Becker CPA Review Regulation 5 Class Notes REGULATION 5 CLASS NOTES

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1 REGULATION 5 CLASS NOTES This lecture covers contract law and sales under the UCC. According to the AICPA's Content Specification Outline these items, and the items found in R6 and R7, should make up between 20% and 25% of your Regulation examination. CONTRACTS I. Terminology A Contract is a legally enforceable agreement! A. Understand sources of contract law The common law and the UCC and the RISE (Real Estate, Insurance, Services and Employment law) mnemonic. II. Creation of a Contract A. Elements of a contract - Agreement (offer and acceptance), consideration and lack of defenses. B. Understand what constitutes a valid offer and acceptance "meeting of the minds." Advertisements generally not offers. Terms must be definite and certain. Offer must be communicated to offeree. C. Termination of offer Revocation, rejection (including counteroffers) and by operation of law (death, insanity, destruction and illegality). D. Acceptance only the offeree may accept. Must use reasonable method - unless specified then must use specified method. Acceptance must be the Mirror Image of the offer except in contracts for sale of goods. E. Mailbox Rule acceptances are effective upon dispatch. Offeror may opt out by stating that "acceptance is effective upon receipt." F. Consideration legal value (not necessarily equal or fair) through a bargained for exchange. Preexisting duty rule - if already legally bound to perform, not adequate consideration. Some promises are enforceable without consideration Detrimental Reliance is the most common equitable claim. III. Defenses A. Fraud - misrepresentation of a material fact, scienter, intent to induce plaintiff's reliance, justifiable reliance by plaintiff and damages. B. Innocent Misrepresentation same as fraud but no "scienter." C. Duress unlawful use of a threat of harm. D. Undue influence abusing a position of trust or confidence. E. Mutual Mistake both parties are mistaken as to a basic assumption of the contract. F. Unilateral Mistake mistake by one party generally not a defense unless the other party knew or should have known of the mistake. G. Illegality. 1

2 H. Minors may disaffirm anytime during minority and within a reasonable time after becoming an adult. They can ratify once they reach the age of majority by failing to disaffirm within a reasonable amount of time, expressly ratifying or retaining the benefits. Can't disaffirm necessities - food, shelter, clothing, etc. I. Intoxication only a defense when the intoxication is so severe that it prevents the person from understanding the nature of the contract. J. Insanity mental defect so severe that it prevents the person from understanding the nature of the contract. K. Statue of limitation 4 to 6 years. L. Statute of Frauds MYLEGS contracts that need to be in writing. Marriage is the consideration, contacts that cannot be performed by their terms within one year, land contracts, contracts by executors to pay estate debts out of personal funds, sale of goods for $500 or more and surety contracts. M. Impossibility events make performance impossible (for example, destruction of subject matter). N. Accord and satisfaction and substitute contract An accord is an agreement to substitute one contract for another and satisfaction is the execution (performance) of the accord. Until the accord is completed a party may sue under the original contract. Substituted contract discharges the original contract immediately. O. Novation it occurs when a new contract substitutes a new party for an old party in an existing contract and all of the parties agree that the old party is immediately released from liability. P. The Parol Evidence Rule prohibits the admission of prior oral or written evidence or contemporaneous oral statements to contradict the terms of a written contract. Exceptions to show fraud, duress, mistake, or any subsequent event or change. IV. Remedies A. Material or substantial breach at common law, the nonbreaching party can be discharged from the contract if there is a material breach; minor breach no discharge just damages. Under Sales Article, nonbreaching party can be discharged for any breach. B. Anticipatory repudiation breach in advance nonbreaching party can treat as a breach and immediately sue for damages; ignore the repudiation, wait for performance and, if no performance, sue; or cancel the contract. V. Damages A. Compensatory money. Consequential - reasonably foreseeable. B. Specific Performance for land and unique items a court order requiring the breaching party to perform. C. Liquidated damages damages agreed to in the contract. Must be reasonable and not a penalty. D. Punitive punish the defendant usually not available for breach of contract. E. Rescission or Cancellation cancel the contract and return parties to their original positions. 2

