable to all third parties, including foreseen and foreseeable third parties, for fraud and constructive fraud, the third-party (primary) beneficiary rule is relevant only in those cases based on negligence. Answers (a), (b), and (c) are therefore incorrect.

2. (c) In order to prove negligence under common law, Mac must prove the following:

1. A duty of care existed.2. That duty of care was breached.3. The injury was proximately caused by the defendant’s breach of the duty of care.4. The plaintiff suffered an injury.

Item I corresponds to the second element – “duty of care”. Item II corresponds to the third element – “proximate cause”. Thus, both items I and II are necessary in order for Mac to recover.

3. (a) Historically, privity of contract was a requirement for a cause of action based upon negligence. This approach was established in the landmark Ultramares case. Under common law, accountants owe a duty to all third parties to make their reports without actual or constructive fraud. Gross negligence amounting



to a reckless disregard for the truth constituted fraud. Accountants have a contractual relationship with their clients thus privity would not be a defense.

4. (d) An auditor’s best defense when sued for negligence is proof that the auditor did not violate generally accepted auditing standards in performing the audit. Lack of privity is not a valid defense with the client who engaged the auditor. A signed engagement letter is not a required part of the audit and the lack of such a letter would not be a valid defense for the auditor. Even if the auditor did not perform the audit recklessly or with an intent to deceive, it is still possible that the auditor failed to exercise reasonable care, under the circumstances in conducting the audit.

5. (a) No official explanation released.

6. (c) No official explanation released.

CHAPTER 48MANAGEMENT OF CORPORATIONS

1. (c) A director of a corporation is entitled to rely on information provided by a corporate officer (unless the director had reason to believe that such information was incorrect). Answer (a) is incorrect since it would be a conflict of interest for a director to sit on the boards of competing businesses. Answer (b) is incorrect since a director would breach his/her fiduciary duty by taking advantage of a corporate business opportunity. Answer (d) is incorrect since directors do not act alone, but as a “board.” Thus, the director has no actual or apparent authority to individually grant a corporate loan.

2. (d) Normally, the board of directors of a corporation has the power to adopt, amend, and repeal the bylaws. It also has the power to declare dividends and fix the compensation of the directors. However, it does not have the power to amend the Articles of Incorporation. Therefore, answers (a), (b), and (c) are incorrect.

3. (d) Generally, a shareholder owes no fiduciary duty to the corporation; his primary concern is his own self-interest. An exception to this rule is the duty of the majority, or controlling, shareholders to the minority shareholders. The courts have held that a group with de facto control of a corporation may not use that control to injure, oppress, or defraud the minority shareholders. Answer (c) is incorrect because a promoter is said to be a fiduciary of the not-yet-formed corporation and has a fiduciary duty to act in good faith and in the corporation’s best interest. Answer (a) is incorrect because the director, in addition to his duty of disclosure, has a duty to act with fundamental fairness. If any contract is determined not to be in the corporation’s best interest, it may be rescinded, and the breaching director may be liable for any loss resulting to the corporation from the transaction. Answer (b) is incorrect because a director owes a fiduciary duty both to the corporation and to its shareholders.

CHAPTER 49REAL PROPERTY

1. (a) Since a mortgage is considered an interest in real property, it must be in writing and signed by the mortgagor. Recording is necessary to make the mortgage enforceable as against subsequent bona fide parties at interest, but not as between the mortgagor and mortgagee regardless of whether or not it is a purchase money mortgage; thus, answers (b) and (c) are incorrect. Answer (d) is incorrect because, generally, a mortgage must meet the requirements of a deed, including its delivery to the mortgagee.

2. (c) A delivered mortgage deed is effective between the mortgagor and the mortgagee without any recording. The purpose for recording a mortgage deed is to notify innocent parties who acquire a subsequent interest in the property of the existence of the lien. Failure to record would permit the subsequent parties to take without being subject to the mortgage lien.

3. (a) Since both mortgages were recorded, the purchaser (Nunn) of the property is constructively aware of the first mortgage held by Lyn. While Nunn assumed the second mortgage, Nunn purchases the property subject to the first mortgage. If Nunn defaults, proceeds from the sale of the property will go toward paying the first mortgage held by Lyn, and if any money remains, the money will be paid to Jay, the second mortgage holder. Answer (b) is incorrect because a first mortgage is paid in full before a second mortgage receives anything. Answers (c) and (d) are incorrect because Nunn has no personal liability to Lyn since the first mortgage was never assumed.



4. (d) A general warranty deed warrants the greatest number of things and thus provides a purchaser with the most extensive protection against defects of title. A general warranty deed warrants that (1) the seller has title and the power to convey the property described in the deed, (2) the property is free from any encumbrances, except as disclosed in the deed, and (3) the grantee (purchaser) will not be disturbed in his/her possession of the property by the grantor (seller) or some third party’s lawful claims of ownership. Answer (a) is incorrect because a quitclaim deed only conveys to the grantee whatever interest the grantor has in the property. If the grantor has no interest, then the grantee receives nothing. Bargain ad sale deeds and grant deeds are essentially the same type of deed. With such deeds, the grantor only warrants that s/he has done nothing to impair the title. However, the grantor does not warrant against prior encumbrances (liens that occurred before grantor’s ownership). Therefore, answers (b) and (c) are incorrect.

CHAPTER 50ENVIRONMENTAL LAW AND LAND USE CONTROLS

1. (a) The federal acts regulating air and water pollution permit citizens or states to enforce the provisions of these acts either by bringing private suits against violators or by suing the Environmental Protection Agency to enforce compliance with the law.

2. (d) CERCLA imposes environmental liability on a broad group of potentially responsible parties. The courts have included the following classes: (1) current owners and operators, (2) owners and operators at the time of waste disposal, (3) generators of hazardous waste, (4) transporters of hazardous waste, and (5) lenders who finance borrowers’ hazardous waste sites. Therefore, answer (d) is correct.

3. (d) The National Environmental Policy Act is centered around requiring the Federal Government and its agencies to consider the effects of its actions on the environment. It does not provide tax breaks to companies to accomplish environmental goals. Answer (a) is not chosen because it correctly states that the Act applies to all federal agencies. Answer (b) is not chosen because it is also correct. The Act does require an environmental impact statement if the environment may be significantly hurt. Answer (c) is not chosen because private litigation is the main way if Act is enforced.

4. (a) Under the Incentives for Self-Policing, Disclosure, Correction and Prevention of Violations, companies that do audits and self-report pay fewer and lesser fines.

CHAPTER 51LEASES

1. (b) An enforceable written residential lease would have to include a description of the leased premises, but would not have to specify a due date for the payment of rent.

2. (d) A tenant has a possessory interest in property according to the lease, and the landlord has a reversionary interest (i.e., once the lease expired, the possession of the property “reverts” to the landlord). If a tenant purchases the building so that the tenant and the landlord are the same party, the lease is terminated since the tenant and the landlord are the same. If a lease does not prohibit assigning or subletting, the tenant is free to assign or sublet without the permission of the landlord. The landlord’s death does not terminate the lease.

3. (a) An enforceable written residential lease would have to include a description of the leased premises, but would not have to specify a due date for the payment of rent, insurance, or all structural repairs.

CHAPTER 52DECEDENTS’ ESTATES AND TRUSTS


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