3 VI. Third Party Rights A. Intended beneficiaries such as donee or creditor beneficiaries have rights under the contract and can sue to enforce their rights. Incidental beneficiaries do not have rights under the contract and, as a result, have no rights to enforce. B. Assignment of rights and delegations of duties general rule any rights can be assigned and any duty can be delegated unless the assignment will increase the assigning party's risk or the delegation involves a specialized personal service. SALES - ARTICLE 2 OF THE UCC I. Overview A. Apply only to the sale of goods. B. Merchant one who deals in goods of the kind sold. The UCC applies to all sales of goods but often has special rules for merchants. C. Offers and Acceptance you must know the distinctions between the UCC and the common law. Merchant's Firm Offer makes an offer irrevocable. Requirements: offeror must be a merchant, the offer must be in a signed writing and the offer must give assurances it will be kept open for a certain time. Note that if no specific time is stated it will be deemed to be open for a reasonable amount of time not to exceed 3 months. D. Mirror Image Rule does not apply. Generally the new terms will be ignored unless the contract is between merchants. If merchants are involved the new terms become part of the contract unless they materially change the terms or if the original offer expressly states acceptance is limited to the original terms. E. Shipping nonconforming goods is an acceptance and a breach unless the seller notifies the buyer that the nonconforming goods are an accommodation, and then there is not acceptance but a counteroffer instead. F. Consideration contracts to buy all of a seller's output or supply all of a buyer's requirements are valid. Modifications to contract terms without consideration are enforceable as long as they are done in good faith. II. Defenses A. Statues of limitations 4 years B. Statue of Frauds contracts for the sale of goods of $500 or more must be evidenced by a writing signed by the party being sued 4 exceptions SWAP Specially manufactured goods; merchant's written confirmation to another merchant; contracts that have been admitted in court; and contracts that have been performed to the extent of acceptance. III. Delivery, Risk of Loss and Title A. If the parties designate when and where delivery or risk of loss will pass, their agreement governs. B. No agreement noncarrier case nonmerchant seller risk passes upon tender of delivery. Merchant seller risk of loss passes on actual delivery. Carrier cases - shipment contract risk of losses passes to buyer when the goods are delivered to the carrier. Destination contract - risk of loss passes when the goods reach their destination. C. Breach nonconforming goods risk of loss stays with seller unless the buyer accepts the goods. 3

4 D. Sale on Approval Risk on seller until approved E. Sale or return risk on buyer until returned. F. Title passes as the parties agree if they do not agree title passes on delivery. If buyer rejects the goods rightfully or wrongfully title revests with the seller. IV. Warranties A. In general, goods must conform to all warranties. B. Express Warranties statements of fact or descriptions of goods that played a part in the buyer's decision (basis of the bargain). Generally cannot be disclaimed. C. Implied Warranty of Title Good title no unstated encumbrances no infringements. Made automatically by any seller. Can be disclaimed by specific terms or circumstances. D. Implied Warranty of Merchantability made by merchants goods are fit for their ordinary purpose. Can be disclaimed generally "as is" or with specific terms. E. Implied Warranty of Fitness for a Particular Purpose when seller knows buyer's specific intention for use and the buyer relies on the seller to pick appropriate goods. Any seller can make this warranty. Can be disclaimed generally "as is" or with specific terms. V. Tort Liability A. Negligence Plaintiff must prove Duty of care, failure to use due care, damages and causation. B. Strict Product Liability Plaintiff must prove product was defective, the product caused the injuries, the product was unreasonably dangerous, seller is in business of selling this product and the product reached the seller without substantial changes. Privity is not required. VI. Remedies A. Buyer/Seller Remedies Anticipatory Repudiation; To Demand Assurances; No punitive; and there is a duty to mitigate damages. B. Seller Remedies Cancel and sue for damages; Withhold Delivery and stop Goods in Transit; Resell and sue for damages; Right to Full contract price; and liquidated damages if reasonable. C. Buyer Remedies Reject nonconforming goods: within a reasonable time; seller may have right to cure; buyer has right to inspect before payment (unless COD sale); and buyer can revoke acceptance for substantial defects a reasonable inspection would show. Buyer also has the right to cancel or rescind for nonconformities. Buyer can sue for damages - even if the buyer accepts nonconforming goods for the difference in value between conforming and nonconforming. Specific performance is permitted for unique goods. If seller is insolvent and buyer has paid part or the entire purchase price, buyer may recover the goods from the seller if the goods are identified. 4

5 There is REQUIRED HW READING on Employer-Employee Law after the lecture text. Topics covered are: 1. FICA, 2. FUTA, 3. Worker's Compensation, 4. Employment Discrimination, 5. OSHA, 6. FLSA, 7. NLRA, 8 ERISA, and 9. COBRA These are included and should be studied because they are within the scope of the Content Specifications released by the AICPA and could appear on your exam. We hope you find these tips helpful. Work hard and you will succeed. 5